January 7, 1997

Investment Proposals Carry a Mixed Bag of Fiscal Side Effects

By FLOYD NORRIS

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Funneling billions into the stock market through Social Security could prove to be a boon to Wall Street, and would conceivably help to send stock prices to new heights.

But the shift would divert billions of dollars that the Social Security system now lends to the Treasury, forcing the Government to borrow more money from investors, and possibly driving up interest rates.

The Social Security Trust Fund now holds only Treasury securities -- Government bonds it buys with the money generated by Social Security taxes in excess of the amount needed to finance current benefits. That situation is expected to last until 2013, when it would begin to spend more than it collects, the advisory council on Social Security said yesterday.

The effect of that practice is to have the Social Security taxes used to pay for other Government expenses each year. By diverting some of that money into the stock market, the Government would be forced to borrow more from investors to pay those expenses. Other things being equal, that could drive up interest rates.

But proponents of the new plan hope that stocks will perform better than bonds, as they have done in recent years, thus eventually giving the system more money to pay benefits.

It may be significant that the proposal to finance Social Security at least in part through the stock market comes when stock prices are at record highs and the public strongly believes that stocks are the best long-term investment. "No one made this proposal in 1974 or 1982," when share prices were much lower, and had declined, noted James Grant, the editor of Grant's Interest Rate Observer.

Although all 13 members of an advisory council that has been examining the long-term health of Social Security favored putting some Social Security money into stocks they split three ways on the details.

Six members would have the Government borrow more money to finance its programs and then use some Social Security tax money to invest in a broad basket of stocks. This option would initially help the stock market as well, while pushing up Government borrowing.

Five members would allow individuals to, in effect, invest part of their own tax payments. That would also force up Government borrowings and tend to raise stock prices. In addition, it would provide a boon to Wall Street, as it sold securities to many millions of new customers.

Two members would raise payroll taxes and then channel the money into the stock market through investments that would be up to individual investors but would be regulated by the Government.

This method would have a neutral effect on Government borrowing, effectively forcing investors to put money into the stock market. It might have a positive effect on stock prices, at least for a time.

Perhaps the most important difference between the proposals is that the idea supported by six members would leave the Government with the responsibility for making full payments. If the stock investments failed to pay off -- and there have been prolonged periods when share prices went down -- it would be up to the Government to make up the difference. In that sense, it is similar to a traditional defined benefit corporate pension plan.

The other two plans would leave investors with some of the choices of investing the money, and the potential losses from poor investments. That is similar to defined contribution plans, such as 401(k) plans, which are becoming more prevalent in corporate America while defined benefit plans are less common.

While all three proposals would tend to push up stock prices by putting more money into stocks, that effect could be temporary. In the long run, the value of the companies whose shares are purchased, as determined by their ability to make profits and pay dividends, would determine valuations.

If critics who say stocks are overvalued now are correct, funneling Social Security money into stocks could inflate a financial bubble, driving up share prices to unreasonable heights, only to see them deflate before the baby boomers retire. Were that to happen, the Social Security system -- or its beneficiaries, depending on who bore the brunt of declining stock prices -- would be worse off than ever.