Social Security and Equities: Lessons from Railroad Retirement

Investing Social Security Trust Fund assets in equi­ties has long been a controversial proposal. Equities have higher expected returns than government bonds, which are the only asset the Trust Fund currently holds. So investing a portion of these assets in stocks could reduce the program’s long-term financing short­fall. But critics see this step as crossing a red line in the government’s involvement in the private economy. They also see the greater risk inherent in equity invest­ments as offsetting the higher expected returns. The experience of the government’s Railroad Re­tirement program, which now invests in equities, pro­vides lessons that address these concerns. Railroad Retirement and Social Security have long been closely connected. Congress created the Railroad Retirement program in 1934, one year before the enactment of Social Security, when it took over the rail industry’s tottering pension plans in the midst of the Great Depression. The two programs have the same pay-as-you-go social insurance structure, funded by a payroll tax on workers and employers. Both had relatively modest Trust Funds, with the assets invested solely in government bonds. In the 1990s, however, the use of equities became central to proposals to reform each program. Nothing was done in Social Security. But in 2001, Congress enacted legislation that introduced equities into the Railroad Retirement program. This brief, based on a recent study, reviews the experience of Railroad Retirement for lessons it might provide on the use of equities in Social Security. The discussion proceeds as follows. The first sec­tion describes the development of the proposal to in­vest Railroad Retirement assets in equities. The sec­ond section discusses how the 2001 reform addressed the risk of political influence on investment decisions. The third section discusses how the reform addressed the financial risk in equity investment. The final sec­tion concludes that investing Social Security assets in equities would require managing the risk of politi­cal influence, by limiting investment discretion, and managing financial risk, by creating an automatic way to respond to major financial shocks.