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Executive Summary #1248es on Social Security

February 5, 1999

February 5, 1999 | Executive Summary on Social Security

Executive Summary: Why the Government-Controlled Investment Would Undermine Retirement Security

As part of his recently unveiled plan to bail out Social Security, President Bill Clinton proposes that the government receive unprecedented power to invest more than $650 billion in the stock market over the next 15 years. The good news is that the White House recognizes private investment as a necessary component of long-term entitlement reform. The bad news is that giving this power to politicians is a recipe for disaster.

The Chairman of the Federal Reserve Board, Alan Greenspan, recently testified before Congress that government-controlled investment "would arguably put at risk the efficiency of our capital markets and thus, our economy." There are four broad concerns about government-controlled investment:

Concern #1:
Government-controlled investment would mean the partial nationalization of major businesses, which would allow politicians to have direct involvement in the economy and influence over the decisions of individual corporations.

Concern #2:
Government-controlled investment invites crony capitalism--industrial policy that allows politicians to control the economy indirectly by attempting to pick winners and losers.

Concern #3:
Government-controlled investment opens the door to corruption by allowing politicians to steer funds toward well-connected interest groups or corporate contributors.

Concern #4:
Government-controlled investment invites "politically correct" decisions at the expense of retirees because politicians could forgo sound investments in unpopular industries (such as tobacco) to steer money toward feel-good causes that are likely to lose money.

To ascertain the risks of allowing government-controlled investment in a reformed Social Security system, analysts have compared the performance of politically influenced investments made by state government pension funds with that of traditional investments. John R. Nofsinger of Marquette University, for example, finds that such policies reduce average annual returns by more than 1.5 percent. Others have determined that these investments have returns between 1.0 percent and 2.5 percent below those of funds that operate in the best interest of workers.

As former Clinton Administration Treasury Department official Alicia Munnell warns, a lower return on pension fund investments eventually will require either increased contributions or lower benefit payments to workers. Consider these notable government employee pension fund miscues:

  • The Texas State Board of Education recently dumped 1.2 million shares of Disney to protest the content of films made by a subsidiary.

  • The Missouri State Employees' Retirement System venture capital fund for new businesses was shut down after three years following poor returns and two lawsuits.

  • Pennsylvania school teachers and state employees saw $70 million of their fund invested in a new plant for Volkswagen. The investment has lost more than half its value.

  • Illinois transferred $21 million of workers' money to the state's general budget.

  • The Kansas Public Employees' Retirement System lost $65 million by investing in a state-based Home Savings Association and $14 million by investing in Tallgrass Technologies, and it squandered nearly $8 million in a steel plant. Total losses of workers' money from these economically targeted investments will be between $138 million and $236 million.

  • New York State and City pension funds were pressured in 1975 into buying bonds to avert New York City's bankruptcy, and, in 1976, into buying bonds to bail out four state agencies.

  • The Connecticut State Trust Fund poured $25 million of workers' money into Colt Manufacturing, a local company that went bankrupt three years later.

  • A California state pension system offered $1.6 billion of workers' money to help to balance the state's budget in 1991.

  • The state of Minnesota lost $2 million of workers' money by dumping tobacco stocks.

  • An independent study estimates that non-economic investing by government-controlled pension funds resulted in more than $28 billion in losses between 1985 and 1989.

Over the next 75 years, the Social Security program will face a shortfall of more than $20 trillion (in 1998 dollars). If no changes are made in the program's design, bringing Social Security into balance will require a 54-percent increase in payroll tax rates, a 33-percent reduction in benefits, a big hike in the retirement age, or a combination of the three. Yet tax increases and benefit reductions would serve only to exacerbate Social Security's other crisis--its poor rate of return--and make it an even worse deal for American workers. Forcing them to pay more to receive even less hardly represents fair and compassionate public policy.

Because the Social Security system is actuarially bankrupt and will not be able to meet its future obligations, policymakers are considering harnessing the power of private investment and compound interest to build retirement security for Americans. Giving this power to politicians, however, is a risky and dangerous experiment.

The safest way to protect the money of American workers for their future retirement is to allow them to have a portion of their Social Security payroll taxes invested by professionals from the financial services industry. Not only do these professionals have the knowledge and the incentive to invest the money wisely, they also are legally obligated to act in the best interests of the workers in their fund.

Daniel J. Mitchell, Ph.D.  is McKenna Senior Fellow in Political Economy for The Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation. This paper is revised and updated from Heritage Backgrounder No. 1240, "Why the Government Should Not Invest Americans' Social Security Money," December 23, 1998.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy