Social Insecurity? The Effects of Equity Investments on Social Security Finances

Amy Rehder Harris, Noah Meyerson and Joel Smith

National Tax Journal, 2001, vol. 54, issue 3, 645-68

Abstract: In 2000, the Social Security system experienced an annual net inflow of over $150 billion, raising its balance to over one trillion dollars. Once the baby boom generation begins to retire, however, the annual surpluses will almost certainly turn into deficits, and the trust funds are predicted to be exhausted in 2038. Investing part of the trust funds in equities would increase the expected returns and thus improve the system's expected long-term finances. But with higher expected returns comes higher risk: Equity investment could potentially leave the system worse off. This paper uses the Long-Term Actuarial Model developed by the Congressional Budget Office to analyze both the higher expected returns and the additional uncertainty that accompany equity investment, while recognizing that uncertainty already exists in the system due to unpredictable demographic and economic factors. We find that there is a clear risk-return tradeoff in the short term, but that (given a consistent policy of equity investment) the magnitude of risk falls substantially over a 75-year horizon.

Date: 2001
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