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For 1967-81 the interest rate basis used for trust fund investments was higher than the all-obligations rate in 9 years, with 1 year being the same. The average excess was 0.35 percentage points.

Furthermore, the current high interest rates are unlikely to last much longer. With interest rates lower in years ahead, a change now to short-term securities would not be nearly as advantageous to the trust funds as continuing the present procedure and having the very large amount of long-term investments "locked in" at 13percent interest, as compared with much lower rates that might be obtained in the future.

Another investment strategy recommended occasionally is for trust funds to roll over their assets into those securities with the highest current yield, but only if such yield exceeds that of current holdings. Such a strategy would be very advantageous to social security, but disadvantageous and inequitable to the general treasury, which would pay the increased interest from general revenues. Thus, while the trust funds would do better with such a strategy, higher Federal income taxes or a larger Federal deficit would result. This would be an indirect form of general revenue financing for social security. Then, too, private investors are not given this "best of both worlds" possibility.

The present investment procedures for the trust funds is proper and equitable to both these funds and to the General Fund of the Treasury. Both the insured persons under social security and the general taxpayers-who are, by and large, the same persons-are treated in a fair, equitable and consistent manner.

The rates of return obtained by the trust funds currently are reasonable in light of past investment experience. The appropriate investment procedure is to choose one investment policy and remain with it, rather than attempting to do better by speculating through jumping back and forth among investment strategies. Thank you, Mr. Chairman.

[The prepared statement follows:]

STATEMENT OF ROBERT J. MYERS, DEPUTY COMMISSIONER OF SOCIAL SECURITY FOR PROGRAMS, SOCIAL SECURITY ADMINISTRATION, DEPARTMENT OF HEALTH AND HUMAN SERVICES

Mr. Chairman and Members of the Subcommittee, I am pleased to be here today to discuss the investment policy of the four Social Security trust funds-the Old-Age and Survivors Insurance Trust Fund, the Disability Insurance Trust Fund, the Hospital Insurance Trust Fund, and the Supplementary Medical Insurance Trust Fund. Although the investment of the assets of these funds is, by law, the responsibility of the Secretary of the Treasury, as Managing Trustee of the several Boards of Trustees, the Social Security Administration has, understandably, always taken a great interest in this matter. Then too, during my many years of association with the program, I have studied the subject with considerable diligence.

Although the interest income of the Social Security program is not a major factor in its financing-whereas in funded private pension plans investment income is a very significant element-neither is it of negligible importance. For example, in calendar year 1980, the interest income of the four trust funds was only 2.46 percent of the total income. However, such interest income was the not insignificant sum of $3.85 billion, which incidentially was 1.5 times as large as the administrative expenses of the program.

INVESTMENT PROCEDURES

Throughout the entire period of operation of the program, the method of investing the assets of the trust funds has changed relatively little. In general, it may be said

that the trust funds receive the tax income and pay the benefits and administrative expenses. The excess of the income over the outgo is invested in obligations of the Federal Government, and the interest therefrom augments the income of the system.

Since the middle of 1940, the Social Security tax collections have been automatically appropriated to the trust funds as they are received by the Treasury Department. Before then, a somewhat different procedure was followed. The authorized appropriations to the Old-Age Reserve Account (as it was called then) were not specifically to be measured by the taxes collected, but rather were to be "an amount to be determined on a reserve basis in accordance with accepted actuarial principles." Underlying legal and constitutional aspects made a distinct division between the taxes collected and the benefits paid seem desirable. In actual practice, however, this language was interpreted to mean that the appropriations should be the estimated net proceeds of the taxes, after deduction for the estimated administrative expenses (which procedurally were paid out of the General Fund of the Treasury but, of course, in practice came from the gross Social Security tax receipts).

After the program was declared to be clearly constitutional in 1937, this indirect procedure was no longer necessary. As a result, the 1939 Act provided for the current automatic-appropriation basis.

The investments of the trust funds can be either in special issues or in any other securities of the Federal Government. Some regular issues have actually been bought, both on the open market and when they were offered to the general public. Special legislation has provided that certain semigovernment issues-such as those of the Government National Mortgage Association-can be purchased the trust funds, even though they are not guaranteed for both principal and interest by the Government.

Most of the investments, however, have been in special issues. As of June 30, 1981, about 92 percent of the assets of the four trust funds were in special issues (see Attachment A).

Before 1940, it was provided that the special issues should bear an interest rate of 3 percent. From then until the 1956 Act, they carried an interest rate slightly below the average coupon rate on all interest-bearing obligations of the United States outstanding at the end of the month preceding the issue of the special issues. The 1956 Act changed the interest basis for special issues so that it was determined from the average coupon rate on all long-term Government obligations (issued initially for 5 or more years), rounded to the nearest 8 percent. The 1960 Act revised this interest basis, so that the interest rate is now determined from the average market yield rate on Government obligations that are not due or callable for at least 4 years from the date of determination. The actual experience over the years as to the interest rates applicable to special issues and the durations until their maturity is described in Attachment B.

ALTERNATIVE POSSIBLE INVESTMENT AREAS

Although there has, at times, been considerable opposition to investing the excess income of the system in Government bonds, no positive support has been offered for any other form of investment. All other possibilities have seemed to be objectionable for overwhelming reasons.

One possible investment practice would be to purchase securities of private_concerns, either bonds or stocks. There are several objections to this approach. First, with the large amount of money available, the Government would control a considerable portion of the private industrial economy, which would, in effect, result in "socialism by the backdoor method." Another practical disadvantage would be the need for a far-reaching and deep-searching investment policy that would permit the trust funds to obtain an adequate rate of interest with reasonable security of principal. Under such a policy the Government would, in effect be setting itself up as a rating organization, because the investment procedures would naturally have to be open to full public view. If no preference were shown for different types of securities, but rather investments were made widely and indiscriminately, there would be a serious danger of loss of principal and diminution of investment income. Another possible procedure would be to invest the funds in social and economic activities such as the construction of housing, dams, hospitals, and the like (as is done in some countries). This method would be open to some objection on the grounds mentioned previously-Government entry into private fields of activity. Even more serious is the argument that any use of public funds for such purposes should be under the control of the elected representatives of the people (Congress), rather than the indirect and less visible approach of having a social insurance organization making decisions as to what is best for the country.

Accordingly, it may properly be concluded that investment of the assets of the Social Security trust funds can feasibly be invested only in securities of the Federal Government.

CRITICISMS OF TRUST-FUND INVESTMENT RESULTS

In the light of current high interest rates, there has been criticism of the investment results of the Social Security trust funds. For example, it has been pointed out that, during the 12-month period ending June 30, 1980, the effective annual rate of interest earned by the combined OASI and DI Trust Funds was only 8.4 percent, whereas private money-market managers currently earn about 13 percent.

This is not a valid comparison, because it contrasts the investment return of a portfolio of securities purchased over a long period of years with the current, relatively high new-issues rate. The securities bought by the trust funds in the past bore interest rates which were proper and equitable at the time of purchase. On the other hand, the high interest rates quoted for private money managers are those obtained for securities purchased currently. Any private investment organization which has built up a portfolio over the years (and has done so in a prudent manner) would currently have a much lower average rate of investment return for its total portfolio than it would for securities bought currently.

Thus, in comparing current investment managers, one should not simply measure the average rate of return on their total portfolios, which may have been acquired with much different timing, but rather one should take into account other factorse.g., how they were doing on their current investments. In that regard, the Social Security trust funds have been obtaining relatively high interest rates on their current investments. For example, the interest rate on special issues acquired in June was 13 percent, and it was at this rate that some $20 billion of new issues were acquired on June 30, with maturities of up to 15 years.

Moreover, as old securities mature, and as new higher-interest securities are purchased, the average effective rate of return for the assets of the trust funds will rise. Thus, as compared with the rate of 8.4 percent for the year ended June 30, 1980, the rate for the year ended June 30, 1981 was 8.8 percent. Attachment C shows these effective rates of returns for various years in the past for each of the trust funds. It is significant to note that, despite each of the funds receiving exactly the same rate on special issues purchased at the same time, the average effective rates for various years differ significantly. This is, of course, due to the different times of purchases of the various securities.

Also, it is of significance to note in considering the investment rate of return of the OASDI Trust Funds in the 12-month periods ending June 30, 1980 and June 30, 1981-namely, 8.4 percent and 8.8 percent, respectively, or an average of 8.6 percent-that the net rate of investment income (before Federal income taxes) of all United States life insurance_companies in calendar year 1980 was 8.0 percent (source: "1981 Life Insurance Fact Book", American Council of Life Insurance, page 61). Thus, the trust funds had an investment experience closely comparable with that of life insurance companies in the aggregate.

A life insurance company which was formed in 1980 would, of course, have had a much higher rate of return, because it would be holding only new investments, at a relatively high rate. This, however, would not "prove" that it was such a sagacious investor, or on the contrary that the older, well-established companies were stupid investors.

CRITICISM OF DURATION OF INVESTMENTS

Finally, the criticism has, at times, been levied that the Social Security trust funds should be invested in short-term Government obligations, rather than longterm ones. It would have been feasible for the investments of the Social Security trust funds to have been in short-term obligations which would be rolled over every year (or even every month) instead of in long-term obligations, generally having a maturity length of 15 years. Thus, at present, this would have the advantage of the high current short-term interest rates. In hindsight-just as with other investment experience-this might have proven to be more advantageous.

Certainly, the general experience in the past has been that long-term interest rates are somewhat higher than short-term ones, even though this is not so at the moment. Accordingly, over the long run, the long-term-interest-rate procedure would seem preferable. Attachment D compares the average market-yield rate of all obligations of the U.S. Government with the corresponding long-term rate that the trust funds receive on new special issues. For 1967-81, the interest-rate basis used for Social Security trust-fund investments was higher than the all-obligations rate

in 9 years (with 1 year being the same). The average excess was .35 percentage points.

Furthermore, the current high interest rates of, say, 15 percent are unlikely to last for much longer. With interest rates lower in years ahead, a change now to short-term securities would not be nearly as advantageous as continuing the present procedure and having the very large amount of long-term investments that are now "locked in" at 13-percent interest, as compared with much lower rates that might be obtained in the future.

Another investment strategy which is recommended occasionally is for the Social Security trust funds to roll over their assets into those securities with the highest current yield, but only if such yield exceeds that of current holdings. Such a strategy would be very advantageous to Social Security, but very disadvantageousand, in fact, inequitable-to the General Treasury, which would have to pay the higher amounts of interest due from general revenues. Thus, while the Social Security trust funds would do better with such a strategy, the additional interest earnings would ultimately be reflected in higher Federal income taxes or a larger Federal deficit. in other words, it would be an indirect form of general-revenue financing for Social Security. And then too, private investors are not given this "best of both worlds" possibility.

SUMMARY AND CONCLUSIONS

The present investment policies and procedures for the Social Security trust funds is proper and equitable to both these funds and to the General Fund of the Treasury. Likewise, both the insured persons under Social Security and the general taxpayers-who are, by and large, the same persons-are treated in a fair, equitable, and consistent manner.

The rates of return obtained by the trust funds currently are reasonable in light of the past investment experience. The appropriate investment procedure is to choose one investment policy and remain with it, rather than attempting to do better by speculating through jumping back and forth among investment strategies.

[Attachment A]

DISTRIBUTION OF ASSETS OF SOCIAL SECURITY TRUST FUNDS, BY TYPE, JUNE 30, 1981

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US Treasury securities only (participation certificates of the Government National Mortgage Association are also marketable, but are not included here).

[Attachment B]

INTEREST RATES AND DURATIONS UNTIL MATURITY OF SPECIAL ISSUES OF
INVESTMENTS OF SOCIAL SECURITY TRUST FUNDS

In 1940-43, the new special issues were for durations of four or five years. Beginning in 1944, some new special issues were for durations of one year (or less); beginning in 1945, all new special issues were of this duration. Accordingly, beginning in 1947, the entire investment portfolio was reinvested each year (on June 30). This procedure was followed until 1957, when a transition was begun toward spreading the investment portfolio of each of the trust funds over the following 10 years. Investments during a fiscal year were made in certificates that mature at the end of such year-June 30. At that time, the funds from the maturities were reinvested in long-term notes (up to seven years until maturity) or bonds (of seven years or more). Then, in 1959, the permanent portfolio of special issues was spread more or less equally over the next 15 years, and this principle was followed until the late 1960s. In order to be equitable to the trust funds as interest rates rose above 44 percent, then, this principle was suspended, and new special issues were given a maturity of seven years, because other provisions of law prohibited a higher rate than 4

percent for longer-term securities. Such prohibition was removed insofar as the trust funds are concerned in mid-1974. Then blocks of special issues at an interest rate of 7% percent were purchased with the funds then available for investment, in equal amounts maturing in each year of 1981-89. Since then the “equal spreading over 15 years" principle has been followed.

The special-issue interest rate was initially 12 percent (in 1940), but as large volumes of long-term government bonds were floated to finance the war effort, the rate gradually decreased and reached a low of 1% percent in the period from May 1943 to July 1946. Thereafter, there was a gradual rise to 2% percent for the period from July 1958 to September 1960, which was the last month before the new basis provided by the 1960 Act went into effect.

When the interest basis was changed by the 1956 Act (effective for October 1956), there was no change in the rate actually made available to the trust funds. As it happened, under the conditions prevailing at that time, the new method of basing the rate on long-term obligations (rather than on all obligations) produced a slightly lower unrounded rate, but the change in the rounding procedure produced a final result that was exactly the same as the previous basis.

The new basis under the 1960 Act produced a sharp increase in the special-issue interest rate, yielding rates of 3% to 4 percent for issues purchased in the last three months of 1960, or appreciably in excess of the 24 percent rate that would have been in effect then under the old basis. During 1961-65, this interest rate was generally between 3 and 4 percent, but thereafter it rose significantly, reaching a high of 7% percent in February 1970. Then the rate fell somwhat and was about 6 percent during 1971-72, but rose to about 634 percent during 1973. Then it increased further in 1974, reaching a peak of 8% percent in September, but fell off to about 7 to 72 percent thereafter through 1977. In 1978, the rate increased to as much as 8% percent and was a high as 102 percent in late 1979. It then increased sharply in early 1980, peaking at 12% percent in March, then fell to 9 percent in June, and thereafter rose to 12% percent in December. Then, in 1981, the rate had a rising trend and was 13 percent in June, 134 percent in July, 14 percent in August, and 14% percent in September.

[Attachment C]

EFFECTIVE RATES OF RETURN FOR SOCIAL SECURITY TRUST FUNDS IN VARIOUS YEARS

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2 Rate not computed because of distortion caused by reallocation of OASDI tax rate between OASI and DI during year.

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