Social Security indexing plan gets revived, but with a twist

President Barack Obama could meet his pledge to ensure the solvency of the nation's Social Security system without requiring dramatic increases in employee contributions, by authorizing investment of the system's $2 trillion trust fund in an indexed portfolio of stocks and bonds.

That's the proposal being revived by Thomas K. Philips, senior risk manager, Malbec Partners Inc., New York, and Arun Muralidhar, chief investment officer, AlphaEngine Global Investment Solutions LLC, Princeton, N.J.

A new wrinkle would transfer the ownership rights for the $700 billion in the Treasury Department's Troubled Asset Relief Program to the Social Security trust funds. If the Social Security system had the TARP assets, the federal government could even ensure that Social Security taxes wouldn't have to be raised at all, Mr. Muralidhar said in an interview.

“It's about doing the right thing for the long term, not the short term,” he said.

They also call for creating a panel — similar to the Federal Retirement Thrift Investment Board, which oversees the federal government's $202 billion Thrift Savings Plan — to oversee the Social Security investments.

The gist of their proposal is laid out in the November-December issue of the Financial Analysts Journal.

To protect trust fund investments, Messrs. Philips and Muralidhar would have the Social Security Administration and the U.S. Treasury enter into a swap agreement in which the variable return on the assets of the trust fund would be swapped for a fixed return from the U.S. Treasury. The fixed real return would be struck at an annualized 5.2%, the rate of return needed to ensure the long-term solvency of the Social Security system, Mr. Muralidhar said. The swap concept was originally proposed in the 2004 book, “Rethinking Pension Reform,” co-written by Mr. Muralidhar and Nobel laureate Franco Modigliani, who died in 2003.

“The short-term return can be exchanged by a long-term return and we can translate our short-term fears or short-term euphoria into long-term confidence based on a rational estimation of what capital markets can deliver,” Mr. Philips said in a separate interview.

Without the $700 billion from TARP, Mr. Muralidhar said adoption of the proposal would mean the combined employee/employer contributions would have to be raised to 13% — from their current rate of 12.4% for the first $106,800 of wages — to accommodate the system's funding gap.

If nothing is done to fix the system now, Social Security tax would have to be raised to about 17.6% by 2041 to keep the system solvent, he said.

“That's a 40% increase in taxes,” Mr. Muralidhar said.

Mr. Obama has said he hopes to ensure Social Security's solvency, without raising the current retirement age, by requiring more affluent taxpayers to pay an additional Social Security tax on income in excess of $250,000 annually.

“There are several ways to fund Social Security liabilities,” said Mr. Philips. “You can either have a small increase in taxes and a more effective investment policy, or a large increase in taxes and the preservation of the current investment policy, which is to invest the system's assets entirely in long-term Treasury bonds.”

Mr. Muralidhar said investing Social Security assets in stocks and bonds is already being done in Canada and Ireland.

One political benefit of using TARP funds for Social Security is it could alleviate concerns of the public that the program is benefiting only large financial institutions, he said.

“A program that is perceived to be bailing out the fat cats is now able to ensure the solvency of one of the most broad-based entitlement programs that benefits the poorer segments of society,” Mr. Muralidhar said.

The Social Security reforms Messrs. Muralidhar and Philips are proposing could be difficult to sell politically, according to some Washington insiders.

The sales job could be particularly difficult since a Clinton administration proposal to consider investing Social Security trust fund assets in equities was shot down in the late 1990s after Alan Greenspan, then chairman of the Federal Reserve, raised concerns that the investments could not be effectively insulated from political interference.

“I seriously doubt that there will be any major effort to implement this kind of plan,” said David John, a senior fellow for the Heritage Foundation, a Washington think tank.

“The way they (Messrs. Muralidhar and Philips) get a higher return is by accepting a higher risk, and as we've seen in the past year, vividly, that risk is real and potentially large,” said Paul Van de Water, a senior fellow at the Center on Budget and Policy Priorities, a Washington think tank.

“By simply transferring the risk from the trust funds to the Treasury doesn't make it go away, and the risk is still borne by the taxpayer. “

Mr. Van de Water also said he believes the reform proposals would only delay exhaustion of the Social Security trust fund, which is projected to run out of money in 2041.

“At the end of the day, you still need to slow the growth in (Social Security) benefits or raise the rate in taxes to provide long run financial balance,” he said.

“While there are good reasons to diversify its (the Social Security trust fund's) portfolio and increase the return on its reserve, at this moment in history, when the stock market has declined so rapidly, it's probably politically infeasible,” said Nancy Altman, author of the 2005 book, “The Battle for Social Security,” and chair of the Pension Rights Center, a Washington advocacy group. (Ms. Altman was not speaking on behalf of the PRC.)