NCPA - National Center for Policy Analysis

Perils Of Trust Fund Investing

January 27, 1999

President Bill Clinton's proposal to invest some $700 billion of the Social Security Trust Fund in the stock market appears to shore-up Social Security without fundamentally changing the program. Actually, economists point out, it is worse than doing nothing at all.

It would inevitably influence corporate decision making. For example,

  • Companies threatening layoffs or resisting unionization might be pressured not to do so, and those making politically incorrect products like tobacco would fear a government sale of their stock would cause the price to fall.
  • Political pressure might also cause the government to buy stock in politically favored companies that do not have good growth prospects.
  • This is what typically happens in countries where governments invest pension assets in stocks; according to a 1994 World Bank study, such investments earn low or negative returns -- much lower than those enjoyed by workers who invest their own pension assets.

The Clinton Administration says the funds will be privately managed, as with corporate pension funds. Or the funds could be invested solely in broad mutual funds that own all companies in, say, the Standard & Poor's 500 index.

However, the S&P 500 is made up of large company stocks, while there are thousands of small companies with publicly traded stock. Investing only in large companies will bias investment in the economy as a whole, to the detriment of growth. On the other hand, investing in small startup companies will greatly increase the risk of loss. So "active management" will be needed.

Finally, as Federal Reserve Chairman Alan Greenspan argues, shifting the trust fund into stocks will not increase the overall rate of return. However, it will reduce the private sector's return because there will be less stock for private investors to own. Nothing is added to the nation's wealth.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, January 27, 1999.


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