Abstract
This Selected Issues paper on the United States analyzes problems in the measurement of output and prices. The paper examines income versus expenditure measures of national output. Sources of consumer price index and findings of the Boskin Commission are discussed, and mismeasurement of output and productivity is analyzed. Developments in productivity across industries in the United States are described. In particular, the paper focuses on the slowdown in aggregate productivity growth that began in the mid-1970s and examines whether this slowdown has continued in recent years and is common across industries.
VIII. Investing Social Security Trust Fund Assets in Private Securities1
1. At present, the Social Security system faces a large unfunded liability position as the value of prospective benefits over the longer-term exceeds the prospective receipts of the system from payroll taxes at currently legislated rates and from investment of Social Security trust fund assets by a substantial margin. The possibility of increasing the return on trust fund assets as one approach to addressing the financial needs of the system has received considerable attention. Under current legislation, Social Security trust fund assets are exclusively invested in special government securities.2 As a remit, the expected yield on these assets is lower than if the trust funds ware allowed to hold a more diversified portfolio.
2. The recent report of the Advisory Commission on Social Security (1997) proposed a, number of options for improving the long-term viability of the system. While the members of the Commission could not agree on a single approach, there was broad agreement that some redirection of assets toward equities and other private securities could be one element in a plan to improve the finances of the system.3 It was taken as given that allowing the trust funds to hold private assets would increase expected returns and improve the longer-term financial position of the Social Security system.4 However, there was no attempt to assess the macroeconomic and intergenerational distribution effects of such a change in the system’s asset holdings. To examine these effects, a simple, theoretical closed-economy macroeconomic model, with two distinct overlapping generations (workers and retirees) was developed.
3. Because Social Security is essentially a pay-as-you-go5 system with defined benefits, the current working (or the retired) population has no direct stake in improving the financial outlook of the trust fund, unless the sustainability of the system is in doubt. Rather, it is the future worker/taxpayer whose burden in supporting the next generation of recipients would either be reduced or increased according to the performance of the trust fund’s portfolio. This is because any shortfall in the system’s receipts relative to its benefit payments would have to be made up through future taxation. Under a variety of assumptions, the model suggests that improving the expected return on trust fund assets, by shifting these in vestments from government bonds to private securities, tends to reduce the future claim on national output of the current working population (i.e., future retirees). As discussed below, whether aggregate saving would be affected, and thereby the level of future output, depends on whether current workers interpret this policy change as affecting their future Social Security benefits.
4. By investing in private securities, Social Security’s longer-term financial position would be improved at the expense of expected returns on the private portfolios of the current working population. The model shows that shifting trust fund assets to private securities induces an accommodating adjustment in the structure of private portfolios, which become more heavily weighted toward lower-yielding government bonds. The aggregate saving function in the model treats saving as depending positively on disposable income and negatively on expected future Social Security benefits.6 If Social Security is perceived as providing defined benefits to retirees, aggregate saving may be unaffected by a shift in the composition of trust fund assets.
5. If aggregate saving is unaffected when trust fund assets are invested in private securities, future real output would remain on the same trajectory as before the policy change, but the future real resources available to current workers would be reduced because the return on the aggregate private portfolio declines. In contrast, the resources available to future workers would increase as their burden of financing the retirement benefits of current workers (future retirees) would be diminished by the higher returns on trust fund assets invested in private securities. This raises an important issue of intergenerational equity.7
6. If, instead, the improvement in the financial position of the Social Security system from investing in private securities leads current workers to feel more secure about the prospect of receiving future benefits, a reduction in aggregate saving may result, since concerns regarding the possible demise of the system may have been helping to support higher levels of saving than otherwise. As a result of lower current saving, the path of future output would be lower. The combination of reduced saving and lower returns on private portfolios would again imply that the future real resources available to the current workers (future retirees) would be significantly lower. The effect on the future generation of workers is, however, less clear. While the level of future real output may be lower as a result of depressed current saving, the obligations of future workers to finance the retirement benefits of current workers (future retirees) would be diminished by the higher returns on trust fund assets inverted in private securities. The model suggests that the net impact on the real resources available to future workers will depend on the extent to which the government actually reduces the future tax burden following the improvement in the Social Security system’s finances and on the return to equities relative to the real marginal product of capital.
7. The model was also used to examine how the effects of a shift in Social Security trust fund assets toward private securities might differ from a current increase in the Social Security payroll tax as a means to improve the longer-term finances of the system. When future benefits are perceived to be decoupled from the value of trust fund assets, it can be shown that an increase in current taxes increases aggregate national saving and, thus, stimulates future real output. It can be shown that while future workers clearly benefit if capital is priced competitively, the impact on current workers depends on several factors. Specifically, it can be shown that, if the marginal propensity to save out of disposable income exceeds the differential rates of return between private securities and government bonds, then the future consumption of current workers (future retirees) would decline. However, if the marginal propensity to save out of disposable income is smaller than the return differential, then future consumption of current workers would increase. The reason for this is that a tax increase in the pure pay-as-you-go case induces two opposing effects. First, it induces current workers to save less, since the tax increase reduces disposable income, tending to reduce the future income stream of current workers, ceteris paribus. Second, because it reduces government borrowing, the tax increase also sets in motion market forces that induce current workers to hold an aggregate portfolio that is more heavily weighted in private securities. This factor, ceteris paribus, raises the yield on private portfolios, tending to increase the future income stream of current workers. On balance, if the induced effect on personal saving is small (i.e., the marginal propensity to save is small) relative to the portfolio effect (reflected in the yield differential between government bonds and private securities), the current generation of workers would capture a share of the increase in future output.
8. An issue that was not formally modeled but that warrants comment involves the question of how capital will be allocated across sectors should a policy change allow Social Security assets to be invested in private securities. When capital is allocated privately, there is a tendency for it to flow toward those sectors with the highest return. Consequently, in the absence of distortions, the resulting allocation of resources tends to maximize national product. Li assessing the possible macroeconomic effects of investing Social Security trust fund assets in private securities, it is critical to consider whether financial capital would continue to pursue the highest rate of return, or whether the allocation of these assets might be influenced by non economic considerations. If investment decisions were to become politicized, the efficient allocation of capital may be undermined and the level of national output reduced.
List of References
Congressional Budget Office, “Implications of Revising Social Security’s Investment Policies,” (September) 1994.
Diamond, Peter, “A Framework for Social Security Analysis,” Journal of Public Economics, 1977, Vol. 8, pp. 275–98.
Diamond, Peter; Lindemena, David; Young, Howard (eds.) Social Security: What Role for the Future?, Washington D.C.: National Academy of Social Insurance, 1996.
Feldstein, Martin, “The Missing Piece in Policy Analysis: Social Security Reform,” National Bureau of Economic Research, Working Paper No. 5413, January 1996a.
Feldstein, Martin, “Social Security and Saving: New Time Series Evidence,” National Tax Journal, Vol. 49(2), June 1996b.
Feldstein, Martin, “Social Security and Private Savings: International Evidence in an Extended Life Cycle Model,” in Martin Feldstein and Robert Inman (eds.), The Economics of Public Services, (New York: Halsted Press) 1977.
Feldstein, Martin, and Anthony Pellechio, “Social Security and Household Wraith Accumulation: New Microeconomic Evidence,” Review of Economics and Statistics, August 1979, Vol. 61(3).
Leidy, Michael, “Investing Social Security Trust Fund Assets in Private Securities,” forthcoming IMF Working Paper, 1997.
Leimer, Dean R. and Selig D. Lesnoy, “Social Security and Private Saving: New Time-Series Evidence,” Journal of Political Economy, Vol. 90(3), 1982.
Report of the 1994–96 Advisory Council on Social Security, “Findings and Recommendations,” Washington, D.C. (January) 1997.
Prepared by Michael Leidy. A complete description of the model and the analyst summarized here is given in Leidy (1997).
There are two Social Security trust funds: the trust fund for Old-Age and Survivors Insurance (OASI, which pays retirement and survivors benefits) and Disability Insurance (DI, which pays disability benefits).
In the Advisory Council report, only the plan identified as “Maintain Benefits” calls specifically for a fraction of trust fund reserves to be invested in equities. However, the other two plans (Individual Accounts and Personal Security Accounts) include provisions to establish individual savings accounts, part of which could be invested in equities.
Investing trust fund assets in private securities is not equivalent to privatizing Social Security (either folly or in part). To be effective, privatization of the system would necessitate raising national saving to fill at least part of Social Security’s unfunded liability. A simple proposal to diversify trust fund assets by investing in private securities would not produce the needed increase in national saving; essentially, it would only redistribute investment income between the private and public sector and redistribute real resources between the current and future generations of workers.
A “pay-as-you-go” system implies that the current benefits of retirees are financed out of current payroll tax receipts. Under such a system, benefits are defined and the financing burden facing current workers depends on the size of the guaranteed benefits to current retirees relative to any trust fund assets that may have been accumulated from past contributions.
The expected yield is not included in the aggregate saving function in the model. The response of private saving to a change in the expected yield is ambiguous theoretically and empirical work on aggregate savings in the United States typically indicates that the income and substitution effects induced by a change in yield are largely offsetting.
It should also be pointed out that current retirees under the pay-as-you-go system may not have folly contributed to the benefits that they are receiving, depending on when the system was established and how the defined benefits may have been modified over time. In such circumstances, current workers would pay for the benefits of current retirees, as well as for a larger part of their own future benefits, if trust fund assets were invested in private securities.