Objectives, Scope, and Methodology

The Chairman of the House Committee on Ways and Means asked us to determine how individual accounts could affect (1) private capital and annuities markets as well as national savings, (2) potential returns and risks to individuals, and (3) the disclosure and educational information needed for public understanding and use of an individual account investment program. As a result, the primary capital market effect is a purely financial one: borrowing in the Treasury debt market (or retiring less debt) to provide funding for investment in private debt and equity markets. Although substantial inflows into the private debt market could, in certain circumstances, result in some increased volatility, both the private equity and debt markets should be able to absorb the inflows without significant long-term disruption. There could eventually be a significant increase in the amount of new funds flowing into the annuities market. However, the magnitude of annuity purchases is likely to build gradually over time as more retirees build larger balances, allowing the market sufficient time to adjust. Redirection of Funds Could Affect Composition of Portfolios

Most proposals use either the Social Security cash flow or federal general revenues as a source of funds for individual accounts. This redirection of funds— selling Treasury debt for the cash to invest in private debt and equity—is a purely financial effect. The extent to which individual accounts affect national saving depends on how they are financed (existing payroll tax, general revenues)—the effect on government saving; how private savings—the savings of households and businesses—respond to an individual account system; the structure of the individual account system (mandatory or voluntary); and the limitation or prohibition of the pre-retirement distribution or loans to make sure retirement income is preserved. If they do not adjust, national saving is on balance unaffected. Return and Risks Are Likely to be Higher With Individual Accounts

There is a risk/return trade-off for individuals under an individual account program; instituting such a program would likely raise both the risks and the returns available to participants compared to the current system. The return that individuals receive would depend on both their investment choices and the performance of the market. Most advocates of individual accounts state that the expected return on investments under an individual account program would be much higher for individuals than the return under the current Social Security program. Under the current Social Security program, risks are borne collectively by the government. They state that history may not be a good predictor of the future. To provide participants with a clear understanding of the purpose and structure of an individual account program, an enhanced educational program would be necessary.
Why GAO Did This Study

Pursuant to a congressional request, GAO provided information on the issues associated with individual social security accounts, focusing on how such accounts could affect: (1) private capital and annuities markets as well as national savings; (2) potential returns and risks to individuals; and (3) the disclosure and educational efforts needed to inform the public about such a program.

What GAO Found

GAO noted that: (1) individual investment accounts could affect the capital markets in several ways; (2) as a source of funds for the accounts, most proposals use either the cash collected from social security taxes or federal general revenues; (3) as a result, the primary capital market effect is a purely financial one: borrowing in the Treasury debt market to provide funding for investment in private debt and equity markets; (4) although the annual flows are likely to be sizeable, both the private debt and equity markets should be able to absorb the inflow without significant long-term disruption; (5) there could eventually be a significant increase in the amount of new funds flowing into the annuities market; (6) however, the magnitude of annuity purchases is likely to build gradually over time as more retirees build larger balances, allowing the market sufficient time to adjust; (7) individual account proposals could also affect the level of financial resources available for private investment by increasing or decreasing national savings; (8) the extent to which individual accounts affect national savings will depend on how they are financed, the structure of the program, and any behavioral responses of businesses and individuals; (9) national savings is more likely to increase if: (a) the government funds would have been spent but instead are not; (b) the program is mandatory and prohibits pre-retirement distributions; and (c) households do not fully adjust their retirement saving; (10) to the extent that households use the opportunities offered by an individual account program to invest in private equities and debt rather than Treasury securities, they could increase both the returns they receive and the risks they face compared to the Social Security program; (11) although asset diversification offers mitigation against certain risks, the returns that individuals receive would depend on and vary with their investment choices and the performance of the private debt and equity markets; (12) most advocates of individual accounts state that the expected future returns on private investments would be much higher for individuals than the implicit return available under the Social Security program; (13) some argue that historical returns may not be a good predictor of future returns; and (14) to provide participants with a clear understanding of the purpose and structure of an individual account program, an enhanced educational program would be necessary.