Every April the trustees of Social Security issue a forecast that the system will run out of money in the 2030s. The forecast also says that aggregate payroll tax receipts will fall below total retirement benefits in 2015. After that, the only way the program can stay afloat will be by cashing in the government IOUs (i.e., bonds) that it has accumulated over the years. The rest of the government will presumably redeem those bonds by raising taxes, cutting expenditures, or issuing new bonds to the public. Social Security will run out of bonds to redeem about twenty years later. At that time (roughly 2035), the revenues of the payroll tax will amount to about two-thirds of the annual benefits owed.
It doesn't take a financial genius to figure out that there are only two options to solve Social Security's solvency problem: Promised benefits can be reduced, or contributions to the system can be increased. Neither reducing benefits nor raising contributions, however, is politically attractive. Many people (including Vice President Gore and Governor Bush) are looking for less painful solutions. President Clinton and a number of policy analysts (such as Henry Aaron, Bob Ball, and Robert Reischauer) have come up with an idea—allow Social Security's central trust fund to invest in the stock market rather than in U.S. government bonds. They argue that the higher average return on stock investments would help the system's financial imbalance.
To understand the proposal, one needs to follow the money. The Social Security system, which is now running a cash flow surplus (due to the low birthrates in the Depression), turns the extra money over to the government in return for bonds. The government spends the money on defense, welfare, or whatever it chooses. If Social Security changes policy and begins using its surplus to buy stocks, then the rest of the government will have to borrow money from the public to maintain its other activities. Thus the government would institute a policy of borrowing from the public in order to buy stocks for the Social Security trust fund; this is called buying stocks on margin. Sometimes it works out well, but it is extremely risky. Hoover senior fellow Tom MaCurdy and I have simulated how this policy would work and find that the policy has about a 25 percent chance of making Social Security's finances worse rather than better. And this is not to mention the thorny corporate governance issues of Social Security's being a major shareholder in most U.S. corporations.
That the government can't solve a serious financial problem by borrowing from the public and buying stocks shouldn't surprise anyone. The saying "there's no such thing as a free lunch" applies to individuals, firms, and, unfortunately, Social Security. If you want to spot a real solution for Social Security look for benefit cuts or contribution increases—any serious proposal needs one or the other.