Small Business Administration Microloan Program

Summary: The Small Business Administration's (SBA's) Microloan program provides direct loans to qualified nonprofit intermediary lenders who, in turn, provide "microloans" of up to $50,000 to small businesses and nonprofit child care centers. It also provides marketing, management, and technical assistance to microloan borrowers and potential borrowers. Authorized in 1991 as a five-year demonstration project, it became operational in 1992, and was made permanent, subject to reauthorization, in 1997.

Summary: The Microloan program is designed to assist women, low-income, veteran, and minority entrepreneurs and small business owners by providing them small-scale loans for working capital or the acquisition of materials, supplies, or equipment. In FY2018, Microloan intermediaries provided 5,459 microloans totaling $76.8 million. The average Microloan was $14,071 and had a 7.6% interest rate.

Summary: Critics of the SBA's Microloan program argue that it is expensive relative to alternative programs, duplicative of the SBA's 7(a) loan guaranty program, and subject to administrative shortfalls. The program's advocates argue that it assists many who otherwise would not be served by the private sector and is an important source of capital and training assistance for low-income, women, and minority business owners.

Summary: Congressional interest in the Microloan program has increased in recent years, primarily because microloans are viewed as a means to assist very small businesses, especially women- and minority-owned startups, to get loans that enable them to create and retain jobs. Job creation, always a congressional interest, has taken on increased importance given continuing concerns about job growth during the current economic recovery.

Summary: This report opens with a discussion of the rationale provided for having a Microloan program, describes the program's eligibility standards and operating requirements for lenders and borrowers, and examines the arguments presented by the program's critics and advocates. It then discusses P.L. 111-240, the Small Business Jobs Act of 2010, which increased the Microloan program's loan limit for borrowers from $35,000 to $50,000, and the aggregate loan limit for intermediaries after their first year of participation in the program from $3.5 million to $5 million.

Summary: It also discusses P.L. 115-141, the Consolidated Appropriations Act, 2018, which, among other provisions, relaxed requirements on Microloan intermediaries that prohibited them from spending more than 25% of their technical assistance grant funds on prospective borrowers and more than 25% of those grant funds on contracts with third parties to provide that technical assistance. The act increased those percentages to 50% (originally in H.R. 2056, the Microloan Modernization Act of 2017, and S. 526, its companion bill in the Senate). In addition, P.L. 115-232, the John S. McCain National Defense Authorization Act for Fiscal Year 2019, among other provisions, increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million.

Small Business Microloans and Training Assistance

The Small Business Administration (SBA) administers programs that support small businesses, including loan guarantees to lenders to encourage them to provide loans to small businesses "that might not otherwise obtain financing on reasonable terms and conditions" and grants to nonprofit organizations to provide marketing, management, and technical training assistance to small business owners. Historically, one of the justifications presented for funding the SBA's loan guarantee programs has been that small businesses can be at a disadvantage, compared with other businesses, when trying to obtain access to sufficient capital and credit. It has been argued that this disadvantage is particularly acute for startups and microbusinesses (firms with fewer than five employees):

Traditional lending institutions, such as banks and investors, are unlikely to offer loans and investment capital to microfirms due to a variety of reasons. One barrier to microlending is a concern that startups and smaller enterprises are risky investments since growing businesses typically exhibit erratic bursts of growth and downturn. The perceived risk of these types of companies reduces the chances of a microbusiness to obtain financing. Another issue is that microbusinesses by and large require smaller amounts of capital, and thus banks or investment companies often believe that it is not efficient use of their time or resources, nor will they receive a substantive return on investment from such a small loan amount.

An Urban Institute survey of SBA 7(a), 504/Certified Development Company (504/CDC), Small Business Investment Company (SBIC), and Microloan borrowers conducted in 2007 found that Microloan borrowers reported having the most difficulty in finding acceptable financing elsewhere. Less than one-third (31%) of Microloan borrowers reported that they would have been able to find acceptable financing elsewhere, compared with 35% of SBIC borrowers, 40% of 7(a) borrowers, and 48% of 504/CDC borrowers.

Since its inception in 1953, the SBA has provided loan guarantees to encourage lenders to issue small businesses loans. Interest in creating a separate loan program to address the specific needs of startups and microbusinesses increased during the 1980s, primarily due to the growth and experience of microlending institutions abroad and evidence concerning private lending practices that led Congress to conclude that a new loan program was necessary "to reach very small businesses that were not being served by traditional lenders of SBA's credit programs."

To address the perceived disadvantages faced by very small businesses in gaining access to capital, Congress authorized the SBA's Microloan lending program in 1991 ( P.L. 102-140 , the Departments of Commerce, Justice, and State, the Judiciary, and Related Agencies Appropriations Act, 1992). The program became operational in 1992. Its stated purpose is

to assist women, low-income, veteran ... and minority entrepreneurs and business owners and other individuals possessing the capability to operate successful business concerns; to assist small business concerns in those areas suffering from a lack of credit due to economic downturns; ... to make loans to eligible intermediaries to enable such intermediaries to provide small-scale loans, particularly loans in amounts averaging not more than $10,000, to start-up, newly established, or growing small business concerns for working capital or the acquisition of materials, supplies, or equipment; [and] to make grants to eligible intermediaries that, together with non-Federal matching funds, will enable such intermediaries to provide intensive marketing, management, and technical assistance to microloan borrowers.

The SBA's Microloan lending program was authorized initially as a five-year demonstration project. It was made permanent, subject to reauthorization, in 1997 ( P.L. 105-135 , the Small Business Reauthorization Act of 1997).

Congressional interest in the Microloan program has increased in recent years, primarily because microloans are viewed as a means to assist very small businesses, especially women- and minority-owned startups, obtain loans that enable them to create jobs. Job creation and preservation, always a congressional interest, has taken on increased importance given continuing concerns about job growth.

This report describes the Microloan program's eligibility standards and operating requirements for lenders and borrowers and examines the arguments presented by the program's critics and advocates. It also examines changes to the program authorized by P.L. 111-240 , the Small Business Jobs Act of 2010, P.L. 115-141 , the Consolidated Appropriations Act, 2018, and P.L. 115-232 , the John S. McCain National Defense Authorization Act for Fiscal Year 2019.

P.L. 111-240 authorized the Secretary of the Treasury to establish a $30 billion Small Business Lending Fund (SBLF) to encourage community banks to provide small business loans ($4.0 billion was issued), a $1.5 billion State Small Business Credit Initiative to provide funding to participating states with small business capital access programs, and about $12 billion in tax relief for small businesses. It also authorized changes to the SBA's loan guaranty programs, including increasing the Microloan program's loan limit for borrowers from $35,000 to $50,000, and the aggregate loan limit for intermediaries after their first year of participation in the program from $3.5 million to $5 million. It also authorized the SBA to waive, in whole or in part through FY2012, the nonfederal share requirement for loans to the Microloan program's intermediaries and for grants made to Microloan intermediaries for small business marketing, management, and technical assistance for up to a fiscal year.

P.L. 115-141 , among other provisions, relaxed requirements on Microloan intermediaries that prohibited them from spending more than 25% of their technical assistance grant funds on prospective borrowers and more than 25% of those grant funds on contracts with third parties to provide that technical assistance. The act increased those percentages to 50% (originally in H.R. 2056 , the Microloan Modernization Act of 2017, and S. 526 , its companion bill in the Senate).

Also, P.L. 115-232 , among other provisions, increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million (originally in H.R. 2056 , the Microloan Modernization Act of 2017, and S. 526 , its companion bill in the Senate).

This report also discusses several bills introduced during the 114 th and 115 th Congresses. For example, during the 114 th Congress,

S. 1445 , the Microloan Act of 2015, would have removed the requirements that no more than 25% of Microloan technical assistance grant funds may be used to provide information and technical assistance to prospective borrowers or on third-party contracts to provide that assistance. It would have also eliminated the Microloan program's minimum state allocation formula. H.R. 2670 , the Microloan Modernization Act of 2015, and S. 1857 , the Senate companion bill, would have increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million, increased the program's repayment terms from not more than 6 years to not more than 10 years for loans greater than $10,000, and required the SBA Administrator to establish a rule enabling intermediaries to apply for a waiver of the requirement that no more than 25% of Microloan technical assistance grant funds may be used to provide information and technical assistance to prospective borrowers. The House passed H.R. 2670 on July 13, 2015. S. 2850 , the Microloan Program Modernization Act of 2016, would have increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million and, among other provisions, eliminated the requirements that intermediaries spend no more than 25% of Microloan technical assistance grant funds on technical assistance to prospective borrowers and no more than 25% of those funds on third party contracts for technical assistance.

H.R. 2056 , the Microloan Modernization Act of 2017, and S. 526 , its companion bill in the Senate would, as introduced, increase the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million and, among other provisions, eliminate the requirement that intermediaries spend no more than 25% of Microloan technical assistance grant funds on technical assistance to prospective borrowers and no more than 25% of those funds on third-party contracts for technical assistance.

H.R. 2056 and S. 526 were amended in committee to require intermediaries to spend no more than 50% of Microloan technical assistance grant funds on technical assistance to prospective borrowers and no more than 50% of those funds on third-party contracts for technical assistance. The House bill, as amended, was favorably reported by the House Committee on Small Business on July 12, 2017, and agreed to by the House on July 24, 2017, by voice vote. The Senate bill was favorably reported by the Senate Committee on Small Business and Entrepreneurship on March 19, 2018.

As mentioned previously, the 50% thresholds were included in P.L. 115-141 and the increase from $5 million to $6 million for the Microloan program's aggregate loan limit for intermediaries after their first year of participation was included in P.L. 115-232 .

The SBA Microloan Program: Funding, Eligibility Standards, Program Requirements, and Statistics

Unlike the SBA's 7(a) and 504/CDC loan guarantee programs, the SBA Microloan program does not guarantee loans. Instead, it provides direct loans to qualified nonprofit intermediary Microloan lenders who, in turn, provide "microloans" of up to $50,000 to small business owners, entrepreneurs, and nonprofit child care centers. There are currently 144 active Microloan intermediaries serving 49 states, the District of Columbia, and Puerto Rico.

The Microloan program's administrative costs (anticipated to be $47.66 million in FY2018) are funded through the SBA's salaries and expenses and business loan administration accounts. In addition, each year the SBA receives an appropriation for credit subsidies for its direct lending (Microloan) program.

Business loan credit subsidies represent the net present value of cash flows to and from the SBA over the life of the loan portfolio. For guaranteed loans, the net present value of cash flows is primarily affected by the difference between the cost of purchasing loans that have defaulted and the revenue generated from fees and collateral liquidation. For direct (Microloan) lending, the net present value of cash flows is primarily affected by the cost of offering below market interest rates to intermediaries because the cost of purchasing loans that have defaulted is typically relatively small because intermediaries are required to maintain a loan loss reserve. In addition, the SBA does not charge intermediaries fees.

In FY2019, the SBA was provided $4.0 million, to remain available until expended, for direct (Microloan) business loan credit subsidies. This appropriation was expected to support about $42.0 million in lending to intermediaries.

The SBA received an appropriation of $31.0 million in FY2019 for grants to selected Microloan intermediaries and qualified "non-lending technical assistance providers" to provide Microloan borrowers and prospective borrowers marketing, management, and technical training assistance.

As shown in Table 1 , Microloan intermediaries provided counseling services to 19,600 small businesses in FY2017. The data indicate that the number of small businesses served by the Microloan technical assistance program has generally increased in recent years.

Intermediary Microloan Lender Eligibility Standards

To become a qualified intermediary Microloan lender, an applicant must

be organized as a nonprofit community development corporation or other entity, a consortium of nonprofit community development corporations or other entities, a quasigovernmental economic development corporation, or an agency established by a Native American Tribal Government; be located in the United States, including the Commonwealth of Puerto Rico, the U.S. Virginia Islands, Guam, and American Samoa; have made and serviced short-term, fixed rate loans of not more than $50,000 to newly established or growing small businesses for at least one year; and have at least one year of experience providing technical assistance to its borrowers.

If accepted into the program by the SBA, an intermediary may borrow no more than $750,000 from the SBA during its first year of participation. After the first year, the maximum loan amount is $2.5 million. By law, an intermediary's total outstanding Microloan program debt must not exceed $6 million.

The SBA approves and lends funds, subject to the availability of appropriations, to intermediaries based on the order in which applications are received. The amount provided is subject to two statutory limitations.

No more than 300 intermediaries may participate in the Microloan program at any given time. During the first six months of each fiscal year, subject to the availability of appropriations, at least $800,000 or 1/55 th of available loan funds (whichever is less) is required to be made available for loans to intermediaries in each state (including the District of Columbia, the Commonwealth of Puerto Rico, the United States Virgin Islands, Guam, and American Samoa).

Any applications that cannot be funded during the first six months "due to geographic limitations will be kept on file in the order they were received" and, subject to the availability of funds, "will be funded during the seventh month of the fiscal year [April]." If the amount of requested loan funds exceeds the amount of available funds, the SBA "may hold back up to 20% of available loan funds to ensure that due consideration is given to new intermediaries and those having the greatest impact to underserved markets." Also, if the amount of requested loan funds from new intermediaries exceeds the amount of available funds, the SBA "may choose to select a new intermediary in an underserved location (a location that is currently unserved by an SBA Microloan Program Intermediary Lender), as determined by the Agency, over a new applicant in an area that is already served by one or more existing Intermediaries."

Intermediary Microloan Lender Program Requirements

Intermediaries are not required to make any interest payments on the Microloan during the first year, but interest accrues from the date that the SBA disburses the loan proceeds to the intermediary. After that, the SBA determines the schedule for periodic payments. Loans must be repaid within 10 years.

The SBA charges intermediaries an interest rate that is based on the five-year Treasury rate, adjusted to the nearest one-eighth percent (called the Base Rate), less 1.25% if the intermediary maintains an historic portfolio of Microloans averaging more than $10,000, and less 2.0% if the intermediary maintains an historic portfolio of Microloans averaging $10,000 or less. The Base Rate, after adjustment, is called the Intermediary's Cost of Funds. The Intermediary's Cost of Funds is initially calculated one year from the date of the note and is reviewed annually and adjusted as necessary (called recasting). The interest rate cannot be less than zero.

Intermediaries are required to contribute not less than 15% of the loan amount in cash from nonfederal sources and, as security for repayment of the loan, must provide the SBA first lien position on all notes receivable from any microloans issued under the program. Unlike the SBA's 7(a) and 504/CDC loan guarantee programs, the SBA does not charge intermediaries upfront or ongoing service fees under the Microloan program.

As mentioned previously, P.L. 111-240 temporarily allowed the SBA to waive, in whole or in part through FY2012, the intermediary's 15% nonfederal share requirement under specified circumstances (e.g., the economic conditions affecting the intermediary and the intermediary's performance) for up to a fiscal year.

Intermediaries are required to deposit the proceeds from the SBA's loans, their 15% contribution, and payments from their Microloan borrowers into a Microloan Revolving Fund. Intermediaries may only withdraw from this account funds necessary to make microloans to borrowers, repay the SBA, and establish and maintain a Loan Loss Reserve Fund to pay any shortage in the Microloan Revolving Fund caused by delinquencies or losses on its microloans. They are required, until they have been in the program for at least five years, to maintain a balance in the Loan Loss Reserve Fund equal to 15% of the outstanding balance of the notes receivable from their Microloan borrowers. After five years, if the intermediary's average annual loss rate during the preceding five years is less than 15% and no other factors exist that may impair the intermediary's ability to repay its obligations to the SBA, the SBA Administrator may reduce the required balance in the intermediary's Loan Loss Reserve Fund to the intermediary's average annual loss rate during the preceding five years, but not less than 10% of the portfolio. Intermediaries are required to maintain their Loan Loss Reserve Fund until they have repaid all obligations owed to the SBA.

The SBA does not maintain detailed data necessary to determine an aggregate default rate for Microloan borrowers. However, in 2007, the SBA estimated that the borrower default rate for the Microloan program was about 12%. Because the Loan Loss Reserve Fund is used to contribute toward the cost of borrower defaults, and is often sufficient to cover the entire cost of such defaults, the SBA's loss rate for intermediary repayment is typically less than 3% each year.

An intermediary may be suspended or removed from the Microloan program if it fails to comply with a specified list of program performance standards. For example, intermediaries are required to close and fund at least 10 microloans per year, cover the service territory assigned by the SBA, honor the SBA determined boundaries of neighboring intermediaries and non-lender technical assistance providers, fulfill reporting requirements, maintain a loan currency rate of 85% or more (where loans are no more than 30 days late in scheduled payments), maintain a default rate of 15% or less, and "satisfactorily provide" in-house technical assistance to microloan clients and prospective microloan clients.

Intermediary Marketing, Management, and Technical Training Assistance

As mentioned previously, in FY2019, the SBA received $31.0 million for grants to Microloan intermediaries and qualified "non-lending technical assistance providers" to provide Microloan borrowers and prospective borrowers marketing, management, and technical training assistance (see Appendix for previous funding levels).

Intermediaries are eligible to receive a Microloan technical assistance grant "of not more than 25% of the total outstanding balance of loans made to it under this subsection." Grant funds may be used only to provide marketing, management, and technical assistance to Microloan borrowers, except that no more than 50% of the funds may be used to provide such assistance to prospective Microloan borrowers. Grant funds may also be used to attend training required by the SBA. Also, intermediaries must contribute, solely from nonfederal sources, an amount equal to 25% of the grant amount. In addition to cash or other direct funding, the contribution may include indirect costs or in-kind contributions paid for under nonfederal programs. Intermediaries may expend no more than 50% of the grant funds on third-party contracts for the provision of technical assistance.

In addition, as mentioned earlier, P.L. 111-240 temporarily allowed the SBA to waive, in whole or in part through FY2012, the 25% nonfederal share requirement for grants made to Microloan intermediaries for small business marketing, management, and technical assistance under specified circumstances (e.g., the economic conditions affecting the intermediary and the intermediary's performance) for up to a fiscal year.

The SBA does not require Microloan borrowers to participate in the marketing, management, and technical assistance program. However, intermediaries typically require Microloan borrowers to participate in the training program as a condition of the receipt of a microloan. Combining loan and intensive training assistance is one of the Microloan program's distinguishing features.

Intermediaries that have a portfolio of loans made under the program "that averages not more than $10,000 during the period of the intermediary's participation in the program" are eligible to receive an additional training grant equal to 5% of "the total outstanding balance of loans made to the intermediary." Intermediaries are not required to make a matching contribution as a condition of receiving these additional grant funds.

Non-lending Technical Assistance Providers

Each year, the SBA is authorized to select qualified nonprofit, non-lending technical assistance providers to receive grant funds to provide marketing, management, and technical assistance to Microloan borrowers. Any nonprofit entity that is not an intermediary may apply for these funds.

The SBA may award up to 55 grants each year to qualified non-lending technical assistance providers to deliver marketing, management, and technical assistance to Microloan borrowers. The grants may be for terms of up to five years and may not exceed $200,000. The nonprofit entity must contribute, solely from nonfederal sources, an amount equal to 20% of the grant. In addition to cash or other direct funding, the contribution may include indirect costs or in-kind contributions paid for under nonfederal programs.

The SBA stopped awarding these grants at the beginning of FY2005. The SBA determined at that time that the non-lending technical assistance providers duplicated much of what was already being provided by Microloan intermediaries and other SBA entrepreneurial development programs.

Microloan Borrower Eligibility Standards

With one exception, Microloan borrowers must be an eligible, for-profit small business as defined by the Small Business Act. P.L. 105-135 , the Small Business Reauthorization Act of 1997, expanded the Microloan program's eligibility to include borrowers establishing a nonprofit childcare business.

Intermediaries are directed by legislative language to provide borrowers "small-scale loans, particularly loans in amounts averaging not more than $10,000." They are also directed, "to the extent practicable ... to maintain a microloan portfolio with an average loan size of not more than $15,000." Microloans for more than $20,000 are allowed "only if such small business concern demonstrates that it is unable to obtain credit elsewhere at comparable interest rates and that it has good prospects for success." The maximum loan amount is $50,000 and no borrower may owe an intermediary more than $50,000 at any one time.

Microloan proceeds may be used only for working capital and acquisition of materials, supplies, furniture, fixtures, and equipment. Loans cannot be made to acquire land or property, and must be repaid within six years. Within these parameters, loan terms vary depending on the loan's size, the planned use of funds, the requirements of the intermediary lender, and the needs of the small business borrower. During the 114 th Congress, H.R. 2670 would have increased the program's repayment terms from not more than 6 years to not more than 10 years for loans greater than $10,000.

On loans of more than $10,000, the maximum interest rate that can be charged to the borrower is the interest rate charged by the SBA on the loan to the intermediary, plus 7.75 percentage points. On loans of $10,000 or less, the maximum interest rate that can be charged to the borrower is the interest charged by the SBA on the loan to the intermediary, plus 8.5 percentage points. Rates are negotiated between the borrower and the intermediary, and typically range from 6.5% to 9%. In FY2018, the average interest rate charged was 7.6%.

Each intermediary establishes its own lending and credit requirements. However, borrowers are generally required to provide some type of collateral (consistent with prudent lending practices), and a personal guarantee to repay the loan. The SBA does not review the loan for creditworthiness.

Intermediaries are allowed to charge borrowers reasonable packaging fees limited to 3% of the loan amount for loans with terms of one year or more, and 2% for loans with terms of less than one year. Intermediaries are also allowed to charge borrowers "actual, paid and documented out-of-pocket closing costs … such as filing or recording fees, collateral appraisals, credit reports, and other such direct charges related to loan closing." These fees may be added to the loan amount and financed over the life of the loan "provided the total loan amount, including the fee, does not exceed $50,000."

Table 2 provides the number and amount of loans that the SBA provided Microloan intermediaries from FY2010 through FY2017, the number and amount of loans to Microloan intermediaries that the SBA approved in FY2018 (before loan cancelations, etc.), and the number and amount of Microloans that intermediaries provided small businesses from FY2010 through FY2018.

As shown in Table 2 , in FY2018, the SBA approved 58 loans to intermediaries totaling $37.3 million. The average approved intermediary loan amount was $643,724. Microloan intermediaries provided 5,459 loans to small businesses totaling $76.8 million. The average Microloan amount was $14,071.

As of the end of FY2018, the SBA had disbursed 1,230 loans to Microloan intermediaries totaling $562.5 million. At that time, there were 485 active Microloan intermediary loans with an unpaid principal balance of $165.3 million.

As shown in Table 2 , the number and amount of Microloans provided to small businesses have generally increased in recent years.

The Microloan program is open to all small business entrepreneurs, but targets new and early-stage businesses in "underserved markets, including borrowers with little to no credit history, low-income borrowers, and women and minority entrepreneurs in both rural and urban areas who generally do not qualify for conventional loans or other, larger SBA guaranteed loans." An analysis conducted by the Urban Institute found that about 9.9% of conventional small business loans are issued to minority-owned small businesses and about 16% of conventional small business loans are issued to women-owned businesses. In FY2018, of those reporting their race, minority-owned or -controlled firms received 47.4% of the number of microloans issued and 33.8% of the amount issued. Women-owned or -controlled firms received 48.7% of the number of microloans issued and 38.9% of the amount issued.

More than three-quarters of all Microloan borrowers (81.0%) in FY2018 were located in an urban area. Also, in FY2018, startup companies received 38.0% of the number of microloans issued and 36.4% of the total amount of microloans issued.

As mentioned previously, the Microloan program's estimated borrower default rate is about 12%. Because the Loan Loss Reserve Fund is used to contribute toward the cost of borrower defaults, and is often sufficient to cover the entire cost of such defaults, the SBA's loss rate for intermediary repayment is typically less than 3% annually. For example, the Microloan program's intermediary default rate was 2.36% in FY2015, 1.60% in FY2016, 2.26% in FY2017, and 2.29% in FY2018.

Microloans are often used for more than one purpose. In FY2018, they were most commonly used for working capital (70.4%), equipment (25.8%), inventory (21.5%), and supplies (7.6%).

Critics of the SBA's Microloan program argue that it is duplicative of other available programs, expensive relative to alternative programs, and subject to administrative shortfalls. The program's advocates argue that it provides assistance that "reaches many who otherwise would not be served by the private sector or even the SBA's 7(a) loan program" and "has provided an important source of capital for low-income women business owners and minority borrowers."

Critics of the SBA's Microloan program argue that its direct lending program is duplicative of the SBA's 7(a) loan guarantee program and its marketing, management, and technical training assistance grant program is duplicative of the SBA's training assistance provided through Small Business Development Centers, SCORE (Service Corps of Retired Executives), and Women Business Centers. For example, President George W. Bush proposed to eliminate all funding for the Microloan program in his FY2005, FY2006, and FY2007 budget requests to Congress, arguing that "the 7(a) program is capable of serving the same clientele through the Community Express programs for much lower cost to the Government." President Bush also proposed to terminate the Microloan program's marketing, management, and technical assistance grant program in his FY2008 and FY2009 budget requests to Congress.

Critics argued in 2007 that about 44% of the SBA's 7(a) program's loan guarantees at that time were for loans under $35,000 (the Microloan program's former loan limit for borrowers), representing more than 17 times the number of loans issued through the SBA's Microloan program. In their view, the 7(a) program had demonstrated that it can service the needs of small businesses targeted by the SBA's Microloan program. They also argued that the SBA's Microloan program's marketing, management, and technical assistance grants program was not necessary because the SBA "already supports a nationwide network of resource partners who provide counseling and training to entrepreneurs, including Small Business Development Centers, Women's Business Centers, and SCORE." They argued that about 94% of Microloan intermediaries are located within 20 miles of a Small Business Development Center, a Women's Business Center, or a SCORE partner.

Advocates argue that the SBA's Microloan program is complementary, not duplicative, of the SBA's 7(a) loan guarantee program. They assert that Microloan borrowers are particularly disadvantaged when seeking access to capital, often having no credit history or lower credit scores than most applicants for the SBA's 7(a) loan guarantee program. In their view, it is important that the SBA has a program whose sole focus is to assist Microloan borrowers in starting microbusinesses and have in place intermediaries that "have essential expertise on the needs of this key demographic."

Advocates also argue that the SBA's Microloan marketing, management, and technical assistance grants program is "a crucial element which enables intermediaries to assist microbusiness owners step by step through their development and growth" and "not only increases the likelihood of full repayment of the loan, but augments business survival and success." As mentioned previously, intermediaries typically require Microloan borrowers to participate in the training program as a condition of the receipt of the microloan.

Critics of the SBA's Microloan program argue that it is expensive relative to other SBA programs, costing about $7,506 per small business assisted in FY2017, compared to $1,316 per small business assisted in the SBA's 7(a) loan guarantee program. President George W. Bush cited the program's higher expense when he recommended in his FY2005, FY2006, and FY2007 budget requests to Congress that the program be terminated and when he recommended in his FY2008 and FY2009 budget requests to Congress that the interest rate charged to Microloan intermediaries be increased to make the program "self-financing."

Advocates argue that the program's higher cost per small business assisted is unavoidable given the relatively unique nature of the program and the special needs of its borrowers. They assert that intermediaries often have to spend a significant amount of time with Microloan borrowers because those borrowers tend to have less experience with the credit application process and a more difficult time documenting their qualifications for assistance than borrowers in the SBA's loan guaranty programs. Also, in their view, raising the interest rate charged to intermediaries to make the program self-financing would reduce the program's cost, but could also defeat the program's purpose. They assert that because microloans are small, it is difficult for intermediaries to generate enough interest income to cover their costs. As a result, if the interest rate charged to intermediaries is increased, they contend that intermediaries would have to pass the increase on to Microloan borrowers. In their view, increasing the program's cost to Microloan borrowers "will create an economic hardship for them and make it more difficult for them to grow their businesses" and "lead to fewer jobs created and fewer tax dollars paid."

On September 28, 2017, the SBA's Office of Inspector General (OIG) released an audit of the SBA's administration of the Microloan program, following up on an earlier audit released on December 28, 2009. The OIG reported a number of deficiencies that it argued needed to be addressed "to ensure effective operation of the Microloan program."

the SBA's oversight of the Microloan program was focused on the intermediaries' ability to repay their SBA loans and was limited to a cursory review of quarterly financial reports supported by only one monthly bank statement. The bank statements were used to simply verify the outstanding balances reported on the intermediaries' quarterly reports. This review process did not allow the SBA to analyze the sources and uses of funds "which is necessary to detect inappropriate fund transfers between the intermediaries' [Microloan Revolving Funds and Loan Loss Reserve Funds] accounts." onsite reviews were conducted only when an intermediary defaulted on its SBA loan. the program was inadequately staffed, operating at that time "with 6 analysts who oversee more than 160 intermediaries, 460 intermediary loans, and approximately 2,500 microloans per year." the reported Microloan borrower default rate of 12% "appeared low given the high-risk nature of the program." the audit identified duplicate loan reporting and 92 Microloan borrowers with outstanding microloan balances exceeding the then-$35,000 limit. the SBA's output performance metrics "do not ensure the ultimate program beneficiaries, the microloan borrowers, are truly assisted by the program" and "without appropriate [outcome performance] metrics, SBA cannot ensure the Microloan program is meeting policy goals." The OIG recommended that the SBA "develop additional performance metrics to measure the program's achievement in assisting microloan borrowers in establishing and maintaining successful small businesses."

In its 2017 audit, the OIG found that the SBA had taken several actions (see footnote below) to improve its oversight of the Microloan program since the 2009 audit but that the agency still had "internal control weaknesses" that prevented it from conducting "adequate program oversight to measure program performance and ensure program integrity."

Specifically, the OIG audited 14 intermediary lenders and 52 microloan files and found documentation deficiencies, or differences between the information contained in the lender's loan file versus that in the SBA Microloan Program Electronic Reporting System (MPERS) in 44 of the 52 files. The OIG also argued that the audit revealed that inadequate documentation exists to show that the "no credit elsewhere" test had been properly administered; that, in some cases, inadequate supporting documentation existed to show how the microloan funds were used by the borrower; and that, in some cases, interest rates and fees were charged that exceeded the limits allowed under the program rules and regulations.

The identified internal control weaknesses

were due to the SBA not having an overall site visit plan, an adequate information system, available funding for system improvements, or clear Standard Operating Procedures (SOPs). Additionally, SBA management focused on output-based performance measures instead of outcome measures.

The OIG recommended that the SBA (1) continue efforts to improve the information system to include outcome-based performance measurements and ensure the data captured can be used to effectively monitor the Microloan Program compliance, performance, and integrity; (2) develop and implement a site visit plan to comprehensively monitor microloan portfolio performance and ensure program results can be evaluated program-wide; (3) update the Microloan program's SOP 52 00 A to clarify requirements regarding evidence for use of proceeds and credit elsewhere; and (4) update the microloan reporting system manual to reflect current technology capabilities. The SBA concurred with the four recommendations and targeted September 30, 2019, for full implementation. For example, the Microloan program's SOP 52 00 B, effective July 1, 2018, clarified requirements regarding evidence for use of proceeds and credit elsewhere.

As mentioned previously, during the 111 th Congress, P.L. 111-240 , the Small Business Jobs Act of 2010, increased the Microloan program's loan limit for borrowers from $35,000 to $50,000, and increased the loan limit for Microloan intermediaries after their first year of participation in the program from $3.5 million to $5 million. It also temporarily allowed the SBA to waive, in whole or in part through FY2012, the nonfederal share requirement for loans to the Microloan program's intermediaries and for grants made to Microloan intermediaries for small business marketing, management, and technical assistance under specified circumstances (e.g., the economic conditions affecting the intermediary and the intermediary's performance) for up to a fiscal year.

No bills were introduced during the 112 th Congress concerning the Microloan program.

H.R. 3191 , the Expanding Opportunities to Underserved Businesses Act, would have increased the Microloan program's loan limit for borrowers from $50,000 to $75,000. S. 2487 , the Access to Capital, Access to Opportunity Act, would have increased that limit to $100,000. S. 2693 , the Women's Small Business Ownership Act of 2014, and its House companion bill, H.R. 5584 , would have increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $7 million. These bills would have also removed the requirements that no more than 25% of Microloan technical assistance grant funds may be used to provi de information and technical assistance to prospective borrowers or on third-party contracts to provide the assistance.

During the 114 th Congress, as mentioned earlier,

S. 1445 , the Microloan Act of 2015, would have removed the requirements that no more than 25% of Microloan technical assistance grant funds may be used to provide information and technical assistance to prospective borrowers or on third-party contracts to provide the assistance. It would have also eliminated the Microloan program's minimum state allocation formula. H.R. 2670 , the Microloan Modernization Act of 2015, and its companion bill in the Senate ( S. 1857 ) would have increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million, increased the program's repayment terms from not more than 6 years to not more than 10 years for loans greater than $10,000, and require the SBA Administrator to establish a rule enabling intermediaries to apply for a waiver of the requirement that no more than 25% of Microloan technical assistance grant funds may be used to provide information and technical assistance to prospective borrowers. The House passed H.R. 2670 on July 13, 2015. S. 1857 was reported by the Senate Committee on Small Business and Entrepreneurship on July 29, 2015. S. 2850 , the Microloan Program Modernization Act of 2016, would have increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million; eliminated the requirements that intermediaries spend no more than 25% of Microloan technical assistance grant funds on technical assistance to prospective borrowers and no more than 25% of those funds on third-party contracts for technical assistance; required the SBA to study and report on the operations of a representative sample of Microloan intermediaries and other intermediaries and make recommendations on how to reduce costs associated with intermediaries' participation in the program and to increase intermediary participation in the program; and required the Government Accountability Office to study and report on the SBA's oversight of the program, SBA's processes to ensure intermediary compliance with program rules and regulations, and the program's overall performance.

P.L. 115-141 , the Consolidated Appropriations Act, 2018, relaxed the requirements that intermediaries spend no more than 25% of Microloan technical assistance grant funds on technical assistance to prospective borrowers and no more than 25% of those funds on third-party contracts for technical assistance by increasing those percentages to 50%. These provisions were originally in H.R. 2056 , the Microloan Modernization Act of 2017, and S. 526 , its companion bill in the Senate (as amended in committee). P.L. 115-232 , the John S. McCain National Defense Authorization Act for Fiscal Year 2019, among other provisions, increased the Microloan program's aggregate loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million. These provisions were originally in H.R. 2056 , the Microloan Modernization Act of 2017, and S. 526 , its companion bill in the Senate.

During the 111 th Congress, congressional debate concerning proposed changes to the SBA's loan guaranty programs, including the Microloan program, centered on the likely impact the changes would have on small business access to capital, job retention, and job creation. As a general proposition, some, including President Obama, argued that economic conditions made it imperative that the SBA be provided additional resources to assist small businesses in acquiring capital necessary to start, continue, or expand operations and create jobs. Others worried about the long-term adverse economic effects of spending programs that increase the federal deficit. They advocated business tax reduction, reform of financial credit market regulation, and federal fiscal restraint as the best means to assist small business economic growth and job creation.

In terms of specific program changes, the provisions enacted in P.L. 111-240 (allowing the SBA to temporarily waive the Microloan program's nonfederal share matching requirements, increasing the loan limit for borrowers from $35,000 to $50,000, and increasing the loan limit for intermediaries after their first year of participation in the program from $3.5 million to $5 million), P.L. 115-141 (relaxing restraints on the use of technical assistance grants), and P.L. 115-232 (increasing the loan limit for intermediaries after their first year of participation in the program from $5 million to $6 million) are all designed to achieve the same goal: create jobs by enhancing micro borrowers' access to capital and technical training assistance.

Determining how specific changes in federal policy are most likely to lead to job creation is a challenging question. For example, a 2008 Urban Institute study concluded that differences in the term, interest rate, and amount of SBA financing "was not significantly associated with increasing sales or employment among firms receiving SBA financing." However, they also reported that their analysis accounted for less than 10% of the variation in firm performance. The Urban Institute suggested that local economic conditions, local zoning regulations, state and local tax rates, state and local business assistance programs, and the business owner's charisma or business acumen also "may play a role in determining how well a business performs after receipt of SBA financing."

As the Urban Institute study suggests, given the many factors that influence business success, measuring the SBA's Microloan program's effect on job retention and creation is complicated. That task is made even more challenging by the absence of performance-oriented measures that could serve as a guide.

The SBA's Office of Inspector General has recommended that the SBA adopt performance-oriented measures, specifically recommending that the SBA track the number of Microloan borrowers who remain in business after receiving a microloan to measure the extent to which the Microloan program contributed to their ability to stay in business. It has also recommended that the SBA require intermediaries to report the technical assistance provided to each Microloan borrower and "use this data to analyze the effect technical assistance may have on the success of Microloan borrowers and their ability to repay microloans." Other performance-oriented measures that Congress might also consider include requiring the SBA to survey Microloan borrowers to measure the difficulty they experienced in obtaining a loan from the private sector; the ease or difficulty of finding, applying, and obtaining a microloan from an intermediary; and the extent to which the microloan or technical assistance received contributed to their ability to create jobs or expand their scope of operations.

Appendix. Microloan Technical Assistance Program Funding


Social Security: The Trust Funds and Alternative Investments

Summary: The Old-Age, Survivors, and Disability Insurance (OASDI) program provides monthly benefits to retired or disabled workers and their family members and to the family members of deceased workers. These monthly benefits constitute a substantial portion of income for a large segment of recipients.

Summary: The OASDI program is financed primarily by payroll taxes on covered earnings up to an annual limit, as well as federal income taxes paid by some beneficiaries on a portion of their OASDI benefits. OASDI program revenues are invested in federal government securities held by the Federal Old-Age Survivors Insurance (OASI) and Federal Disability Insurance (DI) Trust Funds, where they earn interest. The interest earned on assets in the trust funds provides a third stream of revenue to the OASDI program.

Summary: The OASDI Trust Funds are overseen by a Board of Trustees, which is composed of six members: the Secretary of the Treasury, who is the managing trustee; the Secretary of Labor; the Secretary of Health and Human Services; the Commissioner of Social Security; and two public trustees, who are appointed by the President with advice and consent of the Senate. By law, the assets of the OASDI Trust Funds may be invested only in federal government securities issued by the Secretary of the Treasury. Although the Managing Trustee may invest in U.S. securities that are sold on the open market (marketable securities) if it is deemed in the public interest to do so, in practice, the OASDI Trust Funds' assets are invested in nonmarketable U.S. securities, known as special issues. The practice of investing solely in special issues has led the Board of Trustees to effectively adopt the principles of (1) nonintervention in the private economy, (2) security, (3) neutrality, and (4) minimal management. Although not explicitly codified in the Social Security Act, these principles have provided a framework to guide the trustees in their investment operations.

Summary: At the beginning of 2018, the trust funds reported asset reserves of around $2.9 trillion, which represents the projected peak value of the funds. The OASDI program's total costs are projected to exceed its total revenues, due largely to the aging of the baby boomers, thus requiring the trust funds to draw down their assets to pay scheduled benefits. The trustees expect this trend to continue indefinitely, with the trust funds' reserves reaching depletion in 2034. To extend the trust funds' solvency, some argue the trust funds' assets should be invested in equities (i.e., stocks sold on the open market). The main argument for this approach is that equities have historically produced higher rates of return, on average, than U.S. securities, which are the trust funds' only investment option under current law. Proposals favoring equity investment seek to earn higher rates of return for the trust funds than provided by special issues. However, the higher average rates of return associated with equity investing come with more risk. Investing the trust funds in equities would expose them to a higher degree of volatility than the current investment practices.

Summary: The trustees estimate that bringing OASDI program revenues into balance with program costs would require an immediate permanent increase of 2.78 percentage points in the payroll tax rate, from 12.40% to 15.18%, a permanent reduction in benefits of about 17%, or some combination of the two approaches. Although investing in equities may result in a higher return on the trust funds' assets, such a proposal would, by itself, have little effect on the program's long-term outlook, and it would have budgetary implications by requiring the immediate liquidation of the trust funds' existing assets. Because the trust funds are projected to be depleted in 2034 and because costs are expected to exceed revenues indefinitely, any proposal to invest the trust funds' asset in equities without first bringing the OASDI program into balance would result in little change to the program's solvency. Should Congress pass legislation that reduces the actuarial deficit, research indicates that including equity in the trust funds' investment practices could improve the program's financial position. This practice, if enacted, would disregard several of the trust funds' investment principles.

The Old-Age, Survivors, and Disability Insurance (OASDI) program provides monthly benefits to retired or disabled workers and their family members and to the family members of deceased workers. The OASDI program operates as a pay-as-you-go program in which revenues (collected from payroll taxes and taxation of benefits) are paid out as monthly benefits. These monthly benefits constitute a substantial portion of income for a large segment of recipients.

The payroll tax and the taxation of monthly benefits are major contributors to the OASDI program's revenues. For many years, the program's revenues exceeded its costs (i.e., benefit payments), resulting in annual surpluses. Annual surpluses are not needed to cover scheduled benefits, and the money is credited to the Old-Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund, or trust funds. The OASDI Trust Funds are invested in nonmarketable U.S. government securities (government bonds), where they earn interest. This interest provides a third source of revenue to the OASDI program. The combined OASDI Trust Funds had approximately $2.9 trillion in assets at the beginning of 2018.

The OASDI Trust Funds' Board of Trustees (the trustees) manages the trust funds according to requirements set forth in the Social Security Act. Under current law, the trust funds' assets may be invested only in U.S. government securities issued by the Secretary of the Treasury. In practice, the trust funds invest solely in special, nonmarketable U.S. Treasury securities. By investing only in nonmarketable U.S. Treasury securities, or special issues , the trustees have not intervened directly in the private economy. Investing in marketable securities would signify a departure from the norms that govern the current investment practice. Investing in equities—for example, by purchasing company stock in the open market—would demonstrate a similar departure from the trust funds' investment norms and would represent a government intervention into the private market. Some argue this expansion of investment options would be problematic because it dictates government ownership of, and possibly influence on, private companies. Although this event may never come to pass, the historically higher returns on equity investment may motivate policymakers to enact changes to the OASDI Trust Funds' investment options and practices.

Section 201(c) of the Social Security Act establishes the Board of Trustees of the OASDI Trust Funds and states that the Secretary of the Treasury shall be the managing trustee. Subsequent sections outline the main duties of the managing trustee and provide instructions for how to conduct the trust funds' investment activities. The directives include the following:

1. The managing trustee is to invest portions of the trust funds that are not required for current costs. 2. The funds not necessary to meet current costs are to be invested only in interest-bearing securities issued by the Secretary of the Treasury. Upon purchasing a government security (i.e., exchanging tax revenues or earned interest for a government security), the surplus funds are deposited into the General Fund and the funds are available to the rest of the federal government to meet other spending needs, reduce taxes, or reduce publicly held debt. This transaction essentially results in excess revenues being loaned to the government. 3. The U.S. Treasury will make these securities available to the managing trustee for the trust funds' investments. These issues are referred to as special issues or special obligations . a. The maturity of special issues is fixed with due regard for the needs of the trust funds. b. The interest rate earned by special issues is equal to the average market yield on marketable, interest-bearing government securities due at least four years in the future. 4. The managing trustee may redeem any of these special issues, at any time, at par (i.e., face value) plus accrued interest.

The ability to redeem the special issues at any time for par value, thus ensuring they cannot lose value, makes them nonmarketable. Other U.S. government issuances, if sold prior to maturity, are redeemed at the prevailing market rate. Because these special issues can always be redeemed at par, their early redemption at any time does not negatively affect the trust funds' value.

If it is determined to be in the public interest, the managing trustee may purchase non - special issues (e.g., marketable U.S. securities) at the original or market price. Doing so would imply that any redemption, if needed prior to the maturity date of such security, would return the market price and possibly result in losses to the trust funds' capital. The 1957-1959 Advisory Council on Social Security Financing acknowledged that the trust funds could invest in public (i.e., marketable) issues, but recommended amending the Social Security Act to allow investment in public issues only "when they will provide currently a yield equal to or greater than the yield that would be provided by the alternative of investing in special issues." Had this amendment been enacted into law, it would have mandated the preference for special issues.

The Social Security Act provides no direction on how the trust funds' investments should be redeemed. In practice, the trustees have adopted two administrative policies to address this gap. First, special issues are redeemed before maturity only when they are required to cover immediate costs. This policy prevents special issues with a low yield from being redeemed and then immediately reinvested at a higher rate. Second, special issues are redeemed in maturity-date order . This policy provides a reliable order of redemption.

Actuarial Note Number 142 , published by the Social Security Administration's Office of the Chief Actuary (OCACT), outlines the OASDI Trust Funds' investment principles. The note acknowledges that the legislative history of the Social Security Act provides only limited guidance, and the rest can be inferred from the administrative policies adopted over the duration of the trust funds' existence.

Principle 1: Nonintervention in the Private Economy

The principle of nonintervention has long been recognized as important in the consideration of the trust funds' finances. The 1957-1959 Advisory Council on Social Security Financing stated the following in its final report:

The Council recommends that investment of the trust funds should, as in the past, be restricted to obligations [issues] of the United States Government. Departure from this principle would put trust fund operations into direct involvement in the operation of the private economy or the affairs of State and local governments. Investment in private business corporations could have unfortunate consequences for the social security system—both financial and political—and would constitute an unnecessary interference with our free enterprise economy. Similarly, investment in the securities of State and local governments would unnecessarily involve the trust funds in affairs which are entirely apart from the social security system.

The principle of nonintervention is reinforced by the creation and use of the special issue securities as the OASDI Trust Funds' primary investment mechanism. The purchase or sale of large quantities of marketable government securities in the open market by the OASDI Trust Funds could cause market disruptions and appear as interference in the open market operations of the Federal Reserve.

Section 201(d) of the Social Security Act explicitly states the OASDI Trust Funds may only be invested in interest-bearing securities issued by or guaranteed by the U.S. government. These securities are backed by the full faith and credit of the government, offering them a high measure of protection. Furthermore, to the degree that the trust funds remain invested solely in special obligations (special issues), they are well protected from any loss to capital, earning a risk-free return.

With respect to operating neutrally, Actuarial Note Number 142 states the following:

Trust fund investment policies have, for the most part, followed a principle of neutrality, in the sense that they have generally been intended neither to advantage or disadvantage the trust funds (the lenders) with respect to other Federal accounts (the borrowers). The underlying concept is that when the trust funds invest assets by lending to the general fund of the Treasury, these transactions should produce investment results similar to those that might be obtained by a prudent, private sector investor in Federal securities. If the general fund could not borrow from the trust funds, it would have to meet its borrowing needs by selling additional securities to just such private investors.

The practice of neutrality is required, in part, by law in determining the interest rates for the special issues (see " Current Policies and Practices "). It is also encouraged by two administrative policies adopted by the trust funds: (1) only redeeming special issues before maturity when they are needed to meet program costs and (2) ensuring the maturities of special issues are evenly distributed among 1-year through 15-year durations. Note 142 concludes that "the administrative policy governing early redemption of special obligations [special issues], in combination with the policy of spreading maturities, is designed to compensate at least partially for, or neutralize, the advantage of no-risk liquidity."

Principle 4: Minimal Management of Investment

The parameters for the trust funds' investment set forth in the Social Security Act and the administrative policies adopted over time render active or day-to-day management of the trust funds' investments unnecessary. The types of possible investment vehicles are limited by law and by common practices. These practices have also eliminated discretion for when and why securities should be redeemed. Note 142 also explains that adhering to the principles of security and neutrality necessitates following the principle of minimal management, as active management (e.g., profit maximizing) would violate the first two principles.

Performance and Criticism of the Trust Funds

Figure 1 displays the returns earned by the assets in the trust funds over the period 1940 to 2017. The average interest rate is the average of the monthly interest rates on new special issues acquired by the trust funds during that year. In 2003, for instance, the average interest rate for the special issues acquired by the OASDI Trust Funds was 4.1%. The effective interest rate is the interest earned during the calendar year on all of the securities held by the trust funds divided by the average amount of securities held by the trust funds during the year. Since 1985, the effective interest rate has been higher than the average interest rate due to securities in the trust funds acquired in earlier years when interest rates were much higher. For example, Figure 1 shows that in 2003 the effective interest earned by all special issues held in the trust funds was 6.0%.

This relationship between the average interest rate and the effective interest rate is a consequence of the trust funds' special issues being evenly spread over maturity periods ranging from 1 year to 15 years. In an environment of falling interest rates, the trust funds' investment practices result in one-fifteenth of the trust funds' assets coming due each year and being invested at a lower interest rate. For instance, a portion of the special issues acquired in 1989 was invested for a duration of 15 years, thus maturing in 2003. Those special issues returned an average rate of 8.7% and would have then been invested in assets that were expected to earn an average rate of 4.1% (i.e., the average interest rate for new special issues in 2003). Similarly, a portion of special issues acquired in 1994 for a duration of 10 years earned an average rate of 7.1%; these special issues would also have been invested to earn an average of 4.1% (i.e., the average interest rate for new special issues in 2003). It must be reiterated, however, that this duration structure has afforded the trust funds a higher effective rate than the average rate, earned in an essentially risk-free manner.

Criticism of the OASDI Trust Funds' current investment practices stems from the program's long-term solvency issues. The program is facing a funding shortfall due largely to demographic factors, and restoring long-term solvency would require a payroll tax increase or reduction in benefits. Critics argue that if the trust funds had earned a better return in the past, they would be in a better long-term financial position. The 1994-1996 Advisory Council on Social Security stated the following in its final report:

Historically, returns on equities have exceeded those on Government bonds (where all Social Security funds are now invested). If this equity premium persists, it would be possible to maintain Social Security benefits for all income groups of workers, greatly improving the money's worth for younger workers without incurring the risks that could accompany individual investment.… As a matter of financial theory, the diversification achieved by investing in both stocks and government bonds should also reduce portfolio risk for the OASDI Trust Fund.

Starting in 1998, the Social Security Advisory Board (SSAB) replaced the advisory councils. Since then, the SSAB has released numerous reports that affirm the prior advisory council's findings. In reports from 2005 and 2010, the SSAB noted that the increased rate of return offered by equities would eliminate a large portion of the projected funding shortfall and reduce the need for tax increases or benefit reductions.

Because of declining interest rates and the trust funds' duration and reinvestment practice, a portion of the trust funds' holdings was continually being invested in securities that earned less than they did in the past (see Figure 1 ). This trend is expected to continue. Although the SSA's OCACT projects interest rates to increase over the next 10 years, much of the maturing holdings would still be reinvested at a lower rate.

Figure 2 shows the value of the asset reserves in the OASDI Trust Funds at the end of each calendar year from 1957 to 2034 based on historical data and projections. The figure shows the value of assets growing from 1983 through 2017. The Social Security Amendments of 1983 established a number of provisions, including increasing the full retirement age, adding new federal workers into the OASDI program, and taxing Social Security benefits, which had a positive effect on the OASDI Trust Funds. From 1983 to 2017, OASDI program revenues exceeded program cost, resulting in annual surpluses. However, during the 1983-2017 period of sustained annual surpluses, the trust funds experienced falling interest rates (see Figure 1 ).

Figure 2 depicts that at the end of 2017, the trust funds are also projected to be at peak value. For 2018, the trustees project that program costs will exceed program revenues. The assets previously invested in the trust funds will be drawn down to augment annual program revenues and fulfill annual scheduled payments. The trustees also project that under current law costs will exceed revenues for the entirety of their 75-year projection period. Under the projection, the OASDI program will be able to draw upon the trust funds' assets to fulfill scheduled payments until 2034, the date at which the trustees project assets will be depleted.

Alternative Investments and Possible Issues

The 1994-1996 Advisory Council on Social Security identified the demographic implications of the aging b aby b oom generation—those born from 1946 through 1964—and the associated effects on the trust funds as an issue. As a result, the council's final report recommended investing a portion of the trust funds in equities to help alleviate pressure on the OASDI program's long-term actuarial balance. Other alternatives included investments in private (e.g., corporate) bonds, or in social and economic activities, such as housing construction.

The primary argument for the trust funds to invest in private equity is that historical returns on equity have been greater than returns on government bonds. Some critics of this approach are concerned that by investing in private companies and gaining some control over their activities, the federal government would be intervening in the market, resulting in what some have described as "socialism by the backdoor method." The advisory council reasoned as follows:

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 Federal 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 substantial risk of diminution of investment income, or even loss of principal.

Alternatively, it could be argued that if the trust funds invested passively into an index fund, the managing trustee or Board of Trustees could forgo voting rights. Although this may help to solve, or at least alleviate, the issue of government control over private companies, it may introduce new risks. The value of shares in companies included in the chosen index would receive a steady stream of support from routine and unconditional government purchase of their shares. Investing trust fund assets in index funds—for example, by investing in an index of the largest 500 companies—may effectively create an atmosphere where these companies, by the value of their market capitalization , are chosen as the "winners" via the trust funds' purchases. The benefits of being among the winners could provide incentives for companies near the cutoff in market capitalization to adopt accounting methods not generally accepted as good practice. Deceptive accounting methods could be used to inflate stock prices and market capitalization for the purpose of becoming a winner wherein the company would benefit from consistent purchase of its stock by the trust funds.

Investing the trust funds' assets in private equities or bonds could also introduce instability to the financial markets. Whereas Figure 2 shows that the trust funds' values on a year-to-year basis are smooth, the trust funds' balance fluctuates greatly throughout the year. The need to redeem the trust funds' assets throughout the year, combined with the trust funds' ebbs and flows, presents conditions that have the potential to disrupt private markets. Large sales of private stocks and bonds needed to smooth fluctuations in the trust funds' value may create a liquidity crisis where irregular price movements prohibit sales and purchases at market prices; a lack of liquidity is also a reason critics cite for not investing in social projects such as housing or hospitals.

Lastly, for the trust funds to purchase equities, some portion of the trust funds' existing special issues would need to be redeemed to provide the necessary capital. Research presented in the following sections suggests a phase-in of equity purchases worth 2.67 percentage points of the trust funds' value per year. Phasing in the purchase of equities in 2018 at 2.67 percentage points would have required the redemption of approximately $77 billion worth of special issues. In other words, the federal government would have needed to find $77 billion to redeem these special issues so the cash could be invested in equities. Providing that capital for the new equity investments would require a corresponding increase in publicly held debt, a corresponding increase in tax revenue, or a corresponding reduction in other government spending. Subsequent years would require similar redemptions as well.

Investing the trust funds' assets in equities could introduce instability to the financial markets. Conversely, the trust funds would also be subject to the volatility already present in the markets. The higher average returns offered by equity investments are accompanied by higher risk. The degree of volatility, or risk, among investment vehicles is positively correlated to returns; that is, investments that can offer greater returns are accompanied by greater volatility. Likewise, investments that offer lower returns are accompanied by lower volatility. Investing in equities may improve the overall financial health of the trust funds, but it would likely be accompanied by higher volatility, which could pose challenges for a system dependent on dedicated sources of funding.

Figure 3 displays the effective interest rate earned by the special issues in the combined OASDI Trust Funds and the returns of the equity market as measured by the Wilshire 5000 Total Market Index, or Wilshire 5000. During the 1983-2017 period, the Wilshire 5000 returns outperformed the trust funds' effective interest rate in 21 of the 35 years. The average effective interest rate of special issues in the OASDI Trust Funds over this period was 5.8% versus an average return of 12.7% earned in the Wilshire 5000. At the same time, the equity returns demonstrated a higher degree of volatility.

Railroad Retirement Board and Alternative Investments

Many of the issues mentioned above are similar to the experiences of the Railroad Retirement Board, or RRB, an independent federal agency that administers benefits to railroad workers and their families. In 2001, Congress passed the Railroad Retirement Survivors' Improvement Act, which established the National Railroad Retirement Investment Trust (NRRIT). To ensure independence and limit political interference, the NRRIT is not a part of the federal government and is independent of the RRB.

Congress aimed to increase RRB funding by realizing higher returns than would be possible from investing solely in government securities. As such, the act requires the NRRIT to invest a portion of the RRB's assets in non-U.S. government securities, such as private stocks and bonds. The NRRIT investment practices require a diversified portfolio to minimize risk and avoid disproportionate influence over a firm or industry. From the NRRIT's inception to the end of FY2016, the investment returns helped increase the value of assets held by the RRB. From FY2003 to FY2016, annual returns averaged 7.9%, compared with expected returns of 8%. These rates of return are higher than what would have been earned if the NRRIT invested solely in government securities ( Figure 1 ); prior to the act's implementation, the NRRIT was invested in government securities in much the same manner as the OASDI Trust Funds. The overall size of assets held by the NRRIT is considerably smaller than the OASDI Trust Funds. For instance, at the end of FY2017, the market value of NRRIT-managed assets was $26.5 billion, whereas at the end of CY2017, the OASDI Trust Funds held $2,892 billion in assets. For a complete overview of the NRRIT, see CRS Report RS22782, Railroad Retirement Board: Trust Fund Investment Practices .

With accurate and precise knowledge of the OASDI Trust Funds' cash flows from 1983 through 2016, it is possible to model the trust funds' performance had they participated in alternative investments. Research published by Burtless et al. at the Center for Retirement Research in 2017 sought to determine how the trust funds would have benefited if alternative investments began in 1984, after the Social Security Amendments of 1983 ushered in a 34-year period of annual surpluses, and in 1997, after the last Advisory Council on Social Security recommended trust fund investment in equity. This analysis compares how incorporating equity investments would have affected the OASDI Trust Funds ratio. The t rust f und s ratio is the measure of the trust funds' asset reserves at the beginning of the year divided by the projected total cost for the year. According to the trustees, a trust funds ratio above 100% throughout the short-range period (10 years) indicates a financially healthy program, whereas a ratio below 100% signals the program is in a financially inadequate position. The results are presented in Figure 4 below. The scenarios presented below assume that the amount of the trust funds' reserves invested in equities would increase by 2.67 percentage points per year until 40% of reserves were allocated in equities. That is, the trust funds' purchase of equities was phased in until equities represented 40% of total assets.

This analysis yields several insights, the most pertinent of which may be that if the trust funds had invested in equities in the past, they would have higher levels of assets today than they currently do. Figure 4 shows that at the end of 2016, undertaking equity investments in 1983 would have left the trust funds with reserves enough to cover about an additional 1.2 years of program costs (424% less 302%); equity investing beginning in 1997 would have supplied the trust funds with assets to cover an additional 0.88 years of program costs (390% less 302%). In other words, the trust funds would still be facing long-term insolvency even with equity investment. A second item of note is that from 1983 to 2008, when the actual trust funds ratio peaked, the analysis shows that investing in equities would not have drastically improved the financial situation. The actual trust funds ratio was 358% in 2008, contrasted with a ratio of 371% if investment in equities began in 1984 and a ratio of 383% if investment began in 1997. By 2008, the current investment strategy resulted in a similar trust funds ratio, accomplished with less risk, with no intervention into the capital markets, and at minimal cost. A third observation is that despite several large downturns, most notably the 2008-2009 financial crisis, the trust funds would still stand in a better financial position today had equity investments been incorporated. Lastly, in each of these two alternative cases, the trust funds would have owned less than 10% of the total value of the stock market today. This result owes to the growth in aggregate equity value contrasted with the phased-in purchases of equity. Trust fund ownership at this level would perhaps assuage the concerns of critics wary of government intervention in the equity markets.

Alternative Investments and Projections for Future Performance

Impact of Various Policy Options Without Revenue Increase

OCACT maintains relevant estimates on policy options that would affect the program's long-range solvency. The options for investing in equities presented in Table 1 vary by phase-in date, percentage of reserves that would be invested in equities, and assumed real rate of return. Policy options that incorporate equity investing can be assessed by examining their effects on the long-range actuarial balance . Table 1 shows that under current law, the long-range actuarial balance is -2.84% of taxable payroll, indicating that under intermediate assumptions provided in T he 2018 Annual Report , an approximately 2.84-percentage-point increase in payroll tax rate (from current the 12.40% to 15.24%) or a comparable reduction in benefits would be needed to maintain program solvency throughout the projection period and result in a trust funds ratio of 100% at the end of the projection period.

As shown in Table 1 , none of the options that incorporate investing the trust funds in equities is projected to result in an appreciable change in the long-term solvency of the program. The best-performing option, G1, involves investing 40% of the OASDI Trust Funds into equities, phased in from 2019 to 2033, and it assumes a real rate of return of 6.2%. Although OCACT projects this option to improve the long-range actuarial balance by 0.51 percentage points, the trust funds' cash flow operations are still projected to result in depletion, albeit in 2035, one year later than expected under current law.

As shown in Figure 2 , the combined OASDI Trust Funds value at the end of 2017 represents a peak value. As it becomes necessary to draw upon those assets to pay scheduled benefits, there will be less and less money that can be invested. Therefore, the projected drawdown of the trust funds makes any potential advantage of investing in equities less effective over time. Once the trust funds are depleted, the OASDI program's cost is projected to remain greater than revenues indefinitely. When the trust funds are depleted, any measure involving investment in equities would have no effect on solvency, as there would be no money to invest.

Impact of Various Policy Options with Revenue Increase

The Burtless et al. research that examined how the trust funds would have fared by including alternative investments from 1984 to 2016 also sought to determine how the trust funds would perform moving forward from 2017. Table 1 shows that policy options that do not include any increase to revenue do not result in an appreciable change to the current trajectory of the OASDI Trust Funds' insolvency. As such, the researchers' simulations first require that Congress passes legislation to "restore balance to the system." To restore balance to the system, the authors assume that payroll taxes are raised to eliminate the long-run funding shortfall—at the end of 2016 this was projected to require a 2.58-percentage-point increase in the payroll tax. After the balance is restored, there is no longer any long-term funding shortfall, as the actuarial deficit is brought to zero. If enacted in 2016, an increase in the payroll tax of 2.58 percentage points, on a stand-alone basis, would have resulted in the projected solvency being extended from 2034 to 2091.

With balance now restored to the system, the authors present two scenarios. The first scenario is a continuation of current policy in which the trust funds remain solely invested in special issues. The second scenario presents projections in which the trust funds increase the amount of their reserves invested in equities by 2.67 percentage points per year until no more than 40% of the trust funds' assets are equities. This second scenario is similar to the simulated scenarios of past performance presented in " Alternative Investments and Review of Past Performance ."

Once the OASDI program is brought back into balance (i.e., projected to be solvent throughout the 75-year projection period), Monte Carlo simulations are used to model the two scenarios. The results of continuing to invest only in special issues are presented below in Figure 5 , which shows the range of outcomes for the trust funds ratios for simulated special issue returns grouped into percentiles based on the outcome of the final year in the simulation. For instance, the 95 th percentile shows that the average of the top 5% of simulations resulted in a trust funds ratio of 100% in the final year, 2091. Conversely, the 5 th percentile, those simulations in the bottom 5%, resulted in trust fund depletion in 2083, on average. For reference, the graph also shows the projected trust funds ratio from T he 2018 Annual Report (solid black line), which does not include any increase in payroll tax or investment in equities.

The results of the simulations correspond with the Trustees' 2018 Annual R eport . The simulations at the 50 th percentile, the best guess estimate, project that program solvency would be extended to about 2090, assuming first a reduction in the actuarial deficit. The simulations at the 5 th percentile resulted in maintaining short-range financial adequacy through 2071 and solvency through 2082. In essence, Figure 5 shows the improved adequacy of the trust funds' financial position from a tax increase but with no change to the current investment practices.

In contrast, a second scenario, shown in Figure 6 , simulates how incorporating equity investment following the tax increase, wherein the trust funds hold a mixed portfolio of equity (at most 40%) and special issues (at least 60%), would alter the trust funds' performance.

The results in Figure 6 show the potential benefits from equity investing. In this scenario, the simulations at the 50 th percentile, the best guess estimate, resulted in a mixed portfolio that is valued at 330% of the next year's projected costs (i.e., a trust funds ratio of 330%) at the end of the projection period. Comparing the 50 th percentile outcomes under each scenario shows that incorporating equity investments could improve the trust funds' long-range financial position. The only instance in which the special issue-only practice performs similarly to the mixed portfolio is under the worst possible outcomes, those in the 5 th percentile of each scenario. In these groups, the mixed portfolio fails the short-range adequacy test at an earlier date, 2069 versus 2071 for the special issue-only; however, it remains solvent for two years longer than the special issue-only, 2084 versus 2082. In almost all simulated scenarios, the inclusion of equities into the trust funds' investment practices improved their long-range financial position.

A Railroad Retirement Board Approach for Social Security?

The scenarios presented above appear suggest that after the long-term funding shortfall is eliminated, the inclusion of equity investing into the trust funds could improve the Social Security program's solvency. A change of this nature would represent a large departure from current policy.

Since 2002, the National Railroad Retirement Investment Trust (NRRIT) has incorporated equity purchases in its management of a portion of Railroad Retirement Board (RRB) assets. From FY2003 through FY2017, the NRRIT achieved annual rates of return after fees of 8.3%. From calendar years 2003 through 2017, the OASDI Trust Funds achieved an average effective return of 4.5%. Although this comparison in performance between the NRRIT and OASDI Trust Funds covers the 2008-2009 financial crisis, it is somewhat limited in overall duration. In addition, any comparison between the two programs must take into account the smaller size of the NRRIT.

The board of the NRRIT is composed of seven trustees who have expertise in financial management and pension plans. Three of the members are selected by labor unions and three by railroad management. These six members select the final trustee, and all trustees are limited to three-year terms. The trustees hire independent investment managers to invest the NRRIT assets, with no one manager controlling more than 10% of the assets.

Whereas features such as a nonfederal entity of trustees seem easily replicable, other features of the NRRIT model may prove more difficult to copy. The pursuit of higher returns is accompanied by additional risk (see " Equity Investment and Risk "). To compensate for the additional risk, the NRRIT has developed safeguards to protect against periods of low returns. These safeguards include fund reserves of four to six years' worth of benefits (i.e., trust fund ratio of 400% to 600%) and automatic payroll tax adjustments on employees and employers.

To acquire asset reserves of at least four years of annual program costs, thus maintaining a safeguard similar to the NRRIT's, the OASDI Trust Funds would require substantial revenue-increasing or benefit-reducing measures. For instance, as discussed in the previous section, for the OASDI Trust Funds to be brought into balance before the purchase of equities, an increase of 2.58 percentage points to the payroll tax is required. Even with the additional returns generated by equity investments under the best-case scenario presented in Figure 6 (i.e., simulated equity returns in the 95 th percentile), a trust funds ratio of 400% is not attained until 2035.

Some features of the NRRIT model may prove more difficult for policymakers to accept. For instance, automatic payroll tax adjustments could prove hard to implement. About 93% of the work in the United States is covered by Social Security. Given this high coverage rate, some policymakers may object to automatic adjustments to a payroll tax that affects so many workers. In addition, an automatic increase of the payroll tax to maintain a specific trust funds ratio (e.g., 400%) would most likely occur during a period of low equity returns. Thus, such an increase could occur when workers and businesses were already subject to negative equity returns. However, a more sizeable trust funds ratio, such as 600%, could provide adequate contingency funds such that an automatic increase in the payroll tax would not be prompted. Periods with a high trust funds ratio and positive equity returns could prompt an automatic payroll tax decrease. Lastly, the amount of funds managed by the NRRIT versus those managed by the OASDI Trust Funds are different. At the end of FY2017, the NRRIT managed assets with a market value of $26.5 billion. At the end of CY2017, the OASDI Trust Funds managed assets worth $2,892 billion.

Because the NRRIT is an independent nongovernmental entity, it is not subject to the same oversight as federal agencies. Several times since its inception, the RRB Office of the Inspector General (OIG) has expressed concerns regarding the effectiveness of proper oversight of the NRRIT. Most specifically, the OIG noted that, under current policy, there are fewer safeguards protecting the NRRIT than for retirement investments of federal government and private-sector workers. Given the magnitude of the Social Security program and its importance for retired workers, a similar absence oversight may prove unacceptable to policymakers.

Under current law, and assuming the Board of Trustees' intermediate projections will unfold close to its assumptions, the long-range solvency of the OASDI Trust Funds is at risk. In addition, under current law, the trust funds' financial position would not be improved by the inclusion of alternative investments, namely equity investments. However, should Congress pass legislation to reduce the actuarial deficit, available research suggests that investing the trust funds' newly increased assets in equities could result in a higher trust funds ratio (i.e., greater solvency) than if the trust funds' assets were invested in only government bonds. Phasing in equity investments over a sufficient length of time could minimize adverse effects and result in the trust funds holding a relatively small position in the stock market. Although much smaller in scale, the practices of the RRB provide a framework and history for the use of equity investment in a trust fund (see CRS Report RS22782, Railroad Retirement Board: Trust Fund Investment Practices ). This would, however, require putting aside current investment principles and methods that have guided investment practices. These practices have led the OASDI Trust Funds to be managed at a low cost with minimal risk and resulted in no direct intervention in the private equity markets.