Bill Cassidy’s Well-Intentioned but Misguided Social Security Reform

S enator Bill Cassidy (R., La.) has been making the media rounds promoting his idea for a bipartisan Social Security reform plan, including a recent article in National Review Online. I admire Cassidy’s efforts, even more so when the leaders of both political parties have failed to show the initiative that Social Security reform warrants. If every senator were like Cassidy, Social Security’s multitrillion-dollar shortfall would have been addressed rather than left to fester for decades. And yet, Cassidy’s core idea — the federal government borrowing $1.5 trillion to invest in the stock market, with the proceeds directed to Social Security — isn’t a very good one. It’s effectively a tax increase in disguise, and one that comes with considerable risk and instability to federal-government finances.

Policy-makers have known for over three decades that Social Security needs reform, owing to rising longevity, which increases the beneficiary rolls, and low birth rates, which reduce the number of workers whose taxes support the program. The choices also are well known: Revenues flowing into the program must increase or benefits must be reduced. Every reform option — from increasing the $160,000 ceiling on wages subject to taxes or raising the payroll tax rate to making the retirement age higher or reducing cost-of-living adjustments — ultimately comes down to increasing revenues or reducing benefits.

The problem, of course, is that politicians don’t like either option. And so they have delayed a tough decision, thereby making the fix that must someday come even more difficult for Americans.

To his credit, Cassidy has come up with a plan. Unfortunately, though, it is designed to appeal to politicians who otherwise don’t want to make tough decisions, who want neither to raise taxes nor to cut benefits.

Cassidy proposes that, over a five-year period, the federal government borrow approximately $1.5 trillion. The current federal borrowing rate is roughly 3.9 percent. The federal government would reinvest those funds in stocks, private equity, hedge funds, or other instruments that are riskier than U.S. Treasury bonds but offer higher expected returns. The federal Railroad Retirement Fund, which invests similarly, projects a 6.5 percent annual return for the future. The fund would hold its investments for 75 years, presumably building interest along the way. Until then, the federal government would borrow to cover Social Security’s funding shortfalls. After 75 years, the investment fund could, in theory at least, repay that borrowing.

At first glance, Cassidy’s idea appears similar to President Bill Clinton’s proposal to invest part of the Social Security trust fund in stocks or President George W. Bush’s idea for personal retirement accounts that also could hold equities. Cassidy himself cites the Wisconsin Retirement System, the Canada Pension Plan, and the Ontario Teachers’ Pension Plan as similar examples.

And yet, all of these differ in a fundamental way from Cassidy’s proposal: Their investments do not rely on borrowed money. In each of these examples, money from taxes or employee contributions are invested in stocks or bonds. In later years, the funds receive the full balance of these investments, including the initial principal and all interest earned on them. In Cassidy’s plan, where the initial funds are borrowed, the federal government must repay the principal and interest at the government-bond yield, with the remaining proceeds consisting only of the difference between the government-bond interest and whatever return is gained on the fund’s risky investments.

Put another way: The Clinton, Bush, and other plans that Cassidy cites are engaged in an economic transaction. Instead of spending money today, we’re saving it. Those savings, in turn, increase investment, which means more factories, tools, and research to make workers more productive. This increased productivity boosts economic growth, and that larger future economy can help pay Social Security benefits without making future Americans worse off.

None of that is happening in Cassidy’s borrow-to-invest plan. Instead — in a purely financial, rather than economic, transaction — Cassidy’s plan uses a roundabout method of extracting a larger share of future GDP to help pay for Social Security benefits. The federal government borrows today, using the money to purchase stocks that currently are held by Americans. Future taxpayers must repay those loans. And instead of flowing to Americans, the returns from those stocks now flow to the federal government, which by the end of 75 years would own roughly one-third of the U.S. stock market. As Wharton School economist Kent Smetters has shown, Cassidy’s approach is not meaningfully different from simply increasing the capital-gains tax: When the stock market goes up, the federal government takes a slice of the gains. Everything else is simply window dressing.

What Cassidy proposes is what’s called a “pension obligation bond,” which is a borrow-to-invest strategy used by often-desperately underfunded pensions in places like New Jersey or Illinois. In 2015, the Government Finance Officers Association, which represents public finance officials throughout the United States and Canada, put the issue in simple terms: “State and local governments should not issue POBs.” It would be a sad irony if the one practice that Social Security derived from other pension systems is generally considered to be one of the least responsible.

Perhaps the most apt analogy for an ordinary reader would be to imagine reaching middle age and discovering that he had not saved sufficiently for retirement. Common sense, not to mention standard financial planning advice, would involve remediations such as saving more, dialing down the standard of living you expect in old age, or choosing to delay retirement. Indeed, it’s almost unimaginable that a financial planner would advise such a person to take out a loan and invest it in the stock market. The fact that the federal government would do the same thing on Americans’ behalf doesn’t make it a better idea. Government does not absorb risks so much as it passes them on to other stakeholders, including taxpayers, creditors, and Americans who rely on federal programs.

An understandable response to these criticisms is that Congress can do no better than a financing gimmick that does nothing to reduce the burden that rising Social Security costs will impose on future generations. After nearly four decades of congressional inaction, and with leading presidential candidates from both parties who have no plans to fix Social Security, this isn’t an irrational argument.

Yet, if true, it is a damning indictment of the quality of governance in the United States. If Congress can’t implement straightforward tax and benefit changes to keep the single largest spending program the government administers solvent, what can it do? Nonetheless, it is indeed possible that Congress will fail in its obligation to reform Social Security and that — when the program’s trust funds run dry in the 2030s — it will face a hard landing rather than a soft one.

But realism about Congress’s capacity to manage its largest programs doesn’t mean that we should call a poor policy a good one. Our representatives in Congress, both Republicans and Democrats, must engage on Social Security reform, regardless of the political dangers of doing so. I have argued for gradually transitioning Social Security to an Australian-style universal flat benefit, coupled with giving every employee access to a supplementary retirement plan at work. Progressives have argued for raising taxes to fully fund promised Social Security benefits, then raising taxes further to increase benefits across the board.

These are the kinds of discussions Congress should be having, followed by an eventual compromise that both parties can live with. If the only policy Congress can accept to fix Social Security is Cassidy’s multitrillion-dollar leveraged bet on the stock market, that is a sad commentary on the quality of elected leadership in the United States.