SOSTON
PUBLIC
LIBRARY
CONTENTS
Page
Hearing held in Washington, DC, May 4, 1999: How Uniformity Treats Diver-
sity: Does One Size Fit All? 1
Statement of:
Laurence J. Kotlikoff, Professor of Economics, Boston University,
and Research Associate, the National Bureau of Economic Re-
search 3
Darcy Olsen, Entitlements Analyst, Cato Institute 16
Kilolo Kijakazi, Senior Policy Analyst, Center on Budget and Policy
Priorities 27
Prepared statement of:
Hon. Nick Smith, a Representative in Congress from the State of
Michigan 2
Mr. Kothkoff 4
Ms. Olsen 18
Ms. Kijakazi 29
Hearing held in Washington, DC, May 11, 1999: Using Long-Term Market
Strategies for Social Security 57
Statement of:
Gary Burtless, Senior Fellow, Economic Studies, the Brookings Insti-
tution 58
Roger Ibbotson, Professor of Finance, Yale University School of Man-
agement 67
Prepared statement of:
Hon. Nick Smith, a Representative in Congress from the State of
Michigan 58
Mr. Burtless 60
Mr. Ibbotson ; 70
Hearing held in Washington, DC, May 18, 1999: Cutting Through the Clutter:
What's Important for Social Security Reform? 87
Statement of:
Stephen J. Entin, Executive Director and Chief Economist, Institute
for Research on the Economics of Taxation 88
Robert D. Reischauer, the Brookings Institution 105
Prepared statement of:
Hon. Nick Smith, a Representative in Congress from the State of
Michigan :: 88
Mr. Entin 91
Mr. Reischauer (submission of chapter from book "Countdown to
Reform") 108
Hearing held in Washington, DC, May 25, 1999: International Social Security
Reform 159
Statement of:
Dan Crippen, Director, Congressional Budget Office 160
Estelle James, Lead Economist, Policy Research Department, World
Bank 165
Lawrence Thompson, Senior Fellow, Urban Institute 167
(III)
IV
Page
Hearing held in Washington, DC, May 25, 1999 — Continued
Statement of— Continued
David Harris, Research Associate, Watson Wyatt Worldwide 173
Prepared statement of:
Mr. Crippen 161
Mr. Thompson 170
Mr. Harris 175
Additional information suppUed for the record by:
Mr. Crippen 198
Hearing held in Washington, DC, June 8, 1999: The Social Security Trust
Fund: Myth and Reality 201
Statement of:
J. Kenneth Huff, Sr., Vice President for Finance, Board of Directors,
and Secretary/Treasurer, AARP 203
David Koitz, Congressional Research Service 207
Prepared statement of:
Hon. Nick Smith, a Representative in Congress from the State of
Michigan 202
Mr. Huff 204
Mr. Koitz 209
Additional information supplied for the record by:
Hon. Kenneth F. Bentsen, Jr., a Representative in Congress from
the State of Texas:
Treasury bond specimen 215
Social Security Administration letter 216
Mr. Koitz (text of CRS memorandum, dated November 20, 1998) 223
Hearing held in Washington, DC, Jvme 15, 1999: Secure Investment Strate-
gies for Private Investment Accounts and Annuties 229
Statement of:
Steve Bodurtha, First Vice President, Customized Investments, Mer-
rill Lynch & Co., Inc 230
Mark Warshawsky, Director of Research at the TIAA-CREF Insti-
tute 236
James Glassman, De Witt Wallace-Reader's Digest Fellow in Commu-
nications in a Free Society, American Enterprise Institute for Pub-
lic Policy Research 240
Prepared statement of:
Mr. Bodurtha 232
Mr. Warshawsky 238
Mr. Glassman 241
Additional resource: Internet link to working paper on Social Security
privatization submitted by Budget Committee minority staff 256
Hearing held in Washington, DC, June 22, 1999: The Social Security Disabil-
ity Program 257
Statement of:
Marty Ford, Assistant Director of Governmental Affairs for ARCUS,
on behalf of the Consortium for Citizens With Disabilities 258
Jane Ross, Deputy Commissioner for Policy, Social Security Adminis-
tration 264
Prepared statement of:
Ms. Ford 260
Ms. Ross 266
Additional information supplied for the record by Ms. Ross concerning:
Disability program growth 271
Survivor's benefits 279
Disability determination administrative costs 281
V
Page
Hearing held in Washington, DC, June 22, 1999 — Continued
Additional information supplied for the record by Ms. Ross concerning —
Continued
OASDI Current-Pay Benefits : Disabled Workers (table) 286
Hearing held in Washington, DC, June 29, 1999: Review of Social Security
Reform Plans 289
Statement of:
Hon. Judd Gregg, a United States Senator from the State of New
Hampshire 290
Hon. John B. Breaux, a United States Senator from the State of
Louisiana 300
Hon. Charles E. Grassley, a United States Senator from the State
of Iowa 303
Hon. Bill Archer, a Representative in Congress firom the State of
Texas 313
Hon. E. Clay Shaw, Jr., a Representative in Congress from the State
of Florida 320
Hon. John Kasich, a Representative in Congress from the State of
Ohio 330
Hon. Jim Kolbe, a Representative in Congress from the State of
Arizona 347
Hon. Charles W. Stenholm, a Representative in Congress from the
State of Texas 359
Hon. Nick Smith, a Representative in Congress from the State of
Michigan 363
Hon. Roscoe G. Bartlett, a Representative in Congress from the State
of Maryland 375
Hon. Peter A. DeFazio, a Representative in Congress from the State
of Oregon 381
Prepared statement of:
Chairman Smith (introductory) 290
Senator Gregg 293
Senator Grassley 305
Congressmen Archer and Shaw 314
Congressmen Kolbe and Stenholm 349
Chairman Smith 365
Congressman Bartlett 377
Congressman DeFazio 382
Hon. Jerrold Nadler, a Representative in Congress from the State
of New York 389
Additional information supplied for the record by Mr. Kasich concerning:
Wall Street Journal article on saving Social Security 329
Graphic presentation on saving Social Security 332
Social Security Solvency Act of 1999 (S.21), introduced by Senators Moy-
nihan and Kerrey 391
Svmimary of Social Security Preservation Act authored by Hon. Phil
Gramm, a United States Senator from the State of Texas 392
Hearing held in Washington, DC, July 13, 1999: The Cost of Transitioning
to Solvency 397
Statement of:
Rudolph Penner, Arjay and Frances Miller Chair in Pubhc Policy,
the Urban Institute 398
David C. John, Senior Policy Analyst for Social Security, Heritage
Foundation 404
Prepared statement of:
Hon. Nick Smith, a Representative in Congress from the State of
Michigan 398
Mr. Penner 400
David C. John, Senior PoUcy Analyst for Social Security and William
W. Beach, Director, Center for Data Analysis, the Heritage Foun-
dation 406
VI
Page
Hearing held in Washington, DC, July 13, 1999— Continued
Prepared statement of— Continued
Hon. Kenneth F. Bentsen, Jr., a Representative in Congress from
the State of Texas 430
Hon. Eva M. Clayton, a Representative in Congress from the State
of North Carolina 432
Hon. Rush D. Holt, a Representative in Congress from the State
of New Jersey 432
Hon. Paul Ryan, a Representative in Congress from the State of
Wisconsin 434
Chairman Smith's Task Force findings 430
Additional resource: Internet link to working paper on Social Security
privatization submitted by Budget Committee minority staff 435
Additional resources submitted by Chairman Smith:
Prepared statement of William G. Shipman, Principal, State Street
Global Advisors 435
Presentation on individual accounts by Employee Benefit Research
Institute 440
How Uniformity Treats Diversity: Does One Size
Fit All?
TUESDAY, MAY 4, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12 noon in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Members present: Representatives Smith, Herger, Collins, Ryan
of Wisconsin, Toomey, Rivers, Bentsen, Clayton, and Holt. Also
present: Representative Gutknecht.
Chairman Smith. If the witnesses would like to come to the wit-
ness table, we will kick off our meeting.
The Budget Committee Task Force on Social Security will come
to order.
Our witnesses today are Lawrence Kotlikoff, Professor of Eco-
nomics at Boston University, Research Associate of the National
Bureau of Economic Research, Fellow of the Econometric Society,
and a member of the Executive Committee of the American Eco-
nomic Association. He served on the President's Council of Eco-
nomic Advisors, and as a consultant to the International Monetary
Fund, the World Bank, and the Organization for Economic Co-
operation and Development. His book — a little color here, a great
red book — his book. Generational Accounting, describes Dr.
Kotlikoff s research on how Social Security will affect current and
future generations.
So thank you very much. Dr. Kotlikoff, for being here.
Darcy Olsen is an Entitlements Policy Analyst with the Cato In-
stitute working on Social Security, child care, education, health
care and welfare. In particular, she studies the ways of entitle-
ments and how they affect women, children and the poor. She is
the author of Greater Financial Security for Women with Personal
Retirement Accounts, a Cato Institute briefing paper.
Before assuming her present position at Cato, Ms. Olsen worked
as a transitional house manager and drug counselor for the D.C.
Coalition for the Homeless, and was managing editor of the Regu-
lation Magazine.
She is a frequent guest on television and radio programs nation-
wide and has appeared on the Today Show, NBC Nightly News,
and CNN. Her articles and editorials have been published in a va-
riety of newspapers, magazines and journals. Ms. Olsen holds a
bachelor's degree from the School of Foreign Service at Georgetown
(1)
University, and a master's degree in International Education from
New York University.
Thank you for being here.
And Kilolo Kijakazi has been a Senior Pohcy Analyst for the
Center on Budget and Policy Priorities since 1997. Prior to that,
she worked for the United States USDA and Urban Institute, and
Dr. Kijakazi has a Ph.D. in Public Policy from George Washington
University and a master's degree in Social Work from Howard Uni-
versity. Her dissertation, African-American Economic Development
and Small Business Ownership, was published in 1997.
So, Dr. Kijakazi, thank you very much for being here.
This meeting today is going to look at some of the transitional
costs and, in addition, how it affects different groups of our society,
including women, including young people, including the individuals
that are not yet in the work force and those that are coming into
the work force, as well as married women and the benefits they
might expect.
Today's Social Security system has "winners" and "losers." All
workers pay the same rate of payroll tax and all retirees receive
a benefit based on the same payroll calculation of the payroll bene-
fits that they have paid in, but some workers certainly get a better
deal than other workers, and some nonworkers, if they have
spouses, get a better deal than some other workers.
Some young workers worry that they may be on the losing end
of Social Security benefits, if benefits are cut for future retirees.
Understanding how Social Security treats people differently I think
will help this Task Force move ahead with solutions that are going
to be equitable and fair.
[The prepared statement of Chairman Smith follows:]
Prepared Statement of Hon. Nick Smith, a Representative in Congress From
THE State of Michigan
Today's Social Security system has winners and losers. All workers pay the same
payroll tax and all retirees receive a benefit based on the same payroll calculation —
but some workers get a better deal than others.
As a group, married women get higher benefits compared to the pa3rroll contribu-
tions they make because they are eligible for a spousal benefit based on their hus-
bands' wages. In addition, women live longer than men, and the Social Security re-
tirement benefit elderly widows receive is the only income that many of them have.
Although women pay 38 percent of all Social Security payroll taxes, they receive 53
percent of the Social Security benefits. Our reforms should recognize the special sta-
tus that Social Security has given women in the past.
Some young workers worry that they may be on the losing end of Social Security
if benefits are cut for future retirees. The Social Security actuaries tell us that the
system's cash outflow will exceed receipts in just 15 years. Generation X is asking
us to make reforms that increase the rate of return they receive on the tax pay-
ments they make to support the system.
Understanding how Social Security treats people differently will help us design
a future program to give the best deal to everybody.
Chairman Smith. We would ask each of the witnesses to make
a 5-minute presentation, and your printed testimony will be in-
cluded in the record. We will make sure that there is ample time
for anything that didn't come out in the 5 minutes through the
questions. What we do here in Washington sometimes is, we react
to questions based on the message we want to convey.
So Dr. Kotlikoff.
STATEMENT OF LAURENCE J. KOTLIKOFF, PROFESSOR OF EC-
ONOMICS, BOSTON UNIVERSITY, AND RESEARCH ASSOCI-
ATE, THE NATIONAL BUREAU OF ECONOMIC RESEARCH
Mr. KOTLIKOFF. Chairman Smith and other distinguished mem-
bers of the House Budget Committee's Task Force on Social Secu-
rity, I am honored by this opportunity to discuss with you Social
Security's treatment of postwar Americans and the system's con-
tribution to the overall imbalance across generations in U.S. fiscal
policy.
I have in my testimony two sets of findings. One is from a study
that I did with a number of coauthors on Social Security's treat-
ment of different groups in society born since 1945. The study com-
pares women and men, whites and nonwhites, college-educated and
noncollege-educated. It also looks, for each of these groups, within
lifetime earnings categories. The study was based on a micro sim-
ulation analysis in which we start with a representative sample of
the population and use statistical and econometric functions to
grow the sample demographically and economically through time —
to marry them, divorce them, put them in the work force, unemploy
them, have them have children, kill them, etc. One needs to do this
kind of analysis in order to really assess Social Security, because
Social Security is, in large part, an insurance system where how
well you fare depends on your particular outcome.
In the study we pool together the experiences of large groups
who fall within these categories and average their outcomes to-
gether to get an actuarial assessment of how they are being treat-
ed. The bottom line is this: Social Security (the OASI system) does
not represent a very good deal for postwar Americans. On average,
they are losing 5 cents out of every dollar they earn to the OASI
program.
For the middle class. Social Security's lifetime net tax is 7 cents
per dollar earned. Measured in absolute dollars, the rich are the
biggest losers. On average, the lifetime poor are being treated bet-
ter than the middle class, women are being treated better than
men, whites are being treated better than nonwhites, and the col-
lege-educated are being treated better than the noncollege-edu-
cated. These differences are not gigantic, but nor are they trivial.
Another way to assess Social Security's treatment of postwar
Americans is in terms of the rate of return it pays on its contribu-
tions. The rate of return that postwar generations can expect is
roughly 1.9 percent on their contributions. We are thus considering
a system which is yielding a real rate of return that is less than
half of the rate of return you could receive today, if you bought in-
flation-indexed U.S. Government bonds. Those groups that do bet-
ter than others with respect to facing lower lifetime net tax rates
also earn somewhat higher rates of return than others. There are
tables in the testimony that document these results.
The problem, however, with Social Security is not just that it has
been providing postwar Americans with an overall bad deal, de-
spite some of the good things that it does in terms of forcing people
to save and reducing their risks of certain kinds of outcomes. The
problem is that Social Security's generally bad actuarial deal is
likely to get lots worse because this is a system which, as you well
know, is not going to be able to pay for itself through time.
According to the actuaries at Social Security, to pay for Social Se-
curity on an ongoing basis, not just for 75 years, but on an ongoing
basis, we need an immediate and permanent 4 percentage point
hike in the current 12.4 percentage point OASDI tax rate. This
huge requisite tax hike is estimated based on the actuaries' inter-
mediate assumptions. I believe that the intermediate assumptions
are overly optimistic. A number of academic demographers and
economists feel that way as well, especially on the issue of life
span.
So we are talking about a system which is, in present-value
terms, broke and needs a major fix. But the testimony points out,
and I will just close here, that Social Security is part of a larger
set of generational imbalances that are measured through this new
system of analysis which is called Generational Accounting. Table
6 shows the alternative policy adjustments needed in order to
achieve generational balance, a situation in which future genera-
tions pay the same share as current generations of their lifetime
labor income in taxes net of transfer pa3rments received.
If we were to raise income tax rates to make sure that our chil-
dren pay the same tax rates on net as we do, we'd need an imme-
diate and permanent 24 percent increase in income tax rates. This
finding comes from a study that was done last spring by the CBO
and the Federal Reserve. Although the country's current fiscal situ-
ation seems better now than it was last spring, my sense is that
the generational imbalance in the U.S. is still quite significant and
needs attention immediately to resolve.
[The prepared statement of Mr. Kotlikoff follows:]
Prepared Statement of Laurence J. Kotlikoff, Professor of Economics, Bos-
ton University; Research Associate, the National Bureau of Economic Re-
search
Chairman Smith and other distinguished members of the House Budget Commit-
tee's Task Force on Social Security,
I'm honored by this opportunity to discuss with you Social Security's treatment
of postwar Americans and its contribution the imbalance in generational policy.
Social Security's Treatment of Postwar Americans
I've recently coauthored an extensive analysis of this treatment using a micro
simulation model that takes into account the entire panoply of OASI benefits. ^ The
study finds that Americans bom in the postwar period will, under current law, lose
roughly 5 cents of every dollar they earn to the OASI program in taxes net of bene-
fits. Measured as a proportion of their lifetime labor incomes, the middle class are
the biggest losers, surrendering about 7 cents per dollar earned. But measured in
absolute dollars, the rich lose the most.
Out of every dollar that postwar Americans contribute to the OASI system, 67
cents represent a pure tax. The system treats women better than men, whites better
than non-whites, and the college-educated better than the non-college educated.
While the system has been partially effective in pooling risk across households,
it offers postwar cohorts internal rates of return on their contributions that are
quite low — 1.86 percent. This is half the real rate currently being paid on inflation-
indexed long-term U.S. Government bonds.
This assessment of the system's treatment of postwar Americans, which is de-
tailed in Tables 1 through 3, assumes current law will prevail in future years. But,
as you well know. Social Security faces a major long-term funding crisis. An in-
crease of two-fifths in the system's tax rate is needed to meet benefit pajrments on
an ongoing basis. The magnitude of this tax adjustment is more than twice as large
iSee Caldwell, Steven B., Melissa Favreault, Alia Gantman, Jagadeesh Gokhale, Thomas
Johnson, and Laurence J. Kotlikoff, "Social Security's Treatment of Postwar Americans," forth-
coming, Tax Policy and the Economy, NBER volume, Cambridge, Ma.: MIT Press, 1999.
as the requisite tax hike acknowledged in the Social Security Trustees Report under
the "intermediate" assumptions!
The reason for the discrepancy is that the Trustees Report looks only 75 years
into the future. Although 75 years may appear to be a safe enough projection hori-
zon, Social Security is slated to run major deficits in all years beyond this horizon.
The Trustees Report's use of the 75-year truncated projection period explains, in
part, why Social Security's finances are again deeply troubled after having been
"fixed" by the Greenspan Commission in 1983. Each year that passes brings another
major deficit year within the 75-year projection window, and 15 years have now
passed since the Commission met.
As painful as a 40 percent tax hike would be, even it could fall short of what is
really needed to sustain Social Security without cutting benefits. The demographic
and economic assumptions comprising the "intermediate" projections appear to be
overly optimistic on at least two counts. First, they assume a slower growth in life
span than the U.S. has experienced in recent decades. Second, they assume higher
future real wage growth than past experience might suggest.
As Tables 4 and 5 confirm, tax increases of two-fifths or greater or comparable
benefit cuts would significantly worsen Social Security's treatment of postwar Amer-
icans. As a group, Americans bom this year would receive only a 1 percent real re-
turn on their OASI contributions.
Generational Accounting^
Unfortunately, Social Security's unfunded liabilities are only a portion of the
broader set of implicit and explicit fiscal liabilities facing future generations. The
best way I know to understand the overall fiscal burden facing our children is
through generational accounting. ^
Generational accounting is a relatively new method of long-term fiscal planning
and analysis. It addresses the following closely related questions. First, how large
a fiscal burden does current pohcy imply for future generations? Second, is fiscal
policy sustainable without major additional sacrifices on the part of current or fu-
ture generations or major cutbacks in government purchases? Third, what alter-
native policies would suffice to produce generational balance — a situation in which
future generations face the same fiscal burden as do current generations when ad-
justed for growth (when measured as a proportion of their lifetime earnings)?
Fourth, how would different methods of achieving such balance affect the remaining
lifetime fiscal burdens — the generational accounts — of those now alive?
Developed less than a decade ago, generational accounting has spread around the
globe, from New Zealand to Norway. Much of this accoimting is being done at the
governmental or multilateral institutional level. The U.S. Federal Reserve, the U.S.
Congressional Budget Office, the U.S. Office of Management and Budget, the Bank
of Japan, the Bank of England, H.M. Treasury, the Bundesbank, the Norwegian
Ministry of Finance, the Bank of Italy, the New Zealand Treasury, the European
Commission-*, the International Monetary Fund, and the World Bank have been or
are currently involved, either directly or indirectly, in generational accounting.
Generational accounting has also drawn considerable interest fi-om academic and
government economists.
What is Generational Accounting?
Generational accounts are defined as the present value of net taxes (taxes paid
minus transfer payments received) that individuals of different age cohorts are ex-
pected, imder current policy, to pay over their remaining lifetimes. Adding up the
generational accounts of all currently living generations gives the collective con-
tribution of those now alive toward paying the government's bills. The government's
bills refers to the present value of its current and future purchases of goods and
services plus its net debt (its financial liabilities minus its financial and real assets,
including the value its public-sector enterprises). Those bills left unpaid by current
2 This section draws on "Generational Accounting Around the World," a coauthored paper with
Bemdt Raffelheuschen forthcoming in the May 1999 American Economic Review.
3 See Auerbach, Alan J., Laurence J. Kotlikoff, and Willi Leibfritz, eds., Generational Account-
ing Around the World, Chicago, Illinois: The Chicago University Press, forthcoming 1999.
Auerbach, Alan J., Jagadeesh Gokhale, and Laurence J. Kotlikoff, "Generational Accounts: A
Meaningful Alternative to Deficit Accounting," in D. Bradford, ed., Tax Policy and the Economy
5, Cambridge, MA: MIT Press, 1991, 55-110.
4 The European Commission has an ongoing project to do generational accounting for EU
member nations under the direction of Bemd Raffelhueschen, Professor of Economics at Frei-
burg University.
generations must be paid by future generations. This is the hard message of the
government's intertemporal budget constraint — the basic building block of modem
djmamic analyses of fiscal policy.
This budget constraint can be expressed in a simple equation: A+B=C+D, where
D is the government's net debt, C is the sum of future government purchases, val-
ued to the present, B is the sum of the generational accounts of those now aUve,
and A is the sum of the generational accounts of future generations, valued to the
present. Given the size of the government's bills, C+D, the choice of who will pay
is a zero-sum game; the smaller is B, the net pasrments of those now alive, the larg-
er is A, the net pajrments of those yet to be bom.
The comparision of the generational accounts of current newborns and the
growth-adjusted accounts of future newborns provides a precise measure of
generational imbalance. The accoiints of these two sets of parties are directly com-
parable because they involve net taxes over entire lifetimes. If future generations
face, on a growth-adjusted basis, higher generational accounts than do current
newborns, current policy is not only generationally imbalanced, it's also
unsustainable. The government cannot continue, over time, to collect the same net
taxes (measured as a share of lifetime income) from future generations as it would
collect, under current policy, from current newborns without violating the intertem-
poral budget constraint. The same is true if future generations face a smaller
growth-adjusted Ufetime net tax burden than do current newborns. However, in this
case, generational balance and fiscal sustainability can be achieved by reducing the
fiscal burden facing current generations rather than the other way around.
The calculation of generational imbalance is an informative counterfactual, not a
likely policy scenario, because it imposes all requisite fiscal adjustments on those
bom in the future. But it delivers a clear message about the need for policy adjust-
ments. Once such a need is established, interest naturally turns to alternative
means of achieving generational balance that do not involve foisting all the adjust-
ment on future generations.
Generational Accounting versus Deficit Accounting
A critical feature of generational accounting is that the size of the fiscal burden
confronting future generations (the term A in A+B=C+D) is invariant to the govern-
ment's fiscal labeling — how it describes its receipts and payments. The same, unfor-
tunately, is not true of the government's official debt. From the perspective of neo-
classical economic theory, neither the government's official debt nor its change over
time — the deficit — is a well-defined economic concept. Rather these are accounting
constructs whose values are entirely dependent on the choice of fiscal vocabulary
and bear no intrinsic relationship to any aspect of fiscal policy, including
generational policy. In terms of our equation A+B=C+D, different choices of fiscal
labels alter B and D by equal absolute amounts, leaving C and A unchanged.
To see the vacuity of fiscal labels, consider just three out of the infinite set of al-
ternative ways a government could label its taking $100 more measured in present
value in net taxes from a citizen named Nigel. In each case, r is the interest rate,
Nigel's remaining lifetime net-tax pajTnents increase by $100, and there is an addi-
tional net flow of $100 to the government from Nigel this year and no additional
net flows from Nigel to the government next year.
1. "A $100 tax levied this year on Nigel."
2. "An $800 loan made this year by Nigel to the government less a $700 transfer
payment to Nigel, plus a tax levied next year on Nigel of $800 (1+r), plus a repay-
ment next year to Nigel of $800 (1+r) in principle plus interest."
3. "A $5,000,000,000 tax paid this year by Nigel, less a $4,000,000,900 loan to
Nigel this year by the govemment, plus a $4,000,000,900 (1+r) transfer payment
next year to Nigel, plus a repayment next year by Nigel of principle and interest
of $4,000,000,900 (1+r)".
Compared to case I's language, using the language in the other cases will gen-
erate the following: case 2: a $800 larger deficit, and case 3: a $4,000,000,900 small-
er deficit. Although the government's reported deficit is dramatically different de-
pending on how it labels the additional $100 pounds it gets this year from Nigel,
Nigel's economic circumstances are imchanged. Regardless of which language the
govemment uses, it's still getting $100 more in present value from Nigel in net
taxes, and Nigel's own economic resources are, in each case, depressed by $100.
Since Nigel's annual cash flows are the same, alternative choices of language have
no impact on the degree to which he is hquidity constrained in choosing how much
to consume and save.^
Unfortunately, the abiHty to avoid hard pohcy decisions by manipulating the re-
ported deficit has not escaped politicians around the world. In the United States in
the 1980's this practice was christened "smoke and mirrors." It was exemplified by
the government's decision to first put the Social Security system off budget, when
it was running deficits, and then to put in on budget, when it was running sur-
pluses. In France and Belgium substituting words for deeds was used in selling the
assets of state-owned companies to get enough revenue to fall below Mastrict's defi-
cit Umit while maintaining these companies' major liabilities — their unfunded pen-
sion plans. In Germany, the Bundesbank had to prevent the Federal Government
from revaluing its gold stock to meet Mastrict's deficit limit. These and countless
other examples are symptomatic of a much deeper problem, namely, there are no
economic fundamentals underlying the deficit and its use is an utter charade. This
point is of central importance to you Members of Congress as you consider whether
to spend the so-called "surpluses" currently being projected.
Generational Imbalances Around the Globe
Table 6 indicates the size of the generational imbalance in U.S. fiscal policy and
compares it with that in 21 other countries. It does so by showing four mutually
exclusive ways the 22 covmtries could achieve generational balance. The alternatives
are cutting government purchases, cutting government transfer pa5Tnents, increas-
ing all taxes, and increasing income taxes (corporate as well as personal). Each of
these policies is described in terms of the immediate and permanent percentage ad-
justment needed. The magnitudes of these alternative adjustments provide an indi-
rect measure of countries' generational imbalances.
The four different policies are considered under two definitions of government
purchases and transfer pa3rments. Definition A treats education as a government
purchase and not as a transfer payment. Definition B does the opposite. Because
of space limitations, I focus on definition B.
According to the second column in the table, 13 of the 22 countries need to cut
their non-educational government spending by over one fifth if they want to rely
solely on such cuts to achieve generational balance. This group includes the United
States and Japan and the three most important members of the European Monetary
Union: Germany, France, and Italy. Four of the 13 coimtries — Austria, Finland,
Spain, and Sweden — need to cut their non-education purchases by more than half,
and two countries— Austria and Finland— need to cut this spending by more than
two thirds!
Bear in mind that generational accounting is comprehensive with respect to in-
cluding regional, state, local, and Federal levels of government. So the cuts being
considered here are equal proportionate cuts in government spending at all levels.
In the U.S., where a large proportion of government spending is done at the state
and local level, achieving generational balance by just cutting Federal spending
would require that spending to be roughly halved. Given U.S. fiscal nomenclature,
this means "running" Federal surpluses that are more than $300 bilUon larger than
is currently the case.^
Not aU countries suffer from generational imbalances. In Ireland, New Zealand,
and Thailand future generations face a smaller fiscal burden, measured on a growth
adjusted basis, than do current ones given the government's current spending pro-
jections. Hence, governments in those countries can spend more over time without
unduly burdening generations yet to come. There are also several countries in the
list, including Canada and the United Kihgdom, with zero or moderate generational
imbalances as measured by the spending adjustment needed to achieve perfect bal-
ance. What explains these tremendous cross-country differences? Fiscal policies and
^ Moreover, the same set of economic incentives Nigel faces for saving or working are provided
in all four cases. For example, suppose the government imposes an additional marginal tax rate
of t on Nigel's current labor income in order to generate the additional $100 pounds in revenue
measured in present value. In case 1, this would be described as "a tax at rate t on this year's
labor earnings." In case 2, it would be described as "a marginal subsidy at rate 7t to this year's
labor supply plus a marginal tax on this year's labor supply at rate 8t(l+r) where the payment
is due next year." In case 4, it would be described as "a marginal tax of 50t plus a marginal
subsidy at rate 49t to be paid next year." In each case, the net marginal income from Nigel's
earning an additional pound this year is reduced by t times one pound.
® These figures, by the way, come from Gokhale, Page, and Sturrock (1999) — a joint study of
the Federal Reserve Bank of Cleveland and The Congressional Budget Office (CBO). They incor-
porate the latest CBO projections of Federal Government spending and receipts and, therefore,
of Federal surpluses.
demographics differ dramatically across countries. The U.S., for example, suffers
from rampant Federal health care spending. Japan's health care spending is grow-
ing less rapidly, but it's aging much more quickly. The United Kingdom has a policy
of keeping most transfer payments fixed over time in real terms. Germany is deal-
ing with the ongoing costs of reunification.
One alternative to cutting spending is cutting transfer payments. In Japan, edu-
cation, health care, Social Security benefits, unemployment benefits, disability bene-
fits, and all other transfer payments would need to be immediately and permanently
slashed by 25 percent. In the U.S., the figure is 20 percent. In Brazil, it's 18 percent.
In Germany, it's 14 percent. In Italy it's 13 percent.
These and similar figures for other covmtries represent dramatic cuts and would
be very unpopular. So too would tax increases. If Japan were to rely exclusively on
cross-the-board tax hikes, tax rates at all levels of government (regional, state, local,
and federal) and of aU types (value added, payroll, corporate income, personal in-
come, excise, sales, property, estate, and gift) would have to rise overnight by over
15 percent. In Austria and Finland, they'd have to rise by over 18 percent. If these
three countries relied solely on income tax hikes, they had to raise their income tax
rates by over 50 percent! In France and Argentina, where income tax bases are rel-
atively small, income tax rates would have to rise by much larger percentages. The
requisite income tax hikes in the U.S. and (Germany are roughly one quarter. In
contrast, Ireland could cut its income tax rates by about 5 percent before it needed
to worry about over burdening future generations.
The longer countries wait to act, the bigger the adjustment needs to be when ac-
tion is finally taken. Take the UK. It needs an immediate permanent 9.5 percent
income-tax hike, if it wants to achieve generational balance through that channel.
But if it waits 5 years, the requisite income tax hike is 11.1 percent. It's 15.2 per-
cent with a 15-year delay, and 21.0 percent with a 25-year delay.
Conclusion
Generational Accounting is being done in a large and growing nimiber of countries
around the world. Notwithstanding its shortcomings, generational accounting has
four major advantages over deficit accounting: It's forward looking. It's comprehen-
sive. It poses and answers economic questions. And, its answers are invariant to the
economically arbitrary choice of fiscal vocabulary.
The findings reported here are shocking. Aii array of countries, including the
United States, Germany, and Japan, have severe generational imbalances.'^ This is
true notwithstanding the fact that the United States is currently reporting an offi-
cial surplus, that Germany's reported deficit is within Mastrict limits, and that
Japan has the lowest reported ratio of net debt to GDP of any of the leading indus-
trialized countries. The imbalances in these and the majority of the other countries
considered in Table 6 place future generations at grave risk.
In the case of the U.S., Social Security's long-term financial imbalance appears
to be responsible for between a third and two-fifths of the country's overall imbal-
ance in generational policy. Hence, fixing Social Security's long-term financial prob-
lems once and for all should be of the highest priority.
TABLE 1.— AVERAGE LIFETIME OASI NET TAX RATES
[Lifetime Labor Earnings in 1997 Dollars]
n_,,n^ 120k- 240k- 360k- 480k- 600k- 720k- 840k- 960k- , „„^^ r„,.,
""''^"'* 240k 360k 480k 600k 720k 840k 960k 1.08m ' "'"""^ '""'
Cohort 45 0.4 5,5 6.7 6.8 7.1 7.1 6.8 5.9 6.0 3.7 5.5
Cohort 50 -2.3 4.1 5.5 6.0 6.4 6.7 6.6 6.3 6.2 3.6 4.9
Cohort 55 -0.9 4.6 6.0 6.4 6.6 7.2 7.4 7.3 6.7 3.9 5.2
Cohort 60 -0.1 5.1 6.4 7.0 7.1 7.3 7.6 7.4 7.5 3.9 5.2
Cohort 65 0.1 5.1 6.3 7.2 7.0 7.1 7.6 7.5 7.3 4.4 5.5
Cohort 70 0.1 4.8 6.2 6.7 7.2 7.2 7.7 7.8 7.5 4.3 5.4
Cohort 75 -0.3 4.6 6.1 6.7 6.9 7.0 7.2 7.4 7.8 4.5 5.4
Cohort 80 -1.0 4.5 5.8 6.6 6.8 7.2 7.0 7.6 7.5 4.6 5.4
■^ The Congressional Budget Office and the Federal Reserve Bank of Cleveland are in the proc-
ess of revising the U.S. generational accounts in light of recent favorable economic news. The
new results are likely to indicate a smaller generation imbalance. However, CBO's most recent
baseline budget forecast is based on a very strong and highly questionable assumption, namely
that Federal Government discretionary spending will remain constant in real terms over the
next 10 years. Assuming a more plausible time-path of government spending could well leave
the generational imbalance near the level reported in Table 6.
TABLE 1.— AVERAGE LIFETIME OASI NET TAX RATES— Continued
[Lifetime Labor Earnings in 1997 Dollars]
mk- 240k-
240k 360k
360k- 480k-
4gOk 600k
600k- 720k-
720k 840k
840k-
960k
960k-
1.08m
Cohort 85
Cohort 90
Cohort 95
Men 45
Men 50
Men 55
Men 60
Men 65
Men 70
Men 75
Men 80
Men 85
Men 90
Men 95
Women 45
Women 50
Women 55
Women 60
Women 65
Women 70
Women 75
Women 80
Women 85
Women 90
Women 95
White 45
White 50
White 55
White 60
White 65
White 70
White 75
White 80
White 85
White 90
White 95
Nonwhite 45 ...
Nonwhite 50 ...
Nonwhite 55 ...
Nonwhite 60 ...
Nonwhite 65 ...
Nonwhite 70 ...
Nonwhite 75 ...
Nonwhite 80 ...
Nonwhite 85 ...
Nonwhite 90 ...
Nonwhite 95 ...
Noncollege 45
Noncollege 50
Noncollege 55
Noncollege 60
Noncollege 65
Noncollege 70
Noncollege 75
Noncollege 80
Noncollege 85
Noncollege 90
Noncollege 95
College 45
College 50
College 55
College 60
1.2
4.1
5.7
6.3
6.7
6.8
7,0
7.4
7.6
4.4
5,1
1.2
4.0
5.5
6.3
6.7
6.8
7,0
6.9
7.6
4.7
5,3
1.8
3.8
5.3
6.1
6.4
6.4
6.7
7,3
7.3
4.9
5,3
4.7
6.3
7.2
7.3
7.5
7.3
6.9
6,1
6.6
3.9
5,9
3.6
5.4
6.3
6.5
6.7
6.8
7.0
6,5
6.2
3.7
5,5
4.0
5.9
6.5
6.9
6.9
7.5
7.7
7,9
7.0
4.0
5.6
4.2
6.2
7.2
7.3
7.6
7,6
8,2
7,7
7.7
3.9
5.6
4.4
6.1
6.9
7.5
7.4
7,3
7,7
7,5
7.4
4.6
5.9
4.4
6.0
6.9
7,0
7,5
7,3
8,0
8.0
7.9
4.6
5.9
4.0
5.8
6.7
7,1
7,2
7,5
7,6
8.0
8.1
4.6
5.9
4.3
5.3
6.5
7.1
7,1
7,4
7,2
7.8
7.6
5.0
5.8
3.4
5.1
6.4
6,8
6,9
6,9
7,4
7.8
8.1
4.4
5.4
2.8
4.9
6.1
6,8
6,8
7,1
7,0
7.2
7.9
4.9
5.7
1.9
4.6
5.8
6.2
6,8
6,4
6,9
7.5
7.3
5.0
5.6
0.6
4.9
6.0
5,9
6,1
6,1
6,5
5.2
41
2.7
4.4
4.3
3.3
4.7
5,3
5,7
6,4
5,6
5.7
6.0
3.3
3.8
3.0
3.6
5.3
5,6
6,1
6,4
6,7
6.4
5.8
3.7
4.3
2.0
4.2
5.7
6,5
6,5
6,9
6,6
7.0
6.9
3.8
4.7
1.8
4.3
5.5
6,7
6,5
6,7
7,3
7.4
7.0
3.9
4.9
2.0
3.9
5.6
6,3
6,6
6,9
7,3
7.3
6.5
3.7
4.6
2.3
3.7
5.5
6,1
6,5
6,1
6,5
6.7
7.2
4.2
4.7
3.3
3.8
5.1
5,9
6,3
6,8
6,8
7.2
7.3
3.9
4.5
3.1
3.4
5.1
5.8
6,3
6,7
6.3
6.7
6.3
4.2
4.6
2.9
3.5
4.9
5,8
6,5
6,6
7.0
6.3
6.9
4.5
4.7
3.3
3.2
4.8
6,0
5,9
6,4
6.5
6.8
7.4
4,7
4.8
0.3
5.5
6.6
6,9
7,1
7,1
6.9
5,8
5.9
3,7
5.4
2.6
4.0
5.5
6.0
6,3
6,7
6.6
6,3
6.2
3,6
4.8
1.1
4.5
5.9
6,4
6.5
7,2
7,4
7,3
6.6
3,9
5.1
0.3
5.0
6.3
7,0
7.1
7,3
7,7
7,4
7.6
3,9
5.2
0.2
5.0
6.3
7,1
7.0
7,0
7,5
7,5
7.5
4,3
5.5
0.2
4.6
6.1
6,7
7.2
7,1
7,7
7,9
7.5
4,4
5.4
0.3
4.5
6.0
6,7
6.8
6,9
7,1
7,4
7.8
4,4
5.3
1.4
4.3
5.8
6,6
6.8
7,1
7,0
7,7
7.5
4,5
5.2
1.5
3.9
5.5
6.2
6.7
6,9
6.9
7,4
7.4
4,3
5.0
2.0
3.8
5.3
6.3
6.8
6,8
7.0
7,1
7.6
4,7
5.3
2.2
3.4
5.1
6.0
6.3
6,3
6.6
7,2
7.3
4,8
5.2
1.3
5.3
7.0
6.4
7.4
6,4
6.2
6,6
7.0
3,8
5.8
0.3
4.8
5.9
6.0
6.9
7,0
6.4
6,5
6.3
4,1
5.4
0.2
5.3
6.5
6.2
7.1
7,2
7.7
7,6
7.9
4,3
5.6
1.3
5,8
7.0
7.0
7.4
7,5
6.5
8,1
6.9
3,5
5.1
1.9
5.7
6.1
7.2
7.4
7,3
8.1
7,4
5.3
4,8
5.8
1.7
5.4
6.6
6.7
7.1
7,4
7.8
7,4
7.4
4.0
5.4
•0.7
5.1
6.5
6.9
7.3
7,2
7.8
7,7
8.0
4.9
5.9
0.7
5.1
5.9
6.7
6.7
7,4
7.3
7,3
7.9
5.5
6.0
0.1
5.1
6.3
6,8
6.5
6,6
7,3
7,1
8.3
4.7
5.5
1.3
5.1
6.0
6,4
6.2
6,9
7,3
6,1
7.6
4.7
5.5
0.5
5.0
6.0
6,5-.
6.9
6,9
7,0
7,6
7.6
5.5
5.9
0.6
5.7
6.9
7,0
7.2
6,8
6,8
5,7
6.4
3.8
5.7
2.0
4.4
5.7
6,2
6.5
6,8
6,5
6,5
6.1
4.0
5.1
■0.4
4.7
6,0
6,4
6.5
7,4
7.6
7.3
7.0
4.2
5.4
0.3
5.3
6,6
6,8
7.2
7,5
7.6
7.8
7.9
4.2
5,6
0.5
5.2
6,4
7.3
7.0
7,2
7.7
7.8
7.6
4.7
5,8
0.3
5.0
6.5
6.9
7.2
7,2
7.5
8.0
7.4
4.7
5.7
0.3
4.8
6.2
6.5
7,0
7.3
7.2
7.7
8.0
4.8
5.7
■0.4
4.8
6.0
6.4
7,0
7.0
6.9
7,6
7.9
5.0
5.6
■0.9
4.5
5.9
6,3
6,8
6.9
7,0
7.5
7.4
4.6
5.3
■0.5
4.2
5.5
6.4
6,9
6,9
7.1
6.9
7.8
5.2
5.6
■0.9
3.9
5.4
6.2
6,7
6,8
7,1
7.6
7.3
5.6
5.7
-0.2
4.7
6.1
6.5
7.1
7.4
6,9
6.1
5.5
3.6
5.1
•3.0
3.5
5.2
5.6
6.3
6.6
6.7
6.2
6.3
3.3
4.6
■2.2
4.2
5.9
6.4
6,7
6,8
7.1
7.3
6.2
3.6
4.8
•1.0
4.8
6.1
7.2
7.1
7,1
7.6
7.0
7.1
3.6
4.8
10
TABLE 1.— AVERAGE LIFETIME OASI NET TAX RATES— Continued
[Lifetime Labor Earnings in 1997 Dollars]
120k- 240k-
240k 360k
360k- 480k- 600k-
480k 600k 720k
840k- 960k-
960k 1.08m
College 65
College 70
College 75
College 80
College 85
College 90
College 95
0.6
5.0
6.1
6.9
7.0
6.9
7.4
6.8
6.9
4.1
5.2
0.3
4.5
5.9
6.4
7.1
7.1
7.9
7.7
7.6
4.1
5.1
1.4
4.3
6.0
6.9
6.8
6.8
7.2
7.2
7.7
4.3
5.2
1.8
4.1
5.7
6.9
6.6
7.3
7.1
7.6
7.2
4.4
5.1
1.8
3.6
5.4
6.3
6.5
6.8
7.0
7.3
7.8
4.2
5.0
2.6
3.8
5.5
6.2
6.5
6.8
7.0
6.8
7.4
4.4
5.1
3.4
3.5
5.3
5.9
6.1
6.0
6.4
7.0
7.4
4.6
5.0
TABLE 2.— LIFETIME SOCIAL SECURITY BENEFITS AS A SHARE OF
LIFETIME SOCIAL SECURITY TAXES
[Lifetime Labor Earnings in 1997 Dollars]
840k- 960k-
960k 1.08m
Cohort 45 3.47
Cohort 50 -26.22
Cohort 55 -9.75
Cohort 60 -0.98
Cohort 65 1.06
Cohort 70 0.93
Cohort 75 -3.30
Cohort 80 -9.44
Cohort 85 -12.13
Cohort 90 -12.35
Cohort 95 -18.17
Men 45 45.08
Men 50 39.84
Men 55 42.23
Men 60 42.02
Men 65 42.84
Men 70 43.57
Men 75 40.64
Men 80 42.03
Men 85 33.47
Men 90 27.90
Men 95 19.22
Women 45 -4.81
Women 50 -49.48
Women 55 -32.25
Women 60 -20.21
Women 65 -17.16
Women 70 -20.04
Women 75 -22.28
Women 80 -32.32
Women 85 -30.44
Women 90 -28.78
Women 95 -32.35
White 45 2.54
White 50 -28.90
White 55 -11.44
White 60 -3.23
White 65 -1.91
White 70 -2.15
White 75 -2.61
White 80 -13.27
White 85 -14.73
White 90 -19.68
White 95 -21.39
Nonwhite 45 13.72
Nonwhite50 -3.94
53.28
67.05
70.61
73.71
75.72
76.88
75.34
77.60
77.20
67.59
46.35
61.26
67.68
70.62
74.54
76.04
76.79
77.60
76.09
64.58
48.31
62.48
67.29
70.36
75.23
77.78
77.98
78.33
78.05
67.03
51.24
63.52
70.26
71.37
73.61
77.41
78.73
79.98
78.64
68.47
49.97
61.27
69.79
70.99
72.95
74.64
75.55
79.69
80.18
68.63
46.66
60.48
66.49
70.57
71.81
75.41
79.06
77.97
79.79
67.94
45.08
59.98
66.39
68.40
70.07
73.59
74.61
78.97
79.49
67.35
44.24
57.80
65.20
67.69
70.57
70.54
75.24
77.74
79.43
67.47
40.98
55.36
61.82
66.03
68.79
69.75
74.32
77.09
78.42
66.04
39.59
54.43
62.28
66.35
68.66
70.75
71.62
75.37
77.61
65.83
37.01
52.67
59.67
64.04
64.27
67.29
71.66
74.78
78.88
66.19
64.52
72.91
74.38
76.26
77.25
78.26
77.27
79.79
78.88
75.55
60.11
68.09
71.81
73.25
76.40
78.36
78.58
78.47
77.35
73.41
60.71
68.15
71.79
72.59
77.61
80.32
80.63
79.43
79.09
74.47
62.40
69.39
73.47
74.07
75.66
80.79
81.37
80.98
79.42
75.16
59.83
68.20
72.94
74.66
75.39
75.20
76.51
80.69
81.51
75.16
57.88
66.42
69.87
73.43
73.20
77.11
80.16
79.31
80.91
74.42
55.47
66.30
69.74
70.84
73.75
76.65
78.30
80.53
80.74
74.06
53.42
63.66
69.60
70.56
73.49
71.50
76.42
78.38
80.65
73.78
50.42
62.03
65.93
68.60
70.18
73.25
76.36
79.56
79.29
72.43
47.71
60.74
66.78
67.32
70.64
70.66
73.57
76.43
78.43
71.39
44.74
57.40
60.57
67.64
64.90
68.21
72.05
74.81
79.40
70.84
46.40
59.63
62.72
66.80
68.41
71.56
68.99
68.15
69.04
51.73
36.76
53.37
60.08
64.38
70.05
69.71
70.60
75.27
71.90
48.64
39.12
55.87
60.42
66.46
69.48
71.78
73.50
75.42
75.24
54.80
42.28
56.96
65.64
67.16
70.62
71.68
74.70
77.08
76.74
58.33
42.11
53.68
65.39
65.55
68.54
73.65
74.14
77.12
76.40
58.23
37.78
54.54
61.68
65.97
69.38
72.32
76.50
74.62
77.08
57.67
36.71
54.04
61.30
64.02
64.12
68.67
69.65
74.80
76.52
56.98
36.91
50.44
58.81
63.70
66.74
69.17
72.42
76.14
76.21
56.95
33.72
49.90
57.00
62.56
66.56
64.07
70.68
70.75
76.31
56.26
33.94
48.30
57.10
64.96
66.12
70.95
68.01
72.94
75.76
57.31
31.31
47.67
58.51
59.41
63.19
65.87
70.64
74.72
77.63
58.60
53.13
66.23
70.95
73.58
76.24
76.88
74.98
76.83
77.38
67.50
45.14
60.65
67.78
70.41
74.64
75.99
76.97
77.88
75.94
64.29
47.29
61.94
67.43
69.79
75.18
77.66
77.34
77.95
78.31
66.99
50.26
62.64
70.03
71.55
73.68
77.61
78.46
80.29
78.61
68.34
48.55
61.65
69.86
71.23
72.53
74.45
75.69
80.66
80.27
68.77
45.26
59.79
66.13
70.58
71.51
75.84
79.87
77.45
80.12
67.95
44.05
59.57
66.13
67.92
70.11
72.94
74.21
78.61
79.82
67.35
43.06
57.36
64.93
67.70
70.47
70.60
74.84
78.32
79.40
67.40
38.77
54.10
61.06
66.07
68.67
69.46
74.68
76.68
78.68
65.95
36.96
53.10
61.65
66.87
68.13
70.18
71.97
75.04
77.40
65.59
33.28
50.53
58.36
62.96
63.45
67.03
71.57
74.11
78.48
65.58
54.41
72.40
68.73
74.74
69.83
76.80
78.40
83.03
74.74
68.36
53.60
64.67
67.12
71.95
73.68
76.33
75.26
75.66
77.54
66.59
11
TABLE 2.— LIFETIME SOCIAL SECURITY BENEFITS AS A SHARE OF
LIFETIME SOCIAL SECURITY TAXES— Continued
[Lifetime Labor Earnings in 1997 Dollars]
120k- 240k- 360k-
240k 360k 480k
480k-
600k
600k- 720k-
720k 840k
840k- 960k-
960k 1.08m
Nonwhite 55 2.24
Nonwtiite 60 12.48
Nonwhite 65 17.81
Nonwhite 70 16.53
Nonwhite 75 -6.62
Nonwhite 80 7.10
Nonwhite 85 -0.90
Nonwhite 90 12.45
Nonwhite 95 -5.03
Noncollege 45 5.30
Noncollege 50 -23.05
Noncollege 55 -4.37
Noncollege 60 3.22
Noncollege 65 4.74
Noncollege 70 3.12
Noncollege 75 3.03
Noncollege 80 -4.33
Noncollege 85 -8.61
Noncollege 90 -4.56
Noncollege 95 -8.71
College 45 -1.56
College 50 -34.74
College 55 -23.64
College 60 - 10.29
College 65 -6.10
College 70 -2.58
College 75 - 14.28
College 80 -17.13
College 85 - 17.89
College 90 -25.19
College 95 -34.41
54.60
65.80
66.33
73.71
75.64
79.03
84.84
82.59
75.41
67.33
57.34
68.66
71.64
70.27
73.08
75.68
80.86
76.90
78.83
69 37
56.51
59.55
69.42
69.39
75.43
76.06
74.64
69.28
79.53
67.77
52.47
63.42
68.70
70.51
74.00
73.30
72.84
80.71
77.82
67.92
49.04
62.22
67.61
70.31
69.85
76.90
76.53
80.23
77.63
67.39
49.41
59.86
66.52
67.65
71.05
70.30
77.05
75.84
79.61
67.8?
50.00
60.94
65.70
65.86
69.32
71.10
72.17
79.03
76.89
66.48
49.15
59.38
65.35
63.90
70.38
73.12
70.28
77.13
78.91
66.93
48.21
59.91
64.50
67.43
67.70
68.24
72.12
78.05
80.71
68.65
55.9/
68.32
71.98
73.80
74.90
76.55
74.51
79.60
76.15
66,91
48.72
62.25
68.82
71.36
74.19
75.64
77.49
78.61
76.68
63,79
49.96
62.51
66.98
69.63
76.85
78.78
77.81
79.76
78.56
66,41
53.02
65.74
70.13
71.97
74.26
76.40
79.92
82.37
79.11
68,09
50.49
61.92
71.15
70.54
73.41
75.49
76.93
80.6?
80.74
68.23
48.40
62.88
68.33
70.92
71.82
73.64
80.33
77.96
79.67
66.97
47.40
60.77
65.72
69.45
72.18
73.82
75.25
79.22
80.96
66.98
46.66
59.38
64.92
69.60
69.13
71.49
74.45
78.55
80.10
66.45
44.36
57.80
62.14
67.30
68.95
70.01
74.43
75.83
78.92
65.09
41.00
54.62
63.23
66.67
69.00
72.59
73.48
75.26
77.34
64.69
38.65
52.97
61.95
67.04
66.61
69.68
72.27
75.79
79.71
65.59
45.80
63.13
67.65
73.51
76.61
77.35
76.38
74.40
78.18
68.76
40.43
59.09
65.23
69.49
75.13
76.52
75.91
76.47
75.48
65.84
44.81
62.43
67.86
71.66
73.11
76.22
78.26
76.07
77.50
68.00
48.18
59.28
70.48
70.54
72.76
79.21
77.07
76.74
78.23
68.97
49.09
60.19
67.88
71.57
72.32
73.57
72.93
78.32
79.67
69.16
44.11
57.27
64.35
70.11
71.80
77.07
77.99
77.99
79.88
68.93
41.74
59.05
67.17
67.13
68.45
73.37
73.93
78.73
78.35
67.73
40.94
55.97
65.51
65.59
72.25
69.64
75.99
76.94
78.99
68.40
36.44
52.20
61.43
64.75
68.65
69.55
74.25
78.31
78.05
66.92
37.64
54.19
61.20
65.98
68.33
69.21
69.66
75.49
77.81
66.92
34.60
52.25
57.44
60.78
61.76
64.89
71.16
73.66
78.32
66.74
TABLE 3.— AVERAGE LIFETIME OASI NET TAX RATES ASSUMING A 38-PERCENT TAX RATE
INCREASE BEGINNING IN 1999
[Lifetime Labor Earnings in 1997 Dollars]
360k-
480k
480k-
600k
600k-
720k
720k-
840k
840k-
960k
960k-
1.08m
Cohort 45
Cohort 50
Cohort 55
Cohort 60
Cohort 65
Cohort 70
Cohort 75
Cohort 80
Cohort 85
Cohort 90
Cohort 95
Men 45 ....
Men 50 ....
Men 55 ....
Men 60 ....
Men 65 ....
Men 70 ....
Men 75 ....
Men 80 ....
Men 85 ....
Men 90 ....
0.7
5.8
7.0
7.2
7.5
7.5
7.2
6.3
6.4
3.9
5.8
1.8
4.6
6.1
6.6
7.0
7.3
7.3
7.0
6.8
4.0
0.1
5.4
6.9
7.3
7.6
8.1
8.4
8.3
7.6
4.5
1.1
6.3
7.8
8.4
8.5
8.8
9.1
8.8
9.0
4.6
1.8
6.9
8.2
9.1
9.0
9.0
9.7
9.5
9.2
5.5
2.4
7.3
9.0
9.3 ,
. 9.9
9.9
10.6
10.6
10.2
5.7
2.8
7.9
9.5
10.1
10.4
10.4
10.5
10.8
11.3
6.4
8.1
2.9
8.3
9.7
10.5
10.6
11.0
10.8
11.4
11.2
6.8
8.4
2.6
7.9
9.5
10.2
10.5
10.6
10.8
11.1
11.3
6.5
8.0
2.6
7.9
9.3
10.2
10.5
10.6
10.8
10.5
11.4
7.1
8.4
2.0
7.6
9.2
10.0
10.2
10.2
10.5
11.1
11.0
7.3
8.4
5.2
6.6
7.5
7.6
7.9
7.7
7.3
6.5
7.1
4.2
6.3
4.3
6.0
6.9
7.1
7.3
7.5
7.7
7.2
6.9
4.1
6.0
5.0
7.0
7.5
8.0
8.0
8.5
8.8
9.0
8.0
4.6
6.4
5.7
7.6
8.7
8.8
9.1
9.2
9.8
9.2
9.3
4.6
6.7
6.3
8.2
9.1
9.6
9.5
9.3
10.0
9.6
9.4
5.7
7.5
7.0
8.8
9.8
9.7
10.4
10.2
10.9
10.9
10.8
6.1
8.1
7.3
9.3
10.1
10.7
10.6
11.1
11.1
11.5
11.6
6.6
8.6
8.2
9.1
10.3
11.0
10.9
11.2
11.0
11.6
11.3
7.3
8.8
11
8.8
10.3
10.7
10.7
10.6
11.3
11.6
12.0
6.6
8.3
6.7
8.7
9.9
10.7
10.7
10.8
10.8
10.9
11.8
7.2
8.7
12
TABLE 3.— AVERAGE LIFETIME OASI NET TAX RATES ASSUMING A 38-PERCENT TAX RATE
INCREASE BEGINNING IN 1999— Continued
[Lifetime Labor Earnings in 1997 Dollars]
120k- 240k- 360k-
240k 360k 480k
480k-
600k
600k-
720k
720k-
840k
840k- 960k-
960k 1.08m
Men 95
Women 45
Women 50
Women 55
Women 60
Women 65
Women 70
Women 75
Women 80
Women 85
Women 90
Women 95
White 45
White 50
White 55
White 60
White 65
White 70
White 75
White 80
White 85
White 90
White 95
Nonwhite 45 ..
Nonwhite 50 ...
Nonwhite 55 ...
Nonwhite 60 ...
Nonwhite 65 ...
Nonwhite 70 ...
Nonwhite 75 ..
Nonwhite 80 ...
Nonwhite 85 ..
Nonwhite 90 ..
Nonwhite 95 ..
Noncollege 45
Noncollege 50
Noncollege 55
Noncollege 60
Noncollege 65
Noncollege 70
Noncollege 75
Noncollege 80
Noncollege 85
Noncollege 90
Noncollege 95
College 45
College 50
College 55
College 60
College 65
College 70
College 75
College 80
College 85
College 90
College 95
5.7
8.5
9.7
10.0
10.6
10.2
10.7
11.4
11.0
7.4
8.6
0.3
5.2
6.3
6.3
6.6
6.5
6.9
5.6
4.5
2.9
4.8
3.8
3.7
5.2
5.8
6.3
7.0
6.3
6.3
6.6
3.7
4.3
2.2
4.4
6.2
6.4
6.9
7.3
7.6
7.3
6.7
4.3
5.1
0.9
5.3
6.8
7.7
7.7
8.2
7.9
8.3
8.2
4.5
5.7
0.2
5.9
7.3
8.5
8.2
8.5
9.2
9.3
8.7
4.9
6.4
0.2
6.2
8.1
8.7
9.1
9.4
9.9
9.9
8.9
4.9
6.6
0.7
6.9
8.8
9.3
10.0
9.4
9.7
10.0
10.4
6.0
7.4
0.5
7.6
8.8
9.7
10.1
10.7
10.5
10.9
10.9
5.8
7.5
0.8
7.2
8.9
9.6
10.2
10.6
10.0
10.3
9.7
6.2
7.7
0.9
7.3
8.8
9.6
10.3
10.3
10.7
9.9
10.5
6.7
7.9
0.6
7.0
8.6
9.9
9.7
10.2
10.2
10.5
11.1
7.0
8.0
0.6
5.8
6.9
7.3
7.5
7.5
7.3
6.2
6.3
3.9
5.7
2.0
4.5
6.0
6.6
6.9
7.3
7.3
7.0
6.8
4.0
5.4
0.2
5.3
6.8
7.3
7.5
8.1
8.4
8.3
7.5
4.4
5.9
0.9
6.2
7.7
8.4
8.5
8.7
9.2
8.8
9.1
4.6
6.3
1.5
6.8
8.2
9.1
8.9
9.0
9.6
9.5
9.4
5.4
7.0
2.1
7.2
8.8
9.3
9.9
9.9
10.5
10.7
10.2
5.8
7.5
2.8
7.8
9.4
10.1
10.3
10.3
10.4
10.8
11.3
6.3
8.0
2.5
8.1
9.7
10.5
10.6
10.9
10.7
11,5
11.0
6.7
8.2
2.3
7.7
9.4
10.1
10.5
10.7
10.7
11.2
11.1
6.4
7.9
1.8
7.6
9.2
10.2
10.7
10.6
10.7
10.9
11.4
7.1
8.3
1.7
7.2
9.0
9.9
10.0
10.0
10.4
11.0
11.0
7.2
8.2
1.5
5.6
7.3
6.8
7.7
6.8
6.6
6.9
7.4
4.0
6.1
0.0
5.3
6.5
6.6
7.6
7.6
7.0
7.2
6.9
4.4
5.9
0.9
6.1
7.4
7.2
8.1
8.3
8.8
8.6
8.9
4.9
6.5
2.5
7.0
8.4
8.3
8.9
9.0
7.8
9.6
8.3
4.1
6.2
3.6
7.6
8.1
9.3
9.6
9.2
10.3
9.4
7.0
5.9
7.5
4.0
8.1
9.5
9.2
9.8
10.1
10.6
10.2
10.1
5.4
7.5
2.7
8.6
9.9
10.5
10.9
10.7
11.3
11.2
11.4
7.1
8.9
4.7
9.0
9.7
10.5
10.5
11.3
11.2
10.9
11.8
8.1
9.4
3.8
8.9
10.2
10.8
10.3
10.3
11.1
10.8
12.2
6.9
8.7
5.2
9.0
9.9
10.1
9.9
10.6
11.0
9.4
11.4
7.0
8.6
3.3
8.9
9.9
10.3
10.7
10.7
10.8
11.6
11.3
8.1
9.2
0.9
6.0
7.2
7.3
7.5
7.2
7.2
6.1
6.8
4.1
6.0
1.5
4.9
6.3
6.8
7.1
7.4
7.2
7.1
6.7
4.4
5.7
0.5
5.6
6.9
7.3
7.5
8.4
8.7
8.3
8.0
4.8
6.2
1.6
6.6
8.0
8.2
8.5
9.0
9.1
9.2
9.3
5.0
6.8
2.2
7.1
8.4
9.3
9.0
9.2
9.8
9.9
9.5
5.8
7.5
2.7
7.6
9.2
9.6
9.9
10.0
10.3
10.8
10.1
6.2
7.9
3.5
8.2
9.6
9.9
10.5
10.7
10.5
11.2
11.5
6.8
8.5
3.4
8.6
9.8
10.2
10.7
10.8
10.6
11.5
11.7
7.4
8.8
3.0
8.3
9.7
10.2
10.6
10.6
10.8
11.3
11.1
6.8
8.4
3.3
8.1
9.3
10.3
10.8
10.7
10.8
10.5
11.7
7.8
8.9
3.0
7.8
9.2
10.1
10.4
10.7
10.9
11.6
10.9
8.2
9.0
O.I
5.0
6.4
6.8
7.4
7.8
7.3
6.5
5.9
3.8
5.4
2.5
3.9
5.7
6.2
6.9
7.2
7.3
6.8
6.9
3.7
5.1
1.4
5.1
6.8
7.3
7.7
7.8
8.1
8.2
7.1
4.2
5.5
0.0
5.9
7.4
8.6
8.5
8.5
9.0
8.4
8.5
4.2
5.8
1.0
6.7
8.0
8.8
8.9
8.7
9.5
8.8
8.7
5.2
6.6
2.0
7.0
8.6
9.0
9.9
9.8
10.8
10.5
10.3
5.4
7.1
1.5
7.6
9.3
10.4
10.3
10.1
10.6
10.4
11.1
6.1
7.8
2.1
7.9
9.5
10.9
10.4
11.2
11.0
11.4
10.8
6.5
8.0
2.0
7.4
9.3
10.2
10.3
10.6
10.8
11.0
11.5
6.3
7.8
1.3
7.7
9.3
10.0
10.2
10.6
10.8
10.6
11.1
6.6
7.9
0.3
7.3
9.1
9.8
9.9
96
10.1
10.8
11.2
6.8
7.8
13
TABLE 4.— AVERAGE LIFETIME OASI NET TAX RATES ASSUMING A 25-PERCENT REDUCTION IN
SOCIAL SECURITY BENEFITS BEGINNING IN 1999
[Lifetime Labor Earnings in 1997 Dollars]
120k- 240k- 360k- 480k-
240k 360k 480k 600k
600k- 720k-
720k 840k
Cohort 45
Cotiort 50
Cohort 55
Cohort 60
Cohort 65
Cohort 70
Cohort 75
Cohort 80
Cohort 85
Cohort 90
Cohort 95
Men 45
Men 50
Men 55
Men 60
Men 65
Men 70
Men 75
Men 80
Men 85
Men 90
Men 95
Women 45
Women 50
Women 55
Women 60
Women 65
Women 70
Women 75
Women 80
Women 85
Women 90
Women 95
White 45
White 50
White 55
White 60
White 65
White 70
White 75
White 80
White 85
White 90
White 95
Nonwhite 45 ..
Nonwhite 50 ..
Nonwhite 55 ..
Nonwhite 60 ..
Nonwhite 65 ..
Nonwhite 70 ..
Nonwhite 75 ..
Nonwhite 80 ..
Nonwhite 85 ..
Nonwhite 90 ..
Nonwhite 95 ..
Noncollege 45
Noncollege 50
Noncollege 55
Noncollege 60
Noncollege 65
Noncollege 70
3.1
6.7
7.5
7.6
7.8
7.7
7.4
6.4
6.5
3.9
fil
0.4
5.3
6.4
6.8
7.1
7.3
7.1
6.8
6.6
3.9
5fi
1.6
5.8
6.9
7.2
7.3
7.8
8.0
7.8
7.1
4.2
58
2.4
6.3
7.4
7.7
7.9
8.0
8.1
8.0
8.0
4.1
58
2.7
6.4
7.3
7.9
7.7
7.7
8.2
8.1
7.8
4.6
6?
2.6
6.2
7.3
7.5
7.9
7.9
8.4
8.3
8.0
4.6
60
2.3
6.0
7.1
7.6
7.8
7.7
7.8
8.1
8.4
4.8
61
1.9
5.9
6.9
7.6
7.6
7.9
7.8
8.2
8.1
4.9
fi.O
1.6
5.6
6.8
7.3
7.5
7.6
7.8
8.0
8.2
4.7
5.8
1.6
5.6
6.7
7.3
7.6
7.6
7.8
7.6
8.2
5.1
6,0
1.2
5.4
6.6
7.2
7.3
7.3
7.5
8.0
7.9
5.3
6.0
6.2
11
7.9
7.9
8.1
7.9
7.4
6.6
7.1
4.2
6.4
4.9
6.3
7.1
7.1
7.3
7.4
7.5
7.0
6.7
4.0
6.0
5.4
6.9
7.3
7.6
7.6
8.1
8.2
8.4
7.5
4.3
6.1
5./
11
8.0
8.0
8.3
8.2
8.7
8.2
8.2
4.1
6.0
b.9
11
7.8
8.2
8.0
7.9
8.4
8.1
7.9
4.8
6.4
5.8
7.1
7.8
7.7
8.2
8.0
8.6
8.5
8.5
4.9
64
5.5
6.9
7.6
7.9
7.9
8.2
8.2
8.6
8.6
4.9
6.4
5.8
6.5
7.4
8.0
7.9
8.1
7.9
8.4
8.2
5.3
64
5.1
6.3
7.4
7.7
7.7
7.6
8.1
8.4
8.7
4.7
60
4.7
6.2
7.1
7.7
7.7
7.8
7.8
7.9
8.5
5.2
6.2
3.9
6.0
7.0
7.2
7.6
7.3
7.7
8.2
7.9
5.4
62
2.4
6.3
7.0
6.8
6.9
6.8
7.1
5.8
4.6
3.0
5.5
1.1
4.6
5.8
6.2
6.5
7.1
6.2
6.3
6.6
3.6
4.8
0.1
5.1
6.4
6.5
6.9
7.1
7.4
6.9
6.3
4.0
5.2
1.0
5.7
6.8
7.3
7.3
7.6
7.2
7.6
7.5
4.0
5.5
1.3
5.8
6.8
7.6
7.3
7.5
8.0
8.1
7.5
4.2
5.8
1.0
5.5
6.8
7.3
7.5
7.6
8.0
7.9
7.1
4.0
5.5
0.9
5.3
6.7
7.1
7.5
7.0
7.3
7.5
7.8
4.5
5.6
0.1
5.4
6.3
7.0
7.3
7.7
7.6
7.9
7.9
4.2
5.4
0.2
5.1
6.4
6.9
7.3
7.6
7.2
7.4
7.0
4.5 ■
5.5
0.4
5.2
6.2
6.9
7.4
7.4
7.7
7.1
7.6
4.8
5.6
0.1
4.9
6.1
7.1
7.0
7.3
7.3
7.6
8.0
5.1
5.7
3.1
6.7
7.5
7.6
7.8
7.7
7.4
6.3
6.4
3.9
6.1
0.3
5.2
6.4
6.8
7.0
7.2
7.2
6.8
6.6
3.9
5.5
1.5
5.7
6.8
7.2
7.3
7.8
7.9
7.8
7.0
4.2
5.7
2.2
6.3
7.3
7.7
7.8
8.0
8.3
7.9
8.1
4.2
5.9
2.4
6.3
7.3
7.9
7.7
7.7
8.2
8.1
8.0
4.6
6.1
2.4
6.1
7.2
7.5
7.9
7.9
8.3
8.4
8.0
4.6
6.0
2.3
5.9
7.1
7.5
7.7
7.7
7.7
8.0
8.3
4.7
6.0
1.6
5.8
6.9
7.6
7.6
7.9
7.7
8.3
8.0
4.8
5.9
1.4
5.4
6.7
7.3
7.6
7.7
7.7
8.0
8.0
4.6
5.7
1.0
5.4
6.6
7.3
7.7
7.6
7.7
7.8
8.2
5.1
6.0
0.9
5.0
6.4
7.1
7.2
7.2
7.5
7.9
7.9
5.2
5.9
3.5
6.5
7.7
7.2 ,
8.0
7.1
6.6
7.0
7.4
4.1
6.5
1.7
5.9
6.7
6.7
7.6
7.6
6.9
7.0
6.8
4.3
6.1
2.3
6.4
7.3
7.0
7.8
7.8
8.2
7.9
8.3
4.6
6.3
3.5
6.9
7.9
7.7
8.2
8.2
7.0
8.6
7.4
3.7
5.7
3.9
6.8
7.2
8.0
8.2
7.9
8.7
8.0
5.9
5.1
6.5
3.8
6.6
7.6
7.5
7.8
8.1
8.5
8.1
7.9
4.3
6.1
2.1
6.5
7.5
7.8
8.1
8.0
8.4
8.3
8.5
5.3
6.6
3.2
6.4
7.0
7.6
7.6
8.1
8.0
7.9
8.5
5.9
6.7
2.5
6.3
7.3
7.7
7.4
7.4
8.0
7.7
8.8
5.0
6.2
3.6
6.4
7.1
7.3
7.1
7.6
7.9
6.8
8.2
5.0
6.2
2.2
6.3
7.1
7.4
7.7
7.7
7.8
8.4
8.2
5.8
6.6
3.2
6.9
7.7
7.7
7.8
7.4
7.3
6.2
6.8
4.1
6.4
0.6
5.6
6.6
7.0
7.1
7.4
7.1
7.0
6.5
4.3
5.9
2.0
5.9
6.9
7.2
7.3
8.0
8.1
7.8
7.4
4.5
6.1
2.7
6.5
7.5
7.6
7.9
8.1
8.2
8.3
8.3
4.5
6.3
2.9
6.5
7.4
8.1
7.8
7.9
8.3
8.4
8.1
4.9
6.5
2.8
6.3
7.5
7.7
8.0
8.0
8.2
8.5
8.0
5.0
6.4
14
TABLE 4.— AVERAGE LIFETIME OASI NET TAX RATES ASSUMING A 25-PERCENT REDUCTION IN
SOCIAL SECURITY BENEFITS BEGINNING IN 1999— Continued
[Lifetime Labor Earnings in 1997 Dollars]
120k- 240k- 360k-
240k 360k 480k
480k-
600k
600k- 720k- 840k- 960k-
720k 840k 960k 1.08m
Noncollege 75
Noncollege 80
Noncollege 85
Noncollege 90
Noncollege 95
College 45
College 50
College 55
College 60
College 65
College 70
College 75
College 80
College 85
College 90
College 95
2.8
6.2
7.2
7.4
8
8.0
7.8
8.4
8.5
5.1
6.4
2.3
6.1
7.1
7.3
8
7.8
7.6
8.3
8.4
5.3
6.4
1,9
5.9
7.0
7.3
7.7
7.8
8.1
8.0
4.9
6.0
2.2
5.7
6.7
7.4
7.7
7.8
7.6
8.4
5.6
6.4
1.9
5.5
6.6
7.2
7.7
7.8
8.3
7.8
5.9
6.5
2.8
6.1
7.0
7.3
8.0
6.6
6.0
3.8
5.7
0.1
4.8
6.1
6.4
7.1
6.7
6.8
3.6
5.2
0.7
5.5
6.9
7.2
7.5
7.8
6.7
3.9
5.4
1.7
6.0
7.1
8.0
7.8
8.1
7.5
7.6
3.8
5.3
2.1
6.4
7.2
7.8
7.5
8.1
7.5
7.3
4.4
5.8
2.4
6.0
7.0
7.3
7.8
8.5
8.2
8.1
4.3
5.7
1.4
5.8
7.1
7.8
7.5
7.8
8.2
4.6
5.8
1.3
5.6
6.8
7.8
8.1
8.2
7.8
4.7
5.7
1.2
5.2
6.6
7.3
7.6
7.9
8.3
4.5
5.6
0.6
5.4
6.6
7.2
7.6
7.6
8.0
4.8
5.7
0.1
5.1
6.5
7.1
6.9
7.8
8.1
4.9
5.6
TABLE 5.— OASI INTERNAL RATES OF RETURN
[Lifetime Labor Earnings in 1997 Dollars]
0-I20k
120k- 240k-
240k 360k
360k-
480k
600k-
720k
720k-
840k
840k-
960k
960k-
1.08m
Cohort 45 4.91
Cohort 50 5.63
Cohort 55 5.25
Cohort 60 5.03
Cohort 65 4.97
Cohort 70 4.98
Cohort 75 5.09
Cohort 80 5.24
Cohort 85 5.31
Cohort 90 5.31
Cohort 95 5.45
Men 45 3.35
Men 50 3.45
Men 55 3.40
Men 60 3.36
Men 65 3.41
Men 70 3.35
Men 75 3.50
Men 80 3.47
Men 85 3.82
Men 90 4.08
Men 95 4.37
Women 45 5.11
Women 50 6.06
Women 55 5.73
Women 60 5.47
Women 65 5.42
Women 70 5.48
Women 75 5.51
Women 80 5.72
Women 85 5.69
Women 90 5.65
Women 95 5.74
White 45 4.94
White 50 5.69
White 55 5.29
White 60 5.08
3.00
3.27
3.17
3.03
3.10
3.29
3.38
3.42
3.57
3.63
3.73
2.07
2.27
2.19
2.09
2.26
2.46
2.64
2.74
2.96
3.12
3.23
3.42
3.77
3.69
3.57
3.59
3.77
3.82
3.82
3.94
3.92
4.02
3.02
3.33
3.22
3.09
1.53
1.73
1.81
1.54
1.64
1.92
1.95
2.09
2.36
2.29
2.39
1.11
1.21
1.20
1.04
1.14
1.43
1.50
1.53
1.88
1.77
2.16
2.24
2.45
2.50
2.12
2.19
2.48
2.49
2.70
2.82
2.76
2.64
1.51
1.71
1.79
1.56
1.21
1.46
1.49
1.47
1.53
1.57
1.73
1.79
2.00
1.94
2.10
0.92
1.08
1.13
1.00
0.92
1.10
1.40
1.42
1.63
1.74
1.62
1.84
2.15
2.00
2.04
2.21
2.17
2.24
2.23
2.41
2.20
2.59
1.24
1.46
1.55
1.45
0.88
0.97
0.93
1.19
1.27
1.40
1.61
1.53
1.70
1.68
2.03
0.62
0.64
0.49
0.83
0.83
1.13
1.07
1.06
1.47
1.38
1.87
1.80
1.61
1.73
1.63
1.90
1.83
2.28
2.02
2.03
2.01
2.28
0.81
0.93
0.93
1.19
0.78
0.79
0.62
0.63
1.07
1.06
1.20
1.56
1.65
1.47
1.78
0.55
0.35
0.11
-0.09
0.89
0.72
0.68
1.34
1.10
1.41
1.54
1.47
1.65
1.50
1.50
1.37
1.57
1.85
1.83
2.32
1.59
2.09
0.78
0.77
0.62
0.58
0.92
0.54
0.52
0.46
0.97
0.40
1.12
0.97
1.14
1.42
1.33
0.65
0.21
-0.01
-0.13
0.74
0.22
0.51
0.73
0.74
1.12
1.20
1.63
1.41
1.21
1.15
1.27
0.79
1.74
1.46
1.73
1.88
1.65
0.97
0.52
0.62
0.49
0.52
0.56
0.47
0.29
0.34
0.57
0.47
0.52
0.75
0.96
0.93
0.07
0.27
0.17
0.00
0.09
0.31
0.06
0.35
0.17
0.70
0.81
1.81
1.16
1.09
0.97
0.90
1.14
1.26
0.87
1.76
1.47
1.11
0.63
0.52
0.50
0.24
0.53
0.70
0.54
0.57
0.39
0.43
0.52
0.52
0.66
0.69
0.41
0.26
0.48
0.35
0.38
0.11
0.17
0.27
0.25
0.47
0.48
0.25
1.52
1.31
0.99
0.96
1.03
0.95
1.02
1.11
1.05
1.10
0.76
0.48
0.72
0.50
0.56
1.84
1.98
1.81
1.73
1.74
1.80
1.87
1.85
1.99
1.97
1.87
0.88
0.99
0.91
0.85
0.90
0.99
1.07
1.09
1.25
1.32
1.29
3.06
3.15
2.82
2.65
2.67
2.71
2.75
2.75
2.80
2.72
2.59
1.84
2.00
1.82
1.74
15
TABLE 5.— OASI INTERNAL RATES OF RETURN— Continued
[Lifetime Labor Earnings in 1997 Dollars]
120k- 240k- 360k- 480k- 600k-
240k 360k 480k 600k 720k
720k-
840k
840k-
960k
White 65 5.05
White 70 5.06
White 75 5.07
White 80 5.33
White 85 5,37
White 90 5.47
White 95 5.52
Nonwhite 45 4.64
Nonwhite 50 5.11
Nonwhite 55 4.94
Nonwhite 60 4.62
Nonwhite 65 4.43
Nonwhite 70 4.52
Nonwhite 75 5.17
Nonwhite 80 4.81
Nonwhite 85 5.02
Nonwhite 90 4.65
Nonwhite 95 5.13
Noncollege 45 4.86
Noncollege 50 5.57
Noncollege 55 5.12
Noncollege 60 4.91
Noncollege 65 4.87
Noncollege 70 4.91
Noncollege 75 4.92
Noncollege 80 5.11
Noncollege 85 5.22
Noncollege 90 5.12
Noncollege 95 5.23
College 45 5.04
College 50 5.78
College 55 5.55
College 60 5.25
College 65 5.16
College 70 5.07
College 75 5.34
College 80 5.40
College 85 5.43
College 90 5.58
College 95 5.77
3.18
3.36
3.43
3.47
3.68
3.75
3.89
2.91
2.88
2.81
2.69
2.69
2.98
3.18
3.15
3.08
3.15
3.20
2.83
3.12
3.06
2.90
3.02
3.17
3.23
3.28
3.39
3.55
3.65
3.44
3.60
3.38
3.24
3.22
3.46
3.57
3.59
3.79
3.74
3.85
2.34
2.50
2.50
2.64
2.88
2.92
3.02
1.47
1.91
1.96
1.72
2.55
2.20
2.37
2.48
2.38
2.47
2.41
1.85
2.18
2.20
1.97
2.27
2.23
2.36
2.47
2.60
2.78
2.84
2.36
2,45
2,25
2,57
2,54
2.70
2.61
2.76
3.02
2.90
2.95
1.65
1.95
1.98
2.10
2.42
2.34
2.48
1.69
1.82
1.88
1.42
1.61
1.76
1.80
2.05
2.07
2.03
2.00
1.39
1.59
1.83
1.53
1.44
1.68
1.97
2,08
2.30
2.20
2.20
1.81
1.99
1,77
1,57
1,90
2.18
1.92
2.09
2.44
2.38
2.56
1.51
1.56
1.78
1.80
2.01
1.90
2.17
0.93
1.44
1.05
1,59
1.66
1,61
1,53
1,74
1,96
2.13
1.86
1.15
1.38
1.55
1,39
1,56
1.54
1.61
1.56
1.86
1.86
1.83
1.33
1.57
1.37
1.57
1,50
1,61
1,87
2,01
2.13
2.04
2.36
1.30
1.42
1.61
1,56
1,72
1,72
2.10
1.60
1.27
0,89
1,15
1.07
1.30
1.65
1.37
1,61
1,53
1.71
0.97
1.04
0.66
1,00
1,19
1.41
1,33
1,69
1.65
1.64
1.86
0.79
0,83
1,24
1.40
1.38
1.40
1.81
1.32
1.74
1,72
2.21
1.10
1.01
1.25
1.54
1,67
1,51
1,77
0.67
0.90
0.61
1,01
0,85
1.28
0.91
1.61
1.54
1.28
1.81
0.77
0.78
0.37
0.77
0.98
1.25
1.14
1.43
1.58
1.27
1,56
0,78
0,80
0.95
0.34
1.19
0.87
1.24
1,67
1,69
1,62
1,98
0.93
0.26
1,19
1,03
1.09
1.39
1.33
0.48
0.69
-0,90
0,18
1,18
1,27
0,69
0,67
1,44
1,51
1.32
1.01
0.46
0.50
0.28
0,79
0,14
0.96
1.12
1,11
1,25
1,22
0,81
0.63
0.55
0.69
1.27
0.59
1.26
0.82
1.17
1.59
1.41
0.17
0,65
0,51
0.44
0,79
0.99
1.01
-0.36
0.80
0.05
0.73
1.61
0,05
0,33
0.76
0,51
0,78
0,45
0.19
0.33
0.25
-0.09
0.12
0.56
0.48
0.41
0.94
0.98
0.76
0.97
0,73
0,62
0,57
0,46
0,62
0,55
0,94
1.10
0.37
0.37
0,47
0.53
0.62
0.72
0.47
1.11
0.51
0.91
0.64
0.51
0.75
0.76
0.43
0.86
0.53
0.16
0.61
0.62
0.47
0.47
0.29
0.47
0.21
0.39
0.59
0.70
0.30
0.46
0.77
0.61
0.65
0.47
0.39
0.73
0.60
0.71
1.87
1.86
2.00
1.99
1.92
1,78
1,83
1.78
1.65
1.81
1.83
1,86
1.81
1.94
1.88
1.67
1.89
2.04
1.85
1.73
1.74
1.87
1.86
1.92
2.04
2.05
1.92
1.75
1.88
1.75
1.72
1.73
1,74
1,88
1,79
1,93
1,89
1.83
TABLE 6.— INTERNATIONAL COMPARISONS OF GENERATIONAL ACCOUNTING ALTERNATIVE WAYS TO
ACHIEVE GENERATIONAL BALANCE
Country
Cut m government purctiases Cut in government transfers Increase in all taxes Increase in income tax
A
B
A
B
A
6
A
B
24.6
29,1
16,8
11.0
10.7
8.4
97.1
75,7
8.8
10,2
12,1
9.1
5.1
4.8
8.5
8,1
56.8
76.4
25,0
20.5
20.1
18.4
60,7
55.6
11.2
12.4
6.0
4.6
3.7
3.1
11,7
10.0
23.8
26.2
21.3
17,9
12.4
11.7
78,9
74.0
0.0
0.1
0.0
0,1
0.0
0.1
0.0
0.2
9.9
29.0
4.7
4,5
3.4
4.0
5.8
6.7
47.6
67.6
26.5
21.2
20.6
19.4
54.1
50.8
21.1
25,9
17.6
14.1
9.5
9.5
29.5
29.5
-2.1
-4,3
-2.5
-4.4
-1.1
-2.1
-2.5
-4.8
37.0
49,1
18.0
13.3
12.4
10.5
33.3
28,2
26.0
29,5
28.6
25.3
15.5
15.5
53.6
53.6
21.0
28,7
21.4
22.3
8.5
8.9
14.9
15.6
-1.0
-1,6
-0.8
-0.6
-0.4
-0.4
-0.8
-0.8
Argentina
Australia
Austria
Belgium
Brazil
Canada
Denmark
Finland
Germany
Ireland
Italy
Japan
Netherlands ..
New Zealand
16
TABLE 6.— INTERNATIONAL COMPARISONS OF GENERATIONAL ACCOUNTING ALTERNATIVE WAYS TO
ACHIEVE GENERATIONAL BALANCE— Continued
Cut in government purchases Cut in government transfers Increase in all taxes Increase in income tax
Country
A B A BABAB
Norway 11.5 9.9 9.4 8.1 7.4 6.3 11.3 9.7
Portugal 7.6 9.8 9.6 7.5 4.2 4.2 13.3 13.3
Spain 50.6 62.2 22.5 17.0 17.4 14.5 53.9 44.9
Sweden 37.6 50.5 22.6 18.9 16.1 15.6 42.9 41.9
Thailand -38.1 -47.7 -185.1 -114.2 -25.0 -25.0 -81.7 -81.8
France 17.2 22.2 11.5 9.8 7.1 6.9 66.0 64.0
United Kingdom 6.6 9.7 9.6 9.5 2.6 2.7 9.4 9.5
United States 18.7 27.0 19.8 20.3 10.5 10.8 23.8 24.4
A. Education expenditure treated as government consumption.
B. Education expenditure treated as government transfers and distributed by age groups.
Sources: Kotlikoff and Leibfritz (1999) and Raffelheuschen (1998) and authors' calculations.
Chairman Smith. Ms. Olsen.
STATEMENT OF DARCY OLSEN, ENTITLEMENTS ANALYST,
CATO INSTITUTE
Ms. Olsen. Mr. Chairman, members of the committee and col-
leagues, thank you for the opportunity to come here today to talk
to you about Social Security's impact on different groups with a
particular emphasis on women.
I love the title of this hearing, and I loved it from the minute
that Sue said it to me. The title of it is How Uniformity Deals with
Diversity: Does One Size Fit All? When she told me that, I imme-
diately got this picture of my little sister, who is 10 years old, she
is about this high, she is about 60 pounds, and I have this picture
of her putting on my older brother's suit coat, and my older broth-
er— it is funny because he is 6-foot-6 and he weighs about 180
pounds. So I can tell you how uniformity deals with diversity when
it comes to clothing.
Now, on a serious note, in a very important sense, the current
Social Security system does treat everyone in the same uniform
manner, because it gives every worker, no matter what their in-
come, their ancestry or their gender, an inexcusably meager return
on a lifetime of payroll tax contributions. And that is, I think, one
of the most important things to keep in mind as you try to deter-
mine what this Nation's future retirement system should look like.
Substandard returns, whether they are shared equally or un-
equally, are not something to boast about.
That said, I have spent a great deal of time studying the impact
of Social Security on women, and the bottom line is that while So-
cial Security is, on its face, neutral, its impact on men and women
is very different. First of all, because women generally work fewer
years and earn less than men do, their benefits are lower. So the
average woman's benefit is about $600 per month compared to
about $800 per month for a man. The result of those lower benefits
is higher poverty rates, so you have poverty rates among women
that are twice as high as they are among men, 14 percent versus
about 6 percent.
Another problem with the way the system treats women is that
25 percent of working women, one in four of us, pay into this sys-
tem and don't get a dime back in benefits based on all the years
17
of payroll contributions that we have paid. Now, this is the result
of something called the "dual entitlement rule," and you have to
bear with me to explain this. It says, a woman can collect benefits
based on — as being a worker in her own right or as the spouse of
another worker, but she can't collect both benefits. She only gets
the higher of the two.
Now, for 25 percent of women, their benefits as spouses are high-
er than the benefits that they earned in their own right. So wMle
a woman may end up with a larger benefit than she earned in her
own right, she still has paid payroll taxes for which she gets noth-
ing in direct return. Let me give you an illustration.
What it means is this: You can have a wife who has never en-
tered the paid labor force or paid a dime in pa3rroll taxes and she
will be collecting the same exact benefit as a single woman who
has spent 40 years paying payroll taxes to the Social Security sys-
tem.
Now, supporters of this rule think this is OK, because these
women end up with larger benefits than they would have otherwise
based on their own work records. But the truth is that if Congress
would let women take their payroll taxes and deposit them into
personal retirement accounts, women wouldn't need that pref-
erence, they wouldn't need that favoritism. Instead, every single
dollar they earned would work toward their retirements and im-
prove their retirement security.
Now, what I have attached to my testimony is a study that we
have done at the Cato Institute, which shows how much better off"
women would be under this kind of system of personally owned re-
tirement accounts. We studied a cohort of women who actually re-
tired in 1981 using Social Security data, and found that not one of
these women would have been worse off under the private system
and virtually all of them would have been — almost all of them
would have been significantly better off under the private system,
and that is based on actual market returns.
And we also did a perspective analysis and found that the major-
ity of women in our country would gain an additional $800 or more
per month if they were allowed to go to this private system. That
is more than doubling what Social Security is now promising to
pay, but doesn't really have the money to make good on.
So, as you know. Social Security has been written, the rules have
been structured in a way that tries to minimize any inequality of
outcomes through the progressive benefit structure, but there are
significant differences that remain in outcomes. I will give you an-
other example. You can look at different groups of men and con-
sider the African-American man compared to the Caucasian male.
Upon reaching age 65, the average African-American male can ex-
pect to live 2 years less, die 2 years earlier than the average Cau-
casian male, which means that the average Caucasian male in this
sense wins out, and he is the winner because he collects 2 more
years from Social Security than the average African-American
man.
But this is the point: If we focus only on those technical defects,
things like that, things like the dual entitlement rule, we would be
missing the big picture, which is that no matter what group you
are in, Social Security is not a very good deal. Most workers born
18
around 1960, regardless of their gender, their marital status, their
ancestry or their incomes, can expect rates of return on their pay-
roll tax contributions between 1 and 2 percent.
So while Caucasian men may fare better than African- American
men and some people would say that men fare better under this
system than women, no group fares well. So the most important
thing for the Task Force to consider, I think, is that a redesigned
system that is based on individually owned accounts can signifi-
cantly increase the retirement incomes of every worker, no matter
what their retirement income — excuse me, no matter what their in-
come, their ancestry or their gender might be, and that is how a
system of personal accounts will deal with diversity.
Chairman Smith. Thank you.
[The prepared statement of Ms. Olsen follows:]
Prepared Statement of Darcy Ann Olsen, Entitlements Analyst, Cato
Institute
Mr. Chairman, distinguished members of the committee, colleagues: Thank you
for the opportunity to appear before this committee to discuss Social Security and
its impact on varying types of workers, particularly women.
In one fairly important sense, the current Social Security system treats everyone
equally because it gives every worker — no matter what their income, their ancestry,
their gender — an inexcusably low return on a lifetime of pa5rroll tax contributions.
That is one of the most important things to remember when you decide what the
nation's future retirement system should look like. Substandard returns, whether
shared equally or unequally across different populations, are not something to be
proud of.
That said, I have spent a good deal of time studjdng the impact of the current
system on women. The bottom line is that while Social Security does not differen-
tiate between women and men, yet its impact on men and women is quite different.
Because women generally work fewer years and earn less than men do, women
receive lower benefits from Social Security than do men: the average woman's bene-
fit is httle more than $600 per month, the average man's benefit is more than $800.
The result of those lower benefits is higher poverty rates. Poverty rates are twice
as high among elderly women as among elderly men: 14 percent compared to 6 per-
cent.
According to the Social Security Administration, 25 percent of women pay into the
Social Security system and get back nothing in return. (This happens to less than
1 percent of men.) That is the result of the dual entitlement rule, which says a
woman can collect benefits based on her own work record or based on her status
as a spouse, but she cannot collect both. She can collect only the larger of the two.
For 25 percent of women, their benefits as spouses are larger than their benefits
as workers. Therefore, while a woman might receive a larger check as a spouse than
she would have based on her own work record, she has still paid payroll taxes dur-
ing her working years for which she gets nothing. This means that a wife who never
enters the workforce or pays a dime in Social Security taxes can, under Social Secu-
rity, collect the same monthly benefit as a single woman who spent her entire adult
life in the workforce.
Supporters of the dual entitlement rule believe this treatment of women is accept-
able because women end up with larger benefits than they would have based on
their own work records. If the world were static, I might agree with that argument.
But it isn't. The truth is that if Congress would allow women to deposit their payroll
taxes into personal retirement accounts, every dollar they earned would work for
them by increasing their retirement incomes. Couples could also choose to share
their earnings, which would further increase their retirement funds. I've attached
a study we published at the Cato Institute called "Greater Benefits for Women with
Personal Retirement Accounts," which shows just how much better off women would
be if they were allowed to enter a new system of individually owned retirement ac-
counts.
Consider the most difficult scenario: a single woman earning $12,000 a year,
roughly the minimum wage. She pays $1,488 per year in Social Security taxes.
When she retires, Social Security promises her $683 per month (assuming solvency).
If she were allowed instead to save and invest her money in a portfolio of stocks
and bonds earning a 6.2 percent return, she would retire with $936 per month.
19
Those conservatively estimated benefits are roughly 30 percent greater than what
she could expect from Social Security.
Despite the fact that Social Security's rules have been rewritten over the years
to try to minimize inequality of outcomes, significant differences and treatment con-
tinue to exist, especially for women. But if we focus on those technical defects, we'd
be missing the big picture, which is that Social Security isn't a very good deal for
any worker.
Most workers bom around 1960, regardless of gender, marital status, ancestry,
or income, can expect rates of return on their payroll tax contributions between 1
and 2 percent.
Toda/s average 20-year-old male can expect to pay $182,000 more in Social Secu-
rity taxes than he will receive in benefits.
So while men may be "better ofiF' than women under Social Security, neither
group fares well.
The most important thing for this task force to consider is that a redesigned sys-
tem based on individually owned accounts can significantly increase the retirement
incomes of all workers, no matter what their income, their ancestry, or their gender.
That is how a system of personal retirement accounts will deal with diversity.
Cato Briefing Paper No. 38, July 20, 1998:
Greater Financial Security for Women With Personal Retirement Accounts
by darcy ann olsen
Introduction
Plans to privatize Social Security — that is, to redirect payroll tax payments into
personal accounts similar to individual retirement accounts or 401(k) plans — have
become enormously popular. Polls show that a large majority of i\mericans favor
some amount of privatization. Democratic and Republican legislators have intro-
duced bills that would privatize the system to varying degrees. And experts of var-
ious ideological persuasions have endorsed privatization. Yet many questions about
privatization remain, particularly with regard to women. Would poor women be able
to weather market downturns? Would they be capable investors? What about wom-
en's aversion to risk?
Many people agree that a retirement system should address poverty among the
elderly. That, after all, was the primary reason for establishing Social Security. Un-
fortunately, the current Social Security system does not adequately address poverty
among the elderly, particularly elderly women. Although the current Social Security
system does not differentiate between men and women, on average, women receive
lower benefits than do men. That is primarily because women tend to have lower
wages and fewer years in the workforce. Thus, poverty rates are twice as high
among elderly women as among elderly men: 13.6 percent compared to 6.2 percent.
Although Social Security alleviates some poverty, clearly there is room for improve-
ment.
In contrast, research shows that virtually every woman — single, divorced, mar-
ried, or widowed — would probably be better off financially under a system of fiilly
private, personal retirement accounts, the earnings of which could be shared by
spouses. And the greater the contribution rate, the greater the financial security.
Thus, a fully private system with a 10 percent contribution rate would benefit
women more than a partly private two-tiered system. That is true even for poor
women who move in and out of the job market.
Inequity in the Present System
By law, the Social Security system treats all workers equally. Yet the system has
a disparate impact on women because they tjrpically earn less, work fewer years,
and Uve longer than do men. In particular. Social Security punishes married women
who work and favors married women who do not work. A married women who
works her entire adult life may not receive any more benefits than a married
woman who has never worked; a couple with two breadwinners may get fewer bene-
fits than a couple with one breadwinner and identical lifetime earnings, and widows
of two-earner couples may get less than widows of one-earner couples.
Those inequities result from the way benefits are calculated. A spouse can receive
benefits in one of three ways. First, she can receive benefits based on her own work
history. Second, she can receive benefits based on her husband's work history. By
law, a woman is automatically entitled to benefits equal to 50 percent of her hus-
baind's benefits, whether or not she has ever worked or paid Social Security taxes.
Third, she can receive benefits based on a combination of the two.
20
When a woman qualifies for benefits both as a worker in her own right and as
a spouse (or surviving spouse) of a worker, she is subject to the "dual entitlement
rule." That rule prevents her from collecting both her own retirement benefit and
her spousal benefit. Instead, she receives only the larger of the two. And because
the typical woman earns less and works fewer years than her husband, 50 percent
of her husband's benefits is often larger than the benefits she would be entitled to
receive in her own right. Consequently, she receives benefits based on only her hus-
band's earnings — she receives no credit or benefits based on the payroll taxes she
has paid. A woman who never worked at all receives exactly the same benefits.
The second inequity that results under Social Security's dual-entitlement rule is
that a couple with two breadwinners may get fewer benefits than a couple with one
breadwinner and identical lifetime earnings. Table 1 illustrates this point.
TABLE 1.— COUPLES BENEFITS UNDER DUAL ENTITLEMENT
Monthly earnings ($) Monthly benefit ($)
Couple A:
Husband 1,000 573
Wife {no income) 0 287
Total 1,000 860
Couple B:
Husband 500 413
Wife 500 413
Total 1,000 826
Couple C:
Husband 667 467
Wife 333 300
Total 1,000 767
Source: Adapted from Ekaterlna Shirley and Peter Spiegler, "The Benefits of Social Security Privatization for Women," Cato Institute Social
Security Paper no. 12, July 20, 1998, p. 4.
Note: Monthly Earnings is the Average Indexed Monthly Earnings (AIME), which is found by adding the 35 years of a worker's highest in-
dexed earnings and dividing by 420 (the number of months in 35 years). In this example, it is assumed that the workers' combined earnings
equaled $1,000. The Monthly Benefit is the Primary Insurance Amount (PIA). The following progressive benefit formula is applied to the AIME
to determine the PIA (1996): 90% of the first $437 of AIME, 32% of AIME from $437 to $2,635, and 15% of AIME over $2,635.
Each of the three couples has the same total earnings, yet couple A with one
breadwinner receives higher benefits than do couples B and C with two bread-
winners. During 1 year, couple A will receive $1,116 more than couple C. After 10
years, couple A wiU have received more than $11,000 more in retirement benefits
than couple C. As men and women who reach age 65 are expected to live to age
80 or beyond, that inequity can have a significant impact on a couple's quality of
life for many years.
While the dual-entitlement rule has a negative impact on many two-earner cou-
ples during their retirement years together, its most pernicious impact is often felt
after a husband dies. Social Security's survivor benefit rules can leave widows with
up to 50 percent less income than the couple was receiving when the husband was
alive. That is one reason why the poverty rate among widows is 19.2 percent, two
times greater than among widowers. And, in general, the more of the couple's earn-
ings the widow earned, the smaller the share of the couple's retirement benefit she
receives after her husband dies. Table 2 illustrates this point.
TABLE 2.— WIDOWS' BENEFITS UNDER DUAL ENTITLEMENT
Monthly Earnings ($) Couple's Benefit ($) Widow's Benefit ($)
Couple A:
Husband 1,000
Wife (no income) 0 860 573
Total 1,000
Couple B:
Husband 500
Wife 500 826 413
Total 1,000
Couple C:
Husband 667
Wife 333 767 467
21
TABLE 2.— WIDOWS' BENEFITS UNDER DUAL ENTITLEMENT— Continued
Monthly Earnings ($) Couple's Benefit ($) Widow's Benefit ($)
Total 1,000
Source: Adapted from Ekaterina Stiirley and Peter Spiegler, "The Benefits of Social Security Privatization for Women," Cato Institute Social
Security Paper no. 12, July 20. 1998, p. 5.
Note: Monthly Earnings is the Average Indexed Monthly Earnings (AIME), which is found by adding the 35 years of a worker's highest in-
dexed earnings and dividing by 420 (the number of months in 35 years). In this example, it is assumed that the workers' combined earnings
equaled $1,000. The Monthly Benefit is the Primary Insurance Amount (PIA). The following progressive benefit formula is applied to the AIME
to determine the PIA (1996): 90% of the first $437 of AIME, 32% of AIME from $437 to $2,635, and 15% of AIME over $2,635.
Each of the three couples has the same total earnings, yet the widow who never
worked (A) receives higher benefits than the widows who worked (B and C). Widow
A's benefits are approximately 16 percent higher than widow B's and 10 percent
higher than widow C's. As Tables 1 and 2 indicate, the one-earner couple (couple
A) receives the highest retirement benefits while the husband is alive, and the
widow receives the highest survivor's benefit. In addition, the widow who made as
much money as her husband receives less than the widow who earned only half as
much as her husband.
Anna Rappaport of William M. Mercer foimd that the situation for low-income
widows who worked is even worse. For example, the wife of a couple with $34,200
in annual pay gets $1,082 as a widow if she never worked, while the wife who
brought home half that paycheck gets a widow's benefit of only $674. That is a dif-
ference of $408 per month.
The Social Security Administration reports that 24 percent of married and wid-
owed women have their benefits slashed by the dual-entitlement rule. That number
is projected to increase to 39 percent by 2040, as increasing numbers of women earn
higher wages and work more hours. As Jonathan Barry Forman, former tax counsel
to Sen. Daniel Patrick Moynihan (D-N.Y.), puts it, "In short, the Social Security sys-
tem takes billions of payroll tax dollars from these working women and gives them
no greater Social Security benefits in return."
The negative impacts of the dual-entitlement rule are exacerbated by a handftd
of other factors that make women disproportionately dependent on Social Security
benefits. As a result of lower earnings and fewer years of work, women, on average,
earn less Social Security benefits than do men. In 1995 male retirees received $810
in monthly benefits while women received only $621, on average. Lower earnings
and part-time employment also make it more difficult for women to accumulate pri-
vate savings for retirement. In addition, women are less likely than men to have
employer-provided pension plans. Even if they do have pension plans, they generally
save too little because of their moves in and out of the job market.
Those gender-specific issues aside, women, like men, face the larger problem of
Social Security's looming debt and declining rate of return. Federal Reserve Board
chairman Alan Greenspan estimates that Social Security's unfunded liability is
roughly $9.5 trillion. If the government intends to make good on its promise to pay
retiree benefits, it will have to raise taxes or cut benefits in order to meet that reve-
nue shortfall. The Social Security board of trustees has estimated that it would take
a tax hike of at least 6.3 percentage points to put the program in the black. A tax
hike of that size would force workers to pay one-fifth of their wages to Social Secu-
rity. Of course, cutting benefits is no solution either; benefit cuts would give workers
an even worse deal than does the current system. Many of today's young workers
can expect to get a negative rate of return fi-om Social Security, according to the
nonpartisan Tax Foundation. And, as the American Association of Retired Persons
has pointed out, women would suJSer most under reform proposals that reduce re-
tiree benefits.
Benefits of Full Privatization
Women, like men, want to know what would be the likely results under a private
system in which payroll tax payments were redirected into personal accounts simi-
lar to individual retirement accounts or 401(k) plans. Would private accounts in-
crease the overall level of women's retirement benefits? Would private accounts ad-
dress poverty among widows? Would private accounts end discrimination against
working wives?
To answer those questions, Ekaterina Shirley and Peter Spiegler, graduates of
Harvard University's Kennedy School of Government, conducted two empirical anal-
yses. The first is a retrospective analysis using actual earnings histories of 1,585
men and 1,992 women who retired in 1981. The researchers compared Social Secu-
rity benefits with the benefits that hypothetically would have accrued under a pri-
vate plan with a 7 percent contribution rate, a 6.2 percent rate of return, and 50-
22
50 earnings sharing between spouses where apphcable. Earnings sharing lets mar-
ried couples split their contributions 50-50 before depositing them into each person's
account.
Shirley and Spiegler found that all but .11 percent (approximately 3) of the
women collecting benefits would have been better off under the private system. For
those women, the difference between the plans was exactly zero — no woman was
worse off under the private system. For 3.7 percent (approximately 110) of the
women, the difference was less than $2,000. Even though the absolute dollar dif-
ference appears small, it is significant relative to total benefits from Social Security.
Overall, the median value of the accrued difference between benefits fi'om Social Se-
curity and benefits fi-om a privatized plan was $30,000 for single women, $26,000
for wives, $21,000 for divorcees, $23,000 for surviving divorcees, and $20,000 for
widows. As a percentage of Social Security benefits, that difference is substantial.
The median values of that percentage are 58 percent for single women, 208 percent
for wives, 67 percent for divorcees, 58 percent for surviving divorcees, and 97 per-
cent for widows.
In the second analysis, Shirley and Spiegler conducted a prospective simvilation
since the cohort of women in the workforce today has significantly different labor
and marital characteristics than the one that retired in 1981. As complete Ufetime
earnings histories for women who are currently in the workforce do not exist, the
research team simulated the effects of various retirement plans. They compared So-
cial Security; a fully private system; and a two-tiered, or partly private, system.
Under the fully private system, the assumed contribution rate is 10 percent. The
partly private approach woiild channel 5 percentage points of payroll taxes into a
personal account, with the remaining 7.4 percentage points going to Social Security
to finance a "flat benefit" and survivor's and disability insurance. The flat benefit
is equal to % of the poverty rate. As they did in the retrospective analysis, the re-
searchers assumed a 6.2 percent rate of return on invested contributions.
As Figure 1 shows, in every case the fully private system with a contribution rate
of 10 percent would bring all women — whether collecting benefits based on their
own earnings or as wives, divorcees, or widows — with full earnings histories more
than twice the retirement benefits of Social Security.
Moreover, the greater the contribution rate, the greater a woman's financial secu-
rity in retirement. Thus, the fully private system generates significantly higher re-
tirement benefits than does the partly private, two-tiered system. The partly private
system provides only slightly greater benefits than Social Security. The resvdts are
similar for women who have moved in and out of the job market, as Figure 2 shows.
In every case, the fully private system brings all women significantly greater ben-
efits than does either Social Security or the partly private system. For example, the
fully private plan gives married, divorced, and widowed women (with full or inter-
rupted earnings histories) at least $200,000 more in retirement benefits than does
Social Security or the partly private system. That's better than $10,000 per year.
To answer questions about the potential impact of privatization on women with
low to moderate incomes, Shirley and Spiegler ran a simulation using half the na-
tional mean wage level of women. Figures 3 and 4 show that women with low to
moderate incomes (with fuU or interrupted earnings histories) would do far better
under a fiilly private system them under either Social Security or the partly private
system.
23
FIGURE 1.— ACCRUED RETIREMENT INCOME OF MEAN-INCOME WOMEN WITH FULL
EARNINGS HISTORIES
Single
D Social Security
Widowed
D Full Privatization
Partly Private Plao
ri^^''ZT^ ^^^P^^S'T E*^/t™ Shirley and Peter Spiegler, "The Benefits of So-
July 20 1998 ?T2 Women," Cato Institute Social Security Paper no. 12,
FIGURE 2.— ACCRUED RETIREMENT INCOME OF MEAN-INCOME WOMEN WITH
INTERRUPTED EARNINGS HISTORIES
Single
Married
Widowed
D Social Security
D Full Pnvatizanon
■ Pstttly Privae Plan
cial^Sprnntv p'^'^f^T ^^/^T^ ^^^^^y ^'V* P^^^^ Spiegler, 'The Benefits of So-
jSy 20 1998 ^12 Women," Cato Institute Social Security Paper no. 12,
FIGURE 3.— ACCRUED RETIREMENT INCOME OF LOW-INCOME WOMEN WITH FULL
EARNINGS HISTORIES
Siegii
Q Full Privaiizitioa
Partly Private plan
24
Source: Adapted from Ekaterina Shirley and Peter Spiegler, "The Benefits of So-
cial Security Privatization for Women," Cato Institute Social Security Paper no. 12,
July 20, 1998, p. 13.
FIGURE 4. — ^ACCRUED RETIREMENT INCOME OF LOW-INCOME WOMEN WITH
INTERRUPTED EARNINGS HISTORIES
)□ Social Security
□ Full Privatuasion
Partly Piivaw Plati
Source: Adapted from Ekaterina Shirley and Peter Spiegler, 'The Benefits of So-
cial Security Privatization for Women," Cato Institute Social Security Paper no. 12,
July 20, 1998, p. 14.
For example, a married woman with a low income who has moved in and out of
the workforce could expect to gain roughly $125,000 more in benefits under the pri-
vate system than under Social Security. That's nearly $550 more per month than
Social Security would provide. Even women in the worst-case scenario — low-income
single women who do not benefit from the earnings sharing provision and who have
moved in and out of the workforce — would receive greater benefits under full privat-
ization than under Social Security, nearly $100 more per month.
One potential concern is that the positive benefits under privatization are simply
the result of high contribution rates. To address that concern, Shirley and Spiegler
calculated how much each program gives in return for each tax dollar invested. In
other words, they wanted to find out whether women were getting their money's
worth under each program. For example, Figure 5 shows that a widowed woman
with a complete work record would get approximately
$1 in Social Security benefits for each $1 she contributed; imder the fiilly private
plan, she would get approximately $2.50 for each $1 contributed.
FIGURE 5.— money's WORTH TO MEAN-INCOME WOMEN WITH FULL EARNINGS HISTORIES
S3.00-
$2,50
S2.00-
S1.50-
Sl.OO
S0.50-
0 00
r
J
i
a
jS
n
L
1
1
I
1
|£=
Jg
L
1
S:ngk
Mam«d
X
Jsvorced
V
Viidowe4
aSocia! Secursiy
O Fu
': Pfivatuatioa
■ ParUy Private
Plan
Source: Adapted from Ekaterina Shirley £ind Peter Spiegler, 'The Benefits of So-
cial Security Privatization for Women," Cato Institute Social Security Paper no. 12,
July 20, 1998, p. 12.
25
FIGURE 6. — money's WORTH TO LOW-INCOME WOMEN WITH INTERRUPTED EARNINGS
HISTORIES
1 S3 .00
J
■| S2.50
i ""^
§ $1.50
S. SI .00
I
^
1
-^
/
T =
y
t=^
tm
1
h
1
L
L
Single
Married
Widowed
D Socia! SecuDly
□ Full Privatization
Partly Private Plan
Source: Adapted from Ekaterina Shirley and Peter Spiegler, 'The Benefits of So-
cial Security Privatization for Women," Cato Institute Social Security Paper no. 12,
July 20, 1998, p. 14.
In a final simulation, the researchers used half the national mean wage level of
women in each category to examine whether low-income women were getting their
money's worth from each program. As Figure 6 shows, full privatization would give
low-income women with interrupted earnings histories much more value for the dol-
lar than would either Social Security or the partly private plan.
The mone/s worth calculations demonstrate that, even taking into accoimt Social
Security's "progressive" benefit structure, all categories of women would still get
more for their money under a fully private plan.
Shirley and Spiegler's retrospective, prospective, and value-for-the-doUar calcula-
tions show how a ftiUy private system with a contribution rate of 10 percent would
be able to bring all women — single, married, divorced, or widowed with low to mod-
erate or average income — greater financial security than does Social Security. The
implications are real and significant for women, yet many important questions still
exist.
Concerns about Women and Private Accounts
People have raised more concerns about women and private accounts than can be
addressed in this short paper. However, a brief discussion of a few of the most im-
portant concerns should alleviate much uneasiness about personal accoimts.
Low-Income Women as Investors
"Because women are more likely to be living in low-income households, they gen-
erally have less access to good investment advice." It is unlikely that low-income
women would not have adequate access to good investment advice. As the American
Association of Retired Persons points out, "Lots of good information on saving and
financial planning is free — from AARP, investment companies, the Internet, and
your local library. Also, free or low-cost seminars specifically designed for women
are offered in many communities." A market-based retirement system will undoubt-
edly increase investment companies' outreach efforts to women. What is perhaps
even more important, however, is that full privatization does not require that every
participant be an intelligent or experienced investor. The history of 401(k) plans has
demonstrated that workers of all income groups can do well by entrusting their pen-
sion benefits to experienced investors who, for the most part, have fulfilled their re-
sponsibilities. Under a well-structured system with fully private accounts, low- and
high-income workers could expect to receive guidance from fund managers in much
the same way. As Melissa Hieger and William Shipman of State Street Global Advi-
sors point out, "There is no need for a worker who chooses the market-based system
to know how markets work as long as the pension system is properly structured and
sensible guidelines are followed. In fact, most proposals for a privatized national re-
tirement system have regulatory elements that restrict investment strategies that
are either too risky or that would be insufficiently aggressive to provide needed re-
tirement benefits."
26
Low-Income Women and Market Downturns
"Low-income women . . . would be less able than more affluent women to weather
market downturns." One way to address that concern is to see how low-income
women would have fared historically vmder a market-based system. That can be
done by comparing Social Security benefits with simulated market benefits for low-
income workers. For example, Hieger and Shipman compared an initial monthly So-
cial Security benefit with an initial balanced-fund (60 percent equities, 40 percent
bonds) benefit for low-income workers bom in 1950 and 1970. The low-income work-
er bom in 1950 could expect a monthly Social Security benefit of $668; the balanced-
fund benefit would be $1,514. The low-income worker bom in 1970 could expect a
monthly Social Security benefit of $799; the balanced-fund benefit would be $1,431.
In both cases, the market affords low-income workers higher retirement benefits
than does Social Security. Those results are consistent with other studies that show
higher retirement benefits from markets than fi"om Social Security. If, however, the
worst-case scenario arose leaving a worker with insufficient benefits upon retire-
ment, the govemment could finance a safety net fi-om general revenues. Moreover,
if one believes the market-based system is inferior to Social Security, most privat-
ization plans would allow workers the option of staying in the present system. The
freedom to choose is particularly important to low-wage women who do not earn
enough to save and invest on their own. That inability to invest is largely due to
high payroll tax rates. Forcing women to stay in a system that takes 12.4 percent
of their wages only to cheat them of a secure retirement is simply unjust. Low-in-
come women should have the freedom to invest their earnings in a way that will
increase their chances for a financially secure retirement.
Risk Aversion of Women
"With individual accounts, women may fare worse than men because they are
more risk averse." There is some evidence that women tend to be more conservative
investors than men; however, many studies that purport to show that did not con-
trol for education levels or investment-specific knowledge — factors that may account
for some differences in investment behavior. According to the General Accounting
Office, people who are given information about their investment choices and poten-
tial retums are more likely to invest more than those who do not receive such infor-
mation. Investment companies compete vigorously to educate and attract female cli-
ents. For example, OppenheimerFunds has distributed a 160-page booklet called "A
Woman's Guide to Investing." Merrill Lynch, Paine Webber Group Inc., and Smith
Barney have similar marketing strategies. In addition, women who have been m-
vesting for a long time pursue investment strategies that are very close to those of
men. Certainly, experience shows that it is unreasonable to suggest that women,
simply because of their gender, are not capable of becoming perfectly competent m-
vestors. Finally, in a well-stmctured private system, women, as weU as men, could
expect to rely on investment managers to help with investment decisions.
Conclusion
Shirley and Spiegler's research demonstrates how full privatization with eamings
sharing can address the shortcomings of the current Social Security system. First,
both the retrospective and the prospective analysis show that fiiUy private accounts
would significantly improve the retirement incomes of women— single, married, di-
vorced, or widowed with low-to-moderate, moderate, or average income— which
would begin to address the problem of poverty that exists under Social Security.
Second, fully private accounts would end the discrimination currently faced by
women' under Social Security by ensuring that every dollar earned by a woman had
a strictly positive effect on her retirement income. Finally, changing Social Security
into a fully funded system would help ensure that future generations grow up with-
out being saddled by unnecessary debt and grow old with financial security.
Notes
I am grateful to Ekaterina Shirley and Peter Spiegler who did the research on
which much of this analysis is based. Special thanks to Lea Abdnor for her construc-
tive comments, to Carrie Lips for her expert research assistance, and to Michael
Tanner for his support and direction. I take full responsibiUty for all errors.
Chairman Smith. Dr. Kijakazi.
27
STATEMENT OF KILOLO KIJAKAZI, SENIOR POLICY ANALYST,
CENTER ON BUDGET AND POLICY PRIORITIES
Ms. KiJAKAZi. Mr. Chairman and members of the Task Force,
thank you for inviting me to speak today. I will discuss Social Se-
curity's design and how it benefits people of color and women. I will
also talk about the potential impact of proposed reforms on these
two communities.
The program is particularly important to people of color. Social
Security makes up 43 percent of the income of elderly African
Americans and 41 percent of the income for elderly Hispanic Amer-
icans compared to 36 percent of the income for white elderly.
Chairman Smith. Would you say that once more?
Ms. KiJAKAZi. Social Security makes up 43 percent of the income
for elderly African Americans; 41 percent for elderly Hispanic
Americans, and 36 percent for white elderly Americans. This is not
surprising, given the low rates of pension coverage for people of
color. One-third of elderly African Americans and only one-fourth
of elderly Hispanic Americans have pension income, compared to
44 percent of white elderly people.
African Americans and Hispanic Americans are disproportion-
ately represented among low-wage workers. Consequently, it is
much more difficult to set aside resources for retirement savings.
This places greater weight on Social Security as a reliable, guaran-
teed source of income.
The argument has been made that Social Security provides a
lower rate of return to African Americans because of our shorter
life expectancy. This faulty reasoning overlooks the protections So-
cial Security provides for African Americans and low-wage workers.
Three aspects of Social Security help to compensate African Ameri-
cans for our higher mortality rate.
Since African Americans make up a disproportionate share of
low- wage workers, we gain from the progressive benefit formula.
Second, early retirement is an option that is elected by two-thirds
of all workers, including African Americans. Because we have a
shorter life expectancy, receiving a reduced benefit earlier provides
us with more total benefits than if we waited until we were 65.
And third. Social Security is a comprehensive insurance program
that includes the disability and survivors insurance programs in
addition to the retirement program. African Americans benefit dis-
proportionately from the disability and survivors components of the
system.
A study by employees of the Treasury Department found that Af-
rican Americans have a slightly higher rate of return from Social
Security than the general population, or the white population. The
same study showed Hispanic Americans have the highest rate of
return from Social Security, due to their longevity and because
they also benefit from the progressive benefit formula.
Social Security's design also benefits women. Elderly women are
more likely to be poor than elderly men. We work 12 fewer years
on average, very often because we are caring for family members.
We earn lower wages, we are less likely to have pensions. On aver-
age, 30 percent of elderly women receive pension income compared
to 48 percent of elderly men. And we live longer, which means we
must stretch our resources over a longer period of time. Social Se-
28
curity effectively reduces poverty for women. In 1997, three of
every five elderly people removed from poverty were women.
The program provides special protections for women, and these
include spouse benefits that have been described by Ms. Olsen. A
married woman may receive either benefits based on her earnings
history or her spouse's. According to data from the Social Security
Administration, 63 percent of married women receive benefits
based on their spouse's earnings.
Women benefited from Social Security in two ways due to their
longer life expectancy. First, survivors' benefits are more often re-
ceived by women. And second, the cost of living benefits women
more than men since we live longer. As a result of these program
designs, women receive about 53 percent of benefits while paying
only 38 percent of payroll taxes. Social Security is very beneficial
for women.
What impact will reform proposals have on people of color and
women? Proposals that divert pa5rroll taxes into individual accounts
will substantially reduce the guaranteed portion of Social Security
benefits and replace these benefits with the promise of investment
income. These so-called carve-out proposals increase the long-term
imbalance in Social Security and consequently result in a larger re-
duction in Social Security benefits than otherwise would be nec-
essary.
The recently introduced Archer-Shaw proposal would also have
disadvantages for people of color and women. Funding for the indi-
vidual accounts would likely come from funding for nondiscretion-
ary programs, many of which are beneficial to people of color and
women, programs outside of Social Security. The plan would likely
undermine the universal support that Social Security now enjoys.
Social Security benefits would be reduced by $1 for every dollar in
the individual accounts. Those who have the largest accounts, high-
wage earners, would receive only modest Social Security benefits
for their payroll tax contributions, consequently high- wage earners
may reduce their support for the program while low-wage earners
remain reliant on the program. Under the Archer-Shaw plan the
only group of retirees who could receive an increase in government-
funded retirement benefits as a result of the individual accounts
would be high- wage workers.
What should be done to address Social Security's imbalance? Sev-
eral aspects of the Clinton proposal would substantially reduce the
imbalance. The plan proposes to use $2.8 trillion of the unified
budget surplus to pay down the debt. This would reduce interest
payments in the future, and those funds could be used to address
Social Security as baby boomers retire.
The plan also proposes to invest a portion of the trust fund in
equities. Investments would be made in broadly indexed funds by
a politically and financially independent board. This would increase
income to the trust fund without the transition costs, the adminis-
trative costs or risks of individual accounts.
Finally, the plan would create USA accounts, an individual ac-
count system outside of the Social Security system. It would be pro-
gressive and would be targeted to low-wage and moderate-wage
workers. Solvency can be restored without putting at risk the guar-
29
anteed benefit and the features of the program that are most bene-
ficial to people of color and to women.
[The prepared statement of Ms. Kijakazi follows:]
Prepared Statement of Kilolo Kijakazi, Ph.D., Senior Policy Analyst, Center
ON Budget and Policy Priorities
Mr. Chairman and members of the task force, thank you for inviting me to speak.
I am Kilolo Kijakazi, a senior policy analyst with the Center on Budget and Policy
Priorities. The Center is a nonpartisan, nonprofit policy organization that conducts
research and analysis on issues affecting low- and moderate-income families. We are
primarily funded by foundations and receive no Federal funding.
I will discuss how Social Security's design benefits people of color and women and
the potential impact of proposed reforms on these communities.
Social Security's Success
Social Security has been one of the country's most successful social programs. It
is largely responsible for the dramatic reduction in poverty among elderly people.
Half of the population aged 65 and older would be poor if not for Social Security
and other government programs. Social Security alone lifted over 11 million seniors
out of poverty in 1997, reducing the elderly poverty rate fi-om about 48 percent to
about 12 percent. Additionally, Social Security has become more effective in reduc-
ing poverty over time. In 1970, Social Security reduced the poverty rate among the
elderly from about 50 percent to 17 percent, compared to 12 percent today.
Social Security pa5rments provide the majority of the income of poor and near poor
elders. It is the major source of income for 66 percent of beneficiaries age 65 or older
and it contributes 90 percent or more of income for about 33 percent of these indi-
viduals.
The Importance of Soclu. Security to People of Color and Women
Social Security is particularly important to people of color. Elderly African Ameri-
cans and Hispanic Americans rely on Social Security benefits more than white el-
ders rely on the program. Social Security benefits make up 43 percent of the income
received by elderly African American people and their spouses and 41 percent of in-
come received by elderly Hispanic Americans, compared to 36 percent of the income
of elderly whites. This is not surprising given the lower rates of pension coverage
for people of color. Pension income is received by only one third of elderly African
American people and their spouses and one fourth of elderly Hispanic Americans.
By comparison, 44 percent of elderly whites and their spouses receive pension in-
come. Moreover, people of color are disproportionately represented among low-wage
workers. It is, therefore, more difficult to set aside savings for retirement to supple-
ment Social Security.
Social Security is also an important source of income for women. The program
made up 61 percent of total income received by elderly women in 1997 and it was
the only source of income for one out of five elderly women. Compared to men,
women have few resources other than Social Security to draw upon in their older
years. Women have lower rates of pension coverage and pension income than men.
Only 30 percent of women 65 and older had pension coverage in 1994, while 48 per-
cent of men were covered. Of those who began to receive benefits from private sector
pensions in 1993-1994, the median annual benefit for women ($4,800) was only half
of the amount received by men ($9,600). Additionally, women have lower labor par-
ticipation rates and lower wages than men; as a result women are more likely to
be poor. Women make up the majority of those whom Social Security lifts fi"om pov-
erty. In 1997, three of every five elderly people lifted out of poverty by Social Secu-
rity were women.
While Social Security is intended to be one leg of a "three-legged stool" for retire-
ment income, the lack of pension coverage and limited resources for savings place
greater weight on Social Security as a reliable, guaranteed source of income for
many people of color and women.
Social Security's Protections for African Americans
The argument has been made that Social Security provides a lower rate of return
to African Americans because this community has a lower hfe expectancy than the
general population. Based on this premise, an African American worker would con-
tribute payroll taxes, but would not live long enough to receive Social Security bene-
fits sufficient to achieve the same rate of return as non-African American bene-
30
ficiaries. This reasoning is faulty, however, as it overlooks important protections So-
cial Security provides for African-American and low-wage workers including disabil-
ity and survivors insurance.
The design of the Social Security system helps to compensate African Americans
for their shorter life expectancy. There are three aspects of the program that provide
such protection. First, Social Securit/s benefit formula is progressive. Benefits re-
place a larger percentage of pre-retirement earnings for low-wage workers than
high-wage workers. Since African Americans are disproportionately represented
among low-wage earners, they gain from this formula.
The second feature is the option for early retirement. The Social Security System
allows workers either to retire with full benefits at a given age, currently 65, or to
retire early with reduced benefits. A worker can take early retirement at age 62.
Workers who retire at 62 contribute payroll taxes for three fewer years. They also
begin receiving benefits 3 years earlier, with monthly benefits reduced to com-
pensate for the increased number of years during which they will receive benefits.
The reduction in the monthly benefit amount for those who retire early is based
on actuarial tables and is intended to make the amount of benefits received from
age 62 to the point of death equivalent, on average, to the amount of benefits retir-
ees would receive if they waited until the "normal retirement age" to retire. Over
the population as a whole, the Social Security early retirement option is close to a
wash the lower monthly benefits paid are designed to offset the increased number
of years for which benefits will be received.
The story is different, however, for African Americans. Given the shorter life span
for African Americans, the benefits these early retirees receive from age 62 to the
end of their lives exceed the benefits they would receive, as a group, if they waited
until 65 to retire. Starting to receive benefits several years earlier increases the
total benefits they receive and raises their average rate of return. Two-thirds of all
workers, including African Americans retire early. Thus, most African-American re-
tirees are partially compensated for their shorter life span by this aspect of Social
Security.
The third component of Social Security that mitigates the impact of higher mor-
tality among African Americans is the comprehensive nature of the program. Social
Security is not solely a retirement program, but also an insurance system that pro-
tects against risks that are unforeseen or for which workers are not sufficiently pre-
pared. In addition to benefits for retired workers. Social Security provides benefits
to the worker's spouse and dependents when the worker retires or becomes disabled,
as well as survivors' benefits if the worker dies. The divorced spouse of the retired
or deceased worker also is generally entitled to benefits.
African Americans benefit disproportionately from the disability and survivors
components of Social Security. While African Americans account for 11 percent of
the civihan labor force, they comprise 18 percent of the workers receiving Social Se-
curity disability benefits in 1996. When a worker becomes disabled, the worker's de-
pendents also become eligible for Social Security benefits. African Americans made
up 23 percent of children and 15 percent of the spouses who received Social Security
benefits in 1996 because workers in their families were disabled.
As a result of the above-average mortality rates among African Americans, the
African-American community benefits disproportionately from the feature of Social
Security that provides benefits to non-elderly survivors. Although African-American
children comprise about 16 percent of all children in the United States, they made
up 24 percent of the children receiving survivors benefits in 1996. African Ameri-
cans also accounted for 21 percent of the spouses with children who received sur-
vivors benefits. Benefits for non-aged survivors are one of the aspects of Social Secu-
rity most favorable to African-American workers.
Some studies have attempted to estimate Social Security's rate of return for Afri-
can Americans. The Social Security Administration's (SSA) Office of the Chief Actu-
ary has assessed some of these estimates, such as those used by The Heritage Foun-
dation, as well as the methodology for reaching the estimates. The actuaries found
that the methodology was inaccurate and the estimates were wrong. Robert Myers,
a former Chief Actuary of SSA, also has sharply criticized Heritage's estimates as
fundamentally flawed and invalid.
Most of these studies faced a major limitation. They did not have access to the
one database on actual earnings records of workers and actual benefits of retirees,
the Social Security Administration's Continuous Work History database. This infor-
mation is confidential and is not released to the public so that the privacy of work-
ers and beneficiaries will be protected. These data have been available only to
Treasury and SSA researchers. One study that had access to these data was con-
ducted by employees of the Treasury Department (Duggan, Gillingham, and
Greenlees). These researchers found that African Americans had a slightly higher
31
rate of return from Social Security retirees and survivors benefits than the general
population. A second study by the Social Security Administration also used this
database and looked specifically at disability insurance. It shows that Mrican Amer-
icans received substantially more benefits from Social Security Disability Insurance
in relation to the taxes they have paid than whites do. Thus, despite the shorter
life span of African Americans, aspects of the programs such as the progressive ben-
efit, early retirement and comprehensive insurance, offset the effects of higher mor-
tality rates for this community.
Social Security's Protections for Hispanic Americans
Social Security also is of particular value to Hispanic Americans for another rea-
son. Hispanic retirees live longer, on average, than other Americans. The average
American who reaches 65 (including both men and women) will live an additional
17y2 years, while the average Hispanic reaching 65 lives an additional 2OV2 years.
Those with a longer life span receive more monthly benefit checks from Social Secu-
rity. Furthermore, Social Security's annual cost-of-living adjustment a feature most
private annuities do not have is of greater value for those who live longer.
Hispanic Americans thus benefit doubly from Social Security; they benefit both
from Social Security's provision of benefits that keep pace with inflation and cannot
run out no matter how long one lives, and also from Social Security's progressive
benefit formula, which ensures that individuals who earned lower wages and/or had
fewer years in the workforce receive larger monthly benefit amounts, in proportion
to the wages they earned and the taxes they paid, than other workers do. Since His-
panic retirees on average have lower wages and fewer covered years of employment
and also live longer than other workers, they receive benefit levels that return the
taxes they paid in fewer years than average retirees do, while also receiving benefits
for more years than the average retiree.
Hispanics consequently are one of the groups for which Social Security is most
beneficial. A recent Social Security Administration fact sheet notes that Hispanic
American beneficiaries "on average receive a higher rate of return on taxes paid."
A recent analysis by the Deputy Chief Actuary of the Social Security Administration
explains that "a somewhat higher rate of return for Hispanic Americans is to be ex-
pected, based on the higher life expectancy for Hispanic Americans, and the fact
that Hispanic Americans have lower than average earnings."
Social Security's Protections for Women
Several factors within the Social Security benefit structure help to compensate for
the lower earnings of women. The benefit formula helps in two ways. First, the ben-
efit formula is made progressive by providing low-wage workers with a substantially
higher percentage of their pre-retirement earnings than higher wage workers. This
aspect of the formula favors women, since their wages are lower than men's wages.
In fact. Social Security replaces 54 percent of the average lifetime earnings for the
median female retiree and 41 percent for the earnings of the median male retire.
The second way in which the benefit formula helps women is through the deter-
mination of the worker's average wage over his or her work life. This average wage
is a critical part of the benefit formula. The average wage is the amount of earnings
to which the progressive formula is applied. In determining the average, five of the
lowest years of a worker's earnings (including years with no earnings) are elimi-
nated from the 40 years of earnings history that are reviewed. Since women are
more likely than men to have dropped out of the labor force or to have worked part
time, the elimination of the five lowest years helps to raise the average earnings
figure used to compute their Social Security benefits.
In addition to the progressive benefit formula. Social Security provides other com-
pensation to married women. A married woman can receive either a benefit based
on her own earnings history or a spouse benefit equal to 50 percent of her husband's
benefit, whichever is larger. Although the number of women in the workforce has
grown tremendously since the 1960's, some 63 percent of women beneficiaries 65
and older receive benefits based on their husbands' earnings records. Given the
longer life span for women, they also benefit greatly from the survivors insurance
component of Social Security. An elderly woman who outlives her husband can re-
ceive a survivors benefit that is based on her own earnings history or she can re-
ceive 100 percent of her deceased husbands benefit, whichever is larger. Approxi-
mately 74 percent of elderly widows receive benefits based on their deceased hus-
bands' earnings. A woman is eligible for spouse and survivors benefit even if she
is divorced, as long as she was married for 10 years and did not remarry before age
62.
32
Finally, the annual cost-of-living adjustment particularly benefits women due to
their longer life span. Without this annual increase in benefits, the bujdng power
of elderly women would decline substantially as they grow older.
As a result of these protections, women receive a higher rate of return from Social
Security than men. Data from the Social Security Administration indicate that
women pay 38 percent of the payroll taxes, but they receive 53 percent of the bene-
fits.
The Need for Reform
Although the Social Security System has clearly served as an important source
of income for the general population, including African Americans, demographic
changes necessitate reforms in the program to maintain solvency. The baby-boom
generation is aging and will begin retiring in large numbers after 2010. By 2025,
most of this group will be 65 or older.
Moreover, rising life expectancy will further increase the number and proportion
of the population that is elderly. The Social Security actuaries' projections, reported
by the Social Security trustees, show the number of people age 65 and older will
nearly double from 34 million in 1995 to 61 million in 2025. During that period, the
proportion of the total population that is elderly will grow from 12.5 percent to 18.2
{)ercent. There also will be a decline in the rate of growth of the working-age popu-
ation. As a result of these various changes, the ratio of workers to Social Security
beneficiaries will decrease from just over three-to-one today to two-to-one in 2030,
and remain at approximately this level through 2075, the last year of the actuaries'
projections. At that point, the elderly will comprise 22.7 percent of the total popu-
lation.
Social Security pa)rroll tax revenues currently exceed benefit payments and the
trust funds are accumulating assets. The demographic changes that lie ahead, how-
ever, will result in substantial increases in benefit pa3rments in coming decades and
create an actuarial imbalance in the program over the long-term. The actuaries
project that the assets in the trust funds will be exhausted by 2034.
After 2034, the trust funds will be dependent entirely on payroll tax collections
for income. From that time on. Social Security will be insolvent because it will not
have sufficient annual income to make the full benefit payments to which its bene-
ficiaries are entitled by law. This does not mean Social Security will collapse at that
time and have no funds to pay any benefits; to the contrary, the problem is that
after 2034, incoming payroll taxes are projected to be sufficient to cover about 70
percent of the benefit payments, rather than 100 percent of these costs. Policy-
makers need to make policy changes that eliminate this shortfall.
Drawbacks of Some Individual Account Proposals
Some proposals to reform Social Security would be particularly disadvantageous
to people of color and women. Proposals to fully or partially privatize Social Security
by diverting payroll taxes from the Social Security trust funds to individual ac-
counts would have a detrimental impact on low-wage workers, people of color, and
women.
How is it possible for advocates of individual accounts that replace Social Security
benefits to claim that their proposals will benefit people of color , women and low-
wage workers? The answer is proponents of these accounts often fail to factor in the
costs and risk of such individual accounts when determining the rate of return for
the accounts. There are three such types of costs transition costs, the administrative
costs, and the cost to convert accounts to annuities.
If retirement benefits are privatized, the payroll taxes that are currently used to
finance Social Security retirement benefits will instead be deposited in individual
accounts. That will create a financing gap funds will be needed to fulfill the govern-
ment's obligation to pay Social Security benefits to current retirees and those near-
ing retirement. Robert Reischauer, a senior fellow at the Brookings Institution, ad-
dressed this point in his statement at the White House Forum on Social Security
in New Mexico, July 27, 1998. "Whether we retain the existing system or privatize
it, this unfunded liability will have to be met unless we renege on the benefits prom-
ised to today's elderly and near elderly. Dealing with the unfunded liability inescap-
ably will reduce the returns workers can expect on their contributions."
Under a privatized system that diverts all payroll taxes into individual accounts,
workers would have to pay a new tax to continue financing the Social Security bene-
fits of current and soon-to-be retirees. As senior researcher Paul Yakoboski of the
Employee Benefit Research Institute has testified, "Because the current Social Secu-
rity system is largely pay-as-you-go, most of what workers pay into the system
funds today's benefits. . . . [0]n top of paying current benefits, workers moving to
33
a privatized system would have to pay 'twice' for the benefits going to today's bene-
ficiaries and again to their own [personal] accounts."
A study conducted by the Employee Benefit Research Institute incorporated tran-
sition costs into its calculations. It found that for workers who are 21 today and re-
ceive low wages, the rate of return would be lower under the individual accounts
options it examined than under all options it examined to restore long-term balance
to Social Security without individual accounts.
Administrative costs further reduce the rate of return for individual accounts. Ac-
counts that are designed like IRA accounts will result in significant administrative
costs and management fees, which would be paid out of the proceeds of the accounts
and consequently reduce the amounts available in those accounts to pay retirement
benefits. Moreover, additional costs are incurred when the funds in these accounts
are converted to lifetime annuities upon retirement.
Based on data on IRA accounts, two eminent Social Security experts Henry Aaron
of the Brookings Institution and Peter Diamond of M.I.T. have estimated that the
administrative costs for retirement accounts like IRAs would consume 20 percent of
the amounts that otherwise would be available in these accounts to pay retirement
benefits. They note that a 1 -percent annual charge on funds in such accounts eats
up, over a 40-year work career, 20 percent of the funds in the accounts. The 1994-
1996 Advisory Council on Social Security estimated an annual charge of 1 percent
on the assets in privately managed individual accounts.
Furthermore, recent financial data indicate that a 1-percent annual charge is a
conservative estimate. In 1997, the average annual charge on stock mutual funds
was 1.49 percent of the amounts invested in those funds. In addition, Diamond has
noted that administrative and management costs consume approximately 20 percent
of the amounts in individual accounts in Chile's privatized retirement system. Re-
search by Mamta Murthi, J. Michael Orszag and Peter R. Orszag showed that the
combination of these fees and annuitization costs eat up an average of 43 percent
of the funds in privatized retirement accounts in Great Britain.
Some of these costs are fixed-dollar expenses that do not vary with the size of an
account. As a result, such costs would generally consume a larger percentage of the
amounts in smaller-than-average accounts ( and a smaller percentage of the amounts
in large accounts). This suggests these costs would, on average, consume more than
20 percent of the funds in the accounts of lower-wage workers. That is of particular
significance to Afincan-Americans since, as a group, they receive lower-than-average
wages and would consequently have smaller-than-average accounts.
To these costs must be added the costs of converting an individual account to an
annuity upon retirement. The leading research on this matter indicates that an ad-
ditional 15 percent to 20 percent of the value of an individual account is consumed
by the costs that private firms charge for converting accounts to annuities. The Gen-
eral Accounting Office recently noted that "While individual annuities are available,
they can be costly especially relative to annuities provided through Social Security."
Taking all of these costs into account both administrative and management fees
and the costs of converting accounts to annuities Aaron estimates that at least 30
percent and as much as 50 percent of the amounts amassed in individual accounts
similar to IRAs would be consumed by these costs rather than being available to
provide retirement income. (While the administrative cost would be lower for ac-
counts centrally managed similar to the Federal employees Thrift Savings Plan, the
cost would still be significantly higher than the administrative cost for Social Secu-
rity.)
In addition to the costs of these individual accounts, there are some risks. Retir-
ees who are particularly lucky or wise in their investments could receive retirement
income from individual accounts that more than offsets their loss of Social Security
benefits. But retirees who are less lucky or wise, including those who retire and con-
vert their account to a lifetime annuity in a year the stock market is down, would
likely face large reductions in the income they have to live on in their declining
years.
A recent GAO report takes note of these issues. "There is a much greater risk
for significant deterioration of an individual's 'nest egg' under a system of individual
accounts," the GAO wrote. "Not only would individuals bear the risk that market
returns would fall overall but also that their own investments would perform poorly
even if the market, as a whole, did well.
This is a concern for workers in general surveys have found Americans are not
very knowledgeable about financial markets and a particular concern for lower-wage
workers, who generally would not be able to afford as good investment advice as
individuals at higher income levels. Moreover, lower-income groups have less invest-
ment experience and would be more likely to invest in an overly conservative man-
ner because they could not afford to expose the funds in their accounts to much risk.
34
African Americans, Hispanic Americans and women make up disproportionate
shares of the low-income population. As a result, they would be likely to receive a
somewhat lower-than-average return on amounts invested even while, as explained
above, they would likely pay an above-average percentage of their holdings in fees.
Shortcomings of the Archer-Shaw Plan
Representatives Bill Archer and Clay Shaw recently introduced a Social Security
reform plan with individual accounts that attempts to address several of the limita-
tions previously noted. Under their plan, long term solvency would be restored,
beneficiaries would be guaranteed to receive the benefit levels to which current law
entitles them, and Social Security taxes would not be increased. However, there re-
main several shortcomings that have important consequences for people of color and
women.
The Archer-Shaw plan makes large transfers of general revenue to Social Security
that could place too great a strain on the rest of the budget for much of the next
half century. If most or all of the non-Social Security surplus is consumed by tax
cuts, as the Congressional budget resolution envisions (or by a combination of tax
cuts and upward adjustments in discretionary spending levels, as could result from
negotiations between Congress and the Administration), there would be only one
place from which the plan's individual accounts could initially be funded the Social
Security surpluses. This evidently is what the plan's sponsors have in mind.
After about 2012, however, the plan's costs would exceed the Social Security sur-
plus. For several decades after that, financing the individual accounts the plan
would establish would result in substantial problems for the rest of the budget and
likely lead to large cuts in other programs, increases in taxes, or budget deficits.
The cost of the plan would be substantial in these years. The plan's costs include
not only the cost of depositing funds into the individual accounts but also the cost
of higher interest payments on the Federal debt. (Higher interest pajonents would
have to be made because large sums would have been deposited in the individual
accounts rather than used to pay down the debt.) According to the Social Security
actuaries, the net costs of the Archer-Shaw plan the costs of the deposits into indi-
vidual accounts and the higher interest payments on the debt, minus the savings
the plan would produce in Social Security costs would run from $300 billion to $600
billion a year each year fi"om 2016 through 2042.
With the Social Security surpluses no longer able to cover such costs and with
little, if any, surplus likely to remain in the non-Social Security budget in these
years because the baby boomers will be retiring in large numbers and costs for
health care programs and some other expenditures will be mounting accordingly fi-
nancing the individual accounts is likely to entail substantial tax increases or pro-
gram cuts if policymakers seek to avoid sizeable deficits.
Some of the programs that would be cut are likely to be programs that benefit
people of color and women. Thus, while their Social Security benefits are guaran-
teed, other programs of importance to their lives could be reduced.
The plan also raises equity concerns. The only group of retirees who could receive
an increase in government-funded retirement benefits under the plan would be
upper-income workers. Yet a broad array of Americans, including many of average
or modest means, might have to absorb cuts in other benefits or services or tax in-
creases to help finance the individual accounts after 2012.
Finally, there is a high degree of risk that the plan would lead over time to a
substantial weakening of support for Social Security. This is one of the plan's most
significant weaknesses over time, it could undermine the system it seeks to save.
Under the plan, many middle- and upper-middle-income workers would receive only
a modest Social Security benefit, which would equal the difference between the an-
nuity pajrment fi"om their individual account and the Social Security benefit level
to which they are entitled. Social Security would appear to provide little in return
for the 12.4 percent of wages these workers and their employers pay into the Socitd
Security system. As a result, higher-wage workers may become less supportive of
Social Security while low-wage workers remain reliant on the program. The univer-
sal support that the program now enjoys would be placed at risk.
Moreover, the plan could invite misleading comparisons. Many retirees would
likely compare the annuity benefit their individual accotmt would provide which
would have been financed with annual deposits equal to 2 percent of their wages
to their Social Security benefit, financed with 12.4 percent of their wages. They
could conclude Social Security was a bad deal and the law should be changed to
shift large sums from Social Security to individual accovmts. As a number of leading
Social Security analysts have written, however, such a comparison would be highly
misleading; it would ignore the fact that Social Security payroll taxes must finance
35
benefits to previous generations of workers, pay for disability and survivors insur-
ance, and finance the provision of more adequate benefits to low-wage workers and
to spouses who spent years out of the labor force raising children, among others.
If the same amount of additional funding were provided directly to the Social Secu-
rity trust funds and allowed to be invested in a similarly diversified manner, the
Social Security trust funds would secure a higher rate of return than the Archer-
Shaw individual accounts, since the administrative costs of establishing and main-
taining 150 milUon individual accounts would be avoided.
An Alternative Approach
President Clinton has proposed an alternative plan to reform Social Security and
several aspects of the plan could be beneficial to people of color and women. In his
1999 State of the Union address. President Clinton proposed to transfer 62 percent
of the unified budget surplus to the Social Security Trust Funds. These funds would
be used to pay down the debt held by the public.
The President's plan would also invest 15 percent of the trust funds in the equi-
ties. These investments would be overseen by a new independent institution outside
the executive branch that would be designed to be insulated from political pres-
sures. The equity investments would be limited to passive investments in broad
index funds. Investing a portion of the trust funds in equities markets would enable
Social Security to earn higher rates of return and meet its long-term obligations
without having to reduce benefits or raise taxes as much as would otherwise be nec-
essary.
If a goal of Social Security reform is to raise the rate of return to Social Security,
it is not necessary to create individual accounts to achieve this goal. Increased rates
of return are not the result of individual accounts; they are the result of advanced
funding (that is, setting aside the funds needed to pay Social Security benefits in
advance). By investing the Trust Funds in equities, advanced funding can be
achieved without the transition costs or administrative costs of individual accounts.
By contrast, the Archer-Shaw plan is structured in a way that renders it ineffi-
cient. The plan would transfer general revenues to individual accotmts that would
be managed by Wall Street brokerage firms and other private fund managers and
enable these firms to take substantial sums out of the accounts in commissions and
management fees, only to have nearly all of the proceeds from these individual ac-
counts then transferred back to the Social Security trust funds to help pay Social
Security benefits. Based on the actuaries' assumptions regarding these costs, the ad-
ministrative and management costs that would be paid on these accounts would
total approximately $350 billion over the system's first 30 years, equaling $34 billion
a year by 2030 and larger amounts in years after that. It makes little sense to incur
costs of this magnitude.
A third component of the President's plan is to commit 12 percent of the unified
budget surplus to the creation of USA Accounts. The President's plan would pre-
serve the guaranteed benefit that is the cornerstone of the Social Security system
and would not divert any revenue fi-om the trust funds. Furthermore, the USA ac-
counts are designed to be progressive in several ways. They are targeted to low- and
middle-income earners and their spouses. The government would contribute the
same amount of money ($300) to each worker's account. This means the contribution
will represent a higher percentage of income for low-wage earners than for high
wage earners. And under this proposal, the government would also provide progres-
sive matching contributions to workers who add their own savings to their accounts
or to a 401(k)-type employer-sponsored plan. Low- and moderate-income workers
would receive a dollar-for-doUar match. This government match would be phased
down to 50 cents for higher-income workers until the income eligibility ends.
Not only do these accounts primarily benefit low- and moderate- income workers,
they incorporate the spouse protection feature of Social Security that would benefit
women. Spouses, both current and divorced, are eligible for USA accounts even if
they do not work outside the home.
This proposal would not alter the basic structure of the Social Security system
that has played such a vital role in the economic well-being of people of color and
women. At the same time, it would encourage savings using a design that targets
resources to workers who would benefit the most fi-om an increase in their retire-
ment income.
Chairman Smith. Dr. Kijakazi, if I say it enough, I think I am
going to come closer every time.
We will stay pretty close to the 5 minutes for members and if we
have a chance to go around a second or third time, we will.
36
Dr. Kotlikoff, let me start with you.
If we move ahead with your suggestion to move to a partially
privatized system, how would you accommodate the problems that
have been described? Would you make the system progressive, and
how might you do that for the disadvantage it might have to lower-
income workers?
Mr. Kotlikoff. I think that the concerns that were just raised
about the treatment of women and people of color under a
privatized system may arise under certain proposals, but not under
the plan that I have developed with Jeff Sachs, who is an econo-
mist at Harvard. Our plan has been endorsed by 65 top academic
economists, including three Nobel Prize winners.
Our plan would have people contribute 8 percentage points of
their 12.4 percentage point payroll tax to individual accounts. The
other 4.4 percentage points would be left to pay for the survivor in-
surance and the disability insurance programs. If you die early or
if you become disabled, you would still get the same Social Security
benefits you would otherwise get from those programs.
It is just the retirement portion of Social Security that would be
privatized. You and your spouse would contribute 8 percent up to
the covered taxable maximum, and that would be divided 50-50.
Each spouse would get the same size account. So you would have
protection for dependent spouses. Mothers who stay home with
children would have an equal-size account to the husbands.
The plan also has a matching contribution made by the govern-
ment, which is calculated on a progressive basis. So you can have
as much progressivity under our plan as you would like. All ac-
count balances would be invested in a global index fund that is
market-weighted, just like the S&P 500. All you need is a computer
to operate this fund, but you wouldn't be just investing in U.S.
stocks, you would also be investing in U.S. bonds and stocks and
bonds that are listed throughout the world.
Since our plan puts everyone in the same portfolio, everyone gets
the same fair deal and the same good deal that the marketplace
can deliver. Hence, the concern about some people earning higher
rates of return than others would be eliminated in our plan.
Between age 60 and 70 your account balances would be gradually
sold off every day on the market and transformed into an inflation-
protected annuity. This would protect older people from spending
their money too quickly. They would be assured of an annuity until
they passed away. If you died prior to age 70, anything that wasn't
annuitized at that point would be bequeathable to your heirs.
In contrast to our purpose, we now have a system where the chil-
dren of the poor end up not receiving any inheritances when their
parents die because all of the earnings of the parents are com-
pletely covered by Social Security and they are not able to accumu-
late any wealth for their old age.
The only issue left to discuss is paying for the benefits under the
old system. We would give people their accrued benefits when they
reached retirement — that is, the benefits they had earned under
the old system as of the time of the reform. For example, at age
65, Social Security would pay me benefits based on my earnings
record up through my current age, which is 49, with zeroes filled
in on my earnings record thereafter. They would treat me the same
37
as if I were to leave the country right now and never contribute
another penny to Social Security. I would still get a benefit, which
is my accrued benefit at retirement.
So, in the aggregate, everybody is in the new system at the mar-
gin, but everybody gets their accrued benefits, and in the aggre-
gate, there is no new accrual of benefits under the old system. Now
paying off the old accrued benefits means pa3ring off this time path
of benefits, which, declines to zero. How would we do this? The an-
swer is a business cash flow tax. In the long run, you would have
no payroll tax to pay for the retirement portion of Social Security,
but you would have a very vibrant, fair, progressive, protective sys-
tem for American workers that would be yielding a terrific rate of
return on the marketplace.
Chairman Smith. Ms. Olsen, do you have any specific sugges-
tions to accommodate the reduced benefits of private investment in
terms of the benefits collected by a nonworking spouse or a partial-
time-working spouse?
Ms. Olsen. Well, what you would have is a system called "earn-
ings sharing," and there are some details on it in my paper. So, for
example, earnings sharing is a fancy way of saying that a husband
and wife would split their retirement income with each other, and
you can do it from the day that you get married. So, for example,
if I decide to become a stay-at-home wife and not work for the next
20 years or something, every time my husband's payment would go
off into his account, half of it would go into my account. So I would
own my own account and he would own his own account, and in
that case, I could accumulate funds on my own.
In addition, if I reenter the work force at some point, which is
the most likely situation for most women, I would also be able to
start contributing to my account and divide it with him as well. So
both of us end up with significant pools of retirement income in the
end.
I wanted to address just really briefly this notion, when you
asked Larry about the progressive benefit structure and how you
would compensate for it. You wouldn't need to necessarily put a
progressive benefit structure in because the returns in a private
system are so much greater than you get from Social Security. The
reason you have to have a progressive benefit structure under So-
cial Security is because the money is not saved or invested for the
future. When you do that, you eliminate that need and people can
stand very independently with their own accounts.
Chairman Smith. Congresswoman Rivers.
Ms. Rivers. I have a couple of questions. One is a clarifying
question to Mr. Kotlikoff.
When you mentioned earlier that you would need an additional
4 percent, the numbers I have seen are 2.2 percent. Is the 4 per-
cent a product of delay, the longer you wait, the more you need?
Mr. Kotlikoff. No. Social Security's figure was 2.2 last year. I
think the more recent number is 2.07, given the more favorable
economic news. But the 2.07 figure is based on pajdng for the sys-
tem for just 75 years. If you ask Steve Goss, who is the Deputy
Chief Actuary at Social Security, to not truncate his analysis, but
rather to tell you how much it would cost to pay for Social Security
on an ongoing basis (because there are huge deficits in the year
38
1976, 1977 and the year after), Steve will tell you the required tax
hike is double or more.
Ms. Rivers. So for perpetuity?
Mr. KOTLIKOFF. Yes. Let me point out that right now we are 16
years beyond 1983. Back in 1983 when Robert Dole and others,
quote, "saved Social Security," they only looked 75 years into the
future. But there were huge deficits in the outyears back then.
Since 1983, we have brought those big deficits into our current
75-year window. So if you really want to solve this problem, you
have to solve it once and for all. You can't do so by forecasting
based on a truncated horizon.
Ms. Rivers. Unless the human genome people we talked to a few
times are correct, we are all going to live to be 130 years old, and
then nobody's plan is going to work.
Mr. KOTLIKOFF. Good news, bad news. It would be tough to work.
Ms. Rivers. The other question I have is, to go back to the pro-
gressive structure, both Ms. Olsen and Dr. Kotlikoff spoke to it. Be-
cause at some point, Mr. Kotlikoff, you talked about the fairer sys-
tem, a fairer system. And one of the hallmarks of the system has
been that people at the lower end actually draw more recognition
that they will need more to live on. And even though the argument
is that you will get tremendous returns, we had a progressive sys-
tem built in when people were getting three times or four times
what people put in. From the very beginning, there has been a pro-
gressive structure. So I don't think it is based on what the return
is going to be; there is a recognition of the people at the lower end.
What happens to them?
Mr. Kotlikoff. Well, in our proposal you would have the govern-
ment providing a progressive matching contribution. The first so
many dollars would be matched at a certain rate, and the next so
many dollars would be matched at a lower rate, and the next would
be matched at an even lower rate. This would provide a progressive
match, just like the President's USA accounts proposal.
By the way, I forgot to mention, our plan calls for the govern-
ment to make contributions on behalf of the disabled, so they
would be protected as well. Again, we have as much progressivity
as you would like to design, we have protection for dependent
spouses, we have everyone earning the same rate of return, and we
have this done on a large enough scale so it is all very inexpensive
in terms of the transactions costs. Since everybody is invested in
the same portfolio, one could buy that from your local investment
company at a very low, competitive rate. Alternatively, Congress
could just run the whole thing through the Social Security trust
fund and let it play the Provident Fund and manage these ac-
counts. Bear in mind though that there is basically no management
to be done. It is just investing with the computer.
Ms. Rivers. The ongoing costs that the government would con-
tinue to provide matching for lower income, paying fully for dis-
abled, would those be a product of payroll taxes?
Mr. Kotlikoff. Under our plan, we are calling for a business
cash flow tax that would probably start around 8 percentage points
and go down through time to probably around 2 or 3 percentage
points. It would pay for the benefits under the old system that have
been accrued, that you still have to pay off; and it would also pay
39
for contributions for this progressive match and also contributions
on behalf of the disabled.
Ms. Rivers. So that, essentially, employers would continue to
bear the same burden they have up until now?
Mr. KoTLiKOFF. No, the burden on workers would fall because
their 8 percentage point payroll tax is now going to be private sav-
ing into their private account. They are going to get a tax cut.
However, they and everyone else are going to pay this business
cash flow tax, which is effectively a consumption tax. But this is
a broad-based tax, so the middle class and rich elderly, as well as
the workers, would be pajdng this consumption tax.
On balance, the burden on young workers would actually be
lower in moving to this kind of a tax structure. The poor elderly
would be completely insulated because they are living off of Social
Security. Those benefits are indexed to the price level, so their pur-
chasing power is completely protected under our plan. It is just the
rich and the middle class elderly that would, in effect, have to pay
this consumption tax.
Ms. Rivers. Ms. Olsen, one of the questions I had is regarding
the inequities you mentioned, and you gave several, but the one
that stood out was women, because even though women may draw
at a lower rate, isn't it in fact true that women live longer and
therefore may draw, in fact, more than men do from the system?
Ms. Olsen. Yes, absolutely.
Ms. Rivers. So what is the inequity?
Ms. Olsen. The problem is that what happens under the dual
entitlement rule is that you can pay payroll taxes for 40 years and
get nothing in return. Instead, you get a benefit based on being a
spouse.
If you look at the alternative to that, which would be a personal
retirement account, every dollar that you earn would work for you,
regardless. So in other words, under a private system you would
utilize that, all your years of contributions would actually work for
you, whereas in the present system, they are sort of tossed away.
Ms. Rivers. The inequity is between what you would draw under
the current system versus what you project someone would draw
under a privatized system? Is that the inequity you are talking
about?
Mr. KOTLIKOFF. Could I just respond? Let me put an economist's
spin on this.
I would say that the way to think about this is that at the mar-
gin, women in this situation aren't getting anything back, so the
inequity is that they face a higher marginal tax rate. On the other
hand, their average tax is lower under the system. So women are
being given something for doing nothing, but then they are being
told, "if you work, you are going to pay, all together, 15.3 percent
of your pay to Social Security and Medicare, and at the margin get
nothing more back for that contribution.
Ms. Rivers. But since she has the choice of the benefits that are
directly reflective on what she has done as a worker or those as
a spouse, she could choose the higher.
Mr. KOTLIKOFF. It is not inequitable in the sense of the total ben-
efit or average benefit, but it is inequitable in terms of the incen-
tives that people face to work. You are telling women, if you work,
40
you lose this part of your wages and you get nothing back in re-
turn.
Chairman Smith. The gentlewoman's time has expired.
Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman.
Ms. Kijakazi, you indicated, and I believe indicated correctly,
that the Clinton proposal would reduce the government's interest
costs; however, CBO has shown that the public debt would increase
dramatically under the Clinton plan. Wouldn't we have to pay in-
terest on all of that debt as well?
Ms. Kijakazi. My understanding is that the public debt is what
is being reduced. The only portion that is not being affected is the
debt within the government, so it is the public debt that is being
reduced and the interest on that public debt is being reduced.
Mr. Herger. Right. But interest on the government debt being
increased far more, or transferring from public debt, which I be-
lieve is a positive thing, but I believe it is only a part of the equa-
tion.
The other part of the equation is the tremendous amount of debt
that is government debt that ultimately is owed by our children
and grandchildren and those who come after us. I just would like
to, if I could, clarify that somehow we are not forgetting or negat-
ing that debt as though somehow it doesn't count, or that somehow
our Nation and our children aren't going to have to pay for that.
Ms. Kijakazi. I think what you are referring to are the credits
to the Social Security trust fund.
Mr. Herger. Right, correct.
Ms. Kijakazi. That would be in the form of Treasury securities,
and
Mr. Herger. IOUs.
Ms. Kijakazi. And to date, the government has never defaulted
on any of its Treasury securities, for Social Security or bonds held
by the public.
Mr. Herger. Who would pay for that? Why is that true? Where
does that money come from?
Ms. Kijakazi. As benefits need to be paid, the Treasury securi-
ties are redeemed by the Treasury using incoming revenue.
Mr. Herger. But the point is, they are redeemed by somehow
going into debt, by somehow — the ones who ultimately owe it, and
I am very concerned, because it seems like every time we go
through this, we kind of go over that very quickly as though it
doesn't count.
But the fact is, we are trading present debt, which is public debt,
we are trading that for future debt which will— in which the only
ones that will pay for that will be future taxpayers. There isn't any
company or any business that somehow is making money to gen-
erate paying for that. It is only taxpayers. That is the only point,
I believe, that is crucially important that we make at the same
time we make the fact of the positive gain, which — I do believe it
is positive, of reducing public debt, reducing the debt which helps
to lower interest rates.
But it is not like it doesn't count, and that is the only point I
would like to make.
41
Ms. KiJAKAZi. Yes, and the point that I was attempting to make
is that through the President's plan, the surplus is being preserved
by paying down the debt, as opposed to using the surplus for addi-
tional spending or for tax cuts. Reducing the debt creates savings
by reducing interest payments. These savings can be used to help
meet future fiscal demands, especially when the baby boom genera-
tion retires.
Mr. Herger. Right. But again, that is only less than half of the
equation. The other more than half of the equation is, we are creat-
ing this huge government debt that is owed by our children and
our grandchildren to be paid through taxes.
Let me move on to another question, and that is just a — the
present, or at least — I don't want to word this in the wrong way,
but I gather from your testimony that our present Social Security
system, what is so important with it is that we do pay the women,
I believe you mentioned, and minorities, people of color, 1 think you
mentioned that they are getting — I don't want to put words in your
mouth, I am trying to think back as you said it. Percentage-wise
were you saying that they are receiving a
Ms. KiJAKAZi. Women receive 53 percent of benefits as a result
of the progressive benefit, the spouse benefit, survivor's benefits,
their longer life expectancy, and the cost of living adjustment.
Mr. Herger. And the point being you are receiving a higher per-
centage than some of the others are receiving. Is that correct?
Ms. Kjjakazi. Women receive a higher percentage of the benefits
from Social Security than men, yes.
Mr. Herger. Right. Therefore, the way the Social Security is
working, at least in that aspect, is a positive.
Ms. KiJAKAZi. Yes, there are protections for women.
Mr. Herger. OK. Having established that and just going back to
that, what is your feeling of the proposal that just came out by
Chairman Archer of Ways and Means and Chairman Shaw in
which they would preserve Social Security the way it is, but add
to it a system of independent accounts that, unlike the President,
where the government would own them?
And to some extent, they are somewhat similar, but to another
extent they are very, very different, in that the individuals would
own it, which would be above and beyond what was going into So-
cial Security to benefit them. And they would be guaranteed at
minimum the Social Security that they have now.
What would be your thoughts on that proposal as something
being offered to help this incredible problem we have now of run-
ning out of money in 2013 or 2014?
Ms. KiJAKAZi. There are several shortfalls that we are concerned
about. One has to do with the funding. If, as the budget resolution
envisions, the non-Social Security budget is used for tax cuts, that
leaves an amount equivalent to the Social Security portion of the
budget to fund these individual accounts.
Mr. Herger. I believe that would be part of the tax cut, that
would be a part of the tax cut.
Ms. KiJAKAZi. And the rest of the funding for the
Mr. Herger. That would be in excess of and not including the
surplus of Social Security, so it would be — in other words, 100 per-
cent of Social Security would be saved or lock-boxed or however you
42
want to term it, and then it would be above and beyond that of a
surplus that would go to that. I believe that is how the rec-
ommendation is meant to work.
Ms. KiJAKAZi. My understanding is that the Archer-Shaw plan
would use general funds to fund these individual accounts, and if
the non-Social Security portion of the surplus is set aside for tax
cuts, that leaves an amount equivalent to the Social Security sur-
plus to fund these individual accounts.
Estimates show that the cost for the Archer-Shaw plan would ex-
ceed the Social Security surplus around 2012. Thereafter, funds
have to come from large cuts in other programs, tax increases, or
budget deficits. In order to continue funding these individual ac-
counts it is likely that cuts will be made in discretionary programs,
many of which are beneficial to people of color and women.
A second concern is that these accounts would not be sustainable
and that they would undermine universal support for Social Secu-
rity. If, as the plan is designed. Social Security benefits are reduced
by $1 for every dollar that is in these individual accounts, then in-
dividuals who have the largest accounts, which would be the high-
wage earners, would be getting back very little from Social Secu-
rity, while lower-wage earners who have smaller accounts would be
getting back the bulk of their retirement income from Social Secu-
rity.
Chairman Smith. Dr. Kijakazi, I am going to excuse myself and
interrupt you, because the gentleman's time has expired.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Dr. Kotlikoff, if I understand the proposal, you would fund the
transition costs with an 8 percent consumption tax that would
theoretically decline over time, and you would also deduct the 6.2
percent, or the employee half of the payroll tax, from private ac-
counts. Would the employer side, the employer's 6.2, remain in
place as well?
Mr. Kotlikoff. Well, the 8 percentage point contribution could
be divided 4 and 4, between employers and employees.
Mr. Bentsen. And the 4 points would stay in place?
Mr. Kotlikoff. Well, yes, 4.4 would stay in place to pay for DI
and SI. Those programs would stay in place.
Mr. Bentsen. So to fund the transition is an 8 percent consump-
tion tax?
Mr. Kotlikoff. We'll see some good economic news and some fis-
cal improvement, so in terms of the government's cash flow, it
might not need to be 8 percent. We haven't actually done a serious
costing out. Maybe it is 6 percent.
You may be able to get some general revenues to help pay for
the transition as well.
Mr. Bentsen. And then you talked about progressive structure.
There would be a base benefit?
Mr. Kotlikoff. There would be a matching contribution, which
would be structured on a progressive basis. So if you didn't contrib-
ute an3rthing, there would be no matching contribution. But the
government would contribute on behalf of the disabled. The govern-
ment would also require people who are unemployed to contribute
8 percent of their unemployment checks to the program.
43
But to return to your question, if you are a low-income worker
and you put in your contribution, the government is going to pro-
vide a matching contribution, which is going to be a larger percent-
age for you than for a high-income person.
Mr. Bentsen. So there won't be just a base benefit. It would be —
you would have the 4 percent that is paying a base disability bene-
fit or survivor's benefit in the event that you utilize that?
Mr. KOTLIKOFF. If you become disabled, yes. I wouldn't eliminate
the SSI program.
Mr. Bentsen. And the 8 percent, your benefit then would be
whatever the return is on your 8 percent at the time of retirement,
converted into an annuity. So if it was — if you did well, then you
get a good benefit; if you didn't do well, you
Mr. KOTLIKOFF. Remember, everybody is going to do the same
because everybody is in exactly the same portfolio, which is a glob-
al
Mr. Bentsen. But if it is 8 percent of $20,000 versus 8 percent
of $64,000, then the cross-subsidy that occurs right now would be
eliminated. Because a person with 8 percent of $64,000 would have
a larger core, so they would have greater — you know.
Mr. KOTLIKOFF. Somebody earning $64,000 would get a larger
Social Security benefit today than somebody earning $20,000. But
the matching contribution would be a bigger deal for the low con-
tributor under our proposal, because the match is going to phase
out once your contribution gets large enough. So the first so many
dollars is matched at X percent per dollar; the next so many dollars
of your contribution is matched Y, where Y percent is lower than
X percent.
Mr. Bentsen. And Ms. Olsen, under the Cato — or your concept,
rather, I guess — there would be no — you wouldn't get involved in
this progressive match concept. It is just whatever it is, is.
Ms. Olsen. Right. What we would do — well, first of all, when you
talk about a progressive benefit structure, the whole argument is
based on this idea. It depends on what your goal is for a progres-
sive benefit structure. If it is to redistribute income, then I under-
stand where you are coming from.
Mr. Bentsen. Let me interrupt real quick, because that is an im-
portant thing. Is your goal rate of return, or is it a social insurance
system?
Ms. Olsen. My plan — well, the- Cato plan or the Cato plans actu-
ally do both. Because there would be a Federal guaranteed safety
net that you could set at the poverty level or higher, so that you
could ensure that no worker ever retires in poverty, which you
don't do under Social Security; in that sense, that is a social insur-
ance plan.
In the sense that you are allowed to diversify your portfolio and
get returns from the market, you are also increasing rates of re-
turn, which is also met by the plan obviously.
Can I go back really quickly to say that if your goal is to redis-
tribute income, I understand why you want a progressive benefit
structure; but if the goal of a progressive benefit structure is to en-
sure that nobody lives in poverty or to lift the lot of the lower-in-
come workers, Social Security does a terrible job of that, and what
44
will do better is to allow people to save and invest their funds, so
you don't need it at that point.
Mr. Bentsen. My time is running out, so let me ask you this.
We know that the 8 percent tax is something — maybe 7 percent,
something we need to think about. But I mean, on this other plan,
if it is so great, why haven't we done it other than our own inepti-
tude? I mean, surely somewhere there is a catch.
I don't think the market return is going to be that great. Do you
assume the transition costs? An 8-percent tax is a pretty hefty
transition cost, I think. Somewhere else there has to be a transition
cost. Somewhere — and we discussed this last week, somewhere,
somebody gets a lower benefit; and again that is something we are
very concerned about at this end of the equation, because we tend
to hear from those folks.
I mean, who is it? What is the transition cost? Who gets the
lower benefit? Or does no one get the lower benefit, everybody gets
a bigger benefit, and if so, we can sign up tomorrow.
Ms. Olsen. The way we look at it is the way that Milton Fried-
man looks at it, and that is, Social Security has run up a $9 trillion
unfunded liability. Now, you can either make good on that promise
or you can renege.
What we are saying is that by switching to a private system that
is invested, you can stop running up that debt and then you can
figure out how to pay it. All you are doing is making it explicit. You
are not adding any new debt, and in fact, you are reducing future
debt by doing it. You can finance it any number of ways.
Mr. Bentsen. I understand that, but my question is, how are you
proposing that we finance it? Who has what share that they are
having to pay? Because at the end of the day, that share is real
dollars out of somebody's pocket somewhere. I think that is the key
answer that, you know, politicians are going to want here.
Ms. Olsen. The way that we would do it would be to spread the
costs as much as possible. So we would issue a lot of new debt, we
would cut corporate welfare and things like that. We have three or
four different transition plans that I would be happy to supply you
with.
Chairman Smith. The gentleman's time has expired. Maybe we
can get another short round.
Mr. Ryan.
Mr. Ryan of Wisconsin. Thank you, Mr. Chairman.
One of the benefits of sitting at the end of the table is, I get to
hear people's names repeated many times, so I think I have it
down.
Ms. Kijakazi, I wanted to go back to something you just said iii
your last moment of testimony, where you analyzed the Archer
plan and suggested that the Archer plan would be detrimental to
women and minorities, not because of its design, but because of its
funding stream.
I think you were accurate in sa3ring that our surplus streams are
different. The surplus stream is very big from Social Security sur-
pluses and that dries out in about the year 2014 and our on-budget
income tax surplus stream grows. So if we are putting up a perma-
nent funding structure for a 2 percent private account system, as
you suggested, that may dip into the on-budget surplus.
45
Is that what you suggested? Is that correct?
Ms. KiJAKAZi. My statement was that the budget resolution envi-
sions using the on-budget surplus
Mr. Ryan of Wisconsin. When they have to be tapped?
Ms. KiJAKAZi. No, the on-budget surplus would be used for tax
cuts. That leaves an amount equal to the Social Security surplus
to fund the individual accounts proposed by the Archer-Shaw plan.
Once that Social Security surplus is gone, then it is likely that dis-
cretionary programs will be cut to fund the individual accounts.
Mr. Ryan of Wisconsin. You have to have the money some-
where to pay for that. So your point that it is detrimental to
women and minorities is the assumption that the monies that will
be cut in the year 2015 are programs that are aimed at serving
women and minorities, so it is kind of a political projection that in
the year 2015, they are going to go after those programs, not other
programs.
Ms. KiJAKAZi. That among the programs that would likely be cut
are programs that are beneficial to women and people of color.
Mr. Ryan of Wisconsin. So this is not concrete, more of a specu-
lation?
Ms. Kijakazi. That is right. This is one of the concerns that we
have about the Archer-Shaw proposal.
Mr. Ryan of Wisconsin. I would like to go back to something
else.
I have noticed that we have had conflicting testimony as to So-
cial Security's treatment of women and minorities, and different re-
form plans, but in the current system.
I would like to ask each of the panelists to take a look at each
of the panelist's testimony and talk about how your data refutes
the other person's data. Because listening to the three of you, I am
hearing some conflicting evidence. It sounds like there may be ap-
ples-versus-oranges types of comparisons.
I would like to readdress the issue of, now that you have had the
benefit of listening to each other's testimony, is Social Security a
bad deal for all people? Is it a bad deal for women? Is it a bad deal
for minorities? Or is it a good deal with respect to other programs?
And under personal investment account systems, is it a better
deal for these groups we are talking about?
I would like to start with you if I could.
Ms. Kijakazi. Thank you. I would very much like to address that
point.
I think I have cited data that indicate that Social Security is a
good deal for women. Women pay in 38 percent of the payroll taxes,
but receive 53 percent of the benefits. African Americans receive a
slightly higher rate of return than the general population.
Mr. Ryan of Wisconsin. Related to life expectancy issues?
Ms. Kijakazi. For Hispanic Americans or African Americans?
Mr. Ryan of Wisconsin. Both.
Ms. Kijakazi. For African Americans, it is because of the pro-
gressive benefit, early retirement benefits and the disability and
survivors' insurance.
For Hispanic Americans, it is because of the progressive benefit,
their longer life expectancy which means they receive Social Secu-
rity benefits longer — with cost of living adjustments.
46
Now, in terms of individual accounts, what is not being said here
is that when you invest, there is a chance that you will lose some
or all of what you have invested. There is no mention being made
of this.
Mr. Ryan of Wisconsin. Are those comments directed toward
plans that do not have a guaranteed benefits premise or safety net
put in place in those?
Ms. KiJAKAZi. Yes.
Mr. Ryan of Wisconsin. So they are not directed toward the
plans that do have a guaranteed benefits system?
Ms. KiJAKAZi. Yes.
And I have another comment concerning the plans that do have
this guaranteed system.
Mr. Ryan of Wisconsin. OK.
Ms. KiJAKAZi. With respect to the proposals to which Ms. Olsen
has been making reference, some people will be winners. Are those
winners likely to be low-wage earners? No, for several reasons.
Low-wage will have smaller accounts. Women and low-wage work-
ers tend to invest more conservatively — this is logical because they
cannot afford to lose any of their money. Low-wage earners have
fewer resources to purchase good investment advice. Finally, under
these accounts, it is not clear that spouses, especially divorced
spouses, will receive a share of the individual accounts.
Regarding earnings-sharing, a proposal that was also made by
Ms. Olsen, there was a study done in 1988 by the Center for
Women Policy Studies that indicated that there would be an equal
number of women getting fewer benefits than they do under Social
Security, as there would be people gaining from earnings sharing.
Mr. Ryan of Wisconsin. Since my time is running out, I would
like to ask the other panelists to comment on that data that we
have been hearing as well.
Mr. KOTLIKOFF. Let me just say that I think there is no chance
that the system that I am proposing would deliver as bad a deal
as the current system does to postwar Americans. If you look at the
market's rate of return over any 30-year holding period, it has been
a very big, positive number. I am talking about holding not just
U.S. stocks, but global stocks and global bonds as well.
So there is just no chance really that you could get a system that
is going to pay less than 2 percent, which is what the current sys-
tem— well, it is really probably going to be 1 percent if we continue
to go along the way we are going and have a pa3rroll tax hike,
which is going to have to happen.
If you look at table 5 of my testimony, you will see what I think
is the answer to your question. Congressman, about how Social Se-
curity is treating different groups under current law. To brag just
a little bit, I think this is the most extensive study of Social Secu-
rity's treatment of America's workers that has ever been done, be-
cause it is the only one that has been done based on a microsimula-
tion analysis. It takes into account all of the various benefits under
OASI — survivor, mother, father, children's benefits, earnings test-
ing, early retirement benefits, etc. We nearly bugged the Social Se-
curity actuaries to death getting all the details right.
What you find is that women do do a lot better in terms of inter-
nal rate of return than men, but even the women are earning less
47
than the 3.9 percent you could earn bu3dng a long-term Treasury
bond protected against inflation.
You find that nonwhites do slightly worse in terms of rate of re-
turn than do men. That is a difference with Dr. Kijakazi's perspec-
tive, that nonwhites do appear to be doing worse in terms of rate
of return, even taking into account the progressivity and other fea-
tures of the system.
The noncollege educated do not do as well as the college edu-
cated.
The lifetime poor do a lot better than the middle class in terms
of rates of return and certainly than the lifetime rich.
The basic story however is that none of these rates of return is
around 4 percent, and that is what you can get in the marketplace
today with perfect assurance. That is because we are locked into
paying off the liabilities of the old system.
The only way we are really going to help our kids in the long
run — and that means poor with the male kids, poor nonwhite kids,
and poor female kids as well in the future — the only way we are
really going to help them is to limit their fiscal burden and to limit
the liabilities on them; and the privatization in the manner that I
am proposing would certainly do that.
Chairman Smith. Moving on to Representative Clajd^on.
Mrs. Clayton. Thank you, Mr. Chairman.
I want to thank you for having this hearing. This is an area that
I care a lot about, and I am remiss that I haven't propounded my
questions more thoroughly. But let me just ask — and I know I am
going to have difficulty with these names; I haven't been around
long enough to get the names straight.
Ms. Kijakazi, I wondered if your response that women, minorities
and children were doing better in Social Security, which I believe
and have been persuaded they are, is based on the fact that the
safety net isn't based on the rate of return; the safety net is based
on its longevity rather than its percentage of return.
Ms. Kijakazi. It really has to do with Social Security being a
comprehensive program. Social Security is not just the retirement
program from which elderly are benefiting. Social Security includes
disability and survivors' benefits, as well as retirement benefits.
The study that I referred to was conducted by employees of the
Treasury Department who had access to actual earnings and bene-
fit data, so they could look at the actual rate of return received by
workers. These researchers did riot need to use microsimulation,
which make use of estimates and case study examples in order to
try to determine what the rate of return might be. The Treasury
Department researchers used the actual data on workers, retirees,
and survivors.
Mrs. Clayton. Is that based on — let me get — now. Dr. Kotlikoff
just said that his proposal obviously is referring to table 5, and
would enhance the return for, supposedly, female babies who will
be at the age of the transition. And he is doing rate of return, and
of course he bases his rate based on income, more income — you put
in more, you get a better rate.
What I am persuaded to believe is that Social Security has been
a safety net for those at the end of the income spectrum when
there will be no other retirement. I could not participate in my hus-
48
band's retirement, other than his Hfe benefit right now. But yet if
my husband dies and I survived as a spouse under Social Security,
there is a commitment.
Mr. KOTLIKOFF. That is extremely important.
Under my plan you would get your survivor benefit because we
do not change the survivor part of Social Security. Under my plan,
you would get those benefits.
You would also have your private retirement account, which
would be paid out in the form of an annuity which would continue
as long as you live; and it would be indexed against inflation, just
like Social Security retirement benefits.
So my plan, I think, would provide more protection for survivors.
Mrs. Clayton. I like the new plan, so I am trying to figure out
how we would keep — the plan that I like is the one that I have the
privilege of participating in with the government. It just allows you
to take the max and it goes out and you can select or whatever.
But at the same time, I don't think in this plan I have, other
than the fact I make a will and say where my net income will go —
how does yours differ?
Ms. KiJAKAZi. If I could just jump in for a moment, one of the
problems, and I haven't had a lot of time to study Dr. Kotlikoffs
plan, but just in listening to him, one of the things that he does
not seem to be doing is deducting the transition costs from the rate
of return that he has cited. That is an incorrect way to cite his rate
of return. The transition cost must be deducted before he gives the
actual rate of return. The administrative costs must also be de-
ducted from the rate of return.
Mr. KoTLiKOFF. Let me respond to that. I think our proposal is
the only one that is really honest about the transition costs. We are
coming out front and center sajdng, you need to have a way to pay
off the benefits under the old system; and our plan is not doing
that surreptitiously by cutting people's benefits under the old sys-
tem and saying, you are going to lose so many benefits based on
how you do with your private account.
We say, we are going to give you your full, accrued benefits but
you are going to pay for that through a consumption tax that ev-
erybody, young and poor — well, not the poor elderly, but everybody
but the poor elderly would contribute to.
So when I say that in the long run, our kids and the next genera-
tion of kids are going to get a full market rate of return, it is after
that transition. So you are right that during the transition, there
are some real costs, but our plan is the only one that is honest
about those costs, about all of us having to pay off the old benefits
through a consumption tax.
Ms. KiJAKAZi. And the transition period can be
Mr. KoTLiKOFF. Forty-five years.
Ms. KiJAKAZi. Yes, it is a long time.
Mrs. Clayton. Administrative costs wouldn't be as costly as
transition costs, but I gather what you are tr3dng to make sure
there is a safety net, and so your transitional cost is to make
that
Mr. KOTLIKOFF. Under my plan, there are SI, DI programs; the
government is contributing to private accounts on behalf of the dis-
abled; there is progressivity in terms of matching contributions;
49
there is earnings-sharing, contribution-sharing so that nonworking
spouses are protected. There is lots of social protection. There is
every important element that anybody who really loves Social Se-
curity thinks is essential to maintain.
Mrs. Clayton. How much does your plan cost? Have you esti-
mated?
Mr. KOTLIKOFF. The real cost is that you are having a consump-
tion tax which might be somewhere between 6 and 8 percent. The
tax rate is going to decline through time. Also, bear in mind that
you are eliminating a payroll tax or a component of a payroll tax
and replacing it with a consumption tax.
Mrs. Clayton. It is a consumption tax across the board, or like
a sales tax?
Mr. KOTLIKOFF. It is effectively the same as a sales tax, but
again the poor elderly would be protected because they are living
off of Social Security and those benefits are CPI indexed, so their
real purchasing power is insulated. Suppose Steve Forbes has a
birthday party and has a yacht trip, like his dad did, around New
York City and spends $3 million on one party. Under our proposal
he would pay a huge tax, 8 percent of that $3 million on that one
party. So it is really the rich and the middle class elderly who
would be asked to help younger people contribute to paying off this
collective problem.
Ms. KiJAKAZL There is one other point that I would like to ad-
dress and that has to do with the disability insurance program.
Funding for disability insurance is going to run out sooner than
OASI. It is projected to run out in 2022.
You are saying that you would protect disability benefits, but
there has to be a way of funding those benefits once the disability
insurance fund runs out. Once the fund is exhausted, disability
benefits would have to be reduced or taxes would have to be raised.
If disability benefits are cut, then low-wage workers will be least
able to afford to go out into the private sector and purchase disabil-
ity insurance to make up the difference.
Chairman Smith. I don't think Dr. Kotlikoff would agree that
those benefits^ust a short response.
Mr. Kotlikoff. I think the bottom line is we have a very major
intergenerational problem here which is being obfuscated by the
kind of government accounting we are doing. The real impact of the
President's proposal is to lead us to think that we don't have to do
anything to really get our long-run shop in order. That is really
what is going on.
We are not really doing major Social Security reform, or major
Medicare reform, to deal with the impending fiscal disaster that we
have set up.
Chairman Smith. We welcome to the dais Mr. Gil Gutknecht, a
Congressman fi'om Minnesota and a member of the Budget Com-
mittee.
Mr. Gutknecht. Thank you, Mr. Chairman.
I really haven't heard enough of the testimony to ask a particu-
larly intelligent question except to say that I have been having
hearings around my district, and I have made presentations to
high school students, to college students. As a matter of fact, this
weekend I made a presentation to about 150 senior citizens, and
50
as I listened to the ending part of this testimony and some of the
responses to some of the questions, I am reminded of a story that
is told by one of the comics, Rodney Dangerfield.
He comes home one night and his wife is packing. And he says,
Is there something wrong, dear? And she says, I am leaving. Aiid
he says, Is there another man? She looks at him and says. There
must be.
When I look at where we are with Social Security, I really do
think it is a matter of generational fairness or generational equity,
and I think we have to be honest and say that there must be a bet-
ter system than we have today, because what we are doing today
is, we are literally guaranteeing, if we don't make some changes,
that we are going to pass on to our kids obligations to take care
of us that they will not be able to take care of.
This is fundamentally flawed. This is not — in fact, I think we
have all participated to a certain degree politically. We have
demagogued the issue to a sense that — we talk about the Social Se-
curity trust fund; "trust fund" has a nice sound to it. I mean it has
trust and it sounds like there is a fund.
We have really been too slow to be honest with ourselves and
with the American people, and particularly with our kids, that it
is a pay-as-you-go system, OK? And long-term — you know, I was
born in 1951, there were more kids born in 1951 than any other
year. I am the peak of the baby boomers.
So we have to come up with a whole new system. We have to fig-
ure out a way to create some generational fairness. I don't know
how you do that without somehow incorporating a way to get better
than 1.9 percent real rates of return on the money.
And so I am not certain what the perfect answer is, and I am
delighted that we have real experts. I am going to look forward to
looking through the testimony and particularly some of the charts
and studies, because it seems to me we need to bring together some
of the best minds in the United States.
We need to be honest, we need to look at the problem, and I
think over the next year or so, perhaps we can come up with a bet-
ter solution than we have today. Because today what we have on
the table, it seems to me, is a prescription for disaster. It is a little
like the Y2K problem. We know it is coming; we know about when
it is going to start to really become a serious problem, and we have
been given, by the grace of God, about 11 or 12 years to come up
with a solution. But we need to make that solution now.
So I don't really have a question, but I appreciate these hearings,
and I have taken more time than I should.
Mr. Ryan of Wisconsin. Will the gentleman yield?
Mr. GUTKNECHT. I think it is important that since this is a hear-
ing that is on the record that we talk about and reveal the actual
numbers and statistics with respect to debt reduction that have
been achieved with the various different plans we have talked
about. I know we have been talking about the President's plan. I
think it is important to note that the budget resolution that this
committee passed, and passed in the House and the Senate,
achieved $450 billion in additional debt reduction than the Presi-
dent's plan does, and that, in fact, the President's plan leaves us
51
with a resulting budget debt, debt held by the public, or debt sub-
ject to the debt limit of $8.6 trillion.
So it is important to note these things as we take a look at how
these different plans affect the national debt.
Chairman Smith. A quick round and we will try to finish up in
the next 5 or 10 minutes.
I am going to direct this to you, Ms. Olsen. Since you haven't
said much yet, give us a couple of reactions to what has been said.
Ms. Olsen. One of the questions that I did want to address is
the women's question. And, Mr. Ryan, I think what you said was
"apples and oranges," and in a way it is. There is a favoritism to-
ward women because of the progressive benefit structure, but in
absolute dollar terms their benefits are lower. So you could say
they are favored, but you could also say they do worse than men.
Both of those statements are accurate.
What Larry said was exactly the point that I wanted to make
about that, which is that no matter how you slice it, whether
women are — whether there is a progressive benefit structure or
not, whether they do worse or better than men, everybody is get-
ting such a raw deal from this system. At best, you are getting a
2 percent return, most young workers are going to get a negative
return, and when you could just invest in Treasury bonds and get
a 4 percent return, it begins to look worse and worse. So I think
that that is very important.
Also, in my paper, I wanted to address this idea about the low-
income workers. There is a myth out there that Social Security pro-
tects women from poverty and protects low-income people from pov-
erty. That could not be further from the truth. Thirty percent of Af-
rican-American women in our country live in poverty while collect-
ing their Social Security benefits. If they could take 12.4 percent
of their income or 10 percent of their income or even 5 percent of
their income and invest it, they could retire well above the poverty
level, and that is the truth. That is what needs to come out today.
Chairman Smith. All right. I would just like to point out in ac-
knowledging those considerations what I did in my Social Security
bill 4 years ago and 2 years ago. I included two aspects that helped
deal with that problem. One is, I increased survivor benefits from
the 100 percent of the higher benefit rate to 110 percent of the
higher benefit rate. Secondly, I took the lead from Dr. Kotlikoff in
terms of a unified investment opportunity so both the man and the
wife have their eligible investmient opportunity together, and di-
vided by two so you do away with the attorneys during a divorce
settlement.
So I think that was an excellent idea. Dr. Kotlikoff, what do you
call it?
Mr. Kotlikoff. Contribution sharing.
Chairman Smith. Contribution sharing, sold. And you, Ms.
Olsen, also suggested the wisdom of something like that.
Ms. Olsen. Yes, I do. We call it earnings-sharing. There are a
number of— we are actually going to be doing a paper on it, some
technical details, I think June O'Neill might be doing it for us. But
it is a definitely a good idea, an easy way to protect spouses who
do not work, and also to protect people in a divorce so that nobody
runs off with the entire pool of retirement funds.
52
Mr. Bentsen. In Texas we call it community property. Fortu-
nately, I have never had experience with that, and I don't want to,
even though the statistics read differently.
I am glad to hear my colleague from Wisconsin talking about
debt retirement. As he may recall, I offered the amendment in the
committee that would have done more debt retirement than any-
body, but it failed.
Aiid I would also caution him, as he knows as a newer Member
and former staff, that the budget resolution is one thing, but the
final law will determine whether we pay down any debt or not.
Mr. Ryan of Wisconsin. Mr. Chairman, I would like to credit
the gentleman. If your amendment had passed, it would have
achieved the most amount of debt reduction per any plan being of-
fered here in Congress. So I wanted to acknowledge that.
Mr. Bentsen. I appreciate that.
Let me ask very quickly just a couple of questions. Ms. Olsen,
the Shirley and Spiegler plan, if I understand it, does it assume
that 5 percent of the 12.2 percent is transferred to a private ac-
count, and then there is a mandatory supplemental contribution of
5 percent?
Ms. Olsen. Well, they did it several different ways. They did 5
percent with a guarantee, and they also did 7 percent and they also
did 10 percent.
Mr. Bentsen. In your packet it talks about 10 percent, that is,
10 percent — that is, 12.2 — 12.4 minus 5, plus 5. Is that how they
get there? Because they retain 7 percent for a two-thirds flat bene-
fit.
Ms. Olsen. Not in the 10 percent plan. The 10 percentage points
is a full privatization plan that takes 10 percentage points of the
12.4. The 5 percent does have a flat benefit, and that is not in the
small paper that I attached; that is in the larger study.
Mr. Bentsen. It says here under the fully private system, the as-
sumed contribution rate is 10 percent.
Ms. Olsen. Right, and it does not have a flat
Mr. Bentsen. Oh, OK, I see.
Does it assume transition costs?
Ms. Olsen. They did not do transition costs. You had asked that
question earlier and somebody had said, well, you have to deduct
the transition costs from the rate of return. The transition costs is
a cost that has been run up by the Social Security system, so I
don't think that you necessarily have to — I don't think it is fair to
say that you would deduct it from the rates of return.
Mr. Bentsen. Let me tell you why I think that is important, very
quickly, and for all three of you. We were just talking about debt
and we talked about lOUs and we talked about whether a trust
fund is a trust fund.
If you go look in the law, the trust fund is a trust fund under
the law. I am sure somebody could try and weasel their way out
of it. I like pa3dng down debt; before I was in Congress, I liked
issuing debt because I was an investment banker. I also believe in
the sanctity of debt and the contract that goes with it.
The fact is, you can't design these plans and not have a way to
pay for them and then go back and say, well, we are going to make
up for that later. All of these plans and the problem we are in now
53
may be because we have run up debt or the associated debt too
much. But you have to look at the whole picture.
I would say the same for Dr. Kotlikoff, that the 8 percent ulti-
mately at the end of the day will affect your return on investment.
It may not directly, but indirectly it will. And I question even the
argument that while Malcolm Forbes or Steve Forbes may pay
$240,000 for having this boat trip around Manhattan — the elderly,
because they are getting a CPI adjustment, is going to be some of
it; because I doubt that the CPI adjustment will make up com-
pletely an 8 percent consumption tax, particularly when they — at
the lower end they will be consuming more of their disposable in-
come at the upper end.
Mr. Kotlikoff. Let me respond to that.
The elderly would be fully insulated. The rich and middle-class
elderly would be hurt relative to the current system which is not
sustainable. Current workers would be somewhat better off because
they would be rid of an 8 percent payroll tax, although they would
have to pay a consumption tax. Overall and given the consumption
tax is going to be declining through time, they would be better off
than under the current system.
So we are not disguising the fact that there are burdens to be
paid, the transition burdens. We are up front, we are honest about
that.
Mr. Bentsen. And I appreciate that.
Mr. Kotlikoff. In the long run, the rate of return that people
will be able to get will be the full market rate of return. That is
in the long run; that is not during the transition. People will be
able to get the full rate of return on their private accounts, but
there is this additional transition cost.
Mr. Bentsen. And you don't think an 8 percent tax, a corporate
tax, might have an impact on earnings that could affect stock price
and an ultimate rush on investment?
Mr. Kotlikoff. Another thing that needs to be brought out in
this hearing, which hasn't come out, are the macroeconomic im-
pacts of privatizing Social Security. I developed a model with an
economist who is at Berkeley named Alan Auerbach. Our model is
being used at the CBO as, I believe, their primary model for simu-
lating tax reform and Social Security's privatization.
If you simulate transitions under which you actually pay off the
liabilities of the old system, for example with a consumption tax,
you actually have a positive kick to the economy in terms of saving.
In the short run, you depress somewhat consumption as a share of
national output, so you get a higher saving rate. You also get more
capital accumulation and higher real wages, and this helps the
poor. Whether they are nonwhites, whether they are women, re-
gardless, it helps them in the long run.
When you try and engage in a shell game, which is what you are
concerned about, basically just borrow more money to put it into
a trust fund, and you don't really deal with this generational im-
balance in a substantive way, you end up with a worse economy
in the long run.
So sweating the transition is incredibly important and the con-
sumption tax is the way to finance a transition in terms of getting
the best bang for the buck with respect to economic performance.
54
Mr. Bentsen. Thank you.
Ms. Olsen. Can I just follow up? I believe it was Alan Greenspan
who said that the markets have taken into account the unfunded
liability. So I don't think that it is necessarily correct for you to say
that payroll — that the rate of return would necessarily have to go
down in financing the transition.
I don't think that that is necessarily— just let me finish, please.
I don't think that that is necessarily accurate. I think it is debat-
able.
Finally, we don't ignore the transition; it is just that in certain
studies you have to focus. But we have published four different
plans, ways of financing the transition, and as I said before, I
would be happy to get those to you.
Mr. Bentsen. I just want to make sure that when you are doing
this — I mean, transition will have some impact on — whether it is
a sales tax or a consumption tax or whatever, it has to have some
impact. It is not coming out of a different pot of money. All the
money, as Cato well knows, comes from the same taxpayers, so it
somewhere has an impact.
Chairman Smith. I think that is such an excellent point, because
we can talk all we want to about how we are going to divide up
whatever pie exists 20, 30, 40, 50 years from now, but part of the
question is, how do we get a bigger pie so that whatever slice is
coming out is bigger. If we are going to end up under the current
system with two workers tr3ring to earn and produce enough stuff,
as one of my friends puts it, to satisfy their family needs plus one
retiree, how are we going to make sure we have the kind of econ-
omy where we increase our productivity and our research.
And so growth and higher savings and investment has to be part
of our goal.
So specifically. Dr. Kotlikoff, have you looked at the problems of
the intergenerational transfer in terms of that effect? And you can
talk about the other, too, but what about just specifically the con-
siderations of the intergenerational transfer of transferring wealth
from the young to the old and the effect on our economic growth?
Mr. Kotlikoff. Well, the basic story is that if you privatize So-
cial Security, you are going to have some impacts. You are going
to have to burden on current generations. But in burdening those
current generations, you lower their consumption, and thus you in-
crease national saving, increase capital formation, you increase the
tools that workers have to work with and therefore, you make the
economy bigger and more productive.
In our simulations we find out that per capita output is about
15 percent higher after the transition than at the beginning. That
is not enormous, but 15 percent is pretty good. The capital stock
is about 40 percent larger.
The alternative, I want to stress, is just to continue muddling
along and end up 20 years from now with payroll tax rates which
will be 20 to 25 percent to pay for this program. Bear in mind, we
already have an economy in which virtually every citizen is paying
at the margin about 50 cents on the dollar to State and Federal
Governments in different kinds of taxes.
If we add another 10 or 20 percentage points on for a rate that,
we are talking about serious problems, about people who do not
55
want to be in the formal sector, about an erosion of the tax base,
about a Brazil in terms of the fiscal situation. We are also talking
about printing money to pay for our bills. That is the alternative
to doing something sensible like we propose.
Chairman Smith. A wrap-up for Dr. Kijakazi, if you would like
about a minute for a wrap-up or comments, and also Ms. Olsen.
Ms. Kijakazi. I would like to address the last point that you
made about how to improve the economy, how to increase the
money coming into the trust fund.
Individual accounts are not what increases the rate of return to
Social Security; it is advance funding. If one of the goals is to in-
crease the rate of return, you do not have to achieve this through
individual accounts; you can accomplish this by investing part of
the trust fund in equities. Investing the trust fund will increase the
rate of return to Social Security without incurring the administra-
tive costs, transition cost, or risks of individual accounts.
One of the proposals in the Clinton plan is to invest a portion
of the trust fund in equities using a broad market index. A politi-
cally and fiscally independent board set up like the Reserve Board
and the Thrift Investment Board that serves the Thrift Savings
Plan would oversee the investment. Increasing the income to the
trust fund will reduce the amount by which you would have to cut
benefits or raise taxes in the future without putting the individual
at risk.
Chairman Smith. Ms. Olsen.
Ms. Olsen. Thanks for the chance to wrap up.
Just in conclusion I would like to go back to the message that
I started with, which is that it doesn't really matter if men are
doing a little better than women or women are doing a little better
than men, or African Americans are doing a little bit better than
Caucasians under this system.
The point is that nobody in this system has a good deal: The best
returns you are looking at are 2 percent; young people are getting
negative returns; and this is a system that is now $9 trillion in
debt. If we do nothing, we have — we are looking at benefit cuts of
30 percent or a tax increase to almost 20 cents on the dollar.
So this is a system that even though it may favor some or disfa-
vor others, is not a good deal for workers. We know that there is
something much better, and that is a system that is based on indi-
vidually owned accounts that can be saved and invested, that are
prefunded for the future. That is what we need, and that is what
you should consider as you go forward in trying to think about how
we are going to have a real secure retirement system in the 21st
century.
Chairman Smith. Thank you all very much for giving up your
time to testify before the committee today. I would like to announce
that next week, Tuesday at 12 o'clock, Dr. Roger Ibbotson and Dr.
Gary Burtless are going to be here to testify on the long-run invest-
ments in terms of what those long-term investments can do as far
as having a positive effect on Social Security.
With that, thank you all again, and the Task Force on Social Se-
curity of the Budget Committee is adjourned.
[Whereupon, at 1:45 p.m., the Task Force was adjourned.]
Using Long-Term Market Strategies for Social
Security
TUESDAY, MAY 11, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12:10 p.m in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Members present: Representatives Smith, Herger, Ryan, Rivers,
and Clayton.
Also Present: Representative Spratt.
Mr. Smith. The Budget Committee Task Force on Social Security
will come to order.
We have two expert witnesses today to pass on some of their ad-
vice and estimates on the advantages of using investment as part
of our total solution to Social Security. Social Security's unfunded
liability that ranges in estimates from $4 trilHon to $9 trillion can
be solved in three ways, it seems to me. We can cut benefits, we
can increase taxes, or we can get a better return on some of the
investment that individual workers in this country are making.
The current Social Security program gives the average worker a
1.8 percent return on their payroll taxes today. In contrast, cor-
porate stocks have given investors an average of 11.2 percent re-
turn, measured from 1926 until 1998. Opponents of the investment
strategies for Social Security are quick to point out that stock
prices go up and down.
This volatility should not prevent us from considering the bene-
fits of higher investment returns to provide greater retirement in-
come to all American workers. Over time, the ups and downs of the
stock markets have always, if you will, balanced out on the upside,
and investors have learned that they can count on higher returns
for funds that can be invested for the long run. Since many work-
ers pay Social Security taxes for 40 years or more, they can use
this long-term investment strategy and the magic of compound in-
terest to retire much wealthier than they might otherwise.
This investment strategy, I think, requires that a portion of the
Social Security taxes have some of the advantages of capital invest-
ment. That is the purpose of our hearing today.
[The prepared statement of Mr. Smith follows:]
(57)
58
Prepared Statement of Hon. Nick Smith, a Representative in Congress From
THE State of Michigan
Social Security's $9 trillion funding gap can be closed in only three ways:
• Cut benefits
• Raise taxes
• Increase the rate of return earned on workers' contributions
The current Social Security program gives the average worker a 1.8 percent in-
vestment return on their payroll taxes. In contrast, corporate stocks have given in-
vestors average annual rates of return up to 11.2 percent, measured from 1926 to
1998. Opponents of investment strategies for Social Security are quick to point out
that stock prices go up and down.
This volatility should not prevent us from considering the benefits of higher in-
vestment returns to provide greater retirement income to all American workers.
Over time, the ups and downs of the stock market balance out, and investors have
learned that they can count on higher returns for funds that can be invested for
the long run. Since many workers pay Social Security taxes for forty years or more,
they can use long-term investment strategies with confidence.
This investment strategy requires that a portion of Social Security be placed into
pre-funded accounts and invested. This fundamental change to the pay-as-you-go
structure should be considered as a means of strengthening Social Security for the
long run.
Would you like, Ms. Rivers, to make any introductory comments?
I'll introduce witnesses today. Dr. Burtless is a Senior Fellow in
Economic Studies with the Brookings Institution. Dr. Burtless has
published various articles on Social Security, Medicare and social
welfare, and testified before several House and Senate committees.
He has published various articles and presented testimony.
Gary, I am sorry I didn't bring one of your articles or books to
hold up, but I did bring one of Dr. Roger Ibbotson's books, and this
is the annual condensation of what is happening in stocks and
bonds and bills and inflation. It is a book that must sell very well,
because every financial and asset manager has several in their of-
fices.
So thank you. Dr. Ibbotson, for being here today.
Dr. Ibbotson is a Professor of Finance at Yale University's School
of Management, and also serves as Chairman of Ibbotson Associ-
ates, which publishes the annual yearbook. He has been recognized
as a leading expert in measuring rates of return for the last 20
years.
In 1974, during one of the worst bear markets in U.S. history,
Dr. Ibbotson predicted that the Dow would reach 10,000 by 2000.
He apparently underestimated that to some extent, since we are al-
ready there. He is now expecting to see the Dow 100,000 by the
year 2025.
Let's start with each of you making an introductory statement of
approximately 5 or 6 minutes. So, if each of you would make an
opening statement of 5, 6, 7 minutes, and then we will open up for
questions.
STATEMENT OF GARY BURTLESS, SENIOR FELLOW,
ECONOMIC STUDIES, THE BROOKINGS INSTITUTION
Mr. Burtless. I defer to the finance expert. Dr. Ibbotson, on
issues connected to financial history.
My interest in this subject comes from my interest in Social Se-
curity and social welfare protection. Return on investment has be-
come an important issue in thinking about how this kind of insur-
ance and social protection can be made available to people.
59
There is a lot of interest right now in replacing part or perhaps
even all of the Social Security retirement protection with a system
of individual retirement accounts. Mr. Chairman, I heard you say
at the beginning you compared a rate of return under Social Secu-
rity of 1.8 percent, which is, I think, approximately what people re-
tiring today can expect to receive on their contributions and those
of their employers, with 11.2 percent, which was the average rate
of return on common stocks in the United States since 1926.
I think that we have to think about some differences between
these two numbers. One is that 1.8 percent represents a real rate
of return, the rate of return after adjusting for the difference in
prices between when you put your contribution in and when you
make withdrawals in the form of pension benefits. Eleven-point-2
percent, in contrast, is a nominal rate of return. The real rate of
return since 1926 has been closer to 7 percent, and going back to
1871, it has been closer to about 6.3 percent. So if you compare like
to like, the real return in Social Security with a real return in com-
mon stocks, it is a difference of 1.8 percent versus 6.5 or 7 percent.
But there is another difference too, and the other difference is
that 1.8 percent represents a return that is backed by the power
of the government to tax wage-earners, and so it is a very secure
rate of return. There is less uncertainty over what it is going to be.
The 6.5 percent or 7 percent return that we have seen over var-
ious historical periods on common stocks has fluctuated widely over
time. If you look at the picture at the back of my testimony, labeled
figure 1, it shows the historical pattern of 15-year average annual
returns on stock market investments. At the end of 15 years, you
calculate what you would have, adjusting for difference in prices,
if you had invested $1 15 years earher, and then calculate the av-
erage annual return. Figure 1 shows that there has been an enor-
mous range since 1871 in the 15-year trailing real rate of return.
It has averaged 6.3 percent, but there have been six periods when
the rate of return over 15 years was negative; and there have been
eight 15-year periods in which it has exceeded 15 percent. So there
is a very wide variation.
I also heard you say, Mr. Chairman, that over time, if you have
a long enough period for investment, these wide fluctuations even
out, and that is true. But the fluctuations don't completely dis-
appear. The purpose of my calculations in this testimony is to show
ho^y much variation there is left if workers had 40-year careers in
which they invest a certain percentage of their pay in stocks, and
then live on the nest egg that they have accumulated when they
retire.
Chart 3 calculates annuity payments. It shows the situation of
a worker who contributes 2 percent of his pay into stocks and con-
stantly reinvests all the dividends in stocks, and then converts
whatever the nest egg is at the end of a 40-year career at age 62
into a level annuity. The chart shows how much that annuity is
going to be as a share of that worker's peak career earnings.
Mr. Smith. Again, if he invests 2 percent of his taxable paj^oll;
is that what you are saying?
Mr. BuRTLESS. Yes, yes.
Mr. Smith. OK. Go ahead.
60
Mr. BURTLESS. Obviously you would come up with other numbers
if you invest a different percentage of the worker's pay. You can see
that the low point of annuities was the annuity for someone retir-
ing in 1920. That annuity would have replaced about 7.5 percent
or so of his peak pay. At the high point in annuities (in the mid-
1960s) the annuity would have replaced 40 percent of peak earn-
ings. So there is a huge difference in the value of the annuity peo-
ple could obtain under this kind of a system. Chart 4 shows how
the real rate of return — the internal rate of return measured when
people turn 62 — how much that return varied. This rate of return
varied from a low of 2 percent for people retiring in 1920, up to
a high of about 10 percent for people retiring in 1965.
There is one other risk that workers face that private individual
retirement accounts have not protected them against, and that is
inflation after they retire. Chart 5 shows the historical effects of in-
flation on four workers. In particular, it shows the replacement
rate if, instead of measuring it at the date that they retire, we look
at replacement rates at successive ages after retirement. So you
can see for people retiring in 1965, they started out with a very
high pension, 40 percent of their peak pay, but by the time they
were 80, they were only receiving an annuity equal to about 12.5
percent of their peak earnings. That is because inflation had eroded
the value of their pension.
Thus, even though it is true that the real rate of return we can
expect on common stocks is reasonably high, there still is a lot of
variability in the living standard that workers can afford if they
consistently invest in stocks and then try to convert their savings
into an annuity when they reach retirement age.
[The prepared statement of Mr. Burtless follows:]
Prepared Statement of Gary Burtless, Senior Fellow, Economic Studies, the
Brookings Institution
Congress and the public are rightly concerned about the future of Social Security.
Many people have proposed novel and dramatic reforms to the system to assure its
solvency or improve workers' rate of return on their contributions. One popular pro-
posal is to establish a new system of individual, privately managed retirement ac-
counts that could be invested in high-return private securities, such as common
stocks. This approach can push up workers' returns in the long run. But this can
only occur if we increase the level of reserves that back up future pension promises.
In other words, our retirement system must move away from pay-as-you-go financ-
ing and toward greater advance funding. This in turn requires that some Americans
accept a temporary reduction in consumption, either by making larger contributions
to the pension system or accepting smaller pensions.
Individual accounts have no inherent economic advantages over the alternative
proposal to accumulate a larger reserve in the existing Social Security system.
There are some political advantages to accumulating additional reserves in individ-
ual accounts, but there are efficiency advantages to accumulating reserves in a sin-
gle collective accoimt, such as the OASI Trust Fund. Accumulating private assets
under either approach entails financial market risks. In one case the risks are borne
collectively by the government (and ultimately by all taxpayers and pension recipi-
ents). Under a system of individual accoimts, in contrast, the financial market risks
would be borne by individual contributors and pensioners.
Since the basic goal of a government mandated pension system is to ensure work-
ers a predictable and decent income in old age, the reform plan we ultimately adopt
should be one in which the collective, defined-benefit plan provides the bulk of man-
datory pensions, especially for workers with average and below-average lifetime
wages. A single collective fund exposes these contributors to far less financial risk
than an alternative system in which most of their retirement income is derived ft-om
individual investment accounts.
61
Risks and Returns of Individual Accounts
Many critics of Social Security want to scale back the present defined-benefit plan
and replace it partially or fully with a privately managed system of individual de-
fined-contribution pension accounts. Such accounts could be run independently of
traditional Social Security or as an additional element in the existing system. Advo-
cates of individual accounts claim three big advantages from establishing individual
accounts:
• It can lift the rate of return workers earn on their retirement contributions
• It can boost national saving and future economic growth
• It has practical political advantages in comparison with reforms in existing pub-
lic programs that rely on higher payroll taxes or a bigger accumulation of public
pension reserves
Individual account plans differ from traditional Social Security in an important
way. The worker's ultimate retirement benefit depends solely on the size of the
worker's contributions and the success of the worker's investment plan. Workers
who make bigger contributions get bigger pensions; workers whose investments earn
better returns receive larger pensions than workers who invest poorly.
The most commonly mentioned advantage of individual accounts is that they
would permit workers to earn a much better rate of return than they are likely to
achieve on their contributions to traditional Social Security. I have heard it claimed,
for example, that workers will earn less than 0 percent real returns on their con-
tributions to Social Security, while they could earn 8 percent to 10 percent on their
contributions to an individual retirement account if it is invested in the U.S. stock
market.
This comparison is incorrect and seriously misleading. First, the claimed return
on Social Security contributions is too low. Some contributors will earn negative re-
turns on their Social Security contributions, but on average future returns are ex-
pected to be between 1 percent and IV2 percent, even if taxes are increased and ben-
efits reduced to restore long-term solvency.
Second, workers will not have an opportunity to earn the stock market rate of re-
turn on all of their retirement contributions, even if Congress establishes an individ-
ual account system in the near future. As noted above, workers' overall rate of re-
turn on their contributions to the retirement system will be an average of the return
obtained on their contributions to individual accounts and the return earned on
their contributions to whatever remains of the traditional Social Security system.
For most current workers, this overall rate of return will be much closer to the cur-
rent return on Social Security contributions than it is to 8 percent.
Investment risk. Advocates of individual retirement accounts often overlook the in-
vestment risk inherent in these kinds of accounts. All financial market investments
are subject to risk. Their returns, measured in constant, inflation-adjusted dollars,
are not guaranteed. Over long periods of time, investments in the U.S. stock market
have outperformed all other tj^jes of domestic U.S. financial investments, including
Treasury bills, long-term Treasury bonds, and highly rated corporate bonds. But
stock market returns are highly variable from 1 year to the next. In fact, they are
substantially more variable over short periods of time than are the returns on safer
assets, like U.S. Treasury bills. Chart 1 shows the pattern of real stock market re-
turns over the period back through 1871. I have calculated the 15-year trailing real
rate of return for periods ending in 1885^ 1886, and all other years through 1998.
The return is calculated by assuming that $1,000 is invested in the composite stock
index defined by Standard and Poor's and quarterly dividends are promptly rein-
vested in the composite stock. The 15-year trailing return has ranged between -2
percent and 13 percent since 1885. The historical real stock market return averaged
about 6.3 percent.
62
Chart 1.
Real Stock Market Returns, 1871-1998
(15-Year Average Annual Returns)
Average since 1 871
= 6.3 %
1885 1895 1905 1915 1925 1935 1945 1955 1965 1975 1985 1995
Some people mistakenly believe the amiual ups and downs in stock market re-
turns average out over time, assuring even the unluckiest investor of a high return
if he or she invests steadily over a 20-year period. A moment's reflection shows that
this cannot be true. From January 1973 to January 1975 the Standard and Poor's
composite stock market index fell 50 percent after adjusting for changes in the U.S.
price level. The value of stock certificates purchased in 1972 and earlier years lost
half their value in 24 months. For a worker who planned on retiring in 1975, the
drop in stock market prices between 1973 and 1975 would have required a drastic
reduction in consumption plans if the worker's sole source of retirement income de-
pended on stock market investments.
We can evaluate the financial market risks facing contributors to individual re-
tirement accounts by considering the hypothetical pensions such workers would
have obtained between 1910 and 1997. The 88 hypothetical contributors are as-
sumed to have careers that last 40 years, beginning at age 22 and ending at age
62. When contributors reach age 62 they cease working and convert their accumu-
lated retirement savings into a level annuity. To make the calculations comparable
across time, all contributors are assumed to have an identical career path of earn-
ings and to face the same mortality risks when they reach age 62. Contributors dif-
fer in the path of stock market returns, bond interest rates, and price inflation over
their careers and retirement. These differences occur because of the differing start
and end dates of the workers' careers.
The results of this exercise can be summarized briefly. Even though workers on
average obtain good pensions under individual retirement accounts, there is wide
variability in outcomes. Assuming workers deposit 2 percent of their annual pay
into a retirement account that is invested in common stocks, historical experience
suggests their initial pensions can range from about 7 percent of their peak career
earnings to 40 percent of their peak earnings. While most workers would welcome
the opportunity to earn better returns on their contribution to the retirement sys-
tem, defined-contribution accounts would expose workers to a substantial hazard
that their pensions would be too small to finance a comfortable retirement. When
we consider the effects of inflation on the value of annuities after workers retire,
the financial market risks associated with individual accounts seem even bigger.
Details of the calculations. I have made calculations of the pensions that workers
could expect under an individual account plan using information about annual stock
63
market performance, interest rates, and inflation dating back to 1871. ^ I start with
the assumption that workers enter the workforce at age 22 and work for 40 years
until reaching their 62nd birthdays. I also assume they contribute 2 percent of their
wages each year to their individual retirement accoimts. Workers' earnings typically
rise throughout their careers imtil they reach their late 40's or early 50's, and then
wages begin to fall. I assume that the age profQe of earnings in a given year
matches the age profile of earnings for American men in 1995 (as reported by the
Census Bureau using tabulations from the March 1996 Current Population Survey).
In addition, I assume that average earnings in the economy as a whole grow 1 per-
cent a year.
While it would be interesting to see how workers' pensions would vary if we al-
tered the percentage of contributions invested in different assets, in my calculations
I assume that all contributions are invested in stocks represented in the Standard
and Poor's composite stock index. Quarterly dividends from a worker's stock hold-
ings are immediately invested in stocks, too. Optimistically, I assume that workers
incur no expenses buying, seUing, trading, or holding stocks. (The average mutual
fund that holds a broadly diversified stock portfolio annually charges shareholders
a httle more than 1 percent of assets under management. Even the most efficient
funds impose charges equivalent to 0.2 percent of assets under management.) When
workers reach their 62nd birthdays they use their stock accumulations to purchase
a single-hfe annuity for males. (Joint survivor annuities for a worker and spouse
would be about one-fifth lower.) To determine the annuity company's charge for the
annuity, I use the Social Security Actuary's projected life table for males reaching
age 65 in 1995. To earn a secure return on its investments, the annuity company
is assumed to invest in long-term U.S. government bonds. The nominal interest rate
on these bonds is shown in Chart 2. I assume that the annuity company sells a
"fair" annuity: It does not earn a profit, incur administrative or selhng costs, or im-
pose extra charges to protect itself against the risk of adverse selection in its cus-
tomer pool. (These assumptions are all unreahstic. Annuity companies typically
charge an amount that is between 10 percent and 15 percent of the selhng price
of annuities to cover these items.) My assumptions therefore yield an overly optimis-
tic estimate of the pension that each worker would receive.
1 Stock market data are taken from Robert J. Shiller, Market Volatility (Cambridge, MA: MIT
Press, 1989), Chapter 26, with the data updated by Shiller. Inflation estimates are based on
January producer price index data from 1871 through 1913 and January CPI-U data from 1913
through the present. Bond interest rates are derived using 1924 through 1997 estimates of the
average long-bond yield for U.S. Treasury debt; yield estimates before 1924 are based on yields
of high-grade railroad bonds.
64
Chart 2.
"Riskless" Long-term Interest Rate,
1910 - 1997*
14
12
B
•S
-3 6
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Year of retirement
NoU "Riskless' iat«« assumed equal to tiommal U S Treasury long-bond taU ftoro 1924-1997 and equal to adjusted
high-quality taiboad bond rate 1910-1923 (see te>d.)
Chart 3 shows the replacement rate for workers retiring at the end of successive
years from 1910 through 1997. The hypothetical experiences of 88 workers are re-
flected in this table. The worker who entered the workforce in 1871 and retired at
the end of 1910, for example, would have accumulated enough savings in his indi-
vidual retirement account to buy an annuity that replaced 19 percent of his peak
lifetime earnings (that is, his average annual earnings between ages 54 and 58).
The worker who entered the workforce in 1958 and retired at the end of 1997 could
purchase an annuity that replaced 35 percent of his peak earnings. The highest re-
placement rate (40 percent) was obtained by the worker who entered the workforce
in 1926 and retired at the end of 1965. The lowest (7 percent) was obtained by the
worker who entered work in 1881 and retired in 1920. Nine-tenths of the replace-
ment rates shown in the chart fall in the range between 10 percent and 37 percent.
The average replacement rate was 20.7 percent. (For workers retiring after 1945 the
replacement rate averaged 25.3 percent.)
65
Chart 3.
Male Single-life Annuity as a Percent of Career High
Annual Earnings (Measured at Age 62)
45%
40%-
Average since 1910
= 20.7%
19W 1920 J930 1940 1950 I960 1970 1980 1990 2000
Year of retirement
"RepUcMnent rale* is the worksifs intial anjimly divided by hi5 average real annual earnings when he lyas 54-38 years old
Chart 4 shows the real internal rate of return on the contributions made by the
88 workers. This return is measured at age 62, when the worker retires. Since 1910,
when the first worker retired, the real internal rate of return ranged between 2 per-
cent and almost 10 percent. The average rate of return was 6.4 percent.
Chart 4.
Internal Rate of Return Measured
at Age 62, 1910 -1997
o
H
6%
m
1^
4%
<o
.s
-7^
2%
tn
^
0%
. U ./nV : rV
\^i r-v^ I *
r
\
Average since 1910
= 6.4 %
i
1910 1920 1930 1940 1950 1960 1970
Year of retirement
Note Anthmetic average internal rate of return, 1910 - 1997, i
AriUimetic mean return for careers that began after 1925 is 7 2%
1980 1990 2000
J return is 9.9%
The principal lesson to be drawn from these calculations is that defined-contribu-
tion retirement accounts offer an uncertain basis for planning one's retirement.
Workers fortimate enough to retire when financial markets are strong obtain big
66
pensions; workers with the misfortune to retire when markets are weak can be left
with Uttle to retire on. The biggest pension shown in Chart 3 is more than 5 times
larger than the smallest one. Even in the period since the start of the Kennedy Ad-
ministration, the experiences of retiring workers would have differed widely. The
biggest pension was 2.4 times the size of the smallest one. In the 6 years from 1968
to 1974 the replacement rate fell 22 percentage points, plunging from 39 percent
to 17 percent. In the 3 years from 1994 to 1997 it jumped 14 percentage points, ris-
ing from 21 percent to 35 percent. Social Security pensions have been far more pre-
dictable and have varied within a much narrower range. For that reason, traditional
Social Security provides a much more solid basis for retirement planning and a
much more reliable foundation for a publicly mandated basic pension.
The calculations in Charts 3 and 4 ignore the effects of inflation on the value of
workers' annuities after they retire. Workers typically cannot buy annuities that are
indexed to the price level, as Social Security pensions are indexed. Chart 5 shows
how the real replacement rate varied over workers' retirements for four workers
whose retirements began in 1920, 1928, 1932, and 1965. For workers who retired
before World War II, prices did not always rise; in some periods, they fell. A worker
receiving a level annuity receives a windfall when prices decline. The value of his
annuity rises. But rising prices rather than falling prices have been the norm since
the end of the Great Depression. A worker who began receiving a $100 monthly pen-
sion in 1965, for example, would have received a pension worth just $70 by the time
he was 70 and just $31 by the time he was 80. The steep decline in the value of
this worker's pension is shown in Chart 5 with the line labeled "Year of retirement
= 1965."
Chart 5.
Real Annuity as Percent of Career
High Annual Earnings at Selected Ages
I 30%
Age of pensioner
On average, inflation has reduced the rate of return workers would actually have
obtained on their individual-account pensions. Chart 6 shows the trend in rates of
retxim on worker contributions, when the rate of return is calculated at the age of
death of workers rather than at age 62, when they first begin collecting pensions.
Notice that the average reahzed rate of return is 1.2 percentage points lower than
the rate of return calculated at age 62. This simply reflects the fact that, on aver-
age, workers would have received real annuities that are less in value than was an-
ticipated when they first began their retirements.
67
Chart 6.
Internal Rate of Return Measured
at End of Life, 1910-1997
10%
Average since 1910
= 5.2%
1910 1920 1930 1940 1950 I960 1970 1980 1990 2000
Year of retirement
Note AvMsge mttmal rate of return through through end of bfe is 5 2%. imnanum return is 2 1%, maxnnum
return is 7i% Arithmetic mean rettnn for cweers th»t began after 1925 is 6,0%
Conclusion
The debate about reforming Social Secvrity should not rest on exaggerated claims
about the potential gains workers can obtain from a shift to privately managed indi-
vidual retirement accounts. Social Security provides workers with crucial protec-
tions against financial market risks. It is worth remembering that when the system
was established in 1935, many industrial and trade imion pension plans had col-
lapsed as a result of the 1929 stock market crash and the Great Depression, leaving
workers with no dependable source of income in old age. The private savings of
many households was wiped out as well. Given these circumstances, most voters
thought a public pension plan, backed by the taxing power of the Federal Govern-
ment, was preferable to sole reliance on individual retirement plans.
Financial market fluctuations continue to make private retirement incomes uncer-
tain. Workers who invest in financial market assets, such as common stocks, bonds,
and armui ties, are exposed to three kinds of risks: The risk that asset prices will
dechne around the time workers begin to retire; The risk that annuities will be ex-
pensive to buy when the worker must convert his retirement nest egg into a level
annuity; And the risk that price inflation during the worker's retirement will seri-
ously erode the value of his annuity. The existence of these kinds of risk means that
there is a continuing and crucial role for traditional Social Security, even in the case
of workers who earn middle-class wages throughout their careers.
Mr. Smith. Dr. Ibbotson.
STATEMENT OF ROGER IBBOTSON, PROFESSOR OF FINANCE,
YALE UNIVERSITY SCHOOL OF MANAGEMENT
Mr. Ibbotson. Yes, I am an expert in investments, let me say,
and I have some knowledge about Social Security issues, and I
want to actually talk about both subjects here, although I am sure
I will be mostly talking about investments.
Starting out with the Social Security problem. The basic problem
is that this has been — is now, and always has been primarily a
pay-as-you-go system, so that current workers are paying the bene-
fits of current retirees, and the problem we are in that I guess
68
probably everybody here recognizes is that the changing demo-
graphics are changing the mix of workers to retirees. We are hav-
ing far more retirees per worker than we did in the past.
Social Security also — and I just want to bring this up front —
seems to serve another purpose here, and many of us have views
on this. Social Security performs somewhat of a wealth-transfer
system because I — maybe it makes some attempts, but I think par-
tially by design the system is not in balance. The individual ac-
count, if you were taking individual contributions, they do not
match what the individual would get in retirement.
The system has various biases. The most obvious is the young —
favors the young over the old, but it also favors women over men
because women live longer. At low wages, low-wage earners over
high-wage earners because it smooths things out, and there are a
lot of other imbalances.
Now, I am saying these are — we have opinions about what we
want Social Security to do, but it is only a partial retirement sys-
tem and it is also partially a wealth-transfer system.
In terms of getting it on a reasonable footing — I think Chairman
Smith pointed it out — the three items right off the bat, you either
have to reduce benefits in some way, increase savings, or increase
returns on investments. I actually believe that we have to really do
some of the first two of those, however painful they may be to the
American people, that we may have to actually reduce some bene-
fits that may be in the form of, say, delaying the age when you first
get benefits or restricting who is eligible or taxing benefits in some
form. I think that the benefit level cannot be sustained without
substantial increases in savings rates.
Savings rates can come in many different forms too. They can
come in the form of higher payroll taxes, of course, but they might
be — and I am sure we will talk about it today — privatized savings
accounts, or perhaps applying general budget surpluses to make up
part of this shortfall.
What I will try to focus on here mostly, though, is the third item,
getting a higher return on investments, because obviously that is
not painful unless we actually suffer some of the risks associated
with that higher return. But we all would like to get higher returns
where most of us here would be reluctant to have higher payroll
taxes or higher savings accounts and reduced benefits.
I actually think, though, we have to do all three, so I am not sug-
gesting that there is a magic bullet in higher returns; it can only
be a partial solution.
Generally, though, before we could even talk about getting re-
turns, higher returns, we have to talk about making an invest-
ment, because that requires some prefunding. We have the Social
Security trust, but it has only limited prefunding. The funding is
not even close to the potential liabilities here, and I have heard lots
of numbers. I haven't done any calculations, but they have been up
to $10 trillion in liabilities, and the funding is nowhere near to that
extent. But with some funding, then we can have investment.
Now, I have to warn everybody again, unfortunately, that we
have the pay-as-you-go system, we have the current benefits. We
have to really pay the benefits and make the prefunding in some
sort of a pretty long transition period, where to think of a — you
have to pay for your parents' benefits at the same time you are
making investments into your own retirement plans. So you sort of
have to do both here, and that is why straightening this whole
process out is likely to be painful.
But in terms of what to invest in, let me make a simple state-
ment, and that is stocks do out-return bonds over the long run.
They have historically — most of my measures go back to 1926, but
we can go back further, if necessary. But going back to 1926, stocks
have returned 11.2 percent per year. At the same time, U.S. Gov-
ernment bonds have returned 5.3 percent. So there is about a 6
percent differential between stocks and bonds. That 6 percent dif-
ferential has actually a dramatic effect over time because of the
compounding. If you put money away and let it run over 30, 40,
50, 70 years, 73 years in this case, this is amazing. A dollar at 11.2
percent over 73 years grew to $2,351. And $1 in bonds at that 5.3
percent grew to $44, a much lower amount.
Now, it is true that this includes inflation, and the inflator is
about 9, if you divide those numbers by 9; or if you want to rough
it out, divide by 10, still, even dividing by 10, a dollar in real terms
in the stock market grew to $235. That is 73 years; that is really
in our lifetimes there, what — maybe it is a little longer than our
working lives, but it is the kind of result that you can get from
these high returns if they are realized.
The $44, as the $1 grew in bonds, I guess if you divide that by
9, that is about 5, a little less than five times your money, not that
much growth over the long run. Basically you are covering infla-
tion.
Now, as Dr. Burtless has pointed out, stocks have risk, more risk
than bonds; that is true. And there has been — over this period
starting in 1926, there has been a period as long as 20 years start-
ing in the Depression, starting in 1929 where bonds out-returned
stocks, so it is possible to have a long period of time where bonds
do better than stocks.
There has been the worst case — if we go back to the Depression,
stocks lost from their highs in 1929 to their lows in 1932 — they lost
80 percent of their value. So there definitely is a potential down-
side to this. Yet, over the long run, stocks do outperform bonds.
Forty-seven out of the 73 years, stocks had a higher return than
bonds, so about two-thirds of the time, the return on stocks is high-
er than the return on bonds.
Over a long horizon, looking forward, the odds are high that
stocks will outperform bonds. The longer the horizon, the higher
the odds that stocks would outperform bonds. Stocks actually —
since 1926, they have never had a negative 20-year period, and
they have only had — if you take all the overlapping 10-year periods
which is 64 10-year periods that overlap, only two of them were
negative. So the odds of being negative over a 10-year period are
quite low and not very high at all for — we have never had one over
a 20-year period. So I think that over the long run, the odds are
extremely high that stocks will outperform bonds.
I will say, though, that — and I guess we, the American people
and you in Congress on this committee and so forth, have to make
this kind of a judgment. There are risks in the stock market. I
know that the U.S. Government sort of acts as a safety net to the
70
U.S. economy, and when times are at their worst, perhaps the gov-
ernment will be there for us. So we recognize that we are con-
cerned about these risks and still, I believe that the trade-offs are
sufficient here. The odds are high, if we can be long-term investors,
that is the key. If we can be long-term investors, the odds are very
good that stocks will do better than bonds. So generally I would ad-
vocate at least some investment in the stock market.
Of course, this is very different — I will handle this in questions,
I am sure, but it is very different whether this is part of a public
fund which is doing the investing or whether these are privatized
accounts.
Thank you.
Mr. Smith. Thank you.
[The prepared statement of Mr. Ibbotson follows:]
Prepared Statement of Roger G. Ibbotson, Professor of Finance, Yale
University School of Management
Chairman Smith and distinguished members of the House Budget Committee's
Task Force on Social Security.
I am an expert on the long-term investment returns of stock and bond markets.
I am generally familiar with the Social Security structure and issues.
The Problem
The basic problem is that the current system is and has always been primarily
a pay-as-you-go retirement system. Current payroll OASI taxes are used to pay re-
tirement benefits of current retirees. The system is mostly unfunded, and to the ex-
tent it is funded, it is used to hold and offset U.S. Government debt.
The pay-as-you-go system cannot work indefinitely, given the changing demo-
graphics of our workforce, with ever larger proportions of the population being re-
tired.
Also, the Social Security system, partially by design and partially by its very na-
ture, has not paid out individual benefits that are aligned with that same individ-
ual's contributions. In general, the system favors the old over the young, women
over men, low wage earners over higher wage earners, along with numerous other
imbalances. Thus the system works as a welfare wealth transfer system, as well as
a retirement system.
Solution Possibilities
There are only three possibilities: Increased savings, reduced future retirement
benefits, or higher return on investment.
1. Increased Saving Rates. Any reasonable plan has to increase savings rates.
This can come in the form of higher payroll taxes, private savings accounts, or mere-
ly applying projected government surpluses to help solve the problem.
2. Reduced Retirement Benefits. These can be reduced by delaying the age of first
benefits, reducing the amount, restricting eligibility, etc.
3. Higher Return on Investment. Assuming there is a least some prefunding, the
sums could be invested in higher returning assets. The current surpluses are used
to off"set government debt. Alternatively, they could partially be invested in common
stocks, which might be expected to produce higher returns.
Prefunding
In order to earn returns on investment, the investment has to be prefunded. This
is true whether the system continues to be run entirely by the U.S. Government,
or whether it is to be partially privatized. Prefunding requires a transition stage
from the pay-as-you-go system. During this transition, extra investment must be
made, since the current benefits still have to be paid.
Stock Returns vs. Bonds Returns
Stocks usually outperform bonds. Since 1926, common stocks returned 11.2 per-
cent per year, while U.S. Government bonds returned 5.3 percent per year. One dol-
lar invested 73 years ago in common stocks grew to $2,351 versus only $44 in bonds.
71
Over the long run, investing in higher risk assets can have a substantial impact on
accumulated wealth. I expect the historical payoffs for risk to continue in the future
over the long run.
The Risk of the Stock Market
Stocks are riskier than bonds. There has been as long as a 20 year period in
which bonds outperformed stocks. In our worst historical case, stocks lost over 80
percent of their value from their 1929 high to their 1932 low. Yet stocks out-
performed bonds almost two-thirds of the years (47 out of 73). Over longer horizons,
the odds increase that stocks will outperform bonds. U.S. Stocks have never had a
negative return over a twenty year period, and only in 2 of 64 overlapping 10 year
periods.
The U.S. Government often acts as a safety net to the U.S. economy. Stocks will
likely perform worst when the economy is at its worst. Although the long horizon
risk is relatively low, is it acceptable to us? If the system is partially privatized, in-
dividual investors will make their own risk and return trade-offs. Experience shows
that most people are willing to invest at least some of their retirement funds in the
stock market.
I favor investing only a small portion of our Social Security funds in the stock
market. This provides diversification, without creating undue risk.
Mr. Smith. One of the questions certainly is, are individuals ca-
pable of investing their own money? I just relate my experience at
a company called Spartan Motors in Michigan. I was touring the
factory and went into the lunch room and there were three workers
over there, sweaty and obviously line workers. One had tattoos and
another had a pony tail. What they were reading in the lunch room
is the Wall Street Journal. And I asked the CEO, well, gosh, that
is pretty impressive. And he said well, since we started revenue-
sharing in our 401(k) program, the three of them over there will
average having a stock market investment of over $100,000 apiece,
and they have really started studjdng and asking questions.
So one question is, how do we take advantage of the up-market,
if it is going to go up, and how do we minimize the disadvantages
of some of the stocks that are going to go down?
But maybe a specific question for both of you is. Dr. Ibbotson,
why do you think we will see the Dow at $100,000 by 2025? And
the question to you, Dr. Burtless, is, do you think he is under-
estimating this time as he did in 1974, or do you think he is over-
estimating?
We will start with you. Dr. Ibbotson.
Mr. Ibbotson. Well, let me say that that is pretty much the
same forecast that I made in 1974. You take the bond yield, you
add the premium of how stocks outperform bonds on average over
it, and you project it forward. I did that back in 1975; actually, this
was after a very poor period in the market and everybody thought
I was very optimistic. But I made that forecast, essentially adding
about 6 percent return above and beyond the bond return to the
stock return, and projected it forward — and the Dow does back out
the dividends to get the number because the Dow doesn't include
dividends. But just projecting that forward, it is about 10 percent,
it took the Dow — at that time the Dow was in the 800's, it took the
Dow to 10,000 at the end of the century. We got there a little early.
I am making a similar forecast when I take the Dow to 10,000
to 100,000 over the next 25 years, that we would get about a 6 per-
cent return above and beyond what government bonds would pay;
and I am saying, though, that this happens not without risk. In
fact, I actually forecast these as probably distributions, not certain
72
that you get this, but that is the median, middle forecast of what
I would predict.
Mr. Smith. Dr. Burtless, additionally, do you think he is high or
low? I think I hear you saying from your testimony that you do
support capital investment. The question is, how do you minimize
individual risk?
Mr. Burtless. Right. But I hate to get in the business of fore-
casting what the stock market is going to do, because I think it is
inherently very difficult to predict. My guess is that it is also very
likely that stocks will continue to outperform bonds, although I
would say in the next 10 or 15 years, the degree of difference be-
tween stock and bond returns may be lower just because the valu-
ation of stocks is currently so high. Also, interestingly enough, the
real yield that people are obtaining on U.S. Treasury bonds is also
higher than its historical norm. So the difference, I think, at least
in the next 10 or 15 years, is likely to be smaller than it has been
historically.
I think that it does make sense to try to use this third option
you mentioned in your introductory remarks to try to improve the
return on worker contributions as much as we can. I agree with
what my academic colleague here says, that it will be necessary to
either increase contributions or reduce benefits, but to the degree
that we can get a better return on whatever reserves we hold, that
would lessen the need to reduce benefits or increase taxes.
And I definitely think that there is a way to do it and minimize
risk to individual workers, and the simple way is for the Social Se-
curity trust fund to manage the investment in stocks.
Mr. Smith. This means we have 1-minute to go for my time. Ex-
plain how individual workers could minimize risk if we had per-
sonal retirement savings accounts?
Mr. Ibbotson. There are various ways individuals could do it. I
know there are some proposals on the table. Generally, though, I
would think we would want to make it easy for individuals because
I don't think— I don't think we would want individuals given the
total freedom to buy Internet stocks every day, buy and sell them,
but to get them into more or less, maybe a few options of one mix
or another, maybe an aggressive or conservative and a moderate
mix where they are preset for them, and perhaps we would use
index funds, although we wouldn't have to have index funds.
But I would say that it is potentially achievable for individuals
to do this, and I haven't advocated necessarily to do this, because
I think it is very dependent on what system you come up with
here, whether I would be in favor of it or not. But generally indi-
viduals do manage their money in 401(k) accounts, they manage
their money in accounts; they learn to manage their money. I rec-
ognize that we want to make this available to such a wide group
of people that there is some period of time when they have to learn
how to do this. So I think we have to make the options simple for
them at the start.
Mr. Smith. Representative Lynn Rivers, my esteemed colleague
from the great State of Michigan.
Ms. Rivers. Thank you, Mr. Chairman.
Thank you, gentlemen. I have a question first for Dr. Burtless.
73
The kind of annuity that people discuss in the context of Social
Security either doesn't seem to exist or doesn't seem to exist in any
great number out there, which is some sort of annuity that is going
to exist for the life of the person, which is unknown, of course, at
age 65.
Do these kinds of annuities exist? Would it be possible for some-
one to craft something based on a private account that is going to
not just not be eroded by inflation, but is going to last for as long
as they live, say they live 30 years after retirement. We had some-
one here from the Human Genome project telling us that people
are theoretically capable of living until 130 years old.
Mr. BURTLESS. It has long been possible for people to get an an-
nuity for as long as they live. It has not been possible for people
to get an annuity that is indexed to the price level in the United
States. I have been told by Peter Diamond, a Professor at MIT,
that one of his graduate students discovered a small insurance
company in Ohio that is offering indexed annuities, that is, annu-
ities indexed to prices. However, the company was unwilling to say
what the price was they would charge for an indexed annuity, so
it is hard to take that into account when I perform my calculations.
In principle now, it is possible for an insurance company to offer
indexed annuities, because the Federal Government offers indexed
bonds. If the company's portfolio consisted of indexed bonds, then
it could always be sure that it would have enough money in the
account to make the promised annuity payments.
Ms. Rivers. The indeterminate-length annuity, how would that
differ from one for a set period of time?
Mr. BuRTLESS. Oh, insurance companies already offer that vehi-
cle. You can buy one. Because the insurance companies have an ex-
pected life span that they use, they can offer annuities that last
until death. For every 1,000 people that come in to buy the annu-
ity, they have a pretty good idea for those 1,000 people what the
distribution of required payments will be. So they are able to offer
pretty secure unindexed annuities right now; and they have been
able to offer that kind of a plan for a number of years.
Ms. Rivers. OK.
Dr. Ibbotson, I have a couple of questions for you. One is, in talk-
ing about the issue of prefunding — and we have heard people speak
to that before here, and it is a considerable amount of money that
would be necessary to prefund the existing Social Security system.
It seems it would be pretty costly to prefund the new system, and
you recognized that by saying, somewhere along the line we have
to get extra investment.
Most of the witnesses that we have had here — I don't want to say
"all," because I don't remember, but most of the witnesses here
have suggested that for any sort of transition, the general fund sur-
plus that is projected is going to be inadequate. Where else would
you go for the cash to fund a transition?
Mr. Ibbotson. Well, I haven't done any calculations, whether it
would be inadequate or not, and I am not fully aware of the full
surplus plan over all of these years, although I listened to Presi-
dent Clinton's speech. State of the Union address.
Let me say, I would imagine that we would perhaps partially
fund and do this over a long span of time. I have no magic source
74
of extra money. It could come in the form of some payroll piece that
is set aside in some way; it could come from additional surpluses,
but it ultimately has to come out of our pockets in some way. There
is no way to — I have no secret pile of money here under the desk
that I can bring forward here.
Ms. Rivers. All right.
The other question that comes up a lot when we are considering
investments, and I know we have been talking about averages, and
I know that generally the argument is that the stock market yields
a high return, and virtually — some investors do have — how would
you inoculate people from the effects of those losses on their retire-
ment, or would you?
Mr. Ibbotson. Well, if it is totally privatized like IRAs, people
have had their losses and they have made their choices, and I
think they have to suffer them. One way, though, to restrict the
losses is to enforce some diversification so that individuals, say in
a privatized plan, have only a limited number of choices. They can't
just invest in anything. That would enforce diversification on them.
I will say, though, that once we are in the stock market, we can
never insure these losses, or once we totally insure it, we have
given away the extra gain. So although I could devise plans and
give advice to people to reduce their risk, there is no way we could
eliminate the risk.
Ms. Rivers. The other concern that I have, which is a different
kind of risk, is administrative costs that people would be charged
for doing investing; or when such a huge number of people go into
the investment market that you have sort of Herb's Investment
Service springing up on every corner.
What would be the best way to help people move into a direct
investing system?
Mr. Ibbotson. I think that the administrative costs could be
high — I think over time they would be driven down, but we would
have a variety of competition arising. However, I would imagine
that if you are starting out with this, that we have some sort of
a system where the government is setting up some sort of pool of
accounts which have low administrative costs. They would be per-
haps— if we are talking about privatized accounts, they would be
in individuals' names and they could have different asset indexes,
but the accounts would be pooled.
To the extent that the government is doing the investing, I would
certainly recommend that they be indexed, because I would really
be worried about — in spite of how highly I think of everybody here
in the government, I would be worried about all of the political
pressures involved in trying to invest money. I would think that if
the government is actually making the investments that they be in-
vested in as broad of an index as possible and have it be removed
as much as possible from the political process.
Ms. Rivers. Are we going to have a second round, Mr. Chair-
man?
Mr. Smith. Yes.
Ms. Rivers. OK. I will come back to Dr. Burtless in the second
round.
Mr. Smith, I might say that the Thrift Savings Account man-
agers, Mr. Burtless, who charge two basis points would know some-
75
thing about the complexity of setting up something and taking
bids.
Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman.
Dr. Burtless, I think I hear you expressing a concern that so
many of us have, and I have two parents myself who are 80-plus,
and that concern is, it would be nice if we — I don't want to put
words in your mouth, but just to paraphrase what I think I hear
a lot from others, it would be nice to have an investment that was
making the type of return that we have seen averaged over the last
several decades — number of decades. However, what happens if we
go into a 1930's scenario where we get into a downturn, and it is
not there for them? And I think this is a valid concern.
My question would be, what would be your feeling if we say we
are able to, as the Federal Government, as the U.S. Congress and
the President, come up with an agreement where we could guaran-
tee the safety net of a minimum of what we are paying out now
in Social Security, but somehow we were able to, maybe through
a tax return which many of us are looking at, turn back to the tax-
payers in the form of so much percent beyond that, but something
in addition that would be invested; and then we guarantee them
a minimum of this safety net, but still allow a couple percent, or
whatever it might be, that is being invested into the market and
hopefully in as safe a manner as we are able to do.
How would you feel about that?
Mr. Burtless. I think that there are two issues that come up
with respect to a system like that. The first thing is, if you provide
a guarantee to depositors, we have a situation that is not unlike
the savings and loan slow-motion disaster we saw in the late
1980's. Depositors had a guarantee, if they put their money in sav-
ings and loans associations. The owners of the savings and loans
were looking at a situation where if they invested in a very reck-
less manner, potentially they could make a lot of money, but if the
investment came out bad, well, the depositors would be bailed out
by the Federal Treasury, which is, in fact, what happened.
And you do have to worry a little that people will choose very
risky alternatives unless there is some provision like Professor
Ibbotson just mentioned in which you restrict the nature of the in-
vestments they can make. But if you restrict the nature of the in-
vestments they can make, as Representatives Archer and Shaw
have proposed to do, you have lost one of the major advantages of
individual accounts. As I understand the Archer-Shaw proposal, ev-
eryone has to invest in a portfolio that is 60 percent stocks and 40
percent bonds. Well, under this plan people don't get to choose the
amount of risk they are going to face. What is the remaining ad-
vantage to them of being given this option to invest?
Now, it is certainly true that it is practical to offer a guarantee
if you told people exactly how to invest, but then you kind of won-
der, well, why are you offering this option when you could easily
have the Federal Grovernment invest 60 percent in stocks and 40
percent in bonds, and you would vastly reduce the administrative
costs.
76
So there are two crucial issues: administrative costs, I think, and
then if you let people invest in whatever they want, some people
will be induced to invest very risky if they are given a guarantee.
Mr. Herger. Well, just to continue with the question, let's say
we don't let them invest anyway they want; we do have param-
eters. Now let me maybe move to something similar, to the type
of investment that Federal employees have where you do have
some kind of a choice there. But an3rway, there are parameters
there.
Let's say we set something up like that which would be in addi-
tion to the Social Security that we are guaranteeing. I mean, we
can't be — it would seem to me we can't be any worse off than we
already are, because basically part of what you described is what
we already have.
But the second part, if we were to put parameters — and I cer-
tainly agree with you, if we just left it open to do as we did with
the savings and loans, where you just go and put your money in
the riskiest with the highest chance of return — but if you had at
least some guidelines there, would that not be far superior to what
we have now?
Mr. BuRTLESS. If you do have individual accounts and they
amount to only a small percentage of the pa3rroll and there is still
the basic traditional Social Security pension (or perhaps a slightly
scaled-back pension) then if it is a small enough contribution that
you are asking people to make, I don't see a reason to offer a guar-
antee. The guarantee in this system is still the traditional Social
Security pension, perhaps scaled back some. Then people must in-
deed accept the risks that go along with investing a small monthly
amount in their own individual retirement account.
The government should not guarantee people against losses in
what is, after all, a small portion of their contribution to the sys-
tem.
Mr. Herger. But again, maybe you missed what I am asking.
But the thought is that we would, at least for now, at least for the
next decade or so and perhaps somewhat longer, continue with
what we are doing now. This money is coming in — I mean the same
type of arrangements we have now, which basically the Federal
Government is standing good that we are going to pay retirees so
much. But in addition to that, we have a couple percent that we
begin investing so that the point is to get away from the insecurity,
because that is what I hear the criticism is. Those who are criticiz-
ing this are sa3dng well, gee, you know, we don't know, we might
lose out.
So it would seem to me we have our cake and we are able to eat
it too if we are, during these times of the economy going so well,
that we have a golden opportunity to perhaps, if we take it, to do
both. Isn't that far superior to what we are doing now, and that
is, doing nothing?
Mr. Burtless. Well, at the moment, the government as a whole
has a big surplus. I think it is out of the big surplus that people
are thinking, either directly or indirectly, of financing those small
accounts that you just mentioned.
Mr. Herger. Right.
77
Mr. BuRTLESS. And if they really are small accounts, then forcing
people to accept the risk that comes with the choice that they have
made, while still giving them some choice between a really safe in-
vestment vehicle like bonds and perhaps 100 percent being in-
vested in an index fund for all of the stock market, you have given
them a choice amongst several basic risk-and-return opportunities.
You then simply tell them, "This is a small portion of your retire-
ment income; it is not all of it; we still offer a guarantee for the
basic Social Security pension; you accept the risk that goes along
with your small individual account.
Mr. Smith. Representative Clayton.
Mrs. Clayton. Thank you, Mr. Chairman.
Have either of you run a model where it shows the cost-benefit
of moving from — ^you just, in response to the last question, you said
a person putting a small amount of the Social Security would as-
sume the risk. Have you run a model on that one?
Mr. BuRTLESS. I have not run models
Mrs. Clayton. On any of these?
Mr. BuRTLESS. The only calculations I have performed have sim-
ply reflected the kind of pensions workers would have obtained if
they had been faced with the actual investment environment that
stocks and bonds have offered to investors since about 1871. So I
just make calculations for 88 different workers. The first worker
starts work in 1871 and he has a career and then he retires at the
end of 1910. The second worker starts working in 1872, and he has
a 40-year career, and then he retires in 1911. And so on.
So I have looked at the outcomes for 88 different workers, and
each worker followed the same retirement investment strategy
throughout his career. The results of those calculations are at the
back end of the handout I distributed.
Mrs. Clayton. OK. I guess I haven't had a chance to read that.
But the result of that, would those calculations give you the assur-
ance that the benefit for that investment would outweigh any of
those vulnerabilities in that period of time, overcome the costs of
management?
Mr. BURTLESS. Well, there is a simple thing to bear in mind. In
very short periods of time if you invest either in stocks or in bonds,
there are sometimes big changes in the prices that you get if you
try to sell these assets. When the interest rate goes up, for exam-
ple, the value of bonds goes down very quickly. And sometimes, as
you heard Professor Ibbotson say, stocks have fallen in price by 80
percent in the space of 3 years. Even as recently as 1974-1975
there were very dramatic reductions in the value of stock prices.
So when people have their investment savings placed in these
land of assets, in pretty short periods of time, if they are entirely
invested just in one kind of asset, they can face very drastic reduc-
tions in the amount that they can afford to live on when they re-
tire. That is simply a fair description of financial markets in the
United States.
Mrs. Clayton. So the time you invest would remove the vulner-
ability of this kind of fluctuation when it is a short period of time?
With the stocks and bonds, you expect that kind of fluctuation; is
that correct?
78
Mr. BuRTLESS. As I understand what you just said, the longer
that you are invested in stocks (that is, the longer is the career in
which you have placed money in the stock market), the less the vol-
atility. If you look at 3-year periods, you can lose 80 percent on
your investment. I mean, there have been instances where people
could lose 80 percent of their money in just 3 years.
Investment losses that large have never happened for 15-year pe-
riods. If you stretch out the investment horizon to 40 years, I think
there has been no 40-year period since we have had a stock market
in the United States in which people would have lost money. Prob-
ably the lowest return for any 40-year period that I know of is 2
percent. A 2 percent positive real return is the lowest stock market
return we have ever had over a 40-year period.
I do not predict that the future is going to be like the past.
Maybe in the future real returns may dip to less than 2 percent.
Still, the fact of the matter is, even over 40-year careers, there are
major differences in how well people come off. Long-term returns
depend critically on when they start their investment and when
they retire. They also depend on interest rates at the time workers
convert those investment funds into something to live on in their
retirement.
Mrs. Clayton. I was reminded of a show they had on ABC, the
Delaney Sisters, who come from my State and their father, the fa-
ther of the twins admonished them years ago to give 10 percent to
the Lord and 10 percent to savings. They didn't say how much they
had given to the Lord, but they said 10 percent she invested over
a period — after all, she lived to 101, so I guess their life experience
would bear out your testimony that they invested, so they did pret-
ty well on their investments.
Dr. Ibbotson, did I misunderstand you? You feel the value of in-
vesting beyond the individual accounts, whether the government
should invest, is that
Mr. Ibbotson. I actually haven't personally taken a position.
Mrs. Clayton. Let's assume you did take a position; how would
you account for the government's gap in financing the baby
boomers, and assuming you were in a position to invest the so-
called "surplus" that we have, and assuming that the budget reso-
lution we just passed — Mr. Chairman, we didn't do the tax break,
so we won't have that?
Mr. Smith. All the Social Security surplus is set aside.
Mrs. Clayton. So the Social Security surplus we set aside into
an investment pool, how then will we take care of the gap for the
baby boomers who are coming due, say, by 2017 or 2013, or what-
ever year it is, if we have this money set aside and just — Dr.
Burtless' testimony of long-term investment is the way you get the
money, if you can't spend the money twice or you can't spend it for
current obligations and also earn investments. So what will we do
with that scenario?
Mr. Ibbotson. Yes, we can't spend the money twice. I think you
put it very well. We have to first get some investment — put some
investment away, which I am recommending that once you put it
away, if you invest at least some of it in the stock market, you
would likely have higher returns than if you put all of it in the
bond market as we currently do.
79
But you are still saying, how do we put some money away to
start with. Well, I actually believe — I guess I am not running for
office so I can say this — but I actually believe that we have to cut
benefits in some way, because as we get this larger and larger
group of retirees and smaller and smaller group of workers, that
certainly one of the aspects of this is some form of cutting benefits.
Mrs. Clayton. Which benefits would you cut — spousal, disability,
children, which one?
Mr. Ibbotson. You want me to name names here. I guess, since
I am not running for office, I can say that.
I won't name anybody's spouse or anything, but I will say that
I think that there are wealthier people who don't rely as much on
Social Security, so perhaps those benefits could be cut, for the peo-
ple over a certain income or something like that, or taxed in some
way or something. I think there are groups of people, various
groups that we could begin cutting benefits.
I think, though, possibly across the board, we could cut
everybody's benefit by not fully inflating it as we currently do, so
that there is a gradual cutting of these benefits. I am certainly —
that is to say, I certainly wouldn't say this at a political rally, but
maybe it is being public, but I am not running for office so I can
say these things.
Mrs. Clayton. You can change your mind and run for office
later, so be careful.
Mr. Smith. Mrs. Clayton, with your permission, we will do a sec-
ond round.
I guess I would like to follow up on ways that we might look at
to minimize the risk of a down market at the time of retirement.
Could we make some kind of a phased transition from capital in-
vestments to bond investments? Could we gradually say that part
of the savings could be annuitized the first year versus outyears?
Both of your suggestions — assuming that you were faced with
these kinds of personal retirement savings accounts and looking at
ways that we might minimize the risk of a down market at the
time that somebody might turn retirement age.
Mr. Ibbotson. I would like to answer that, if I may. I think there
are a lot of things we can do to mitigate this risk. We can, as you
said, smooth out — we don't have to buy an annuity when you are
65; we could buy some of the annuity early and some of it later,
and smooth it out over some period of time to reduce the risk of
that annuity. In the investment accounts, presumably these would
be set up in very diversified ways.
A lot of the scenarios we are looking at are all stock investments,
and I don't think we are really advocating 100 percent stock invest-
ments here. These sound like terrible cases of losing 80 percent of
your money. But in a diversified portfolio, you don't get anything
like those kinds of losses over that worst 3-year period in history.
So I think there is diversification, perhaps running index funds,
perhaps smooth over the annuities when the annuities are pur-
chased. There are a variety of things that will reduce this risk.
They won't eliminate it, but they can definitely reduce the risk and
make this palatable.
Mr. Smith. Dr. Burtless.
80
Mr. BURTLESS. The reason that I invest in stocks, the primary
reason is simply because they offer good returns adjusted for risk.
I think that in many pubhc discussions of alternatives to Social Se-
curity, a common number that I hear — and it comes from Professor
Ibbotson's calculations — is that stocks return 11.2 percent or 11.5
percent; and Social Security returns 2 percent or 1 percent. It is
important to bear in mind what those two numbers mean. There
is only one way that you get a rate of return of 7 percent, which
is the real (inflation-adjusted) rate of return that we have seen in
the United States since 1926 in common stocks. The only way you
get that is to accept the risk that comes with stock investments.
To the degree that you shift funds out of stocks into assets that
reduce the variability of your portfolio, you are accepting a lower
return. You know, that is the point of finance, to teach you how
you select the allocation in which your trade-off for risk and return
yields greatest satisfaction. You don't get 7 percent average returns
if you mix your investments across both stocks and bonds.
Mr. Ibbotson. I agree with that. I want to say one other thing
just to get these numbers straight.
The 11.2 percent return on stock markets — I think the compari-
son is with the bond market return, which historically has been 5.3
percent; it is not — the 1 percent number that we are talking about
is, yes, it is after inflation, but they are also different participants
because we don't — what we put in is not what we get out because
of the imbalances of the system. Different participants and dif-
ferent, I guess, age brackets and so forth get different amounts out,
and that is not just the investment return, that is somebody who
puts in their money today, what their investment is, but that is
presuming that part of your money is going to pay somebody else's
benefits.
Mr. Smith. A question on if there were individual investment ac-
counts where individuals had some flexibility on where to invest
their money and how to diversify.
Are the American workers intelligent enough, concerned about
their investment enough that somehow they would learn, or indus-
try and businesses would come in to help teach individuals how to
properly invest to minimize risk and maximize gain?
Mr. BuRTLESS. Let me answer. I think there are three answers.
First of all, I think it is fair to say that Americans are capable
of handling their own investments. It is also fair to say that their
abilities and their tastes for risks differ tremendously. And it is
also important to point out the findings of the empirical studies of
how people make the choice between different kinds of investments
when they are offered just a few, as 401(k)s t5rpically offer.
Women are less tolerant of risk than men are. In other words,
they tend to put their money in safe investments like guaranteed
income contracts. Older workers are less tolerant of risk, which
makes sense, than younger workers. And low-income workers are
less tolerant of risk than high-income workers, meaning that they
would probably obtain a lower return, although with lower risk.
Mr. Smith. Dr. Ibbotson.
Mr. Ibbotson. I think all of those empirical results are correct,
and I think it makes sense. It is all right for some people to be less
risk-tolerant than others and to have portfolios that take less risk.
81
You want to match the risk preferences to the people if it is a pri-
vately-based plan.
Mr. Smith. Is there any evaluation anyplace, any studies that
look at IRAs, 401(k)s, in terms of the effort of those individuals to
better familiarize themselves with investment information?
Mr. BuRTLESS. Yes. The Employee Benefit Research Institute
conducted analyses of the effect it makes if employers have good
information campaigns. I think that there are differences across
employers in how risky and how sensible the distribution of 401(k)
investment choices made by their employees is. So the firms that
spend more to help their workers learn have workers who appear
to be making better judgments.
Mr. Smith. Representative Rivers.
Ms. Rivers. Thank you. Some people are talking about privatized
accounts, are talking about what I call the live-free-or-die model,
which is a purely privatized system where people take their risks,
take the consequences of their risks, and some people do very well
and some people don't, and the government stays out of it. Most
of the people we have heard from in here are talking about some-
thing less than that.
As I listen to both of you, we are talking about finding a way to
insulate losses to some extent, rather than accepting the individual
variability that might come from big losses for some people, big
gains for others. We are talking about directing investment dis-
tribution, so much in stocks, so much in bonds. We are talking
about limiting investment choices so that people don't have too
high a taste for risk.
So I am left with, why would we go to an individualized,
privatized system? Is it purely ideological? If the government is
going to protect to some extent against loss, is going to direct what
the load of investments will be, and is going to direct the kinds of
things that can be invested in, if all we are looking for is a higher
return, why go to an individualized system as opposed to just let-
ting the Social Security Administration invest funds?
Dr. Ibbotson.
Mr. Ibbotson. Well, I think that some individuals want to make
these decisions, and they want to have control over their lives; and
some of them want to take on more risk, some of them want to
take on less risk. We don't want to leave it parameter-free.
Ms. Rivers. But you favor the government limiting many of
those choices, right?
Mr. Ibbotson. Yes, but still, even with limited choices, people
like to make choices, and we generally believe, I think, in this
country, in allowing people to make choices where it is reasonable.
And so I don't think it is purely ideological; I think there are bene-
fits of making a choice. It does work with IRAs and other 401(k)
accounts. It can be successful, and I think over time people get bet-
ter at these sorts of things, too.
Ms. Rivers. Dr. Burtless.
Mr. Burtless. I think one reason we have a Social Security sys-
tem is the fact that in the 1930's the private retirement system
failed so conspicuously for such a large proportion of the aged pop-
ulation. The other reason we have it is the view, both among work-
ers and voters, that maybe individually we are not completely to
82
be trusted in saving for our own retirement. We think that having
a system in which money is withheld from us automatically and
then given to us when we reach retirement age has real advan-
tages for us. We see this in unionized companies. Almost all union-
ized companies have pension plans. Those pension plans take away
from workers the ability to choose for themselves how much of
their current pay should be invested for retirement and how much
should be available right now. One reality is that the retirement
system exists because we don't completely trust people to make all
of these choices.
I agree with Professor Ibbotson, though, to the degree that we do
need some choice. Many people think it is good to let people make
their own decisions regarding the risk they are willing to absorb
and the return that that will yield them.
But I think that there is a second political reality. I have sat on
a couple of panels; I have had debates with people who are very
much in favor of individual accounts. I think the second reality is
that there are many people who just do not trust public decision-
makers to allocate the investment funds. They don't trust the gov-
ernment to select stocks, to buy corporate bonds, or to make real
estate investments. And they don't trust public officials to vote the
shares if they did own corporate stocks.
So there is a view that it is preferable to let 144 million individ-
ual Americans accumulate small retirement investments in private
accounts and then leave it up to Fidelity or Barclay's or Vanguard
to decide how to vote the shares in those accounts. That is politi-
cally the safest thing to do.
I do not agree with this view. I have a fundamental disagree-
ment with it. The Federal Reserve Board's retirement plan and the
Thrift Plan covering Federal employees have shown that it is per-
fectly possible to make apolitical decisions about how to invest re-
tirement funds. So I fundamentally disagree with the critics of pub-
lic control over the retirement investments. I do recognize, how-
ever, that there are many people whose views I respect who do not
trust public decisionmakers to make investment decisions.
Ms. Rivers. Let me ask both of you about a very political deci-
sion. That is, right now, within the political system, there is a bias
on the return for low-income people. They do better under the sys-
tem than higher-income people do. If we create a privatized system
or a somewhat privatized system where people are investing a per-
centage of wages, we are going to see people who already have
money doing much better than people who are in low-income posi-
tions. Frankly, I looked at poverty figures last night, which suggest
that the number of working poor are growing all over the country.
Should we have some sort of way to address this in the Social
Security system, or should we let — I don't want to say "let," that
is not the right word. Should we ignore the increasing gap that the
investing will create between the haves and the have-nots in our
country?
Mr. Ibbotson. I think what you are saying is that the higher-
wage investors are willing to take more risks.
Ms. Rivers. Well, they are investing more, so they are getting
more back.
83
Mr. Ibbotson. They invest more, they take more risk, they end
up with more, and I am sure that is Hkely to be true, given choices
here, that they would be the ones more Ukely to be taking the risk.
I think that— I said at the outset that Social Security plays a
welfare function as well as a retirement function, and I think it
would be difficult for me to say, let's get rid of that welfare func-
tion. I think that there are reasons to have this safety net for the
American people, and so I think it is — any movement to privatize
is only going to be a partial movement. Certainly the system would
be largely in place and would still, it seems to me, take on these
welfare characteristics.
Ms. Rivers. Dr. Burtless.
Mr. BuRTLESS. I am very much in favor of the attempted redis-
tribution in the Social Security system in favor of low-lifetime-earn-
ings workers. There is a real question about whether, in fact, the
formula is redistributive enough if you account for the difference in
longevity amongst higher- wage and lower- wage workers. I don't
really know the answer to that question.
I suspect that the system is still redistributive in favor of low-
wage workers. That is a feature of the system I very much favor,
because I think you can look at that as wealth transfer, but it is
also a form of insurance.
When you are 20 years old, and beginning to make contributions
to Social Security, you don't know whether you are going to be one
of the lucky workers who earns high wages throughout their ca-
reers. You may be completely confident that you are, but bad luck
could dog your steps before you reach retirement, and then you
very much welcome the fact that the system is redistributive in
favor of people like you.
Mr. Ibbotson. I want to say some of these redistributions might
be reasonable that we want to redistribute from high wage to low
wage, but do we really want to distribute from young to old, be-
cause when the young become old, then we don't have the money
to do it for them, the same way that we don't for the current older
generation.
Mr. Smith. Dr. Burtless, did I understand you to say you support
the kind of investment limitations, such as the thrift savings ac-
count, but still that could be an individually owned investment ac-
counts?
Mr. Burtless. My view is that if you are going to have individ-
ual accounts that represent a very small percentage of workers'
pay, the only feasible way to do it is through the thrift savings
plan-type operation where you offer people perhaps four or five in-
vestment options. The Treasury or the Social Security Administra-
tion could collect people's contributions. It could use a bidding proc-
ess to hire the least expensive manager to handle the investment
funds. And it could delegate the voting of the investment shares to
third parties. Then the Social Security Administration would dis-
tribute money that is in these individual accounts to workers upon
their death or their retirement. That is, I think, the only feasible
way to manage small individual accounts.
The idea that you can have individual accounts managed by Fi-
delity and a thousand other investment companies only becomes
84
feasible if contributions represent a big percentage of people's pay,
1 or 2 percent is just not enough.
Mr. Smith. Mr. Merger.
Mr. Herger. Thank you.
Dr. Burtless, I am happy to hear you say that none of us know
the answers, or obviously we would be President, we would be run-
ning things if we did. But it seems to me the system we have now
almost could be described as mutually shared misery. If all you are
going to live on was what you get from Social Security, I mean, no
one can live on that. So — but at least — and my understanding was
it was never meant to be a full retirement; it was supposed to be
something that people could fall back on. Hopefully, they would
save some money during their lives and have something else in ad-
dition to this.
But I think this idea of maybe at least continuing to guarantee
that, that minimum amount — which again is not enough for anyone
really to live on — and this idea of having maybe a couple percent,
or whatever it is, more that people can invest in the t3rpe of invest-
ment that we, as Federal workers, have I think is exciting.
I serve on the Ways and Means Committee. We had an individ-
ual who had set up, or helped set up in Chile this system, and he
was saying how exciting it is in Chile. People walk around with
these little, their little red books that show how much they have
invested to see how much it has grown; and quite frankly, I find
it kind of exciting myself, over the years that I have been in Con-
gress, to have invested some in this savings plan that we have and
to be able to look at, see — we have had incredibly good years here
that we certainly can't expect to go on forever, but it is exciting to
see this — as Einstein said, the most powerful force is compound in-
terest— to see how this account is building.
So I think that this prospect of perhaps guaranteeing this, at
least this floor of mutually shared misery that I would frame Social
Security currently being at — at least guaranteeing that; plus giving
people hope and maybe encouraging them more to invest — and par-
ticularly those who haven't been investing before — is an incredibly
exciting concept, at least for me.
Mr. Ibbotson. I share your excitement, but I also share Dr.
Burtless' concern about the guarantee here, because the guarantee
that you are talking about for these miserable current benefits is
really more than we can afford, though. It is not — it is a liability
that is uncovered, and it may not be enough to live very well on,
but it isn't just a guarantee that we can make and then have some-
thing good happen on top of it.
I am thinking that we just can't — we can't guarantee at the level
we are at.
Mr. Herger. But that is what we — in essence, that is what we
have been doing since 1935; is it not? We are basically guarantee-
ing, if not stated, at least very explicitly implied that we are guar-
anteeing that in the form of Social Security that we currently have.
Mr. Ibbotson. We are guaranteeing it, we have been guarantee-
ing it, and our problem is that we can't afford the pay-as-you-go
system to continue to guarantee it because the dramatic shift in
the number of workers, far less workers per retiree
85
Mr. Herger. Beginning in 2012 or 2013; I understand that. But
I think what is exciting, about this plan at least — and I don't claim
to be an expert on it, because I am not — but at least the Archer-
Shaw plan is that you would actually get to a point where we
wouldn't need it after a period of time, and one would actually take
the place of the other. We wouldn't be in this position where we
are now of having this unfunded liability incredibly that we have.
Mr. Ibbotson. That is what makes the top part of this so excit-
ing to all of us here, that perhaps in this additional piece it could
be big enough to cover some of the guarantees and some of the —
and perhaps some upside. But without some extra payments in, we
certainly
Mr. Herger. Right.
Mr. Ibbotson. — we can't even make the guarantees of where we
are, much less add anything on top of it.
Mr. Herger. But as I understand it, his plan does have 2 per-
cent on top of, which is additional, at least now, while we have this
surplus.
Anyway, thank you very much, both of you.
Mr. Smith. Well, I would close on an interesting bit of trivia.
In researching the testimony back in 1934 and 1935, the Senate
argued very vigorously, and two votes in the Senate insisted that
private investment options for retirement savings should be an op-
tion to the fixed benefit program of the government and that wasn't
changed until they went to conference committee between the
House and the Senate where a decision was made that we should
disallow any individual the ability to make those retirement invest-
ments. So a decision in conference committee was made to have the
fixed benefit program that we have now that has got us into a
great deal of problems.
Let me just say that 3 weeks from today we hope to cover the
issue of. Is the Social Security Trust Fund Real, and to what extent
is there a difference between when we run out of tax money to pay
benefits and the year 2034 when the actuaries say that it becomes
an actuarial problem. So is the trust fund real, and how is the gov-
ernment going to pay that back if they do pay it back?
Two weeks from today. May 25, will be the national retirement
reforms in other countries. Testifying will be Dan Crippen, Direc-
tor, Congressional Budget Office; and David Harris from Watson
Wyatt Worldwide, and Lawrence Thompson, a Senior Fellow at the
Urban Institute.
Next week will be titled Establishing a Framework for Evaluat-
ing Social Security Reform with Dr. Robert Reischauer from The
Brookings Institution and Steve Entin from the Institute for Re-
search on the Economics of Taxation.
So, gentlemen, again, thank you very much for your time and ef-
fort to be here today. Your testimony will be entered in total in the
record, as well as your comments. Thank you very much for help-
ing us.
[Whereupon, at 1:30 p.m., the task force was adjourned.]
Cutting Through the Clutter: What's Important
for Social Security Reform?
TUESDAY, MAY 18, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12 noon in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Members present: Representatives Smith, Herger, Ryan, Toomey,
Bentsen, and Holt.
Mr. Smith. The Social Security Task Force will come to order.
During the past 50 years, Congress has enacted reforms that
both expanded and contracted the Social Security program. In
1972, Congress increased benefits by 20 percent. The following
year, as the House of Representatives voted for an additional 11
percent increase — raising benefits by more than 30 percent in just
2 years — Representative Barber Conable stated, "Nobody is worry-
ing about where we are headed with Social Security. We better not
put off a careful review much longer if we are to face the next gen-
eration with as much sympathy as we are here showing to the last
generation."
In less than 5 years, the system faced financial crisis. Congress
passed legislation in 1977 that included tax increases and benefit
cuts to "fit" Social Security's problems.
By the early eighties, Social Security again faced insolvency.
Representative Conable was among the experts who served on the
Greenspan Commission, which recommended reforms that were to
assure Social Security's long-term health. Many of the rec-
ommendations of the Greenspan Commission were enacted by Con-
gress in 1983. Despite these reforms, Social Security today has a
$9 trillion unfunded liability, and is facing a cash deficit as early
as 2013.
This short history only serves to emphasize the difficult task we
face as we again work to recommend changes that will bring long
term solvency to Social Security. During the past months, we have
heard about many problems with reform. Now it is time to think
about overcoming these problems and implementing solutions that
end the cycles of insolvency that Social Security has experienced in
the last 20 years.
(87)
88
Prepared Statement of the Honorable Nick Smith, a Representative in
Congress From the State of Michigan
During the past 50 years, Congress has enacted reforms that both expanded and
contracted the Social Security program. In 1972, Congress increased benefits by 20
percent. The following year, as the House of Representatives voted for an additional
11-percent increase — raising benefits by more than 30 percent in just 2 years — Rep-
resentative Barber Conable stated, "Nobody is worrying about where we are headed
with Social Security. We would better not put off a careful review much longer if
we are to face the next generation with as much sympathy as we are here showing
to the last generation."
In less than 5 years, the system faced financial crisis. Congress passed legislation
in 1977 that included tax increases and benefit cuts to "fix" Social Security's prob-
lems.
By the early eighties, Social Secvirity again faced insolvency. Representative Con-
able was among the experts who served on the Greenspan Commission, which rec-
ommended reforms that were to assure Social Security's long-term heailth. Many of
the recommendations of the Greenspan Commission were enacted by Congress in
1983. Despite these reforms. Social Security today has a $9 trilhon unfunded liabil-
ity, and is facing a cash deficit as early as 2013.
This short history only serves to emphasize the difficult task we face as we again
work to recommend changes that will bring long-term solvency to Social Security.
During the past months, we have heard about many problems with reform. Now it's
time to think about overcoming these problems and implementing solutions that end
the cycles of insolvency that Social Security has experienced in the last 20 years.
Successful reform needs bipartisan support. I encourage my colleagues to work
with me to make 1999 the year we enact Social Security reforms that puts this im-
portant program on a solid foundation for the 21st Century.
Dr. Reischauer, you have testified before various congressional
committees. You have been testifying and talking to the budget
committee over the years and we look forward to your testimony.
Mr. Entin, we will start with you for approximately 5 minutes,'
five to 7 minutes and then Dr. Reischauer for five to 7 minutes.
Ken, unless you would like to make a statement early on here?
STATEMENT OF STEPHEN J. ENTIN, EXECUTIVE DIRECTOR
AND CHIEF ECONOMIST, INSTITUTE FOR RESEARCH ON THE
ECONOMICS OF TAXATION
Mr. Entin. Thank you, Mr. Chairman, it is a pleasure to be here
this afternoon.
My name is Stephen J. Entin. I am the Executive Director and
Chief Economist of the Institute for Research on the Economics of
Taxation. I did serve in the Treasury, but only in the Reagan Ad-
ministration. I left between Mr. Baker and Mr. Brady. Two Sec-
retaries were enough and I thought time to move on.
I did work on eight Social Security Trustees' reports, which was
quite an experience, and before that I worked on the issue on the
Joint Economic Committee Staff. So I have been following Social
Security issues for more than 20 years.
I had some thoughts about what you might focus on in designing
a new or reformed Social Security/Retirement System. In thinking
about Social Security reform, we need to keep something very im-
portant in mind. This is not just about Washington and it is not
just about the Federal budget. It is primarily about a better retire-
ment system for Americans and a more productive working life for
Americans.
To date, the Federal budget issues and the concerns of Washing-
ton policy makers relating to Social Security seem to be driving the
debate rather than what is best for the economy and for the people
as they work and retire.
89
Rigid budget rules and static revenue estimation could prevent
the adoption of the most effective reforms. We need to sweep such
impediments aside and give more attention to the interests of the
people and the consequences for the economy.
The most important thing to remember is this. We need higher
output and productivity to support a rising retired population. Re-
tirees and workers will want to consumer higher levels of real
goods and services. Someone has to produce them.
If productivity of future workers is higher than currently, they
will be able to support the added consumption of the more numer-
ous retirees without dipping into their own consumption. If we do
not improve the productivity of the economy, growing numbers of
retirees will force a reduction of the living standards of future
workers. Or, we will have to curtail the benefits we are promising
the retirees.
Higher real output requires fewer unfunded transfer payments
and more real saving and investment. A funded saving system will
always outperform a tax/transfer system due to real investment
and compound interest.
When you design the new system, please judge the changes both
in the design of the new system and in the financing of the transi-
tion with that real growth objective in mind.
In short, we must make workers more willing to work, savers
more willing to save, and investors more willing to invest in ex-
panded economic capacity.
You can make workers more willing to work by letting them di-
vert a portion of their payroll tax to personal accounts, and allow-
ing the saving to build tax-deferred, as in an IRA.
If you design the new system carefully, workers could get 2 to
3 times what Social Security can afford to pay with only half the
contributions that they must now put into Social Security. Workers
^yould get more after-tax benefits from their earnings over their
lifetimes, in effect receiving a higher compensation package, which
would increase the incentive to work.
The increased work incentives depend on the reform's allowing a
"carve out" rather than an "add on" approach to obtaining money
for the required saving accounts. It also assumes that the workers
benefit substantially from the retirement savings.
For the saving to have the maximum value to the workers, they
must be free to use all or much of the money as they see fit. The
withdrawals must not be so severely regulated, or taxed, or tied to
reductions in other retirement benefits, or so completely tied up in
redistribution arrangements such as mandated annuities, that the
workers question their value. The accounts must be the workers'
money, not Washington's.
Bear in mind that saving in the retirement accounts may sub-
stitute for other saving. It may displace some foreign capital
inflows, or it may flow abroad (and should be free to do so if work-
ers can get higher returns in global mutual funds). The saving
going into the new accounts will not automatically lead to higher
domestic investment and wages in the United States, unless we
take steps to reduce the taxes on domestic investment to encourage
people to put the saving to work here.
90
Consequently, to ensure a good outcome, please combine the So-
cial Security reform with investment incentives such as expensing
or faster write-offs of plant and equipment (that is, shorter asset
lives).
Also, be sure to give the saving accounts IRA treatment, and ex-
tend IRA treatment for other forms of saving so that it does not
decrease as the result of the policy change. Ideally, we would adopt
a full blown tax reform to promote domestic investment and saving.
The two reforms would be mutually supportive.
A few other design issues of note:
Do not keep younger people in the system. Bring it to a close
some day.
Do not confuse retirement saving systems with welfare. There
should be a safety net, but you do not have to mix it with a retire-
ment plan that will be unproductive for future participants under
current projections.
Do not have government running the show or owning or voting
stock in U.S. businesses.
Next, let me turn to the financing and transition issues.
I do not think you need to hurt current retirees by crimping
COLAs. I do not think you should cut benefits much for people age
55 and above. They do not have time for compound interest to work
in their favor very long.
However, do cut government spending wherever else you can to
free up resources for private sector expansion. That gives the best
outcome, as you can see from the charts attached to my testimony.
Do not borrow any more than you have to. It either takes saving
away from investment, or forces reliance on foreign capital, which
means that foreign savers and lenders to the United States get the
earnings from the investments, instead of the U.S. retirees.
Do not raise taxes. Cutting taxes on labor just to raise them
again or to raise taxes on labor and capital does not do any good
in promoting incentives to work or to save and invest. Substituting
income tax increases on labor and capital for payroll taxes on labor
would actually reduce the trend rate of growth, because capital is
more sensitive than labor to taxation.
You might sell some Federal assets. This would help you with
your short term financing arrangements. However, unless the as-
sets are totally out of use, selling them would not add much to
GDP, but it might help your short run budget picture.
Do take account of the higher output that a good reform of the
retirement system could trigger in calculating the revenues that
you would have in the future. Do dynamic estimation, not static.
And again, to make sure of a good outcome: Do include some in-
vestment incentives.
I have just a few other considerations and then I will stop.
Please do not do another patch job as in 1977 and in 1983. The
Chairman has referred to these and how they did not really take
hold and work. The problem is not merely the very small long-term
average deficit of 2 percent of payroll that you see in the Trustees'
report.
This is one of those reforms where more is better than less. The
more people can put their own saving to work in a real funded sys-
tem, the better the retirement income picture is going to be.
91
Finally, trust the people. They can manage their own affairs to
a considerable degree. They can hire other people to help them if
they feel they cannot do their own investing. They are the ones
who are most interested in their own futures and they are the ones
you can trust with their own money.
We have the money to proceed, fortunately because of the good
economy and the strong budget picture. We barely have the time
to proceed. We need to tackle Social Security reform and tax reform
together. They reinforce one another and we need to start now.
Thank you.
[The prepared statement of Stephen J. Entin follows:]
Prepared Statement of Stephen J. Entin, Executive Director and Chief
Economist, Institute for Research on the Economics of Taxation
Social Security reform is essential to give workers a better means of providing for
their retirement income than the current system can possibly deliver. The reform
eflfort has been given great urgency by the rapid approach of the retirement of the
baby boom generation, which will throw Social Security into deep deficit, and create
an enormous budget problem for the Federal Government.
The objective of reforming the current system of providing retirement income
must not simply be to avoid future Federal deficits when the baby boom retires. The
objective must be to adopt a new approach to providing retirement income that im-
proves the functioning of the economy and the incomes of people at all stages of
their lives, and that avoids future budget problems as well. Furthermore, the new
system must be designed under reahstic dynamic assumptions about its impact dur-
ing and after the transition on the economy and the Federal budget.
Many Social Security reform proposals would allow workers to divert a portion of
their payroll taxes to personal retirement accounts in exchange for reduced future
Social Security benefits. Because of the higher returns available on private saving,
workers could be made substantially better off as a result. The economy would im-
Erove as well. Meanwhile, however, benefits to cvirrent retirees would still have to
e paid. If pa3Toll taxes were diverted to personal accounts, the government wotdd
have to finance the resulting gap in the Federal budget. To date, the Federal budget
issues and the concerns of Washington policy makers relating to Social Security
seem to be driving the debate, rather than what is best for the economy and for
people as they worker and retire. Instead, the interests of the people and the con-
sequences for the economy should be given more attention in designing an alter-
native system and handling the transition.
Static Revenue Assumptions and Rigid Budget Rules Driving the Process
Each point of payroll tax reduction would cost about $36 billion in revenue annu-
ally as of 1999, rising to $45 billion by 2004. These figures assume no economic
gains and revenue reflows from the reduction in the pa3rroll tax. Thus, to leave
budget deficit or surplus projections unchanged, cutting the pa3Toll tax rate by, for
example, 5 percentage points would require trimming Federal spending, increasing
borrowing, or raising other taxes by about $180 bilUon to $225 billion per year,
under static economic assumptions.
The authors of a number of reform proposals have incorporated specific amovmts
of Federal borrowing, tax increases of a particular level and duration, and reduc-
tions in future Social Security benefits in their plans to pay for the transition to
their new retirement income systems. In making these estimates and offsets, they
have often followed restrictive budget scoring rules, conventions, or assumptions
that limited their options and colored their results.
The Social Security Administration follows the Federal budget convention of em-
plojdng static economic assumptions, in which the effect of a tax or spending change
on the economy and of the resulting change in the economy on Federal revenues
and outlays are ignored in estimating GDP and the budget numbers. Furthermore,
the Federal budget rules require that tax and entitlement changes be matched by
offsetting changes in the same budget categories. Consequently, the last official Ad-
visory Council on Social Security restricted its tax and spending recommendations
to the Social Security accounts, and made no forays into other Federal taxes and
outlays. These efforts may provide the appearance of a workable transition to an
alternative retirement plan on paper, but they may fall far short in practice, and
may not be the optimal approach.
56-994 OQ . A
92
Budget Surpluses to the Rescue?
Projected budget surpluses might eliminate the requirement of budget neutrality
and aJlow for a net tax cut in connection with Social Security reform. For example,
the National Commission on Retirement Policy wants to reserve projected surpluses
for funding part of its proposal to divert 2 percentage points of the payroll tax to
personal saving accounts that, unlike the current trust fund, need not be invested
in Treasury bonds.
Unfortunately, the economy might not continue to expand as vigorously as in re-
cent quarters, nor throw off large revenue increases, unless some of the rising reve-
nue stream is "reinvested" in the expansion through growth-enhancing tax rate re-
ductions on capital and labor inputs. Fundamental tax reform is an attractive com-
peting use for surpluses, and would enhance investment and saving incentives by
moving toward a consumed-income based tax system. Short of full-scale tax reform,
growth-enhancing tax changes might include faster depreciation or expensing of in-
vestment, reduced double taxation of corporate income and capital gains, expanded
IRA and pension eligibility and contribution Umits, and lower tax rates on Igibor in-
come.
In the presence of a surplus, then, the trade-offs are between cutting the payroll
tax as part of Social Security reform and either paying down a portion of tne na-
tional debt, cutting other taxes, or increasing Federal spending. As will be discussed
below, the chances for a successful reform of Social Security would be greatly en-
hanced if the reform were coupled with reductions in the taxation of domestic in-
vestment and saving.
Needed: A Broader Objective— Enhanced Saving, Productivity, Investment,
AND Income
Various alternatives to the Social Security System and the various means of fi-
nancing the transition would have important effects on individual and business be-
havior and on the economy as a whole. These effects are too important to ignore,
either in the design of the new system or in choosing how to finance the transition.
Ultimately, caring for a relatively larger retired population will require a more
productive work force in the future. Future retirees will want to consume goods and
services produced by future workers. If future workers are sufficiently more produc-
tive than workers today, then future retirees and future workers can both enjoy a
rising standard of living. If not, then the rising numbers of retirees will cut into
the living stemdards of fiiture workers, or future retirees will have to make do with
lower living standards than they are being promised. If the baby boom and later
generations are to be self-reliant in retirement, steps must be taken now to increase
their saving and the rate of investment and productivity growth in the United
States.
Increasing the financial assets and incomes of future retirees and raising the pro-
ductivity of future workers can work hand in hand. If workers are able to save more
for their own retirement, they will be more self sufficient upon retirement and make
fewer demsmds on future workers for support. Their saving will add to capital for-
mation somewhere in the world, and enable them to consume the added output that
their added saving has produced, rather than tap into the income and output of
their children and grandchildren. Furthermore, if the saving is put to work increas-
ing the stock of physical capital and human capital in the United States, then U.S.
workers will be more productive and better paid throughout their lives.
The push to overhaul of Social Security is driven in part by growing awareness
that a program of real funded saving would be better than the current unfunded
pay-as-you-go system at raising employment, investment, productivity, and income.
Proposals to replace Social Seciuity with a funded personal saving system and
methods of financing the transition must be judged with that saving and investment
objective in mind. Four key elements are involved: the labor supply, personal saving,
national saving, and domestic capital formation. A well-crafted reform should in-
crease all four.
If a switch to private saving were done in a manner that improves the perform-
emce of the economy, it would reduce the net cost of the transition, and reduce the
amoimt of transition funding that would be required. These d)mamic revenue effects
shovild be considered when formulating the reform program.
Labor Market Effects of Reform
Diverting a portion of the payroll tax to personal accoimts, and allowing the sav-
ing to build tax-deferred, as in an IRA, would increase the amoimt of retirement
income available to workers. The returns would exceed those possible under Social
93
Security. Workers would get more after- tax benefits from their earnings over their
hfetimes, in effect receiving a higher compensation package, which would increase
the incentive to work. Labor force participation and hours worked would rise.^
A larger, more willing labor force would give the capital stock more labor to work
with, boost the returns on capital, and trigger some additional investment and sav-
ing. These labor market effects are moderate in magnitude but are highly likely to
occur. They would result in a significant improvement in personal income and na-
tional output.
Higher employment would result in additional income and payroll taxes. In-
creased availability of labor would boost the retvim on capital, and induce some ad-
ditional investment and yield some additional business taxes.
The increased work incentives depend on the reform's allowing a "carve-out" rath-
er than an "add-on" approach to obtaining money for the required saving accounts.
It also assumes that the worker benefits substantially ft-om the retirement savings.
For the saving to have the maximum value to the workers, they must be free to
use all or much of the money as they see fit. The withdrawals must not be so se-
verely regulated, or taxed, or tied to reductions in other retirement benefits, or so
completely tied up in redistribution arrangements such as mandated annuities that
the workers question their value.
Freedom to Choose
Workers will place the maximum value on the new system if they have significant
fi-eedom of choice in how they participate. They should have choices of how to invest
their money, how much to contribute, when to withdraw it, and how to withdraw
it. There should be no minimum retirement age. If a worker has saved enough to
buy a minimum retirement annuity, he should be fi-ee to begin to make withdrawals
at any age, or to scale back his contributions. Workers should not have to run their
retirement plans through the Social Security Administration, or be Umited to three
investment options as imder the Federal Employee Retirement System. Private fund
managers or workers should have voting control of the stock in the accounts. Stock
should not be owned or controlled by a Federal agency.
Carve -Out vs. Add-On
Requiring that people save a portion of their income over and above current "con-
tributions" to Social Security would not yield the same gains in work incentives as
a carve-out of the pa3rroll tax. Under mandatory saving, individuals retain their
ownership of the income, and have access to it at a later date, with interest. How-
ever, the mandated saving forces individuals into a different use of their income,
and a different time pattern of saving and/or consumption, than they would have
chosen fi-eely. It is a "tax" to the extent that it reduces their utility. The inconven-
ience may be substantial for low income wage earners who have little room to re-
duce current outlays.
Government could require people to save a certain portion of their income starting
immediately, and gradually phase out or reduce Social Security benefits for future
retirees, and gradually reduce the payroll tax in distant decades as it is not needed
to pay benefits. Such a program would not be well received by the affected genera-
tions. For generations working prior to the payroll tax cut, it would make Social Se-
curity, already a bad deal, even worse.
It is for these reasons that reform proposals usually attempt to improve the deal
for current workers by giving them a tax break or other assistance to help them
save. The assistance would not have to match the benefit cut dollar for dollar be-
cause the returns from private saving exceed projected Social Security benefits. In
a sense, the public would be willing to buy its way out of the program.
Forced Annuitization
Some reform proposals developed in Washington would require that all the assets
in mandated personal retirement accounts be converted to annuities upon retire-
ment. The stated objective is to protect the worker from outhving his retirement in-
come. In fact, the objective may be to protect the government from the possibility
that some retirees may spend down their retirement funds too fast and end up ask-
ing for public assistance in their very old age.
While annuitization is insurance against living too long, it is also a gamble that
one will not die too soon. If a worker dies the year after retiring, he will get vir-
1 See, for example, the labor market discussion in Martin Feldstein, "The Missing Piece in Pol-
icy Analysis: Social Security Reform," American Economic Review (May 1996).
94
tually nothing back on his annuity; nearly all his assets will go to someone else in
the annuity pool who Uves longer than average. Annuities die with the beneficiary
(or beneficiaries, in the case of a joint annuity). There is generally no residual asset
to leave to heirs.
Forcing retirees to convert all the saving in their retirement accounts to annuities
goes too far. The government's only legitimate interest is to avoid having to suoport
the destitute. At most, a safety-net level annuity should be aU that is required. Al-
ternatively, reqtiire that a minimum balance be m£dnt£iined in the account, accord-
ing to age. Workers should be free to use assets in excess of such amounts any way
they like, including leaving an estate for their children.
Capital Market Effects
The effects on saving, investment, and income from a well-designed reform could
be even greater than the positive labor force effects. Cuts in the cost of capital can
yield very large increases in the capital stock because the productivity of capital de-
clines very slowly as the quantity rises. However, positive effects on investment may
depend critically on how tne reform is structured, and are not a sure thing.
Some studies^ have assumed that most of the saving in the personal saving ac-
counts set up under reform would represent an increase in total saving by Ameri-
cans, and that the additional saving would translate almost dollar for dollar into
additional investment by businesses in the United States. The additional invest-
ment is assumed to earn the current rate of return, )rielding higher levels of taxable
business income, and generatiiig significant revenue reflows to help pay for the
transition.
There are a number of problems with this scenario.
The saving in the new retirement accounts may substitute for other saving being
done by Americans. The accounts will not reduce the tax on other forms of saving,
nor make it more rewarding to save, at the margin. Low income workers who now
save very little would be Ukely to save more due to the new accounts. Absent better
tax treatment of ordinary saving, however, other savers might substitute the re-
quired retirement saving for some of the saving they are currently doing.
Furthermore, we live in a global economy. Additional saving by U.S. residents
may be invested abroad through global mutual funds or other foreign assets, or dis-
place some foreign lending to the U.S. (Americans should have the option to invest
abroad to achieve diversification and the best yields; it would be unwise and ineffec-
tive to try to shut the saving in.) Consequently, saving available in the United
States may not rise dollar for dollar with the increase in domestic saving.
There is also no guarantee that businesses will be eager to borrow the additional
saving and invest it in the United States. Without a change in the tax treatment
of investment in plant, equipment, structures, or inventory in the United States,
business may not want to add to domestic capital. If the rate of return on financial
assets falls as a result of the additional saving in the new accounts to entice busi-
nesses to borrow, it may discourage other saving by Americans or discourage capital
inflows fi"om abroad. Even if American businesses borrow the added saving, they
may invest the proceeds abroad to obtain higher returns. Since saving appears to
be sensitive to the rate of return, these offsets could be significant. They would re-
duce domestic emplosrment, income, and tax reflows.
Finally, if additional investment were to occur, the higher capital stock would de-
press the rate of return on capital, depressing profit and government revenue
reflows below levels that might otherwise be anticipated.
For aU these reasons, there would be no cause to expect the saving in personal
retirement accoimts to resiilt in dollar for dollar increases in private U.S. saving or
the stock of physical capital in the U.S. Both would increase, but by how much is
uncertain. Some revenue feedback would be likely, but the very large amounts pre-
dicted by some papers on the subject appear to be overly optimistic.
Policy Steps to Ensure a Favorable Outcome
Steps could be taken to ensure that the accounts do not reduce other saving, and
to encourage businesses to take up the additional saving in order to expand invest-
ment in the United States. In particular, faster depreciation or expensing (imme-
diate write-off) of plant, equipment, structures, and inventory, would raise the after-
tax return on investment sited in the United States. The return to U.S. savers
2 See, for example, the capital market discussion in Martin Feldstein, "The Missing Piece in
Policy Analysis: Social Security Reform," American Economic Review (May 1996); also, Peter J.
Ferrara, "A Plan for Privatizing Social Security", CATO Institute Social Security Paper No. 8,
April 30, 1997.
95
would be increased. There would be less chance that other saving by U.S. residents
would fall, less chance that foreign investment in the United States would decUne,
and more incentive for businesses to use additional saving to expand their oper-
ations in the United States as opposed to abroad.
Further steps to increase domestic saving, such as easing contribution limits and
ehgibihty requirements for IRAs and pensions, reducing the double taxation of divi-
dends and the taxation of capital gains, and ending the estate tax, would all in-
crease the incentive to save.^ In effect. Social Security reform would be greatly as-
sisted by adopting the tax treatment of saving and investment recommended in all
the major consumed-income-based tax reform proposals that attempt to end the in-
come tax bias against saving and investment. Tax reform and Social Security reform
are not only compatible, they are mutually reinforcing both philosophically and in
practical terms.
Financing Options for the Transition and How They Stack Up in Furthering
Saving, Investment, and Work Incentives
There will be many specific proposals for deahng with the Federal budget implica-
tions of the transition, with many variations as to detsiils. Fundamentally, however,
all the financing options are variations on a small number of themes: cut Federal
spending, increase Federal borrowing, raise taxes, and sell assets. (Again, in surplus
terminology these are: less Federal spending than otherwise, less debt repayment
than otherwise, less tax reduction than otherwise, and asset sales.) One could re-
duce the amount of funding required by recognizing the positive budget effects of
Social Security reform as the higher levels of saving, growth, income, and employ-
ment it generates raise revenues and reduce social safety net outlays (d5Tiamic scor-
ing).
The choice of transition financing will have important consequences for personed
saving, national saving, and domestic investment. Assuming a budget neutral ap-
proach, one can describe the possible outcomes as follows: On- or off-budget cuts in
Federal spending would permit the tramsfer of some portion of general revenues to
the Social Security retirement and disability programs (OASDI), or would stretch
remaining payroll tax receipts further to support current retirees, with no adverse
economic effects. Higher income or payroll taxes to support OASDI during the tran-
sition would reduce incentives to work and invest, depress private saving, and
would cancel out potential increases in national saving and growth. Federal borrow-
ing would not be helpful. If the nation is to benefit the most from privatization, the
saving in the retirement plans should be used to add to the stock of private capital,
raise productivity, and increase employment and wages, not to finance additional
deficit spending. Finally, for the greatest benefit, the increased investment should
be located in the United States. Ensuring an increase in domestic investment in
plant, equipment, and structures requires improved tax treatment of domestic in-
vestment spending by businesses.
Spending Cuts
Federal spending cuts have the potential to raise national saving more than other
methods of financing the transition. The greater are the spending reductions (or the
less the increases that would otherwise occur), the less that the government would
be borrowing or taxing away the nation's scarce saving, and the more that the sav-
ing could be directed toward additional capital formation. Furthermore, if the gov-
ernment were to spend less on goods and services, it would be absorbing fewer real
resources (e.g., labor and materials), freeing them for private investment or other
uses, such as investment. However, cutting government spending deprives the pub-
lic of the value of the government services foregone. Their value must be weighed
against the value of the additional personal savings and retirement income that the
cuts would make possible, and the costs of alternative methods of financing the
transition.
The best way to finance the transition to private saving for retirement is to trim
on-budget Federal spending for goods and services. Unfortunately, the PAYGO
budget rules reqviire that tax reductions be offset by tax increases or entitlement
cuts. Worse yet, OBRA90 made it a violation of budget rules to weaken the 5-year
and 75-year "actuarial balance" of the OASDI trust funds. These rules require that
3 Ideally, all saving, whether mandated by the Social Security reform program or done in addi-
tion to the required amounts, and whether for retirement or not, should receive pension treat-
ment. Either the contributions and earnings should be tax deferred until withdrawal, as with
a deductible IRA, 401(k) plan, or company pension; or the saving should be on an after-tax basis,
with no tax on withdrawals, as with a Roth IRA.
96
offsets to a payroll tax reduction be made within the confines of OASDI, rather than
by meems of cuts in on-budget discretionary Federal spending or other entitlements.
The budget rules must be eliminated or waived to produce a sensible Social Security
reform. (H.R. 3707, introduced in the last Congress by Representatives Sam John-
son (R-TX) and J. D. Hayworth (R-AZ), and S. 1392 introduced by Senator Sam
Brownback (R-KS) would allow discretionary spending cuts to be used for tax reduc-
tion.)
People would have to choose between the government spending or the tax relief,
retirement income increases, and improved job opportunities that people coidd get
fi-om additionaJ private saving. If the question were put to them squarely, they
might well decide that nothing that government spends money on (with the possible
exception of basic national defense and medical research) is as valuable as replacing
pa3Toll taxes with private saving.
It would be difiBcvdt to cut Social Security benefits for current recipients or people
close to retirement. Current Social Security beneficiaries will get relatively Uttle of
the economic and personal financial gains of the switch to a funded personal retire-
ment system. They will not share in the rise in wages, unless they are still working
while drawing benefits. It seems unreasonable to impose much of the cost of the
transition on people already drawing benefits. People in their late 50's, who are soon
to retire, have Uttle time to save to replace lost benefits. It is unreasonable to place
any great burden on this group. However, the projected growth in real per capita
Socisd Security benefits (a rougn doubling over the 75 year planning period) should
be scaled back for future retirees to bring the system into balance with projected
tax revenues. That much adjustment would be necessary even if fundamental re-
form were not imdertaken.
Borrowing
Federed borrowing could be increased (or debt reduction reduced) to pay for a por-
tion of the transition costs. However, additional Federal borrowing of an amount
equal to the deposits in personal retirement accovmts would effectively divert the
aaditional saving to financing the deficit rather than increasing private investment.
Savers would either purchase the additional Federal bonds directly for their retire-
ment accounts, or they woiild purchase existing stock or private sector bonds from
other individuals who would, in turn, buy the additional Federal debt. Either way,
the saving would not be invested in additional private sector securities issued to fi-
nance additional private sector investment. The best that can be said for borrowing
is that it is less damaging to saving, investment, employment, and output than tax
increases. It should be used sparingly.
Borrowing is often described as a way of spreading the cost of the transition over
several generations. This is a misconstruction, and describes only the memagemcnt
of the Federal budget, not the economic "cost" of the transition. In terms of real eco-
nomic consequences, transfer payments are always paid for in the year they are
made. People who receive transfer payments in a given year can purchase goods and
services in that given year. Others in the population must give up income and the
enjoyment of goods and services in that given year, either in the form of higher
tEixes or reduced ability to borrow for their own uses the saving absorbed by the
government.
Borrowing Cannot Boost National Saving
The real cost of the transition from an unfunded to a funded retirement system
is the cost of adding to national saving and investment to provide future retirement
income. The cost of adding to saving and investment is the current consumption
that must be given up. If we continue to pay benefits to current retirees, maintain
other current consumption, and still want to boost the stock of plant and equipment
in the United States, we can do so only insofar as foreign savers are wiUing to in-
crease their lending to the United States to finance our investment. Borrowing to
save does not increase net worth or national saving in the present. National saving
wo\ild rise only in the future as the debt was serviced and repaid. The cost of the
future Federal debt service and repayment would equal the Federal borrowing in
present value. Put another way, the added national income from investments made
with borrowed money would have to be devoted to serving the added debt. It would
not be available for spending by retirees.
Tax Hikes
Tax hikes to finance the transition would be self-defeating if the objective is to
cut taxes to assist cxurent workers to save. Individual and corporate income tax rate
97
increases or curtailed depreciation write-offs would reduce the incentive to save and
invest and reduce income available for saving and investment. Payroll tax increases
that offset the redirection of the payroll tax to individual retirement accounts would
reduce the incentive to work and to hire. All would reduce the future productivity
growth and growth of real output necessary to ease the burden of caring for an
aging population.
Failure to use a budget surplus to cut taxes on saving, investment, and work
would have the same adverse consequences, compared to what could be achieved by
appropriate tax relief Current budget surpluses could help to pay for future Social
Security outlays only if they were used to reduce taxes in a manner that increased
saving, investment, work incentives, and the productivity of future workers.
Asset Sales
Asset sales could produce some immediate revenue for the government and help
with the near term budget problem during the transition. However, asset sales
would primarily affect the timing of government revenue without having much ef-
fect on the government's "balance sheet," national saving, or the performance of the
economy.
Asset sales would reduce government borrowing in the current year. However, the
purchasers would have to use their own current saving or borrow to pay for the as-
sets, reducing the availability of private saving for other investment by as much as
the reduction in Federal borrowing. Consequently, there would be no increase in na-
tional saving from an asset sale. The sale of government-owned financial assets,
such as loans, would provide current revenue for the government, but would reduce
future interest income by the same present value. There would be no permanent
benefit to the Federal budget.
Similarly, the sale of government-owned real property currently leased to the pri-
vate sector would provide current revenue for the government, but wovild reduce fii-
ture revenue from leasing by the same present value, if the leases have been let
at fair market rates. (If the leases are for less than market rates, constituting a sub-
sidy, and if the property could be sold for fair value, the government would gain,
but at the expense of the lessee.) Again, there would be no permanent help for the
Federal budget. Furthermore, if the leased property is being put to its most efficient
use, the privatization would not boost economic activity or output.
By contrast, sale of government property that has been withheld from productive
use, or fi'om its most valuable use, could increase the effective supply of economic
resources for use by the private sector and expand economic activity. Furthermore,
the new owners of the assets might invest in improvements to the properties that
they would not do as leaseholders. Sale of this type of asset would generate some
increase in national output.
Drawing Down the Trust Funds (Not an Option)
The OASI and DI trust funds are not a means of pajrment of future benefits.
Treasury must pay benefits from current taxes or borrowing whenever benefits are
due. The trust hinds represent past tax revenue that the Treasury "borrowed" from
OASI and DI and spent on other government outlays. To acquire the money to "re-
deem" the Federal 'Taonds" in the trust funds to pay future benefits. Treasury would
have to borrow additional money fi-om the public, raise taxes, or cut other spending,
just as it would have to do if the trust funds did not exist.
"Crediting the trust funds" with cvirrent budget surpluses, which would in fact be
borrowed back by the Treasury to reduce debt held by the public, would in no way
aid in the futiire financing of future Social Security benefits. Treasury would just
have to borrow the money back fi-om the public at a later date. It is nonsense to
suggest that reducing the level of the national debt today would make it easier to
add to it later to deficit finance future benefits. The future borrowing would cut into
future saving and investment and reduce future output as effectively as if the debt
had never been drawn down.
Illustrations of Possible Outcomes of Reform Under Different Behavior
Assumptions and Approaches to Financing the Transition-*
The baseline projections reflect current law and use economic assimaptions similar
to those in the budget forecasts of the Congressional Budget Office and the Office
* The scenarios presented here were developed with the assistance of Gary and Aldona Rob-
bins and simulated using the Fiscal Associates general equilibrium model. For more on the
Continued
98
of Management and Budget. Fiscal Associates extended the baseline to accommo-
date the longer time horizons used in Social Security projections. To avoid the need
for a future tax increase, baseline benefits paid by the Old-Age and Survivors Insur-
ance (OASI) program were reduced to eliminate the program's long-run deficit.
The attached charts illustrate optimistic and pessimistic assumptions concerning
the saving and investment behavior of the public following Social Security reform.
They also show that, for each set of assumptions, a range of outcomes is likely de-
pending on the means chosen to finance the transition to the reformed system. The
scenarios fully incorporate the labor market effects described above in all examples.
In the "strong saving response" case, it is assumed that the additional saving in
the mandated accounts does not substitute for other saving, and that it lowers the
cost of capital and stimulates investment substantially without further changes in
the tax treatment of investment or ordinary saving. It assumes that cross-border
saving flows are not so sensitive to changes in the rate of return that they largely
offset the changes in domestic saving.^
In the "weak saving response" case, it is assumed that the additional saving in
the mandated accounts displaces other saving in the absence of tax relief, and that
it does not lower the cost of capital nor spur investment substantially without a
change in the tax treatment of investment. It assumes a very open economy in
which cross-border saving flows are highly sensitive to changes in the rate of re-
tum.6
A third case is illustrated in some charts. It assumes the weak saving and invest-
ment response, but adds a tax change — a shift fi-om depreciation to expensing of in-
vestment outlays — to ensure that the reform generates the additional saving and in-
vestment that the "strong response case" takes for granted.
GDP — gross domestic product — is output generated in the United States by labor
and capital, regardless of the nationality of the factor. The returns on foreign-owned
capital located in the United States accrue to the foreign owners, not to U.S. resi-
dents. However, U.S. workers benefit fi"om capital located in the United States, re-
gardless of who owns it, because it raises their productivity and wages.
GNP — gross national product — includes income received by U.S. residents earned
abroad, such as returns on capital that they own in other countries, less payments
to foreigners of the income fi-om assets they own here. One major objective of Social
Security reform is to increase GNP, income of U.S. residents, not merely output in
the United States.
Chart 1. Chart 1 shows the increase in GNP (percentage change ft-om baseline)
for a transition financed by reductions in government sending. The increase is
large — nearly 8 percent of GNP — where the saving is largely new saving, and in-
vestment responds strongly. It is smaller — about 2 percent of GDP — where the in-
vestment response in lower. There is still a beneficial effect fi-om the labor market
response to higher retirement income fi'om personal saving accounts. The chart il-
lustrates the rise in the GNP from combining the mandated saving program with
an improved treatment of capital investment. With expensing, the GNP rises more
than 6 percent even under the weak response assumptions (and rises faster in the
short run than in the strong case). Adding investment incentives to the reform
greatly increases the chances for a favorable outcome.
model, see Gary and Aldona Robbins, "Tax Reform Simulations Using the Fiscal Associates
General equilibrium Model" in the Joint Committee on Taxation Tax Modeling Project and 1997
Tax Symposium Papers, Washington, D.C.: Joint Committee on Taxation, November 20, 1997.
5 The "strong response" illustration follows the normal workings of the Fiscal Associates
model, which yields a more moderate outcome than the more extreme "strong response" de-
scribed in the text. The model allows for a moderate reaction by other saving and foreign capital
movements to changes in the relative risk-adjusted rates of return to capital inside and outside
the United States.
6 The "weak response" assumptions were designed by the author to be a foil for the extreme
opposite viewpoint. They strictly apply "marginality;" if there has been no change in the tax
treatment of incremental saving or investing, or in the relative returns at the margin here and
abroad, not much vsdll change. They assume a perfectly integrated world financial system, in
which people supplying marginal saving regard domestic and foreign assets as perfect sub-
stitutes.
99
CHART 1 Percentage Change In Real GNP
Produced By Social Security Reform Depends
On Responses Of Saving And Investment
10.0%
0.0%
strong response of
saving and investment
Weak response of
saving and investment
2000 2005 2010 2015 2020 2025 2030 2035 2040
Year
5% Reduction in OASDI Taxes. Assumes Spending Reduction to Finance Transition.
Changes relative to baseline GNP.
Charts 2 and 3. Chart 2, using the weak response case for illustration, and Chart
3, using the strong response case, show the different effects on GNP from three al-
ternative approaches to financing the payroll tax cut and the transition — cutting
government spending, borrowing, and raising other taxes.
100
CHART 2 Percentage Change In Real GNP
Produced By Social Security Reform
Under Various Transition Funding Options
5.0%
a. 0.0%
o
o
"5
a>
-5.0%
c
OS
x:
O
a>
o>
« -10.0%
c
-15.0%
Spending Reduction
Financed through Debt
2000 2005 2010 2015 2020 2025 2030 2035 2040
Year
5% Reduction in OASDI Taxes.
Assumes weak response scenario for saving and investment.
Changes relative to baseline GNP.
Cutting spending gives the best rise in GNP under either assumption about the
strength of the saving and investment response. Spending restraint reduces the cost
of capital by making additional real resources available to the private sector and
permits added saving to flow into investment.
Debt finance comes in second. It forces the additional private saving to be re-
turned to the government to fineuice added government debt, in which case the addi-
tional investment must be paid for by foreign savers, who then receive the capital
income. (Alternatively, foreign savers buy the government debt, and U.S. residents
must pay added taxes to pay the interest to the foreign lenders.) There is less gain
to U.S. residents. In fact, in Chart 2, the weak response case, the increased borrow-
ing, year £ifter year, reduces GNP below the baseline. Workers earn more than
vmder the baseUne even in this case, but U.S. ownership of capital is reduced, and
capital income drops below the baseline, reducing total U.S. income. If reform is to
work well, there should be some reduction in government spending. For the best
outcome, Washington should not try to hold itself harmless and impose all the cost
of reform on the private sector.
101
CHART 3 Percentage Change In Real GNP
Produced By Social Security Reform
Under Various Transition Funding Options
8.0%
-2.0%
Spending Reduction
Tax Increase
2000 2005 2010 2015 2020 2025 2030 2035 2040
Year
5% Reduction in OASDI Taxes.
Assumes strong response scenario for saving and investment.
Changes relative to baseline GNP.
The tax increase is the worst method of financing the transition. The tax increase
is assumed to be across-the-board on labor and capital. Raising taxes on labor and
capital to cut taxes on labor reduces GNP relative to the baseline in the weak re-
sponse case. Employment and real after-tax wages would fall relative to the base-
line. In the strong response case, the tax financing causes GNP to fall initially, later
rising by less than under the other financing methods.
Chart 4. Chart 4 illustrates the different impact on GNP and GDP of borrowing
to finance the transition. Borrowing does not prevent additional capital from being
installed to utilize the additional labor induced by the pa3Toll tax reduction. Gross
domestic product rises by as much as if government spending had been cut to make
way for added investment. However, in the case of borrowing, either the additional
capital is financed by foreign savers, or the added government debt is foreign owned,
freeing up U.S. saving to pay for the investment. Either way, foreign savers are en-
titled to the interest or dividend pa3maents, which absorb the added GDP made pos-
sible by the added capital. Consequently, gross national product and total income
accruing to U.S. residents is lower in the case where foreigners own the additional
capital.
102
CHART 4 Changes In GDP Vs. GNP
Under Various Transition Funding Options
3.0%
2.0%
c 1.0%
(0
o 0.0%
0.
•1 .0%
Change in
Reduction
GNP with
Spending
GDP with Spending
or Debt Financing
.**^^»*^
Change ir
Reduction
\
V
/ \ 1
Change in GNP with Debt Nl j
Financing %. !
N
2000 2005 2010 2015 2020 2025 2030 2035 2040
Year
5% Reduction in OASDI Taxes.
Assumes weak response scenario for saving and investment.
Changes relative to baseline GNP, GDP.
Charts 5 and 6. Chart 5 shows the additional jobs created in the strong, weak,
and investment incentive cases, assuming spending reductions cover the transition
cost. Long term, an additional 4 million to 7 million jobs could be created. Chart
6 shows ultimate increase of 6 percent to 10 percent in the average real after-tax
wage in the three cases, again assuming spending cuts.
103
CHART 5 New Jobs Produced By
Social Security Reform
2000 2005 2010 2015 2020 2025 2030 2035 2040
Year
5% Reduction in OASDI Taxes.
Assumes Spending Reduction to Finance Transition.
104
CHART 6 After-Tax Real Wage Increases
Produced By Social Security Reform
12.0%
2.0%
0.0%
Weak response boosted
by investment incentive
2000 2005 2010 2015 2020 2025 2030 2035 2040
Year
5% Reduction in OASDI Taxes.
Assumes Spending Reduction to Finance Transition.
Conclusion
The transition to a better retirement income system will take some effort, but the
benefits are well worth it. Done right, reform could boost real after-tax wages by
6 percent to 10 percent, and create an additional 4 to 7 million jobs. Retirement in-
come wovdd be significantly larger than under current law.
For maximum economic benefits, the reform effort must increase the reward to
labor. Increased work incentives depend on the reform's allowing a "carve-out" rath-
er than an "add-on" approach to obtaining money for the required saving accounts.
Workers must have real ownership of their retirement savings, and the flexibiUty
to use it as they see fit.
Care must be taken to finance the transition to the new system without damaging
the economy. One carmot count on economic growth to make the transition painless.
There wiU be a need for substantial restraint in the growth of Federal spending.
Additional Federal borrowing should be avoided as much as possible, although there
is no need to repay large amounts of existing debt.
To encourage a net increase in saving, the individual saving accounts and other
retirement saving should receive one or another type of IRA or pension tax treat-
ment. Tax increases must be avoided. To ensure a substantial increase in domestic
investment, depreciation should be replaced with immediate expensing of invest-
ment outlays, or, at the very least, asset lives should be shortened.
105
If these steps were taken, future generations wovild enjoy significantly higher in-
comes and lower taxes during their working years and in retirement.
Mr. Smith. Dr. Reischauer.
STATEMENT OF ROBERT D. REISCHAUER, THE BROOKINGS
INSTITUTION
Mr. Reischauer. Mr. Chairman, let me start by applauding the
leadership and the focus that you have provided to this issue over
the last several years. While I do not always agree with your policy
prescriptions, I really do applaud the courage that you have shown.
I also want to congratulate this Task Force for providing free
lunch to witnesses. I think in a way, for me an3rway, this is a pay-
back for the many times I sat in this chair or at the Ways and
Means Committee when I was invited to testify at 11 and it would
stretch on to 1, 2, and 3. The Members would slip out one by one
to get something to eat and to go to the bathroom and the witness
would be tied to the chair.
Mr. Smith. As an economist, you know there is no such thing as
a free lunch, we are expecting magnaminous testimony.
Mr. Reischauer. Well, I figured a privatizer like Steve would be
picking up the tab in the end, so I had no qualms about this at
all.
I was asked to say a few words about the criteria for evaluating
proposals to reform Social Security and I have listed them on the
handout that you have. In deciding which one or two are the most
important, I think it is worth reflecting on the primary reason why
the Nation established a mandatory pension system back in 1935.
The reason was the belief that, left to their own devices, many
workers would not save sufficient amounts to support themselves
and their dependents when they could not longer work. People tend
to be myopic. They focus on immediate needs and those crowd out
their long run needs.
In addition, there are those whose earnings are so low or so un-
stable that even if they did salt away what any reasonable person
might think was a pretty hefty proportion of their incomes each
year for retirement, the amount that they would have accumulated
by the time they turned 65 would not be sufficient to purchase an
annuity of an adequate size.
Of course, we could, as Steve has suggested, just decide that
those who are myopic or those who tried, but failed to save enough
for retirement, be picked up by the welfare system — SSI, Food
Stamps, whatever — but as a society, we decided back in 1935, and
have reinforced this decision several times through history, that
that would create a moral hazard for many low wage workers and
would be demeaning to many who had spent all of their working
lives as independent individuals and then were forced into a posi-
tion of dependency.
When you consider these roots of Social Security, I think the
most important dimension on which reform proposals should be
evaluated relates to benefits. Are they adequate? Are they stable
and predictable? Retirees have little ability to cope with unexpected
fluctuations in their incomes. They need protection against market
risks. They need protection against unanticipated inflation. They
need protection against living a long and healthy life.
106
Is the distribution of benefits fair? Fair, of course, is in the eye
of the beholder, but generally, our society has viewed that basic re-
tirement income should be more evenly distributed than earnings
are and that those basic retirement incomes should provide some
protection for widows and widowers and divorcees and others.
The second criterion that is worth focusing on deals with the eq-
uitable distribution of risk. Any long term contract inevitably in-
volves risk and the question is who is going to bear that risk? Is
it going to be individuals or society? Of course, society is made up
of individuals and one has to ask if society bears that risk, is it tax
payers? Is it beneficiaries? Is it workers or general taxpayers or
both? When something unexpected happens, the consequences have
to be absorbed by some group or some individuals and the question
you want to ask when you look at these reforms is who is bearing
that burden? Is it spread out over time or concentrated in a short
period of time?
A third criterion is the return on contributions. Is it fair? To the
extent that contributions exceed the amount that we need to pay
for benefits of current retirees, we would want those contributions
to be receiving a fair or a market rate of return. That is not the
case with the current system and that is why some of us have sug-
gested a more diversified portfolio of assets for the Social Security
Trust Fund and why others believe that Individual Accounts are an
appropriate way to go.
Fourth, administrative efficiency, simplicity and ease of compli-
ance. We have a system now which is very efficient. It is worth re-
flecting when we think about changing that system how much ad-
ditional administrative costs are going to be imposed. Virtually all
of the proposals that have been put forward keep the Survivors In-
surance system. They keep the Disability Insurance system and
they often provide some scaled back Social Security benefit or a flat
benefit of some kind. As long as we keep SI and DI in existence,
we are going to have virtually all of the administrative costs of the
existing system, so any change we adopt, no matter how efficient
it is, is going to add to the cost of running our overall retirement
system.
What about with respect to employers? All of these systems, and
the current one, impose costs on employers. A lot of the discussion
ofl;en seems to assume that all employers are sophisticated and
computerized, but that is not the case. We have to design a system
not for IBM, not for the Federal Government personnel system, but
for the real world. And in the real world, 5.4 of the 6.5 million em-
ployers do not have computerized payroll systems. There are lots
of mistakes made even in the very simple system that we have now
11 million W-2s do not match Social Security Administration
records. Four and a half million of these discrepancies, after
months of working on them, remain unresolved; 500,000 employers
send in their W-3s late, send them in unreadable states or do not
send them in at all. You want to ask is the system that you are
considering capable of dealing with a world like that? And often the
answer is no.
With respect to participants, it is worth noting that we are not
designing the system for people such as ourselves, people who are
interested in investments, people who are sophisticated, know how
107
to use information. Instead, we are designing one that can work for
the 27-year-old male who has three jobs during the year in dif-
ferent parts of the country; the individual who maybe has several
marriages during his life, has different dependents resulting from
these marriages, and so on. We want to design a system that can
work for the bottom 30 percent. If we were worried about people
like ourselves, we really probably would not have the mandatory
retirement pension system that we have right now.
Political sustainability. Continuity is important. You do not want
a mandatory retirement pension system that is in constant flux.
That is not an endorsement of rigidity. We probably have had a
system that has been too rigid over the last 65 years. One that has
not changed itself to reflect the very profound social, economic and
demographic changes that this country has experienced since 1935.
But we do want a structure that is inherently stable and one that
does not set up dynamics for changes that we would not approve
of.
Let me give an illustration of this. Think of a system with indi-
vidual personal accounts with private ownership. Will we be able
to ensure that the savings that are built up in those accounts are
there when people retire? You will be under tremendous political
pressure, I think, to let people dip into their accounts for worth-
while purposes. For example, if the individual is sick and cannot
receive adequate medical attention, are you going to deny them the
ability to use the resources? Probably not. And, as taken place with
the IRAs, the system will begin to unravel.
Finally, the macroeconomic
Mr. Smith. Dr. Reischauer, I am going to ask you to sort of wrap
it up.
Mr. Reischauer. OK. There is the macroeconomic dimension.
Here, we want to insure that whatever reform we adopt adds to na-
tional saving and economic growth and does not discourage the
labor of forced participation of those who are beyond the retirement
age or reduce the work effort of those who are below the retirement
age.
[A chapter submitted from Dr. Reischauer's book, "Countdown to
Reform," follows:]
108
7
Proposals to Reform Social
Security: A Report Card
Policy makers and the public face a bewildering array of proposals
to reform or replace Social Security. Members of Congress, busi-
ness organizations, academicians, and think tanks have produced
dozens of proposals. The 1994-96 Advisory Council on Social
Security alone developed three different plans, none of which won
majority support.
Fortunately for the interested citizen, almost all proposals fall
into one of three categories: plans to replace the current system entire-
ly with private accounts, plans to replace the current system partly
with private accounts, or plans to strengthen and modernize the cur-
rent system. There are two other approaches to Social Security
reform — making retirement savmg strictly voluntary and imposing
means or income tests as a condition for benefits — but few have devel-
oped detailed plans along such lines. Moreover, for the reasons we
describe in Boxes 3-6 and 7-1 (see page 118), we consider these
approaches both ill considered and unworkable.
In this chapter, we propose four criteria for evaluating reform
plans. We apply these criteria to several plans that exemplify the three
major approaches to reform and grade these plans from A to D.' We
give no plan a failing grade of F because all would restore financial
balance to the nation's basic retirement system. A grade of D means
109
Box 7-1
Why Means 1'estlng of Social
Seci'ritv Doesn't Make Sense
Peter G. Peterson, former secretary of Commerce, has proposed that all federal benefits to
individuals, including Social Security and Medicare, be subject to an effluence test.°
Under this plan, which has been endorsed by the Concord Coalition, households with
incomes at least $5,000 over the national median would have their benefits scaled back
1 percent for each $1 ,000 by which their annual income including benefits exceeded the
threshold. In other words, a household with an income $30,000 above the threshold
would hove its benefits scaled bock 30 percent. The maximum amount by which benefits
could be reduced would be 85 percent.
This approach seeks to lower benefits most for those wfro need them least. This same prin-
cfpte is reflected in the current Social Security benefit formula, which provides higher
replacement rates for workers with low average earnings than for yrarkers vnith high aver-
age earnings. It also is the logic behind the progressive income tax.
Unfortunately, this principle would have undesirable consequences if applied fo Social
Security benefits. It would increose penolties on work ond saving, raise insurmountable
administrative problems, and undermine the basic rationale of Social Security.
To see how tf>e affluence test would work if applied to income — and the problems if would
generate — consider a retired wife receiving $10,000 a year in Social Security and her
working husband v»4io earns $30,000 a year. They also receive $25,000 in income from
their investments. Given median income of $32,000 in 1 997, the affluence test would
reduce the retiree's Social Security by $2,800. If the retiree's husband slopped vAjrking, she
vAjgId not suffer this benefit reduction. They could olso avoid the affluence test in whole or
in port if ffiey shifted their investments into assets llxit generated little income, but promised
subsequent capital gains.
These responses, which would undermine the intent of an income test, could be minimized
if the test were applied to net worth, rather than annual income. Unfortunately, net worth
tests are even more costly to administer than income tests, as they require annual valua-
tions of all ossets, many of wfiich are not generally traded. Furthermore, asset tests are eas-
ily evaded now ifiat the financial market is global.
An income test violates the fundamental political compact that underlies Social Security —
that a lifetime of work in jobs requiring payment of tne payroll tax entitles a worker to a
benefit based on overage earnings when that worker reaches retirement age. Without
this principle, there would be no rationale for financing benefits with a payroll fox or
relating benefits to past earnings. An income test upsets this principle bv denying benefits,
regardless of earnings or payroll taxes paid, to people who saved a lot, nod earnings, w«-e
lucky in investments, or were blessed oy significant inheritance. The principle of relating
benefits to past earnings is not sacrosanct. But introducing an income or asset test would
erode the political basis for payroll tax-supported social insurance.
o. Peter G. Peterson, Will America Grow Up Before It Grows Old? (New York: Random House, 1 996),
and Facing Up: How to Reicve ihe Economy from Cruihing Debt and Restore ihe American Dream
(New York: Simon <x\d Schuster, 1 993).
110
that we regard a plan as so severely flawed that it does not merit seri-
ous consideration. A grade of C means that a plan contains major
shortcomings according to the criteria we propose. A grade of B
means that a plan has significant strengths and meets most require-
ments for reform, but comes up short in one or more key respects.
The grade of A means that a plan meets all major requirements for
reform and falls seriously short in none. Not everyone will agree with
our evaluations. Some may object to the particular criteria we have
selected or the importance we attach to them. Others may think we
have been too harsh or lenient in grading a particular plan. In the
end, you must form your own judgment.
Criteria for Reform
Our first criterion requires that a good reform plan ensure adequate
benefits that are equitably distributed and represent a fair return for
taxes paid. Current benefits are not unduly generous, as we showed
in Box 6-1. For that reason, adequacy means that large benefit cuts
are unacceptable because they would result in insufficient protection
for retirees, the disabled, and survivors. Overall benefit increases are
also undesirable because they would further swell the added costs
the retiring baby boomers will generate. Equity requires that protec-
tion be maintained for low earners, large families, and other vulner-
able people. And a fair return means that plans should be invested
wisely and not incur needless administrative costs.
Our second criterion is that the unavoidable risks of long-term
pension commitments should be shared broadly^ not placed on the
shoulders of individual workers. Our third criterion for judging plans
is administrative efficiency and feasibility. In addition to avoiding
needless administrative costs, the plan should not be unduly com-
plex for private businesses, workers, and the government. Finally, we
give higher grades to plans that raise national saving. A plan's con-
tribution to national saving is determined by its additions to reserves
held in either the trust funds or individual accounts, less any induced
reductions that take place in private saving or government surpluses
outside the retirement system.
Other consequences of Social Security reform are also impor-
tant. How reform will influence retirement decisions, for example,
Ill
will be of increasing importance as labor force growth slows to a crawl
during the first decades of the twenty-first century. Reform may also
change the relative treatment of one- and two-earner couples, a subject
of particular concern to the growing number of working women.
While these — and many other— dimensions of reform are of concern,
no plan that provides inadequate benefits, fails to protect low earners,
and gives a poor return for each dollar of taxes paid; that subjects
workers to excessive risk; that generates needless administrative com-
plexity; and that does nothing to boost national saving should merit
serious consideration. (See the appendix to this chapter, page 141,
and Table 7-1, for some specifics about the major plans.)
Proposals to Replace Social Security
Several plans would replace Social Security with a wholly new system
based on personal retirement accounts. The plans differ in how much
assistance they would give low earners beyond the accumulation in
each worker's personal account, how much discretion individuals
would have to select investments for their accounts, how much con-
trol participants would have over the way benefits are paid from their
personal accounts when they retire, how much risk individual work-
ers would face, how the plans would be administered, and how the
costs of transition to the new system would be paid for.
Person.al Security Account Pl.\n
The Personal Security Account plan, advanced by five members
of the 1994-96 Advisory Council on Social Security, would gradual-
ly replace Social Security with two other benefits, one based on bal-
ances accumulated in mandated IRA-like personal retirement
accounts, the other a flat annuity based on how long the recipient
had worked and the age at which benefits were first received.
The plan would be phased in over many years. Workers under
age 25 when the new plan came into effect would receive benefits
only under the new system. Workers between the ages of 25 and
55 would receive a blend of benefits under the new and old systems.
Retirees and workers over age 55 would remain under the current
112
113
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k ixj
X i i X
X \ : X
Ulx
X ■ X ■
58°
9: V c
■6 2; P 3 t
114
Social Security system. No retiree would receive benefits entirely
under the new system for about forty years. Payroll tax rates would
be increased 1.52 percentage points until virtually all adults now
alive are either dead or retired — that is, for about seven decades, a
period the architects designate "the transition." The added tax is
needed because continued Social Security benefits for current retirees
and older workers, the new flat pension, and deposits into person-
al accounts would cost more than the current 12.4 percent payroll
tax will generate. Even with the tax increase, the new system would
run a deficit for the first few decades, forcing the government to
borrow approximately $2 trillion (in 1998 dollars). Eventually, as
Social Security phases out, revenues would exceed costs and the
debt would be paid off. When all the initial borrowing had been
repaid — around the year 2070 — the supplemental payroll tax could
be repealed.
The Personal Security Account plan has other important impli-
cations. The first-tier flat benefit would guarantee inflation-protect-
ed payments until the worker and his or her spouse died. The
second-tier benefit would not provide protection against inflation or
a long life unless the worker chose to purchase an inflation-indexed
annuity with his or her personal account balance. All of the flat ben-
efit, but none of the pension provided from the personal accounts,
would be included in income subject to the income tax. Relative to
current rules, this feature would raise taxes on low- and moderate-
income retirees and decrease them on higher-income retirees. The
Personal Security Account plan would retain the disability insurance
program but would gradually cut benefits. Furthermore, the disabled
would not have access to their personal retirement account until they
reach retirement age. Even then, the balances of those who became
disabled when young and made deposits for only a few years would
be small. Workers would enjoy control over investment and with-
drawal of their retirement funds, but would sacrifice reliability and
face sharply higher administrative costs.
Benefit Adequacy and Equity. While the plan promises good
benefits for retirees on the average, it provides poor protection to cer-
tain vulnerable groups. It cuts disability benefits as much as 30 per-
cent. Divorcees who earned little during their married years, possibly
because they were busy raising children, could find themselves with
little more than the flat benefit. Because the Personal Security
115
Account plan would permit workers to invest their individual
accounts in quite different portfolios, some workers would do poor-
ly and, therefore, have to depend on the flat benefit for the bulk of
their retirement income.
Protection against Risk. The pension provided through the flat
benefit — an inflation-adjusted annuity — would provide reliable pro-
tection against risk. That derived from the personal accounts, how-
ever, would expose retirees to considerable uncertainty. Pensions for
workers with similar earnings would vary widely because returns
on personal accounts would depend on how funds were invested,
what administrative fees were imposed by fund managers, how high
asset values were when balances were withdrawn, and whether pen-
sioners bought annuities when they retired. Those who invested
unvv'isely, had bad luck, or spent their accumulated savings too fast
could find themselves dependent, in their later years, on the plan's
flat benefit.
Administrative Efficiency. The Personal Security Account plan
does poorly on this criterion. The administrative structure for the
current Social Securit)' system would have to be maintained for many
years. In addition, the tax collection and record-keeping systems need-
ed for payment of survivor and disability benefits would continue
and a simplified system would have to be established to administer the
flat benefit. Another new structure would be required to ensure that
employers made timely and accurate deposits into personal accounts
and that the financial institutions managing personal accounts com-
plied with the inevitable regulations. The administrative burdens
imposed on small employers would be so burdensome that we doubt
that the plan could actually function as envisioned. Even large
employers would find it onerous to direct periodic deposits — many of
which would be less than $100 a month — to the numerous fund man-
agers chosen by their employees.
On average, workers would face dramatically higher adminis-
trative costs that would seriously lower the net returns to workers,
compared to plans that managed similar investments centrally. Since
some of these costs do not vary with the size of accounts, they would
represent a larger portion of income of small accounts than on large
accounts.- Furthermore, those pensioners who wished to buy annu-
ities would face large additional costs.
116
National Saving. The Personal Security Account plan ranks rel-
atively high on adding to national saving because it raises payroll
taxes. However, the personal accounts would be so similar to existing
IRAs and 401 (k) plans that workers would probably reduce other
private saving more than if the accounts were held and managed cen-
trally by the government. Furthermore, if experience with IRAs is
any indication. Congress would come under pressure to allow with-
drawals from personal accounts for specified meritorious uses well
before retirement. Such withdrawals would reduce the resources avail-
able to support retirement pensions and any positive effect on nation-
al saving. A similar problem would arise with all individual account
plans, but it is most serious for plans that set up accounts similar to
current tax-sheltered savings arrangements.
Overall, we give the Personal Security Account plan a grade of C
(see Table 7-2).
Table 7-2
Report Card for the
Personal Security Account Plan
_„_.^_.___ __.._
'"gram"!
Adequacy, equity, and a fair return
c +
Protection against risk
c
Administrative eFficiency
D
Increased national saving
B
Overall grade
C
Feldstein Plan
Under a plan crafted by Martin Feldstein, professor of economics at
Harvard University and a former chairman of the Council of Economic
Advisers, each worker would deposit 2 percent of his or her earnings, up
to the maximum subject to the payroll tax, in a personal retirement
account.' Workers would receive an income tax credit sufficient to offset
the cost of these deposits. For those with no tax liability or liabilities less
117
than 2 percent of earnings, the tax credit would be refundable. For as
long as they last, the projected budget surpluses would be used to finance
the tax credits. Increased federal borrowing, tax increases, or spending
cuts would then be required for a number of years.
The personal retirement accounts, which would represent a massive
infusion of new resources into the mandatory retirement system, would
be invested in regulated stock and bond funds chosen by the worker
and administered by private fund managers. When workers reached
retirement age and began to draw pensions from their personal retire-
ment accounts, their Social Security benefits would be reduced by $3 for
every $4 withdrawn. In effect, the benefits promised by the current
Social Security program would become a floor under pensions. Overall,
retirees would receive an estimated 60 percent of their benefits from
Social Security and 40 percent from their personal accounts. Higher
earners would depend more on their personal accounts than these aver-
ages suggest, and some would receive nothing from Social Security.
The reductions in Social Security benefits would eventually be suffi-
cient to close the projected long-term Social Security deficit.
Benefit Adequacy and Equity. This plan would raise, not lower,
the baby boomers' pensions. Given widespread concern about the pro-
jected costs of supporting pension and medical benefits for the elderly
and disabled, we regard proposals to raise benefits as imprudent. The
Feldstein plan would provide larger retirement benefits than those of
any other plan we examine, larger in fact than those promised by the
current Social Security system. More generous benefits are possible
because the plan uses the budget surpluses projected for the next two
decades to support deposits into individual accounts."' When these sur-
pluses begin to shrink, taxes dedicated to retirement pensions will have
to be raised, other spending cut, or deficits incurred for several decades.
The benefit increases would be inequitably distributed. Benefits
would rise proportionately more for high earners than for low earn-
ers. The contribution to individual accounts and, hence, the size of
account balances would be a constant fraction of income. Social
Security benefits are proportionately larger for low earners than for
high earners. Since the plan would reduce Social Security benefits by
three-quarters of any benefits derived from individual accounts, pen-
sions for high earners would rise proportionately more than would
pensions of low earners. The following simple numerical example,
which is presented in monthly amounts, illustrates this point.
118
AvERAGf Social Indivioual Total Change
Easnings Security Account Pension in Pension
Low Earner $1,000 $560 $240 $620 +11%
High Earner $5,600 $1,375 $1,340 $1,720 +25%
The Social Security benefits in the table correspond approximately
to the replacement rates of low and maximum earners — 56 percent
and 25 percent respectively. Each worker contributes proportionate-
ly to individual accounts and, therefore, receives a pension propor-
tionate to earnings. When Social Security benefits are reduced by
three-quarters of the pension based on the individual account, the
low earner's total pension goes up 11 percent, the high earner's by 25
percent. Since high earners are likely to select higher-yielding, albeit
riskier, portfolios, the increase in benefits for higher earners relative
to that for low earners is likely to be even larger than this illustration
shows. In short, high earners would tend to receive little from Social
Security and, in the extreme case, might receive nothing.
Protection against Risk. At the level of the individual pension-
er, the Feldstein plan provides substantial protection against mar-
ket risk because it guarantees participants a pension at least as large
as that promised by the current benefit formula. However, the plan
is likely to undermine political support for a defined-benefit guar-
antee like Social Security among high and moderate earners because
most of them would eventually receive pensions based predomi-
nantly on their personal accounts. We explore this issue in more
detail in the next chapter. Furthermore, the plan poses major fiscal
risks because the commitment to increased pensions would generate
severe budget pressures, particularly after currently projected budget
surpluses end. The fiscal duress would affect all government spend-
ing and taxes.
Administrative Efficiency. The Feldstein plan would be complex
and costly to administer. As was true with the Personal Security
Account plan, administrative and investment management fees will
eat into returns on personal retirement account balances. The IRS
would face numerous problems when it tried to refund the tax cred-
it to those with no or limited tax liabilities. Nor would it be easy for
the Social Security Administration to design and operate a system
119
that reduced Social Security benefits by $3 for every $4 withdrawn
from each retiree's personal account.^
National Saving. The effects of the Feldstein plan on national
saving are complicated and unclear/ Initially, the plan would not
affect saving at all, as the deposits in individual accounts would sim-
ply substitute for the reduction in federal debt that will occur if the
projected budget surpluses are not dissipated through tax cuts or
spending increases. The longer-run effects on saving depend on how
successive Congresses and presidents react when the surpluses are no
longer large enough to sustain the required deposits into the individ-
ual accounts and on the extent to which individuals cut back on other
saving to offset mandatory saving in individual accounts.
The Feldstein plan deserves the same overall grade that was given
to the Personal Security Account plan (see Table 7-3).
Table 7-3
Report Card for the Feldstein Pl.\n
CWRWA
Jimm
Adequacy, equity, and a fair return
B +
Protection against risk
B-
Administrative efficiency
D-
Increased notional saving
D
Overall grade
C
Reduce Social Security and Supplement
It with Small Personal Accounts
Another group of proposals would supplement a reduced Social
Security system with small defined-contribution personal retirement
accounts. These plans would scale back defined-benefit Social Security
120
pensions by different amounts and in different ways, and would cre-
ate personal retirement accounts of various sizes and forms.
Individual Account Pl.^n
The Individual Account plan, crafted by Edward M. Gramlich,
chairman of the 1994-96 Advisory Council on Social Security, would
cut back Social Security outlays sufficiendy so that the current 12.4
percent payroll tax would cover future program costs. Benefits rel-
ative to those promised under current law would be cut gradually —
by little for low earners and up to more than 25 percent for high
earners (see the appendix to this chapter, pages 142-43, and Table 7-
1 for details). An increase in the employee payroll tax by 1.6 per-
centage points would finance small personal retirement accounts
invested in a restricted number of index mutual funds managed by a
government agency. Balances would be converted into inflation-pro-
tected annuities when workers reach retirement age.
The annuities would be small. A worker with median covered
earnings who was 40 years old when the plan was implemented
would receive an annuity of about $125 (in 1998 dollars) a month
starting at age 65, which would equal about 13 percent of the work-
er's expected Social Security benefit under the current system.' Older
workers, who would start contributing at a later age, would con-
tribute for fewer years and would receive less; younger workers would
participate for more years and receive larger pensions. Because pay-
roll taxes would fully finance the new individual accounts, the plan
would require no other transitional taxes or borrowing. However,
the Individual Account plan would cut disability benefits by varying
amounts depending on earnings. As with the Personal Security
Account plan, individual accounts can do nothing to offset these cuts
until the disabled reach retirement age, and not much even then for
workers who become disabled when young.
Benefit Adequacy and Equity. Despite its name, the Individual
Account plan would continue to rely heavily on Social Security,
although benefits provided through that program would ultimately be
cut by over 25 percent for high earners. On the average, pensions
financed by individual accounts would fill in this gap for people of
121
retirement age. But the disabled would suffer reduced benefits until
they reached retirement age. The cuts in the defined-benefit compo-
nent of the reformed system are larger than necessary because the
Individual Account plan would continue to prohibit managers of the
Social Security trust funds from investing in a diversified portfolio.
The adequacy of pensions based on individual accounts would vary
among workers of a given age and over time, depending on their
choice of index funds and market performance.
Protection against Risk. The individual accounts would be sub-
ject to market risk, but the variation would be less than that of the
Personal Security Account and Feldstein plans because investments
would be limited to a few centrally managed index funds. The pen-
sions based on personal retirement accounts would never constitute
more than a modest portion of future retirees' pensions — about 30
percent of the benefits for an average wage worker and 20 percent of
those for a low earner. Both the pension provided through the scaled-
back Social Security and that provided from the individual account
would be inflation-protected annuities.
Administrative Efficiency. Administrative costs for the Individual
Account plan would be somewhat higher than those under Social
Security. Central administration, mandatory annuitization, and the
limited number of indexed investments would hold down costs. But
the federal government would have to establish arrangements for
depositing funds in accounts of each worker's choice, educating them
about the options, and responding to questions. It would also have to
keep track of divorces if funds accumulated in personal accounts were
divided at divorce, an important protection for lesser earners, usual-
ly wives, and an issue facing all plans with individual accounts.
National Saving. The increased payroll tax and the benefit cuts
would both raise national saving. Workers would probably reduce
their private saving less per dollar in their individual account than
they would under the Personal Security Account and Feldstein plans
because these centrally held accounts would not be viewed as good
substitutes for IRAs or 401(k) plans, from which withdrawals under
certain circumstances are permitted.
We give the Individual Account plan a solid B for an overall
grade (see Table 7-4).
122
Table 7-4
Report Card for the
Individual Account Plan
pttm\A ! Oram' i
Adequacy, equity, and a fair return
B
Protection against risk
B
Administrative efficiency
8-
Increased notional saving
B+
Overoll grade
B
MoYNiHAN (Social Security Solvency) Plan
Senator Daniel Patrick Moynihan (Democrat of New York) pro-
poses to cut payroll taxes, substantially lower Social Securit)' benefits,
and authorize workers to set up individual accounts. Payroll taxes would
be cut 2 percentage points until 2025 — 1 percentage point for workers
and 1 percentage point for employers (see the appendix to this chapter,
page 145, and Table 7-1 for details). Workers would be permitted to
spend or save the 1 percentage point cut in their portion of the payroll
tax. They could save it either in voluntary personal accounts modeled on
the Thrift Savings Plan and administered by a new government board or
in special Individual Retirement Accounts managed by financial insti-
tutions of their choosing. If an employee established a personal account,
the worker's employer would have to match the worker's contribution.
Withdrawal of account balances at retirement would be unrestricted.
From 2025 to 2060, the payroll tax rate would be raised peri-
odically to keep program revenues in line with benefit payments.
After 2045, the combination of payroll taxes and deposits in per-
sonal accounts would exceed the current payroll tax rate. In 2060, the
13.4 percent payroll tax rate together with contributions to a per-
sonal account would claim 15.4 percent of covered earnings, 3 per-
centage points above the current payroll tax.
Because the Moynihan proposal would cut average payroll tax col-
lections over the next 75 years, it would have to cut Social Security ben-
efits more than would be necessary if taxes were maintained.
Retirement, survivor, and disability benefits would be cut by an average
123
of about 20 percent relative to current law, but the cuts would grow over
time and be larger for the long-term disabled and the very old than for
those who are just beginning to receive benefits. The cuts result from
holding annual inflation adjustments 1 percentage point below the CPI
and by cutting benefits across the board through increasing the age at
which unreduced benefits are paid. Over time, the Moynihan plan would
return Social Security to a pay-as-you-go system, with reserves sufficient
to fide the system over a severe economic downturn.
The Moynihan plan would deny full inflation adjustments under
the personal income tax and under all indexed benefit programs
except Supplemental Security Income. Over time, this would cause
massive increases in income tax burdens and reductions in entitle-
ment spending for benefits for veterans, civil servants, and others.
Benefit Adequacy and Equity. This plan would ercxle benefits steeply
and in ways that could hurt vulnerable groups the most. Those who
received benefits the longest — the very old and the long-term disabled —
would suffer the largest benefit reductions from the cumulative effects of
the 1 percentage point reduction in the annual cost-of-living adjustment.
In 2017 when the age at which unreduced benefits are paid would reach
68 under this plan, benefits for a 62-year-old retiree will be 35 percent
smaller than those available at age 68. Hardship among the very old,
especially widows and widowers, could increase if many are encouraged
by the elimination of the earnings test for early retirees to draw these
gready reduced benefits at age 62 or 63, supplementing them with earn-
ings while still in their 60s. When such early retirees reach their mid-70s
and find even part-time work burdensome, the reduced benefits may
prove inadequate, particularly for low earners, the group least likely to
have set up voluntary investment accounts. The less-than-complete
adjustment for inflation would only compound their difficulty.
Protection against Risk. Because workers could invest their vol-
untary accounts in a wide range of assets, they would be exposed to
a good deal of investment risk. Social Security would provide only
partial protection against inflation, and pensions derived from the
voluntary accounts would have none. With no restrictions on when or
how retirees could convert their account balances into retirement
income, some could outlive these pensions.
Administrative Efficiency. Government administrative costs would
rise because it would be necessary not only to retain the Social Security
124
Administration in full, but also to create a wholly new government-
managed individual account system and to ensure compliance for pri-
vately managed accounts. Small and medium-sized businesses would
face virtually insurmountable challenges in trying to make the program
work. They would have to keep track, pay period by pay period, of
whether workers (including new hires and departing workers) wanted to
contribute to individual accounts or not; whether those who made con-
tributions wanted their funds deposited in the government-managed
program or in a privately administered account; and, for those who
chose private accounts, which of the many thousands of private fund
managers that would be vying for business the worker had selected.
National Saving. If all of its provisions remained in force, the
Moynihan plan would raise national saving even though it would
return to pay-as-you-go financing of Social Security. One explanation
for this is that income tax collections would rise dramatically, the
inevitable consequence of not indexing the rax brackets, exemptions,
and the standard deduction. Another is that the growth of mandato-
ry spending would slow because the plan would deny full inflation
adjustments under all indexed benefit programs except Supplemental
Security Income. If, as we think highly probable, Congress acted to
preserve full inflation adjustments for the income tax system and key
benefit programs, the plan would reduce national saving.
The Social Security Solvency plan developed by Senator Moyni-
han is inadequate and merits an overall grade no higher than a D
(see Table 7-5).
Table 7-5
Report Card for the Moynihan
(Social Security Solvency) Plan
CRirCKM
Graoc
Adequacy, equity, and a fair return
F
Protection ogainst ri$k
c+
Administrative efficiency
D-
Increased national saving
D
Overall grade
D
125
BREAUX-GREGG (TVVENTY-FIRST
Ceni'ury Retirement) Plan
The plan proposed by Senators John Breaux (Democrat of
Louisiana), Judd Gregg (Republican of New Hampshire), and others
would divert 2 percentage points of the current payroll tax to indi-
vidual accounts modeled on the Thrift Savings Plan and cut Social
Securit)' benefits an average of 25 to 30 percent (see the appendix to
this chapter, page 146, and Table 7-1 for details).** Cuts of this size
would be necessary both to close the current projected long-term
deficit and to free up 2 percentage points of the payroll tax for indi-
vidual savings accounts. Retiring workers would be required to convert
a portion of their account balances into an inflation-protected annu-
ity. Together with the retiree's reduced Social Security benefit, this
annuity would have to be sufficient to meet a standard for minimum
retirement income.
Social Security benefits would be cut in four ways: by increasing
the age at which unreduced benefits are available to 70 by 2029 and
at a slower pace thereafter, by reducing the spouse's benefit, by shav-
ing the cost-of-living adjustment, and by cutting replacement rates
for all retirees except those with average earnings below approxi-
mately $5,700 in 1998, a threshold that would rise at the same rate
as average earnings. A new minimum benefit would be established
that was equal to 60 percent of the poverty threshold for those with
twenty years of covered earnings, rising to 100 percent of the pover-
ty threshold for those with forty years of earnings. A fail-safe mech-
anism would automatically keep the program in long-run balance
and ensure that financial balance would not be jeopardized by unex-
pected developments.
Benefit Adequacy and Equity. The Breaux-Gregg plan, like the
Individual Account plan, combines mandatory individual accounts,
administered along the lines of the Thrift Savings Plan, with a scaled
back Social Security system. The Breaux-Gregg plan, however, lowers
both retirement and disability benefits more than the Individual
Account plan does — 30 to 40 percent for moderate and high earners.
Larger cuts are necessary because the plan widens the program's
deficit by diverting payroll taxes from Social Security, whereas the
Individual Account plan raises payroll taxes to finance the personal
126
accounts. As a consequence of these cuts, the assured element of pen-
sion protection would be drastically curtailed.
Protection against Risk. Because the investment options and
management of the individual accounts would be patterned after
those of the federal employees' Thrift Savings Plan, investment risk on
these accounts would be moderate and similar to that of the In-
dividual Account plan. The minimum Social Security benefit in the
Breaux-Gregg plan, which is equal to the poverty threshold for a
worker with forty years of participation, would provide some pro-
tection to low earners if returns from their individual accounts turned
out to be sub-par. This safety net, however, would become less mean-
ingful over time because productivity growth will push up real
incomes while the poverty threshold is adjusted only for inflation.
The minimum benefit could undermine poHtical support for the system
if many low and moderate earners received pensions based on the guar-
anteed minimum rather than on the Social Security benefit formula.
This development would weaken the fundamental relationship between
earnings and contributions on the one hand and benefits on the other.
The mandatory annuitization of a portion of the personal accounts
would protect people from outliving their pensions.
Administrative Efficiency. The central administration and invest-
ment management of the personal accounts, investment in a restrict-
ed number of index funds, and mandatory annuitization would hold
down overhead costs of the Breaux-Gregg plan. These costs, howev-
er, would exceed those of the Individual Account plan because of the
complexity inherent in calculating the portion of each personal
account that would have to be annuitized and the difficulties associ-
ated with administering both the annuity and the remaining balance.
National Saving. Because it does not raise payroll taxes, the
Breaux-Gregg plan would add much less in the near term to national
saving than the Individual Account plan. Unlike the accounts under
the Personal Security Account plan, those of the Breaux-Gregg plan
would not be considered good substitutes for IRAs or 401(k) plans.
Overall, we give the Twenty-first Century Retirement plan spon-
sored by Senators Breaux and Gregg a grade of C+ (see Table 7-6).
127
Table 7-6
Report Card for the Breaux-Gregg
(Twenty-first Century Rftirement) Plan
1&.A
0«A«a
Adequacy, equity, and a fair return
C
Protection against risk
c
Administrative efficiency
Increased nationai saving
B-
Overall grade
'* 1
Retain Social Security with Changes to
Restore Financial Balance
The final approach to Social Security reform preserves the current
system and continues to rely on a defined-benefit system to assure
basic retirement income. Mandatory pensions would remain tied
exclusively to each worker's past earnings and years of work, not to
fluctuating asset prices.
Ball Plan^
Robert M. Ball, a former commissioner of the Social Security
Administration, has proposed to restore projected long-run financial
balance by increasing payroll tax revenues, cutting benefits modestly,
and investing part of the trust funds' reserves in equities (see the
appendix to this chapter, page 147, and Table 7-1 for details).
Investment of up to 40 percent of the reserves in common stocks by
2015 would close roughly half of the projected long-term deficit.
Increased revenues, which would come from subjecting a greater pro-
portion of benefits to the personal income tax and increasing the
maximum earnmgs subject to the payroll tax, would contribute
another one-third. Extending coverage to newly hired state and local
128
workers and increasing from 35 to 38 the number of years of earnings
used to compute benefits finish the job.
Benefit Adequacy and Equity. The Ball plan would provide larg-
er benefits than any of the other plans described in this chapter, save
the Feldstein plan, which would appropriate projected budget sur-
pluses and then raise taxes or cut other program spending to boost
benefits. Vulnerable groups would be well protected. The plan, how-
ever, does not modify the spouse's or survivor's benefits or attempt to
modernize Social Security in other ways to reflect the economic and
social changes that have occurred over the past half century.
Protection against Risk. Because this plan would rely exclusive-
ly on defined-benefit pensions, it would spare workers exposure to the
risks to their basic pension income that are inherent in individual
accounts."* Annual cost-of-living adjustments would preserve the pur-
chasing power of benefits from inflation. However, the Bali plan
would probably not permanently solve the Social Security fiscal
imbalance. Because the plan proposes only modest changes, Social
Security would eventually fall out of close long-run actuarial balance,
even if all economic and demographic assumptions prove accurate.
Unpleasant surprises could cause deficits to appear sooner. While fur-
ther adjustments to benefits or taxes could close any shortfall, we
think current public distrust of the retirement system and of govern-
ment in general make it vital to adopt reforms that will restore finan-
cial balance and sustain it even if economic and demographic
assumptions turn out to be overly optimistic.
Administrative Efficiency. The Ball plan would maintain the
current low-cost administrative structure for taxes and benefits. It
would incur small added costs associated with investing the trust
funds' reserves in equities but should amount to no more than 1/100
of a percent of funds invested."
National Saving. Because the Ball plan would cut benefits and
raise taxes only modestly, it would contribute less to national saving
than several of the other plans.
Overall, the Ball plan deserves a strong B+ (see Table 7-7, page
138).
129
Table 7-7
Report Card for the Ball Plan
[c«rmMA
GrtADf 1
Adequocy, equity, and a fair return
A-
Protection against risk
B+
Administrative efficiency
A
Increased nafional saving
C+
Overall grade
B+
Maintain Structure Plan
The plan we described in Chapter 6 also relies exclusively on
defined-benefit retirement pensions. The distinctive characteristic of
this plan is the creation of a new Social Security Reserve Board
(SSRB), modeled on the Federal Reserve Board, that would manage all
financial operations of Social Security.'* The operations of the Social
Security system would be removed from the budget presentations of
the executive and legislative branches. The SSRB would be charged
with achieving, over the course of several decades, reserve balances
similar in magnitude to those that would be required of private pen-
sion funds under the Employee Retirement Income Security Act. The
trust funds' investments would be diversified among government
bonds and private stocks and bonds. In addition, we propose some-
what larger benefit curs than does the Ball plan to boost reserve accu-
mulation and to raise national saving. The benefit cuts would be
designed to reflect the changes that have occurred in the labor force
and in life expectancy since the program was enacted.
Benefit Adequacy and Equity. This plan reduces benefits some-
what more than the Ball plan but it does not cut pensions signifi-
cantly for vulnerable groups such as the disabled. Most surviving
spouses would experience a smair increase in benefits. Retired cou-
ples in which one spouse had little or no earnings history, on the
other hand, would experience a modest decline in their pension. By
130
investing the trust funds' reserves in a diversified portfolio, the plan
would bring to people dependent on public pensions the higher yields
that a broad portfolio of public and private bonds and stocks makes
possible.
Protection against Risk. Like the Ball plan, the Maintain
Structure plan preserves the key advantage of defined-benefit pen-
sion plans by spreading risks broadly among the general population.
Benefits would remain fully protected from inflation. Because the
plan more than closes the long-term deficit, uncertaint)' about future
adjustment would be less than under the Ball plan. Furthermore, it
incorporates a mechanism that would help to ensure that if the
reformed program were to fall out of long-run actuarial balance in the
future, policymakers would enact corrective measures.
Administrative Efficiency. This plan maintains all the adminis-
trative efficiencies of the current system.
National Saving. This plan would add moderately to nation-
al saving. It would isolate Social Security surpluses from the general
budget process so that they are more likely than under current
budget rules to add to national saving.
Nobody will be surprised if we award the plan we sketched out
in Chapter 6 the top overall grade, an A- (see Table 7-8). That plan
best meets the criteria we set forth earlier in this chapter.
Table 7-8
Report Card for the
Maintain STRrcrrRE Plan
CiirrfiUA ; Gram ^^
Adequacy, equity, and a fair return
B+
Protection against risk
A
Administrative efficiency
A
Increased national saving
&+
Overall grade
A-
131
Conclusion
No perfect way exists to reform the nation's mandatory retirement
program; all plans involve tradeoffs among desirable objectives. Table
7-9 is our "grade sheet" for the seven plans. We did not give our
plan a straight A because we think no plan that cuts benefits or rais-
es taxes merits that grade. Furthermore, our plan — like all others- —
contains politically unpopular provisions that elected officials will
find hard to endorse.
While investing Social Security's growing reserves, collectively
or through individual accounts, in assets that have higher yields than
government bonds can help, that policy change alone cannot close the
projected deficit. To finish the job, future retirees will have to accept
smaller benefits than those promised under current law or future
workers will have to pay higher taxes. The weightlifter's maxim, "no
pain, no gain," applies also to pension policy. The question is: Whose
gain and whose pain.''
Table 7-9
Summary Report Card
Pun
Graoc '
Personal Security Account
C
Feldstein
c
Individual Account
B
Moynifian
D
Breaux-Gregg
c.
Boll
B+
Maintain Structure
A-
132
Features of the Personal
SECURrrv Account (PSA) Plan «
General Changes
♦ All newly hired state and local workers would be brought into the system.
♦ The retirement earnings test would be repealed.
♦ The scheduled increase to 67 in the age at which unreduced benefits are paid
would be accelerated to 201 1 and raised thereafter to reflect improved odult life
expectancy.
♦ The age of initial benefit eligibility would be raised gradually from 62 to 64
by 201 1 .
♦ Disability benefits would be reduced gradually, for workers who are currently
young, by up to 30 percent.
♦ Payroll taxes would be increased 1 .52 percentage points for the next sewenly-lwo
years.
For Workers under Age 25
First Tier
♦ Workers with thirty-five or more years of covered employment would receive a flat,
inflation-protected benefit equal to 76 percent of the benefit paid to low-wage
workers under the current system. This benefit would be reduced 2 percent for
each year of work under thirty-five years and by up to 30 percent if clotmed earli-
er ihon the standard retirement age.
♦ Spouses with fewer than ten years of work would receive a Rat benefit equal to
half the benefit payable to the primary worker; widows and widowers would
receive at least three-quarters of a couple's combined benefit.
♦ The flot benefit and spouse's, survivors, and disibility benefits would be financed
by employers' payroll tax (6.2 percent of covered earnings) and 1 .2 percentage
points of the employees' payroll tax.
♦ All of the flat benefit would be subject to income tax.
Second Tier
♦ Personal Security Accounts would be established through a financial Institution of
the worker's choice. Five percentage points of the worker's earnings would be
deposited in these accounts.
♦ Individuals could invest bolances under rules similar to those governing Individual
Retirement Accounts.
♦ At the age of initial eligibility for first tier benefits, each person could use the accu-
mulated balance to buy an annuity, withdraw funds on a fixed schedule, or hold
funds for transfer to heirs through bequest; all withdrawals would be exempt from
income tax.
Continued on the following page
133
Features of the Personal
Security Account (PSA) Plan ' .oov.
For WoRKfRS Age 25 to 55
First Tier
♦ These workers would receive pensions from a blended system based mostly on
Social Security for older workers ond mosHy on tf>e First Tier of the new system for
younger workers.
Second Tier
♦ These workers would hove the same Personal Security Accounts as for vounger
workers, but smaller amounts would accumulate because deposits would have
been mode for a briefer period.
For Retirees and Workers Over Age 55
♦ These workers would receive Social Security, with general modifications listed
above.
0. Reporf of ihe 1 994- 1 996 Advisory Council on Social Securiiy, Volume I: Findings and
Recommendotions (Washington, D.C.: U.S. Government Prinfing Office, 1997).
134
FEAT{'RES of the iNDIVIDrAL ACCOUNTS (I A) PLAS''
Changis in Social Security
♦ Benefits would be reduced gradually for all newly retired workers with overage
adjusted lifetime earnings above about $5,724 (in 1 998, and adjusted upward by
the growlh in average wages).
♦ The number of years of earnings used to compute benefits would be increased
from thirty-five to thirty-eight.
♦ Social Security benefits would be taxed the some as contributory private pensions.
♦ All newly hired state and local workers would be brought into the system.
♦ The scheduled increase to 67 in the age at which unreduced benefits ore paid
would be accelerated to 201 1 and raised thereafter to reflect improved adult life
expectancy.
♦ The spouse's benefit would be cut from one-half to one-third of the primary work-
er's benefit, but surviving spouses would be assured a benefit equal to ot least
three-quarters of the couple's combined benefits.
Personal Accounts
♦ A new 1 .6 percentage point payroll tax would be imposed on employees and its
proceeds would be deposited in individual accounts that resembled the accounts
held in the federal employes' Thrift Savings Plan (see Box 6-4).
♦ When workers retired, their account balances would have to be converted into
inflation-protected annuities.
a. Report of ihe 1 994- 1 996 Advisory Council on Social Securify, Volume I: Findings and
Recommendationj (Woshinglon, D.C; U.S. Government Printing Office, 1997).
135
Features or the Movniii-W
(Social Securot Sol\en'cv) Plan-'
Benefit Cuts
♦ The annual cost-of-living adjustment to benefits would be 1 percentage point less
than the change in the Consunner Price Index.
♦ The age at v>4iich unreduced benefits are paid would be increased two months
each year until it reached 68 in 201 7, and by one month every two years there-
after until it reached 70 in 2065.
♦ The number of years of earnings used to calculate benefits would be increased
gradually from thirty-five to thirty-eight.
Revenue Increases
♦ Benefits would be taxed in the some fashion as contributory private pensions.
♦ The maximum taxable earnings vrauld be increased gradually by about 1 8
percent.
Other Changes
♦ The payroll tax rate woM be cut by 2 percentoge points and then raised
gradually to support the system on a pay-as-you-go basis.
♦ Voluntary retirement savings accounts would be established for those workers who
wanted to contribute 1 percent of earnings to them. Employers would have to
match the employees' contributions. The worker could choose to hove the account
manoged by the government's Voluntary Investment Fund Board, which would offer
investmente similar to those available to federal employees in the Thrift Savings
Plan or by a private financial institution. Account bobnces could be wirtidravni in
any form upon retirwnent.
♦ All newly hired state and local workers would be brought into the system.
♦ The retirement earnings test would be repealed.
o. S. 1 792, 1 05lh Congress, 2d Session, ond "Senolor Doniei Patrick Moynihon Sociol Secwrity
Solvcfwry Act of 1 998, Brief Description of Provisions and Supplementary Materials from the
Congressionol Budget Office and ifie Sociol Security Administration," mimeo, Morch 1 998.
136
Features of the Breaux-Gregg
(TwENTY-FrRST Crntury Rktirkmen t) Plan*
Changes in Social Security
♦ The spouse's benefit would be gradually reduced from one-half to one-third of the
primary worker's benefit.
♦ Benefits would be computed by summing all of a worker's adjusted earnings and
dividing by forly.
♦ Benefits would be reduced gradually for all newly retired workers with average
adjusted lifetime earnings above about $5,724 (in 1 998 and adjusted upward by
the growth in overage wages).
♦ All newly hired stote and local workers would be covered.
♦ The age at which unreduced benefits are paid would be increosed two months a
year, reaching age 70 in 2029, and by one month every year and a half there-
after, reaching 72 in 2065.
♦ The oge of initial eligibility for benefits would be increased two months o year,
reaching age 65 in 2029, and by one month every y&ar ond a half thereafter,
reaching 67 in 2065.
♦ The retirement earnings test would be eliminated for all those above the age at
which unreduced benefits are available.
♦ The early retirement penalty and the delayed retirement credit would be increased
to make them more accurate.
♦ The annua! cost-of-living adjustment would be reduced to account for o portion of
the bias remaining in the measured CPI.
New Minimum Benefit
♦ A minimum benefit would be established equal to 60 percent of the poverty thresh-
old for those with twenty years of covered earnings and rising by 2 percentage
points per additional year to 1 00 percent of the poverty threshold for those with
forty or more years of covered earnings.
Personal Accounts
♦ Personal accounts similar in investment options and mronagement to accounts held
in the federal employees' Thrift Savings Plan (see Box 6-4) would be established
using 2 percentage points of the existing poyroll tax. Supplemental voluntary con-
tributions of up to $2,000 per year wouia be permitted.
♦ Upon retirement, a portion of the accounts' balances would have to be used to
purchase an inflation -protected annuity that, when added to the scaled back Social
Security benefit, met a minimum Hireshold for retirement income adequacy. Excess
balances could be withdrawn according to the retiree's needs.
O. S. 2313, 105th Congress, 2d Session, ond t^tional Commiijion on Retirement Policy, the 2 1st
Century Retirement Secunly Plan," Center for Sh-otegic ond International Studies, Moy 1 9, 1 998.
137
Features of ihe Ball
(Rfstork Long-term Balance) Plan-*
BcN»:iT Cuts
♦ The number of years of earnings used to compute benefits would be increased
from thirty-five to thirty-eight.
REVENUf InCRIASES
♦ Benefits would be taxed in the same fashion as contributory privote pensions.
The maximum eornings subject to the payroll fox would be increased gradually by
about 1 8 percent.
Other Changes
All newly hired state and local workers would be brought into the system.
By 201 5, 40 percent of the trust funds' reserves would be invested in a diversified
portfolio of common stocks.
o. Robert M. Ba!l wif<\ T>iomos N. Beihdl, Straight Talk Afaoirf Socio/ Security: An Anat/iii of rf>e
(ssues <n rfie Current Debate, Century Foundation/Twentieth Century Fund Report {New York; Century
Foundation Press. 199S).
Mr. Smith. Thank you. And without objection, I am going to ask
Mr. Bentsen to ask the first question. He has to leave to make a
speech. So Ken, go ahead.
Mr. Bentsen. Thank you, Mr. Chairman, and thank you all for
your testimony.
Some of my colleagues might say that this committee room is the
land of free lunch, but I am not going to get into more on that
issue, but for both of you, in reading Mr. Entin's testimony is it —
Mr. Entin, your testimony seems to state that without question, in
order to make an equitable transition, even if you go to a fully
privatized system, but to pay the benefits that are accrued to cur-
rent retirees that there has to be some public, some form of general
revenue investment that you rank or you give the pros and cons,
but am I reading that correctly, whether it is asset sales, debt, cut-
ting Federal spending to redivert Federal revenues into the system,
is that right?
Mr. Entin. Yes, and I regard all Federal revenues as revenues
and all Federal outlays as outlays. I do not attach specific cat-
egories or labels to them. You need some money somehow to pay
the current benefits to the current retirees.
Mr. Bentsen. And then the other question is for both of you is
you state, and particularly, Mr Entin, in your testimony at the be-
ginning you talk about that none of the studies, or all of the stud-
ies so far have used static economic assumptions as it relates to the
macroeconomic impacts of going to a privatized system and in fact,
there are both issues of increased national savings that would
occur and economic growth as a result of that as well as labor pro-
ductivity for sociological reasons related to control of your invest-
ments and things like that.
138
With respect to the former, is that only true and I ask this be-
cause I do not know, is that only true at a time when you are run-
ning a general surplus because at some point I think we probably
may go into a deficit and in a deficit period then we are just swap-
ping— we are swapping who is investing in government bonds at
some point. I mean we sell Treasuries to the Social Security Trust
Fund by law. We also sell to plug a hole and in times of deficits
you have to plug a hole. Somebody has to buy them, so if we use
either what were Social Security revenues to buy private securities
or it is done through private investments, is not that just swapping
out for — I mean do not we lose some of that effect if we are running
a deficit in the future?
Mr. Entin. In a sense, all of this is musical chairs as you have
pointed out. When I had new math growing up, the teacher pointed
out that zero was just one number on the number line and minus
numbers and plus numbers were certain distances above and below
each other and it did not matter whether you had a plus sign or
a minus sign in front of them, it was the difference between them
that mattered. If you were running a surplus and you do not spend
the money and you do not cut taxes, you are going to buy debt
back. That is negative borrowing.
If you are running a deficit, it is going to be adding to the debt.
That is positive borrowing. In a sense, if you are running a surplus
and then you decide to spend the money instead of paying down
the debt, you are doing more borrowing than you would have done,
so less debt repayment is equivalent to more borrowing and it does
not matter if you start from a surplus or a deficit situation. You
are doing less debt repayment than you would otherwise do.
Do not worry too much about that one little break even point of
zero. That is not where the effect comes. If I am thinking of buying
back some debt or in a sense not borrowing any more than I would
otherwise do, that is one impact. The alternative to that may be
that I could have cut taxes. You need to ask yourself a question,
whether you are in a small deficit or a small surplus situation: Is
pa3dng down a little debt (or not borrowing a little) more produc-
tive in promoting private saving and investment, or is a tax cut on
investment activity itself going to trigger more of a response and
increase investment more?
If you do the arithmetic in any way, shape or form, accelerated
depreciation, or lower corporate rates, are more likely to trigger a
large increase in the capital stock than just paying down a little
debt which may or may not get borrowed by a business for invest-
ment inside the United States.
Mr. Bentsen. Mr. Reischauer.
Mr. Reischauer. I agree with almost everything Steve said. If
we were to use the budget surpluses to reform Social Security and
we were comparing a world in which we funded individual accounts
with the budget surplus versus a world in which we paid down
debt, there would be no difference in the overall macroeconomic
consequences.
Would either of those two options be better or worse from an eco-
nomic growth standpoint than a tax cut? There certainly are tax
cuts that would probably have a larger impact, but the tax cuts
that the Congress is most likely to enact are not the ones that
139
Steve has been talking about. They are things hke the marriage
penalty reduction which, if anything, would have a negative impact
on economic growth.
Mr. Bentsen. Thank you. Thank you, Mr. Chairman.
Mr. Smith. Let me start with each of your evaluations of the im-
portance of having Social Security plans scored to show they are
going to keep Social Security solvent. I mean my preference is that
we do not stop just at 75 years because I think it is somewhat mis-
leading and some of our witnesses have said in the past that the
76th year in some cases would mean that we go billions of dollars
into debt.
How important is it to start with that the proposals that we have
seen be scored for at least 75 years or more?
Mr. Reischauer. The issue here, I think, is that you want a sys-
tem that is sustainable given our current set of assumptions for the
long term. You do not want a system, a solution that is balanced
over a 75-year period if that means huge surpluses in the first 35
years and huge deficits in the next 40 years. What you would like
is a system that in the 75th year was in balance and looking for-
ward, remained in balance. The plan that Henry Aaron and I pro-
posed in our book is such a plan and I think some of the others
are, but many of them are not.
Mr. Smith. Well, such as the President's. The President is sug-
gesting that somehow we
Mr. Reischauer. But he is not proposing a plan that eliminates
the deficit over the 75-year window.
Mr. Smith. Correct. I mean he says let us reinforce the commit-
ment that the United States is going to pay these benefits in the
future by adding additional bonds to the Social Security Trust
Fund.
Steve, Mr. Entin, your comment.
Mr. Entin. Anything you decide to do ought to be reasonably
funded. It is better to have a funded than an unfunded system,
year by year by year, because deficit finance does eat into saving
and growth.
Mr. Smith. Excuse me, I cut you off. Go ahead.
Mr. Entin. Well, whether you decide to focus Social Security
more on a basic safety net program and let people do their retire-
ment more in their private accounts, or whether you combine them
as we do in the current system and have a big Federal program,
whichever way you go, you should, set it up such that it is afford-
able at a reasonable tax rate year by year by year by year, yes.
Mr. Smith. OK, a question on the trust fund itself. If in the year
2010 the current estimate that you are going to need some money
from someplace else, and there is only three ways to come up with
that money to continue the benefits stream that has been prom-
ised. The three ways as I see them is you do more public borrow-
ing, you cut other government expenditures or you increase taxes.
With or without a trust fund, those are your three alternatives.
How real is the trust fund, Mr. Entin?
Mr. Entin. As soon as the system needs more money than it is
taking in in payroll taxes, the Secretary of the Treasury has to
come up with money from somewhere other than the trust fund be-
cause there is no money in the trust fund and cannot be.
140
When he takes one of those trust fund securities and redeems it,
he is issuing another security into the market or he is raising other
taxes or the Congress is cutting other spending to give him the
money to do it. This is the same outcome as if the trust fund were
not there. It is not a funding source. It is only an accounting de-
vice.
In the Budget Committee you work often with actual outlays and
you also work with budget authority. You have set Social Security
up such that it is allowed to order the Secretary of the Treasury
to pay benefits up to the point where it has got current revenues
coming in under the payroll tax (its dedicated revenue source) and
any previous excess that had been given over to the Treasury in
the past. Social Security is allowed to spend that much. It does not
mean the Treasury has the money. Treasury has to go out and get
the money. But that sum of current tax revenue and past surpluses
in the trust fund is the authority that you have given Social Secu-
rity to go on its merry way without coming back to Congress for
another authorization and appropriation. The trust fund is only
budget authority. There is no real money in budget authority. It is
the leash you have the system on. Do not ever think of it as a
source of funding.
Mr. Smith. The effects of reform plans on economic expansion is
important so that the future pie is big enough to accommodate
those two families, plus the effort to support one retiree. What is
the effect since probably other government spending is not going to
be substantially reduced which leaves the two alternatives of in-
creased public borrowing or increasing taxes. Please give us your
impression of the effect on the general strength and growth of the
economy of those two options.
Mr. Entin. If you raise taxes in a lump sum way that does not
affect behavior very much, fine. If you are going to borrow as op-
posed to raising taxes on investment, well that is fine for the short
run. You would be better off than raising taxes on investment. Of
course, you cannot borrow indefinitely and if the system is going
to hemorrhage and be in deficit for the next 75 years, and beyond
that date, forever, you cannot do the borrowing route, not forever.
So ultimately you have to trim benefits or cut other government
spending if you want to preserve growth.
Mr. Smith. Mr. Reischauer, my understanding is part of your
proposal is supporting the concept of adding additional, if you will
lOUs to the trust fund?
Mr. Reischauer. No. We cut benefits. We raise revenues a little
bit and we increase the rate of return on the trust fund's assets by
diversified investment in a portfolio of bonds and stocks.
In one sense, the trust fund is an accounting device. In another
sense, it is a political device and by that I mean it sends a signal
about where the adjustments that you spoke of will take place
within our society. If the trust fund had in it right now $9 trillion
worth of bonds (we can argue about whether those are real lOUs
or not real lOUs or whatever) and we came to the point where pay-
roll tax receipts and interest pa5rments on these reserves were in-
sufficient to pay benefits, then it strikes me it would be inconceiv-
able to say to beneficiaries we are going to reduce your benefits or
even to pa3n"oll taxpayers, workers that we are going to raise the
141
pa3rroll tax to make the necessary adjustment. The adjustment
would take place in the balance of our budget. It might take the
form of increased borrowing or increased income taxes or reduced
spending on discretionary items or Medicare cuts or something like
that. But it is really a very important political device pointing out
where the adjustments will take place. If we have a system, as we
do now, which is partially funded or more or less pay-as-you-go,
and you come up to this crunch time, it is open for debate whether
we will ask beneficiaries to tighten their belts a little bit or work-
ers to pay a little higher payroll taxes or make the adjustment in
the balance of the budget.
Mr. Smith. Mr. Holt, we will assume that I went first and Mr.
Bentsen went next, and so we will go to Mr. Toomey next.
Mr. Toomey. Thank you, Mr. Chairman. A couple of questions.
In part of your testimony, Mr. Entin, if I understand it correctly,
you address the question of whether savings that arise from a per-
sonal account system would crowd out savings that are already oc-
curring. And I guess my basic question is while there is quite likely
to be a certain amount of substitution effect, even absent the kinds
of tax changes that you refer to such as faster depreciation or ex-
pensing that would, I agree, encourage capital investment and
therefore encourage the likelihood of a greater net increase in sav-
ings, but absent all of that would there not still be a net increase
in savings if we did move to a system where workers had the op-
tion of putting a portion of their payroll tax in personal accounts?
Mr. Entin. Yes, there would, but I was trying to counter the
more extreme view on the other side that all of the saving would
be new saving, that it would all be invested by American busi-
nesses and American capital, and that corporate income tax re-
ceipts would go through the roof and they would help pay for the
system in a short time.
I gave the opposite situation. What if it is all displaced? What
if some of it flows abroad? What if the businesses invest the money
in Canada and they do not pay a higher corporate tax here until
they bring the money home some time in the very distant future?
And I suggest that if you have the domestic investment incentives
and you begin treating other saving as it should be treated, which
is to give pension treatment to it as you would under a sales tax
or the Armey tax or the Nunn-Domenici system, you give yourself
an insurance policy. You are more iikely to have it come back.
Having said that though, we do treat saving and investment
rather badly under the current tax code, and if businesses are rath-
er fully invested in the United States, given the current tax and
regulatory climate, there could be a great deal of slippage across
borders. Either we buy the new issue of stock that is coming out
of some internet company and the foreigners do not, so the capital
inflow does not happen; or saving does rise and some company does
borrow it, but puts its plant in Mexico; or we buy a global mutual
fund if returns here are not all that high. So you do have to watch
out for this stuff. We live in a global economy much more so today
than we did 20 or 30 or 65 years ago. That is why I would urge
you to put the two policies together. You will get a lot more bang
for the buck.
142
Mr. TOOMEY. I agree with that philosophically, but since it is
very, very difficult to do even one, to contemplate doing both is
rather ambitious indeed. A follow up, quick question, if American
corporations choose to take this capital and invest it abroad and as-
suming that they are behaving in a rational fashion, is it not there-
fore still safe to assume that this capital generates the same kind
of return, although it may happen outside of our borders and there-
fore there is that added economic activity and taxable income to
the government?
Mr. Entin. That is very true. There are several things to distin-
guish here. The retiree still owns a share of stock and the retiree
will get a dividend on it and the retiree will have a better life and
there will be some tax on that dividend unless you give it Roth IRA
treatment, which you probably should. So yes, there is that factor.
The added gain, however, from having the plant built in the
United States as opposed to abroad is that, while the worker is
working and before he begins to get his dividend, his own saving
is being put to work to expand the capital stock in the United
States. Consequently, his productivity and wage will be higher
while he is working and he will have a higher level of income while
he is working and so will his children while they are working. Also,
the government will get some revenue feedback from the higher in-
come taxes of the higher-paid workers, and from their higher pay-
roll taxes. It does give you a little bit of the money back to help
pay for the transition.
Mr. TooMEY. Thank you. Last question that I have, some of the
Social Security reform proposals are in some ways really not re-
form so much as proposals to address the funding deficit of the sys-
tem. Is it your opinion that if we were to use the Social Security
surplus and it will take additional surpluses in a reform system
that does solve this funding deficit without fundamentally trans-
forming the system into one of a prefunded personal account, that
that would be better not to pursue that and instead wait for the
opportunity to make the profound reforms or that we ought to do —
solve the funding problem if that is all we can do?
Mr. Entin. Very soon you are going to have no choice but to
solve the funding problem. You have got a deadline. If you just
solve the funding problem, there will be a great tendency (and this
is a psychological problem, not a factual or technical one) on the
part of the Congress to say, "We have done the job, let us not do
any more." In that case, it will have passed up the opportunity to
give people much higher incomes while they are working and much
higher incomes while they are retired by moving from an unfunded
to a funded system that would promote a good deal of economic
growth and capital formation and productivity gains.
Mr. TooMEY. Thank you. Thank you, Mr. Chairman.
Mr. Smith. Mr. Holt.
Mr. Holt. Thank you, Mr. Chairman. You have addressed my
first question which was a little, I wanted a little more elaboration
on the effect on savings and I think you have, you have said a lot
about that.
But let me ask, I guess, a general question that has to do with
political pressures and I would like to ask both of you on this. With
an individual saving program, how can Congress resist the pres-
143
sure that will come from the general populace to seek benefits that
are closer to the highest yield benefits that the more successfiil in-
vestors are getting? In other words, we can easily talk about put-
ting a floor in there, so that no one loses their shirt, but this could
turn out to be a very expensive program if it is a spiral with every-
one trying to receive returns that are comparable to the highest re-
turns that the shrewd investors are receiving. I see that as a fun-
damental political problem that would have to be guarded against.
Do you have any comments on that?
Mr. Reischauer. You are implying that individuals would have
wide latitude to decide what their contributions were invested in
as opposed to many of the plans which suggest that there be a lim-
ited number of index funds, something like the Federal Employees
Retirement System funds or even a situation like the Archer-Shaw
plan which says there will be many fund managers, but all will be
invested 60 percent in stock, and 40 percent in bonds and there
will be indexed funds so that in a world like that, the benefits and
returns would be the same across the various taxpayers.
I agree with I think where you are coming from which is that
if there are wide differences in returns and wide differences in the
pensions that result from a system like this, it will be politically
unsustainable and those who feel they came out on the short end
will exert political pressure to have their situation redressed.
Mr. Entin. I take a different view. The current system has bene-
fits that range from about minus 2 percent to plus 3 percent. There
is a wide spread between the benefits that low-income workers get
and the benefits that high-income workers get. The percentage re-
turns are higher at the bottom, but the difference in dollar benefits
is quite sharp. You have got benefits of around $11,000 for the av-
erage wage worker; $8,000 at the bottom and currently as high as
$14,000 or $15,000 for workers at the top end of the pay scale. A
married couple in the future (75 years out) where they were both
professionals and paying taxes right at the top was covered by the
system would take home in today's money over $60,000 in benefits.
And a single retiree, at the low end of the spectrum would take
home around $20,000. You have got discrepancies in the current
system as well.
If people have their own IRAs and pensions and savings bank ac-
counts, they generally do not find out what their neighbor is get-
ting. Under a reform program, if you did not have the government
mandating restrictive packages where everybody had to put their
money into the same investment option, and people were allowed
more latitude, there would be variation in outcome, but it may be
that people are happier that way.
I have a very good friend who certainly is as intelligent as I am
and whose parents left him as much money as mine did. I put mine
in a mixture of bonds and stocks, but he put his in bonds (and a
couple of utilities) because he swore he would never lose a dime.
My savings have grown more than his and I keep sajdng, "Why do
you keep doing this?" And he says, "Because I am happy this way.
I am never going to lose anything and your portfolio might drop 5
or 10 percent some day." I am happy because I am more com-
fortable with risk than he is. He is happy because he is less com-
fortable with risk than I am.
144
People should have the option to do what makes them happy,
and if they are happy, they are not going to make these complaints.
And if they are not part of the government guaranteed safety net,
if they are living off their own retirement income, and if the safety
net is still there for everybody who needs it (and Bob, I do want
to keep a safety net), then I do not think they will have a com-
plaint. I think if people know they are not investing in America
Online, they are investing in Potomac Electric, and that they are
therefore going to get a different rate of return, and if they make
that choice up front, they will live with the consequences, willingly.
Mr. Holt. Thank you. That is all for the moment.
Mr. Smith. Mr. Ryan.
Mr. Ryan. Hi, Steve. It is good to see you again. Mr. Herger and
I and members of the Budget Committee have worked on what we
call the lock box and I know you may go down that questioning as
well, but let us assume the lock box is in place. I would like you
to comment on lock box legislation.
What will be achieved if the lock box is achieved is the off-budget
surplus, the Social Security surplus for lack of a better term, will
be used to pay down publicly held debt if we do not have a Social
Security plan to which to dedicate those dollars.
Can you comment on the economic policy and the economic ef-
fects of buying down publicly held debt with off-budget surpluses
as opposed to spending that money up here for something else, and
not as opposed to tax cuts because I think you touched on that a
little earlier. Do you believe that buying down publicly held debt
will help us when 2013 comes because those bonds will be re-
deemed on top of a lower level of publicly held debt? Let us put
aside benefit cuts or tax increases. We had a vote of 416 to 1 ear-
lier this year against benefit cuts or tax increases. So the will of
Congress has essentially spoken on this issue in a resolution
against benefit cuts, tax increases which leaves you redeeming
these bonds, and increasing debt absent a comprehensive Social Se-
curity reform plan. Can you comment on that, each of you?
Mr. Reischauer. I strongly favor paying down debt and reserv-
ing, protecting the Social Security surplus for this purpose I think
if you do that you are going to strengthen the economy as well as
reduce interest payments, as well as prepare yourself for the situa-
tion the second decade of the next century in which you are going
to have to find some way of making ends meet within the Social
Security system. So I am strongly in favor of a policy such as you
described.
Mr. Entin. If we could sit down for 15 minutes in your office
with a pad of paper and I could draw pictures, I would be happier
right now, but maybe we can do that later.
Let us think ultimately in terms of the real economy and not just
these financial transactions. We will only start with the financial
transactions. If your only choice is to spend the money on current
government consumption or pay down the debt, meaning there
would be less current government consumption, you have an eco-
nomic benefit because the resources the government would have
consumed, manpower, steel, concrete, computer chips, whatever,
would not be taken by government and would be left for the private
sector to potentially build an apartment building, a factory, an air-
145
plane or machine. By refraining from consumption, you are trans-
ferring real resources to the private sector for private sector expan-
sion, which is better than having the government spend the money.
Yes.
The mere fact that you are paying down debt will not necessary
change interest rates very much in a huge global economy, how-
ever. It will not trigger a huge burst of private sector investment
just because of the change in government finances. It may help pri-
vate sector growth because of the resource transfer, but not be-
cause of the finances.
When it comes time to issue another bond in 30 years to redeem
the trust fund to help pay for the baby boomers, you will be bor-
rowing money at that time. And it won't matter much whether you
have been borrowing a lot or not borrowing a lot, whether the gov-
ernment is big or small as a share of the economy; the incremental
damage by issuing that piece of paper 30 years from now, and tak-
ing a certain amount of resources 30 years from now, will probably
be the same whether you start from a high base or a low base, as-
suming that the resource transfer will be the same magnitude in
either case.
Now if you have managed through debt reduction to keep taxes
lower 30 years from now than otherwise because you are not pay-
ing a lot of interest, so that tax rates can be lower rather than
higher, that is good. But raising the tax rate by that same amount
to redeem that trust fund bond in the future will still do some
damage. It will do a little less damage if the rate were low to start
with.
Mr. Ryan. So you are saying crowding out does not occur?
Mr. Entin. Do not think of it in terms of financial crowding out.
Think of it in terms of resource crowding out and ask yourself do
you want to raise taxes in either case?
Bringing down debt today simply to reissue it later is not going
to undo the damage later.
Mr. Ryan. One quick question for each of you. There is legisla-
tion in both the House and the Senate — Domenici has it in the Sen-
ate and some of us have it in the House. It would take apart the
debt ceiling — you have the private debt and then you have the pub-
lic debt — and rachet down the public debt ceiling. It is sort of a
staircase where we ratchet down the public debt ceiling by the
amount of the Social Security off-budget surplus.
What is your thought on that legislation specifically? Do you
think that cash management issues arise with the Treasury De-
partment? Or do you think that that is an appropriate way given
the fact that it is tough to keep that money from being spent up
here? Is that a good way to capture those savings and apply it to
public debt?
Mr. Entin. My former colleagues at the Treasury would scream
if they had any ceiling put on them. They always do.
If it keeps you from doing the spending in the first place, you are
never going to hit the ceiling anyway. So if it will stop you from
spending, fine. But basically, you have to decide to stop spending.
You have got to behave yourselves, one way or another. However
you go about making yourselves do it, that is fine.
146
Mr. Ryan. Well, you do not see any ill economic effects from
changing the debt ceiling in that kind of way.
Mr. Entin. No.
Mr. Reischauer. The proposal that Senator Domenici put for-
ward, I think, is seriously flawed in the same way that the
Gramm-Rudman-Hollings procedure was seriously flawed in that it
ratchets down the debt ceiling without regard to the state of the
economy and other factors that can affect spending and revenue in
the country.
I am not completely familiar with your proposal, but the version
that I had seen earlier did not suffer from that
Mr. Ryan. There is a new version that takes into account a reces-
sion, and the bill would change the date of debt buydowns to May
1 to help take care of the bad cash flow months. So the new version
of the bill tries to take those criticisms into account.
Mr. Reischauer. There are lots of uncontrolled forces that, un-
controllable forces that affect the spending and revenue of this
country as anyone who has lived through the last three Aprils
should know on the revenue side or anybody who has taken a
glance at the Medicare figures over the last 2 or 3 years. There is
not an analyst alive that 3 years ago would have told you that
Medicare spending for the first 6 months of 1999 would be 2.5 per-
cent below the level for the first 6 months of 1998. These things
are inexplicable and you do not want to write into law procedures
and rules that do not reflect the uncontrollable nature of our gov-
ernment activities.
Mr. Ryan. Well, let me ask you
Mr. Smith. The gentleman's time has expired. Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman. I do want to follow up
on this question and it may be a little bit different aspect of it. I
think Mr. Entin you made a comment that concerns so many of us
and that is that we, the Congress, have to behave ourselves. I
think that is what concerns the American public, the American
voter. I mean everybody. And of course, the age long temptation is
that it is — it would appear to be much easier, I am oversimplify-
ing— easier to be re-elected if we are spending than if we are say-
ing no, tightening our belts. At least that is undoubtedly over-
simplification that I see it in.
Coming back to some of the legislation that we have, specifically,
some legislation that I have concerning the lock box and the goal
behind the lock box to somehow make it more difficult for the Con-
gress, not impossible, but more difficult for the Congress to spend
this money, money that is, or dollars or somehow allocated, dollars
that will be needed for retirement, particularly after the year 2013,
my question goes into the unified budgeting, something we have
been doing since 1969, something that was done, evidently, to help
make the war in Vietnam appear not a deficit, not to be as large
as it really was and one aspect of the legislation that I have would
at least have us where we are not counting it an3rmore. It is still
there, but at least not on one line after the other and the purpose
of this is to make it more difficult for those of us here in the Con-
gress to spend money which really is not ours to spend or at least
that is the way many of us look at it.
147
I was just wondering if you would comment, your support or op-
position of this, whether this is something that is something that
we should be pursuing to try to return this to as it was prior to
1969 or not.
Mr. Entin, first.
Mr. Entin. As I mentioned earlier, I really think of all govern-
ment revenues as revenues and all government outlays as outlays
because that is the economic effect.
When Mr. Ryan asked the question, he said, if we are going to
spend it or pay down debt, as between the two, what would I say?
If you really wanted to return this money to the people and not
have it for government to spend, and if it were from the payroll
tax, one thing you could do is to temporarily cut the payroll tax.
That would give some additional work incentives and help the
economy grow a little bit in the interim. I think that would be as
good as paying down the debt.
Or, you could give a temporary tax cut to capital. I would rather
see you give a permanent one, but if you are going to open things
up, that would be the way to go.
You have pointed out that there is a problem with labeling and
with the way people perceive things. You are right, they do per-
ceive things that way. They look at that number, and if we gave
them a different number to look at, they would see something dif-
ferent. The best thing, however, is to give them a thorough edu-
cation in what all the numbers mean and to point out that in a
sense, it is rather a semantic game, and that they should not think
of things that way. That is a lot more work than trying to address
this symptom (and that proposal would address the symptom) but
ultimately, I think it might pay off.
If you carefully explain to people and to the members that we
really have to do something about saving and investment, and not
play the game of envy of rich versus poor, it would be good for ev-
erybody. The workers would be more productive and have higher
wages. And it is really the only way to address this problem with-
out cutting into people's living standards at some point or another.
This is more important for them than the current transit subsidy
or the Big Dig in Boston or the highway demonstration projects in
West Virginia or the shale oil subsidy in wherever it is.
If you were to ask the voters, "Would you be willing to give up
some of this Federal spending in order to double or triple your re-
tirement income, and be able to do it by setting aside only 5 per-
cent of your income instead of the current 10 plus percent payroll
tax?" People might very well say, "Gee, I am going to look into
that. Oh yes, I see. You can cut the Federal spending. I am going
to stop demanding it because I would be much better off if you did
the other thing."
Mr. Herger. Well, I would like to pursue that if I could, just
with that line of thinking. This is a concern I have is that in the
eyes of the American taxpayer, they see this money and I want to
now expand this, not just to the trust fund of Social Security, but
the trust fund of the airport trust fund, the trust fund of the road
trust fund which we have not been talking about and probably 112
other trust funds. Is that the American taxpayer thinks in terms
of this is money that they are setting aside to be spent just in this
148
area, but yet we know that is not what has happened. This money
has been co-mixed and even though what you are saying is true
and it would be nice if we could take the time to be able to try to
explain this to each and every American and each and every Mem-
ber of Congress who probably semi already understands it, but the
fact is that is not what is happening and I would almost debate
from a political standpoint what you are saying would be nice, but
next to impossible to do and be successful at.
I am concerned that we need to begin separating what the people
have dedicated this money for and either changing what we are
doing and calling it something else which would be fine if by policy
we decide to do that, but otherwise begin spending this money
whether it be in Social Security to allow the taxpayer to invest it
in a fund, in a form which you would probably term a tax reduc-
tion, but yet it is utilizing those same dollars. Whatever it is, I
think we need to be honest and I believe what we are doing now
is nothing short of being dishonest, in essence.
An3rway, I wish we had more time to pursue that, but thank you.
Mr. Smith. We will start a second round at this time. Let me ask
the question regarding some of the other proposals. One of the
other proposals suggests adjusting the CPI. Is that a good way to
enact reform? Starting with you. Dr. Reischauer and then you, Mr.
Entin.
Mr. Reischauer. I think it is an inappropriate way to reduce
benefits if you decide that reducing benefits is important to — the
solution to Social Security's problem.
If you reduce the CPI through some rule like indexing the bene-
fits to CPI minus half a percentage point, then what you are basi-
cally doing is saying that the burden of these cuts will fall most
heavily on the old, old and we know quite well that as people age,
their incomes fall because their pension benefits fall and their re-
tirement savings are depleted as they get older. I think it is not
an equitable or a sensible thing to do.
Mr. Smith. Mr. Entin.
Mr. Entin. Well, you have touched on a real pet peeve of mine,
if I may say so, sir. I am not a big government fan, but over the
years I have spent at the Treasury and as an economist I have de-
veloped a lot of respect for the technicians in the various depart-
ments when it comes to number gathering. I think to second guess
the Bureau of Labor Statistics on the CPI would be a major mis-
take.
To actually force them to reduce their CPI number beyond what
they think is appropriate, or to take the number and then fudge
it by half a percent, would hit the retirees and it would hit the
workers. Of course, it would hit the retirees twice and the workers
once in the following sense. You would be trimming Social Security
benefit growth over a worker's retirement, but as each worker dies
that effect goes away. Each new worker comes in under the un-
changed initial benefit formula with a new initial payment, and he
starts from scratch, and then you start whittling his subsequent
COLAs down again. You have got a sort of limited saw tooth saving
on the retirees. But on the workers and on the retirees' other in-
come, subject to the income tax, you would be watering down in-
come tax indexing. The tax brackets, in real terms, would narrow
149
a little more every year. The effect would go on and on and on and
get worse and worse. More and more people, retirees and workers,
would be pushed up through the tax brackets. They would have
less incentive to work, and less incentive to save. Labor costs would
go up. It would be slow, not as fast as with bracket creep before
the 1981 tax cut where we instituted indexing. Not as bad as in
the late 1970's when we had double digit inflation. But you would
still have bracket creep. It is bad for the economy and it is a hid-
den tax hike and it never stops. So it is a very bad thing to do.
Mr. Smith. Let me query your impression of the effect on the
economy by going outside the traditional FICA tax or payroll tax
to solve the problem of Social Security.
Mr. Reischauer. I think you can make a case for why general
revenue transfer to the Social Security trust fund is appropriate
and that case would be based on the fact that during the first sev-
eral decades of the Social Security system that system was asked
to perform a welfare function. We boosted benefits very signifi-
cantly over what the original law called for in an effort to raise in-
comes of the elderly and by doing so we reduced old age assistance
pajnnents.
However, that aside, I am not a big fan of using general revenues
to strengthen the system. I think the system through some judi-
cious and rather small benefit reductions and some expansion of
the tax base by bringing in new employees of state and local gov-
ernments and an investment policy that collectively invested a por-
tion of the trust fund reserves in a diversified portfolio is sufficient
to bring the system into long-run balance.
Mr. Smith. Mr. Entin.
Mr. Entin. I would have no objection to general revenue infu-
sions if they were being used in a transition to a system where the
Federal role in the retirement side of Social Security were substan-
tially reduced, if it were temporary and leading to a great shrink-
age of that role.
The welfare aspects of Social Security ought not to be handled
by a payroll tax. They ought to be handled by the income tax be-
cause welfare is a transfer from those who can pay to those who
cannot, and the income tax more generally follows that ability to
pay than the payroll tax.
Again, you have a system that is combining a welfare system —
a safety net floor — with a retirement system. They did not need to
be merged. I am trying to urge you to get people to do more and
more of their retirement saving in personal accounts, and shrink
the retirement portion of the government system. Keep a safety
net, perhaps by helping people put money into their retirement ac-
counts out of general revenue, if they cannot contribute enough
while they are working. Alternatively, when they get ready to re-
tire, if their accounts are not quite big enough, add something to
it. But do not merge the welfare and retirement systems the way
they are now.
Use general revenues to transit out of the current system. Do not
use general revenues to support an unfunded system that simply
drags on without promoting real saving, does not move us to real
saving, does not move us to real investment and does nothing to
expand the economy.
150
Mr. Smith. Mr. Ryan.
Mr. Ryan. Dr. Reischauer, I would like to go back to where we
were with the debt ceiling language that we have been talking
about. You mentioned in your first answer that you thought bu3ring
down public debt was a good idea but you seemed to have concerns
about the way we do that.
Could you address those concerns? Ratcheting down publicly held
debt to capture off-budget surpluses to dedicate them toward pay-
ing down publicly held debt is basically encapsulated in this legis-
lation about which we are talking.
It seems to be an artificial way of making sure it gets done, but
what are your concerns with how that is done, provided these cash
management problems are addressed in the legislation? Do you
think they can be addressed? I would love to see your reaction to
the legislation after its latest changes and if you do not think that
is the right way of going about it, how else would you propose to
doit?
Mr. Reischauer. Well, I will be glad to look at the revised ver-
sion of your bill, but I would be more comfortable if the Congress,
in its budget process, began to focus on the non-Social Security por-
tion of the budget and said that we are not going to run deficits
in that portion of the budget, not ever.
Obviously, there are going to be wars. There are going to be re-
cessions, when this is unavoidable. But we are not going to con-
sider tax cuts or spending increases to the extent that they might
tip that balance into the negative. I am not sure debt ceiling legis-
lation does much except create periodic crises in the Congress than
can be used or misused, for other legislation. I have watched debt
ceiling bills through the last 20 years and they are not pretty
things to watch.
Mr. Ryan. Well, your comments on the on-and-off-budget sur-
pluses I thought were interesting. With the budget resolution, we
make a pretty strong difference between on-and-off-budget sur-
pluses and with the on-budget surpluses as you well know, we
dedicate that toward tax reduction. I would like each of you to com-
ment on the economic benefits toward dedicating on-budget sur-
pluses toward tax reduction.
Specifically, we want to make sure that these surpluses do mate-
rialize so we can take care of these issues. If we do not have these
surpluses, we are really stuck. So if you could comment on that.
Mr. Reischauer. Well, I am concerned about what you did in the
budget resolution for two reasons. One is these surpluses are high-
ly uncertain and we all know that. And the surpluses are based on
a set of totally unrealistic assumptions.
Mr. Ryan. Too conservative or too liberal?
Mr. Reischauer. Too conservative. And I am making this rather
rude statement based on your behavior, not on what you have been
saying. I see no way in which you are going to stay within the dis-
cretionary spending caps this year. I see no way you are going to
stay within those caps over the next 3 years. To make a commit-
ment on the tax side which would tend to be irrevocable, I think,
is quite frankly irresponsible, given that situation when the Chair-
man of your Appropriations Committee is sajdng there is no way
we can live within these caps.
151
The Chairman of the Senate Appropriations Committee is saying
there is no way we can Uve within the caps. And everybody is sit-
ting around waiting for somebody to cry uncle on the caps.
Mr. Ryan. But you would agree that higher economic growth will
assure that these surpluses materialize?
Mr. Reischauer. If we have higher economic growth, the sur-
pluses will materialize, but I am not sure why we should assume
there will be higher economic growth.
Mr. Ryan. From tax cuts. Obviously, you mentioned not all tax
cuts are created equally, but some tax cuts, you would agree, do
promote economic growth and I would like Mr. Entin to comment
on this.
Mr. Reischauer. But what we are talking about here is the dif-
ference in the impact on economic growth between paying down the
debt which is imbedded in the baseline assumptions and the tax
cut and I would be very surprised if on balance the tax cut that
made its way through the Congress had a greater impact on eco-
nomic growth than pajdng down the debt. It will not be a tax cut
that is designed by
Mr. Ryan. Fair enough. If you could comment on this, Steve.
Mr. Entin. I am glad to see that Bob thinks that if I were put
in charge of designing the tax cut I could do some good. I agree
with him.
Mr. Ryan. Do not be so modest.
Mr. Entin. I take more liberties as I get older. Now that I am
older than some of the Members. It did not used to be that way.
Mr. Ryan. I get that every day.
Mr. Entin. The way to cut through all of this, really, is to have
the Congress go away somewhere out of the limelight, get a real
education in what the numbers mean and how the economy works,
agree to put politics aside and do what is technically the best that
we can figure out, as economists with reasonably modern training,
that you ought to do. Then go back and, as a united group, tell the
public, "We did this for your good, and here is why it is for your
good, and we think you will agree with us if you look at it care-
fully."
In reality, what you are faced with, however, is the very open po-
litical huriy burly that goes on, where the technical stuff is not
really considered, and it is people maneuvering for advantage. That
is very distressing for technicians such as us to deal with, but I
guess we have to.
I am not terribly afraid of a Gramm-Rudman t5^e ceiling be-
cause I remember from the Reagan years that when the economy
slowed down, the ceiling was adjusted. You have a projected sur-
plus. I suppose every year when the CBO reestimates the surplus,
it will automatically, perhaps, readjust the amount that you are
locking up. If there were an emergency, I am sure Congress would
pass an adjustment.
Mr. Ryan. And that is in the bill
Mr. Entin. The restrictions just make it a little harder to do, so
that does not bother me particularly. What bothers me is your need
to do it. I S3n3ipathize with your need to do it. I understand where
you are coming from. I just wish you did not have to.
152
Mr. Smith. If the gentleman will yield with your time up any-
way. Let me just follow up a little bit on the question of separating
the debt limit for the on-budget and off-budget debts. I have heard
some of your comments relate to the suggestion that the trust fund
debts are not that real. Is there any legitimacy to that?
I am concerned that separating the on-budget and off-budget
debt limits in some way reduces the realness of the debt owed to
the trust funds and I am just nervous that there is a danger that
politicians are going to act on the Social Security trust fund as they
did on the transportation trust fund; that is simply wipe it out and
say well, we do not owe it any more.
We have come to a compromise settlement and I see some danger
there, that it is going to promote additional borrowing from the off-
budget trust funds without the intent of repayment. Can I get your
reactions?
Mr. Reischauer. I really have not thought that through. That is
the first time I have heard that concern being raised, that if debt
owed to the trust fund is not part of debt subject to limit, it will
carry, in a sense, less weight in the political system. I do not think
so. I think that the figures in the trust fund balances and the size
of the population, 65 and over, or 62 and over, insure that that
debt has very real political meaning.
Mr. Smith. I mean if we have debt limit for public debt, is there
a danger that we simply increase some of the taxes coming in to
the highway, to the airport trust fund or any of the 136 other trust
funds, including Social Security because we do not have that kind
of pressure?
Mr. Entin, your reaction?
Mr. Entin. I hope I am not misunderstanding the question,
Mr. Ryan. Will the gentleman yield?
Mr. Smith. Yes, Paul.
Mr. Ryan. Is your concern that if we splice the debt ceiling in
half, we have a private debt ceiling and a public debt ceiling and
we are racheting down the public debt ceiling, but leaving the pri-
vate debt ceiling. I think we understand private and public debt as
it is commonly known.
Private debt owned within government — Social Security trust
fund and trust fund debt — and public debt are, for example, public
bond holders debt. That is how the politicians call the difference in
these debts.
Are you concerned that if we separate the ceilings and we ratchet
down the public debt ceiling, that we will have a new financial debt
tool that will disregard or pile debt over on the private side? Is that
your concern?
Mr. Smith. Well, no, that if we have got an absolute mandate to
lower the debt to the public, so the ramifications of increasing the
airline ticket tax to bring in more surplus from that trust fund to
spend on other government programs, in other words more trust
fund debt but no increase in public debt.
Mr. Ryan. Right.
Mr. Smith. So to a certain extent you are suggesting that the
debt owed to the trust funds is less important than the debt
Mr. Ryan. And you think that might change the behavior of fu-
ture Congresses
153
Mr. Smith. Well, it could.
Mr. Ryan. And Executive Branches?
Mr. Smith. Yes.
Mr. Ryan. And grow private debt to take care of the problems
we have with public debt going down?
Mr. Smith. To grow the debt to other trust funds could be a dan-
ger.
Mr. Ryan. Yes.
Mr. Smith. Mr. Entin.
Mr. Entin. I suppose if money were tight, then yes, you would
raise the money flowing into a trust fund, say the gasoline tax, for
example, and then spend it on something else. It would not be that
you are defaulting on the trust fund debt in the gasoline trust
fund. You just would not be using the money as it flowed in for the
specified purpose. That debt would still be there and you might
choose to leave it on the books forever. It would be a mockery, but
you could leave it on the books forever.
It is for that reason that I would prefer not to see any trust
funds. I think the highway lobby should go to the Appropriations
Committee and the Transportation Committee every year and duke
it out with the airport lobby and the other lobbies and the other
committees for general revenues. I do not think there should be
dedicated trust funds. Then you cannot get away with this and
they cannot get away with it.
Mr. Smith. Did you suggest that earlier to Mr. Shuster?
Mr. Entin. He did not ask, sir. If he had, I would have said that.
Mr. Smith. Mr. Herger.
Mr. Herger. Well, just a comment on that. My concern is and
just my feeling is and I really feel this is the — I think I am reflect-
ing at least the opinions of those I represent in rural Northern
California and with complete respect to you, Mr. Entin, that is not
the way, at least the taxpayers I represent want to see it. I am
very much aware that that is the way it is taking place. I mean
what you are describing is basically what is happening today. And
what has been happening since the creation of these trust funds.
But the taxpayer does not see it that way, at least the over-
whelming majority that I represent and I would go so far as to say
that those nationally, that when they go and buy a gallon of gas
and there is so much of that tax that they are told is going to a
gasoline tax and they are riding these rural roads that have pot-
holes in it, by golly, they want every penny of that to be going to
repair those potholes.
And the individuals that are paying taxes on an airline ticket
want to see those airports improved. And this concept which is ac-
tually taking place that you mentioned that they should duke it out
is exactly what I would contend the American public does not want
to have happening, but yet is what is happening and we need to
somehow get off this fix that we have been on, dedicate these,
whatever we call it, maybe we need to come up with a new name.
Obviously, trust fund has not worked.
So maybe we need to call it something else and begin having it
work as it was originally intended and as most Americans think it
is doing now.
Your comment?
154
Mr. Entin. You are taking a tax which you are viewing and your
constituents may be viewing as a user fee and then you are not
using it for the use for which they are paying the fee.
Mr. Herger. Precisely.
Mr. Entin. If these, in fact, were user fees closely tied to the out-
lays and the purpose specified, and it could be made to work that
way, I would see the complaint more clearly.
But you have a more fundamental problem. The gasoline taxes
that your people are paying in your district may go to put more
roads together halfway across the country. The spending is not
local. They do not have control over the user fees they are paying.
It is not going to the highways they want fixed. Or it may go back
to your district if you are very skillful here in Congress in making
certain that it is for your district. But some other Members may
not be as skillful for their districts.
The basic rule is, if the Federal Government could actually
charge a meaningful user fee for a particular service, it could be
privatized because the private sector could charge the user fee and
provide the service too. The government is supposed to get involved
when there are externalities or public goods, and you cannot use
the market because of market failure. So if you could be doing it
the way you hope it would work, you would not really have the re-
sponsibility for doing it at the government level in the first place.
Some other nations — Canada is in the act and I think Britain
has already completed it — some other nations are privatizing their
airports. No private airport would put up with the obsolete and un-
reliable computer systems that the FAA is sticking us with. People
would get better service at the airport, better service from the air
traffic control system, if private enterprise were doing it and charg-
ing the airlines that were landing at that airport for better service.
We have an airport trust fund which half the time is not being
used for the purpose it was intended, and when it is being used for
the purpose it was intended, some Washington bureaucracy picks
which airport is going to get which service this year, and some air-
ports are getting absolutely nothing for years and years and years,
and they have plane crashes.
If those airports wanted to get going faster, and they were will-
ing to pay more for it, and they were private, they could do it. But
if it is public, they cannot.
I would say you have a bigger problem with these trust funds
than the mere fact that we are abusing the heck out of them. They
really should not be there in the first place because the government
should not be doing these activities in the first place.
And if government is going to intervene, it should be transferring
the money to the local authorities, and the local authorities should
be able to add their gasoline tax, their California gasoline tax, and
their county gasoline tax if there is such a thing, to repair the
county roads.
Mr. Reischauer. Let me jump in here and say your constituents
should be quite happy to pay that gasoline tax, even if it leads to
improved roads in Michigan.
Mr. Herger. And I agree with that. We drive all over
Mr. Reischauer. You drive all over.
Mr. Herger. Exactly.
155
Mr. Reischauer. People drive from Michigan to visit Northern
CaUfornia. Goods that you purchase come from Michigan. It is one
large system.
The best studies of the highway trust fund show that, looked at
over the last decade or so, there is no squirreling away of re-
sources, that the obligations that have been made, will for all prac-
tical purposes absorb the resources that have been paid into that
system.
And for many of the other trust funds that you are taking to task
here it is worth remembering that a large portion of the costs of
our air traffic control system and our airways system are being
borne by general revenues. And this is not a situation in which the
air traveler, in a sense, is being immensely short changed.
I am interested in Steve's complaints about the U.S. airports.
And I am not great fan of them, but having traveled abroad, I am
not great fans of a lot of the airports abroad either. Anybody who
sat in Paris for four or 5 days waiting for their air traffic control-
lers to get off of a strike or something like that
Mr. Smith. I think we will sort of bring this out of the air and
back down to the earth of Social Security and Mr. Ryan has a ques-
tion on USA accounts.
Mr. Ryan. Earlier in your testimony, Steve, you talked about
possible crowding out that might occur from a private Social Secu-
rity system or a pseudo-private Social Security system crowding
out other investment and I think you might have touched on that
a little bit. Dr. Reischauer.
Looking at the President's USA account proposal, the early in-
ception of the proposal seemed to have glaring problems whereas
it would have crowded out private savings portfolios. They say that
they have addressed those concerns with new provisions in their
proposal. I am not so sure that is the case.
Could you comment on the President's USA account proposal
with respect to whether it will displace current private savings
portfolios and pensions, 401(k)s? Will this send a signal to busi-
nesses that well, we have this USA account proposal so I do not
have to offer this to my employees.
Do you think it is going to go down that type of a road? Could
you comment on that?
Mr. Entin. It is like trying to shoot down a cloud. It has got a
lot of problems and you really do not know where to aim.
First of all, it is taking money that could be used to cut taxes
on IRAs and 401(k)s to make them go up. I would not even object
to having the government give some money to individuals who are
too poor to put much aside in the 401(k) plan to help them put
some money into one. The plan, however, has a peculiar tax treat-
ment. There are alternative uses of the money that could do just
as much good without the peculiar structure.
The next problem is, you get the money if you earn as much as
$5,000 a year, and you continue to receive it as you earn more in-
come, but then when you go above a ceiling amount of income, you
start losing the government subsidy. That has the effect of boosting
your marginal tax rate by a percent and a half, so in effect, it is
an implicit increase in tax rates which discourages other saving.
Maybe not horrendously, but it is still a bad thing to keep adding
'56-004 00 . fi
156
new phase-outs to the tax law. At IRET we did a paper a couple
of years ago, written by Mike Schuyler, pointing out 26 phase-outs.
We have added to them since. They all have implicit, hidden mar-
ginal tax rate effects. The Joint Tax Committee did a paper about
the same time. We keep adding to these things.
The USA plan is a most peculiar way to deal with saving. Why
does not the government simply treat saving fairly, as in a con-
sumption based income tax, and then let people do what they want
to do. If people are poor, we can give them some help doing it. But
there is no need to have all of these peculiar rules and regulations
and tax hikes involved.
Mr. Ryan. In a nutshell, do you think that USA account proposal
will have an adverse impact on private savings?
Mr. Entin. I do not see how it is going to improve total national
saving. Exactly what it does to the private saving versus the gov-
ernment budget surplus and where the fall out comes, I will not
guess, given the complexity of the program, but I not think it is
going to help total national saving.
Mr. Reischauer. I would come down that it would have a slight
impact in a positive direction on national saving. Obviously, the
distribution of the resources versus paying down debt with them is
a wash, except to the extent that the distribution to the savings ac-
counts might lead to some slight reduction in other private saving,
but at the same time, the matching component of this should en-
courage slightly some saving by individuals. The fact that the Ad-
ministration has allowed 401(k) contributions to be used as the in-
dividual's match, I think, protects it from the first concern that you
raised in your question.
Mr. Smith. I am going to ask either of you if you have a closing
statement. Maybe you might react to the concern that many of us
have right now that there looks like the chances of passing Social
Security reform that is going to keep the system solvent are not
good at this time because of the perception of political consequences
of coming out with a proposal that increases taxes or cuts benefits
or changes the way that investments are made to some of the
money coming in.
What are your suggestions? I mean I am going to move ahead
with it. I am going to yell and scream and hopefully the Members
of this Task Force will also. Congress tends to be shifting its con-
sideration to partial fixes such as additional bonds into the trust
fund, such as proposals of putting in a lock box that might help us
some in future years when we start borrowing back the money.
Do either of you have any suggestions of how we might take ac-
tion to keep the momentum going in terms of increasing our
chances to pass legislation that will keep Social Security solvent?
Mr. Reischauer. I do not have any particular suggestions. I
think this kind of issue does not move forward without strong and
consistent presidential leadership and a willingness on the part of
the President to take significant risk, political risk. And given the
other issues that are on the agenda right now, and the lateness of
the date, I do not see that happening.
Mr. Entin. If you can do it right, go ahead. If you cannot do it
right, stall. There is an educational problem, although I think the
public may be ahead of the politicians (not ahead of the pollsters,
157
they are capturing the pubHc's feeUngs). I think the pubhc may be
ahead of the Washington estabHshment.
People want private accounts. They trust them more than a sys-
tem they know is underfunded and may not be there for them.
They may not reahze just how much additional economic growth
and income they could get even while working if they had private
saving accounts. If anything, that information would strengthen
the public's resolve to move toward private accounts.
The public may be well ahead of the Congress. I think, sir, your
proposal and the reaction you have gotten in your district is more
realistic as to what is happening out there than some of what we
hear around the city about how it still may be the "third rail" and
so forth. You know better. Your people know better.
You have a plan that gradually moves those people away from
reliance on Social Security and more toward reliance on the per-
sonal accounts that are going to be set up. There is a scaling down
of Washington's involvement embedded in your plan.
The public is ready for that. If you can explain the benefits, I
think the public will not only let you proceed, but will urge you to
proceed, so go to the grass roots.
When John Kennedy campaigned, it was on the basis of getting
the country moving forward again. He explained how his tax reduc-
tion plan would do it. He had an investment tax credit, and he had
marginal rate cuts, and the recession in the late Eisenhower ad-
ministration kept Richard Nixon out of the White House for a
while. Reagan came in with the same notion. He wanted the tax
cuts to get the economy moving forward.
If you present the right kind of Social Security reform as a way
of getting the country moving forward, of increasing people's wel-
fare over their lifetimes, of expanding their incomes, I think you
will find that the public will be dragging the Congress along and
saying, "Move now! We are willing to do it." Until you have got the
public dragging the Congress, you may find people coming up with
inferior plans such as we have now in some cases.
The President's plan is basically to open up the general revenue
floodgates, not to help us transit to a smaller system that is more
private, but to open up the general revenue floodgates so that we
never have to fix the system. That is where he seems to be going,
and I think there is a little bit of that even in the Archer-Shaw
proposal.
So if that is the best you can do, stall. If you can get the public
dragging you in the right direction, you will have solved your mo-
mentum problem and you will have solved your quality problem at
the same time.
Mr. Smith. Thank you both very much. For the record, the Steve
Goss and the actuaries are doing their last stages of scoring our
plan and hopefully that will be introduced in the next couple of
weeks.
Gentlemen, again, thank you very much and I appreciate your
time that you sacrificed today.
The Task Force is adjourned.
[Whereupon, at 1:49 p.m., the Task Force was adjourned.]
International Social Security Reform
TUESDAY, MAY 25, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12 noon in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Chairman Smith. The Budget Committee Task Force on Social
Security will come to order. For the purpose of today we have select
witnesses talking about what is happening in some of the other
countries around the world. The United States was the last of the
developed countries to adopt a compulsory Social Security insur-
ance program aimed at eliminating poverty among the elderly. Ger-
many introduced its first plan in 1889, and now is still having a
tremendous imposition of taxes on its citizens to fund its retire-
ment program.
When Congress passed ours, the Social Security Act of 1935, the
legislators looked to the examples provided by other countries to
design our system. As we consider Social Security reform, we again
have the opportunity to learn from experiences abroad. The demo-
graphic changes beyond the unfunded liability of our own system
are a global phenomenon. Most European countries face even more
alarming dependency ratios than we have in the U.S. and already
have a higher payroll taoa than we do.
In Eastern Europe, the average payroll tax is 40 percent. In
Western Europe, the average payroll tax is above 20 percent, and
some countries impose a tax as high as 70 percent.
All over the world, policymakers are considering and implement-
ing reforms that bring stability to their Social Security systems.
Chile inaugurated privatization with reforms adopted back in 1981.
Australia implemented its own reform plan in 1987. Great Britain
passed reforms in the 1980's, that moved that country to a partially
privatized system. We can draw from the wisdom our global part-
ners have gained through up to 20 years real time experience with
reform, taking the best of their ideas and certainly learning from
some of their mistakes.
Once we have learned from these examples, we can design a re-
form plan that will become a model for more of the other countries
of the world, and being able to implement this program in this
country is extremely important and time is definitely not on our
side. The longer we put off reforms, the more drastic those reforms
are going to have to be.
(159)
160
Representative Clayton, do you have a statement?
Mrs. Clayton. I don't. Again, we thank you for structuring these
hearings and look forward to the witnesses' testimony.
Chairman Smith. The other members', including our ranking
member Ms. Rivers, statements will be entered into the record if
they have one.
Our witnesses today are Dan Crippen, who has served as Con-
gressional Budget Office Director since February 1999, has held
senior policy positions in the White House and the U.S. Senate. He
was chief counsel and economic policy advisor to the Senate major-
ity leader from 1981 to 1985. In addition to his 10-year government
career as an economic policy specialist, he has substantial private
sector experience.
Estelle James, Estelle, welcome, is Lead Economist in the Policy
Research Department at the World Bank and principal author of
Averaging the Old Age Crisis: Policies to Protect the Old and Pro-
mote Growth.
Mr. Lawrence Thompson is a Senior Fellow at the Urban Insti-
tute, has spent his career dealing with education, income security
and health issues. He served as Principal Deputy Commissioner for
the Social Security Administration from 1993 to 1995 and as As-
sistant Comptroller General at the GAO from 1989 through 1993.
Mr. David Harris is Research Associate at Watson Wyatt World-
wide and advises and examines major international Social Security
systems in Europe, Asia/Pacific, North and South America, cer-
tainly Australia. David was awarded the 1996 AMP Churchill Fel-
lowship to research what influences public confidence in life insur-
ance and superannuation in various international markets. He has
worked as a consumer protection and superannuation regulator in
the United Kingdom and Australia during the 1990's.
We thank you all for taking the time to come to this hearing and
share your ideas, thoughts and recommendations with this Task
Force.
Mr. Crippen, what we will do is any written testimony you have
will be totally included in the record and we would ask you to limit
your introductory comments to approximately 5 minutes so that we
have maybe a little more time for questions. Mr. Crippen.
STATEMENT OF DAN CRIPPEN, DIRECTOR, CONGRESSIONAL
BUDGET OFFICE
Mr. Crippen. Thank you, Mr. Chairman. Actually, I hope to be
able to beat your mark and offer about 3 minutes' worth of com-
ments and look forward to the questions.
The report that brings us here today is the Congressional Budget
Office's (CBO's) report on the experiences of five countries with
privatizing their social security systems. That report is the basis
for the remarks I am about to make. It was written principally by
Jan Walliser, an economist who is now at the International Mone-
tary Fund (IMF), and was released by CBO in January, just before
I arrived.
The aging of the population, as you stated in your opening re-
marks, Mr. Chairman, is not unique to the United States. Most de-
veloping countries are experiencing growing retirement populations
that we supported by fewer workers. Those facts mean, in part,
161
that traditional pay-as-you-go pension and health care programs
for retirees will be strained. Other countries have, and the United
States is considering, reforms to those programs to help ensure fu-
ture benefits and ease the burden on future workers.
Judging the desirability of reform — indeed judging the results of
other countries' reforms — depends on at least two related ques-
tions: Can the reform help economic growth? And can the reform
reasonably be expected to work? The first question I would submit,
Mr. Chairman, is critical. It is ultimately the size of the economy
that determines our ability to support a growing elderly population
with fewer workers. Increasing national savings should enhance
productivity and thereby economic growth. Increased savings can
result from funding a previously unfunded pension system.
The second criterion is meant to include considerations of practi-
cality, ease and cost of administration, protection against severe
losses, and the extent of regulation.
Our comparisons of the five countries, Mr. Chairman, suggest the
following observations. First, none of the five countries successfully
maintained permanent funding of their government-run defined
benefit system. Second, privatization has probably increased na-
tional savings and economic growth in the countries we examined.
Third, administrative concerns, including costs of administration,
do not appear to be insurmountable.
Mr. Chairman, the details of any reform are important, and the
United States is vastly different from any of the countries exam-
ined here, but we are all bound by one truth: the larger the econ-
omy, the easier it will be to meet our obligations to future retirees.
The experience of the five countries suggest that privatization can
help.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Crippen follows:!
Prepared Statement of Dan L. Crippen, Director,
Congressional Budget Office
Mr. Chairman and members of the committee, I am pleased to be with you this
morning to discuss the lessons from the experience of other countries that have re-
formed their Social Security systems at least in part through privatization.
The retirement of the baby-boom generation in the United States will put our So-
cial Security program under financial pressure, and a debate is now proceeding
about how to pay for retirement in a financially sound way. Many recent proposals
would allow workers to invest some portion of their earnings in personal retirement
accounts. The amoimts accumulated in those accounts would replace some of Social
Security's benefits. Because some of a worker's retirement income would come from
savings in his or her account rather than from government transfers, such plans
would partly privatize Social Security.
Other countries face the same demographic and financial pressures as the United
States. In fact, for many countries, the pressures are much more severe and imme-
diate. Some countries have already responded to those pressures by privatizing their
public pension systems to some extent, and their experience can offer lessons for the
design of privatized pension systems. The economies and pension systems of those
countries differ considerably from those of the United States, however, and compari-
sons should therefore be made cautiously.
The Congressional Budget Office (CBO) released in January a paper that reviews
the experience of five coimtries — Chile, the United Kingdom, Australia, Argentina,
and Mexico — that have introduced individual accoimts to fully or partly replace
162
their public retirement system.^ Such plans are defined contribution plans — that is,
retirement income depends in part on the uncertain returns on contributions to the
accounts. Some other countries have relied on more traditional measures to close
the financing gap, such as changing benefit rules and retirement ages or increasing
payroll taxes, but those countries were not included in our analysis.
All five coimtries already had some type of old-age income support system before
reform. Those systems relied primarily on "pay-as-you-go" financing, in which taxes
collected each year mainly or entirely finance the benefits paid to retirees in the
same year. For example, in the United Kingdom (U.K.), a payroll tax finances the
government's expenditure for pensions (and other benefits) in the same year. Before
reform, three of the other countries also generated most of the revenue for their
pension systems by earmarked taxes on wages.
By contrast, a system with personal retirement accounts can prefund retirement
income by requiring people to accumulate savings during their working years. For
example, Chile's system requires workers to invest in personal retirement accovmts
ft-om which workers may withdraw money only after they retire. Moving from a pay-
as-you-go system to a prefunded private system, however, imposes a financial bur-
den on transitional generations.
All five countries encountered the same set of issues in privatizing their systems,
and those issues are also relevant to efforts to privatize the U.S. Social Security sys-
tem.
• Policymakers have to decide who will pay for the transition between the pay-
as-you-go system and a prefunded system. The transitional generation must con-
tinue to support retirees under the old system while saving for their own retire-
ment. That issue is obviously not unique to privatization and must be faced in any
reform of Social Security that moves toward a prefunded system.
• Some countries have required workers to shift to a new system of private ac-
counts, and others have allowed workers to choose whether to join the new system
or stay in the old pay-as-you-go system. Allowing choice can mean that the pay-as-
you-go system lingers on and may (as in the United Kingdom) entail some addi-
tional administrative problems. But it can also help workers accept the change, par-
ticularly older workers who have substantial accrued benefits.
• Policymakers must decide whether to offer minimum benefit guarantees and
how generous the guarantees should be. Without such guarantees, some people risk
not having adequate retirement income. Making such guarantees, however, imposes
a contingent liability on future taxpayers.
• Coimtries must decide how to regulate investment choices in the retirement
system and how the retirement funds may be used. Regulation may be needed to
limit fraud and risk— both the risk to retirees if investments turn sour and the risk
to taxpayers if the plan guarantees minimum benefits. Regulations about how the
retirement funds may be used, such as conditions for withdrawal and whether annu-
ities would be mandatory, are also important. However, regulations also limit an in-
dividual's choice about investment and retirement.
Types of Privatization Plans
The countries we examined followed one of three major models in privatizing their
pension systems. Chile, Mexico, and Argentina used a model in which workers es-
tablish private retirement accounts. The United Kingdom allowed its workers to
choose between the old pension system and the new system. Australia based its sys-
tem on employers' contributing to retirement accounts for workers.
THE CHILEAN MODEL
Chile, a pioneer in privatization, replaced its pay-as-you-go system with a system
based on private retirement accoimts in 1981. New workers had to establish private
accounts. Workers already in the old system could choose to remain there or switch
to the new system and earn a more attractive expected return on future contribu-
tions. To encourage switching, the government compensated workers who did so
with "recognition bonds" that would be paid into a worker's accoimt at retirement.
Workers with siifficient years in the system were guaranteed a minimum retirement
income of about 25 percent of the average wage. Obligations to existing workers
were financed with general revenue and debt (the recognition bonds).
Mexico and Argentina generally followed the same model as Chile, with some
modifications. In Mexico, for example, all workers have been required since 1997 to
join the new system and save in private accounts. At retirement, however, workers
iSee Congressional Budget Office, Social Security Privatization: Experiences Abroad, CBO
Paper (January 1999).
163
who have contributed to both systems may choose to receive benefits fi-om either
system (but not both). Argentina has both benefits that are financed on a pay-as-
you-go-basis (similar to those in Social Security) and private retirement accounts.
People who choose to contribute to private accounts receive an additional pension
that reflects their contributions to the old system (like the recognition bonds in
Chile).
THE U.K. MODEL
The United Kingdom, when it began its reforms in 1986, followed a different
model. Its existing retirement system already had a privatizing option; that is, peo-
ple whose employer offered a pension were allowed to opt out of part of the govern-
ment's pay-as-you-go system. Those who did so received a rebate on their payroll
taxes. The reform simply extended that option by allowing workers who set up a
personal pension plan to opt out as well. Transition costs are financed out of general
revenue (possibly including debt) and by reduced benefits in the government system.
THE AUSTRALIAN MODEL
The third model is that of Australia, which chose to base its reformed system on
employers by requiring most of them to contribute to workers' retirement funds. Un-
like the other four countries, Australia never had a Social Security-like system fund-
ed by earmarked contributions. Instead, the government used general revenues to
pay for a means-tested pension that was not regarded as an entitlement. Because
the old system lacked a specific entitlement, it did not require the government to
compensate workers for any benefits accrued under the old system. However, if the
reform succeeds in replacing the government pension, it will be true in Australia,
as in the other countries, that one generation wiU pay for their parents' as well as
their own retirement.
Design Issues
The experiences of the countries that have already begun their reforms highlight
the importance of the design of the new pension systems. Our analysis revealed
three issues: the need for additional information if a complex system is to work; the
need to regulate investment choices; and the need to regulate withdrawals from the
accounts.
INFORMATION REQUIREMENTS OF A COMPLEX SYSTEM
The reform in the United Kingdom demonstrates the difficulties that can arise if
the new system offers workers a large array of choices and decisions to make but
does not ensure that the worker has sufficient knowledge to make informed deci-
sions. In the U.K. case, figuring out whether they should stay in their employer-
based plans or switch to the newly available private accounts was difficult for many
workers. If they switched, they would lose accrued benefits in the employer plans
but would gain a more attractive return in the private accounts. Under pressure
fi"om sellers of the private accounts — including, apparently, some fraud — some work-
ers made poor decisions. The United Kingdom responded to that problem with more
careful regulation. Sellers of private accounts now have to provide enough informa-
tion to enable workers to make a reasonable decision.
REGULATION AND RISK
Regulation of investment choices within the private accounts differs among the
five countries. Such regulation could be important to protect either retirees or tax-
payers, who in many cases are on the hook to finance a minimum benefit guarantee
if investments in the accounts prove to have been unwise. One would expect, there-
fore, that systems that guarantee a minimum benefit would tend to have more regu-
lation, though that is not always the case.
Neither the United Kingdom nor Argentina has a contingent minimum benefit.
A worker whose investments went sour (and who had worked long enough to qual-
ify) would have to rely on a basic pension that was not means-tested. The basic pen-
sion therefore does not depend on how successful the worker's investments are. The
possibility of poor returns in the private accounts does not explicitly impose any
risks on taxpayers. Of course, taxpayers still have to pay for the basic pension.
By contrast, the basic pension is means-tested in Chile and Mexico. Workers in
those countries can choose their investment portfolio. (Australia also has a means-
tested pension, but employers generally choose the portfolio.) Consequently, workers
in Mexico and Chile have an incentive to invest in risky assets offering high ex-
pected returns — the worker reaps all the benefits if the gamble pays off and can rely
164
on the basic means-tested pension if it does not. Taxpayers in those countries thus
have a greater interest in ensuring that returns on tne private accounts do not fall
too low. (Means-tested pensions can also have other disadvantages: for example,
they can reduce incentives to work and save.)
The taxpayer thus bears part of the risk of poor investment choices in Chile, Mex-
ico, and Australia but not in the United Kingdom or Argentina. One would therefore
expect the United Kingdom and Argentina to have Uttle regulation and the others
to regulate investment choices more closely. As expected, regulation of investment
choices is minimal in the United Kingdom, consisting mainly of the ordinary "pru-
dent man" fiduciary standard, and is quite stringent in Chile and Mexico. The odd
couple are Australia and Argentina. In Australia, taxpayers bear some of the risk
of the accoimts, but regulation is as light as in the United Kingdom. In Argentina,
by contrast, taxpayers do not bear that risk, but regulation is as heavy as in Chile,
which has in other respects also been a model for Argentina.
REGULATION OF WITHDRAWALS
In Australia, workers can "game" the system by withdrawing all their money fi-om
the accounts at retirement and spending it, for instance, by paying down their mort-
gage or buying a new house. Housing receives special treatment vinder the rules for
the means-tested pension. Currently, most people qualify for the pension. If that
practice continues, the reform will have made almost no difference in the govern-
ment's costs for retirement. Australia's experience suggests the importance of estab-
lishing rules that govern when, how, and for what purpose funds may be withdrawn
from the accounts. Many proposals for reform in the United States, for example,
prohibit lump-sum withdrawals and require workers to purchase an annuity at re-
tirement. Having such rules would avoid the problem Australia encountered.
Administrative Costs
Most analyses of the administrative costs associated with proposals to privatize
pension systems examine the cost of managing private accounts. That is, of course,
only one part of the cost of a proposal; both the current Social Security system and
any reformed system also impose administrative and accounting costs on employers
and workers. CBO is now conducting a more detailed study of administrative costs
in a privatized system.
Comparing the administrative costs of managing private accounts for the five
countries is quite difficult. Some plans take out administrative costs as an initial
payment at the time of investment, and other plans charge an annual fee. The dif-
ferent fee mechanisms preclude any direct comparison, particularly since most of
the reforms are recent and the plems have not matured. Nevertheless, a couple of
lessons have emerged.
First, fees and commissions of individual accounts appear to be close to what
managed mutual fiinds charge for individual accounts in the United States. In
Chile, account fees and commissions are about 1 percent of the assets held in Chil-
ean pension accounts. A 1-percent charge is quite common for managed mutual
funds in the United States. The large accounts in Australia that give limited choices
to workers seem even less costly, with fees approaching those that index funds
charge in the United States (about Vs percent of assets). In addition to managing
investments, systems with individual accounts need to collect and maintain data in
more detail and collect it more frequently than a large-scale public system without
individual accounts. Such systems therefore tend to be more expensive than, for ex-
ample, the U.S. Social Security system.
The second lesson is that design choices seem to affect management costs. In
Chile and the United Kingdom, for example, funds are marketed directly to individ-
uals, which leads to relatively high sales costs and little bargaining power for pur-
chasers. In addition, workers in Chile can switch funds several times a year, and
workers in the United Kingdom can contribute sporadically and to several small ac-
counts. All those factors increase total administrative costs. In Australia, by con-
trast, companies representing many individuals and contracting on a more stable
basis face much lower fees.
National Saving
All of the reform plans hoped to reduce strains on the government's financing of
retirement and, by encouraging private saving, increase the national saving rate.
That is an important goal because the only way that real resources can be put aside
for retirement is through saving and capital investment in plant and equipment and
human capital (education and training).
165
Because of limited information on what the governments and workers would have
done had the pension systems not been reformed, estimating the reforms' exact im-
pact on national saving is difficult. In the United Kingdom, the fiscal tightening as-
sociated with pension reform indicates that the government offset little if any of the
additional private saving in personal retirement accounts. In Chile, a fall in govern-
ment saving probably offset only a portion of the increased private saving. As a re-
svilt, Chile's national saving rate may have increased by 2 percent to 3 percent of
gross domestic product (GDP). In Australia, estimates indicate that under certain
behavioral assumptions, the reform might increase national saving by about 1.5 per-
cent of GDP in the long run. The saving effect of reforms in Mexico and Argentina
cannot yet be ascertained; however, the gains in national saving are probably less
in Mexico and Argentina than in Chile.
Another important lesson fi-om the countries we studied is the difficulty of fund-
ing a retirement system controlled by a national government. Several of the covm-
tries intended to fund or partially fund their systems over time. However, in each
case the good intentions were overcome by demographic pressures and the ease with
which trust funds can be deployed for other purposes. A motivating force for privat-
ization may have been the failure of the national governments to establish and
maintain a cache of assets in a trust fund as we commonly understand it.
Conclusion
The aging of the population is not unique to the United States — many countries
are experiencing growing retirement populations supported by fewer workers. Those
facts mean, in part, that the traditional pay-as-you-go pension and health care pro-
grams for retirees will be strained. Other countries have undertaken, and the
United States is considering, reforms to those programs to help ensure future bene-
fits.
Judging the desirability of reform — indeed, judging the results of other countries'
reforms— idepends critically on at least two related questions: Can the reform help
economic growth? And can the reform reasonably be expected to work?
The first question is critical. It is ultimately the size of the economy that deter-
mines our ability to support a growing elderly population with fewer workers. In-
creasing national saving should enhance productivity and thereby economic growth.
Increased saving results from funding a heretofore unfunded system with real as-
sets, not with increases in government debt.
The second question addresses considerations of practicality, ease and cost of ad-
ministration, protection against severe losses, and the extent of regulation.
Our comparisons of the five countries suggest that:
• None of the five countries successfully maintained permanent prefunding of
their government-run, defined benefit pension system.
• Prefunding through privatization offers an opportunity to increase national sav-
ing and economic growth.
• Administrative concerns, including cost, do not appear to be insurmountable,
but the details are important.
Chairman Smith. Ms. James.
STATEMENT OF ESTELLE JAMES, LEAD ECONOMIST, POLICY
RESEARCH DEPARTMENT, WORLD BANK
Ms. James. Hello. I was asked to talk mainly about how other
countries have covered transition costs and also the issue of admin-
istrative costs. So I will focus on those two issues.
Let me just say, though, on the issue of economic growth, which
Dan Crippen just referred to and which I agree, is crucial: Only one
country has had experience long enough really to do empirical
studies on the impact on savings, financial markets and growth,
and that is Chile. The preliminary evidence we have from Chile is
encouraging, although, of course, we will have to do many more
studies over many more years to know for sure what the con-
sequences are. But so far, the consequences seem to be positive for
savings, financial market development, and growth.
Now on the issue of transition costs and administrative costs, we
basically have two models of reform around the world. There is the
166
Latin American model, where there are individual accounts and
where there was basically what we might call a carve-out; that is,
money was diverted from the old system to the new system. And
then we have the OECD model, which features group choice and
in most countries was an add-on. Where you have an add-on, you
don't have the transition cost issue but in the Latin American
countries you did have the transition cost issue.
Latin American countries covered transition costs in a variety of
ways.
1. Downsizing the old system, but always very gradually in a
way that does not affect current pensioners because you know for
sure if you cut benefits of current pensioners it is unfair and you
will have tremendous political opposition that will doom the re-
form.
2. These coimtries have kept part of their systems pay-as-you-go
by keeping older workers in the old system and by retaining a pay-
as-you-go pillar in the new system; all the various proposals that
we have in the U.S. include that kind of idea. That cuts the transi-
tion costs, the financing gap.
3. Countries have used other revenue sources, such as a surplus
in the treasury, or a surplus in the Social Security system, or pri-
vatization assets. Now we don't have privatization assets but we do
have a surplus. Chile in particular has used that method to finance
the transition.
4. Finally, practically every country has used some debt finance
to help the country over the crunch in the first few years. We can
anticipate a long-term fiscal saving, but there may be a period in
the beginning and in the intermediate stage where there would be
a fiscal deficit, and most countries have used debt financing as part
of their plan for covering that deficit.
The idea is you spread the burden out over many generations, so
it is not true that one generation bears a double cost, and then
some of the younger people who reap the benefits of the reform also
pay some of the costs. So I think that is a lesson that is relevant
to the U.S. We shouldn't be afraid of a little bit of deficit financing,
if that is necessary as parts of a larger reform program.
Now, on the issue of administrative costs, as you all know that
is one of the most critical issues and one of the most controversial
issues. Chile has been criticized for the high administrative costs
of its individual account systems. In fact, this is an issue that, with
my colleagues at the World Bank, we are now investigating very
closely. So far what we have found is both good news and bad
news. The good news is that fees and administrative costs in Chile
are not as high as is sometimes believed. You hear numbers like
15 or 20 percent thrown around but actually it is 15 or 20 percent
of your incoming contribution and once you have paid that fee you
don't pay any other annual fees on that particular contribution for
the rest of your life. If you average that cost out as an annual per-
centage of assets, over the lifetime of a full career worker, it turns
out to be less than 1 percent. It is around 70 basis point depending
upon the assumptions that you make.
So compared with other financial institutions, this is actually a
pretty good deal.
167
On the other hand, it does reduce benefits by 15 or 20 percent
compared with a system where there were no costs. So it is some-
thing that we have to think about, but it is not as prohibitive as
sometimes appears.
Now the second thing we found is that if you look at mutual
funds in the U.S., which we used as a basis for comparison, the
costs are actually on average somewhat higher than those in Chile,
and in both cases marketing costs were a large share of the total.
We infer from this that in retail financial markets you are likely
to have high marketing costs, and if there is a way of setting up
a system to avoid those marketing costs this would benefit the
workers ultimately.
Now, when we looked at the costs of institutional investors, we
found — in the U.S. again — we found that the costs are much less
than for the retail mutual funds, largely because the marketing
costs in that sector are much lower. We infer that the challenge in
setting up an individual account system is how to set it up in such
a way as to benefit from those institutional rates.
Chile did not do that, but other countries are trying to do that.
For example, Bolivia used a bidding process to auction off rights to
run the individual accounts to two firms in an international bid-
ding contest, and their costs appear to be about half those in Chile.
Sweden is using a negotiated fee ceiling to try to keep the lid
down on costs, particularly marketing costs, and we will be watch-
ing carefully to see how that actually works.
So the lesson is that how you set up the individual account sys-
tem matters. The costs in the Latin American model are not as
high as is sometimes said, but I think it is possible to do better.
Thank you.
Chairman Smith. Thank you. Mr. Thompson.
STATEMENT OF LAWRENCE THOMPSON, SENIOR FELLOW,
URBAN INSTITUTE
Mr. Thompson. Thank you. I am going to address myself entirely
to the administrative aspects of individual accounts, and if I can
leave you with one thought it is this: that no one in the world has
implemented a scheme which I think would be acceptable in the
U.S. That doesn't mean it can't be done. But, you have to be very
careful in looking through the various trade-offs that are involved.
The risk is that you will adopt a policy thinking that the adminis-
trative details can be worked out when they can't be worked out
in a way that is acceptable. I will develop that point if I could for
a second.
First of all, in a number of ways, the U.S. is different from al-
most everybody else who has tried to do individual accounts. First,
we don't start with a clean slate. When we talk about individual
accounts in Social Security, invariably we liken them to 401(k)s
and other kinds of instruments which already exist in this country.
We evoke in people's mind an image of what individuals accounts
in Social Security will look like and how they will operate. People's
expectations are going to be upset if what actually emerges is a
good deal less attractive than 401(k)s.
Secondly, we seem to have ruled out certain options which I
think are promising options in other contexts. Specifically we seem
168
to have ruled out employer mandates, which is how Australia and
Switzerland have created individual accounts at reasonable cost.
There are trade-offs involved in employer mandates. We seem to
have ruled discussion of those trade-offs out of our current political
debate. We are not going to increase the burden on employers, so
we have closed off the employer mandate option.
Third, most of the individual account proposals in this country
deal with a pretty small contribution rate. I have a table in my
statement that compares how individual accounts operate in sev-
eral countries. You will notice that Sweden is the only one which
has a contribution rate anywhere near that rate discussed here.
Their contribution rate is 2.5 percent contribution rate. Most of the
conversations in this country are in the neighborhood of 2 percent.
Most other people are dealing with two and three and four times
as much, which means the accounts are much larger in those other
countries than they are here.
Lastly, we are not talking about dividing up an Eastern Euro-
pean huge single pillar that tried to finance the entire retirement.
We are talking about making adjustments to what is already a
two-pillar system that has a significant amount of private pension
in it.
Well, I say that the devil is in the details and it is doubly true
in the case of individual accounts, and so I lay out five objectives
that people seem to have when they advocate individual accounts,
and I talk through what the difficulties are in achieving each of
these objectives with the idea of leaving you with the notion that
there is no clear magic bullet here.
The first objective is to provide workers with a reasonable rate
of return, which seems to be the number one rhetorical point made
in the debate in this country. Estelle has talked about the adminis-
trative costs in the Latin American systems, and I think she has
probably given accurate figures with respect to the costs of manag-
ing the funds. She has not talked about the costs of annuitizing
them when you are done, and if you add together the annuity costs
and the management costs you easily get to a situation where you
are spending 1 percent of your gross domestic product running a
pension system.
The most recent estimates out of the UK are that 40 percent of
the money that was in the personal accounts gets dissipated into
administrative charges and fees. The numbers in Latin America
are closer to maybe a quarter.
Sweden is trying to implement an alternative which, as Estelle
says, hopes to get rid of the marketing costs and negotiate lower
fees. The jury is out about whether they can actually do it or not.
They have run into some problems. We can discuss that, if you like.
Now, on the other hand, most of these countries that have gone
to these individual accounts have done so for a reason, and that is
that they don't trust central management of the funds, or they
have had bad experiences or something. And so if you are in a posi-
tion where the choice is between central management you don't
trust and incurring administrative costs that are rather high,
maybe you take the administrative costs. You have to pick your
poison, though. You are Hkely to get burned either way, or you run
the chance of being burned either way.
169
Secondly, we want to make sure that the contributions are han-
dled responsibly and that they are not invested in a risky way. I
am struck by the fact that the administrative process, as used in
most of these countries, do not take the care that we are used to
having in making sure that money gets posted to the right account.
In the end, each employee has to check his statement to make sure
that his money got there because no one is double-checking, match-
ing account numbers and names and so forth, which is the policy
in the U.S. before we post accounts.
It is also the case though that many of these other countries, not
counting the United Kingdom, have fairly tightly regulated their
investments and probably have minimized the odds that people will
lose their money in risky investments. Some of the proposals in the
U.S. do not have that feature, and that needs to be examined care-
fully.
Third, we want to provide workers with choice. In the UK sys-
tem, although it is terribly expensive, it does do a good job of pro-
viding workers with choice. The Latin American systems don't do
a very good job of providing workers with choice because for a com-
plex set of reasons they end up producing a set of choices in which
everybody is offering the same portfolio, or almost the same port-
folio. So the choice is more apparent than real.
In the U.S. debate, there are people who advocate some variation
on the Federal Thrift Savings Plan, which allows a very sharply
constrained choice but at least allows some choice between two or
three or five portfolios. And the hope is that that choice will be
enough choice but can be done in a way that will not involve unrea-
sonable administrative costs.
I already mentioned a fourth objective, which is to not impose an
increased burden on employers, which seems to have ruled out the
Australian and Swiss models from our debate and probably also
rules out the mechanics of how most of the Latin American models
work because they all work on monthly reporting, and we have an-
nual reporting in this country.
We used to have quarterly and we went to annual to reduce the
burden on employers. I am not sure you want to go back to mul-
tiplying by 12 the number of reports that each employer has to file
to make an individual account system work.
But once you go to annual reporting, you introduce a whole new
feature, which is that you have big time lags between when the
money is taken out of the worker's paycheck and when it actually
makes it into the individual accounts, as much as 18 to 24 months,
which is not the way the Federal Thrift Plan works. So I alert you
that when you use the Federal Thrift Plan model for Federal work-
ers that money goes into the account they selected as soon as it is
taken out of their paycheck. You can't operate that kind of a model
across the country on a national basis. You are going to have big
time lags. Nothing necessarily wrong with that, but you have got
to be up front with people about what you are actually proposing.
Lastly, insulate the economy from inappropriate political inter-
ference. There is a lot of concern in this country that if the central
fund was held in equities, or a chunk of it was held in equities,
that the Congress would get their fingers in there dictating about
what securities should be divested and that there would be issues
170
of who is going to vote those shares and so forth. I only point out
that a Federal Thrift Plan model has essentially the same set of
problems because there is a block of assets and they are being held
centrally even though they are being held nominally in individual
accounts. Somebody has got to figure out how to vote the shares
and the Congress can dictate what is going to happen in the future
to tobacco stocks.
So those are the kind of issues you have to work your way
through. There is no good answer, and it is important to consider
carefully what the trade-offs are.
[The prepared statement of Mr. Thompson follows:]
Prepared Statement of Lawrence H. Thompson, Senior Fellow,
The Urban Institute
Many advocates of individual Social Security accounts implicitly assume that an
acceptable strategy can be developed for implementing their plan. International ex-
perience suggests that this is a dangerous assumption. No country has yet success-
fully implemented individual accounts in a way likely to be acceptable in the U.S.
Supporters of individual accounts need to pay more attention to administrative de-
tails if they want to avoid another catastrophic health fiasco.
One of the most contentious elements of the current debate about refinancing So-
cial Security is whether to introduce a system of mandatory individual investment
accounts. This part of the debate ranges across a variety of considerations. These
include likely impacts of one or another course of action on: benefit adequacy, bene-
fit predictability, rates of return to Social Security contributions, the progressivity
of the retirement income system, the behavior of future political office holders, com-
peting social philosophies, the macro economy, and the future fiscal position of the
Federal Government. With so many dimensions to discuss, it is a debate that could
go on for a long time and become quite confusing.
Most of the attention so far has been on policy trade-offs. They are important and
should be thoroughly analyzed and debated. But, people who are serious about cre-
ating mandatory individual accounts must also focus on the practical aspects of how
such accoxints can be administered. Administration of these accounts is a case where
the devil is truly to be found in the details. In this regard, a number of countries
have created mandatory individual accounts of one form or another, and it is my
beUef that none of them has yet devised an administrative structure and strategy
that is likely to be acceptable in the United States.
The Competing Objectives
Constructing a national system of individual accounts involves important choices
which require balancing competing objectives. Quite likely, no structure can be de-
vised that will achieve of the objectives fully. The challenge of somebody trying to
design an individual account proposal for the United States is to decide which objec-
tives to sacrifice in the interest of achieving others.
An outline summary of the different models proposed or implemented around the
world is attached. The rest of this statement will concentrate on the competing ob-
jectives and the challenges in achieving them.
Among the important objectives that individual account systems are designed to
achieve, five stand out:
1. providing workers with a reasonable rate of return on their mandated
contributions
Particularly in the U.S., the case in favor of individual accounts almost invariably
begins with the assumption that they would provide a higher return than does the
traditional Social Security program. Getting decent returns, however, requires keep-
ing administrative costs at reasonable levels and assuring that investment decisions
are guided only by concerns of maximizing returns at acceptable risk. Experience
elsewhere suggests these are more easily said than done. Administrative costs are
the Achilles Heel of all of the decentrahzed individual account systems currently in
operation around the world. In the Latin American systems, roughly one-quarter of
the money that goes into the fimds is lost to administrative fees. In the U.K, ad-
ministrative charges are averaging 40 percent of the system's resources. Before long,
these countries will find that they are spending more than 1 percent of their GDP
171
just to administer their pension systems. Australia and Switzerland have managed
to avoid such high administrative costs by relying on employer-sponsored accounts
rather than allowing the complete decentralization found in Latin America and the
U.K Sweden is trying to implement an alternative arrangement designed to avoid
the administrative cost problems found in Latin America and the U.K., but the
Swedes have encountered some practical problems and their system is not yet oper-
ational.
The costs associated with decentralized administration of the system must be
weighed against the possible loss of returns if funds are held in a form and in a
place where political interference can produce poor investment returns. One study
tracking returns paid on accounts in the provident funds of Malaysia and Singapore
concludes that they fell short of the market returns available elsewhere in the re-
spective countries by an amount roughly equal to the administrative charges found
in Latin America. Apparently you get to pick your poison.
2. ASSURING THAT CONTRIBUTIONS ARE HANDLED RESPONSIBLY AND THAT EXCESSIVELY
RISKY INVESTMENTS ARE AVOIDED
I am struck by several differences between the administrative processes used in
public pension systems in the U.S., Sweden (and other OECD countries I have stud-
ied) and the processes used in other parts of the world. One of these differences has
to do with the care taken in accounting for the money withheld from worker's pay-
checks. In the U.S., one of the most burdensome aspects of the earnings posting
process involves double checking everything to make sure that the right amount was
reported by the employer and that it is going to the right account. Something like
one out of every ten earnings reports has errors that need to be followed up. The
Latin American individual account model embodies comparatively little of this care.
In that model, reports of contributions flow into the system each month and are
pretty much processed as they are received. In the last analysis, each worker must
check his or her investment statements to make sure that their money really did
get deposited correctly and must take the initiative to resolve any discrepancies that
may arise when mistakes are found. That the Latin Americans do not check the
data as closely as we do is more a reflection of the intrinsic character of the model
than of the quality of their implementation. They are collecting information on each
employee's contributions each month. I doubt that it is possible for any institution
to process that much information every month and still run as many cross checks
as the U.S. uses to process its information.
On the other hand, the Latin American model tightly regulates the kinds of in-
vestments that pension funds can undertake. Once the money makes it to the fund,
the odds that it will be lost to excessively risky investment are minimized. In con-
trast, some of the proposals that have been made for the U.S. seem to be structured
to encourage workers to invest in the riskiest assets possible. This is the logical re-
sult of guaranteeing current law benefits to those whose investments didn't work
out.
3. PROVIDING INDIVIDUAL WORKERS WITH A REASONABLE DEGREE OF CHOICE ABOUT
HOW THEIR MONEY WILL BE INVESTED
Presumably, one of the advantages of individual accounts is the ability of workers
to exercise more control over their retirement nest egg. Obtaining this advantage
requires, however, that they be allowed, some choice about investment forms and
strategies.
Choice costs money. Though the U.K. system is expensive to operate, it does give
each participant a wide choice of investment instruments. On the other hand, the
Australian system has been criticized for not guaranteeing choice to workers. Aus-
tralia is currently debating whether to mandated that each worker have at least
four options, but pension providers warn that administrative costs would rise as a
result.
On the other hand, spending lots of money doesn't guarantee a meaningful choice.
The Latin American systems give participants little real choice about investment
strategies. Owing to the structure of the guarantees built in to those systems and
the regulatory strategies, every competing pension provider holds essentially the
same portfolio of assets.
The Thrift Savings Plan model in the U.S. represents one attempt to balance
choice and costs. Choice is provided, but it is sharply constrained by being limited
to a handful of indexed funds that are defined by the plan but managed by private
firms. To date, this has proved to be about the most efficient way to offer at least
some degree of choice. But it requires a far more direct role for government in oper-
172
ating the system than many of the designers of systems in other coxintries would
be comfortable with.
4. AVOIDING AN INCREASED BURDEN ON EMPLOYERS
Public policy in the U.S. is more sensitive to sparing employers undue burden
than any other covmtry I know. Many countries require all employers to file infor-
mation electronically; those that do not require electronic filing at least require em-
ployers to file on standardized forms. We do neither.
The Australian and Swiss systems of individual accounts are administered fairly
efficiently, but they are examples of are model that has been proposed and rejected
in this country. Each is a variation on the Mandatory Universal Pension System
(MUPS) plan proposed by President Carter's Pension Commission and rejected
owing to the desire to avoid any further employer mandates.
The Latin American model also requires monthly reporting of every individual's
earnings and contributions. In the U.S., we used to require such reports to be filed
quarterly, but we reduced the frequency to once a year to lighten the burden on em-
ployers. It is doubtful that we would adopt a system that relied on monthly report-
ing by employers.
The price paid for avoiding monthly reporting is that the resulting system has
major time lags built in. For example, both the U.K. and Sweden require only an-
nual reports from employers. In both cases, therefore, the money withheld from a
worker's paycheck sits around someplace for up to 24 months before it gets trans-
ferred to the fund of the worker's choice. Presumably, we would have to adopt the
same policy in the U.S. In effect, money withheld from your paycheck in January
1999 won't be invested according to your preferences until around September 2000.
The Federal Thrift Plan does not siiffer from time lags like these. In this respect,
it is not possible to build a system of individual accoimts in the U.S. that will look
like the Federal Thrift Plan.
5. INSULATING THE ECONOMY FROM INAPPROPRIATE POLITICAL INTERFERENCE
A common fear voiced in the U.S. is that government ownership of a large port-
folio of assets could give government undue influence over the economy through the
influence it could exert on corporate management. Such concerns also helped con-
vince the Swedes to adopt a more decentralized approach, more or less as a replace-
ment for a more centrally managed fund that has been part of their Social Security
program since the 1960's.
The governance problem is usually raised in connection with proposals to invest
the current trust fund in private securities. Presumably, however, to the extent that
the concern involves how shares are voted and whether a subsequent Congress man-
dates divestiture of certain assets, the concerns are equally applicable to a system
of government-operated individual accounts under a modified thrift savings plan
model.
The Challenge for the U.S.
If the U.S. decides to create a system of mandatory individual retirement ac-
counts, it will have to also develop an administrative strategy for organizing the sys-
tem and a management strategy for running it. We should expect that we will have
to make serious compromises from the ideal in developing both. The result will like-
ly not be something that looks like todays 40 Kk) plans. Indeed, we will probably
have to create an entirely new institution to implement an approach that had never
before been tried anjrwhere in the world.
What we can learn from experience abroad is what not to do. We don't want the
employer burdens that are associated with the Australian, Swiss and Latin Amer-
ican systems. We don't want the administrative costs associated with the U.K. and
Latin systems (indeed, at the contribution levels most people are discussing here,
we couldn't possibly afford them.) Instead, we want choice, we want security, and
we want the politicians to keep their hands off" of the funds. Now we just have to
figure out how to do it.
SUMMARY OF INDIVIDUAL ACCOUNT PLANS
Plan
Latin Amer-
ica' (Chile)
Switzerland
Australia
UK
Sweden
CSIS?
General Characteristics:
Is Participation Compulsory?
Contribution Rate
Yes
13%
Yes
7-18%
Yes
9%
No
4.8-5.8%
Yes
2.5%
Yes
2%
173
SUMMARY OF INDIVIDUAL ACCOUNT PLANS— Continued
Plan icaMcS Switzerland Australia UK Sweden CSIS^
Budget Financing? Transition No No Partial No Partial
Who Collects? Pension Pension Pension Tax auttior- Tax auttior- Tax auttior-
fund fund fund ity ity ity (IRS)
Who Remits? Employer Employer Employer Employer Employer Employer
Who Maintains Records? Pension Pension Pension Investment Government Government
fund fund fund mgr
Employer Reporting Frequency Monthly Monthly Monthly Annual Annual Annual
Investment Management:
Who Selects Investment Manager? .... Worker Social Part- Employer Worker Worker Government
ners
Who Selects Investment Strategies? .. Investment Investment Investment Worker Worker Government
mgr mgr mgr
How/ Many Options for Workers? None None 0-5 Unlimited Unlimited 4 or 5
Maximum Time Lag Days Days Days 18-24 18-24 18-24
months months months
Withdrawal of Funds:
Lump Sum Withdrawal Allowed? No Up to 50% Yes Up to 25% No Limited
Annuities Mandatory? No Yes No Yes Yes No
Price Indexing Required? Yes No No To 3% Not decided No
Who Picks Annuity Provider? Worker Pension Worker Worker Government Government
fund
Guarantees:
Absolute rate of return? No Yes No No No No
Relative rate of return? Yes No No No No No
Minimum Benefit? Yes No No No No No
Prior Law Benefit? No No No No No No
Solvency of Investment Company? .... Yes Yes No No No Implicitly
'Similar approaches are followed in the other Latin American countries as well as Poland and Hungary; others tend to use government to
collect.
2 Proposal of the Center for Strategic and International Studies.
Chairman Smith. Thank you very much.
Mr. Harris.
STATEMENT OF DAVID HARRIS, RESEARCH ASSOCIATE,
WATSON WYATT WORLDWIDE
Mr. Harris. Thank you, Mr. Chairman, committee members.
Thank you for the invitation today to discuss ostensibly the Aus-
traHan, British and Chilean retirement systems, with particular
reference to the individual retirement accounts.
My comments today will mainly dwell on the Australian model
as such, but also will make observations on the British and Chilean
approach retirement reforms.
As a former regulator who has worked in both Australia and the
United Kingdom, where I critically evaluated existing and planned
Social Security reforms, I think the importance of international
comparisons in shaping the public policy debate concerning Social
Security reform is especially important.
It should be stressed that as has been commented by previous
speakers, that no one particular international model that I will talk
about today can be used as a template for Social Security reform
in the United States.
Yet the experiences of Australia, Chile and the United Kingdom
certainly help resolve or dispel what I call the Chicken Little men-
tality of individual accounts related to Social Security. That is that
individual accounts simply can't function and function effectively
with regard to administrative costs, for example.
174
What is striking about the Austrahan system is that pohtical
pressures are the reverse of those in the United States. It was a
Federal labor government, if you like it, a democrat leaning govern-
m.ent, that largely introduced the system in 1987 and then re-
formed it in 1992. This policy was not only supported by organized
labor but also was actively encouraged by the leadership of the
Australian Council of Trade Unions, if you like the AFL^CIO ver-
sion in the United States.
Businesses and consumer groups also backed the changes. Such
a unified approach to reforming Australia's superannuation system,
or pension system, was due to possible fiscal concerns about the
impact of an aging population on Australia's economy.
Moreover, organized labor argued that the coverage of super-
annuation which had been narrowly confined, if you like, to a rel-
atively affluent 40 percent of the workforce should also cover all
workers through compulsory employer contributions.
The consensus was to create a retirement system with three dis-
tinct pillars. The first pillar is a means tested, pay-as-you-go, un-
funded Old Age Pension. Full pension payments equate to only 25
percent of MTAWE average weekly earnings, with revenue being
generated from Federal taxation and provided out of consolidated
revenue. In recent years, this benefit has been means tested by
strong income and assets tests.
The second pillar is a mandated individual account based system
which receives currently 7 percent of an employee's salary in excess
of $450 Australian per month, roughly $230 U.S. The concentration
level will eventually rise to around 9 percent by 2002. Additionally,
what is important to stress, Mr. Chairman, is that workers are vol-
untarily contributing today, as in tomorrow, 4 percent of their sal-
ary on a voluntary basis into these accounts. Largely these ac-
counts exist on an employer sponsored, defined contribution basis,
but it is important to note that individuals can seek and do pur-
chase individual superannuation retirement accounts from life in-
surance and fund manager providers.
Workers can choose professionally managed equity or bond
funds, fixed income securities or a mix. I think it is important to
note that the third pillar sees again individual retirement accounts
created on a voluntary basis with contributions largely received
through savings rebates and taxation.
I think what is important to note about the Australian super-
annuation approach is that it doesn't involve government control to
any great extent with regard to investing monies on behalf of indi-
vidual account holders as seen possibly in Chile. Except for the
normal standards of regulation associated with disclosure and pru-
dential solvency, fierce and effective competition between industry
participants has effectively driven down the fees and increased re-
turns, so that administrative costs, and this is an important point
to stress, as a percentage of assets on the management has fallen
to the range of 69 to 83 basis points in 1997 in Australia.
If you are in Australia today, you can effectively purchase and
pay for a superannuation account and pay roughly fees and charges
of about 66 cents U.S. per week, and that is an important point to
note, that administrative costs are continuing to decline as the sys-
tem matures.
175
Contrary to what is often argued in the United States, even the
small account holders in Australia can minimize charges and maxi-
mize returns. For women and disadvantaged groups especially, re-
sponsive superannuation accounts have developed that take ac-
count of seasonal or broken career patterns. To reach these groups,
the government has had a rigorous program of public education,
which begins with those who need to be made aware of how the
plan effectively is structured for their retirement and their individ-
ual responsibility.
Quickly, to move to effective regulation, which is often a concern
with some of the Social Security models, particularly Chile and the
UK, what Australia did clearly was identified that consumer pro-
tection or minimizing consumer protection risks had to be en-
shrined through legislation and in Australia we adopted much of
the SEC regulations, which has meant that large scale mis-selling,
as in the format or the form that has occurred in the United King-
dom, has been effectively minimized.
In effect, the long-term retirement outlook for Australians living
on Main Street appears promising.
Just quickly, I would like to make some comments about Chile
and the UK. I think Chile's approach is that back in 1991 they
didn't have much of an alternative. Their effective pay-as-you-go
system was effectively becoming bankrupt. I think they initiated a
bold system of contributions, and I think considering the develop-
ment as has been described by Estelle James with regard to the
capital markets, I think it has been very, very strong and very ef-
fective. The concern obviously has administrative costs but also the
consumer protection detriment.
I think the UK is interesting. What is important to note with the
UK is that pension funds as a percentage of assets as a percentage
of GDP in the UK, it is about 77 percent. So clearly the UK has
a strong and effective retirement record with regard to provision-
ing.
I think the UK today through the Blair government is adopting
a planned Social Security model through the stakeholder pension
that will see individual defined contributions likely to be enshrined
by 2001.
So in summary, Mr. Chairman, and committee members, I think
it is important to note that today and tomorrow, as in tomorrow,
individuals in Australia, Chile and the UK will be exposed less and
less to the vagaries of political risk associated with their long-term
retirement nest eggs.
Through providing the necessary infrastructure, all three coun-
tries are benefiting from empowering their citizens to be proactive
with regard to their retirement savings and also minimizing the
long-term liabilities linked with the retirement of the baby boomer
generation in the next century.
Thank you.
[The prepared statement of Mr. Harris follows:]
Prepared Statement of David O. Harris, Research Associate, 1996 AMP
Churchill Fellow, Watson Wyatt Worldwide
The views in this statement are those of the author and do not necessarily reflect
the views of Watson Wyatt Worldwide or any of its other associates.
176
Mr. Chairman, I am pleased to appear before the Budget Committee's Task Force
on Social Security to broadly discuss the Social Security reform experiences in Aus-
tralia, Chile and the United Kingdom. All three countries have shared since the be-
ginning of the 1980's a political and economic will to "grasp the thorny nettle of So-
cial Security reform." The successes and otherwise of these international Social Se-
curity models provides a useful "blueprint" for the United States in its ongoing dis-
cussions over the future of Social Security reform. My testimony will largely con-
centrate today on the experiences generated by Australia in moving toward a more
fully funded approach to its retirement needs, in the late 1980's and early 1990's.
Additionally details are provided on the Chilean and British Social Security reform
initiatives. While economic and demographic comparisons are not as strong with
that of Australia, policy makers in the United States would be well served in look-
ing at what lessons can be gained from these two models.
As a former International Research Manger for the Office of Fair Trading in the
United Kingdom and a regulator of retirement products in Australia, I see it as very
important for this Committee to comprehend the experiences of how Australia, Chile
and the United Kingdom have fostered individual retirement accounts. Certainly it
can be argued that the following international experiences, combined with the reali-
ties of an increasingly aging "baby boomer" population in the United States, will
help solidify the need for individual retirement accoimts.
Australia
developing and nurturing an individual retirement system
For Australia, a coimtry that at the beginning of the twentieth century had one
of the highest standards of living in the world, the Old Age Pension, introduced in
1909, appeared to be both a stable and viable approach to meeting an individual's
retirement needs in the future. Under the system a flat rate benefit is provided
which equates to a maximum of 25 percent of male average weekly earnings. Before
the 1980's a common mentality among retirees was that after paying taxes over
their working lives, they were now entitled to an Old Age Pension from the Federal
Government.
Yet as commodity prices slumped in the early 1980's and Australia encountered
a deep recession, both politicians and bureaucrats aUke realized that the current
Old Age Pension could not be sustained with the rapid aging of the population. Sim-
ply put, Australia could no longer afford a "non-earmarked PAYG Old Age Pension"
with its associated generous qualification requirements. The demographic concern
toward Australia's aging population were echoed by the then head of the Association
of Superannuation Funds of Australia, Susan Ryan who commented:
"For Australia the percentage of the population aged over 65 is expected to rise
fi"om 15 percent of the population, 2.9 million, to 23 percent by 2030, that is, 5 mil-
lion people. The percentage aged over 85 is expected to more than double fi-om
around 2 percent to more than 5 percent amounting to 650,000 Australians over
85."i
Surprisingly for some in the United States, it was the Australian Labor Party,
a social democratic political party who, with trade union (organized labor) support
began to generate the momentum for change of Australia's retirement system. In
the first instance the newly elected Federgd Government began the process of ensur-
ing the long-term viability of the Old Age Pension at its current level. Maximum
payments per fortnight by the mid 1980's were now determined through the inter-
action of a comparatively stringent income and asset tests.
Clearly to engineer or make such a significant shift in the overall retirement
structure of any country requires a strong political resolve and vision for the future
of a nation's citizens. In AustraUa's case, more through coincidence and luck a popu-
lar Federal Government, through trade union support was able to convey to the na-
tion the impending problems Australia would confront, if it did nothing about ad-
dressing its aging population. This theme of the realization and admittance of a fu-
ture retirement hurdle was best summarized in the Better Incomes: Retirement into
the Next Century statement which expressed a commitment to: "maintain the age
pension as an adequate base level of income for older people' but went on to state
that persons retiring in the future would require a standard of Uving consistent
with that experienced whilst in the workforce."^
1 Susan Ryan, "Quality of Life as It Relates to Australia's Aging Population or Living to 100
in a Civilized Society," Association of Superannuation Funds of Australia, Speech, 1997.
2 Senate Select Committee on Superannuation: "Safeguarding Super," June 1992, p. 7, Can-
berra, Australia.
177
For trade unions, which had strongly supported the election of a Federal Labor
government in 1983, increasing superannuation coverage was seen as a major prior-
ity. Before the introduction of mandated, second pillar, superannuation accounts,
the extent of coverage of superannuation was limited to roughly 40 percent of the
workforce. Typically employees who were covered by superannuation were employed
in middle class, "white collar" jobs where usually women and people from minority
groups were under-represented. Brandishing this as a major bargaining tool, the
trade union movement set about convincing the Federal Government that the level
of superannuation coverage needed to be extended, via compulsory contributions
into individual accounts. Such a position adopted by the ACTU was in line partially
with its coimterparts in the United Kingdom and Denmark but yet diametrically op-
poses the position adopted by the AFL-CIO in the United States with regard to So-
cial Security reform. By 1986 circumstances were ideal for the introduction of a
widespread emplo3Tnent based retirement incomes poUcy. Continuing wages pres-
sure and demands by the union movement on the government for a comprehensive
superannuation policy to be initiated saw the introduction of award superannuation,
set at 3 percent of an individual's yearly income. This amount was paid by the em-
ployer as part of centrahzed wage increase of 6 percent, with 3 percent of this
amount being deferred into individual retirement accounts.
By the actions of the Conciliation and Arbitration Commission in requiring com-
pulsory contributions of 3 percent to be made into individual superannuation ac-
counts, award (employment conditions) superannuation was bom. In the years that
would proceed its actual implementation in 1987, individual superannuation account
balances would gradually increase. The trade imion movement and the Federal Grov-
emment would work together in refining and improving the delivery and regulation
of superannuation products to employees. Moreover trade unions would not simply
just advocate a policy of increased superannuation coverage during the 1980's and
early 1990's but would rather become vigorous in the running and management of
specific superannuation funds. Such specific involvement in the day to day oper-
ations of superannuation funds was directed principally toward industry funds.
These funds generally gravitate aroimd an occupation or industry and are sponsored
by employer and employee organizations. Fundamentally they were estabhshed to
receive the 3 percent mandated award contribution. As at Jime 1996 there were 159
industry funds with 5.8 miUion accoimts (35 percent of total accounts) and $17.6 bil-
lion in assets (6 percent of total assets).
Most experts and politicians agreed that 3 percent was not a sufficient level to
generate adequate retirement income for employees once leaving the workforce. On
this basis the Federal Government would again intervene in 1992 to reposition Aus-
tralia's long term retirement income strategy.
STRUCTURE OF THE AUSTRALIAN SUPERANNUATION INDUSTRY— SECOND PILLAR
With a delay to the 1990-1991 wage case occurring, where the ACTU and the
Government supported a further 3 percent round of award superannuation the then
government saw its opportunity to act in a decisive manner toward retirement sav-
ing.
In August 1991 the then Treasurer foreshadowed the Government's intention of
introducing a Superannuation Guarantee Levy which commenced on July 1 1992.
In issuing a paper on the levy the Treasurer indicated that such a scheme would
facilitate:
• a major extension of superannuation coverage to employees not currently cov-
ered by award superannuation;
• an efficient method of encouraging employers to comply with their obligation to
provide superannuation to employees; and
• an orderly mechanism by which the level of employer superannuation support
can be increased over time, consistent with retirement income policy objectives and
the economy's capacity to pay.^
Additionally in a statement Security in Retirement, Planning for Tomorrow Today
given on 30 June 1992, the then Treasurer, the Hon John Dawkins MP, reaffirmed
the government's position and direction on the aging of Austraha's population and
the need for compulsory savings for retirement:
"Australia, vmlike most other developed countries, meets its age pension ft-om cur-
rent revenues. Taxation paid by today's workers is thus not contributing to workers'
future retirement security; the revenue is fully used to meet the annual cost borne
by governments.
3 Senate Select Committee on Superannuation: "Safeguarding Super," June 1992, p. 13, Can-
berra, Australia.
178
"And, like most other people, Australians generally undervalue savings for their
own future retirement. Private voluntary savings cannot be relied upon to provide
an adequate retirement security for most Australians. This is so even with the very
generous taxation concessions, which are available for private superannuation sav-
ings.
"* * * In the face of these factors, changes are required to the current reliance
on the pay-as-you-go approach to funding widely available retirement incomes. This
means that we need now to start saving more for our future retirement. It also
means that saving for retirement will have to be compulsory. It means that these
savings will increasingly have to be "preserved" for retirement purposes. Lastly, the
rate of saving will have to ensure retirement incomes, which are higher than that
provided today through the age pension system.
"There seems to be a general awareness in the commvmity that something has to
be done now to meet our future retirement needs. "^
The Superannuation Guarantee Charge Act 1992 requires all employees to con-
tribute to a complying superannuation fund at a level, which increased from 3 per-
cent p.a. in 1992 to 9 percent p. a. It should be noted that some discrimination was
made for small business in how the levy was introduced and increases, based on
the size of the annual pa5rroll. If the employer chooses not to pay the levy he or
she will have a superannuation guarantee charge (SGC) imposed on their business
operations by the Australian Taxation Office (ATO). By deciding to neglect their ob-
ligations under Act the employer will not receive favorable taxation treatment in re-
gard to contributions made by them on their employees' behalf
At the present time the levy is currently at 7 percent which will increase progres-
sively by to 9 percent by 2002. The threshold for paying this levy was based initially
on the individual earning a minimum of $450 per month. More recently employees
may decide to opt out of the system and take the contribution in cash up to a level
of $900 per month.
TABLE 1.— DETAILS OF THE PRESCRIBED SUPERANNUATION REQUIREMENTS LINKED WITH THE
MANDATED SECOND PILLAR
Employer's Prescribed Rate of
Employee Support (Percentage)
July 1, 1997-June 30, 1998 6
July 1, 1998-June 30, 1999 7
July 1, 1999-June 30, 2000 7
July 1, 2000-June 30, 2001 8
July 1, 2001-June 30, 2002 8
July 1, 2002-03 and subsequent years 9
In March 1996, the then Labor Federal Government lost office and was replaced
by a conservative. Liberal Coalition Government under Prime Minister John How-
ard. It had been the intention of the Australian Labor Party, with trade union bless-
ing to further expand the compulsory nature of superannuation by gathering a 3
percent contribution from individual workers and providing an additional 3 percent
to certain workers who met pre-defined income criteria. In total this would have
meant that many workers' individual superannuation contribution accounts would
have been receiving total contributions of 15 percent. Treasury estimates suggest
that over a forty-year period these contributions would translate out to be approxi-
mately 60 percent of one's salary on retirement.
With regard to the taxation of superannuation, Australia has pursued a course
which is quite unique and which on the whole I cannot agree with in terms of de-
sign and the overall rate of taxation applied. Based on Andrew Dilnot's model devel-
oped at the Institute of Fiscal Studies in London, Australia's taxation of super-
annuation can be described as TTT. Taxation of contributions at a rate of 15 per-
cent, along with possible additional taxation of 15 percent for members' contribu-
tions who earn over $73,220. A further tax of 15 percent is levied on the investment
income of superannuation fund and finally the benefits can be subjected to varying
tax treatment of between 0-30 percent, depending on timing of the contributions.
The profile of the second pillar of Australia's retirement system depicts both a di-
versity and adequacy of return that reflects strong and vigorous competition among
the financial services industry in Australia. Through a trustee structure, super-
4 The Hon John Dawkins, MP, Treasurer: "Security in Retirement, Planning for Tomorrow
Today, 30 June 1992, ppl-2, Canberra, Australia.
179
annuation funds are managed in the most efficient and effective manner for mem-
bers. Life insurance companies and fund managers, like in the United States play
an active role in the management and investment of superannuation fund assets.
Additionally specialized administration companies have developed services that
allow superannuation fund trustees to outsource much of their investment and ad-
ministrative functions. This intense competition has led to in part returns being
maximized and administrative fees being minimized.
Varying measurements exist for evaluating the success of how Australia has con-
tained administrative costs, compared with other international models. In a recent
paper presented at the National Bureau of Economic Research Conference, on the
administrative costs of individual accoimts, Sylvester J. Schieber, Vice President,
Watson Wyatt Worldvdde and John B. Shoven, Charles R. Schwab, Professor of Eco-
nomics, Stanford University made the following conclusions about Australia's cost
structure:
"The Association of Superannuation Funds of Australia estimates that the aver-
age administration costs of their system equal A-$4.40 i.e., U.S.-$2.85-per member
per week. In U.S. currency terms, administrative costs at this rate for a system that
held average balances of $1,000 would be nearly 15 percent of assets per year. For
a system that held average balances of $5,000, it would drop to 3 percent per year.
For one that held average balances of $10,000, administrative costs would be 1.5
percent per year. By the time average account balances got to be $30,000, adminis-
trative costs would be under 0.5 percent per year. This pattern is important because
it reflects the pattern of accumulating balances in a retirement system like Aus-
tralia's as it is being phased in, as Australia's is now."^
Further evidence of the relatively low cost structure associated with super-
annuation accounts in Australia is highlighted in Table 4 prepared by the Financial
Section of the Austrahan Bureau of Statistics, on behalf of Watson Wyatt World-
wide.
TABLE 2.— ADMINISTRATIVE COSTS AS A PERCENT OF ASSETS UNDER MANAGEMENT IN
AUSTRALIAN INDIVIDUAL ACCOUNT SUPERANNUATION FUNDS DURING 1996 AND 19976
Number of members m the plan 1996 (percent) 1997 (percent)
1 to 99 0.689 0;619
100 to 499 0.849 0.673
500 to 2,499 0.803 0.797
2500 to 9,999 0.854 0.837
10,000 or more 0.922 0.846
Total 0.900 0.835
Source: Australian Bureau of Statistics, Belconnen, Australia Capital Territory, tabulations of a joint quarterly survey done by the Australian
Bureau of Statistics and the Australian Prudential Regulation Authority (APRA).
A further effort to define the average administration costs for accumulation funds
was published in the June Quarter 1998 of the APRA Bulletin. In analyzing super-
annuation fund administration, the regulatory authority indicated that average
weekly administration charges were A-$1.35 per member or US-$0.86. I would like
to mention briefly that investment decisipns and strategies are developed solely be-
tween the investment managers and associated trustees of each superannuation
fund. The Australian Government plays no role in shaping directly or indirectly the
investment decisions of the individual superannuation fvmd but rather through reg-
ulation stresses the need for a sensible and sustainable investment strategy. Regu-
lations refer to this approach as the prudent man test. Further, the December issue
of the APRA Bulletin highlights that 39 percent and 16 percent of the total super-
annuation assets of A-$377 bilUon or US-$234.07 are invested in equities & units
in trust and overseas assets. Clearly this level is deemed appropriate by govern-
ment, trustees and superannuation fund members alike. A concise overview of the
Australian superannuation industry as at December 1998, is provided in Table 3.
5 Schieber SJ & Shoven JB: "Administering a Cost Effective National Program of Personal Se-
curity Accounts" (Draft), NBER, Cambridge MA, December 4, 1998, p. 16.
6 Ibid., p. 17.
180
TABLE 3.— OVERVIEW OF THE AUSTRALIAN SUPERANNUATION INDUSTRY— DECEMBER 1998
T,mo n( h.n^ Total Bssets Number of funds Members (thou-
'^P^ °' '""" (billions) (June 1998) sands)
Corporate 69 4,259 1,456
Industry 26 108 5,847
Public Sector 84 62 2,878
Retail (including RSAs)— RSAs 102 363 8,957
Excluded 47 169,825 348
Annuities, life office reserves etc 49
Total Assets/Funds/Members 377 174,617 19,486
Source: APRA Bulletin, Australian Government Publishing Service, December 1998.
Unlike some other international retirement models, the third pillar of Australia's
retirement income system is characterized by individual retirement accounts being
generated on a voluntary basis through the private annuity, retail funds manage-
ment and life insurance markets. Some taxation and concessional rebates offered for
spouses and more generally savings incomes that are aimed at retirement provision
have seen this sector grow in recent years. With regard to final benefits, Australia
allows these to be taken in the form of a lump sum or annuity. Past experience has
seen a lump sum favored by many retirees but with changes in recent tax laws, an-
nuity and allocated pension vehicles are increasing in popularity.
I would like to now turn briefly to the mechanics associated with selling, distribu-
tion and withdrawal of benefits from the superannuation accoimt. One of the rea-
sons why Australia has been so successful in keeping administrative costs low and
also avoiding the problems associated with mis-selling is through effective and cost
efficient regulation. Strict rules govern how superannuation policies are sold and
switched. Moreover consumers are required to receive minimum levels of informa-
tion about the superannuation products at the time of sale and also on a regular
basis. Clearly it is felt that, as this is the largest financial transaction that a con-
sumer will enter into in their life, effective disclosure should be provided to encour-
age transparency in the transaction. Increasingly superannuation account holders
are being provided with greater investment choices. Some retail funds for example
offer between 5-7 investment choices and proposed legislation by the Federal Gov-
ernment will force employers to offer choice of funds. Consequently effective con-
sumer protection strategies will provide an important deterrent for any forms of
mis-selling from occurring.
As I have mentioned effective consumer protection strategies are crucial in offset-
ting the transitional risks linked with nurturing a more fully funded retirement sys-
tem. In a recently published chapter of the book Consumer Protection of Financial
Services, edited by Mr. Peter Cartwright and published by Kluwer Law Inter-
national, Sue Jones and I argued that public education was crucial for the success
of any associated Social Security reforms. Australia's experience of public education
campaigns associated with Social Security reform took place in 1994 and was deliv-
ered between 1995-1996 by Federal Government agencies. To build a better under-
standing and stress the value of superannuation the Federal Government through
the Australian Taxation Office, Department of Social Security and the Insurance &
Superannuation Commission initiated a comprehensive publication campaign. This
campaign harnessed both electronic and print media to convey several main themes
including the future benefits of superannuation for the nation and the individual,
information on how the new mandated system functioned and how a regulatory
body was active in safeguarding superannuation assets. The estimated cost of this
campaign was approximately A-$ll million in 1995 or the equivalent US-$159 mil-
lion on a per capita basis. When devising the elaborate and integral public edu-
cation campaign, the Federal Government was committed to directing part of the
campaign toward women and ethnic minorities.
The United Kingdom
It should be noted that the United Kingdom's (UK) pension system has been un-
dergoing a period of reform for over twenty years. The UK pension system is struc-
tured effectively in two tiers. The first is a benefit provided by the state, which con-
sists of the basic state pension and a significant level of means tested benefits. Since
1981, the level of the basic state pension has been formally indexed to the increase
in prices. This form of state benefit is by far the major core of the British govern-
ment's state provision responsibilities. Currently 10.6 million individuals receive the
benefit at a cost of £32 billion (4.7 per cent of GDP). This compares favorably with
other major OECD countries, as noted in Table 4.
181
TABLE 4.— PROJECTED FUTURE STATE SPENDING ON PENSIONS AS A PERCENTAGE OF GDP
1995 2000 2010 2020 2030 2040 2050
Australia 2.6 2.3 2.3 2.9 3.8 4.3 4.5
Canada 5.2 5.0 5.3 6.9 9.0 9.1 8.7
France 10.6 9.8 9.7 11.6 13.5 14.3 14.4
Germany 11.1 115 11.8 12.3 16.5 18.4 17.5
Italy 13.3 12.6 13.2 15.3 20.3 21.4 20.3
Japan 6.6 7.5 9.6 12.4 13.4 14.9 16.5
Netherlands 6.0 5.7 6.1 8.4 11.2 12.1 11.4
New Zealand 5.9 4.8 5.2 6.7 8.3 9.4 9.8
United Kingdom 4.5 4.5 5.2 5.1 5.5 4.0 4.1
United States 4.1 4.2 4.5 5.2 6.6 7.1 7.0
Source: OECD, cited in Johnson (1999).
To receive the benefit you must be aged over 65 for men and 60 for women, with
the benefit calculated on a flat-rate, contributory basis. As of April 1999, the first
pillar has been worth £66.75 a week for a single pensioner, which equates to 15 per
cent of average earnings. An additional dependant addition of £39.95 a week is also
provided where one partner does not meet the necessary contribution criteria. The
second tier, compulsory for all employees above a certain floor, consists of the State
Earnings-Related Pension Scheme and a largely vibrant smd evolving private pen-
sion market.
In 1948 the Beveridge Report had developed a compulsory pension system which
consisted only of the first tier. In effect this was the basic state pension and means
tested National Assistance. Yet increasingly, pressure on the Government to provide
a more substantial second tier approach for all workers developed, partly as a result
of the strong growth in occupational schemes. Between 1953 and its peak in 1967,
occupational pension coverage expanded from 28 to 53 percent of employees. This
coverage in recent years has declined which partly can be attributed to an overall
trend in changing employment patterns.
In 1975 the Social Security Act introduced the State Earnings Related Pensions
Scheme (SERPS). Its design allowed occupational schemes to contract out of SERPS
to avoid the scheme substituting for private sector provision. Effectively the design
of the second tier pension was for those people not in occupational schemes.
During the initial period of this second tier pension scheme benefits, were com-
paratively generous with toda/s levels. SERPS guaranteed contributors to the
scheme an additional pension of 25 percent of their earnings between lower and
upper earnings limits. The scheme was compvdsory. As indicated, employers and
contributors could contract out of SERPS only into a salary-related occupational
scheme if it offered benefits at least equal to those provided by SERPS.
Earnings in the best 20 years counted toward the pension at a rate of 1.25 percent
of earnings between lower and upper limits. These limits were revalued in line with
average earnings. Once payments commenced, the additional pension was uprated
annually in line with consumer prices. The cost of uprating the basic pension (first
tier) and SERPS was met by the National Insurance Fund.
Pensions under SERPS matured in 20 years and, as a result of the 20 best earn-
ing years formula, were especially advantageous to some groups. Employees earning
more than the Lower Earnings Limit (LEL) for National Insurance Contributions
(NICs) £57 per week for 1994-95 pay Class 1 NICs earn entitlement to SERPS as
well as the basic pension unless they are contracted out. The Upper Earnings Limit
(UEL) must by law lie between 6.5 and 7.5 times the basic state pension, and stood
at £430 per week in 1994-95— around 120 percent of average male earnings.
In June 1985 the Conservative Government published a Green Paper, Reform of
Social Security. This document highlighted the implications of the basic state pen-
sion and SERPS over the following 50 years. The concerns raised by this paper in
regard these two forms of pensions provisions can be summarized by Budd and
Campbell:
"The Green Paper pointed out that the increased cost of the basic pension would
benefit aU pensioners equally. However the case was different for recipients of
SERPS. Its earnings- related nature meant that the newly-retired would benefit
more than older pensioners. Also half the extra cost would result from pa3rments to
members of contracted-out schemes (to provide indexation top-up to the Guaranteed
Minimum Pension). The cost of SERPS (in 1985 prices) was expected to be about
182
£24 billion in 2035, compared with a basic pension cost in 1985 of about £15 bil-
lion."^
A significant change to SERFS took place in the second half of the 1980's when
the Social Security Act 1986 provided that from 1999 onwards, SERFS additions to
the basic state pension would be calculated not on the basis of the best 20 years
rule but instead on lifetime average earnings. Now SERFS would provide 20 percent
of average earnings over the whole working life of the individual. The current cost
of SERFS is only around two billion pounds per annum, due to relatively few retired
eeople having significant entitlements. By 2030 in contrast, these entitlements will
ave grown to its maturity point.
In summary SERFS payments in the future will progressively diminish as a per-
centage of a person's final retirement income through changes in the 1980's which
saw these payments linked to prices rather than earnings.
The UEL has fallen fi-om 140 percent of average earnings to 120 percent and will
continue to fall. With price indexation, and 2 percent real earnings growth per
annum, the UEL will be less than 60 percent of average male earnings by 2030,
implying a maximum SERFS pension of only 10 percent of average male earnings.
CONTRACTING OUT OF SERFS
As indicated previously, when SERFS was introduced members and employers of
occupational schemes had the ability to generate a contracting-out rebate if the
scheme agreed to provide a guaranteed minimum pension, related to individual av-
erage lifetime earnings. This rebate was initially set at 7 percent of earnings (be-
tween LEL and UEL for National Insurance contributions). The current rate, apply-
ing from 1993-94 onwards, is 4.8 percent.
In 1988, the contracting out option was extended to a further range of products,
principally personal pension products. The reason for this decision is subject to some
conjecture. Some elements say it had an ideological basis spawned by the then
Prime Minister, Margaret Thatcher who felt that Government should not be in-
volved in pensions provisions for the second tier. More likely was that advice pro-
vided by the Treasury and Gk)vemment Actuary's Department indicated that
through the affects of an aging population, the United Kingdom's economy would
be crippled by overly generous welfare payments. The condition for leaving SERFS
is not, that a guaranteed minimum pension should be paid, but that a guaranteed
minimum contribution should be made. This minimum level is the contracted-out
rebate. Levels of rebate offered to people newly contracted out into personal pen-
sions (or group defined contribution schemes) was set above the rebate for those in
occupational pensions. Initially, an extra 2 percent "incentive" rebate was offered
with the aim of "kick-starting" the personal pensions sector. In 1993-94, this de-
clined to an incentive rebate of 1 percent restricted to the over 30's. The rationale
for this policy was that a large number have already taken out personal pensions,
and so a kick-start is no longer required.
Through allowing people to contract out of their SERFS entitlements and transfer
fi-om occupational schemes personal pensions in 1988 received a significant boost in
sales growth and long term product development. The popularity of these products
was quickly established and thus by 1992 23 percent of male and 19 percent of fe-
male employees had contracted out and were in personal pensions.
Concern in Treasury and other areas of Government was that these new retire-
ment vehicles were only being used to receive the rebate provided through transfer-
ring out of SERFS. In 1991, 24 percent of employees had contracted-out into per-
sonal pensions yet about three-fifths of these personal pensions had been estab-
lished simply to receive the associated rebate and incentives provided by the Gov-
ernment. Such a situation led or induced the mis-selling of pensions, which has con-
tinued to erode a recovery in the public confidence, within the industry.
Overall personal pensions today are "manufactured" by a number of providers.
These companies are mainly life insurance companies although building societies,
unit trusts and other financial organizations are permitted to administer pensions
(at least up to retirement). Restrictions on investments are relatively few and it is
important to note that even supermarkets in the United Kingdom are offering such
financial services products on an execution basis.
In general, the deposits ft-om personal pension funds must be used to purchase
annuity. Recent legislative amendments have increased the individual's freedom of
choice between annuity suppliers. The Government has ensured that the same tax
privileges extend to personal pensions, as which exist for occupational schemes.
■'Budd, A. & Campbell, N.: "The Roles of the Public and Private Sectors in the UK Pension
System"— 1996, HMSO London, United Kingdom, p.7.
183
A concise summary or assessment of personal pensions and the future role that
they are likely to play in the British market is provided by Mr. CD. Daykin, the
United Kingdom's Government Actuary in his report to the European Commission.
" Personal pensions at the minimum level for contracting-out are imlikely to pro-
vide a very inadequate income in retirement. A major challenge for education (and
marketing) is, therefore, to persuade people that they must make additional vol-
untary contributions and that the responsibility for ensuring an adequate retire-
ment is theirs. The State will not provide more than the basic flat-rate pension. Of
course, there will still be the possibility of means-tested income support, but the
whole thrust of encouraging private provision for pensions is to lessen the depend-
ence on State Benefits.
Views differ as to the likely success of these objectives. Trade unions and staff"
associations in general remain very suspicious of personal pensions, which they see
as putting too much of the risk (particularly of investment performance relative to
inflation) on the individual and too much money (commission, profit, etc.) into the
hands of financial intermediaries, insurance companies and other financial institu-
tions. The preferred option of organized labour is the final salary occupational pen-
sion scheme, if possible with full price indexation of pensions, both in payment and
in deferment." s
Chile
Chile was the first South American country to move toward adopting a manda-
tory, funded, privately managed defined contribution retirement system in 1981. In
1980, Chile passed Decree Law 3500 and 3501, which partially replaced the state-
run-pay-as-you-go (PAYG), unfunded Social Security system. This system had func-
tioned in Chile since 1924 and by the mid 1970's symptoms of its long term weak-
ness, in providing benefits for recipients was increasingly becoming pronounced.
In effect the reforms meant that ft-om May 1 1981, new workers were eliminated
fi-om having the option of becoming a member of the complex unftmded national de-
fined benefit scheme, or in this paper referred to as the first pillar. Workers were
also given the option up to 1985 of remaining with the old system or joining the
new scheme.
By 1985 98 percent of workers had already joined the new scheme. Like any
PAYG system, the first pillar failed to establish a strict hnkage between the amount
of benefits and contributions to the system. This flaw can often lead to irresponsibil-
ity and unaccountability, a trend complicated by the fact that the impact of inappro-
priate economic decisions will be passed on to other generations.
Chile quite obviously displayed these characteristics with a progressive decline in
the numbers of workers matched against existing retirees:
"To illustrate the long-term effects of this trend, let us examine the active work-
ers/retirees ratio of the old system. While the system's ratio was 8.6 in 1960, it de-
clined sharply to 2.5 in 1979. At first glance, the drop could be attributable to the
aging of the population. However, in 1960, the number of people over 60 years of
age was 15.6 percent of those between the ages of 20 and 60; in 1980 the ratio was
16.7 percent, indicating that there were no significant changes in the average age
of the population. This data shows that the old system was structvired to provide
benefits that surpassed its ability to pay."^
To assist workers in making contributions to the new defined contribution ac-
counts, the dictatorship mandated that employers raise wages by 18 percent for ex-
isting workers and new labor force entrants. Clearly the advantage of introducing
such reforms under a miUtary dictatorship was highlighted in this aspect or transi-
tion of the Chilean Social Security system. Today the first pillar of the Chilean So-
cial Security system can be described as a minimum benefit funded fi-om consoU-
dated revenues. Such a benefit guarantees retirement benefits worth the higher of
75 percent of poverty or 25 percent of a worker's average pay over the 10 years prior
to retirement. This benefit will only be generated "if his or her defined contribution
account is too small to generate equivalent income (i.e., to provide annual benefits
greater than 75 percent of poverty or 25 percent of the worker's average pay), In
such cases, the worker's defined contribution account is taxed 100 percent to help
pay for the first-tier benefit. In other words, no Chilean receives payouts from both
8 Daykin, CD.: 'Tension Provision in Britain — Report on Supplementary Pension Provision in
the United Kingdom," 1994, HMSO, London, United Kingdom.
^Larrain, L.A.: "A Bold Step in Chile's Reforms: Privatization of the Pension System,"
Institute Libertad y Desarrollo, Center for International Private Enterprise, 1993, Santiago
Chile, p.2.
184
of the system's tiers. If workers do not accumulate enough in their defined contribu-
tion accounts, they must forfeit their balance and receive the minimum benefit." 1°
As a basic safety net the State provides a minimum pension to employees only
when the second pillar is unable to generate a sufficient pension, in retirement for
the employee. A minimum wiU occur where their pension produces a monthly in-
come which is less than Ch$51,014. Employees are required to have at least 20
years coverage to be eligible for the minimum pension. This minimum pension is
not indexed, but adjusted by the government fi*om time to time.
Under the system all benefits are provided through the AFP (pension fund admin-
istration companies). These are privately owned and managed companies who are
regulated by the Superintendency of Pensions and are required to meet a variety
of solvency and consumer protection issues. Although some pressure is mounting to
lift the current retirement age in Chile, the existing level remains at 65 for men
and 60 for women. Due to its defined contribution characteristics, the new system
relies on the merits of the AFP generating a sufficient rate of return on its invest-
ments. The assessment of the likely benefits to be provided by the annuity that is
purchased from a hfe insurance company, via accrued contributions was estimated
by the Instituto Libertad y DesarroUo:
"Actuarial calculations indicated that retirement for men at age 65 and for women
at age 60, with a pension of approximately 75 percent of their last active year's in-
come, required a system that could deliver an average annual rate of return of 4
percent. This seemed perfectly compatible with the potential of Chile's economy." ^ ^
All covered or "dependent" workers must lodge 10 percent of their monthly earn-
ings in a savings account with an approved, high regulated intermediary called the
AFP. Each AFP manages a single fund, with the complete return on the fund being
allocated to the individual accounts. An additional ftinction of the AFP is also to
provide survivors and disability insurance, according to rules prescribed by the gov-
ernment. Once the worker becomes eligible to receive pension benefits he or she has
one of two options. They can choose a sequence of phased withdrawals provided by
the AFP or purchase a real annuity. This latter option will require the affiUate to
purchase the annuity from a Ufe insurance company.
With Chile's long history of using indexed debt during periods of high inflation,
this has allowed the regulator to quite easily restrict the annuity option to indexed
annuities. UnUke other privatized models such as that in the United Kingdom and
Australia, it is very rare to find any employer sponsored pension plans. With strong
competition amongst multi-nationals to retain good quality staff, some are evaluat-
ing the possibilities for developing supplementary retirement benefits.
The major drawbacks associated with the Chilean model is the overall costs asso-
ciated with administration, distribution and regulatory restrictions. In response to
these concerns the regulators tightened the transfer rules, requiring account holders
to produce ID card and the most recent statement of their account. The net effect
has been that transfers have dropped dramatically. In five they have decreased from
220,000 a month to 22,000 with the sales force being consequently halved.
For example the administrators face extensive restrictions on investments. They
must guarantee a return within a certain band of the average return of the indus-
try, if needed, through their personal resources. The administrators can offer only
one fund, the affiliate can invest with only one AFP. Existing banks, mutual funds,
or insurance companies cannot manage mandated savings. Also transfer between
different pension funds are restricted based on minimum stay periods and transfer
fees. The fund administrators can charge fees as a percentage of salary (which is
typical) and of the assets managed, as well as flat transaction fees for deposit, with-
drawal, account statements.
In summary there is no doubt that the Chilean model has some ambiguous char-
acteristics which are seen to detract from the overall system. The Chilean system's
high administrative costs, relative to other government systems, pose a large prob-
lem for the Superintendency. The major historical statistics of the system are noted
in Table 5.
lOEBRI Notes: "Chilean Social Security Reform as a Prototype for Other Nations," EBRI,
Vol.18 Number 8, August 1997, Washington, United States, p.2.
"Larrain, L.A.: "A Bold Step in Chile's Reforms: Privatization of the Pension System,"
Instituto Libertad y DesarroUo, Center for International Private Enterprise, 1993, Santiago,
Chile, p.6.
185
TABLE 5.— CHILEAN PENSION FUND SYSTEM— MAJOR HISTORICAL STATISTICS, 1981-1996
Total Assets (MM US$) Annual Return Number of Affiliates Number of Contributors
1981
1982
1983
1984
1985
1986
1987
1990
1991
1992
1993
1994
1995
1996
291.82
12.7
1,400,000
NA
919.50
26.5
1,440,000
1,060,000
1670.24
22.7
1,620,000
1,230,000
2177.54
2.9
1,930,353
1,360,000
3,042.00
13.4
2,283,830
1,558,194
3986.09
12.0
2,591,484
1,774,057
4,883.07
6.4
2,890,680
2,023,739
5954.12
4.8
3,183,002
2,167,568
7,358.64
6.7
3,470,845
2,267,622
9,758.30
17.7
3,739,542
2,642,757
13,810.67
28.6
4,109,184
2,486,813
15,399.57
4.0
4,434,795
2,695,580
19,788.07
16.7
4,708,840
2,792,118
23,925.72
17.8
5,014,444
2,879,637
25,433.17
(2.5)
5,320,913
2,961,928
27,523.17
3.5
5,571,482
3,121,139
Source: Superintendency of Private Pension Fund Administrators.
On the issue of market efficiency and competition a similar argument can be
mounted that seemingly excessive or ineffective regulation puts an undue cost on
AFPs and the market for private annuities. Associated regulations, which relate to
the requirements for capital to enter the system, investment limitations, annual re-
turn requirements, and management fee limitations place an indirect cost on the as-
sociated affiliate and impact on associated competition among industry affiliates.
"The new system imposes minimum and maximum restrictions over the funds"
rate of return on pension investments, such that no AFP is permitted to earn 2 per-
cent more or less than the all AFP average. In addition, AFP commissions are sub-
ject to regulatory restrictions, including the requirement that commissions be levied
only on new contributions (and not on assets or returns). New entrants to the AFP
fund group are permitted, with minimum capital requirements for reserves set at
approximately US$120,000— $480,000 (in 1991$). Finally, the Chilean government
tightly limits AFP investments by specific asset class: the maximum allowable do-
mestic (Chilean) equity holding was 30 percent of the fund's portfolio, while the for-
eign equities cap was 10 percent (later Ufted to 20 percent), and government bonds
can constitute no more than 45 percent of the AFP portfolio." ^^
Conclusions
For the United States, one particular international model cannot be used as a
template for Social Security reform. Yet clearly the experiences of Australia, Chile
and the United Kingdom lend weight to the argument that Social Security reform,
through the use of individual retirement accounts, can be successful, based on re-
turns generated on individual retirement accounts but moreover through the har-
nessing of the individual rather than the state, in providing for one's standard of
living in retirement.
Today as in tomorrow individuals in Australia, Chile and the United Kingdom
will be exposed less and less to the vagaries of political risk associated with their
long term retirement "nest egg." Through providing the necessary infi"astructure, all
three countries are benefiting fi'om empowering their citizens to be proactive with
regard to their retirement savings and also minimizing the long-term liabilities
linked with the retirement of the baby boomer generation in the next century.
Mr. Herger [presiding]. Thank you very much. I want to thank
each of our witnesses for, I beheve, very interesting and positive
testimony. At a time when we have the incredible challenges we
hear facing us as a Congress for what we are going to do to help
preserve and save Social Security, I think it is exciting, for me any-
way, to hear some, I think, positive things that are going on.
Mr. Thompson, if I could ask you a question, if I could. State
Street Global Advisors has designed an administrative model for
12 Mitchell, O.S. & Barreto, F.A.: "After Chile, What? Second-Round Pension Reforms in Latin
America," NBER, Cambridge, United States, p. 4-5.
186
worker accounts that uses current treasury and Social Security
record systems. Bill Shipman of State Street testified to us that
costs for a private account using this system could be as low as
$5.00 a year. Are you familiar with these proposals? Do they allevi-
ate your concerns?
Mr. Thompson. I am not familiar with that particular proposal.
I am trying to lay concerns that you should worry about on the
table. If you collect money through the Social Security-IRS mecha-
nisms, you can keep the costs of collection down; you can do it
without imposing a lot of burden on employers.
Those are the pluses. The minuses are there is tremendous time
lags built in. You are not describing a system that looks like a
401(k) any longer. It is a system in which if I want my money
going into the S&P 500, I may watch the S&P 500 move up by 30
percent while I am waiting for the money to actually get there be-
cause it is sitting in some account some place waiting to be proc-
essed.
There is the time lag issue, and then there is the question of
once you get the money centrally processed who is going to actually
manage it? Now, the Swedes are trying a middle ground here in
which they process it centrally. They try to keep the administrative
costs down through central processing, but they allow people — or
they propose to allow people — to invest in any of a large number
of mutual funds. So there is a lot of choice.
The jury is out as to whether they can make that work. The first
challenge they will face is going to be to constrain the number of
mutual funds that register to participate to a manageable number.
The other option is the thrift plan model, where you have a cen-
tralized system in which the government decides which five indexes
are going to be used. We tell the worker this is all you can do, just
one of those five, and you have got all of these concerns about do
you trust the government. Do you trust them to vote the shares?
Do you trust them not to manipulate the holdings? Do you trust
them to put the money in the account on time?
I happen to trust the government but a lot of people don't, and
those are the kinds of things that you have to struggle with.
Mr. Herger. Well, I think the point that you brought up is one
that we certainly need to consider this year, this 2-year, this lag
time. Anyway, I felt it was very interesting.
On Mr. Shipman again, his testimony again during that pe-
riod
Ms. James. If I could just comment about State Street.
Mr. Thompson. Let me just underscore the point Estelle made,
and then I will give it to Estelle, and that is the thing that drives
the costs in so many of these programs is the marketing costs. The
first thing you need to do is to figure out how to organize the sys-
tem to keep the marketing costs from getting out of hand.
Ms. James. Right. I think in the State Street plan there would
be a competitive bidding process so marketing costs would be kept
down. And would be very little communication with workers.
One of the things that drives up costs in mutual funds is you can
pick up the phone and there is an 800 number. And I think that
is specifically excluded; that is, those costs are not included in the
State Street cost estimate.
187
If you wanted a bare-bones plan, that is what you would have
to do, you would have to eliminate a lot of the service that people
are now accustomed to. But, in fact, that is what you should do for
small plans. It wouldn't be economical otherwise.
I think in the State Street
Mr. Herger. How would we, for that year or 2-year period of
time, until they would reinvest it then, according to what the de-
sires of each individual is
Ms. James. Yes, you could — I think, after a certain period people
would be permitted to take their money out into a broader set of
options, but then they might incur additional costs which are not
included.
Mr. Herger. Right.
Ms. James. I think that would be the plan, to have a kind of base
level for everyone for small accounts and then the possibility of opt-
ing out at higher costs for other
people.
Mr. Herger. Anyone else care to comment on that?
Ms. James. Could I make an additional point that the one or 2-
year delay, we should remember, the one or 2-year delay in invest-
ing money only applies to the incremental money that has come in
each year.
So suppose the system has been in effect for 5 or 10 years, you
have a buildup of assets, and those are invested in individual ac-
counts. Those are not sitting in some account somewhere. It is only
the incremental amount that sits in a big pot, and that could be
invested in a large aggregate fund either in treasuries or in some
mixed portfolio, and everyone would then get a pro rata share of
that. So I think the one or 2-year delay on the incremental amount
is not as forbidding as it appears at first. There are ways of han-
dling that problem.
Mr. Harris. Can I just make an additional comment, just quick-
ly, on the experience of administrative costs and handling of ac-
counts in Australia? I think it is important to note that Australia
has 19.7 million individual accounts for a workforce of about 9 mil-
lion workers, and it is important to note that people say that indi-
vidual accounts can't operate but when I hear these statements I
cast mine back to when we were regulators and developing the sys-
tem. We envisaged that companies would become specific adminis-
trative costs or administrative companies. The Fidelities and the
Vanguards in the United States operate in Australia very effec-
tively and how they do it is they go into a company and say, we
will run your accounts for you at a very low, low cost. Today, ad-
ministrative costs companies are becoming very specialized with
very, very, very good technologies, and administrative costs are
going down, not up, in Australia. That is important to note through
economies of scale.
Mr. Herger. Thank you. I think it is also interesting to note
when Social Security began in 1935, in the early thirties, the ad-
ministrative cost was incredibly high then, I think even much high-
er percentage wise than what we are talking about here.
We have about 6 minutes on a vote.
Mrs. Clayton. I will retain my questions.
188
Chairman Smith. If you don't mind, we will recess, run over and
vote and come back and then Ms. Clayton will inquire.
Mrs. Clayton. What I will do is I will submit my questions. I
won't be able to return.
Mr. Herger. ok. Thank you. We will recess until the vote is
over and come right back. Thank you.
[Recess.]
Chairman Smith [presiding]. The subcommittee is reconvened.
Let me ask the witnesses, on your time schedule, what we have be-
fore us is three more 5-minute votes, which takes on the average
of 10 minutes a vote. Our original thought was we would adjourn
at about 1:30. Dan, Estelle, Larry, what are your schedules?
Mr. Crippen. Mr. Chairman, I have a 1:35 appointment based on
the earlier schedule, which I could probably change if you would
like me to.
Ms. James. I could stay until I become very hungry. You have
sandwiches? Then I can stay indefinitely.
Mr. Thompson. I can stay.
Chairman Smith. And Dave?
Mr. Harris. Yes, certainly.
Chairman Smith. Let me just throw out a couple of questions.
And Kurt or somebody, if you would keep track of the television
monitor and after they start the next 5-minute votes then give me
a holler and I will run over there.
Steve Entin, who is chief economist at the Institute of Research
on the Economics of Taxation testified last week that private ac-
counts could boost growth by as much as 10 percent. What is your
observation in other countries or what is your analysis, starting
maybe with you, Dan, and going down?
Mr. Crippen. Especially since Estelle has her mouth full. She
probably knows more about the answer to your question than any
of us here. Again, the report that I have referenced is only about
five countries, and in the case of Chile, the United Kingdom, and
Australia, it looks like national savings increased. As Estelle said
earlier in her remarks, at least in the case of Chile, there is some
preliminary evidence of increased economic growth. Nothing at the
moment suggests 10 percent or numbers like that. We are talking
about increases in net national savings of 1 percent and 2 percent,
but such increases are significant, depending, of course, on how
long the time frame is. Small amounts now add up to large
amounts later.
Chairman Smith. And maybe include in a different attitude
about the same question the significance of this kind of forced or
significantly encouraged private savings, the extent to which that
may reduce other savings and investment.
Mr. Crippen. I have to defer to my colleagues. Neither this re-
port, nor anything else I know of, speaks to that question. I don't
know whether it could induce additional savings. Again, the most
important thing, I think, that we all need to keep our eye on — and
most economists agree — is this: Does whatever we are trying to do,
reform of any kind, increase net national savings either by the gov-
ernment or individuals and, in so doing, boost economic growth and
give us a larger economy? That is the first and foremost question.
As far as other incentive effects are concerned, I don't know.
189
Chairman Smith. I hear you saying it might reduce other sav-
ings but probably there is going to be a net increase in overall sav-
ings with some kind of a government pension plan?
Mr. Crippen. It really depends, Mr. Chairman. If, for example,
you decided to set up individual accounts but the Federal Govern-
ment borrowed the money to do it, it would be a wash. You would
have, in theory, no effect on national savings. However, if you take
the surplus and set up private accounts, or if the government pays
down debt, there could be a positive effect. You recall that last
year, for the first time in a long time, we paid down some of the
debt held by the public, which resulted in an increase in net na-
tional savings right there. So there are any number of ways to
boost savings, but the increase has to be in the net, not just moving
money around.
Chairman Smith. Ms. James.
Ms. James. Yes. As I said before, in Chile there seemed to be an
increase in private saving. The mandatory saving apparently was
not offset by a decrease in voluntary saving. Of course, that doesn't
mean that that would be the outcome in the United States or some
other country.
For example, if the credibility of your retirement benefits became
greater, if people really expected the mandatory plan to bring
about greater retirement benefits because of the higher rate of re-
turn, this might induce them to cut back on private voluntary sav-
ing. On the other hand, in the U.S. people do so little private vol-
untary saving that I don't think this is a big concern.
The question of how the transition is financed is a key question,
as Dan said, because if you — because ultimately in order to in-
crease savings you have to cut someone's consumption. If we are
determined to keep Social Security benefits and other government
spending where they are and if we are going to have a carve-out
and not an add-on, then it is not clear where the extra saving
comes from.
The extra savings could come from having an additional t£ix to
fund the individual accounts or it could come from cutting back on
other government expenditures to finance the transition, or it could
come from saving the surplus if you think that otherwise the gov-
ernment would spend the surplus. Those are all ways that you
could have additional saving relative to what you would have with-
out the individual accounts. But ultimately it has to mean less pub-
lic or private consumption if you want to have more saving.
Chairman Smith. I am going to take the liberty of being some-
what exceptional here. Mr. Thompson and Mr. Harris, I am going
to ask also for your responses which will be on the record, and I
hope all the other committee members will review, and so if you
would also give your response to this question without anybody set-
ting up here except staff, and then we will be in recess for approxi-
mately another 10 minutes to finish these last two votes.
So with that, please excuse the impropriety.
Mr. Thompson. OK. Well, I would make a couple of points. First
the evidence about the impact on the economy is strongest with re-
spect to the impact on the growth of financial markets, and less
strong with respect to whether savings would be increased. Improv-
ing financial markets is a very important goal the transition econo-
190
mies and probably in many Latin American economies. It is not a
very important goal in the United States. We don't need to have
better financial markets to improve our economy.
The evidence is pretty good that savings have increased in Aus-
tralia. I think the Chilean evidence is somewhat more mixed about
whether the savings actually went up as a result of their pension
reform.
In the U.S., as Estelle says, it is all a question of what's the
package and what's the counterf actual. If the package is that the
Federal budget surplus will be distributed to individual accounts
and the counterfactual is that it will be used to cut taxes, there is
a good chance of producing more savings. Most of the increase in
savings is going to come from people who are asset constrained —
lower-income people who don't have very many assets. The money
will go into their individual account and they don't have any way
to offset it, so they will end up having more savings. The higher
income people can adjust their portfolios rather easily and are
probably not going to increase their savings as much. So whether
you have increased savings or not is going to be a question of
what's the counterfactual.
If the alternative is a tax cut or something else that wouldn't in-
crease savings, you will get some increased savings. You will get
it mostly among lower wage workers. The amount that you are
talking about probably isn't very great if you are talking about ac-
counts that start with 2 percent of contributions and it is only the
lower half of the income distribution that is likely not to offset it
by adjusting their other portfolios.
Mr. Harris. I think it is important to consider with regard to the
experience in Australia that back in 1983 the assets in super-
annuation retirement accounts were 32 billion in Australian dollars
in 1993. Today, they stand, as of the of December, at $377 billion,
certainly a significant shift. The reality is that individuals are sav-
ing more for their retirement.
I think the challenge, though, that has been encountered in Aus-
tralia has been the shift of savings from bank accounts to more
long-term retirement vehicles, and certainly that shift of flow of
funds has caused some concern certainly in the banking sector in
terms of how they can adjust their practices, and more importantly
banking these days has involved a complete suite of financial serv-
ices.
What is important also to note in the Australian experience was
the strong and aggressive development of the capital markets back
in 1983, and certainly in the mid-eighties the capital markets with-
in Australia was relatively small and limited. Today, it is very ag-
gressive with major U.S. players, Merrill Lynch and other provid-
ers. Vanguard and Fidelity, entering the market and being very ag-
gressive in providing services.
I think the challenge obviously with regard to savings is also on
the national level Australia has, like the United States, been a na-
tion traditionally that doesn't save a heck of a lot of money, and
more importantly what you are seeing is that the government is re-
lying increasingly on the superannuation saving to do funding of
infrastructure and privatization programs.
Thank you.
191
Ms. James. I could just add that when I look at the various pro-
posals that are floating around in the U.S., and many of them in-
volve the use of the surplus to finance the transition to individual
accounts, I think what is motivating many of the supporters of
those plans is the presumption that if you didn't put that surplus
into individual accounts the money would either be used to cut
taxes or to increase government expenditures. Relative to those two
alternatives — that is if the surplus were used either to cut taxes or
increase government expenditures on the one hand or if they were
saved in individual accounts on the other hand — then you would
get more saving if the money went into individual accounts.
I think that is the reasoning that lies behind some of the propos-
als that have been made in the U.S.
Chairman Smith. The Task Force will reconvene. Please accept
my apologies. We are unusually loaded with votes for a Tuesday
afternoon, and Mr. Dan Crippen has agreed to respond to written
questions.
It seems to me that, Mr. Harris, at the end of your written state-
ment you raise the issue of reduced political risk of private ac-
counts. Do you feel that this reduced political risk has compensated
for the assumption of market risk in the countries you studied?
Mr. Harris. Yeah. I would like to respond to that and tell you,
yes, I think clearly the concern, obviously, that has taken place, for
example, in Germany, France is that in the long term that people
are making retirement provisions at the moment under a system
where, say, they are going to be retiring on 70 percent of their final
salaries.
It is likely that the government will have to do two things: one
is to cut benefits by a number or increase taxes by a certain per-
centage, and it is the same dilemma that politicians have con-
fronted in this country, whether it be cutting benefits by 25 percent
or increasing taxes by 30 percent.
I think the challenge that Australia faced politicians, in talking
to politicians while a regulator, was that they felt that the political
risk was largely being devolved out, that is, that under the current
system, while politicians can alter the regulations and the overall
structure of the system slightly, generally the market risk would
now, if you like, be more closer aligned with the individual.
Now, what that has meant in Australia is the real rates that re-
turn on average in 1997 was something like over 12 percent, about
12.2 percent; and market failure with regard to individual retire-
ment accounts has largely been minimized in Australia through ef-
fective regulation.
So, in summary, I think what is, I think, relieving for an Aus-
tralian is to know that their retirement responsibility is largely en-
gaged with a financial firm, whether it be a life insurance company
or a mutual provider, rather than being tied to the whims of politi-
cal change possibly, as being confronted by a Frenchman or some-
body living in Germany, for example.
Chairman Smith. In terms of other countries using their retire-
ment pension program safety net, if you will, as a welfare program,
give me your analysis of what other countries are doing in this re-
gard.
192
Mr. Harris. Sure. I think with Austraha what is important is to
make a distinction with the U.S. program — is that the old-age pen-
sion or the first pillar is essentially a welfare payment, that is, it
is a flat rate 25 percent of that whole total average weekly earn-
ings, which is means-tested through income and assets.
What is important, I think, is the long-term projected future
state pending for the pensions programs in Australia, for example,
is a percentage of GDP. Currently it is about 2.6 percent of GDP.
By 2040, 2050 it will be about 4.3 to 4.5.
Now, that compares to, say, the United States at about 7.1, 7
percent; but if you look at the programs, compare it, say, to Ger-
many or France who don't look at their first pillar as welfare, it
is mainly as income or placed under a pay-as-you-go system, the
numbers get very, very frightening.
For Germany, for example, by 2050 the projections are by the
OECD that it will be 17.5 percent of their GDP will be consumed
by future state spending on pensions.
Chairman Smith. Excuse me. That represents 45, 50 percent of
wages?
Mr. Harris. Basically it is 17.5 percent of their GDP as a per-
centage will be consumed in state spending on their pensions, on
their first pillar.
Chairman Smith. And do you have a feel how that relates to
wages, anybody?
Mr. Harris. Obviously, what is happening
Chairman Smith. There is a percentage of wages?
Mr. Harris. In Germany and France, for example, the social
costs of, say, hiring a worker in Germany, for example, the social
contribution costs are about 22 percent. So if you hire a worker,
say 100,000 U.S., you are going to have to make contributions of
roughly 42,000 into the social insurance programs.
Chairman Smith. Let me get Ms. James's and Mr. Thompson's
reaction to using general funds to progress more if it is to the ex-
tent that it becomes more of a welfare program.
Ms. James. Well, I think that you have to make a basic distinc-
tion, basic choice, about whether you want to have one contribution
that does both the redistribution and the savings part of old-age se-
curity or whether you want to split those two; and many of the re-
forming countries have split them and they have a first pillar that
is largely redistributive and a second pillar that handles people's
individual accounts.
Whether you are looking at the Latin America countries or most
of the OECD countries, they have this split; and often some of that
first pillar is financed out of general revenues.
In the case of Chile, the first pillar is just a minimum pension
guarantee that goes to people who haven't accumulated enough in
their second pillar.
In Argentina, everyone gets a flat benefit. Everyone who has
worked for 30 years gets a flat benefit that is about 25 percent of
the average wage.
Now, in some of these countries you do use general revenue fi-
nance. General revenue finance is actually more redistributive than
getting the money from a contribution because it has a much
broader tax base. It is more distributive and would generally be
193
considered less distortionary because you don't have a high tax lev-
ied against payroll. Instead, you have a much lower tax rate levied
against all income, and this is a very broad tax base.
This would require a much larger revamping of the U.S. system
than is being considered in most of the proposals here, but you
could make a good economic argument for that.
Chairman Smith. Mr. Thompson.
Mr. Thompson. Economists have always liked the approach of
separating the insurance aspect and the redistribution aspect, but
the rest of the population has never been quite so interested in
that approach.
This is a philosophical issue. The Australians have had a long
tradition of running a means-tested program in which many people
participate. They accept that a majority of the aged population will
get benefits, and 60 percent of the population participates, and no-
body thinks that there is anything particularly wrong with that.
In the United States, means-testing has a different feel to it.
Traditionally, it was deemed that something was wrong with you
if you have to turn to a means-tested program; there was a fair
amount of looking down your nose at the situation.
We have responded to that philosophical position by basically
trjang to assure that if somebody worked all their life, when they
reach retirement they would get a decent income — a poverty line
income or an income a little bit above the poverty line — without
having to turn to a means-tested program.
Currently in the U.S., if you work for 30 years at the average
wage, you will get a Social Security benefit that keeps you above
the poverty line, although not a whole lot of above it. You and your
widow won't have to turn to SSI. One could make the system some-
what more efficient by reducing the Social Security benefit and
having SSI come in as an offset to pick up more of the income sup-
port load.
The most important single thing to worry about, though, is
whether that is the way you want to treat old people who have
worked all their lives.
Ms. James. When we think about the Australian means test, it
is important to realize it is not a means test for a small proportion
of the population. It is a benefit that the majority of people qualify
for. Only the top one-third of people do not get that benefit.
So it really excludes the upper third, rather than simply includ-
ing a small group; and furthermore, the house that you own is not
counted as part of that means-and-asset test. So it is really geared
to benefit the large middle class, and that is part of the reason why
it gets broad support in Australia.
Chairman Smith. So, Mr. Harris or Ms. James, what is the per-
centage of retirees that are going to retire next year that would be
eligible for the fixed-benefit Australian program?
Ms. James. Oh, about two-thirds of them.
Chairman Smith. Pardon?
Ms. James. About two-thirds.
Mr. Harris. I think it is slightly higher at the moment. It is
about 71 percent. I think what is important to note is long-term as-
pects of this. As people's superannuation or retirement accounts
are increasing, their eligibility for this old-age benefit is declining.
194
So, in other words, the long-term projections by the common-
wealth treasury are that the actual cost of the public spending as-
sociated with the old-age program will be largely contained. It will
increase slightly, but if they hadn't brought in the mandated super-
annuation program, bumping up people's assets, it would have
been pretty much a runaway expense on the budgetary process.
Ms. James. That is probably one of the reasons why they added
this mandatory retirement savings account, in order to contain the
future government expenditures on the means-and-asset tested
benefits.
Chairman Smith. I have been suggesting, and I would ask you
to evaluate the truth of this, is that the quicker that the United
States deals with reforms of our Social Security program so that
we don't end up being in the kind of situation that we now see
Japan or a lot of Europe, the more economic competitive advantage
we will have over these other countries. Can you react to that
statement?
Mr. Harris. I would maybe like to jump in and say that certainly
I think that is a very valid point. The analysis Watson Wyatt
Worldwide are doing currently in an international study with one
of my colleagues, Dr. Syl Schieber, on this issue, looking at 24
countries, we are looking in the future where the large global in-
dustry companies, for example, the GEs, the IBMs will have to
make an effective decision where they allocate their capital, and
the question will be asked where are the flexibility and the state
Social Security programs.
I think, clearly, the international competitiveness of some coun-
tries, like Italy, where by, say, 2040, 2050, the figures I have that
they are going to be dedicating 21 percent of their GDP toward
state pension payments, the question has to be asked whether that
will be sustainable. And that compares to, say, Australia at the
same time of 4.3 percent and the United States at 7.1 percent.
Japan, of course, is 14.9 percent.
So, clearly, the question would have to be asked are global indus-
try participants going to be seeking nations or countries that are
globally competitive with regard to employee remuneration and
benefit generation.
Ms. James. Yes. If we move toward funding sooner that means
that contribution rates won't have to rise as far or as fast as they
would have to rise otherwise.
Now, if contribution rates go up, one of two things can happen:
either workers' take-home pay will go down, that is, workers will
absorb that whole increase of the contribution rate by having lower
wages— that won't make the workers of the future very happy — or
if wages don't immediately bear that full burden, employers will;
and that means employers' labor costs will go up, and they will be
less interested in employing American workers.
Just as a current example, when I was in Berlin a couple of
years ago and Berlin was under reconstruction, there was a lot of
employment there, but the jobs were not being done by Berliners.
Instead, Berliners were unemployed.
In East Berlin there was a very high unemployment rate yet
workers were being brought in from Portugal, Spain, and Poland
because of the high social insurance costs that could be avoided by
195
importing workers. That gives you a very dramatic example of hov^^
employers do respond to higher labor costs.
Mr. Thompson. Let me just say that it depends a whole lot on
how you resolve this issue. There are some proposals that are float-
ing around which would make matters worse, I think.
Proposals which create huge government guarantees, I think,
should be looked at very carefully. They're mortgaging the future
by betting that the stock market will continue to rise at some fairly
rapid rate. They're mortgaging the future treasury by saying that
no matter if the market goes sour, the government will pay you off
anyway. I don't think that is going to help anybody's international
competitiveness. That is a foolish idea.
So settling this in a way that everyone believes is a fair way, a
way that preserves some work incentives and a way that probably
deals forthrightly with the fact that if people live longer, they are
either going to have to work longer or else they are going to have
to put more away each year they do work and doesn't try to sweep
that away under the rug through some shell game with the stock
market — settling it in a responsible way is going to help. But pa-
pering over the problem by moving a lot of money around and hop-
ing nobody noticed that its all a shell game, and creating a guaran-
tee out there that in 2020 the Secretary of the Treasury may have
to find billions of dollars to write checks that nobody bothered to
cover, that isn't going to help.
Chairman Smith. Couple of illusions that disturb me greatly.
One is that as the economy expands, somehow that is going to
solve Social Security in this country. To the extent that we have
benefits based on wage inflation rather than traditional inflation,
that is just not true in the long run.
Ms. James. Growth is good for workers, and it is good for pen-
sioners; but it is not going to solve the Social Security problem.
Chairman Smith. I am frustrated with my dealings with some of
the strong senior organizations such as AARP that are just so con-
vinced that they don't want to do anything to the pay-as-you-go
fixed-benefit program because they like the illusion of security. And
have any of you got any suggestions how to get a message out to
seniors that that security is illusionary?
Ms. James. I don't know. There is actually an interesting paper
by someone named John McHal^ at Harvard University, where he
has calculated the changes in Social Security wealth in a number
of different European countries just due to changes in the pension
formula, which gets back to the political risk issue that you raised
before. And he shows that there have been substantial changes in
people's Social Security wealth simply by, a vote of the legislature.
Mr. Thompson. I say, this part of the conversation depresses me.
A few years ago there was a realization that we are going to live
longer and we are going to have to make painful choices about how
to adjust to longer lifespans. Unfortunately, in the last couple of
years, the voices that are selling something for nothing seem to
have risen to be louder than anybody else's. As long as others claim
to have a plan that doesn't cost anything and guarantees current
law benefits off into the future, why should the AARP have a de-
bate and discussion about raising the retirement age or cutting
196
benefits or raising contribution rates. That is the unfortunate part
of this poHtical debate right now.
Chairman Smith. Are there any other countries in the world that
are going to a pay-as-you-go program?
Mr. Thompson. What do you mean "going" to one?
Chairman Smith. That are changing from some kind of a fixed
contribution to go to a guaranteed benefit? To my
knowledge
Mr. Thompson. No one that I know of went to a pay-as-you-go
as a conscious decision. Usually, they start off with partial funding;
and it sort of dissipates for one reason or another.
Countries that go to individual accounts soon start to build in
guarantees.
Everybody starts building in guarantees. Now, if you have a sys-
tem in which there is a fairly reasonable base, that is a defined-
benefit base, then the temptation to build guarantees is less. But,
the more you rely on some kind of a defined-contribution individual
accounts for the retirement income, the more the political pressure
is to have the government guarantee some minimum income or
minimum return or something like that. Guarantees like this are
another thing I would urge you to try to avoid getting involved in.
Chairman Smith. Let me ask each one of you to finish up with
a closing statement of a couple minutes, and then I think we will
adjourn. Mr. Harris, starting with you.
Mr. Harris. I think, just to add some closing comments, I think
it is important, obviously, to consider with regard to Social Security
the examples or the experiences that other countries are facing
today.
The United States' trading partners, whether it be Italy, Ger-
many and France, are certainly in the grips of an enormous prob-
lem, probably more of a dilemma than the United States finds
itself. The challenge that the United States does have, though, or
the advantage, is it is discussing or debating these issues.
In France, Germany and in countries, say for example, Sweden,
there is a, if you like, a strong inertia, can we take on, can we re-
form this system, this is our right.
I think to add to your comment about the AARP, one thing that
was very important in Australia was the generational impact. The
future generations effectively, if you don't reform a pay-as-you-go
system, are going to somebody has to eventually pay; and the poli-
ticians that I would talk to in Australia, and certainly in the
United Kingdom, they feel benefit in that they are seeing the sys-
tem developing such that the individual is playing a greater role
in shaping their retirement futures rather than state.
And I think that is the theme I would like to leave you with is
that the politician is there to build the infrastructure, the system,
whereby the individual can be empowered to greatly shape their fu-
ture destiny in terms of retirement, but at the same time don't
avoid the requirement to provide a basic safety net or basic re-
quirement for people with retirement needs in the future.
Chairman Smith. Mr. Thompson, do you have a comment?
Mr. Thompson. Just to reiterate that these are very complicated
systems that get built, and people can design all kinds of theoreti-
cal structures. You need to be very careful in that in analyzing
197
those structures, because if you buy into one of these, you are put-
ting your name on how it is going to operate.
And the experience around the world is that there are very seri-
ous tradeoffs, and there are compromises that will have to be
made. The political process is one which makes the compromises
but tends to oversell the result. And now you are over selling in
a program which is a very popular program that lots of people are
going to be watching, and I don't think you want to be in a position
of telling people you have designed a system which, when they look
at it, they say we don't like this system.
So be careful and look closely at the details of what you are de-
signing and how it is going to work.
Chairman Smith. Ms. James.
Ms. James. OK. Four points: first of all, we do see that countries
around the world are reforming and it is still spreading from Latin
America, the OECD countries, now Eastern Europe is reforming.
So, you know, there is a movement toward prefunding, toward de-
fined-contribution plans as part of the system; and I think we can
learn both from the successes and the problems of those systems.
So that is point number one.
Point number two is I think we have an increasing consensus
among economists and among policy makers that some degree of
prefunding is desirable in a Social Security system. When we first
published averting the old-age crisis in 1994, that was a kind of
controversial idea; and I would say it is not very controversial right
now.
I think that the whole world of academics and policy makers has
moved to recognize that prefunding is important for the economy
as a whole and for the old-age systems as populations age. So it
is important because it is a mechanism of increasing national sav-
ings and keeping contribution rates relatively level and sensitive to
the aging of the population. So that's point number two.
Point number three is once you have funds, you have to decide
how you are going to invest those funds, who is going to have con-
trol over those funds. And the advantage of putting the funds into
individual accounts is that it insulates you somewhat from political
manipulation of the funds.
Of course, this is very controversial here in the U.S. My own per-
sonal, purely personal, opinion is that if you have centrally man-
aged funds, it is impossible to totally insulate it from political ma-
nipulation; but that is— people will differ on that judgment, and
that is a very key issue that you have to think about.
Now, point number four is if you decide to have individual ac-
counts, in order to avoid that political manipulation, then you have
to think very carefully about how to set up the accounts so as to
keep administrative costs low while still preserving some degree of
choice and incentives for good performance. That is your job.
Chairman Smith. Thank you very much, and for your informa-
tion. As chairman of this Task Force, I send a synopsis of each of
your comments to the 435 Members of the House. So, again, thank
you very much for giving some of your time. Again, my apologies
for the in and outs of our votes this morning, but thank you all
very much.
198
Congressional Budget Office Letter Dated June 24, 1999,
Submitted for the Record
Congressional Budget Office,
U.S. Congress,
June 24, 1999.
Hon. Nick Smith,
Chairman, Task Force on Social Security, Committee on the Budget, U.S. House of
Representatives, Washington, DC.
Dear Mr. Chairman: The Center on Budget and Policy Priorities (CBPP) recently
prepared a critique of my testimony on Social Security reform in other countries,
which was presented to the House Ways and Means Committee on February 11,
1999. CBPP distributed its paper at the hearing before the House Budget Commit-
tee's Task Force on Social Security on May 25, 1999, at which I testified. Because
I did not receive the paper in time to comment on it then, I request that this re-
sponse be included in the record.
The Center's report concludes that the experience of the countries, examined in
the Congressional Budget Office's (CBO's) paper Social Security Privatization: Expe-
riences Abroad (January 1999), has little relevance to the United States — yet iron-
ically, it cites the virtually identical experience of this nation. The CBPP report also
makes a case for examining more mature, industrialized nations but provides no
such examples. The paper claims as well to offer proof that Social Security surpluses
have heretofore been saved, presenting a hypothesis that it does not prove — in fact,
the evidence suggests the opposite.
The retirement of the baby-boom generation, which dramatically lowers the ratio
of workers to retirees, will challenge us to improve the solvency of our retirement
programs. Policjonakers have proposed a variety of possible reforms ranging from
funding our traditional Social Security program to relying on private accounts.
There is tremendous uncertainty about how Social Security reform proposals would
work in practice and how they would affect the economy — two central questions in
evaluating any such plan.
In attempting to answer those questions, it is natural to ask what can be learned
from other countries and from our own history. Unfortunately, the lessons are not
always clear. Not only is the past hard to interpret but each country's experience
has unique features. As I observed in my testimony, "The economies and pension
systems of those countries [specifically, Chile, the United Kingdom, Australia, Ar-
gentina, and Mexico] differ considerably from those of the United States' and "com-
parisons should therefore be made cautiously."
My testimony, which focused on experiences abroad, included a simple observation
drawn from CBO's January 1999 analysis: none of the five countries CBO studied
successfully maintained permanent prefunding of their government-run, defined
benefit pension systems, although four of them expressly intended to do so. The
United States' experience with prefunding, which was outside the scope of my testi-
mony, is consistent with that finding. As the CBPP paper noted, the Social Security
program in this country was originally set up as a funded system, but the goal of
building large reserves was soon abandoned in favor of pay-as-you-go financing.
CBPP argues that it is understandable that a new retirement system would have
trouble building up balances in the early years. Although that observation seems
empirically correct, it misses two crucial points that the experience of the other na-
tions indicated above. First, those countries explicitly intended to create prefunded
trust funds — and actually began the process. Nevertheless, they ultimately failed in
their objective.^ Second, after they established their retirement systems, the coun-
tries did not later convert them to prefunded systems. In general, the demographics
(that is, the ratio of workers to retirees) were far more favorable to prefunding in
earlier decades than they are today; in the future, the demographics will continue
to worsen with the retirement of the baby boomers.
One interpretation of those facts is that it could be difficult to prefund the U.S.
Social Security program within its current framework. Despite projections that cur-
rent-law Social Security revenues will exceed benefits until 2014, some observers be-
lieve that pressures will inexorably mount to use the resulting Social Security sur-
pluses for either tax cuts or additional spending. That view has some currency at
many points along the political spectrum, and the Administration seems to share
those concerns. Indeed, the President recommended as part of his framework for re-
form that the proposed transfers from the general fund to the Social Security trust
1 The history of the United Kingdom is actually more robust than the CBPP paper suggests.
The U.K. started with a pay-as-you-go system, then tried to convert to partial funding — only to
return to the pay-as-you go model.
199
funds be recorded as outlays. That proposed change in budgetary accounting would
redefine — and reduce — the size of the measured unified budget. In the Administra-
tion's view, the redefinition would limit temptations to spend the surplus. Congres-
sional interest in establishing a Social Security "lockbox" arises from precisely the
same concerns about the hkely failure to save the Social Security surpluses.
In that context, the CBPP critique raises an interesting issue that I did not dis-
cuss in my testimony: how to interpret what happened after the 1983 amendments
to the Social Security Act. A review of recent fiscal history suggests that the sur-
pluses that accumulated in the Social Security trust funds were spent on other
items in the budget. (Although that is hterally true, the result could be indicative
of higher spending or lower taxes than would otherwise have been the case.)
Indeed, after adjusting for the effects of the business cycle, the unified deficit in
the next 12 years remained higher than it was in 1983. According to CBPP's hypoth-
esis, by realizing the trust fund surpluses, the government should have reduced,
rather than increased, the adjusted unified budget deficit. Yet as the Social Security
surpluses grew, even without adjustment the unified deficit fluctuated with no ap-
parent relation to the trust funds. Since 1983, the Social Security surpluses have
been spent on other programs, and the government accumulated debt, not assets.
And at least through the last fiscal year, at the same time that the Federal Govern-
ment has been collecting historically high revenues, an on-budget deficit remains —
because we are still using some of the Social Security surplus to finance the rest
of the budget.
Although alternative explanations are possible, the coincidence of U.S. history and
that of other countries raises legitimate concerns about the potential difficulties of
prefunding Social Security. CBO's January 1999 paper was limited to five countries
that have "privatized their retirement systems." Although there may be examples
of "western, industrialized countries with mature retirement systems" (other than
the United States and the United Kingdom, whose efforts failed) that have success-
fully prefunded their retirement systems, CBPP does not provide them in its cri-
tique.
I hope this letter clarifies the issues noted above. Feel fi-ee to call me if you have
any questions.
Sincerely,
Dan L. Crippen,
Director.
[Whereupon, at 2 p.m., the Task Force was adjourned.]
The Social Security Trust Fund: Myth and
Reality
TUESDAY, JUNE 8, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12 noon in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Chairman Smith. The vote is over. The Budget Committee Task
Force on Social Security will come to order.
I will give a statement, and then, Lynn, if you would like to
make some comments, and then we will proceed with our witnesses
today.
I ran to make the vote. Excuse me a minute.
The problems facing Social Security as our society ages are, I
think, much better known today certainly than they were 2 or 4
years ago. We on this Task Force have been studying the pressures
on its pay-as-you-go financing system and various options for modi-
fying and strengthening it. Today, the Task Force directs its atten-
tion to the Social Security Trust Fund.
The Social Security Trust Fund has existed as an accounting en-
tity since 1937. The government credits it when payroll taxes ex-
ceed Social Security payments and debits it or comes up with other
creative financing when benefits exceed taxes. It was created to
keep track of all of the funds that the government collected for So-
cial Security benefits.
The 1983 reforms, however, changed the role of the Trust Fund.
At that time Social Security stood on the brink of default. In re-
sponse. Congress passed the recommendations of the so-called
Greenspan Commission, which included a payroll tax increase, the
taxation of some benefits, an increase in the retirement age as well
as some other changes. The higher payroll tax caused money to
come in very quickly to Social Security and ultimately dramatically
expanded the so-called Trust Fund to the point that the Trust
Fund now stands at more than $740 billion for Old Age Survivors
and $92 billion more for disability insurance. We must find an ef-
fective way to hold and pay back this enormous sum of money for
the retirement of the baby boom and future generations.
It is in this role that the Trust Fund could fail. It cannot work
because it holds no independent assets. Though the Trust Fund is
backed by government securities, these have a different meaning
than they would in a private account for you or me. If I hold a gov-
(201)
202
eminent bond, I have an asset that the government will give me
money for or that I can sell at any time. If the government holds
a bond on itself, however, its obligation to give itself money is
somewhat meaningless. The government cannot make these bonds
good, as needed in 2014, except by borrowing, reducing other ex-
penditures or increasing taxes.
Clearly the Trust Fund means less than the public imagines. But
what does it mean? Does it exist? Can Americans depend on it?
Some, including the AARP, have said that the Social Security is
OK until 2034. But what will the government have to do to honor
the Trust Fund beginning in 2014?
I think as a heads up, we should look at what happened to the
Highway Trust Fund when the highway bill was redrafted, and ap-
proximately $22 billion of the Highway Trust Fund money was
written off.
[The prepared statement of Mr. Smith follows:]
Prepared Statement of the Honorable Nick Smith, a Representative in
Congress From the State of Michigan
The problems facing Social Security as our society ages are well known. We on
this Task Force have been stud3ang the pressures on its pay-as-you-go financing sys-
tem and various options for modifying and strengthening it. Today, the Task Force
directs its attention to the Social Security Trust Fund.
The Social Security Trust Fund has existed as an accounting entity since 1937.
The government credits it when payroll taxes exceed Social Security payments, and
debits it when benefits exceed tgixes. It was created to keep track of all the funds
that the government collected for Social Security benefits.
The 1983 reforms, however, changed the role of the Trust Fund. At that time. So-
cial Security stood on the brink of default. In response, Congress passed the rec-
ommendations of the Greenspan Commission which included a payroll tax increase,
the taxation of some benefits, and an increase in the retirement age. The higher
payroll tax caused money to come rushing into the Social Security Trust Fund, to
the point that the Trust Fund now stands at more than $740 billion for Old Age
Survivors and $90 billion more for Disability Insurance. We must find an effective
way to hold and pay back this enormous sum of money for the retirement of the
baby boom and future generations.
It is in this role as a savings account that the Trust Fund could fail. It cannot
work because it holds no independent assets. Though the Trust Fund is backed by
government securities, these have a different meaning than they would for you or
me. If I hold a government bond, I have an asset that the government will give me
money for or that I can sell at any time. If the government holds a bond, however,
its obligation to give itself money is meaningless. The government cannot make
these bonds good, as needed in 2014, except by borrowing, reducing other expendi-
tures or taxing citizens.
Clearly, the Trust Fund means less than the public imagines. But what does it
mean? Does it exist? Can Americans depend on it? Some, including the AARP, have
said that Social Security is OK until 2034. But what will the government have to
do to honor the Trust Fund beginning in 2014?
These are our questions for today. I look forward to our witnesses' presentations.
Chairman Smith. Anjrway, our questions today relate to the
Trust Fund. I look forward to our witnesses' participation, and,
Lynn, would you have a comment?
Ms. Rivers. No, Mr. Chairman.
Mr. Bentsen. If I might, I don't have a comment, but I would
like to welcome J. Kenneth Huff, Sr., of Whitesboro, Texas, who
will be testifying today. He is the vice president for finance on
AARP's board of directors and previously acted at the national sec-
retary/treasurer of the association. Mr. Chairman, I just think that
of all of the moves that you have made, this may be one of the best
moves in having him testify. I welcome Mr. Huff.
203
Chairman Smith. Certainly, I am not sure who is responsible for
having this great Texas weather up here in Washington.
Mr. Bentsen. It is actually cooler in Texas.
Chairman Smith. Our other panelist is David Koitz, a specialist
in Social Security legislation, education and public welfare for the
Congressional Research Service. David has been working with CRS
for 20 years and has become an expert on Social Security.
So with that, Ken, do you want to go first?
Mr. Huff. It doesn't matter to me.
Chairman Smith. Mr. Huff, why don't you go first with your tes-
timony? All testimony will be included in the record, so if you could
hold it to approximately 5 or 6 minutes and then be available for
questions, that would be appreciated.
STATEMENT OF J. KENNETH HUFF, SR., VICE PRESIDENT FOR
FINANCE, BOARD OF DIRECTORS, AND SECRETARY/TREAS-
URER, AARP; AND DAVID KOITZ, CONGRESSIONAL RE-
SEARCH SERVICE
STATEMENT OF J. KENNETH HUFF, SR.
Mr. Huff. Thank you, Mr. Chairman and, for your kind remarks,
Congressman Bentsen.
I am a volunteer. I am a member of the AARP board of directors.
I am vice president of and still secretary/treasurer of the associa-
tion. I live in a little town called Whitesboro, Texas, 3,250 people,
in north central Texas, and we have a lot of Social Security recipi-
ents in that area.
AARP appreciates the opportunity to present its views regarding
the Social Security Trust Fund. We know there is widespread con-
fusion about the Social Security Trust Funds. This confusion that
we have erodes public confidence in our Nation's primary income
protection program and undermines the national consensus about
strengthening the program for future generations.
The System is not in or near crisis. The Social Security trustees
show that if no changes are made, the program could pay full bene-
fits on time until 2034. That is a 2-year improvement from 1998
and 5 years longer than estimated in 1997.
Today the Trust Funds have a reserve of $850 billion. The FICA
taxes, which workers and their employers pay in, are credited to
specially designated Trust Funds in the Federal Treasury. After
Social Security benefits and administrative benefits have been
paid, any remaining money is invested in special issue government
securities. Special issue bonds are redeemable prior to maturity.
These securities, which are in essence a loan from Social Security
to the government, are similar to the bonds issued by the Treasury
and are backed by the full faith and credit of the government.
If Social Security did not have reserves to lend the Treasury, the
government would have had to reduce other expenditures or find
alternate sources of funding such as higher taxes, or issue addi-
tional debt. The government in times of deficit utilizes the funds
that it receives from selling bonds to Social Security and other in-
vestors to help pay expenses. As we begin to move toward budget
surpluses. Social Security's annual surplus would not be needed for
204
government expenditures. Instead it would automatically be used
to pay down the national debt.
The Trust Funds have more revenue than is needed for benefits
through 2013. Beginning in 2014, Social Security expenditures will
exceed incoming revenue, and interest earnings will be needed to
honor currently promised benefits. The government would need suf-
ficient revenue to pay Social Security's interest earnings just as it
needs sufficient funds to pay any holder of government bonds.
Starting in 2022, incoming revenue and interest earnings will not
fully cover benefits, and the Trust Funds' reserve will be drawn
down until it is exhausted in 2034. Even without any Trust Fund
assets, incoming revenue will fund over 70 percent of the benefits
thereafter.
Social Security's investment policy has been characterized as a
raid on the Trust Funds and the bonds described as worthless
lOUs. However, this is not so. Mr. Chairman, Chairman Bill Ar-
cher stated in a November 20, 1998, interview with AARP's Bul-
letin staff, and let me quote, he said, "We are talking about a So-
cial Security system that is not projected to run out of money for
34 years. All of the Social Security payroll taxes immediately go
into government bonds, and those government bonds are the safest
investment in the world. That money could never be used for any-
thing but Social Security benefits."
That is the end of the quote. Mr. Chairman for the record, I have
his complete interview that he gave to us at that time.
The Social Security Advisory Board noted that Congress has
never allowed the Social Security program to reach the point that
benefits could not be paid, and it is not expected to in the future.
AARP believes that it would be prudent to act sooner rather than
later. We need to move beyond a discussion of whether Social Secu-
rity first faces financial difficulty in 2014 or 2034 or whether the
Trust Funds hold worthless lOUs. Rather on the eve of the 21st
century, what really counts is that we make the necessary deci-
sions to put Social Security on sound financial footing for the fu-
ture. This solution should maintain the program's guiding prin-
ciples, ensure income adequacy, and achieve solvency in a fair and
timely manner.
AARP looks forward to working with our elected officials on a bi-
partisan basis to ensure Social Security's continuing role as a foun-
dation of income security for current, as well as future, bene-
ficiaries.
This, Mr. Chairman, concludes my testimony.
[The prepared statement of Mr. Huff follows:]
Prepared Statement of J. Kenneth Huff, Vice President for Finance,
American Association of Retired Persons
AARP appreciates the opportunity to present its views regarding the Social Secu-
rity trust funds. Our own experience, supported by pubUc opinion polls, suggest that
there is widespread confusion about the size and use of the trust funds. As our elect-
ed officials broaden their dialogue with the American people about the Social Secu-
rity program and its future, AARP hopes for improvement in the public's under-
standing of the role the trust funds play in financing current and future benefits.
This information could increase confidence in the system as well as help forge public
consensus about ways to strengthen the program for the long-term. We encourage
Congress and the Administration to continue their efforts to move forward on Social
Security solvency legislation. Prompt action means we can adopt more incremental
205
solutions and gradually phase-in any changes, with adequate lead time for those
now working.
While the program faces a long-term challenge, it is not in crisis. Social Security's
trust funds have a reserve of $850 billion, which is invested in special issue, govern-
ment securities. These securities earn an average interest rate of over 7 percent.
AARP believes it would be prudent to adopt a long-term solvency solution now when
Social Security is building a sizable reserve for the future.
I. Public Opinion and the Trust Funds
Any discussion about Social Security should be grounded in a solid understanding
of the program, its financing, and the impact on the American people and their fam-
ilies of any changes to the program. Social Security is designed to protect workers
against "the hazards and vicissitudes" they might face if they were left solely re-
sponsible for their own and their family's financial security upon the retirement,
disability, or death of a breadwinner. The program provides a near universal, de-
fined benefit that serves as the income base to which workers can add an employer-
provided pension, as well as personal savings.
Public opinion polls consistently demonstrate that Americans of all ages strongly
support Social Security and believe society should honor the long-term benefit com-
mitment to people when they retire. Many people, particularly younger workers,
lack confidence in the program's long-term viability. Their lack of confidence reflects
concerns directly related to the program, such as the notion that the trust fands
have been "raided," as well as concerns that have less bearing, such as a lack of
faith in all institutions, including government.
A July 1998 poll by Harris and Teeter Research Companies for the Wall Street
Journal found that 79 percent of the American people agreed that the Federal Gov-
ernment had used the Social Security trust funds for other purposes. (Only 13 per-
cent did not). Similarly, this March, a Rasmussen Research poll showed that by
more than 3 in 1 (60 percent to 19 percent) respondents beheved that if the govem-
rnent kept Social Security money in a trust fund, our political leaders were more
likely to spend the money than save it for the future. A poll released in May for
National Public Radio, the Kaiser Family Foundation, and the Kennedy School of
Government shows that 65 percent of those surveyed believe one of the major rea-
sons why Social Security will be unable to pay benefits in the future is because the
trust funds were stolen. This percentage is consistent with other polls and has re-
mained steady over time.
Despite a lack of confidence in Social Security, most Americans (8 in 10) still want
to know that Social Security will be there for them "just in case they need it." (DYG
Inc., 1996) Those benefits can and will be available, but any reform effort will be
made easier if a more informed public actively participates in the national dialogue
about the future of Social Security.
II. The Trust Funds
A. THE REALITY
Many people believe the system is in or near crisis, but this fear is unfounded.
Social Security is the nation's most closely monitored Federal program, and the only
one that projects future income and costs over 75 years. For most of Social Secu-
rity's history, the program operated on a pay-as-you-go basis. Most revenue was im-
mediately spent to pay benefits with only' a modest trust fund reserve to cushion
against an economic downturn. Starting in 1977, Social Security shifted toward par-
tial pre-funding (advance funding)-a trend accelerated by the Social Security
Amendment of 1983. As a result, the program has been taking in more revenue than
it pays out in benefits and has been building up a larger reserve to help pay for
the benefits of an increasing number of retired workers in the future.
The intermediate projections from the 1999 Social Security trustees' report indi-
cate that without a single change to current law, the program can pay full benefits
on time until 2034-a 2-year improvement from 1998 and 5 years longer than esti-
mated inl997. The trust funds will continue taking in more revenue than is needed
for benefits through 2013. Beginning in 2014, Social Security expenditures will ex-
ceed incoming revenue, and interest earnings will be needed to fully honor currently
promised benefits. At that time, the government will have to have sufficient revenue
to pay Social Security's interest earnings, just as it will need sufficient funds to pay
interest to the holders of any government bond. Some suggest that Social Security
will face a serious crisis in 2014 when incoming revenue falls short of expenditures.
However, the government currently finds the necessary resources to honor its inter-
est obligations to all its current bondholders, and it has never reneged on its debts.
206
Starting in 2022, incoming revenue and interest earnings will not fully cover bene-
fits, and the trust fijnds reserves will be gradually drawn down until they are ex-
hausted in 2034. Even without trust fund assets. Social Security's incoming revenue
will finance over 70 percent of benefits for decades after 2034.
B. THE MYTHS
Lack of confidence in the program's ability to pay future benefits results fi"om the
view that the trust fiinds have been stolen and/or the trust funds hold worthless
lOUs. In fact, workers and their employers' payroll tax contributions are credited
to specially designated trust funds in the Federal Treasury. Any money collected
that is not disbursed for benefits or to administer the program must be invested,
as has always been required, in special issue, interest bearing government securities
(or government-backed securities). The bonds are redeemable prior to maturity, if
needed, at par value (i.e. without risk of principal price fluctuations). These securi-
ties, which are in essence a loan from Social Security to the government, have the
same status as any other bonds issued by the Treasury and are backed by the full
faith and credit of the government. Just as individuals loan the government their
money when they purchase Treasury bills, notes, or savings bonds. Social Security
loans its revenue to government. The government, in times of deficit, uses these
funds to help pay for expenses such as highways, education, or food inspection. As
we begin to move into fiscal surpluses, any reserves not needed for government ex-
penditures are automatically used to pay down the national debt. Indeed, the House
has already passed, and the Senate is currently considering, a Social Security "lock-
box" mechanism better to protect these funds.
If Social Security did not have reserves to loan the Treasury, the government
would have had to reduce expenditures, find an alternative source of funding such
as higher taxes, or issue additional debt that would be purchased by other investors.
The trust funds currently hold about 14 percent of the entire national debt, and pri-
vate investors, including pension funds hold almost 70 percent of the remainder.
The remainder of the debt is held by other government trust funds, such as the civil
service and military retirement trust funds.
One common misperception is that the Social Securit/s government bonds are
worthless lOUs. All government bonds represent future financial claims against fu-
ture pubhc revenue. Securities in the Social Security trust fund accounts, along with
other Social Security revenues, give the Treasury the means to write Social Security
checks. Just as a positive balance in a checking account means an individual can
draw on that account, a balance in the Social Security trust funds means that
checks can be written on the Social Security accoiint.
While all government programs have Treasury accounts, for Social Security, the
trust fund designation means that the total amount received by Social Security
beneficiaries is not subject to the annual Congressional appropriation process. As
long as there are balances in Social Security's trust fund accounts, benefits are paid
with monies designated specifically for that purpose.
The Social Security trust funds represent a long-term commitment on behalf of
the government to the American people. And, as long as the program has been in
operation (64 years), all Social Security revenue has been used to pay benefits and
administer the program, with any remaining funds used to purchase government se-
curities, as required by law. There has been no "raid" or misappropriation of the
Social Security trust funds.
III. The Future: Action Is Needed
In its July 1998 report. Why Action Should be Taken, the Social Security Advisory
Board wrote, "Congress has never allowed the Social Security program to reach the
point that benefits could not be paid, and it is not expected to in the future." AARP
believes that it would be prudent to act sooner rather than later and well before
the 75 million Boomers become eligible for retirement benefits in 2008.
We need to move beyond a discussion of whether Social Security first faces finan-
cial difficulty in 2014 or 2034. Rather, on the eve of the 21st century, what really
counts is that we make the necessary decisions to put Social Security on sound fi-
nancial footing for the future. Earlier remedial action is desirable to strengthen the
fiscal health of the program, improve public confidence, and maximize the oppor-
tunity for individuals to adjust their plans.
The Association looks forward to participating on a bipartisan basis with our na-
tion's elected officials to achieve a solution to Social Security's long-term problems.
This solution should maintain the program's guiding principles, ensure benefit ade-
quacy, and achieve solvency in a fair and timely manner. Social Security must con-
207
tinue its role as the foundation of lifetime income security for tomorrow's bene-
ficiaries.
Chairman Smith. David.
STATEMENT OF DAVID KOITZ
Mr. KoiTZ. Chairman Smith, members of the Task Force, I am
not here to refute or substantiate myths about Trust Funds. Per-
haps you could see my role as one of clarifying how they work and
what the balances and securities of the funds mean.
The costs of Social Security, both its benefits and administrative
expenses, are and always have been largely financed by taxes on
wages and self-employment income commonly referred to as FICA
and SECA taxes. Contrary to popular belief, these taxes are not de-
posited into the Social Security Trust Funds. They flow into deposi-
tory accounts across the country and always have. Along with
many other forms of revenue, these taxes become part of the oper-
ating cash pool or what is commonly referred to as the U.S. Treas-
ury. In effect, once these taxes are received, they become indistin-
guishable from other moneys that the government takes in. They
are accounted for separately through the issuance of securities to
the Trust Funds, and always have been, but this basically involves
a series of bookkeeping entries by the Treasury Department. The
Trust Funds themselves do not receive or hold money. They are
simply accounts. Similarly, benefits are not paid from the Trust
Funds, but from the Treasury. As the checks are paid, securities
of an equivalent value are removed from the Trust Funds.
When more Social Security taxes are received and spent, the
money does not sit idle in the Treasury, but is used to finance
other operations of the government. The surplus is then reflected
in a higher balance of Federal securities being posted to the Trust
Funds. These securities, like those sold to the public, are legal obli-
gations of the government. Simply put, the balances of the Social
Security Trust Funds represent what the government has borrowed
from the Social Security System plus interest. Like those of a bank
account, the balances represent a promise that if needed to pay So-
cial Security benefits, the government will obtain resources equiva-
lent to the value of these securities.
While generally the securities issued to Trust Funds are not
marketable, that is, they are issued exclusively to the Trust Funds,
they do earn interest at market rates, have specific maturity rates,
and by law represent obligations of the U.S. Government.
What often confuses people is they see these securities as assets
for the government. When an individual buys a government bond,
he or she establishes a financial claim against the government.
When the government issues a security to one of its own accounts,
it hasn't purchased anything or established a claim against some
other person or entity. It is simply creating an lOU from one of its
accounts to another.
I don't mean to suggest that its worthless. However, it is just one
arm of the government making a commitment to another arm of
the government. Hence, the building up of Federal securities in
Federal trust funds, like those of Social Security, is not a means
in and of itself for the government to accumulate assets. It cer-
tainly establishes claims against the government for the Social Se-
208
curity System, but the Social Security System is part of the govern-
ment. Those claims are not resources that the government has at
its disposal to pay future Social Security benefits.
Generally speaking, the Federal securities issued to any Federal
Trust Fund represent "permission to spend." In the words of this
committee and the Appropriations Committee, its budget authority.
In other words, as long as a Trust Fund has a balance of securities
posted to it, the Treasury Department has legal authority to keep
issuing checks for the program.
In a sense, the mechanics of a Federal Trust Fund are similar
to those of a bank account. The bank takes in the depositor's
money, credits their account, and then loans it out. As long as the
account shows a positive balance, they can write checks that the
bank must honor.
In Social Security's case, its taxes flow into the Treasury, and its
Trust Funds are credited with Federal securities. The government
then uses the money to meet whatever expenses are pending at the
time. The fact that this money is not set aside for Social Security
purposes does not dismiss the government's responsibility to honor
the Trust Funds' account balances. As long as those funds show
balances, the Treasury Department must continue to issue Social
Security checks.
The key point is that the Trust Funds themselves do not hold fi-
nancial resources to pay benefits; rather, they provide authority for
the Treasury Department to use whatever money it has on hand
to pay them. If the Treasury lacks the resources to meet these
claims, it must borrow them, or, alternatively. Congress would
have to enact legislation to raise revenue or cut spending.
The significance of having Trust Funds for Social Security is that
they represent a long-term commitment of the government to the
program. While the funds do not hold "resources" that the govern-
ment can call on to pay Social Security benefits, the balances of
Federal securities posted to them represent and have served as fi-
nancial claims against the government, claims on which the Treas-
ury has never defaulted nor used directly to finance anything other
than Social Security expenditures.
As a final point, I was asked to comment on how much of future
Social Security benefits could be financed if the System did not
have Trust Fund balances to rely on during the period from 2014
to 2034. While the System's Board of Trustees has projected that
the balances of the Trust Funds coupled with the System's income
would be sufficient to finance all Social Security costs until 2034,
they estimate that the System's tax revenue will fall below the ex-
penditures in 2014, 20 years earlier. In effect, at that point the
government would be paying a portion of the System's benefits
with general funds; that is, moneys that it would owe the System
then from prior Social Security surpluses.
The question that I was asked is if, h3T)othetically, the Trust
Fund balances did not exist in 2014 and interest was not accruing
on them, how much of the benefits could be paid with the Social
Security tax receipts flowing into the Treasury at that time. Based
on the Trustees' 1999 intermediate or best estimate, about 99 per-
cent of the projected benefits in 2014 would be payable with incom-
ing Social Security receipts, including both pa5n-oll taxes and in-
209
come taxes from the taxation of Social Security benefits. However,
over the period from 2014 to 2034, the shortfall would grow stead-
ily. In 2020, less than 85 percent of the benefits would be payable
with incoming receipts. By 2034, only 71 percent would be. For the
2014-2034 period as a whole, the shortfall would be about 22 per-
cent, meaning that only about 78 percent of the benefits would be
payable. If this average shortfall existed today, it would amount to
about $85 billion a year.
I would emphasize again that this is a hypothetical figure, and
as such it is not a projection of the degree to which the System
would be insolvent. Its significance is in representing the extent to
which the government would be asked to support the System with
its other resources. These government payments would be owed to
the System, and as such would be an "asset" to the Social Security
System, but not an asset to the government itself.
The basic point is that while considerable attention has been
drawn to the System's projected point of insolvency, that is, the
year 2034, the potential strain that the System may place on gov-
ernmental resources could start much sooner.
Mr. Chairman, this concludes my statement.
Chairman Smith. Thank you.
[The prepared statement of Mr. Koitz follows:]
Prepared Statement of David Koitz, Congressional Research Service
Chairman Smith and members of the Task Force, I was asked to provide you with
an overview of the nature and operations of the Social Security trust funds.
Where Do Surplus Social Security Taxes Go?
The costs of the Social Security program, both its benefits and administrative ex-
penses, are largely financed by taxes on wages and self-employment income, com-
monly referred to as PICA and SECA taxes. Contrary to popular belief, these taxes
are not deposited into the Social Security trust funds. They flow each day into thou-
sands of depository accounts maintained by the government with financial institu-
tions across the country. Along with many other forms of revenues, these taxes be-
come part of the government's operating cash pool, or what is more commonly re-
ferred to as the U.S. treasury. In effect, once these taxes are received, they become
indistinguishable from other monies the government takes in. They are accounted
for separately through the issuance of Pederal securities to the Social Security trust
funds — which basically involves a series of bookkeeping entries by the Treasury De-
partment— but the trust funds themselves do not receive or hold money. ^ are simply
accounts. Similarly, benefits are not paid from the trust funds, but from the treas-
ury. As the checks are paid, securities of an equivalent value are removed from the
trust funds.
Yes. When more Social Security taxes are received than spent, the money does
not sit idle in the treasury, but is used to finance other operations of the govern-
ment. The surplus is then reflected in a higher balance of Pederal securities being
posted to the trust funds. These securities, like those sold to the public, are legal
obligations of the government. Simply put, the balances of the Social Security trust
funds represent what the government has borrowed fi'om the Social Security system
(plus interest). Like those of a bank account, the balances represent a promise that
if needed to pay Social Security benefits, the government will obtain resources in
the future equal to the value of the securities.
1 Public Law 103-296 requires the Secretary of the Treasury to issue "physical documents in
the form of bonds, notes, or certificates of indebtedness for all outstanding Social Security Trust
Fund obligations." Under prior practice, trust fund securities were recorded electroni-
cally.I74Does This Mean That the Government Borrows Surplus Social Security Taxes?
210
Are the Federal Securities Issued to the Trust Funds the Same Sort of
Financial Assets That Individuals and Other Entities Buy?
Yes. While generally the securities issued to the trust funds are not marketable,
i.e., they are issued exclusively to the trust funds, they do earn interest at market
rates, have specific maturity dates, and by law represent obligations of the U.S. gov-
ernment. What often confuses people is that they see these securities as assets for
the government. When an individual buys a government bond, he or she has estab-
lished a financial claim against the government. When the government issues a se-
curity to one of its own accounts, it hasn't purchased anything or established a
claim against some other person or entity. It is simply creating an lOU from one
of its accounts to another. Hence, the building up of Federal securities in Federal
trust funds — like those of Social Security — is not a means in and of itself for the
government to accumulate assets. It certainly establishes claims against the govern-
ment for the Social Security system, but the Social Security system is part of the
government. Those claims are not resources that the government has at its disposal
to pay future Social Security benefits.
What Then Is the Purpose of the Trust Funds?
Generally speaking, the Federal securities issued to any Federal trust fund rep-
resent "permission to spend." As long as a trust fund has a balance of securities
posted to it, the Treasury Department has legal authority to keep issuing checks
for the program. In a sense, the mechanics of a Federal trust fund are similar to
those of a bank account. The bank takes in a depositor's money, credits the amount
to the depositor's account, and then loans ?t out. As long as the account shows a
positive balance, the depositor can write checks that the bank must honor. In Social
Security's case, its taxes flow into the treasury, and its trust funds are credited with
Federal securities. The government then uses the money to meet whatever expenses
are pending at the time. The fact that this money is not set aside for Social Security
purposes does not dismiss the government's responsibility to honor the trust funds'
account balances. As long as those funds show balances, the Treasury Department
must continue to issue Social Security checks. The key point is that the trust funds
themselves do not hold financial resources to pay benefits — rather, they provide au-
thority for the Treasury Department to use whatever money it has on hand to pay
them. If the Treasury lacks the resources to meet these claims, it must borrow
them, or alternatively, Congress would have to enact legislation to raise revenue or
cut spending. The significance of having trust funds for Social Security is that they
represent a long-term commitment of the government to the program. While the
funds do not hold "resources" that the government can call on to pay Social Security
benefits, the balances of Federal securities posted to them represent and have
served as financial claims against the government — claims on which the Treasury
has never defaulted, nor used directly as a basis to finance anj^hing but Social Se-
curity expenditures.
How Much of the System's Future Benefits Would Be Payable If the System
Relied Exclusively on Its Tax Receipts?
As a final point, I was asked to comment on how much of future Social Security
benefits could be financed if the system did not have trust fund balances to rely on
during the 2014 to 2034 period. While the system's board of trustees has projected
that the balances of the trust funds coupled with the system's income would be suf-
ficient to finance all Social Security costs through 2034, they estimate that the sys-
tem's tax revenues would fall below its expenditures in 2014. In effect, at that point
the government would be pa)ring a portion of the system's benefits with general
funds, i.e., monies it would owe the system then from prior Social Security sur-
pluses. The question I was asked is if, hypothetically, the trust fund balances did
not exist in 2014 and interest was not accruing on them, how much of the benefits
could be paid with the Social Security tax receipts flowing into the Treasury at that
time. Based on the trustees' 1999 intermediate or best estimate, about 99 percent
of the projected benefits in 2014 would be payable with incoming Social Security re-
ceipts, including both payroll taxes and income taxes resulting from the taxation of
Social Security benefits. However, over the period from 2014 to 2034, the shortfall
would grow steadily. In 2020, less than 85 percent of the benefits would be payable
with incoming receipts. By 2034, only 71 percent would be. For the 2014-2034 pe-
riod as a whole, the shortfall would be about 22 percent, meaning that only 78 per-
cent of the benefits would be payable. If this average shortfall existed today, it
would amount to about $85 billion a year. I would emphasize again that this is a
hypothetical figure, and as such it is not a projection of the degree to which the sys-
211
tem would be insolvent. Its significance is in representing the extent to which the
Government would be asked to support the system with its other resources. These
government payments would be owed to the system, and as such would be an
"asset" for the system, but they would not be an asset for the Government itself.
The basic point is that while considerable attention has been drawn to the system's
projected point of insolvency — i.e., the year 2034 — the potential strain that the sys-
tem may place on governmental resources generally could start much sooner. Mr.
Chairman, this concludes my statement. I'll be glad to take any questions you and
other members of the task force may have.
Chairman Smith. The Congressional Budget Office last year esti-
mated that if there were no traumatic cuts in other expenditures,
or if there were no additional public borrowing, total taxes would
have to go up to 85 percent of earnings to accommodate continued
payments of Social Security and Medicare within the next 40 years
if there was no Trust Fund. Maybe the question is do you agree
that paying back the Trust Fund is only as good as Congress and
the White House's willingness to pay back that Trust Fund? In
other words, the law could be changed like it was with the Trans-
portation Trust Fund to wipe it out.
Both of you; Dave, you make a comment first, and then Ken.
Mr. KoiTZ. In an abstract sense, the security for pa5rments from
the Social Security System comes from laws, from Congress and
the administration. The balances of the Trust Funds have, for the
most part, served as a contingency source of budget authority.
When we get out to 2014, to 2020, 2025, with the projected impact
of looming demographic changes, meaning the baby-boom genera-
tion of retirees coming on strong, and we don't have equivalent
growth in the labor force to support it, we are going to have rapidly
rising government expenditures for entitlements. I don't think that
anyone can predict what is going to happen with discretionary
spending and what the national debt is going to be, but it seems
pretty obvious that the demographics are going to push up the cost
of entitlements.
One of the ways that I would look at it is that the government's
aggregate costs have been in the range of 19 to 23 or 24 percent
for the last 60 years. Its revenue base has rarely exceeded 19 per-
cent. This year it is up to 20; but rarely has it exceeded 19 percent.
If we look at some of the CBO projections and other projections
made by others, we see entitlement spending going up to 25, 30,
or maybe 40 percent of GNP in the future. So I don't really think
that you get the full picture if you focus only on the balance of the
Trust Funds. I think that you have to look at the aggregate impact
of the demographics, in particular on long-term entitlement spend-
ing.
Going back to something that you raised a moment ago, if we got
out to 2014, in the absence of a budget surplus at that point, I
think that you hit it right on the head: We would have to borrow
money, raise taxes, or cut spending. But if we had budget sur-
pluses, unified budget surpluses, that is, excess receipts flowing
into the government in the aggregate, there would be a potential
source of funds for these costs. I think the question is can budget
surpluses be sustained through this period when we have rising en-
titlements? How long could we sustain them with the curve going
up?
Chairman Smith. So, Ken, maybe expand my question a little bit
for your response. The government's choices are almost identical
212
with or without a Trust Fund. If Washington is going to keep its
commitment on benefits, then with the current estimate of 2014 for
revenues to begin to fall short of benefits, one of three things will
have to occur: Dramatical cuts in our spending, increased taxes, or
increased public borrowing. So those three choices are the same
with or without a Trust Fund. So how real is the Trust Fund?
Mr. Huff. I agree. There is no question that when we get the
2014 and then move on to 2022, things are going to happen just
as you enumerated. You are going to have to cut expenses or raise
revenue or create the debt on it. I don't disagree with David's state-
ment that 2034 becomes more
intense.
Chairman Smith. Ken, in your testimony you said that maybe we
should adopt incremental solutions and gradually phase in
changes. You also say let's get at it and come up with a solution.
Mr. Huff. Absolutely. What I meant to say is the same thing as
1983, make some changes that will lengthen the life of it. The same
thing happened in 1983. As I said, we were almost bankrupt at
that time. Yet these changes were made and it sustained the Sys-
tem up to now and into the future. We may have to do that from
time to time in the years ahead.
Chairman Smith. I have seen the AARP write in its magazine,
there is no problem with Social Security until 2034. It has been
suggested that we would hit about 75 percent of benefits. But that
could be drastic, couldn't it, since roughly a third of our population
depends on Social Security for 90 percent or more of its retirement.
David, what happens; have you projected those years after 2034,
how much benefits would have to be cut below 75 percent in those
subsequent years?
Mr. KoiTZ. Well, if the Trust Fund falls to a zero balance in
2034, and at that point we are relying on tax revenues, it is basi-
cally the same question that you asked me to address in my testi-
mony, only it occurs 20 years later. At that point, based on the ac-
tuary's projections, we would have the revenues to pay the equiva-
lent of 71 percent of benefits. By the end of the projection period,
2075, I think that it drops below 68 or 69. I don't know the exact
figure.
Chairman Smith. It is out there. It keeps dropping.
Mr. KoiTZ. But not as rapidly as in the next 25 years.
Chairman Smith. Ken, has the AARP ruled out privately owned
capital investment accounts as part of a potential solution?
Mr. Huff. Do you mean privatizing the System?
Chairman Smith. Having some privately-owned accounts within
the System.
Mr. Huff. We haven't ruled that out. Our policy says that we en-
courage supplemental accounts similar to what we have under
IRAs and 401(k)s. The thing that we do not want, we do not want
a carve-out of the existing payroll taxes benefits that go into the
Fund. Anything that we might encourage to encourage savings, to
get people to do these things, we are not opposed to that as long
as it is supplemental to the Social Security System as we now
know it.
Chairman Smith. Lynn Rivers.
213
Ms. Rivers. Thank you. I don't have a lot of questions because,
frankly, I am sort of mystified by the point of the hearing today.
Generally we hear from people who have proposals or who are sug-
gesting ways to deal with issues that we are — that are a part of
the debate. I am a little surprised because the facts that I heard
today are pretty much the facts that I heard on a regular basis,
that everybody is talking about, everybody. I am more concerned
about how we are going to develop the strategy to redeem the
Treasury instruments, which is really the question of the Trust
Fund, at least in my view, how to address this.
Chairman Smith. If you would yield, it just seems to me so im-
portant. AARP is the leading senior organization. Their reaction to
go against politicians that come up with proposals, make it so im-
portant to go ahead to have them come and talk to us.
Ms. Rivers. Come and say what about the Trust Fund?
Chairman Smith. To the extent that the Trust Fund, they feel,
is going to keep the program solvent and how important it is to act
now.
Ms. Rivers. Policymakers that help us move where?
Chairman Smith. You are 3rielding?
Ms. Rivers. Yes, I am.
Chairman Smith. The burr is out from under the saddle, and we
are moving ahead with reform this year. It seems to me unless peo-
ple like the individuals on this Task Force can become a catalyst
to continue moving the discussion ahead and hopefully moving the
solution ahead, and I see senior organizations because of their con-
cern, because of the importance of Social Security in their lives, as
being instrumental in how we develop proposals and how much
credit we give to that.
Ms. Rivers. What I would like to do is be a part of any effort
from any — with any group of people concerned about this to de-
velop a strategy of how we face the redeeming of the instruments
in the Trust Fund. If people are committed to finding a solution,
that is why I am here. Thank you.
Chairman Smith. Mr. Ryan.
Who was here first?
Mr. Toomey.
Mr. Toomey. Well, I for one would like to thank the Chairman
for scheduling this. I think this is a useful discussion.
I just wanted to get some clarification, I guess, really as to
whether or not there is agreement about one of the fundamental
natures of the Trust Fund.
Mr. Huff, you indicated that you were in agreement with the
other gentleman's opinion; that is, that there are no resources in
this Trust Fund. I agree with that. That seems clear to me. But
the testimony on page 4, it would seem to me, would differ from
that. What I read in the last paragraph states, "Securities in the
Social Security Trust Fund accounts, along with other Social Secu-
rity revenues, give the Treasury the means to write Social Security
checks. Just as a positive balance in a checking account means an
individual can draw on that account" — it seems to me the exact op-
posite is the case. In fact, securities in the Social Security Trust
Fund don't provide any means whatsoever. They simply create an
obligation on the part of the Treasury to go out and find the
214
means, which is rather different from actually possessing the
means.
Mr. Huff. Which paragraph?
Mr. TOOMEY. Last paragraph on page 4.
Mr. Huff. Which says, Social Security did not have the reserves,
the government would have had to reduce other expenditures, find
alternate sources, or issue additional debt?
Mr. TooMEY. That is not the page that I am reading, sir. Page
4 begins with, "One common misperception is that the Social Secu-
rity's government bonds are worthless lOUs."
Mr. Huff. Let me see if I can find it.
Mr. TooMEY. Under Roman numeral HB, Myths.
Mr. Huff. All right. I was referring to my oral remarks, and you
were referring to the written testimony that we have submitted.
Let me read it to you, if I may.
"One common misconception is that the Social Security's govern-
ment bonds are worthless lOUs. All government bonds represent
future financial claims against future public revenue. Securities in
the Social Security Trust Fund accounts, along with other Social
Security revenues, give the Treasury the means to write Social Se-
curity checks. Just as a positive balance in a checking account
means an individual can draw on that account, a balance in the So-
cial Security Trust Funds means that checks can be written on the
Social Security account."
I assume that what we are talking about there is the bonds are
issued based upon the faith and credit of the Federal Government.
As far as I know, they have never reneged on these. I put money
in a bank up to $100,000 because the government guarantees that
if that bank fails, that they will pay the funds. So basically what
we are saying here is that regardless of even though the money is
not there, the obligation is there by the Federal Government to re-
place those funds and honor the debits that they have against the
fund.
Mr. TooMEY. I don't dispute that the Federal Government will
feel an obligation to make Social Security payments to seniors, but
what I object to is the characterization that these bonds in the
Trust Fund provide the means to write those things, or an asset
to draw upon in the way that a positive balance in a checking ac-
count is.
Mr. Huff. I see what you are saying, and maybe we need to
make it more clear what we are talking about; that is that the
trust funds establish an obligation.
Mr. TooMEY. I appreciate that because I have had many con-
versations with my constituents in my district, and they feel there
were assets just like a pile of gold in Fort Knox, and we know that
that is not the case.
Mr. Huff. I come from the State of Texas, and I have handled
the accounting from the State of Texas for a number of years. We
have our employees' retirement system, our teachers' retirement
system. The money flows into those funds, and investors use those
to buy securities. These may be obligations of a corporation. We de-
pend on that and know that when we need the money to pay the
benefits that accrue, that we can draw on that.
215
I can only assume that as 2014 rolls around, and we are going
to have to start drawing, we are going to have to start paying some
money in order to honor the benefits that are there. I just feel like
there is not that much difference in what we are saying.
Mr. TOOMEY. Thank you.
Chairman Smith. Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
I have a number of specific questions. Let me follow up on my
colleague's comment. If all of us went to the bank tomorrow and
decided that we would all withdraw our cash, I think that all of
us know that the bank would not have the cash to pay everyone.
In fact, I think that the way that the bank would get the money
to pay is to go to the Federal Reserve; the Federal Reserve would
buy back bonds for the cash to go into the system. The Trust works
that way.
I would ask unanimous consent to insert into the record at this
point both a copy of the specimen of the Treasury bond that is
issued to the Federal Old Age and Survivors Trust Fund as well
as the letter to me, in response to a letter that I wrote, from the
Commissioner of Social Security from last year regarding interest
on the Trust Fund, on bonds in the Trust Fund, as well as a cite
from section 201(d) of the Social Security Act with respect to depos-
its in the Trust Fund.
Chairman Smith. Without objection, so ordered. Are those actual
size. Ken?
Mr. Bentsen. It is the actual size of the specimen.
Chairman Smith. Without objection, so ordered.
[The specimen referred to follows:]
THE UNITED STATES OF AMERICA
I tXXXXX.XXX.XXX I NO OOOOOQ
THE FEDERAL DISABILITY INSURANCE TRUST FUND
I)..ii-J: 00/00/00
Due: 00/00/00 XX%
crsip- xxxxxxxxx
dljt NOT TRANSFERABLE
[The letter referred to follows:]
216
Office of the Commissioner,
Social Security Administration,
October 9, 1998.
Hon. Kenneth E. Bentsen, Jr.,
House of Representatives, Washington, DC.
Dear Mr. Bentsen: This is in response to your letter of September 1, 1998, re-
questing an opinion on whether interest earned on the surplus payroll tax revenues
is the property of the Social Security trust funds or is general revenue of the Fed-
eral government.
Section 201(f) of the Social Security Act states that "The interest on, and the pro-
ceeds from the sale or redemption of, any obligations held in the Federal Old-Age
and Survivors Insurance Trust Fund and the Federal Disability Insurance Trust
Fund shall be credited to and form a part of the Federal Old-Age and Survivors In-
surance Trust Fund and the Disability Insurance Trust Fund, respectively * * * *"
Section 201(d) of the Act states that "It shall be the duty of the Managing Trustee
to invest such portion of the Trust Funds as is not, in his judgment, required to
meet current withdrawals. Such investments may be made only in interest-bearing
obligations of the United States * * *". Thus, by law, all income to the trust funds
that is not immediately needed to pay expenses is invested in securities guaranteed
as to both principal and interest by the Federal government and the interest from
that investment belongs to the respective trust fund.
As you requested, I am enclosing the full text of the section of the Social Security
Act that deals with this issue.
Sincerely,
Kenneth S. Apfel,
Commissioner of Social Security.
Mr. Bentsen. This is actually sort of interesting. I want to get
into the specifics of this.
First of all, the Trust Fund is legally created in Section 201 just
in the same way that a trust indenture is created between a bor-
rower and the lender, correct?
Mr. KoiTZ. Sure.
Mr. Bentsen. So there is a legal obligation that exists. I am try-
ing to get away from a philosophical to a legal structural side.
There is a flow of funds that occurred that I think, Mr. Koitz, you
talked about in part. Employees and employers pay their FICA tax.
It goes into an administrative account in XYZ Bank which are all
over the country, is ultimately pulled into the Treasury, and all
Treasury funds become fungible. But then an entry is made into an
account for purchase of a Treasury bond, which, by law, Social Se-
curity is required to invest in Treasury bonds backed by full faith
of the Federal Government. So by purposes of the Trust Fund, they
do receive an asset in the Trust of a book entry Treasury bond plus
interest, correct?
Mr. KoiTZ. Absolutely.
Mr. Bentsen. The interest and the asset is, in part, determined
by the fact that the bond pays interest. So it is not a par bond, zero
interest bond, it is an interest-earning instrument or asset within
the Trust Fund. So I am fairly comfortable with the flow of funds.
I think there is a philosophical argument or economic argument
beyond which how much the government borrows in the gross
sense and their ability to pay their debts, but that would affect the
quality, would it not, of not just the Treasury bonds in the Old Age,
but all Treasury bonds, because these bonds, which also by law
they could either have special issue bonds or they could buy mar-
ketable bonds, but these bonds are not cheaper in the sense that
the rate is different or richer in the sense that the rate is different
than marketable Treasury bonds; is that correct?
Mr. KOITZ. That is correct.
217
Mr. Bentsen. So they don't trade one way or the other.
In terms of the question that it is a contingency source of budget
authority, do you mean by that within the sense of the Trust Fund
itself being able to pay benefits or other types of governmental
spending?
Mr. KoiTZ. Absolutely, only the Trust Funds.
Mr. Bentsen. OK. Now, if you have a completely private trans-
action where you go out and issue debt and you — under a trust in-
denture, and the funds flow into the general funds, in most cases
those funds don't sit idle, but are invested in some interest-bearing
account, money market or whatever, depending on what the with-
drawals are going to be. So if you look at the account of the Trust
Fund, it is not going to necessarily say cash on hand. It is going
to say, Boston Company Money Market, No. 123, or something to
that effect.
That is sort of how the Social Security Trust Fund works, is it
not, that if you look at the Trust Fund, it says a whole list of U.S.
Treasury bonds that are down and various rates of interest that
are accrued; is that right?
Mr. KoiTZ. I am not sure I agree with that. I think the basic
thrust of your first few questions is whether the securities given to
the Social Security Trust Fund are any different than any other
Federal security. I have to say "yes" in form, but not in substance.
They earn interest, they have maturity dates, and the interest
rates are based on what is going on with Federal securities in the
marketplace. So in all important respects, or substantial respects,
the securities of the Trust Funds are as real as the securities
bought and sold in the financial marketplace.
However, this is where we get to be talking about apples and or-
anges with the issues. The fact that the government has given a
commitment to Social Security is a form of asset for Social Secu-
rity, but the question is, where does the Treasury get the money?
If there is a strain on the Treasury, and I said there might not be
because we might have budget surpluses, but if there were to be
a strain on the government's financial resources in 2014 or 2020,
2025, 2030, where would we get the resources? We don't simply
have a bump-up in costs. This is not analogous to a pig running
through a p3^hon. What we have is continuously rising entitlement
expenditures under almost anybody's projections.
What I am getting at is — the question isn't so much whether or
not the Trust Fund securities are as real as any other government
security, it is how does the government come up with the resources
to make good on all of its
Mr. Bentsen. My time is running out, but this leads to my next
question. The obligation to pay based upon those securities, based
upon this security, is very real. If the government, this is my opin-
ion, and I think it is a pretty sound one. My opinion is if we were
to default on one of these securities, it would be akin to defaulting
on a publicly held bond and would cheapen the debt of the United
States, which would have a number of effects. So I think there is
a legal trust. I think it is created by the same legal concept that
if you and I went out and structured a private deal and a flow of
funds.
218
The next question is is there a pledge for payment of benefits,
current payment of benefits, beyond the assets of the Trust, a
legal — not a philosophical, but a legal claim, or is it only against
whatever the assets of the Trust are, and once they are depleted,
they are gone?
Mr. KoiTZ. No is the answer to your question, simply. The condi-
tions for payment of Social Security are defined under benefit pay-
ment rules in the act, not by the size of the Trust Fund.
I go back to my analogy to budget authority. As long as you have
a balance in that fund, there is a requirement for the Treasury De-
partment to make good on the benefit commitments that are pre-
scribed by the rules under the act. It is not a defined contribution
system. It is not an IRA or a 401(k), where the assets to pay bene-
fits flow out of the buildup of the accumulation in an account. Once
the Trust Fund balance falls to zero, if we don't have enough tax
revenues coming in then to cover the payments, there is nothing
in the act that I know of or in any other act that says, you shall
go on paying full benefits.
My best guess is, and it is based on past comments made by the
Treasury Department, that if we got to that point — and as you
said, we have never been there, we have always honored the pay-
ments of the Trust Funds — if we got to that point, the Treasury
Department would delay pa3mients.
Mr. Bentsen. I think there are two different things. What you
are saying is that if the Trust Fund was depleted, all paid off, that
had become assets of the Trust Fund, and no more assets in the
Trust Fund, and you didn't have enough revenue, annual revenues,
to pay the full annual benefits, you are saying there is no pledge
beyond what is there, cash on hand and accrued assets. I don't
think that I agree with you, if bonds came due that were in the
Trust Fund and Treasury is in a squeeze, that we would then de-
cide to default on that. What we would probably have to do is roll
bonds from government-held to public-held.
That raises other economic questions, but I don't think that we
would agree that we would
Mr. KoiTZ. If I even gave you the implication of that, it was a
misreading of what I said.
Mr. Bentsen. That was my confusion.
Chairman Smith. Mr. Ryan.
Mr. Ryan. I just had a couple of technical questions on this Trust
Fund subject. You mentioned that the tax on benefits goes to Social
Security. What other revenue sources outside of FICA taxes go to
Social Security? Is it not — it is my understanding that after 1993,
the tax bill, 50 to 85 percent doesn't go to Social Security, but goes
to Medicare. Can you give me just a brief description of funding
sources; what portion of it, if any, goes to Social Security, what
goes to Medicare, and the earnings limit as well?
Mr. KoiTZ. Social Security benefits first became taxable in 1984.
Up to 50 percent of the benefits could be taxed under the 1983
amendments. That portion still goes to the Old Age, Survivors, and
Disability Trust Funds. The provision in 1993 increased the tax-
ation on those same people, going up to an 85-percent rate. That
money is credited to the Hospital Insurance portion of the system.
219
You have got basically three sources of tax receipts. You have
FICA taxes, which is the tax levied on wage earners, and shares
paid by their employers; SECA taxes, self-employed taxes; and in-
come taxes on benefits. Those are the cash sources of the Trust
Fund. Then you have interest credited to the Trust Fund in the
same form as marketable securities, as I mentioned before. That is
done twice a year. Then, there are some very small general fund
infusions; military gratuitous wage credits is the foremost one.
Mr. Ryan. How big is the revenue stream coming from tax on
benefits?
Mr. KoiTZ. I would have to guess — I think it is about $8 billion;
not quite that much goes
Mr. Ryan. $8 billion a year? That is not 50 percent that goes to
Social Security. How big is the hospital fund?
Mr. KoiTZ. $6 billion.
Mr. Ryan. That is very helpful. Thank you.
I yield back, Mr. Chairman. Reclaiming my time, I yield back.
Chairman Smith. He yields back.
As you review history, several times when there is more money
coming in from the Social Security taxes than was needed to pay
current benefits, we expanded the program. So as you look at the
increases in benefits over the year, it is substantial. Of course, the
biggest changes to the Social Security Act was when we added
Medicare. Likewise in our history when we were running out of
money, when there was less money than needed, tsixes were in-
creased or benefits cut before it became time, Mr. Bentsen, to real-
ly call on some of these Trust Fund payments.
So we do have precedents that when we came close to calling on
additional revenues of the Trust Fund, sometimes we have used
those alternate funding sources. But likewise, in desperation, rath-
er than paying back, rather than digging deeper into the Trust
Fund, we have increased taxes. In fact, we have increased taxes
something like 36 time^ since 1936.
So that is a little bit of my concern. How high can we increase
taxes in the future, how much of an imposition is this going to be
on economics expansion, and is it reasonable to put off the final de-
cision until the solution becomes so desperate? I think time is not
on our side and that the quicker we come and develop a solution,
the more positive it is going to be as far as continuing our economic
stream.
Ken, as an accountant and economist, your comments.
Mr. Huff. I agree. I think we need to do something about it.
First of all, we have a lot of people out there that don't believe it
is going to be around when they retire. I think that if we make
some arrangements and start fixing the problem, maybe we will in-
crease confidence in the System. Quite frankly, if you go back, this
is nothing new. Back in my days of Social Security, there were a
lot of people then that didn't believe it would be there. Well, it is.
AARP supports fixing the problem and fixing it this year if we
can. As I have mentioned to you, I think that when you get a fix,
there is going to be a fix that is going to have some warts on it.
I think that if we get together on a bipartisan meeting and try to
fix the problem so that when we — so the fix won't be any more in-
jurious than it would be if we wait several years to make the fix.
220
Chairman Smith. David, do you have a comment?
Mr. KoiTZ. Well, it is pretty hard to argue with the sooner that
you can do it, the better, because you can then phase it in in small-
er increments and get a fuller solution in the long run.
I guess the only additional comment I would make is that in the
past, especially in 1977 and 1983, when we had fairly severe finan-
cial issues to deal with, we tended to focus on the issue by looking
at average balance over 75 years. This was the focus of the debate
both here on the Hill and in the press. I would say there is too
much focus again on the average 75-year imbalance. It is like a
magic bullet, that is, to achieve an average 75-year solution. I
think that you have got to analyze at how any plan will achieve
balance between income and outgo all of the way out, which means
to 2075.
I think that was one of the problems with the 1983 amendments.
The 1983 amendments largely showed average balances because
they built up large reserves in the front end and shortfalls in the
long run. I think that if we had acted on projections as to what
that particular plan, that package of changes, would have done on
a 10-year incremental basis or 5-year incremental basis all of the
way out to the end of the 75-year period, I think perhaps Congress
might have come to a different package of proposals. So my com-
ment is look at what happens in 2075 as well as the average.
Chairman Smith. The President has suggested adding another
bond to the Trust Fund. When that is technically scored by the ac-
tuaries over at the Social Security Administration, they assume
that all of this money is going to be paid back.
I think that has got to be an assumption that we are going to
pay back the Trust Fund money, important as any other debt. Of
course, the problem of paying it back is imposition on taxpayers or
other funding programs. But that being the case, it still seems that
the illusion of the Trust Fund by simply writing a $5 trillion lOU
to the Trust Fund today and passing it in Congress, technically
that would keep Social Security solvent for the next 75 years, but
it really doesn't do anything to the huge problems and the imposi-
tion that we put on taxpayers and other spending programs. It
seems to me this is a little bit illusionary to the Trust Fund in
terms of somehow having to come up with the money to pay it
back.
Any comments, and then we will move on.
Mr. KoiTZ. You could get rid of this problem very quickly by
crediting the Trust Fund with general revenues to the tune of
something on the order of $3 trillion today. That money earning in-
terest, supplemented by the current law revenue stream, would be
sufficient to get rid of the problem over 75 years. But there are two
levels of debate. One is what do you do with the Trust Funds; how
do you keep that budget authority flowing? The second issue is
where does the money come from? That perhaps is a tougher one,
because if you have $3 trillion additional government securities
posted to this ledger, the money has to
Chairman Smith. Aren't you sort of overstating it a little bit,
that that would solve the problem by writing another giant lOU to
the Trust Fund?
221
Mr. KoiTZ. I am trying to distinguish between two levels. One is
how do you deal with the imbalance of the numbers that the trust-
ees have projected over the last 12 years? You could deal with that
simply by crediting the Trust Funds with that amount of govern-
ment securities. But that is not the real issue. The real issue, I
think, at another level, is where does the government get the
money to make good in 2034 on a piece of those balances?
Chairman Smith. Representative Rivers.
Mr. Bentsen.
Mr. Bentsen. On that point, you are right. It is a question of the
amount of resources and the allocation of resources that you are
looking at. What you are saying in making that comment is sa3ring
pouring into the general revenues a System that has been a dedi-
cated source of funds coming in. That is, in part, what the adminis-
tration proposed, I think, an ingenious way of— basically what they
did, what they are proposing is to transfer publicly-held debt to
Trust Fund-held debt by buying back publicly-held bonds in the
name of the Trust Fund, just transferring the Trust Fund from one
entity to another entity, but you still have a general revenue flow.
But I think, Mr. Chairman, for my purposes at least, this hear-
ing of the Trust Fund, myth or reality, has to come to at least one
conclusion; that is, if you look at the Code, the Trust Fund is a
legal reality. The dedication of both revenues and assets are a legal
reality. The question of a fund imbalance or benefit imbalance is
a reality. It is a fiscal reality. And the question of whether or not
the government spends too much money in the aggregate or is in-
capable in the future to service all of its debt is a fiscal reality. But
the pledge within the Trust Fund is a legal reality, which is default
on the bonds in the Trust Fund would be akin to a default on any
other U.S. Treasury bond.
Mr. Huff, I want to say that I appreciate your testimony today
because all of us on *this panel and all of our colleagues in the
House and the Senate have certainly heard from our constituents
who say that there is no Trust Fund, "you are just raiding the
Trust Fund." That is not really accurate. What is going on is, I
guess, government has leveraged the Trust Fund and its other
Trust Funds, and in the broad scheme of things may raise its cost
to borrowing in the future, including the ability to repay the bonds
that are in the Trust Fund. But they are real, and we should make
that point very clear. I think it is very commendable that AARP
is taking this very responsible position in putting that word out.
Chairman Smith. If the gentleman would yield. In effect, didn't
we really default on the bonds in the Transportation Trust Fund
when we wrote off that 22 or $24 billion?
Mr. Bentsen. No. I would argue that we defaulted on the 1997
budget agreement because we just said we are going to come out —
to evade caps, in effect, by about $20 billion. But we have not de-
faulted on any bonds.
Chairman Smith. But we wrote off $22 billion of these sheets of
paper to the Highway Trust Fund legislatively, and so that makes
me very nervous
Mr. Bentsen. I would be glad to sit down and look at that more
closely. I don't think that we did that. I think that what we did
222
was we reallocated funds. The Trust Fund came out whole. That
is the question — we did it legislatively.
Chairman Smith. Let's look at it, but we did not pay the $22 bil-
lion. We wrote it off in exchange for taking the Highway Trust
Fund out, $22 billion.
It is also a legal obligation, simply. Our Social Security law, we
have a law that says we are going to pay these kinds of benefits
based on this kind of structure for paying benefits. That is a legal
obligation with or without the Trust Fund, it seems to me.
Mr. Bentsen. I think, reclaiming my time, that is a very impor-
tant question. Mr. Koitz's opinion is that the obligation only inures
to the assets within the Trust Fund and current revenues. It is a
legal question that I would encourage the Chairman to perhaps
bring in some legislative — legal legislative scholars to give us their
opinion as well. No doubt were we to get to that situation, and
Congress were to be hard and fast, the matter would be litigated
long after we are gone.
Chairman Smith. Wrap-up comments in a minute or so by each
of you, Mr. Koitz or Mr. Huff?
Mr. Huff. We appreciate the opportunity to appear before the
committee. We look forward to assisting in solving this problem.
Our staff would stand ready to work with members of this commit-
tee.
Let me sum up by just reading something to you here. This was
written by our Executive Director, that appeared in our bulletin
here a short time ago. He says, "Social Security reform is dead only
if the public allows it to be. AARP is not ready to write its eulogy
yet. There is too much at stake for our members and future genera-
tions who will feel the impact of this reform the most. Ultimately,
the problem is not a lack of ideas, it is a lack of consensus and
trust, and the building blocks of reform are on the table. They need
to be discussed and evaluated to see how they would work and
whether or not they would ensure solvency and guarantee security.
There is still time to achieve Social Security reform this year. Ac-
complishing this goal, however, depends upon whether our political
leaders can trust each other enough to work out a solution and
whether the public demands it."
Chairman Smith. I would just make a footnote on that state-
ment. When I was writing my first Social Security bill that in-
cluded some private investing back in 1994, there was a tremen-
dous misunderstanding of Social Security. When I met with the
AARP specialists, they understood the problem and the con-
sequences almost better than any other organization that I met
with at that time. So my compliments.
Mr. Huff. We would be happy to work with you.
Chairman Smith. Mr. Koitz, closing comments.
Mr. Koitz. I don't really have a wrap-up. However, I must say
that I am not alone out there, based on the trustees' projections,
that 2034 is a very difficult point for the System, and that in the
absence of other changes, we couldn't pay full benefits. That is the
position of the trustees. It also is the position of the President.
One other bit, perhaps a helpful comment to the committee, is
that there is an American law, a CRS American Law memoran-
223
dum, fairly recently, that addresses this question. I would be glad
to furnish it to committee.
[The information referred to follows:]
Text of Congressional Research Service Memorandum,
Dated November 20, 1998
To: House Committee on the Budget, attention Steven Robinson
From: Thomas J. Nicola, Legislative Attorney, American Law Division, Congres-
sional Research Service
Subject: Whether Entitlement to Full Social Security Benefits Depends on Solvency
of the Social Security Trust Funds If Congress Does Not Change the Law
This memorandum responds to an inquiry regarding whether entitlement to full
Social Security benefits depends on solvency of the Social Security Trust Funds if
Congress does not amend the law to adjust ehgibility requirements, benefit levels,
or revenues. The Social Security Trust Funds are formally known as the Federal
Old-Age and Survivors Insurance Trust Fund and the Federal Disability Insurance
Trust Fund, sometimes referred to as the OASDI Trust Funds. This question has
been raised because of actuarial estimates of projected insolvency of the Trust
Funds in the future.
The Social Security Trust Funds are not like private sector trust funds. There is
no body of assets comprised of Social Security tax revenues that is held separately
and managed for the benefit of participants in the Social Security system. Instead,
the OASDI Trust Funds are accounts maintained on the books of the United States
Treasury. General Accounting Office, "Treasury's Management of Social Security
Trust Funds During the Debt Ceiling Crises," GAO/HRD-86^5, B-221077.2, 5
(1986).
The Social Security system operates on a "pay-as-you-go" basis in the sense that
taxes paid now finance benefits for today's beneficiaries. Current workers and their
employers and the self-employed pay taxes on wages and self-employment income
under the Federal Insurance Contributions Act (FICA) and the Self-Employed Con-
tributions Act (SECA), respectively, to the general fund of the Treasury rather than
to the OASDI Trust Funds.
Social Security benefits are paid fi-om the general fund of the Treasury. On the
payment date, usually the third day of the month, a portion of the Treasury securi-
ties held by the OASDI Trust Funds is redeemed to reimburse the general fund for
Social Security benefits paid by electronic funds transfer on that date. Additional
securities are redeemed four to five business days later to reimburse the general
fund for benefits paid by check on the benefit payment date. Actual payroll tax reve-
nues received during the month are deposited directly into the general fund of the
Treasury to keep it whole for the normalized tax transfer to the Trust Funds.
In months when Social Security revenues exceed the amount of Social Security
benefits paid, the surplus is invested in Treasury securities. Each June 30, any sur-
plus for the year, after correcting for actual payroll taxes received, is converted to
long-term securities and credited to the OASDI Trust Funds. In months when reve-
nues are lower than the amount paid in benefits, the Secretary must redeem short-
term securities that had been sold to the Trust Funds during the year to cover the
excess payments.
Securities credited to the Trust Funds earn interest at market rates, have specific
maturity dates, and represent full faith and credit obligations of the United States
government. Interest on them also is credited to the Trust Funds in the form of an
equivalent amount of Treasury securities. Section 201 of the Social Security Act,
codified at 42 U.S.C. §401. Id. at 5-6. See Koitz, David, "Social Security Taxes:
Where Do Surplus Taxes Go and How Are They Used?" Congressional Research
Service Report No. 94-593 EPW 2-3 (updated Apr. 29, 1998).
The 1998 Annual Report of the Board of Trustees of the Social Security and Medi-
care (Hospital Insurance) Trust Funds, released on April 28, 1998, estimated that
the OASDI Trust Funds would be credited with surplus income until 2020, when
Trust Fund reserves would peak at $3.8 trillion. Those reserves then would be
drawn down as persons bom during the post- World War II baby boom retire and
collect benefits.
The trustees estimated that the DI Fund would be exhausted in 2019 and that
the OASI Fund would be depleted in 2034; on a combined basis they would be insol-
vent in 2032. Koitz, David, and KoUman, Geoffrey, "The Financial Outlook for Social
Security and Medicare," Congressional Research Service Report No. 95-543 EPW 1-
2 and 4 (updated May 7, 1998).
224
The trustees calculated that taxes paid to the OASDI Trust Funds would begin
to lag behind expenditures in 2013, when the program would begin to rely in part
on general revenues to finance interest payments on securities credited to the
OASDI Trust Funds. In 2021, the reserve balance of the Trust Funds would begin
to be drawn down. By 2025, $1 out of every $5 of Social Security outflow would de-
pend upon general fund expenditures for interest payments and the redemption of
government securities held by the Trust Funds. Id.
Balances in the Trust Funds are claims against the Treasury. When the securities
comprising those balances are redeemed, the claims will have to be financed by rais-
ing taxes, borrowing from the public, or reducing benefits and other expenditures.
Executive Office of the President, Office of Management and Budget, Budget of the
United States Government Fiscal Year 1999: Analytical Perspectives 328 (1998).
The projected insolvency of the Social Security Trust Funds has raised a question
regardmg whether entitlement to benefits would be jeopardized as a matter of law.
Social Security is an entitlement program. Section 202(a) of the Social Security Act,
codified at 42 U.S.C. § 402(a), for example, states, in relevant part, that:
(a) Old-age insurance benefits. Every individual who
(1) is a fully insured individual (as defined in section 214(a)),
(2) has attained age 62, and
(3) has filed an application for old-age benefits or was entitled to disabil-
ity insvirance benefits for the month preceding the month in which he at-
tained retirement age (as defined in section 216(1)(1)),
shall be entitled to an old age benefit for each month * * *
Entitlement authority has been defined as:
[ajuthority to make payments (including loans and grants) for which budget
authority is not provided in advance by appropriation acts to any person or gov-
ernment if, under the provisions of the law containing such authority, the gov-
ernment is obligated to make the pajrments to persons or governments who
meet the requirements established by law.
2 U.S.C. §§622(9) and 651(c)(2)(C), quoted in General Accounting Office, Account-
ing and Financial Management Division, A Glossary of Terms Used in the Federal
Budget Process: Exposure Draft (Glossary) (Jan. 1993).
Budget authority is authority provided by law to enter into obligations that will
result in immediate or future outlays involving Federal Government funds. 2 U.S.C.
§622(2), quoted in Glossary at 21.
The definition of entitlement authority emphasizes the obligatory nature of bene-
fit payments under the law creating the entitlement. "Entitlements are created by
'rules or understandings' from independent sources, such as statutes, regulations,
and ordinances, or express or implied contracts." Orloff v. Cleland, 708 F.2d 372,
377 (9th Cir.1983), citing Board of Regents v. Roth, 408 U.S. 564, 577 (1972), and
Perry v. Sinderman, 408 U.S. 593, 601 (1972). See also Erickson v. United States
ex rel. Department of Health and Human Services, 67 F.3d 858, 862 (9th Cir. 1995).
The Supreme Court in Flemming v. Nestor, 363 U.S. 603 (1960), elaborated on
the relationship between a beneficiary's legal entitlement to receive Social Security
benefits and the power of Congress to change that entitlement by amending the So-
cial Security Act:
Broadly speaking, eUgibility for benefits depends on satisfying statutory con-
ditions as to (1) employment in covered employment or self-employment (see
§ 210(a), 42 U.S.C. § 410(a)); (2) the requisite number of "quarters of coverage"—
i.e., 3-month periods during which not less than a stated sum was earned — the
number depending generally on age (see §§213-215, 42 U.S.C. §§413^15); and
(3) attainment of the retirement age (see § 216(a), 42 U.S.C. § 416(a)). * * *
Of special importance in this case is the fact that eligibility for benefits, and
the amoxint of such benefits, do not in any true sense depend on contribution
to the program through the payment of taxes, but rather on the earnings record
of the primary beneficiary. * * *
* * * each worker's benefits, though flowing from the contributions he made
to the national economy while actively employed, are not dependent on the de-
gree to which he was called upon to support the system of taxation. It is appar-
ent that the noncontractual interest of an employee covered by the Act cannot
be soundly analogized to that of the holder of an annuity, whose right to bene-
fits is bottomed on his contractual premium payments.
It is hardly profitable to engage in conceptualizations regarding "earned
rights" and "gratuities." Cf. Lynch v. United States, 292 U.S. 571 [1934]. The
"right" to Social Security benefits is in one sense "earned," * * *
* * * But the practical effectuation of that judgment has of necessity called
forth a highly complex and interrelated statutory structure. * * * That program
was designed to function into the indefinite future, and its specific provisions
225
rest on predictions as to the expected economic conditions which must inevitably
prove less than wholly accurate, and on judgments and preferences as to the
proper allocation of the nation's resources which evolving economic and social
conditions will of necessity in some degree modify.
To engraft upon the Social Security system a concept of "accrued property
rights" would deprive it of the flexibility and boldness in adjustment to ever-
changing conditions which it demands. * * * It was doubtless out of an aware-
ness of the need for such flexibility that Congress included in the original Act,
and has since retained, a clause expressly reserving to it "[t]he right to alter,
amend, or repeal any provision" of the Act. § 1104, 49 Stat. 648, 42 U.S.C,
§ ^1304. That provision makes express what is implicit in the institutional needs
of the program.
Flemming at 608-610.
These passages indicate that legal entitlement to Social Security benefits depends
on meeting eligibility standards set out in the Social Security Act. Recognizing the
changing nature of the program and the need to predict future economic develop-
ments, predictions that may not be wholly accurate as Flemming v. Nestor noted.
Congress has expressly reserved the right to "amend, alter, or repeal any provision"
of the Social Security Act. 42 U.S.C. § 1304.
In addition to its power to adjust Social Security eligibility requirements and reve-
nues. Congress appears to have created a fallback, at least on a month-to-month
basis, if taxes and interest credited to the OASDI Trust Funds should not be suffi-
cient to meet benefit payments. Section 201(a), 42 U.S.C. § 401(a), in relevant part,
states that:
* * *in any case in which the Secretary of the Treasury determines that the
assets of either such [Old-Age and Survivors Insurance or Disability Insurance]
Trust Fund would otherwise be inadequate to meet such Fund's obligations for
any month, the Secretary of the Treasury shall transfer to such Trust Fund on
the first day of such month the amount which would have been transferred to
such Fund under this section as in effect on October 1, 1990, and such Trust
Fund shall pay interest to the general fund on the amount so transferred on
the first day of any month at a rate (calculated on a daily basis, and applied
against the difference between the amount so transferred on such first day and
the amount which would have been transferred to the Trust Fund up to that
day under the procedures in effect on January 1, 1983) equal to the rate earned
by the investments of such Fund in the same month under subsection (d) of this
section.
This language authorizes the Secretary of the Treasury to borrow from the gen-
eral fund, but any amount borrowed must be repaid. It appears to be stopgap au-
thority designed to deal with temporary conditions that may prevent timely invest-
ments in nonmarketable government securities. Insolvency of the OASDI Trust
Fimds creates a much greater problem that this authority does not appear adequate
to remedy in a comprehensive way.
A publication of the General Accounting Office has described the relationship be-
tween a beneficiar/s legal right to receive the full amount of an entitlement pay-
ment and the amount that may be paid if there is a funding shortfall.
Congress occasionally legislates in such a manner as to restrict its own subse-
quent funding options. * * * [EJntitlement legislation [is] not contingent upon
the availability of appropriations. A well-known example here is Social Security
benefits. Where legislation creates, or authorizes the administrative creation of,
binding legal obligations without regard to the availability of appropriations, a
funding shortfall may delay actual pa5mrient but does not authorize the admin-
istering agency to alter or reduce the "entitlement."
Even under an entitlement program, an agency could presumably meet a
funding shortfall by such measures as making prorated pa3rments, but such ac-
tions would be only temporary pending receipt of sufficient funds to honor the
obligation. The recipient would remain legally entitled to the balance.
General Accounting Office, Office of General Counsel, I Principles of Appropriations
Law 3-33-3-34, n. 21 (2d ed. 1991) (Principles).
During a Social Security budgetary crisis in 1983, then-Secretary of Health and
Human Services Richard S. Schweiker testified that Congress had authorized bor-
rowing between the Social Security Trust Funds and the Medicare Trust Fund,
known as the Hospital Insurance (HI) Trust Fund, in 1981, to be repaid with inter-
est. He indicated that pursuant to this authority, granted in Pub. L. No. 97-123,
benefits could be paid through June 1983. He said that interfund borrowing was
used three times: the OASI Trust Fund borrowed $581 million from the DI Trust
Fund on November 5, 1982, $3.4 billion from the HI Trust Fund on December 7,
1982, and a total of $13.5 bilhon, $4.5 from the DI Trust Fund and $9.0 biUion from
226
the HI Trust Fund, on December 31, 1982. Recommendations of the National Com-
mission on Social Security Reform: Hearings Before the House Comm. on Ways and
Means, 98th Cong., 1st Sess., Serial 98-3, 222 (1983) (prepared statement of Rich-
ard S. Schweiker, Secretary of Health and Human Services).
The Secretary added that, "Since the borrowing authority has expired [it expired
on January 1, 1983J, the OASI will, in the absence of further legislation, be unable
to pay retirement and survivor's benefits on time beginning in July 1983." Id. The
Secretary's testimony appeared implicitly to acknowledge that a funding shortfall in
the Trust Funds would delay paying Social Security benefits, but would not extin-
guish a beneficiary's legal entitlement to them.
While an entitlement by definition legally obligates the United States to make
payments to any person who meets the eligibility requirements established by the
law setting out the entitlement authority, a provision of the Antideficiency Act, sec-
tion 1341 of title 31 of the United States Code, prevents an agency from paying
more in benefits than the amount available in the source of funds available to pay
them, in this case the OASDI Trust Funds.
This provision, in relevant part, states that:
An officer or employee of the United States government or of the District of
Columbia government may not
(A) make or authorize em expenditure or obligation exceeding an amount
available in an appropriation or fund for the expenditure or obligation;
(B) involve either government in a contract or obligation for the payment
of money before an appropriation is made unless authorized by law; * * *
The Act prohibits making expenditures either in excess of an amount available
in a fimd or before an appropriation is made. In the case of Social Security benefit
payments, the Act would appear to prohibit paying more money in benefits than the
amount of the balance in tne Trust Funds and the amount being credited to them.
If the Funds should become insolvent, it appears that the Social Security Adminis-
tration would be able to pay only an amount of benefits equivalent to Social Security
receipts ft-om payroll taxes and other sources as they are being received to avoid
violating the Antideficiency Act's prohibitions. Section 201(a) of the Social Security
Act, 42 U.S.C. § 401(a) appropriates Social Security taxes. Section 201(d), 42 U.S.C.
§ 401(d) makes interest on and proceeds ft-om the sale or redemption of government
securities held by the OASDI Trust Funds a part of the Fvmds and credits these
amounts to them.
Violations of the Antideficiency Act are punishable by administrative and criminal
penalties. Section 1349 of title 31 of the United States Code makes an officer or em-
ployee who violates the Act's prohibitions subject to appropriate administrative dis-
cipline, including, when circumstances warrant, suspension from duty wthout pay
or removal from office. An officer or employee who knowingly and willfully violates
the Act can be fined not more than $5000, imprisoned for not more than 2 years,
or both. While there is a statute that provides a criminal penalty for knowing and
willful violations, no one appears to have been prosecuted under it. II Principles at
6-90 (2d ed. 1992).
If the Antideficiency Act limits the amount of benefits that may be paid to the
amounts that have been and are being credited to the Trust Funds, interesting
questions arise as to whether a beneficiary who is paid only a portion of the benefit
amount set out in the Social Security Act could file suit to be paid the diffierence.
If the status of the Social Security Trust Funds should allow pajniient of only 75
percent of benefits, for example, could a beneficiary sue for the difference, the re-
maining 25 percent? If a beneficiarj- may file such a suit, what would he the likely
disposition? If a beneficiary should succeed in obtaining a court judgment against
the United States, would the individual be able to satisfy that judgment?
It appears that a beneficiary who does not receive a full benefit payment may be
able to file a claim for the difference. Subsection (g) of section 205 of the Social Se-
curity Act, 42 U.S.C. § 405(g), grants a right of judicial re\dew to any indiWdual,
after a final decision of the Commissioner of Social Security made following a hear-
ing to which he was a party, irrespective of the anioimt in controversy. The action
may be brought in a district court for the judicial district where the plaintiff resides
or has a place of business and must commence within 60 days after the notice of
decision was mailed or within such further time as the Commissioner allows. The
court has power to enter, upon the pleadings and transcript of the record, a judg-
ment affirming, modifying, or reversing the decision of the Commissioner. Findings
of the Commissioner as to any fact, if supported by substantial evidence, are conclu-
sive. The judgment of the district court is final, but may be appealed to the Court;
of Appeals and the United States Supreme Court.
Filing suit pursuant to section 205(g) appears to be the exclusive way to obtain
judicial review of a determination by the Commissioner of Social Security to deny
227
a claim, in our example, for the difference between a benefit payment of 75 percent
that was paid and the remaining 25 percent set out in the statute as the full bene-
fit. Subsection (h) of section 205 of the Social Security Act, 42 U.S.C. §405, cap-
tioned "Finality of Commissioner's Decision," states that findings and decisions of
the Commissioner after a hearing are binding upon all individuals who were parties
to a hearing. It adds that:
No findings of fact or decision of the Commissioner of Social Security shall
be reviewed by any person, tribunal, or governmental agency except as herein
provided. No action against the United States, the Commissioner of Social Secu-
rity, or any officer or employee may be brought under section 1331 or 1346 of
Title 28 to recover on any claim arising under this chapter.
Section 205(h) expressly bars any district court from hearing any case brought
under section 1331 of title 28, which grants jurisdiction to district courts to hear
civil actions arising under the Constitution, laws, or treaties of the United States,
known as Federal question jurisdiction. It also precludes jurisdiction under section
1346 of title 28 of the United States Code. Sometimes referred to as the "Little
Tucker Act," this section grants jurisdiction to district courts to hear claims against
the United States for less than $10,000 that are "founded either upon the Constitu-
tion, or any act of Congress, or any regulation of an executive department, or upon
any express or implied contract with the United States, or for liquidated damages
in cases not sounding in tort."
The Tucker Act itself, section 1491 of title 28, grants jurisdiction to the Court of
Federal Claims for claims against the United States regardless of dollar amount
founded upon the same bases as the Little Tucker Act. Section 205(h) of the Social
Security Act, 42 U.S.C. § 405(h), does not expressly deny jurisdiction under the
Tucker Act to the Court of Federal Claims to hear claims of any amount for Social
Security benefits.
Jurisdiction to hear claims for Social Security benefits under the Tucker Act, how-
ever, appears to have been foreclosed by some decisions of the Court of Appeals for
the Federal Circuit, the court that hears appeals of decisions by the Court of Fed-
eral Claims. In Marcus v. United States, 909 F.2d 1470 (Fed. Cir. 1990), a panel
of the Court of Appeals for the Federal Circuit held that section 205(h) of the Social
Security Act denied jurisdiction to the Court of Federal Claims pursuant to the
Tucker Act to hear a claim for Social Security benefits, even when the beneficiary
asserted that he was entitled to relief under the Constitution. See also Saint Vin-
cent's Medical Center v. United States, 32 F.3d 548 (Fed. Cir. 1994).
Would a beneficiary be likely to prevail in a suit for the difference between the
amount available in the Trust Funds and the entitlement amount set out in the So-
cial Security Act, the 25 percent difference in our example? It appears that a district
court may have authority to enter a judgment against the United States to a bene-
ficiary who has exhausted administrative remedies and filed suit, but it may not
order the United States to pay the amount in controversy. See III Principles at 14-
5 (2d ed. 1994). The Supreme Court in Reeside v. Walker, 52 U.S.dl How) 272, 275
(1850), held that no officer is authorized to pay any debt due from the United
States, whether reduced to judgment or not, unless an appropriation has been made
for that purpose. The Court cited article I, section 9, clause 7 of the Constitution,
which states that, "No money shall be drawn from the Treasury, but in consequence
of appropriations made by law; * * * ." See also Office of Personnel Management
V. Richmond, 496 U.S. 414, 424-426 (1990), and Rochester Pure Waters District v.
Environmental Protection Agency, 960 F.2d 180, 184-186, n. 2 (D.C.Cir. 1992), the
latter of which observed that there may be an exception to the general rule an-
nounced in the Reeside case where a court orders an expenditure for a constitu-
tional reason such as to remedy a violation of the Equal Protection Clause.
Congress has created on the books of the Treasury the OASDI Trust Funds, ap-
propriated an amount equivalent to 100 percent of taxes received, and provided that
interest on and proceeds from the sale or redemption of government securities held
in the Trust Funds shall be credited to and form a part of them. Section 201(a) and
(0 of the Social Security Act, 42 U.S.C. § 401(a) and (f). It also has stated that
amounts credited to the Trust Funds are the only source of funds to pay benefits.
Section 201(h) of the Social Security Act, 42 U.S.C. § 401(h). Consequently, it ap-
pears that unless Congress changes the law, a beneficiary would not be likely to ob-
tain an amount or satisfy a judgment sufficient to cover the difference between the
amount that the Trust Fund balances permit the Social Security Administration to
pay and the full benefit amount prescribed in the Social Security Act.
Another interesting question is whether there is a source of funds other than the
Social Security Trust Funds that a beneficiary may use to satisfy a court judgment
against the United States for the difference between the amount paid and the full
benefit, 25 percent in our example. Section 1304 of title 31 of the United States
228
Code establishes the Judgment Fund; it appropriates necessary amounts to pay
final judgments, awards, compromise settlements, and interest and costs specified
in judgments or otherwise authorized by law.
The Judgment Fund is available to pay a judgment, however, only if pajrment is
"not otherwise provided for." 31 U.S.C. § 1304(a)(1).
The question of whether payment is "otherwise provided for" is a question of
legal availability rather than actual funding status. As a general proposition,
if payment of a particular judgment is "otherwise provided for" as a matter of
law, the judgment appropriation is not available, and the fact that the defend-
ant may have insufficient funds at the particvdar time does not make the judg-
ment appropriation available. 66 Comp. Gen. 157, 160 (1986); Department of
Energy Request to Use the Judgment Fund for Settlement of Femald Litiga-
tion, Op. Off". Legal Counsel, December 18, 1989. The agency's recourse in this
situation is to seek funds from Congress, the same as it would have to do in
any other deficiency situation.
There is only one proper source of funds in a given case.
m Principles at 14-26 (2d ed. 1994).
In the case of Social Security benefits, the source of funds appears to be otherwise
provided for in the OASDI Trust Funds. As noted earlier, section 201(h) of the So-
cial Security Act, 42 U.S.C. § 401(h), states that benefits shall be paid "only" fi-om
amoimts credited to the Trust Funds. As a result, it does not appear that a bene-
ficiary, if successful in obtaining a court judgment against the United States for the
difference between the amount paid and the full benefit amount, could satisfy the
judgment fi^om the Judgment Fund.
Conclusion
This memorandimi has addressed whether insolvency of the Social Security Trust
Funds may prevent a beneficiary from receiving the full amount of benefits pre-
scribed in the Social Security Act if Congress does not amend the Social Security
Act with respect to eligibility standards or payroll tax rates or take other budgetary
action to meet the shortfall. Our research reveals that insolvency of the Trust Funds
would not extinguish the legal right, i.e., the entitlement, of a beneficiary to receive
the full amoimt of a benefit payment. Under the Antideficiency Act, however, the
Social Security Administration would be able to pay only a benefit level equivalent
to Trust Fund receipts as they become available. Under our finding, if an amount
sufficient to pay only 75 percent of benefits is credited to the Trust Funds as Social
Security taxes are received, for example, each beneficiary would receive only 75 per-
cent of the benefit.
There appears to be legal authority granting jurisdiction to a district court to hear
a case brought by a beneficiary who has exhausted administrative remedies to chal-
lenge pa)nment of an amount less than the full benefit amount. It is possible that
a court may enter a judgment in favor of a beneficiary who has filed suit, but the
Supreme Court has held that a court generally cannot order officers of the United
States to pay an amount unless it has been appropriated by Congress. Article I, sec-
tion 9, clause 7 of the Constitution states that, "No money may be drawn from the
Treasury, but in consequence of appropriations made by law; * * *"
In our example, an amoimt sufficient to cover 75 percent of benefits would rep-
resent the full amoxmt that Congress has appropriated and made available for bene-
fit payments. The Social Security Act appropriates to the Trust Funds 100 percent
of Social Security taxes and provides that interest on and proceeds from the sale
or redemption of government securities held in them shall be credited to and become
part of the Fimds.
As a result, it appears that a beneficiary who may obtain a judgment against the
United States for the difference between the amount paid and the full benefit would
have to await congressional action to adjust the Social Security Act or otherwise
raise revenue to provide the Social Security Trust Funds with an amount sufficient
to pay the full benefit.
Chairman Smith. Thank you both very much. A special thank
you to you, Mr. Huff, to take the time and making the effort to ap-
pear.
The next meeting of the Task Force will be next Tuesday, and
the subject matter will be investments, the cost of those invest-
ments, and handling investments that guarantee no loss.
So thanks again. The Task Force is adjourned.
[Whereupon, at 1:30 p.m., the Task Force was adjourned.]
Secure Investment Strategies for Private
Investment Accounts and Annuities
TUESDAY, JUNE 15, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12 noon in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Members present: Representatives Smith, Herger, Toomey, and
Rivers.
Chairman Smith. The Budget Committee's Social Security Task
Force will come to order for the purpose today of examining secure
investment strategies for private investment accounts and annu-
ities talking with Steve Bodurtha and Dr. Warshawsky and Jim
Glassman. There are going to be two votes and that means it is
going to be 25 minutes from now when the final vote is finished,
maybe 20 minutes. We will vote and come back.
So I think we will proceed for the next maybe 10 minutes and
then with our excuses it is going to take maybe 15, 20 minutes for
L3nin and I and the other Members to go vote.
It seems to me public understanding is one of the keys to suc-
cessful Social Security reform. When Americans understand how
serious the situation is or the consequences of doing nothing, I
think they are going to be the pressure or the catalyst that encour-
ages their representatives to move ahead with solutions. With the
solvency of the system in question, what I have seen over the last
5 years is special interest groups are coming in to make sure that
their territory is protected.
And so we have seen, first of all, senior organizations come in to
say don't cut the COLA, don't cut any benefits in any way, and if
you have to raise money some place else, do that. So a protection-
ism from seniors, from near retirees, certainly from young people
that already have expressed their concern and skepticism of wheth-
er retirement benefits are going to be available for them when they
retire, but at the same time at least the statistics that I have seen
indicates that those young people are investing less of their own
money.
It seems to me that workers with personal accounts will have in-
vestment choices that give them stable incomes in their golden
years, but it will also give them ownership which is an assurance
that politicians can't change or interrupt them. Today a representa-
(229)
230
tive from TIAA-CREF will tell us about the life annuity program
used for investors.
Steve Bodurtha is in charge of Merrill Lynch's Customized In-
vestment Group. He has 15 years of Wall Street experience in ap-
plying financial innovation to investment products. He has pio-
neered the discipline of protected growth investing which seeks to
grow wealth while essentially totally eliminating risks. So Steve,
thank you very much for taking time to be here today.
Dr. Mark Warshawski is director of research at the TIAA-CREF
Institute which supports the non-profit financial service organiza-
tion and pension system for workers in U.S. educational and re-
search institutions. Dr. Warshawsky has authored numerous publi-
cations on pensions and retiree health benefit plans, individual an-
nuities and life insurance, financial planning and asset allocation,
national health expenditures, corporate finance in the securities
market.
James Glassman serves as a resident scholar at the American
Enterprise Institute, well known in Washington as a financial col-
umnist for the Washington Post and host of the TechnoPolitics
weekly PBS program on science and public policy. Mr. Classman's
articles have appeared in the New York Times, the Wall Street
Journal, Forbes, and many other publications.
Chsdrman Smith. And Lynn, would you have an opening com-
ment?
Ms. Rivers. No.
Chairman Smith. If you will excuse us, we will return as soon
as possible so the Task Force is temporarily in recess.
[Recess.]
Chairman Smith. The Task Force will reconvene. Without objec-
tion, all of the prepared testimony will be entered in the record,
and if you would hold your comments to some place between 5 and
7 minutes to give us time for questions, that would be good.
STATEMENTS OF STEVE BODURTHA, FIRST VICE PRESIDENT,
CUSTOMIZED INVESTMENTS, MERRILL LYNCH & CO., INC.;
MARK WARSHAWSKY, DIRECTOR OF RESEARCH AT THE
TIAA-CREF INSTITUTE; JAMES GLASSMAN, DE WITT WAL-
LACE-READER'S DIGEST FELLOW IN COMMUNICATIONS IN A
FREE SOCIETY, AMERICAN ENTERPRISE INSTITUTE FOR
PUBLIC POLICY RESEARCH
Chairman Smith. Mr. Bodurtha, Merrill Lynch.
STATEMENT OF STEVE BODURTHA
Mr. Bodurtha. Thank you. Chairman Smith, Congresswoman
Rivers, distinguished Task Force members. Thank you for inviting
me to testify in this important forum regarding the development of
secure investment strategies for personal retirement accounts and
annuities in the context of Social Security reform.
At the outset, let me say that I am not here to discuss the merits
of personal retirement accounts. Rather, I have been invited be-
cause of my knowledge of and experience in developing secure fi-
nancial products that protect principal and provide investors the
opportunity for significant growth potential. My testimony is lim-
ited to that subject.
231
Growth oriented investments, such as stocks, have historically
provided the best opportunity to increase wealth over the long run.
And yet, potential downside risk keeps many people from investing
in stocks, even when long-term growth is the objective, in planning
for retirement, saving for college, or meeting future health and pa-
rental care needs to name just a few examples. When aversion to
risk stands in the way of investing for long-term growth, people
may fail to achieve important financial goals.
To help with this problem, we at Merrill Lynch have pioneered
the concept of protected growth investing, which combines partici-
pation in the long-term appreciation potential of growth assets,
such as stocks, with protection of principal.
The purpose of protected growth investing is simple: To allow the
pursuit of growth with limited risk.
Protected growth assets are financial instruments with features
of both stocks and bonds. In recent years, an array of exchange list-
ed, protected growth assets have been issued to meet varying in-
vestor needs. While each has its own unique set of terms, most pro-
tected growth assets share certain common features. When you buy
a protected growth asset, you are purchasing an asset at an offer-
ing price that t5rpically ranges between $10 and $1,000.
Protected growth investors will receive all or substantially all of
their initial principal at maturity. Protected growth assets gen-
erally are structured as debt obligations or bank deposits. Some,
however, may be in the form of a mutual fund or annuity. Because
protected growth assets are issued or backed by financial institu-
tions or other companies, the payment of principal at maturity and
the returns, if any, depend on such issuers creditworthiness.
Most of Merrill Lynch's protected growth assets are listed and
traded on the New York Stock Exchange or the American Stock Ex-
change. Protected growth assets such as equity link deposits and
annuities generally will not be exchange listed, however. An illus-
tration may provide a better idea of how protected growth investing
works. I will use the example of one of our protected growth invest-
ment products called a MITTS for marketed index target-term se-
curity.
In this example, an investor in this MITTS security is entitled
to receive the principal amount of the security let's say $10 plus
a supplemental payment equal to 100 percent of the price apprecia-
tion excluding dividends in the ABC composite stock price index.
And you can think of that as a generic example. It could be the
S&P 500 or the Dow Jones industrial average to add some other
examples.
That appreciation is measured between the offering date and the
maturity date of the MITTS security. For this hypothetical exam-
ple, all of the $10 initial principal amount is backed and protected
by Merrill Lynch and Co. Investors in no event will receive less
than the principal amount of $10 at maturity subject to Merrill
Lynch's ability to pay its debt obligations regardless of how the
stock index does.
This MITTS security provides that investors will receive a sup-
plemental payment equal to 100 percent of the index's price appre-
ciation, if any, between the original offering date and the maturity
date. Let's look at three scenarios to understand what an investor
232
will earn when they purchase such an investment. If the stock
index is up, for example, 50 percent at maturity, an investor's re-
turn at maturity is the $10 principal amount plus a $5 supple-
mental payment.
The total final pa3rment at maturity is $15. If the index is un-
changed over the life of the investment, an investor's return at ma-
turity is again the $10 principal amount plus no supplemental pay-
ment. As a result, the total final payment at maturity is $10. And
if the index is down, for example, 50 percent at maturity, an inves-
tor's return at maturity will be $10 principal plus no supplemental
payment. The total final payment in that case is $10 simply reflect-
ing the return of the investor's principal.
There are several other important features that you should know
about. One, most of the protective growth investments come in the
form of bonds or deposits. An investor in these cases does not own
stocks, and, therefore, they do not participate or receive dividends
or have underl3ring voting rights with respect to the stocks. It is
also fair to point out that not all of these investments give you full
participation in the markets upside. In my example, I used a par-
ticipation rate of 100 percent. It is possible that some of these in-
vestments may offer only 80 percent of the market's participation
in the upside.
In addition, the protection mechanism is available at maturity.
Between the offering date and maturity, the market price of these
investments can fluctuate above or below the protection level, per-
haps substantially. Also people should have in mind and keep in
mind that there may be an opportunity cost associated with these
investments. In the examples that I mentioned where the index is
unchanged or goes down over the life of the investment, the inves-
tor simply receives their $10 initial principal back. They receive no
credit, if you will, for the time value of money.
That concludes my oral testimony. My complete statement is sub-
mitted for the record. Thank you.
Chairman Smith. Thank you.
[The prepared statement of Stephen Bodurtha follows:]
Prepared Statement of Stephen G. Bodurtha, First Vice President,
Customized Investments, Merrill Lynch & Co., Inc.
Introduction
Chairman Smith, Congresswoman Rivers, distinguished Task Force members,
thank you for inviting me to testify in this important forum regarding the develop-
ment of secure investment strategies for personal retirement accounts and annuities
in the context of Social Security reform. At the outset, let me say that I am not here
to discuss the merits of personal retirement accounts in the context of Social Secu-
rity reform. Rather, I have been invited because of my knowledge of, and experience
in, developing secxire financial products that protect principal and provide investors
the opportunity for significant growth potential. My testimony is limited to that sub-
ject.
We at Merrill Lynch applaud the Task Force's ongoing efforts to meet the chal-
lenge of reforming Social Security in a manner that guarantees the long-term sol-
vency of this vital program, increases national savings, and helps ensure that all
Americans have an opportunity to retire in economic security. We look forward to
assisting this Task Force, and Congress as a whole, in any way we can in achieving
this critical task.
233
Pursuing Investment Growth While Limiting Risk
Growth-oriented investments, such as stocks, historically have provided the best
opportvmity to increase wealth over the long run. And yet, potential downside risk
keeps many people from investing in stocks, even when long-term growth is the ob-
jective— in planning for retirement, saving for college, or meeting future health and
parental care needs, to name just a few examples. When aversion to risk stands in
the way of investing for long-term growth, people may fail to achieve important fi-
nancial goals.
To help with this problem, Merrill Lynch has pioneered Protected Growth'^'^ in-
vesting, which combines participation in the long-term appreciation potential of
growth assets, such as stocks, with protection of principal.
The purpose of Protected Growths^ investing is simple: to allow the pursuit of
growth with limited risk.
The Advantages of Protected Growth^m Investing
Protected Growths^ assets are financial instruments with features of both stocks
and bonds. The benefits of Protected Growths^ assets include protection of prin-
cipal, growth potential of stocks, opportunity for diversification, low minim vmi in-
vestment and liquidity.
Protected Growth^M assets promise to repay aU or substantially all of their prin-
cipal amount at maturity, even in the event of dramatic stock market price declines.
The ability of a Protected Growths^ asset to repay principal, of course, is subject
to the creditworthiness of its issuer — that is, the company, financial institution or
other entity that provides the principal protection.
growth potential
These assets offer the investor the opportunity to participate at maturity in the
potential appreciation of an index, a stock portfolio, an individual security or some
other potential growth opportunity. These growth opportunities are generically re-
ferred to as "market measures."
diversification
Because Protected Growths'^ assets may be tied to a variety of market measures,
they can complement the investment diversification of an investor's current portfolio
mix of stocks, bonds, mutual funds and cash. The diversification available through
these assets tends to be greater than what an investor may be able to achieve by
purchasing individual eqixities.
LOW MINIMUM investment
Initial offering prices start as low as $10 per unit, providing the investor with an
affordable means of participating in the performance of a number of different
growth opportunities.
LIQUIDITY
Most of Merrill Lyuch's Protected Growths^ assets issued to date are listed on the
New York Stock Exchange, or the American Stock Exchange. This generally allows
the investor to buy and sell Protected Growths^ assets, as well as monitor daily
price quotations pubhshed in the financial pages of major newspapers.
Protected Growth^m Assets Key Features
In recent years, an array of exchange-listed Protected Growth^M assets have been
issued to meet varjdng investor needs. While each has its own unique set of terms,
most Protected Growth^M assets share certain common features.
When you buy a Protected Growth^^ asset, you are purchasing an asset at an of-
fering price that typically ramges between $10 and $1,000.
Protected Growth'^M investors will receive all or substantially all of their initial
principal at maturity — making principal protection a key feature of Protected
GrowthsM investing.
Protected Growths^ assets generally are structured as debt obligations or bank
deposits. Some, however, may be in the form of a fund, or annuity. Because Pro-
tected GrowthsM assets are issued or backed by financial institutions or other com-
panies, the payment of principal at maturity and the return, if any, depend upon
such issuers' creditworthiness.
234
Protected Growth-'*'^ investing tjnpically offers the opportunity to participate in the
growth of a particular market measure. This participation is usually stated in per-
centage terms and is referred to as a "participation rate." As an example, a 100 per-
cent participation rate would give an investor the right to receive 100 percent of the
price appreciation of a market measure, while a 90 percent participation rate would
give the investor the right to receive 90 percent of such appreciation.
In certain instances, investors' participation in a market measure may not begin
untU the market measure has appreciated above a specific minimum level, some-
times referred to as a "minimum threshold." Also, participation rates may specify
a maximum return level or "ceiling."
Protected Growth'*'^ assets usually are offered with a final maturity date. Matu-
rities can range from one to 5 years or more.
Protected Growth^^ assets typically do not make regular interest or dividend pay-
ments to investors, and purchasing a Protected Growths'^ asset does not constitute
ownership of the imderlying securities or index comprising the market measure. As
a rule, the market measure to which Protected Growth^^ assets are linked is speci-
fied at the time they are originally issued.
Most of Merrill Lynch's Protected Growth^"^ assets issued to date are listed and
traded on the New York Stock Exchange, the American Stock Exchange or NASDAQ
between the time of their initial issuance and their final maturity date. Protected
Growth'*'^ assets such as equity-linked deposits and annuities generally will not be
exchange-listed, however.
Protected Growtrsm Investing Hypothetical Example
An illustration may provide a better idea of how Protected Growth'^'^ investing
works. Consider the following hypothetical Market Index Target Term Security SM
(MITTS).
GENERAL DESCRIPTION
At maturity, an investor in this MITTS security is entitled to receive the principal
amount of the security ($10) plus a supplemental payment equal to 100 percent of
the price appreciation (excluding dividends) in the ABC Composite Stock Price Index
between the offering date and maturity date of the MITTS security.
OFFERING PRICE
The initial offering price of this MITTS security is $10.
PRINCIPAL PROTECTION
For this h3npothetical example, all of the $10 initial principal amount is backed
by Merrill Lynch & Co., Inc. (rated Aa3/AA-). Investors in no event would receive
less than the principal amount of $10 at maturity, subject to Merrill Lynch's ability
to pay its debt obligations, no matter how the ABC Index performs.
PARTICIPATION RATE
This ABC Index-linked MITTS security provides that investors will receive a sup-
plemented payment equal to 100 percent of the Index's price appreciation, if any,
between the original offering date and maturity date of the issue.
MATURITY DATE
This ABC Index-linked MITTS security matures 5 years after the issue date.
HYPOTHETICAL RETURN SCENARIOS
1. Index [/p — ABC Index is up 50 percent at maturity. An investor's return at ma-
turity is the $10 principal plus a $5 supplemental pajmient. The total final payment
is $15.
2. Index Unchanged— ARC Index is unchanged at maturity. An investor's return
at maturity is the $10 principal plus no supplemental pajonent. The total final pay-
ment is $10.
3. Index Down- ABC Index is down 50 percent at maturity. An investor's return
at maturity is the $10 principal plus no supplemental pasrment. The total final pay-
ment is $10.
235
Reasons To Consider Protected Growth^m Investing
Protected Growths'^ investing allows investors to participate in growth opportxini-
ties that otherwise may be too volatile for their risk tolerance. The result is preser-
vation of capital with long-term growth potential. Here are some of the ways these
investments can help satisfy various needs and objectives.
building and protecting wealth
If an investor's financial plan dictates a need for growth, but they are reluctant
to take the risks of bu3dng stocks or other investments, Protected Growths'^ assets
may be an attractive alternative. For example, retirees who need growth to hedge
against inflation over two or three decades of retirement, but don't want to risk
principal loss, may find these assets an attractive choice. Parents or grandparents
investing for a child's college education may buy Protected Growth'*'^ assets to main-
tain appreciation potential while limiting downside exposure as the child's coUege
years grow near.
maintain and add to equity exposure during uncertain times
If investors are concerned that the market is near a peak or do not wish to be
exposed to turbulent market fluctuations, they can lock in accumulated stock mar-
ket gains by reducing their existing direct equity holdings and using Protected
Growths'^ investing to continue participation in potential ftiture market advances.
benefit from index-based investing
Even professional money managers may find it difficult to outperform market in-
dices consistently over the long term. Committing a portion of assets to index-linked
Protected Growth^"^ instruments can be a sensible strategy, particularly in volatile
markets when stock selection cem be more challenging.
enhance investment performance
Protected Growth^M investing may be an effective method of boosting potentisil re-
turns on money investors may have idle in low-earning bank accounts and money
market investments without greatly increasing their risk. Protected Growth^^ in-
vesting may give investors a way of adding high-quality growth assets to balance
a portfolio that is otherwise over-weighted by fixed-income instruments.
staying the course
Some investors tend to sell on price declines and thus fail to benefit fi-om the long-
term growth potential of stocks. The principal protection available with Protected
Growth^M investing can make it easier to stay with a well-planned investment strat-
egy and remain invested even during the most turbulent times.
A WAY to pursue NEW INVESTMENT OPPORTUNITIES WITH LIMITED RISK
If investors have an interest in investing in specific markets or sectors around the
globe or in certain strategies, but do not want the risk of owning the investments
directly. Protected Growth^w investing may offer a sound choice.
Other Important Features
Protected Growth-^^^ investing was created for investors willing to accept a speci-
fied level of participation in a growth opportunity in exchange for a known degree
of principal risk. Investors who are wiUing to assume greater risk may want to in-
vest directly into stocks and other growth investments for potentially higher long-
term returns. In addition. Protected Growth^M Investing usually is not appropriate
for investors seeking current income.
NO DIVIDENDS PARTICIPATION OR VOTING RIGHTS
Protected Growth^"^ assets do not provide the investor with direct ownership of
stocks and typically do not provide participation in dividends paid by any stocks
that may be included within the market measure. Furthermore, Protected Growth^M
assets do not convey any voting rights.
DIFFERENT TERMS AND FEATURES
Each Protected Growths'^ instrument has its own particular structure. While most
pay only at maturity, some make annual payments or provide a minimum )deld on
236
the original principal. Still others have participation rates greater than or less than
100 percent.
MATURITY DATES
Maturities vary from issue to issue. However, most Protected Growths^ assets are
offered with original maturities of one to 5 years or more.
CREDITWORTHINESS OF ISSUER
The timely pajmnent of principal at maturity and the market-linked return, if any,
depend on the issuer's or backing institutions ability to pay. Protected Growth^w
assets typically are backed by highly creditworthy financial institutions or compa-
nies, most of which are rated A or better. Keep in mind that Protected Growths^
notes and deposits are not mutual fund investments, and investors have no owner-
ship rights in the underlying market measure.
LIQUIDITY
While Protected Growth'^'^ investing is designed for long-term investors, investors
can typically sell investments prior to maturity. However, like most equity and fixed
income investments, the price investors receive when they sell may be higher or
lower than the price they paid. Of course, if they hold the investment imtil matu-
rity, their principal is protected according to the terms of the issue.
MARKET PRICE FLUCTUATIONS
Remember that Protected Growth^^^ assets can be viewed as a cross between
stocks and bonds, and their market value prior to maturity may not track closely
the performance of the market measure, particularly in the early years. Investors
must be sure to look at the specific terms and understand the various factors that
may affect the market price of each particular Protected Growths^ issue.
UNDERSTANDING THE PRINCIPAL PROTECTION LEVEL
If investors purchase a Protected Growth^^ asset in the secondary market, they
should be aware that their protection at maturity is based on the principal amount
of the original offering. For example, if an investor pays $12 per unit for an issue
with 100 percent protection of its $10 original principal amount, they wiU have $2
of principal at risk for every unit bought. On the other hand, if an investor pays
$8 per unit of that issue, the issuer is still obligated to pay the investor at least
$10 per unit, gi-ving the investor a minimum return of $2 per unit.
TAXATION
Investors should consider the tax consequences of Protected Growth-'*'^ investing.
For Protected Growths^ notes or deposits issued after August 12, 1996, £my return
earned by investors is considered to be ordinary interest income even if they sell
the investment prior to maturity. In addition, the investor is likely to owe tax annu-
ally on imputed income, even though the return, if any, is typically paid at matu-
rity.
OPPORTUNITY COST
Investors who purchase Protected Growth'^'^ assets typically give up interest or
dividend payments. Protected Growth^M assets may protect only some or all of the
original investment and should be purchased by investors who do not require cur-
rent income or the assurance that they will earn a return on their investment.
Chairman Smith. Dr. Warshawsky.
STATEMENT OF MARK J. WARSHAWSKY
Mr. Warshawsky. Good afternoon, Chairman Smith and mem-
bers of the Task Force. I am pleased to speak at this meeting
which gives a good opportunity to review research and information
relevant to understanding some of the considerations for the use of
life annuities as the primary or only method of distribution from
individual accounts under various Social Security reform proposals.
According to the Social Security Administration, Office of the Ac-
tuary, in 1998, a woman age 62 could expect to live to age 84 while
237
a 62-year-old man could expect to live to age 80. The life expect-
ancy statistics I have just cited are expectations, that is, averages.
If at retirement you knew your exact date of death, you could
schedule a draw down of pension and personal assets so that the
flow depleted those assets just at the moment of death. In reality,
however, almost everyone is uncertain about how long they will
live.
Again, according to the Social Security actuary, a woman aged 62
currently has a 25 percent chance that she will live imtil age 92
and a 10 percent chance that she will live until age 97. Is there
a way of ensuring people that will have a sufficient income in these
extra years? There is. It is called the life annuity. In its most basic
form, an annuity whether issued by a life insurance company, an
employer pension plan, or a government program such as Social Se-
curity, pools the mortality risks of people together. It pays out a
higher flow of income, about 30 percent, to each participant for his
or her entire lifetime than if the individual were left to his or her
own devices.
Four arguments have been put forward over the years to provide
a rationale for the mandatory provision by Social Security of old
age annuities rather than voluntarily through the private market.
Foremost of these arguments is that there is a significant moral
hazard problem. Moral hazard is a term of art among social sci-
entists. If individuals accumulate or are given a large sum of
money at retirement to enable them to support themselves com-
fortably in old age, a significant percentage will willfully or acci-
dentally spend or lose their retirement assets quickly and be forced
to rely on public assistance programs for their sustenance. The
mandatory provision of life annuities is judged to be necessary be-
cause it is thought that ultimately public support programs will be
widely utilized and to maintain the dignity of the age.
The second problem that a mandatory system is suggested to
solve is adverse selection, which is also a term of art used by actu-
aries and economists. This problem occurs if individuals with high-
er than average mortality risks such as those with serious illness
conclude that annuities are too expensive for them and thereby
avoid the purchase of annuities. If this avoidance behavior is wide-
spread, insurance companies will price annuities with the trun-
cated market in mind, and life annuities would be priced less at-
tractively. Hence, the benefits of pooling mortality risks would be
reduced to those in need of it. Mandatory provision of annuities
helps reduce the adverse selection problem.
A third problem mentioned is not unique to individual annuities
but is attributed broadly to many individual insurance and finan-
cial products. Marketing costs which can include massive advertis-
ing campaigns may include some socially wasteful expenditures.
The final problem sometimes mentioned for individual annuity
markets is the lack of inflation indexation.
The questions of moral hazard and adverse selection can be han-
dled largely by mandating annuitization of individual accounts
through the private market. The question of inflation indexation
can also be addressed at least partially through the private market.
Since the issuance of inflation index bonds by the Treasury and
other borrowers and the nascent formation of derivatives markets
238
for these securities, insurance companies can also begin to design
and issue inflation sensitive life annuities.
For example, my own company, TIAA-CREF, recently introduced
an inflation index bond account that can be used for variable life
annuity payouts. And as I have explained in research papers which
I have shared with staff, providers of individual annuities, aggdn
referring to TIAA-CREF's experience, have also devised several
types of annuities that provide for increases in income as the annu-
itant ages.
I thank you for your kind attention to my remarks and I would
be glad to answer your questions.
[The prepared statement of Mark Warshawsky follows:!
Prepared Statement of Dr. Mark J. Warshawsky, Director of Research,
TIAA-CREF Institute
Good afternoon. Chairman Smith and members of the Task Force. I am Mark
Warshawsky, Director of Research at the TIAA-CREF Institute, the financial and
economic research and education arm of TIAA-CREF. Founded in 1918, TIAA-
CREF is a nonprofit financial services company and the nation's largest private pen-
sion system, providing defined contribution pension plans to almost 2 million work-
ers in the nonprofit education and research sectors and making retirement income
payments to almost 300,000 annuitants. I am pleased to speak at this meeting
which gives a good opportunity to review research and information relevant to un-
derstanding some of the considerations for the use of life annuities as the primary
or only method of distribution from individual accounts under various Social Secu-
rity reform proposals. Any opinions I express are my own and do not necessarily
represent the official position of TIAA-CREF. I have shared with your staff two re-
search publications providing more details than time allows in my remarks this
afternoon.
Many study groups and bills introduced in Congress have come out in favor of
some form of individual account system to supplement or partially replace the tradi-
tional defined benefit-indexed annuity structure of Social Security. Hence, for the
first time since the 1930's, it is sensible to address, as your Task Force is doing,
first-principle questions concerning the payout phase of any Federal retirement in-
come program.
According to the Social Security Administration, Office of the Actuary, in 1998,
a woman age 62 could expect to live to age 84, while a 62-year-old man covild expect
to Uve to age 80. The life expectancy statistics I have just cited are expectations,
that is, averages. If, at retirement, you knew your exact date of death, you could
schedvde a draw down of pension and personal assets so that the flow depleted those
assets just at the moment of death. In reality, however, almost everyone is uncer-
tain about how long they will live. According to the Social Security Actuary, a
woman age 62 currently has a 25 percent chance that she will live until age 92,
and a 10 percent chance that she will live until age 97. Is there a way of insuring
that people will have a sufficient income in these "extra" years?
There is. It is called the life annuity. In its most basic form, an annuity, whether
issued by a life insurance company, an employer pension plan, or a government pro-
gram, pools the mortality risks of people together. It pays out a higher flow of in-
come (about 30 percent) to each participant for his or her entire lifetime than if each
individual were left to his or her own devices.
Four arguments have been put forward over the years to provide a rationale for
the mandatory provision by Social Security of old age annuities rather than volun-
tarily through the private market. These arguments maintain that there are prob-
lems in the operation of a /oluntary private market for individual life annuities.
Foremost of these arguments is that there is a significant moral hazard problem.
If individuals accumulate or are given a large sum of money at retirement to enable
them to support themselves comfortably in old age, a significant percentage will
willfully, or accidentally, spend or lose their retirement assets quickly and be forced
to rely on public assistance programs for their sustenance. A milder form of the
moral hazard problem is that individuals will underestimate their life expectancies,
avoid the purchase of individual annuities, and spend down their assets completely
before most of them die, again forcing many to rely on public or private charities
for continued existence. The mandatory provision of life annuities is judged to be
239
necessary because it is thought that ultimately public support progrjuns will be
widely utUized, and to maintain the dignity of the aged.
The second problem that a mandatory system is suggested to solve is adverse se-
lection. This problem occurs if individuals with higher than average mortaHty risk,
such as those with serious illness or with inherited predispositions toward certain
diseases, conclude that annuities are too expensive for them, and thereby avoid the
purchase of annuities. If this avoidance behavior is widespread, and it is impossible
for insurance companies to sell low-priced annuities exclusively to low life expect-
ancy individuals, insurance companies will price Emnuities with a truncated market
in mind, and life annuities would be priced less attractively to those expecting rel-
atively short lives. Hence, the benefits of pooling mortality risks would be reduced
to those in need of it. Mandatory provision of annuities helps reduce the adverse
selection problem.
A third problem mentioned is not unique to individual annuities, but is attributed
broadly to many insurance and financial products marketed to individuals. Msirket-
ing costs, which can include massive advertising campaigns and large commission
fees for brokers and agents, may include some socially wasteful expenditures. The
final problem sometimes mentioned for individual annuity markets is a lack of infla-
tion indexation. Unlike Social Security since 1972, individuals covered exclusively
by fixed annuities piirchased in the private market would have been exposed to un-
expected increases in the rate of inflation.
Before I introduce some evidence on these problems, a general consideration can
be posed against these argimaents. No matter how complex or complete the benefit
structure of a Federal Government compulsory program, it cannot possibly take into
account the variety of individual situations and preferences. Competitive private
markets and organizations, by contrast, reflect more immediately and completely
the changing and variable desires and needs of individuals and respond more quick-
ly to new ideas and financial technologies. In my papers, I have devoted several sec-
tions to the remarkable innovations in the private annuity market over the years,
many of which I am proud to say that TIAA-CREF introduced. And yet other inno-
vations are possible now.
On the question of whether moral hazard is a significant problem, the evidence
is suggestive, but not conclusive. The fact that the poverty rate increases with age
in the over-age-65 population is suggestive of a moral hazard problem. Perhaps be-
cause they take lump-sum or periodic distributions from their retirement plans and
fail to purchase Ufe annuities as they age, individuals use up their financial re-
sources and rely solely on public retirement income programs. Similarly, because in-
dividuals fail to purchase long-term care insurance, they fall to Medicaid to support
them as they require long-term care. While some individuals purchase single pre-
miimi immediate annuities (SPIAs) and seem to choose reasonable payout forms and
features, commercial market activity is still relatively small. The behavior of TIAA-
CREF participants is more reassuring on this score, but it must be recalled that em-
ployer sponsors of TIAA-CREF plans historically required annuitization of aU assets
accmnulated through their pension plans, and TIAA-CREF stUl recommends
annuitization as appropriate for most of its participants.
On the question of whether adverse selection is a problem, there is evidence fi:-om
studies which I have authored or co-authored that there is a difference in the mor-
taUty experience of the general populationand annuity purchasers and that the dif-
ference imposes a not insignificant cost on individual annuities.
As I mentioned earUer, the questions of moral hazard and adverse selection can
be handled largely by mandating annuitization of individual accounts through the
private market. The question of inflation indexation can also be addressed, at least
partially, through the private market. Since the issuance of inflation-indexed bonds
by the US Treasury and other borrowers, and the nascent formation of derivatives
markets for these securities, insurance companies can also begin to design £md issue
inflation-sensitive Ufe annuities. For example, CREF recently introduced an infla-
tion-indexed bond account that can be used for variable life annuity payouts. As I
explain in my papers, providers of individual annuities, especially TIAA-CREF,
have also devised several types of annuities that provide for increases in income as
the annuitant ages.
Thank you for your kind attention to my remarks. I will be glad to answer any
questions.
Chairman Smith. Mr. Glassman.
240
STATEMENT OF JAMES K. GLASSMAN
Mr. Glassman. Thank you, Mr. Chairman. Mr. Chairman, Con-
gresswoman Rivers, and members of the Task Force, I am honored
that you have asked me to testify here today on this very impor-
tant subject.
My name is James Glassman. I am the DeWitt Wallace-Reader's
Digest Fellow in Communications at the American Enterprise In-
stitute and for the last 6 years, I have been a financial columnist
for the Washington Post and I have just completed a book on the
stock market titled "Dow 36,000," which will be published by Times
Books in September.
I am also a great admirer, Mr. Chairman, of your efforts to re-
form Social Security. I am a strong supporter of allowing all Ameri-
cans to participate in the growing American economy through stock
ownership. It is really a shame that so many Americans, especially
the young and the less well-off, have missed the opportunity to par-
ticipate in the increase in the stock market since 1982 from 777 on
the Dow to well over 10,000. One reason they have missed that op-
portunity to participate is that many of the dollars that could be
saved or could have gone into stock market investing have been di-
verted into payroll taxes into a system by which Americans will get
very low returns under Social Security.
You asked specifically that I address the question of how to insu-
late personal retirement account holders from losses and as the —
and to provide adequate retirement income as the system
changes — when and if the system changes. I have three answers to
your question on insulation.
First, complete insulation against risk is impossible. No one in-
vestment is entirely risk-free, not even Treasury bonds. Treasury
bonds can lose their value, lose their bujdng power in a significant
way with inflation. There is a new class of Treasury bond, however,
that does provide some protection. But in general, a complete insu-
lation against risk is impossible. The only way that Social Security
payments themselves are protected is through the taxing power of
the Federal Government.
Second, in an uncertain world, investors have their best chance
of gaining a secure retirement income and avoiding losses by mak-
ing continual investments in a diversified portfolio of stocks over
a long period of time. This is what I personally preach, probably
too much, twice a week in the Washington Post. The reason is not
only do stocks return a lot more than bonds but over long periods
of time, stocks are actually less risky when we define risk as we
do most of the time in financial terms as volatility, the extremes
of the ups and downs of returns. And let me just quote Jeremy
Siegel from the Wharton School in his book, "Stocks in the Long
Run:" "Though it may appear to be riskier to hold stocks and
bonds, precisely the opposite is true," writes Professor Siegel. "The
safest long-term investment for the preservation of purchasing
power has clearly been stocks, not bonds."
Unfortunately, however, many Americans, most Americans have
been frightened out of long-term investing in the stock market to
the degree to which they should be invested.
Therefore, that brings me to the third — my third point, which is
that despite the excellent returns and low risks of stocks, because
241
of this risk aversion, many investors, many Americans who are not
investors now need other kinds of vehicles. Just let me give you an
example of what Americans will be missing if they put all their
money into bonds instead of stocks, and I use the Ibbotson statis-
tics.
I know that Roger Ibbotson has testified in fi'ont of this commit-
tee. From 1925 to 1997, an investment of $1 in large company
stocks rose to $1,828 while investment of $1 in long-term govern-
ment bonds rose to just $39. So it is important that people are in-
vested in the long-term in stocks. What's the best way to do that
and protect them on the downside?
Well, there are many very interesting investment vehicles, one of
which Steve Bodurtha has described here provided by — developed
by Merrill Lynch & Co. Called MITTS or market index target term
securities. Steve described them at length. They were launched
about 7 years ago and they trade on major exchanges but few in-
vestors seem to be aware of them. Paine Webber, Solomon Smith
Barney, Lehman Brothers and other firms also provide similar ve-
hicles. The point about MITTS is very simple. There is no downside
risk or very, very little downside risk. It is kind of Uke a bond but
instead of being paid interest, you get paid the appreciation of a
particular stock index in the case of one that I think that people
should be — should think about for this kind of investing, the Stand-
ard & Poor's 500 stock index which reflects the activity of roughly
the largest 500 stocks on the U.S. stock exchanges.
There are also, as Mark Warshawsky explained, annuities. There
are many vehicles that can limit risk while providing large upside
returns of the sort that the stock market provides. These kinds of
vehicles serve as a response to the argument that individuals will
lose their shirts if they are aUowed to make their own choices
about investing for their retirements. In fact, the technology and
the imagination currently exist to limit risk on the downside in a
trade-off for trimming slightly the gains on the upside. It is a deal
that many Americans would gladly accept.
In sunmiary, Mr. Chairman, and members of the Task Force,
complete insulation from risk is impossible but the kind of risk re-
duction that prospective retirees want and should have is not only
possible but is here today. Thank you.
Chairman Smith. Thank you very much.
[The prepared statement of James Glassman follows:]
Prepared Statement of James K Glassman, DeWitt Wallace-Reader's Digest
Fellow in Communicationsin a Free Society, American Enterprise Institute
FOR Public Policy Research
I am honored that you have asked me to testify here today on this very important
subject.
My name is James K Glassman, and I am the DeWitt Wallace-Reader's Digest
Fellow in Conununications at the American Enterprise Institute. For the past 6
years, I have also been a syndicated financial columnist for the Washington Post,
and, with the economist Kevin Hassett, I have just completed a book on the stock
market, titled "Dow 36,000," which wiU be published by Times Books this Septem-
ber.
You asked that I specifically address the question of how to insulate personal re-
tirement account holders from losses and provide adequate retirement income —
when and if the current Social Secvirity system changes fi"om a defined-benefit sys-
tem of government-guaranteed annuities to a defined-contribution system in which
242
individuals own their own retirement accounts and are allowed broad choice in de-
ciding the investments that will comprise them.
I have three answers to your question on insulation.
First, complete insulation is impossible. No investment is entirely risk-free, not
even Treasury bonds. When inflation rises, the buying power of the interest and
principal on bonds declines. Jeremy Siegel of the Wharton School at the University
of Pennsylvania examined data going back to 1802 and foimd that over one 20-year
period, bonds lost an annual average of 3 percent of their value.
Social Security payments themselves are protected only because the Federal Gov-
ernment has the power to tax. That is important to keep in mind. The only way
to be sure that someone will get increased Social Security benefits, after inflation,
is to tax someone else.
Second, in an uncertain world, investors have their best chance at gaining a se-
cure retirement income and avoiding losses by making continual investments in a
diversified portfolio of stocks over a long period of time.
This statement may seem counter-intuitive, but anyone who has studied the stock
market knows that it is correct and actually uncontroversial.
The least risky way to invest for the long-term is by owning stocks, stocks and
more stocks.
Kevin and I have written an entire book on this subject, but to summarize. * * *
While over short periods, stocks are highly risky, over longer periods, research by
Siegel and others shows clearly that stocks not only produce higher returns than
bonds, but are also less risky.
For example, over holding periods of 20 years, when the worst average annual
performance by bonds was minus-3 percent, as I noted, the worst average annual
performance by stocks was plus-1 percent. Unlike bonds or even Treasury bUls,
stocks have never produced a negative return for any holding period of 17 years or
longer.
As Siegel writes: "Although it may appear to be riskier to hold stocks than bonds,
precisely the opposite is true: the safest long-term investment for the preservation
of purchasing power has clearly been stocks, not bonds."
Over the past 70 years, stocks have produced returns averaging 11 percent annu-
ally, roughly twice the retvmis of bonds. Since 1871, stocks have outperformed bonds
in every holding period of at least 30 years.
"Risk" in financial terms is defined as volatility — the extremes of the ups and es-
pecially the downs of the returns that stocks produce, year to year.
History is no guarantee of the future, but it is the best guide we have. And history
confirms that for long-term investors — and this, by definition, is what investors
would be in a system that allows the private personal investment of some or all of
the payroll tax dollars that now go to Social Security — stocks are both less risky and
more lucrative than the alternatives.
The best vehicles for stock investing are broadly diversified mutual funds — either
index funds that track the Standard & Poor's 500 index or the Wilshire 5000 index,
or funds managed by individuals and teams. More than 3,000 U.S. -equity funds now
exist. The choices are copious and attractive.
Third, despite the excellent returns and low risks of stocks over the long term,
many individuals are extremely averse to what they perceive to be the riskiness of
stocks. This aversion may be irrational — economists have studied what's called the
"equity premium puzzle" for decades — but it is undeniable.
Americans who fear stocks may make the terrible mistake of putting their retire-
ment dollars into money-market funds. Treasury bills or bonds. From 1925 to 1997,
an investment of $1 in large-company stocks rose to $1,828 while a $1 investment
in long-term government bonds became just $39, according to Ibbotson Associates,
a Chicago research firm.
Another example: A one-time investment of $10,000 twenty years ago plus addi-
tional monthly investments of $100 became $416,000 in the Vanguard Index 500
fund, which tracks the S&P large-company stock index. By comparison, even an ex-
cellent fund. Dodge & Cox Balanced, with assets roughly divided 60 percent stocks
and 40 percent bonds, under the same circumstances, grew to just $258,000 — a dif-
ference of $158,000.
But there are interesting alternative equity investments that provide guarantees
ag£iinst loss while at the same time no restrictions on gains. The most popular of
these were developed by Merrill Lynch & Co. and are called MITTS, or market
index target-term securities.
Although the first MITTS were laimched 7 years ago and trade on the American
Stock Exchange, few investors seem to be aware of them. Paine Webber, Salomon
Smith Barney, Lehman Brothers and other firms offer similar vehicles.
243
A MITTS security trades just like an individual stock, but it is tied to a particular
basket of stocks, or index. Let's use the example of Merrill's first MITTS series,
which was sold to the pubUc in January 1992 at $10 a share. Each share was really
like a bond because it carried a promise to pay investors back, in August 1997, the
original $10-plus an amount equal to the percentage increase in the S&P 500 over
that period, plus an extra 15 percent of that, times $10.
There was another promise: If the S&P was lower in 1997 than it was in 1992,
investors wouldn't be penalized. Merrill would still return the entire $10 initial in-
vestment.
When the shares were issued, the S&P was 412. Five years later, it was 925.
That's an increase of 125 percent. Add 15 percent of that and you get a total in-
crease of 143 percent — times $10 equals about $14 per share. Add the original $10,
and the shares were worth $24.
MITTS come in lots of flavors. Merrill offers MITTS linked to a technology index,
a health care index, a European index and more.
Another MITTS guarantees a return of the original $10 plus an adjustment for
increases in the consumer price index. Paine Webber's mid-cap security, similar to
MITTS, is geared to mid-cap stocks and matures in June of next year. It came out
at $10, which is guaranteed in the year 2000, but it currently trades at $25.
The Merrill S&P 500 is a natural investment for a personal retirement account.
A series that began in 1997 offers a guaranteed retium of principal plus the increase
in the S&P index over 5 years with a bonus of 1 percent. Think of these instruments
as bonds which, instead of paying a fixed 7 percent interest a year, instead pay
"contingent interest" in a lump sum at the end of several years. The interest is con-
tingent, or dependent, on what happens to the S&P 500. And even if the S&P falls,
the interest can't be negative. You will get your principal back.
What's the catch? First, the bond (if you think of it that way) is an obligation of
Merrill Lynch & Co., or another issuing party— not of the Federal Government. If
the issuing party defaults, an investor could be in trouble. This problem has been
partially handled, however, by creating instruments that combine a bank deposit,
backed by Federal insurance, with an S&P 500-growth feature. But the insurance
goes up only to the Federal hmit of $100,000.
Second, an investor gets no dividends fi-om the index. Even in the ciurent low-
dividend environment, the money that you forgo can be 15 percent or more of the
original investment in 5 years. Over an extended period, it is not a trivial amount.
TTiird, there are negative tax consequences for these instruments if they are. held
in taxable accounts. The Federal Government treats MITTS as though they were
zero-coupon bonds, and investors must pay taxes on phantom income before they re-
ceive it.
Fourth, these investment firms are not charitable institutions. They are offering
instruments that are profitable to them. The truth is that in only seven out of 69
rolhng 5-year periods since 1926 have stocks failed to make money. Investors are
being insured against an event that has only a 10 percent likelihood of occurring.
Stocks have lost money in only 3 percent of all 10-year periods since 1926.
But the securities — and similar annuity vehicles issued by insurance companies —
provide an important service to risk-averse Americans.
They serve as a response to the argument that individuals wiU lose their shirts
if they are allowed to make their own choices about investing for their retirements.
In fact, the technology and the imagination currently exist to limit risk on the down-
side in a tradeoff for trimming gains on the upside. It is a deal that many will glad-
ly accept.
In summary, complete insulation fi-om risk is impossible, but the kind of risk re-
duction that prospective retirees want is not only possible, but also here today.
Thank you, Mr. Chairman.
Chairman Smith. Mr. Bodurtha, the first question is how do you
hedge or how do you take positions on the future markets to back
your guarantees?
Mr. Bodurtha. There are a variety of ways in which Merrill
Lynch would hedge the obligation that creates when it issues a
product like a MITTS. And I guess the best analogy to use is that
Merrill Ljrnch in this role is fiinctioning a little bit like an insur-
ance company. We are — instead of insuring someone's home
against some other risk, we are ensuring the client, the investor
against the risk of possible market declines. So the primary way
in which we protect ourselves is to run, if you will, a diversified
244
book of risks. We, like an insurance company, get a lot of benefit
out of diversifying our business and doing this type of business
with both our institutional or retail customers.
From time to time, we will enter into stock trading, futures trad-
ing, and things like that to hedge some of the risk; but I would say
that that represents only a portion of the activity that we conduct.
We can also interact with other large-scale institutional investors,
including insurance companies and pension funds who, for a price,
are willing to help provide this kind of downside protection.
Chairman Smith. Is there a minimum length of time that you
say this has got to be at least 5 years or whatever?
Mr. BODURTHA. No. The maturities on these investments gen-
erally range from 1 to 10 years, those that are publicly available.
It is possible — I am aware of some of these investments that have
been structured going out even longer so the technology exists to
address even a 20- or 30-year time horizon.
Chairman Smith. Bill Shipman said, at least in his earlier book,
that there was no 12-year period that didn't result in a positive re-
turn on the index stocks. Roger Ibbotson said and I didn't quite un-
derstand it, Mr. Glassman, but I think he said that a 20-year pe-
riod would result in the highest positive return as far as the length
of time even though you have got ups and downs. Is that consistent
with what you and Mr. Warshawsky suggest?
Mr. Glassman. I am not sure that — if you look at 20-year periods
or 1-year periods, over time the average return should be about the
same. I think the key question really is risk over long periods. The
longer you go out, the longer the period is, the lower the risk. And
there has never been, according to Siegel's research, there has
never been a period longer than 17 years in which the stock mar-
ket has not produced a positive return after inflation which is a
pretty amazing statistic. And those periods go all the way back to
1802, and they are overlapping periods, 1802 to 1818, 1803 to 1819,
and so forth. History is no guarantee of the future, but it is pretty
clear that the longer you go out, the more risk is reduced.
Chairman Smith. Representative Rivers, this is going to be sort
of self-serving here. I am going to talk about my bill just a little
bit. I think there is a growing number of people. Republicans,
Democrats, the President, that have suggested that some capital
investment is going to be part of the solution for ultimately decid-
ing how we make Social Security secure.
Some have suggested government should control the invest-
ments. Others have suggested, letting individuals invest wherever
they want to invest. That was my first bill back in 1995 that I
wrote that said anything that was eligible for an IRA investment
would be eligible for this retirement investment. The bill I intro-
duced last session suggested that it should be limited to certain
more safe investments such as index stocks, index bonds, index
small cap funds or index global funds, sort of the thrift savings lim-
itation on investments.
Can I get each of your reactions to your feelings or thoughts on
what kind of capiteil investments should be incorporated in Social
Security reform?
Mr. Glassman. Well, I can answer that. First of all, I think
that — imfortunately I think investments have to be mandatory and
245
I think people must be fully invested during the entire period, until
whenever their retirement starts. I don't think that the govern-
ment should mandate particular investments. I think it is perfectly
reasonable to have some kind of requirements for investment com-
panies to qualify as — to qualify for investment vehicles, but I think
that if an individual, as today with the 401K plan, wants to put
all of his or her money into Treasury bills or money market fuiid,
I think that would be a huge mistake but I think that is perfectly
reasonable.
I mean, I understand people who feel that way. I think over time
they would be educated in a way where they wouldn't be doing
that.
Chairman Smith. Mark or Steve have a comment?
Mr. Warshawsky. There are a couple of points to make about
some of these issues. One is there definitely is a trade-off, and it
is a very difficult trade-off between the political issues that Eire in-
volved in centralized investments versus the costs, the inevitable
administrative costs which are involved in decentralized individual
investments. So it is a very difficult balancing act that I think
would need to be made.
The other consideration in terms of the types of investments to
offer if they were to be offered in individual accounts is what — par-
ticularly at the outset — is what people can understand and what
they can be educated about. We, at TIAA-CREF, are very careful
when we introduce a new account. We are very careful that it be
introduced with full explanation and that it tnily represent a new
type of an asset class as opposed just to introducing a new account
for its own sake because it introduces a lot of confusion and sort
of diversification for no real purpose.
So I think it is very important if Congress does decide to go down
that road, to have asset classes and investment choices which are
very carefully crafted and limited, certainly initially, because of the
educational needs.
Chairman Smith. Mr. Bodurtha.
Mr. Bodurtha. I would say if Congress does elect to make more
investments eligible for Social Security, two criteria to those that
have been discussed already would be creditworthiness to the ex-
tent that you have obligations, bonds and so forth eligible for Social
Security. I would focus on some standard for creditworthiness. You
might also focus on liquidity, giving investors the abiUty to change
their mind and make adjustments in their financial planning as
they go forward.
Chairman Smith. Representative Rivers.
Ms. Rivers. Thank you, Mr. Chairman. I have a couple of ques-
tions. To Mr. Warshawsky, you were talking about annuities. Are
annuities a good deal in terms of yes, you get security, but are they
a good deal financially for people who purchase them?
Mr. Warshawsky. Well, the type of annuities that I was address-
ing in my comments are life annuities in terms of the payout
phase. In other words, they are not what is t3rpically discussed in
the typical market in terms of as an accumulation product, but
what I was referring to was the actual payout over a lifetime.
And the answer to your question is in general yes and it de-
pends. It depends on where the annuity comes fi-om, whether it is
246
an individual product or whether it comes through a pension plan
or sort of a group arrangement and so the answer depends. I think
in general the answer is yes, though, because an annuity rep-
resents a type of insurance against the possibility of outliving your
assets which is basically not available anywhere else.
Ms. Rivers. Are they expensive?
Mr. Warshawsky. Again, the answer is it depends.
Ms. Rivers. Is this the sort of security or the sort of insulation
of risk that most people would be able to avail themselves of or do
you have to have a substantial amount of money to put this kind
of annuity together initially?
Mr. Warshawsky. No. I don't think that the latter is necessary
at all. I think they are available for any account size. Again, I
would say it is largely a question of how the annuity is structured
and how it is marketed. This is also in a sense a relative question
of how does it compare to other financial products or other insur-
ance products and I think it is comparable.
Ms. RrvERS. Mr. Bodurtha, I have a couple of questions. When
you were talking about the MITTS, I understand that it is hard to
say where the market is going to be at any given time, but what
we have been doing here week after week after week as we look
at changing the system is we have looked at projections on yields
and we have used projections on 3delds as the basis for determining
whether or not moving to a privatized system is better than having
the current system.
What are the jdelds that somebody can expect with these new
kinds of investments?
Mr. Bodurtha. Well, I am not a stock market prognosticator,
and I guess one of the fortunate things about protective invest-
ments that I am involved in is that they are really contractual com-
mitments. In other words, unlike some other investments where if
the stock market goes up
Ms. Rivers. But it is a contract just for the investment price, not
for a certain return?
Mr. Bodurtha. In other words, it is an investment contract in
the sense that if an investor gives us $100 today, it is written in
the prospectus that we will owe them, for example, $100 back mini-
mum in 5 years' time, plus 80 percent of whatever the stock mar-
ket's gain is.
Now, we look to a lot of the historical Ibbotson statistics and
things like that to get the sense that stock returns historically can
range anywhere between 8 and 12 percent and higher, and if stock
market continues to provide those types of returns over the long
run, then in my example we are committing to provide sort of 80
percent of that
return.
Ms. Rivers. One of the things you said is that return is subject
to Merrill Lynch's ability to pay.
Mr. Bodurtha. Yes.
Ms. Rivers. What would affect Merrill Lynch's ability to pay?
Mr. Bodurtha. Really just general creditworthiness of the firm
so all the way from Merrill Lynch's basic health of the business,
profitability and the like. As long as Merrill Lynch is run well and
rated well and so forth, it should have the ability to pay.
247
Ms, Rivers. When you made the analogy of— you made an anal-
ogy to insurance companies. Insurance companies do well paying
out occasional claims. They get in big trouble if there is a hurricane
or earthquake or some sort of major disruption. Merrill Lynch is
not underwritten by the FDIC. It is their basic creditworthiness.
How would they handle a big disruption in the system?
Mr. BODURTHA. Well, interestingly enough, over the term, I think
it is a fair question to sort of ask this in sort of what are the over-
all implications for Merrill Lynch and so forth. The answer really
is we have — we have seen some pretty volatile markets over the
life of this t5^e of investment already and so, for example, when
emerging markets last fall were a bit roiled, the U.S. equity market
was quite strong. Merrill Lynch has lots of other businesses in
bonds. Its business is globally diversified. So we have already had
a chance to see over the last 7 years and experience som.e volatile
times on how this product will perform in those occasions.
Let me also add that there are a variety of issuers out there and
just like today when people buy a triple A rated bond or buy a gov-
ernment bond whether it is issued by the United States or some
other sovereign entity, it is really important that they understand
that they are relying on the creditworthiness of that entity and so
the techiiology or the capability of this — that this type of invest-
ment represents is important for people to know about regardless
of whether they think Merrill Lynch is a good risk at any given
time.
Ms. Rivers. We had a debate here last week about whether or
not the U.S. government was a good credit risk and essentially
spent quite a lot of time debating the time frame from 2013 to
2034.
Do you think Merrill Lynch is a better credit risk than the
United States Government?
Mr. BODURTHA. No, I wouldn't say that.
Ms. Rivers. Thank you. Thank you, Mr. Chairman.
Chairman Smith. If we would give you the ability to tax, would
you think it would be helpful. Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman. This is really a fascinat-
ing committee to serve on with the Chairman. The issues that we
are dealing with are probably one of the most profound issues that
we have before our Nation today and how to somehow preserve a
retirement for those who have been paying into it and felt they
were going to get it for years but yet, as we know looking at the
facts, around the year 2014, we begin running out of money.
I can't think of any issue that is more important to our Nation
as a whole than the one that we are dealing with. A question for
you, if I could, Mr. Glassman. I am a long time admirer of yours.
I appreciate your candor in your articles that you write, editorials
and others. Putting on our pragmatic hat, and not to imply that is
not always on, but knowing what we are dealing with, somehow
this third rail of somehow changing the chemistry or the makeup
of Social Security in a way that any of us are still in office after
we do so.
We hear a lot on what has been proposed of a guarantee, of a
basic guarantee. At least guaranteeing what those in Social Secu-
rity are receiving now, which isn't a lot, which really is a piddly
248
little when you look at it for what they were putting into it, but
somehow transferring over into something else that would be actu-
arially sound somehow, that would be the goal of everyone, I am
sure.
I guess the question is, can we do that. But my question to you
would be should government guarantee personal accounts, some-
how guarantee it at the level that they would be receiving from So-
cial Security to begin so, and if so, what kind of guarantee should
be offered.
Mr. Glassman. Should government guarantee personal accounts?
No. Should government provide a kind of a cushion or let's say a
mini-Social Security kind of cushion that would either be deter-
mined by income or just everybody gets the same as it works in
Britain now? I think that is a good idea. If you guarantee personal
accounts, it creates an enormous problem that Mr. Warshawsky,
Dr. Warshawsky, referred to in a different context called moral
hazard.
Basically, the people know — if I know that whatever I do in my
investing the government is going to back me up, I am going to do
some pretty wild things most likely. It is not a particularly good
idea. But to have a kind of a safety net retaining a portion of Social
Security as it is now, I think that's a reasonable thing to do. I am
not necessarily sure I am in favor of it, but I think that would be
the way to handle the problem that you bring up.
Mr. Herger. Any other comments by anyone? OK. I think I
have — I think this is a very important point because we see that.
I think that we have seen it. We saw it back in the savings and
loan when somehow people think that they are going to — can't lose,
that there is that tendency to get a little more risky than perhaps
you would if you didn't have that guarantee.
Mr. Glassman. Also, Congressman, if I could interrupt, it is a
slightly different subject, but I think we saw it to some extent in
the crisis in Asia where some banks felt that since the Inter-
national Monetary Fund and other institutions bailed them out in
the past in Mexico, that they would bail them out again in Asia.
These are very serious kinds of problems. We want people, we
want investors to be at risk. You can't remove risk from investing.
Risk is an important discipline. It makes people invest wisely. If
you take that away, people are going to do things which, down the
road, will end up costing the Federal Government a lot more
money.
Mr. Herger. That is a good point. This idea of too big to fail, we
see a number of examples on that. Again, does anybody wish to
make a comment on that? OK.
Thank you very much. I have no further questions, Mr. Chair-
man.
Chairman Smith. We will start a second round. Maybe following
up, Wally, on how we can devise a safety net. A safety net is politi-
cally very popular because if you end up not having anything, then
you would be more likely to go on Medicaid or other more des-
perate welfare programs.
The proposal that we are developing in our bill looking for a safe-
ty net, and we haven't got it written yet so I am going to take this
opportunity to get your advice and ideas on it, the three of you. Is
249
it reasonable to say that if you are less risky after you hit the age
60 and you reduce your holdings to less than 60 percent in capital
investments or stock investments and 40 percent or more in secure
investments such as bonds, then you would be entitled to at least
95 percent of what you would otherwise have had.
So we are a little desperate looking for a way to approach what
Wally is talking about, some kind of a safety net that doesn't, Mr.
Glassman, like you suggest, have such a high guarantee that it
makes everybody willing to go into the highest possible, most risky
investments but at the same time have some kind of individual dis-
cretion. Thoughts, ideas from any of you.
Mr. Glassman. I think it is a real problem, these kind — kinds of
details. I am not really sure how to iron them out. I think that for
political reasons the safety net is needed.
I also feel very strongly that once the vast majority of Americans
become invested prudently in the stock market and in the bond
market, that their returns will and the size of their accounts will
swamp anything that they would be getting from Social Security,
which almost makes this point almost irrelevant. I mean, I don't
have the statistics at the tip of my tongue, but it doesn't take much
investing over a long period of time, you don't have to take that
much money away, to have a nest egg by the time you are 50 that
could be turned into an annuity that would produce income far in
excess of anything you would get from Social Security.
So I realize that for political reasons you do have to fret over the
safety net issue, but I think that we will be at a stage not too long
from now that it will be irrelevant. In my opinion, as I said to you
earlier, Mr. Chairman, I think one of the best ways to get there is
through the current vehicle of tax deferred accounts, through IRAs.
If you could expand IRAs or expand 401(k)s to unlimited degree,
which I think would be a good idea, and then let people transfer
money that they currently pay out to Social Security into those ac-
counts, that may solve a lot of the problems.
Chairman Smith. The current Social Security offers inflation in-
dexing of benefits. Is there any prospect for the private sector to
offer such things, Steve, inflation indexed annuities, or some kind
of similar protection?
Mr. BODURTHA. Well, in fact, we have begun that process. I
think, frankly, a lot will depend on how the government TIPS pro-
gram, the inflation index bonds that itself offers, unfolds. One of
the MITTS that we offered combines a degree of inflation protec-
tion along with participation in the equity market. That has been
tried. I won't tell you that it has been tried on a widespread basis,
but I guess the point is the private sector does have some ability
to adapt and address some of these concerns.
Mr. Warshawsky. Let me also try to answer your question. Cur-
rently in the United States there are no, strictly speaking, true in-
flation indexed annuities. However, in the United Kingdom there
are such products.
Of course, in the United Kingdom they have had much more ex-
perience with inflation indexed bonds issued both by the Grovem-
ment, the United Kingdom Government, and by private investors.
Here in the United States we have much less experience with it.
It is a fairly recent program.
250
So I think theoretically, and more than theoretically, it certainly
is technologically possible. Our company, as I mentioned in my tes-
timony, offers an inflation indexed annuity, I should say a variable
annuity, which is invested in inflation indexed bonds. So that gives
you close to inflation protection, but not 100 percent.
Perhaps, returning to your prior question, I think we also believe
at TIAA-CREF that people should be invested, not just in the
safest investments but also in investments which give them a pos-
sibility of higher returns even in the annuity phase. So TIAA-
CREF was the inventor of the variable annuity such that even in
the annuity phase, the pay-out phase, people still participate in the
stock market's performance. Given, as the statistics which I cited,
that people have the possibility, and increasingly so, of living after
their retirement 20, 30 years, even beyond there is a lot to be
gained by participating in the equity market.
So I think maybe in response to your prior question, I think that
is something that should be considered as well.
Chairman Smith. Representative Rivers.
Ms. Rivers. Thank you, Mr. Chairman.
Mr. Glassman, you said something that I found interesting. You
said once people got invested in the new system, their income
would swamp Social Security, their Social Security income. I guess
that I would argue that we will have a problem with the cost of
moving to a new system swamping the current budget. And we
have to get through that before we can get to any new system.
The question that I have is while we look forward to those opti-
mistic post-transition plans, how do we get there? How do we deal
with the unfunded liability that exists with Social Security today
before we can go to a new system for the next generation?
Mr. Glassman. There is no doubt, Congresswoman, that it is a
major problem. I don't think that keeping a system which has enor-
mous deficiencies simply because it costs something in the transi-
tion stage is a good reason to keep it.
It is true of almost every Federal program. It was true, for exam-
ple, of the Freedom to Farm Act, that if you want to make a change
and there are people benefiting from the current system, then un-
fortunately you have to lay out a lot of money in order to — buy
them off is not a good term, but to effect that transition.
In the long-term, it is going to be better for every one. I abso-
lutely would not deny that it is expensive. Well, it appears to be
expensive, at any rate. But you said it exactly right in your ques-
tion. There is an unfunded and actually unrecognized liability
under the current system.
Some people have said, well, let's just make it transparent. Let's
actually issue bonds. We have this liability, let's turn it into some-
thing that is real and tangible. As you know, there have been lots
of proposals including one from my colleague at the American En-
terprise Institute, Carol}^! Weaver, who was part of the Social Se-
curity Advisory Council that offered a plan that involves slightly
higher taxes. It is going to cost something.
Ms. Rivers. Do you think it is fair for — some people have argued
that the only way to actually compare plans to the existing situa-
tion is to include in the new system the unfunded liability. In other
words, it is not reasonable to say that the new system starts on
251
Tuesday as if nothing has ever happened before, and the only way
to make a comparison in terms of what works or doesn't work or
what is a good plan is to look at the new system and the old system
along with whatever transition plan that has to deal with the un-
funded liability.
Mr. Glassman. I think that is perfectly reasonable. I would also
say that the current system, the unfunded liability is in the current
system, it is not in the new system. There is this multi-trillion dol-
lar liability that the Federal Government has. We have to make
that transparent and, yes, I agree with what you just said.
I do think though that in the long run it will be better not just
in returns. I think there are other reasons that it is better for
Americans to be able to participate in this growing economy.
Ms. Rivers. So you think that the costs would be worth it?
Mr. Glassman. Absolutely.
Ms. Rivers. Even if that meant raising taxes?
Mr. Glassman. Yes.
Ms. Rivers. Mr. Warshawsky, I have a question for you that goes
back to the annuities. Social Security currently provides survivors
benefits which are equivalent to $300,000 in life insurance. In sur-
vivors benefits and disability, to some extent, even out across the
differences in race in gender, et cetera, the differences in life
expectancies. Should the annuities, if we go to a new system based
on annuities, should they have some sort of provision to be fair
with respect to sex and race?
Should we consider that because, in fact, our current system does
in a different way by the benefits it provides.
Mr. Warshawsky. I think I see the gist of your question. I actu-
ally gave some testimony to the Senate Aging Committee in Feb-
ruary on women's issues in Social Security reform.
There the tenor of what the session was about and the answers
that I addressed to that question is that I think a reasonable model
for how this might be handled, vis-a-vis gender is what is required
currently in the pension framework, which is that pricing for annu-
ities be on a unisex basis. And that would strike me as to be some-
what comparable to what is done in Social Security.
Ms. Rivers. The last question that I have for anyone interested
in answering it, is we were talking about a safety net. But the safe-
ty net currently is not just Social Security benefits upon retire-
ment, it is disability if one becomes injured during their preretire-
ment years, survivor's benefit if one dies.
If we are looking at survivor's benefits, disability benefits, mini-
Social Security if that is what we are going to call it, how much
is that going to cost? Again, arithmetically, what are you left to in-
vest? I guess that I am trying to put this whole package together.
Low-risk investment plus survivors benefits plus disabihty plus
some sort of Social Security guarantee, does that add up to more
costs than we have now?
Mr. Glassman. In all of the analyses that I have seen and ever
written about regarding reforming Social Security, any careful ana-
lyst looks only at the portion of payroll taxes that involve the re-
tirement portion of Social Security. Sloppy people may do the other,
but
Ms. Rivers. There are a lot of sloppy people on Capitol Hill.
252
Mr. Glassman. Life insurance, survivorship benefits, and disabil-
ity seem to me to be separate issues. I can tell you I personally feel
that those things would be better left to the private sector.
If you are talking about a life insurance policy that someone buys
when he or she first goes to work, which is the way it works with
Social Security, I don't think that it would be very hard to con-
struct a life insurance policy where you wouldn't have to make very
much in the way of premium pajonents. To pay them over 40 or
50 years, that is a pretty nice life insurance policy. I don't think
that anybody is really hot on making those changes right now.
Ms. Rivers. Thank you. Thank you, Mr. Chairman.
Chairman Smith. I would like to mention, Lynn, that out of the
seven Social Security proposals that the Ways and Means reviewed
last Wednesday, none of them go into that amount of the tax that
now accommodates the disability and survivor benefit portion.
On annuities, it seems to me that there is some similarity be-
tween an annuity and a no-risk investment. Should we consider an-
nuities as part of the investment guidelines? Right now, in my
draft legislation, we say that if a person wants to retire at an ear-
lier age and has enough money to buy the kind of annuity so that
the annuity, along with what they have already earned on Social
Security, can guarantee the rest of the population that they are
never going to be starving and without housing or, in other words,
have the same kind of benefits that Social Security would return,
then they can buy that annuity to help retire at an earlier age even
if they want to retire at 50, 55, or 59 or whatever.
Should we consider annuities as part of an investment portfolio
in addition to other investments, and then that brings the question,
what kind of returns do we traditionally expect on annuities?
Mr. Warshawsky. I think there are sort of two issues here which
are being combined. One is the focus on an annuity as a form of
a payment for life, guaranteed for life. But the payments them-
selves don't necessarily have to be guaranteed.
As I indicated before, that you can have such a thing as a vari-
able annuity where the payments reflect the underlying invest-
ment, such as the stock market, and therefore they can vary over
time. But the payments continue for the remainder of the life of the
policyholder or the participant in the plan. So when I am speaking
about annuities, I am really referring to the lifetime guarantee as
opposed to the guarantee of any return. There are also annuities
which are fixed annuities which do involve the guarantee of a re-
turn based on the guarantee of the insurance company that is un-
derwriting the annuity. That is an alternative investment as well.
It is more conservative, the returns are lower, but they are guaran-
teed by the insurance company.
Chairman Smith. So roughly, if you are looking at a fixed annu-
ity or variable annuity or a guarantee no-loss provision under the
programs that Merrill Lynch has developed compared to an in-
dexed 500, what kind of returns you are looking at. Maybe, Steve,
starting with you in terms of your low risk portfolio.
Mr. BODURTHA. Well, this will change depending on market con-
ditions. I would be pleased and would actually like to supply some
follow-up information on what has actually happened with some of
these investments over their life. But in light of the cost of the
253
downside protection, investors should expect to get something less
than the index return and maybe that is going to be something
along the lines of today's marketplace of 80 to 90 percent. In other
words, if the stock market appreciates by a certain amount that in-
vestor, through protected investments, might be able to participate
80 to 90 percent of that with no risk of loss of principal.
Chairman Smith. Dr. Warshawsky, what about a fixed annuity?
Mr. Warshawsky. I will quote, our own fixed annuities are in
the 6 percent range currently in current market conditions.
Chairman Smith. Steve, is there any limit to how much of these
secure investments can be offered by Merrill Lynch? Could they be
offered to a substantial part of the Social Security population?
Mr. BODURTHA. Excellent question. I think, like the Govern-
ment's own program with the TIPS, the inflation index. Treasury
notes, this is still a pretty youthful market. It is good to know that
there is more than one vendor, and my comments aren't to sort of
suggest that Merrill Lynch should be the only provider for this type
of a program.
So there are multiple providers, somewhere between 10 and 20
on a global basis, I would say that are large scale global institu-
tions. Together I think they could provide a significant amount of
volume of this product. But it is something that would need to be
coached along as well through interaction with the government.
Chairman Smith. Here again, I just heard of these in the last 6
months. Did I understand you to say they have been there for the
last 5 years?
Mr. BODURTHA. Seven years.
Chairman Smith. So is the aggressiveness of your marketing sort
of waiting to get more experience so you can decide just how far
you can expand?
Mr. BODURTHA. I would say with the roaring bull market, people
are doing well with conventional stocks and mutual funds and
things likes like that. We really see this as a problem solving tool.
When investors, if investors can stomach the risk and the full
downside risk of stocks, then it is quite possible they should be
fully invested in stocks, as Jim has discussed. However, we find
that some investors, some of our clients need to have equity market
exposure to reach their long-term goals, but that is not what they
are practicing. The reason they are not practicing that is the fear
of downside risk and that is when we introduce the product.
Chairman Smith. Let me finish up with one last question. If part
of our goal has got to be a secure retirement, then part of the goal
has to be to have a strong enough economy in this country in fu-
ture years so that the pie that we are dividing up is big enough
to accommodate the needs of the workforce and the retirees who
they must support. To spur growth, I think it is just so important
to have informed investors.
We should allow money to go where individuals presume are the
best possible companies so that those companies get that invest-
ment money and they put it into research and they put it into the
purchase of tools, equipment, facilities that are going to increase
their efficiency of production, their productivity, their competitive-
ness. One issue as we significantly expand investment opportuni-
ties, possibly through Social Security reform, is that the more flexi-
254
bility there is for individuals to choose investments, I would think,
Mr. Glassman, the greater chance that the money is going to go
into those areas that are most likely to help us get that bigger pie
in the future.
Mr. Glassman. Mr. Chairman, I completely agree with you. I
think it is one of the problems with some of the discussions of
using only index funds for investment, as I have heard in other
venues. That if you, for example, restrict or somehow overly en-
courage investments only in, let's say. Standard & Poor's 500 index
type funds or MITTS, that leaves 6,700 other listed companies that
won't be getting any money, that won't be getting those investment
dollars. I think that investment dollars flow to their best uses
when people have a broad array of choices. I think that that is
what we should aim for.
Chairman Smith. Mr. Bodurtha.
Mr. Bodurtha. I just come back to my comment earlier, which
is to say I think it is hard if you are going to elect to go down this
road to evaluate on the basis of merit some investments over oth-
ers.
I think there is a tradition in the private sector and the public
sector with the administration of public pension funds for estab-
lishing minimum standards of investment suitability. Creditworthi-
ness, liquidity, and other standards should be the guide posts if
Congress elects to go down that road.
Chairman Smith. I am going to ask you, Mr. Warshawsky, then
I am going to ask for each of you to make a closing statement of
an3rthing that we should be considering. Dr. Warshawsky.
Mr. Warshawsky. In response to your question, it is certainly —
everything that you have indicated is certainly true. There are,
however, a couple of other considerations. Certainly, in terms of in-
dividual accounts, private accounts, there would be a consideration
of the administrative costs that would be involved in setting up
such a system which could, depending on how that is organized
and depending on a lot of details, which could eat up some of that
benefit which you have indicated.
The other consideration which was inclusive in your question is
that that is under the assumption that people will understand
what it is that they are investing in and can evaluate its appro-
priateness. That requires some education. So that is yet another
consideration as well.
Finally, I would say that it is not like in comparison to other
countries where these individual accounts have been set up where
they are basically starting from scratch. It is really a phenomenal
boost to those economies to get those accounts going because it in-
troduces markets which they have never had before. This is cer-
tainly the experience in Eastern Europe. Here in the United States,
we are far from starting from scratch. So I think that some of what
the benefits that you have indicated are already there. So it is a
matter of a lot of trade-offs, and a matter of degree.
Chairman Smith. Wrap up summaries, any comments, Mr.
Glassman first.
Mr. Glassman. Yes. I think that one idea that I hope people take
from this hearing is that vehicles currently exist that limit the
downside for investors. They don't completely erase it, but they
255
limit it in ways that I think make people feel much more com-
fortable about investing in stocks, which is what they have to do
in order to get the kinds of returns that would be a good deal high-
er than those in Social Security.
Let me also comment on what Dr. Warshawsky just said about
not starting from scratch. It is true in the United States if we move
to a private, partially privatized system of Social Security, we are
not starting from scratch. We might not get the same kind of eco-
nomic boost that other countries have gotten. But there are good
things about not starting from scratch.
One is that we have a structure of 3,000 equity mutual funds
around. We have things like MITTS. We have people who are cer-
tainly not completely educated in investments, but they are more
educated than they were, let's say, in Chile in the beginning of the
1980's.
The other thing is not all Americans are participatmg m the
stock market. Right now at this point it is roughly 50 percent. That
is the thing that irks me the most, that so many Americans have
not been able to participate in the growing American economy the
way that rich people have and the way that a great extent that the
older people have. The young and the not well-off have not partici-
pated, and it is partly because payroll taxes are so high.
They don't have any money to save. That is why I think we
should start moving in this direction that we have been discussing
today. Thank you.
Chairman Smith. Steve.
Mr. BODURTHA. I would just like to close by giving some perspec-
tive, that I don't view this issue as being one of choosing between
a path that is 100 percent risky or 100 percent safe.
The point of my testimony is simply to let you know that rather
than sort of accepting the Merrill Lynch product somehow is lock,
stock, and barrel as an appropriate prescription for your work, I
simply want to point out that this type of thing is possible.
And it is possible to combine some pursuit of growth while limit-
ing of risk. Whether you choose to accept the Merrill Lynch for-
mula for delivering that, the point is the financial markets have
the capabiUty to do some of the ability to do the heavy lifting here,
to do some of the work which we all want to see done here.
Mr. Warshawsky. Just sort of follow-up to this most recent dis-
cussion that we are now having, I think there are a lot of ways of
providing increased opportunities for all Americans to participate
in the financial markets and to secure their retirement income se-
curity.
Certainly, reforms in Social Security are one approach, but then
there are also other approaches which include widening the avail-
ability of individual retirement accounts and a pension reform pro-
posal which would widen pension coverage which are, again, built
on current systems that we have in place but perhaps to make
them more widely available.
I think when Congress is considering Social Security reform, I
think it is very important that it should be considered in a broader
context of pension reform, individual private savings vehicles, and
then, hopefully, the balances, the necessary balances and tradeoffs
can be considered in that framework.
256
Chairman Smith. Very good. Gentlemen, thank you very, very
much for contributing your time and thought today. We appreciate
it. If you have any other ideas, please let us know. If we have other
questions, then you might expect a letter in the mail. But for now
thank you very much, and the Task Force is adjourned.
[Additional resource on Social Security privatization submitted
by the Budget Committee minority staff follows:]
Internet Link to National Bureau of Economic Research Working Paper,
"The Costs of Annuitizing Retirement Payouts From Individual Accounts"
http://nberws.nber.org/papers/w6918
[Whereupon, at 1:43 p.m., the Task Force was adjourned.]
The Social Security Disability Program
TUESDAY, JUNE 22, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 12:10 p.m. in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Present: Representatives Smith, Toomey, Rivers, Bentsen, and
Holt.
Chairman Smith. The Budget Committee Task Force on Social
Security will come to order.
We will proceed with my statement. Representative Rivers, if she
would like to make a statement, also any of the other members
that would like to put a statement into the record, without objec-
tion that statement will go into the record.
Let me say that I think today's meeting on Social Security dis-
ability program is important. DI is too often overlooked as we de-
velop modifications to Social Security.
In 1965, 1 million workers were collecting disability benefits.
Last year, in 1998, 6 million workers and family members received
$49 billion. So it went from 1 million workers to 4.4 million work-
ers in 1998, plus another 1.6 million that were family members of
those disabled in 1998.
Social Security disability benefits are becoming a more signifi-
cant part of the cost of Social Security. Reforms that restore sol-
vency to Social Security are especially important for the disability
program, because we have less time before the disability trust fund
reaches insolvency. The estimates are that by 2010, program ex-
penses will exceed receipts. By 2020, Social Security projects that
11 million people will be receiving disability benefits. Even if all
that has been borrowed from that trust fund is paid back, the dis-
ability trust fund will be depleted at that time.
It was interesting that Federal Reserve Chairman Alan Green-
span has told this Task Force that the main reason that the actu-
arial estimates of the 1983 changes that were costed out to keep
Social Security solvent for the next 75 years were wrong is the in-
creased number of people that have gone on disability. The actual
numbers are way beyond what they projected in 1983.
The Social Security reform proposals presented to the Ways and
Means Committee 2 weeks ago do not privatize the disability insur-
ance program.
(257)
258
Ljnin, I was just sajdng of all the 8 proposals that were before
the Ways and Means Committee 2 weeks ago, none of them
touched the disability insurance portion of the Social Security pro-
gram. I have asked today's speakers to help us understand the de-
tails of the disability program. This way, Congress can design re-
forms that keep the disability program strong and protect its bene-
ficiaries.
Would you have a comment?
Ms. Rivers. Only to thank the members of the panel for being
here today. I agree with Mr. Smith, that this is an often over-
looked, but very important part of Social Security protections here
in this country. I am very interested in hearing what you have to
say.
Chairman Smith. The Social Security Administration has two
representatives to discuss the Social Security disability program,
Jane Ross, the Deputy Commissioner for Policy, and Mark Nadel.
Mark, is that the right pronunciation? He is Associate Commis-
sioner for Disability and Income Assistance. Marty Ford is Assist-
ant Director of Governmental Affairs for ArcUS and speaking on
behalf of the Consortium for Citizens With Disabilities.
Ms. Ford, if you would proceed first.
STATEMENT OF MARTY FORD, ASSISTANT DIRECTOR OF GOV-
ERNMENTAL AFFAIRS FOR ARCUS, ON BEHALF OF THE CON-
SORTIUM FOR CITIZENS WITH DISABILITIES
Ms. Ford. Chairman Smith and members of the Task Force,
thank you for this opportunity to discuss the Social Security Sys-
tem solvency issues from the perspective of people with disabilities.
We believe that the title II Old Age, Survivors and Disability In-
surance programs are insurance programs, not investment pro-
grams, designed to reduce risk from certain specific or potential life
events for the individual.
They insure against poverty in retirement years, they insure
against disability limiting a person's ability to work, and they in-
sure dependents and survivors of workers who become disabled, re-
tire or die.
In fact, more than one-third of all Social Security benefit pay-
ments are made to 6.7 million people who are non-retirees.
People with disabilities benefit from the title II trust funds under
several categories of assistance. Those categories include disabled
workers, (and I think that these are probably the folks that people
most often think about in terms of disability insurance); disabled
workers whose benefits are based on their own work histories, as
well as their dependent families; retirees who are disabled and
whose benefits are based on their own work histories; and I would
like to point out two other categories: Adult disabled children who
are dependents of disabled workers or retirees, and adult disabled
children who are survivors of deceased workers or retirees.
People with disabilities cannot easily be separated out of any
portion of title II. For instance, adult disabled children receive ben-
efits from the retirement and survivors programs based on the
work history of their parents.
The definition of disabihty is uniform across these programs and
across the country. Administration of the programs includes deter-
259
mination of disability eligibility under rigorous standards, due
process and opportunity for appeals up to the Federal courts.
The nature of the OASDI programs as insurance against poverty
is essential to the protection of people with disabilities. The pro-
grams provide benefits to multiple beneficiaries across generations
under coverage earned by a single wage earner's contributions.
Partially or fully privatizing the Social Security trust funds
would shift the risks that are currently insured against in title II
from the Federal Government back to the individual. Plans which
spend the current or projected Social Security trust funds on build-
ing private accounts would be devastating for people with disabil-
ities, and we oppose them.
We believe that Social Security is a system that works. We be-
lieve that Congress should only consider legislation that maintains
the basic structure of the current system based on workers' payroll
taxes, preserves the social insurance programs of disabiUty, sur-
vivors, and retirement, guarantees benefits with inflation adjust-
ments, and preserves the Social Security trust funds to meet the
needs of current and future beneficiaries.
Certainly changes are necessary within the basic structure to
bring the trust funds into long-term solvency. However, those
changes need not and must not be so drastic as to undermine or
dismantle the basic structure of the program. Many privatization
proposals try to address the very high transition costs associated
with privatization through deep cuts in the current prograni. In ad-
dition, although many solvency proposals claim to leave disability
benefits untouched, they actually include elements that will hurt
those with disabilities.
Proposals that claim to offset cuts by the creation of individual
accounts ignore the fact that many people with disabilities are sig-
nificantly limited in their ability to contribute to those accounts for
themselves or their families.
In my full testimony, which I would hope will be entered into the
record, I have highlighted some basic components of the major pro-
posals that could have a negative impact on people with disabil-
ities. These are provided in order to assist in understanding how
people with disabilities could be affected by the various proposals.
They include things such as: First, the potential impact of changes
to the benefit formula because disability benefits are also based on
the primary insurance amount a^d any change to that formula
would also affect the disability program.
Second, access to retirement accounts — under many proposals,
disabled workers under age 62 would not have access to their indi-
vidual retirement accounts. Third, issues of privatization of retire-
ment and survivors only and the use of annuities which may seri-
ously affect people who are adult disabled children and need to de-
pend on their parents' work history and earnings, perhaps well be-
yond their parents' lifetime.
The impact of these and other components must be judged in
combination with all other components of any plan under discus-
sion. To that end, we urge the Task Force to follow through on a
suggestion made at a Ways and Means Committee hearing earlier
this year to request a beneficiary impact statement from the Social
260
Security Administration on every major proposal or component of
a proposal under serious consideration.
We believe that in a program with such impact on millions of
people of all ages, it is simply not enough to address only the budg-
etary impact of change, but also the people impact of change must
be studied.
Thank you very much for considering our viewpoints. We look
forward to working with you.
[The prepared statement of Ms. Ford follows:]
Prepared Statement of Marty Ford, Assistant Director of Governmental
Affairs for ARCUS, on Behalf of the Consortium for Citizens With Dis-
abilities
Chairman Smith and members of the Task Force, thank you for this opportunity
to discuss the Social Security system solvency issues from the perspective of people
with disabilities. , . ^^ ■ ,. m, a ^ ^u
I am Marty Ford, Assistant Director for Governmental Affairs of The Arc of the
United States, a national organization on mental retardation. I am here today in
my capacity as a co-chair of the Social Security Task Force of the Consortium for
Citizens with Disabilities. r • i
The Consortium for Citizens with Disabilities is a working coalition of national
consumer, advocacy, provider, and professional organizations working together with
and on behalf of the 54 million children and adults with disabilities and their fami-
lies living in the United States. The CCD Task Force on Social Security focuses on
disability policy issues and concerns in the Supplemental Security Income program
and the disability programs in the Old Age, Survivors, and Retirement programs.
For more than 60 years, the Social Security program has been an extremely suc-
cessful domestic government program, providing economic protections for people of
all ages. It works because it speaks to a universal need to address family uncertain-
ties brought on by death, disability, and old age. The Social Security system has
evolved to meet the changing needs of our society and will have to change again
in order to meet changing circumstances in the future. However, any changes must
preserve and strengthen the principles underlying the program: universality, shared
risk, protection against poverty, entitlement, guaranteed benefits, and coverage to
miiltiple beneficiaries across generations.
People With Disabilities Have a Stake in Social Security Reform
The Title II Old Age, Survivors, and Disability Insurance (OASDI) programs are
insurance programs designed to reduce risk from certain specific or potential life
events for the individual. They insure against poverty in retirement years; they in-
sure against disability limiting a person's ability to work; and they insure depend-
ents and survivors of workers who become disabled, retire, or die by providing a
basic safety net. While retirement years can be anticipated, disability can affect any
individual and family unexpectedly at any time. According to the Social Security Ad-
ministration, a twenty-year-old today has a 1 in 6 chance of dying before reaching
retirement age and a 3 in 10 chance of becoming disabled before reaching retire-
ment age. ^ , 1 , .
People with disabilities benefit from the Title II trust funds under several cat-
egories of assistance. Those categories include: disabled workers, based on their own
work histories, and their families; retirees with benefits based on their own work
histories; adult disabled children who are dependents of disabled workers and retir-
ees; adult disabled children who are survivors of deceased workers or retirees; and
disabled widow(er)s. .
More than one-third of all Social Security benefit payments are made to lb.7 mil-
lion people who are non-retirees, including almost 4.7 million disabled workers,
nearly 1.5 miUion children of disabled workers, about 190,000 spouses of disabled
workers, and 713,000 adult disabled children covered by the survivors, retirement,
and disability programs. Other non-retirees include non-disabled survivors and de-
pendents. For the average wage earner with a family, Social Security insurance ben-
efits are equivalent to a $300,000 life insurance policy or a $200,000 disability in-
surance policy.
Beneficiaries with disabihties depend on Social Security for a sigmficant propor-
tion of their income. Data from the Census Bureau's Current Population Survey in-
dicates that, in 1994, the poverty rate for working age adults with disabilities was
261
30 percent. The recently conducted National Organization on Disability — Harris Poll
revealed significant data on employment of people with disabilities: 71 percent of
working age people with disabilities are not employed, as compared to 21 percent
of the non-disabled population. The capacity of beneficiaries with disabilities to work
and to save for the future and the reality of their higher rates of poverty must be
taken into consideration in any efforts to change the Title II programs.
I. Maintaining Old Age, Survivors, and Disability Insurance as Insurance
Programs
The nature of the OASDI programs as insurance against poverty (for survivors;
during retirement; or due to disability) is essential to the protection of people with
disabilities. The programs are unique in providing benefits to multiple beneficiaries
and across multiple generations under coverage earned by a single wage earner's
contributions. Proposals that partially or fully eliminate the current sharing of risk
through social insurance and replace it with the risks of private investment will be
harmf\il to people with disabilities who must rely on the OASDI programs for life's
essentials, such as food, clothing, and shelter, with nothing remaining at the end
of the month for savings and other items many Americans take for granted.
Privatization of the Social Security trust funds would shift the risks that are cur-
rently insured against in Title II from the Federal Government back to the individ-
ual. This could have a devastating impact on people with disabilities and their fami-
lies as they try to plan for the future. The basic safety nets of retirement, survivors,
and disability insurance would be substantially limited and individuals, including
those with limited decision-making capacity, would be at the mercy of fluctuations
in the financial markets. In this document, the use of the term privatization does
not include the proposals for the Federal Government to invest a portion of the trust
funds in the private market. Those proposals contemplate shared investment with
no shift of the risks from the government to the individual.
In addition, solvency plans which are likely to produce substantial pressure on the
rest of the Federal budget in the future could have negative impact on people with
disabilities, ultimately reducing the other services and supports upon which they
also must rely. Plans which spend the current or projected Social Security trust
fund surpluses on building private accounts would have such negative results. Plans
which create private accounts fi-om non-Social Security surpluses, though promising,
must be weighed against other priorities, such as preserving Medicare.
In short, we believe that Congress should only consider legislation that maintains
the basic structure of the current system based on workers' payroll taxes; preserves
the social insurance disability, survivors, and retirement programs; guarantees ben-
efits with inflation adjustments; and preserves the Social Security trust funds to
meet the needs of current and future beneficiaries. Certainly, changes will be nec-
essary within the basic structure to bring the trust funds into long-term solvency.
However, those changes must not be so drastic as to undermine or dismantle the
basic structure of the program.
II. Effects of Proposals to Privatize and to Pay for Privatization
Many proposals try to address the very high transition costs associated with pri-
vatization through deeper cuts in the current program; these cuts could negatively
affect people with disabilities. In addition, many solvency proposals claim to leave
disability benefits untouched. However, as described below, these plans include ele-
ments that will seriously hurt those with disabilities. Further, proposals that claim
to offset cuts in the basic safety net by the creation of individual accounts based
on wages ignore the fact that many people with disabilities are significantly limited
in their ability to contribute to those accounts for themselves and their families.
Following are some basic components of the major proposals that could have a
negative impact on people with disabilities. While some proposals may have been
modified for introduction in this Congress, the various components are still "on the
table" for discussion. These must be critically analyzed since the combined effects
of the provisions may push many people with disabilities and their families into or
further into poverty.
Changes to the Benefit Formula -A common element in several reform plans is
a modification to the benefit formula so that the Primary Insurance Amount (PIA)
is lower. This change also would cut disability benefits since they, like retirement
benefits, are based on the PIA. Such a modification would reduce disability benefits
from 8 to 45 percent or more, depending on the plan, with some of the major propos-
als resulting in cuts of 24 to 30 percent. Reducing the PIA would force more people
with disabilities further into poverty.
262
Access to Retirement Accounts — Under many plans, disabled workers younger than
age 62 would not have access to their individual investment account to offset the
cuts created by changes to the benefit formula. About 85 percent of disabled workers
are below age 62 and would have to make up for lower disability benefits with their
own resources, which may be limited, until age 62. In addition, those adult disabled
children who are substantially unable to earn a living or save for retirement, or
those workers who are disabled early in their work years, could have no individual
retirement account to access, even if allowed, and could have little to no personal
assets to supplement benefits.
Conversions from Disability to Retirement / Adequacy of Accounts — Upon reaching
normal retirement age, disabled workers (DI program) convert from disability to re-
tirement benefits. At this point, disabled workers could find their individual ac-
counts are inadequate because the proceeds from individual accounts would nec-
essarily be limited by the fact that, while disabled and not working, no additional
contributions could have been made. If the disabled worker were able to work, earn-
ings would likely be lower than average. Therefore, the disabled worker would have
far less accrued (in both principal and investment return) than had s/he been able
to contribute throughout their normal working years or been able to contribute at
higher rates due to higher earnings. Yet, Social Security benefits also would have
been reduced due to changes in the benefit formula. In addition, there would be a
substantial number of adult disabled children who would have no accounts or mini-
mal accounts at retirement age.
In addition, for each worker, there would be only one individual account. Now,
Social Security will pay benefits to spouses, children, adult disabled children, sur-
viving spouses, and former spouses. Under individual account proposals, those ac-
counts would have to be divided among, or may be unavailable to, those who can
now get benefits.
Computation of Years of Work — The proposals to extend the computation period
for retirees could hurt those people with disabilities whose condition or illness forces
a reduction in work effort (with resulting lower earnings) in the years prior to eligi-
bility for disability benefits. These proposals would increase the number of years of
earnings that are taken into account in deciding the individual's benefit amount. Es-
sentially, the number of years of "low" or "no" earnings that are now dropped in
the computation would be reduced; thus, the years of low and no earnings that peo-
Ele with disabilities may experience prior to eligibility for disability benefits would
ave a more substantial effect on the individual's average earnings when computing
their retirement benefits.
Maintaining the Purchasing Power of Benefits — Social Security benefits are ad-
justed for inflation so that the value of the benefit is not eroded over time. Some
proposals would reduce annual cost-of-living adjustments (COLAs) by arbitrary
amounts. These arbitrary reductions cumulate over time so that a 1-percent reduc-
tion in the COLA would result in a 20 percent reduction in benefits after 20 years.
For people with disabilities who must rely on benefits fi"om the OASDI system for
a substantial period of time, cuts could be devastating. It is critical that benefits
be set at meaningful levels to support such individuals and that appropriate COLAs
be included to ensure that the purchasing power of the benefit is not reduced over
time.
Raising the Normal Retirement Age TA^flA^ — Raising the normal retirement age
could create an incentive for older workers to apply for disability benefits in two
ways. (1) If only the NRA is increased, the early retirement age benefit would be
reduced to a greater degree than under current law (reflecting the actuarial reduc-
tion in benefits based on drawing benefits for a number of years earlier than NRA).
Disability benefits, unless similarly reduced, would then become more attractive to
older workers. (2) For many of those in hard, manual labor jobs who simply can no
longer work at the same level of physical exertion, leaving the workforce before NRA
will be necessary. Many would apply for disability benefits. These added pressures
on the disability insurance program (to make up for changes in the retirement pro-
gram) would increase costs and potentially create political pressure for more drastic
changes in the disability program based upon its "growth".
Privatization of Retirement and Survivors Only — Some privatization proposals
claim they privatize retirement and survivor's protection but leave disability protec-
tion alone. There would be no intended direct effect on the disability insurance pro-
gram. However, the systems are not so easily separable: those adult disabled chil-
dren who depend upon retirees' dependent benefits or upon survivor's benefits would
be directly negatively affected. The private accounts of the parents are unlikely to
be adequate to provide basic support to adult disabled children for the rest of their
lives, perhaps decades after the parents' deaths (especially if the parents were them-
selves dependent on the private accounts for any length of time before death) and
263
some plans would require the parents to purchase annuities. Where a deceased
worker's funds are required to go to the estate, there is no assurance that, upon
distribution of the estate, the adult disabled child would be adequately protected for
the future. Where funds are transferred to the worker's surviving spouse's account;
again, there may be no protection of the adult disabled child.
Annuities -Where retirees are required to purchase annuities with individual ac-
count proceeds (as some plans require), no funds would be available for the surviv-
ing adult disabled child when the retiree dies. Again, the adult disabled child may
live for decades after the death of the parent; a typical annuity approach makes no
plans for these dependents/survivors.
Opting Out of the System -One proposal which allows individuals to opt out of
the system would require those who opt out to purchase disability insurance.
Whether this insurance would be comparable to the current disability insurance sys-
tem is unknown; currently, there is no insurance comparable to Social Security dis-
ability benefits which includes indexing for inflation and coverage of family mem-
bers. In addition, as the disability community well knows, disability insurance (or
for that matter, health or other insurance) is essentially non-existent for most peo-
ple who already have disabilities. Also, there is no guarantee of support through
this means for dependents or survivors with disabilities.
Flat Retirement Benefit -One proposal would replace the benefit formula with a
flat retirement benefit ($410 in 1996 dollars). This plan would provide a disability
benefit (based on the primary insurance amount) using the current law formula, but
reduced to reflect the age-based reduction applicable to age 65 as the NRA rises.
This would lead to a 30 percent reduction when fully phased-in. Without the protec-
tion of well-funded private accounts, which people with disabilities are unlikely to
have, this reduction would harm beneficiaries in the disability insurance program.
Increased Risk and Capacity to Manage Accounts -The increased risk associated
with retirement that depends upon private account earnings is an issue for every-
one. In addition, the capacity of an individual to manage these private accounts
profitably is similarly an issue for everyone, and involves many factors including
education, money management skills, and risk-taking. The risks and management
issues become a much more significant concern when considering people with cog-
nitive impairments, such as mental retardation, or mental illness, when the impair-
ment creates substantial barriers to the individual's ability to make wise and profit-
able decisions over a lifetime. In many cases, the person may be unable to make
any financially significant decisions. Privatization removes the shared-risk protec-
tion of social insurance and places these individuals at substantial personal risk.
Again, we strongly recommend that Congress only consider legislation that main-
tains the basic structure of the current system based on workers' payroll taxes; pre-
serves the social insurance disability, survivors, and retirement programs; guaran-
tees benefits with inflation adjustments; and preserves the Social Security trust
funds to meet the needs of current and future beneficiaries. Changes necessary to
bring the trust funds into long-term solvency must not be so drastic as to undermine
or dismantle the basic structure of the program.
To assist the Task Force, and, indeed all parties to the debate, we urge the Task
Force to follow through on a suggestion made at an earlier Ways and Means Com-
mittee hearing to request a beneficiary impact statement fi"om SSA on every major
proposal, or component of a proposal, under serious consideration. In a program
with such impact on millions of people of all ages, it is simply not enough to address
only the budgetary impact of change; the people impact must also be studied and
well understood before any change is initiated. For our constituency, people with
disabilities, their very lives depend on such analyses.
Again, I thank the Task Force for considering our viewpoints on these critical
issues. People with disabilities and their famihes will be vitally interested in the
Task Force's work; the CCD Task Force on Social Security pledges to work with you
to ensure that disability issues remain an important consideration in reform analy-
sis and solution development.
Chairman Smith. Without objection, the full written testimony of
all the witnesses will be entered into the record.
Commissioner Ross.
264
STATEMENT OF JANE ROSS, DEPUTY COMMISSIONER FOR
POLICY, SOCIAL SECURITY ADMINISTRATION; ACCOM-
PANIED BY MARK NADEL, ASSOCIATE COMMISSIONER FOR
DISABILITY AND INCOME ASSISTANCE
Ms. Ross. Thank you, Mr. Chairman and members of the Task
Force, for inviting me to discuss these vital issues about the Social
Security disability program. I was asked in particular to compare
our DI program with private disability insurance, so I will be pro-
ceeding to do that.
The Social Security disability insurance program is truly irre-
placeable in American life and the same protection is unlikely to
be provided through private insurance at any cost. I would like to
briefly describe the coverage that is provided by Social Security. I
will be reiterating some of the things Ms. Ford talked about, and
then examine the two major responses by the private sector to indi-
viduals with disabilities, Workers' Compensation and private long-
term disability insurance.
With regard to our program, approximately 150 million workers
and their families are covered by Social Security against all kinds
of losses, retirement, death, and disability. The importance of this
disability protection in particular is understood when you consider
that an average 20-year-old stands about a 25 to 30 percent chance
of becoming disabled before reaching retirement age, so 25 or 30
percent of the people who begin in the work force will become dis-
abled enough to draw out benefits.
Last year, Social Security paid benefits to almost 5 million se-
verely disabled workers and about 2 million members of their fami-
lies. The total cash benefits that went to these beneficiaries in 1998
was more than $47 billion. What we need to emphasize about the
Social Security disability program is that everyone is covered, there
is no underwriting and no exclusions, and only the most severely
disabled become a part of our beneficiary population.
These are people with a very limited ability to return to the
workplace. We continue to press for ways that we can help them
return to the workplace. Nonetheless, this is a group of people that
has already been judged incapable of working at any job.
What is the actual cash value of this disability insurance pro-
gram that we are operating and what does it mean to an individual
family?
Well, for a 27-year-old average wage earner with a spouse and
two children, the Social Security disability protection is equivalent
to about $233,000 as a disability income insurance policy. This
means that the worker and his or her family would receive over
$1,500 in monthly Social Security benefit payments and these pay-
ments would be adjusted for inflation.
Also if the worker is entitled to disability benefits for more than
2 years, he or she becomes eligible for Medicare benefits. As you
can appreciate, these medical benefits are invaluable for many dis-
abled individuals, since it is quite difficult and expensive to find
health insurance in private markets once you become disabled.
And what about the costs of the program? As you know, the So-
cial Security disability program is financed by a payroll tax of 1.7
percent on covered earnings, half paid by the employer and half by
265
the employee. As I said earlier, these taxes last year paid for more
than $47 billion in benefits.
Now let me take just a minute for a brief review of other disabil-
ity insurance programs, specifically Workers' Compensation and
private disability coverage.
Let me begin by telling you that there is very little data on these
private programs, either on the costs or the benefits of them. We
have tried to pull together what is available, and I will do my best
to give you a good explanation.
The Workers' Compensation system is also nearly universal and
it is a system for replacing lost wages of workers who become dis-
abled as result of an injury on a job, not as a result of a disease
or non-work injuries. Basically this insurance is provided by em-
ployers in all 50 states and benefits include a weekly payment until
the worker medically recovers to the extent possible.
At some point, if the worker is unable to return to work, then
payments are based on the extent of disability and medical insur-
ance is provided.
It is also important to note that Workers' Compensation pro-
grams integrate with Social Security if the worker is sufficiently se-
verely disabled for a lengthy period of time and there is a maxi-
mum amount of combined benefits, which is 80 percent of
prediisability earnings.
Then moving from the Workers' Compensation to private disabil-
ity plans, there are generally two categories of private disability in-
surance, short-term and long-term plans. Within each category
there are many variations, but let me try and give you the overall
drift here.
Short-term disability plans generally refer to a formal plan in
which benefits begin after sick pay has ended. About a third of full-
time American workers have such a plan. These plans usually re-
place about half to three-quarters of earnings and last for about 6
months.
A somewhat smaller percentage of American workers have em-
ployer sponsored long-term disability insurance. However, employ-
ees in most arduous jobs, those presumably that would be most in
need of such protection, are the least likely to have it.
Long-term employer-sponsored disability plans usually replace
about 60 percent of predisability earnings, up to a maximum dollar
amount, and these plans also are typically integrated with Social
Security and Workers' Compensation, thereby reducing the
amounts paid for by the private plan.
Individually purchased insurance plans as opposed to those pro-
vided by employers are also available. They tend to be plans that
are purchased only by high wage earners or self-employed individ-
uals. So this private long-term disability most times has a broader
definition of disability than we have in the Social Security disabil-
ity insurance program. More likely it is your inability to return to
your customary work, and there is a good deal more emphasis on
helping people to return to work because of this less severe defini-
tion.
One final point I would like to make: Because of the potential ad-
verse selection risk to insurers, the disability income insurance
market is heavily underwritten. Persons who are at higher than
266
normal risk of becoming disabled or persons whose income stream
is not consistent over time would be deemed unlikely to be insur-
able by the providers of this private disability insurance. In this
environment, it is highly unlikely that a market for private disabil-
ity insurance would emerge to provide the same kind of universal
coverage as we have under the Social Security disability program.
In conclusion, I want to revisit the question I posed at the begin-
ning of my testimony: Can private disability insurance provide the
same level of protection to all workers at the same low cost of So-
cial Security disability insurance? It seems very unlikely that the
private market could replicate that coverage at similar cost.
Social Security is a mandatory, virtually universal social insur-
ance program. Private insurers are selective, excluding those indi-
viduals at higher risk of becoming disabled. A great many people
would simply not be able to buy private disability insurance at any
price and Social Security returns about 97 percent of the pre-
miums, if you want to call the taxes that, that it takes in, gives
97 percent back to beneficiaries, while private insurers return far
less, as little as 45 percent of the premiums they receive.
Private disability insurance can and does serve a valuable pur-
pose today by providing additional financial protection to those who
can afford it and who qualify, but only Social Security provides cov-
erage to all workers and their families at a lower cost and greater
value than any private insurance now available.
Again, thank you for the opportunity to talk with you today, and
I would be happy to answer any questions that members of the
Task Force have.
[The prepared statement of Ms. Ross follows:]
Prepared Statement of Jane L. Ross, Deputy Commissioner for Policy, Social
Security Administration
Mr. Chairman and members of the Task Force, thank you for inviting me to dis-
cuss the Social Security Disability (SSDI) program and whether private insurance,
by itself, can provide the same degree of protection to all working Americans at the
same low cost. In my statement today, I will outline the scope and purpose of SSDI,
and the cost and value of coverage. Then I will discuss the two types of insurance
now provided by the private sector to deal with disabilities: first, workers compensa-
tion which applies only to disabilities caused by work, and second, private disability
plans that apply to any disability.
Social Security Disability
The Social Security system as a whole operates as a social insurance program.
That is, Social Security spreads the cost of protection against the risk of lost income
due to retirement, death, or disability over the entire working population, with more
protection, per dollar earnings, for lower paid workers and for workers with depend-
ents. Consequently, the value of benefits for any given worker depends on his or
her individual circumstances-earnings level, marital status, dependent children,
years in the workforce, and age at disability or death. Like Social Security in gen-
eral, the SSDI program provides an extra measure of protection for lower-wage
workers. Due to the progressive nature of the program, the benefits formula re-
places a greater percentage of pre-retirement earnings for lower-wage workers than
higher-wage workers.
Largely absent from the current public debate is the fact that about one third of
Social Security beneficiaries are not retirees or their dependents. They represent se-
verely disabled workers, their children, or the surviving family members of workers
who have died. Social Security pays benefits to more than 4.7 million disabled work-
ers, nearly 1.5 million children of disabled workers, and almost 200,000 spouses of
disabled workers. Because about 25 to 30 percent of today's 20-year olds will become
disabled before retirement, the protection provided by the SSDI program is ex-
267
tremely important. This is especially true for young families often struggling to af-
ford adequate private insurance. For a young, married, average worker with two
children. Social Security is the equivalent of a $233,000 disability income insurance
pohcy. In addition, SSDI benefits, like retirement benefits, are adjusted for inflation,
so that the value of the benefit is maintained over time. Disabled workers and their
dependents received $47.6 billion in cash benefits under the Social Security program
in fiscal year 1998.
Furthermore, SSDI benefits are the gateway to the Medicare program to those in-
dividuals who have been eligible for disability benefits for 24 months. These benefits
provide health care coverage that to many SSDI beneficiaries is simply irreplace-
able, since many would not be able to obtain insurance in private markets simply
because they are already disabled. The Medicare program paid over $24 billion in
benefits in fiscal year 1998 to individuals whose entitlement to Medicare is based
on their SSDI benefits. Thus, about $72 billion was paid in fiscal year 1998 from
the Social Security and Medicare programs on behalf of disabled workers and their
families.
As with the retirement program, SSDI is funded through a payroll tax on covered
earnings, paid by employees, their employers, and the self-employed. The current
payroll tax on earnings is 0.85 percent for employees and employers, each, and 1.7
percent for the self-employed.
SSDI is designed to protect workers covered under the Social Security program
who become severely disabled, and it strives to ensure that applicants are judged
on the basis of a uniform set of standards. The criteria we use to award disability
benefits requires that the condition either be expected to result in death or last at
least 12 months. To qualify, the individual must be unable to perform any substan-
tial work in the national economy because of a medical condition. Thus, the inability
to do one's own past work or the inability to find suitable employment are not a
sufficient basis for meeting the definition of disabiUty. Additionally, applicants must
have worked 20 quarters during the 40 quarter period ending with the quarter in
which disability began (special provisions apply for workers who are under age 31),
and they must complete a 5-month waiting period after the onset of the disability.
After a claim is taken in one of Social Security's field offices, it is forwarded to
one of the State Disability Determination Services. These state employees are re-
sponsible for following up on at least 1 year's worth of medical evidence in support
of the claim, scheduling consultative examinations if necessary, and making the dis-
ability determination at the initial and reconsideration (the first level of appeal of
an adverse initial determination) levels. The States are fully reimbursed for making
these determinations. The process of evaluating an individual's disability accounts
for the administrative costs for the disability program being somewhat higher (3.3
percent of benefits) than those for the retirement and survivor program, largely be-
cause of the cost of obtaining medical evidence and the need for a thorough evalua-
tion by a physician or other highly trained professional reviewer.
While the Social Security eUgibility criteria are very strict, we also have a very
structured system to ensure that applicants' rights are protected and that those ap-
plicants who are eligible, actually get their benefits. Currently, a physician must be
part of the decision-making team, although we are testing a system where certain
claims, generally the most severe and obvious cases, would be decided by a trained
layperson. After a reconsideration denial, a claim can be appealed to an administra-
tive law judge, then the Appeals Council and up to a Federal court. We also are
testing a model, which would streamline the process by eliminating the reconsider-
ation step.
While the primary purpose of SSDI is to replace a portion of income, the program
also includes provisions designed to encourage beneficiaries to return to work. Even
when individuals have significant disabilities, with appropriate support and voca-
tional rehabilitation (VR), they may be able to work again. The primary mechanism
that is used by Social Security to help people return to work is the referral of bene-
ficiaries to State vocational rehabilitation services. I would like to mention at this
time the Administration-proposed legislation in 1997 that called for a Ticket to
Independence program that would further our efforts at rehabilitation by introduc-
ing the concept of consumer choice in obtaining emplojrment services. Similar legis-
lation overwhelmingly passed in the House in 1998 and has now evolved into the
Work Incentives Improvements Act that passed the Senate by a vote of 99 to 0 on
J\ine 16, 1999. The President's budget provides full funding support for this legisla-
tion.
I would like to turn now to a discussion of the range of workers compensation and
private disability benefits available.
268
Workers Compensation
While SSDI covers workers with severe disabilities regardless of how the disabil-
ity was developed, the workers' compensation (WC) system is designed to provide
reimbursement for lost wages and medical expenses for workers who become dis-
abled as a result of an on-the-job injury. WC laws were first enacted in the early
1900's and now separate programs are provided in each of the 50 States and the
District of Columbia. Virtually all employers are required to secure their compensa-
tion liability either through private insurance, by self-insuring, or by membership
in a State fund. Employers who secure their compensation liability are protected
from other liability that could arise because of injuries to their employees.
One of the primary goals of an effective WC program is to restore the injured
workers to their previous employment, and thus the programs emphasize medical
and vocational rehabilitation. Other benefits include v/eekly pa)anents that are
based on the degree of disability sustained as a result of the injury, and such medi-
cal care as the nature of the injury or process of recovery may require. Benefit pay-
ments totaled $42.6 biUion in 1996.
Workers compensation is not a stand-alone system. It is the first payor, but inte-
grates with Social Security. In most States if workers go on the Social Security dis-
ability rolls, the Social Security pajmient is reduced, so that the combined Social Se-
curity/workers compensation amounts are limited to 80 percent of pre-disability
earnings.
Employer-Provided Private Disability Insurance
Modern-day Private disability insurance grew up in a climate which climate that
already included Social Security and other public benefits such as VR and WC. As
a result, these private plans assumed the existence of Social Security and were tai-
lored to integrate with it. There are many different types of private disability insur-
ance plans. While they fall under two general categories, short-term (STD) and long-
term (LTD), there are many variations. About two-thirds of long-term plans are em-
ployer-sponsored, and about one-third of plans are individually purchased. Further
adding to the variety are the differing definitions and provisions within the plans;
there is no standard terminology.
Defining Disability
The definitions of disability within the types of plans vary to some extent, but
they generally share major characteristics. While short-term disability plans have
different definitions of disability, they typically include payments for short-term im-
pairments as well as pregnancy. Employer-sponsored long-term disability plans usu-
ally have a more lenient definition of disability for the first 2 years, after which the
definition becomes more stringent. Generally, the initial definition is the inability
to perform the employee's usual occupation. After 2 years, the definition usually re-
quires the employee to be unable to perform any occupation, similar to the Social
Security definition. Finally, while there are exceptions, most individually purchased
plans define disability as the inability to perform one's usual occupation for the en-
tire benefit period-generally to age 65.
While SSDI benefits are limited to age 65 as well, the individual begins receiving
retirement benefits on attainment of age 65, and the conversion from disability to
retirement benefits is invisible to the beneficiary.
Coverage— Who and What is Covered
Short-term disability and long-term disability plans serve different purposes and
have different provisions. Generally, short-term disability plans refers to a formal
plan in which benefits begin after sick play has expired, though benefits but may
be in lieu of sick pay. Based on Bureau of Labor Statistics (BLS) data, nearly 4034
percent of full time private sector plus State and local government workers in this
country have some type of short-term disability plan..
Short-term disability plans usually replaces from 40-70 percent of earnings, but
it can replace earnings entirely. Benefit periods range from 30 days to 6 months,
though some plans have terms of up to 24 months. Ninety percent of employees re-
turn to work within 8 weeks, often because the impairments covered are not severe,
e.g. recovery from pregnancy surgery. Because of the short-term nature of most
short-term disability impairments, there is little connection between short-term dis-
ability plans and Social Security. Ideally, employer sponsored long-term disability
plans begin paying when SDT short-term disability benefits end. The earnings re-
269
placement rate for these long-term disability plans is about 60 percent of pre-dis-
ability earnings, up to a maximum dollar amount.
Only one third of full-time workers currently have employer-sponsored long-term
disability plans.
It is worth noting that employees with the most arduous jobs — those who presum-
ably need the protection the most-are less likely to have long-term disability plans.
Ideally, employer sponsored LTD plans begin pa5ang when SDT benefits end. The
earnings replacement rate for these LTD plans is about 60 percent of pre-disability
earnings, up to a maximum dollar amount. Based on BLS data, slightly under 1/
3 of full-time workers currently have employer-sponsored LTD.
The following chart shows the percentage of employees of state and local govern-
ment, small private firms (under 100 employees) and medium/large firms with em-
ployer sponsored LTD by job t3^e of occupation.
Benefits
In contrast with STD, employer-sponsored LTD plans generally are integrated
with Social Security and Worker's Compensation. LTD plans are cost driven. Long-
term plans are generally oriented toward their net costs. can provide both cash bene-
fits and rehabilitation services. That is they screen their clients beneficiaries with
a view toward rehabilitation, and decisions on what benefits to provide often turn
on the cost of rehabilitation vs. the cost of benefits, in addition to job availability.
Many larger employers use disability management strategies including early inter-
vention and partial or residual benefits to encourage return to work.
In determining cash benefit levels, employer-sponsored LTD long-term disability
plans generally usually are integrated with Social Security and Worker's Compensa-
tion. These LTD plans are constructed to take into account Social Security. Those
employees who meet the Social Security definition of disability are encouraged or
required to apply for Social Security benefits. In fact, insurers and employers count
on the integration of their of their plans with Social Security; LTD long-term dis-
ability benefits are generally offset — reduced — by Social Security benefits.
Individually Purchased Disability Insurance
We were unable to obtain data on participation rates for individual Individual dis-
ability plans are thought to be a small part of the private market although there
is a lack of data on the actual extent of coverage. However, experts believe partici-
pation is quite limited because they tend to be very expensive. Participation is most-
ly limited to highly compensated employees or self-employed individuals. These
plans may replace up to 80 percent of earnings, though more typical replacement
rates are 60-70 percent. Often, pajrments of these plans, in contrast to employer-
sponsored LTD long-term disability plans, are not reduced by Social Security or
other programs.
The Private Sector Dollar Costs of Coverage
The out of pocket costs of SSDI coverage is a payroll tax of 0.85 percent. Assum-
ing a worker married with 2 children, average earnings since age 22 and onset of
disability at age 35, it would take $203,000 of disability insurance to equal pay-
ments to the family unit. It is difficult to present meaningful information on the
price of private disability insurance because it varies so much by age of customer
and variations in size of coverage.
Perhaps the most useful approach in examining the cost of private disability in-
surance is viewing it in terms of value to the beneficiary. This value can be deter-
mined by looking at the proportion of the premium dollar that is returned as bene-
fits to policyholders. We can determine this proportion by looking at the cost struc-
ture of companies, although they vary from company to company.
Costs vary from company to company. One major insurer estimated costs as
shown on the following chart. It should be noted that claims processing costs are
included under benefits and risk management, only 45 cents of every premium dol-
lar is returned to beneficiaries.
Claims processing costs account for about 3 percent of this category.
Clearly it is difficult to compare private and public sector costs since the enter-
prises are so different. As previously noted. Social Security disability administrative
costs are about 3 percent of payroll the disability payroll taxes. It would be tempting
to conclude that the private sector costs are similar, since private sector claims proc-
essing costs in this example are estimated at 3 percent. But administrative costs
are also embedded in other categories, such as acquisitions (which represents items
270
such as underwriting and sales) and customer service (for instance, billing and other
policy services). . And the bottom line is that the Social Security system returned
97 percent of the money it takes in to beneficiaries while private firms return far
less-as little as 45 percent of the money it takes in.
Access to Private Insurance Coverage
Because of the potential adverse selection risk to insurers, the disability income
insurance market is heavily underwritten. Persons who are at higher than normal
risk for becoming disabled, or whose income stream is not consistent over time,
would likely be deemed uninsurable by the providers of private disability insurance.
In this environment, it is highly unlikely that a market for private disability insur-
ance would emerge to provide the same universal coverage available under SSDI.
Even if an individual is able to purchase a policy from a private company in the
current market, comprehensive disability insurance is much more expensive than
SSDI. SSA has a broader risk pool. If SSA were allowed to exclude individuals fi-om
coverage because those individuals had a high likelihood of becoming disabled, as
do private companies, SSA's "premiums" would decrease.
Conclusion
Private disability insurance serves an important purpose in providing an addi-
tional degree of financial security for the minority of the workforce that enjoys cov-
erage. However, Social Security Disability Insurance and private plans serve dif-
ferent purposes However, the operative word is additional. Though Social Security
provides nearly universal and portable coverage, only the most severely disabled in-
dividuals receive benefits. For those found to be disabled, benefits are also extended
to dependents. Only Social Security provides coverage to all workers and their de-
pendents. I would note that 25 million workers lack health insurance. It is hardly
likely that employers who now cover about one third of employees with long term
disability coverage would provide all workers with disability coverage. Moreover the
universal coverage that all workers now have under Social Security is provided at
lower cost and greater value than now available on the private market. Assuming
a worker married with 2 children, average earnings since age 22 and onset of dis-
ability at age 35, it would take $203,000 of disability insurance to equal payments
to the family unit. The cost of such coverage varies by insurance company.
Private insurance was built around existing public programs and depends on pro-
grams such as Social Security as a way of containing costs. In addition, some larger
employers in the private sector provide a range of disability management services
including early intervention, rehabilitation and partial benefits where cost effective.
Mr. Chairman, this concludes my remarks. I would be happy to entertain any
questions you or the other Task Force Members may have.
In addition to Social Security information and administrative data, we have relied
on the following sources of information:
BLS reports on Employee Benefits in State and Local Governments, 1994.
BLS, Employee Benefits in Small Private Establishments, 1996.
BLS, Employee Benefits in Medium and Large Private Establishments, 1995,
1997.
Berkowitz, Edward, Dean, David, Lessons fi-om the Vocational Rehabilitation /So-
cial Security Administration Experience, in Disability ,Work and Cash Benefits, ed.
Mashaw, Reno, Burkhauser, M. Berkowitz, Upjohn Institute for Employment Re-
search, Kalamazoo, Michigan, 1996.
Owens, Patricia M, Insurance Issues and Trends: A Focus on Disability Manage-
ment including Rehabilitation, in Private Sector Rehabilitation: Insurance Trends &
Issues for the 21st Century, ed. Perlman and Hansen, National Rehabilitation Asso-
ciation, Alexandria, Virginia, 1993.
Workers' Compensation: Benefits, Coverage, and Costs, 1996, National Academy
of Social Insurance, March 1999.
Chairman Smith. Thank you very much. Does the Social Security
Administration know why there has been such a significant in-
crease of people going onto disability? We have seen the rate of dis-
ability among the total number of covered workers increase 300
percent over the last 30 years. Is the Social Security Administra-
tion aware of why that number has grown so rapidly? Not in terms
271
of numbers with the population, but in terms of the rate of the
total number covered?
Ms. Ross. We think there are a variety of reasons for the growth
in the program. In the beginning of the 1990's, when there was a
substantial increase, a good deal of it was probably related to the
fact that we had an economy with very high unemployment. People
who are working but have severe disabilities may be fine in an or-
dinary economy, but if they should lose their job, then it is ex-
tremely difficult for them to find another one. So the high unem-
ployment in the early nineties was certainly one of the important
features.
There have also been some changes in laws and some court cases
which have contributed to the growth of the program. So there is
a variety of kinds of things that have happened over time. I will
provide more information for the record.
[The information referred to follows:]
The reasons for the growth in the disability program include:
• Age of disabled workers. The average age of disabled workers is decUning.
Younger beneficiaries mean fewer conversions to retirement benefits and fewer
deaths (i.e., longer on the DI rolls).
• Business cycle. Job losses during recessions encourage individuals to file for dis-
ability and discourage those on the rolls from seeking employment. Recent data in-
dicate that a 1-percent increase in the unemployment rate translates into a 4-per-
cent increase in DI applications.
• Increased participation of women in the workforce. Increased labor participation
by women increases the percentage of the population insured for disability. This in-
crease in the insured population accounted for 9 percent of the overall DI growth
between 1988-1992; 19 percent of the growth among women. Although women are
less likely to apply for benefits than men are, once they are on the rolls they are
less likely to leave.
• Legislative changes (1984 Disability Amendments). First, revised criteria for
evaluation of mental impairments, pain and subjective symptoms. Added weight
given to opinion of treating physician; combined effect of multiple impairments. Sec-
ond, medical improvements — the standard of review for termination of disability
benefits. Third, benefits continued during appeal of termination decision in a dis-
ability review.
• Impact of court decisions. Federal court decisions on appeals of our disability
determinations have often resulted in a more generous interpretation of SSA's regu-
latory disability standard, and a consequent expansion of the DI rolls.
Chairman Smith. Mr. Nadel, did you have additional testimony?
Mr. Nadel. No, I do not.
Chairman Smith. The GAO considers Social Security disability to
have a heightened vulnerability to waste, fraud and abuse and mis-
management. Medicare has made significant changes in terms of
trying to reduce fraud. Have we moved in that direction in any way
with Social Security disability?
Ms. Ross. One of the important things Social Security has been
doing over the past few years to make sure that our program has
achieved a high level of integrity is doing continuing disability re-
views. That is to say when people are on our rolls, every few years
we reexamine them to be sure that they still meet the standards
of our disability program. For many years, right through the early
nineties, especially when so many people were coming on the rolls,
we didn't do nearly as many continuing disability reviews as we
ought to have been doing. Now we are working off our backlog, and
in a couple of years we will be doing each year just those that need
to be conducted that year.
272
Chairman Smith. This is a re-medical evaluation, so they would
go back to the doctor again?
Ms. Ross. Yes, sir.
Chairman Smith. What is happening in that review?
Ms. Ross. Well, each year we do find some
Chairman Smith. What percentage roughly have you decided are
capable of doing some work?
Ms. Ross. This is an evaluation to see if they have medically re-
covered. My understanding is that of the group of people that we
look at, something like about 6 percent of the people we find have
recovered or have improved so that they no longer are eligible.
Chairman Smith. I guess I am not totally sure of the guidelines.
Is it that a person has to be incapable of doing any work, or what
is the criteria to be eligible for Social Security disability as opposed
to workman's comp?
Ms. Ross. That is a good question. What we say is a person is
unable to do any job in the economy because of a medically deter-
minable impairment that is going to last 12 months or longer. So
the definition is that you can't do any kind of work to a meaningful
degree.
Chairman SMITH. The latest GAO performance and accountabil-
ity series states only 1 in 500 DI beneficiaries return to work after
receiving benefits. GAO recommended that SSA put together em-
phasis on return to work efforts.
Has this been done? How can we improve the return to work ef-
forts?
Ms. Ross. Well, first of all, one of the reasons that few people
return to work is because our population is severely disabled. But
we don't stop there. We think that it is important to see if there
are things that we can do to provide incentives for people to try
work. The Kennedy-Jeffords bill, which is moving through the Con-
gress right now, has a variety of provisions in it which the adminis-
tration supports which ought to help with people at least attempt-
ing to return to work.
For example, there is a "ticket to independence," which gives peo-
ple who are disabled a much broader range of vocational rehabilita-
tion options that they can try. That could be very positive. Quite
importantly, it provides much more extensive Medicare coverage,
because one of the things that disabled people tell us is that one
of the reasons they are reluctant to try work is they are afraid they
will lose their health insurance and never be able to regain it.
These are important things.
Chairman Smith. Mr. Nadel, your comment, and then Ms. Ford,
and then we will move on.
Mr. Nadel. In addition to the legislation, we also have some ini-
tiatives under way. For example, we are planning a demonstration
project in 10 States to help people with mental illness, particularly
with mood disorders, which accounts for about a quarter of the DI
roles. The plan there would be to facilitate people getting a full
range of treatment, including pharmaceuticals, which they other-
wise might not normally be entitled to, so that they would be able
to eventually get better, get off the roles and return to work. So
there are things in addition to just the waiting for the legislation
to be passed.
273
Chairman Smith. Ms. Ford, your comments?
Ms. Ford. Yes, I would like to comment on a couple of the ques-
tions you just raised. Back on the issue of why there are more peo-
ple with disabilities, I think one thing to add to what Ms. Ross has
said is that medical advances have improved the life expectancy of
people with conditions that in the past would have caused an ear-
lier death. That is another reason for the increase in the roles.
The disability community has supported maintaining the integ-
rity of the Social Security System through the use of the continuing
disability reviews. We think that such reviews are very important
in terms of maintaining the integrity of the program.
In terms of the work incentives bill in the House, H.R. 1180,
there is another important aspect of it, too, and that is the begin-
ning of a nationwide — or I should say — a demonstration program
that will go on on a fairly large scale to test the usefulness of doing
a cash offset for those people who are likely to have low-wage,
entry-level jobs that don't carry health insurance. People in that
situation must look at both the issue of health care coverage when
they go to work and also whether or not they can actually earn
enough to sustain themselves, given the level of disability that they
are living with. This appUes to many of the people I represent
through The Arc of the United States, people with mental retarda-
tion.
So we are looking also at the demonstration program that will
test that cash offset to allow people to have a lower cash benefit
as their earnings increase.
Chairman Smith. Thank you.
Representative Rivers.
Ms. Rivers. Thank you, Mr. Chairman.
Ms. Ross, I am curious. You don't know if you can answer this
question, but one of the discussions that we have had around Social
Security is the idea of raising the retirement age to 70 or maybe
higher. Is there any likelihood that if we were to do that, we would
see an increase in disability claims for people, say, between the
ages of 60 and 70?
Ms. Ross. Yes, there is. As a matter of fact, our actuaries have
incorporated that kind of an estimate into their calculation of say-
ings from changing the retirement age. I think our estimate is
something like 20 percent of the savings from changing the retire-
ment age would be offset by more people coming onto the disability
roles.
People may be willing to hang in there and wait for retirement
if they are waiting until 65, but they may not be able to continue
to work beyond that time.
Ms. Rivers. Are all of the costs associated with paying disability
payments borne by that designated portion that is collected, or does
other Social Security money have to go in to make the pot adequate
to meet the needs of all those who have claims?
Ms. Ross. Right now the 1.7 percent payroll tax is adequate to
finance the benefits as well as the administrative costs of operating
the disability program. But as the Chairman said earlier, the dis-
ability program, as well as the old age and survivor program, is
facing financial challenges and will actually run out of money soon-
274
Ms. Rivers. Which brings me to another question that I want to
ask Ms. Ford. Given that we know that comphcates the issue all
the more, Ms. Ford, could you believe for folks who draw on-
young people who are disabled and draw against their parents'
earnings, do they get enough to live on under Social Security?
Ms. Ford. Well, it depends entirely on what the parents have
earned, because, and correct me if I get this wrong, the adult dis-
abled child, first of all, has to have been severely disabled since
childhood, and the benefit level that that person receives while the
parent is still living, as either disabled or retired, would be 50 per-
cent of the parent's benefits, depending on whether the family max-
imum affects them in any way. When the parent dies, the adult
disabled child would get up to 75 percent of the parent's benefit,
again, depending on whether there is a family maximum impact.
So it depends entirely on what the parent has earned, and many
disabled adult children receive SSI to supplement the Title II bene-
fit as well.
Ms. Rivers. One of the complaints we get in our office often is
for people in their twenties in particular who are drawing Social
Security and find that they can't live on it, and it is not a nice mes-
sage to deliver that we are already having trouble with the system,
and the likelihood of benefits going up is not good.
Ms. Ford. That is right. I don't think people with disabilities
could afford a reduction in those benefits in any way. With SSI al-
ready supplementing many people, it is an indication that the ben-
efits are not high enough. That is one of the reasons why people
want to be able to work if they possibly can, and figuring out a way
to make it possible to have some income while the individual is
working, if possible, and while maintaining a reduced benefit level
would help our folks tremendously.
Ms. Rivers. Ms. Ross, what is the Social Security Administra-
tion's plan as we move toward the future and see an increased de-
mand for this, and if, as I mentioned earlier, we see an increase
because the age goes up, do we have to look at raising taxes for
that portion, that 1.7 has to go up to 1.9 or 2? How is the Social
Security system anticipating dealing with that?
Ms. Ross. Well, as we have talked about solvency overall, we
have tried to address disability in addition to old age and sur-
vivors. So when the President put forward his proposal about
transferring 62 percent of the surplus and investing some of it in
the market, and then also looking for some kinds of cuts or benefit
changes, we have tried — we are very cognizant we are doing this
for the whole OASDI program, we haven't left it out.
Ms. Rivers. The overall fix speaks to that.
Ms. Ross. Right.
Ms. Rivers. Thank you very much.
Chairman Smith. The gentleman from Pennsylvania, Mr. Pat
Toomey.
Mr. Toomey. Thank you. Chairman. I just wanted to follow up
on a point that you made earher. In regard to the question, can pri-
vate disability by itself provide the same degree of protection to all
working Americans at the same low cost as SSDI, the answer to
that obviously is no, according to your testimony. But it strikes me
that the answer is not obviously no.
275
The next sentence is that if private disabihty would become a
substitute rather than a complement to Social Security, its cost
would be prohibitively higher, and not everyone would be allowed
access to vital coverage.
Isn't it more accurate to describe the cost to some would be high-
er, but the cost to others might be lower?
The other question I would have is wouldn't it be accurate to
characterize the cost as really consisting of two categories; one is
direct benefits that are paid, and the other is the cost of admin-
istering those benefits? If you maintained a standard for benefits,
it is not obvious to me why a private mechanism might not be able
to manage the administration at a lower cost or the same cost.
The last part of this is isn't it fair to say the current cost for
SSDI is not really fully reflected in the sense we know we have a
looming financial shortfall there, so we haven't really fully ac-
counted for that cost, at least in terms of how we pay for it.
I am just wondering if you could comment on that?
Ms. Ross. Surely. I have a couple of points, and maybe Mark has
a couple of others.
First of all, I want to go back to this business of underwriting.
The Social Security System has no rules about who can become a
part of our insurance program. Anybody who is a worker and pays
their taxes can become a part, regardless of the regularity of your
work, and regardless of your previous impairment-related history.
That is unlikely to be the case if firms that are in business to make
profits, quite appropriately, were involved in this business. There
would be simply people who are uninsurable. So I think that is an
issue that needs to be worried about.
Then in terms of administrative costs, the Social Security System
now runs about 3 percent administrative costs. So 3 percent of our
tax dollars are going to run the program, while the information we
were able to gather suggested that 45 percent or so of the costs of
some private insurance goes to administration because they were
dealing not only with actually operating the program, they had
other kinds of costs like sales, which are something you would have
to do if there were a lot of firms in the private sector.
So I think it is a difference in what is involved in costs in the
private sector. You are certainly right that right at the moment the
entire Social Security System is looking forward to making sure
that we are able to meet the financing challenges. I don't anticipate
that the administrative costs would be higher, and we certainly
plan to have a system which covers disabled people in about the
same way.
Mr. Nadel. If I could add, sir, it is not altogether clear that were
you to privatize the entire system, that the costs for people, any
group of people, would be lower, because the costs currently reflect
that it is an underwritten system, so that the higher risks are al-
ready screened out. So in the pricing of the private insurance, their
actuarial assumption is based on a pretty good risk pool. So it is
true, were you to in some fashion try to substitute private insur-
ance, people would probably end up at the low end paying what
they pay now; others would pay considerably more if you made it
compulsory. Some people would pay a huge amount more.
276
But the people that would be pajdng less are probably paying
less right now. But, again, it is conjectural. But the point is the
current pricing reflects people who are insurable and are pretty
good risks.
Mr. TOOMEY. As a follow-up to that, it strikes me that sometimes
we design systems around the exceptions rather than designing a
system for the large numbers and then dealing with the exception.
So I am just wondering, you mention in a privatized system there
might be people who would simply be uninsurable. That may well
be the case. Do you have any estimate of what percentage of the
work force would be uninsurable and, therefore, need to be dealt
with in a separate system?
Ms. Ross. I don't have any idea how you would come up with the
number. I certainly don't have one off the top of my head, but there
are people — anybody who already had some sort of disabling condi-
tion before they became part of the work force, I would assume
they would be if not uninsurable, at least someone who had a very
high cost associated with them.
Mr. ToOMEY. It just strikes me there are many kinds of insur-
ance for many kinds of risks, and there are people who are more
prone to those risks than others, and, nevertheless, the large ma-
jority of people are typically able to acquire the kind of insurance
they need. I would suspect the same would apply here.
That is all.
Ms. Ford. Thank you.
The experience of people with disabilities is that once you have
a disability, you cannot acquire the insurance. You cannot acquire
the disability insurance, and many people cannot acquire appro-
priate health care insurance because they have what is called a
preexisting condition, and they are considered uninsurable by the
insurance companies. Families experience this with the birth of a
child with a significant disability. Adults experience it if they are
uninsured and have an accident of some sort.
Mr. ToOMEY. I am not disputing any of that. I am fully aware
of that. I am just wondering what sort of magnitude of percentage
of the United States population fits that description?
Ms. Ford. I am not sure, but I go back to at least one-third of
the beneficiaries in the Title II programs are not retirees. A signifi-
cant proportion of those are people with disabilities or their de-
pendents.
Mr. ToOMEY. Thank you.
Chairman Smith. The gentleman from New Jersey, Mr. Rush
Holt.
Mr. Holt. Thank you, Mr. Chairman. I just want to make sure
I understand, Ms. Ross, your claim about the difference in adminis-
trative costs between the Federal program and private programs.
In the 3 percent administrative costs that you point to for Social
Security disability, is there an3^hing that is not included? I just
want to make sure we are comparing apples and apples here when
you talk about the 45 percent that some private insurers would
charge for this.
Is there any sales or customer service that is included in one
that is not included in the other? I realize Social Security you don't
277
have sales costs per se, but you do have the same customer service
costs.
Ms. Ross. That is right.
Mr. Holt. There is certainly some cost of informing the public
that is equivalent to sales costs, although much reduced, of course.
Ms. Ross. That is all true, and that is incorporated in the 3 per-
cent, which reflects the cost of Social Security employees as well as
employees of disability determination services who work in State
offices and do our determinations, actual determinations of disabil-
ities. So we are pretty comfortable that this is a very good reflec-
tion of the amount of the payroll tax dollar that is going to run the
program however you define that.
Mr. Holt. That is my only question for the moment. Thank you.
Chairman Smith. We will start a second round. It has been sug-
gested the Americans with Disabilities Act has resulted in more in-
dividuals with disabilities being employed, and those individuals
have pushed themselves to work and to perform, but usually end
up not lasting the 30 or 40 years, but once they get over 10 years,
there is a greater number of these individuals that go on disabiUty.
Do we know that to be true, or have we got any statistics on
that?
Ms. Ross. I don't know any documentation of that particular
anecdote. The purpose of the two laws is quite different, one is to
make sure that you are treated fairly in the workplace and that
you are accommodated appropriately. The other is to make sure
that you have some income if you can no longer work.
I can logically see how both of those things could happen.
Chairman Smith. Ms. Ford, it seems to me that to the extent
that that might be true, then if they were not on Social Security,
they would be on SSI, so the taxpayers in some way are going to
have to accommodate the problem.
Ms. Ford. Well, remember that the SSI program uses the exact
same definition of disability and all of the rigorous assessments
that go with it. So you are dealing essentially with the same level
of impairment in the person, whether you are deaUng with the
Title II program or the SSI program.
I am not sure, I don't know where I would get the data to answer
your original question, but I think it probably is true that for peo-
ple who are able to use the ADA to foster remaining in the work
force and getting accommodations from their employers to help
them remain at work, the longer they can stay at work before they
might possibly end up on the disability programs, the better. It is
better for them and obviously better for the system, but I don't
know how you would get a handle on that number.
Chairman Smith. I was just wondering. In terms that SSI is fi-
nanced and paid for out of the general fund with all of the tax reve-
nues coming in, and if that individual has put in 40 months of
work, then it comes strictly from the payroll taxes. So just thinking
out loud, is there some accommodation to some of those individuals
that work over 40 quarters that are now coming out of the payroll
tax, where workers have to pay their tax to cover those benefits,
as opposed to less than 40 quarters, then it would be coming out
of the general fund.
278
Mr. Nadel. If I could add, the Social Security Administration is
undertaking a very important piece of research which I think will
shed some light on your initial question about the natural work
history of people with disabilities. We will be undertaking a large-
scale disability evaluation study which will extensively study a
sample of individuals with disabilities, some of whom are on our
roles, some of whom are not on our roles, as well as a sample of
nondisabled, which I think will provide a lot of information on the
work life, the kinds of factors that have enabled people with dis-
abilities to work, how long they have been able to work and so on.
So while it is not satisfying for purposes of this hearing, I think
down the road the agency will be able to provide a lot more infor-
mation on just that question.
Chairman Smith. Yes, Ms. Ford?
Ms. Ford. Thank you. I just wanted to comment that from the
perspective of the person with disability, if you have earned or if
your parent has earned your coverage under Title II, there is a
very big distinction between receiving Title II benefits and receiv-
ing SSI, and that is, for instance, in your ability to retain your re-
sources and your assets. If someone is not entitled to Title II bene-
fits, and they are disabled, and they desperately need support, they
will have to impoverish themselves in order to become eligible for
SSI. So the difference in the quality of life, especially when looking
at someone who may have put the time in in the work force, or the
parent has put the time in in the work force, is quite significant.
I don't know if that helps in where you are going.
Chairman Smith. A former Commissioner of Social Security once
suggested to me that one reason that individuals that might not
otherwise be qualified for disability benefits were going on Social
Security disability was because of pressure from Members of Con-
gress that kept calling the Social Security Administration saying,
"look, I have the signed doctor's report, put this person on Social
Security." So I would like your reaction to whatever validity that
might have and whether you can withstand that political pressure?
Ms. Ross. We have a very stringent set of rules on the way we
determine disability. You actually have to go through a five-step se-
quence of evaluation which starts with are you doing any work at
all currently, and do you have a severe disability, and do you meet
our medical listings, can you do your former work, or could you do
any work in the economy?
While it is a very complex assessment, and it is certainly subject
to a lot of judgment, I would suggest that it is not really subject
to a great deal of external pressure.
Chairman Smith. So the letters that Congress writes the Social
Security Administration have no effect?
Ms. Ross. Well, you have really put me in a tough spot here. I
don't know whether to say yes or no. We are always thrilled to
hear what you have to say, but I think the process does not lend
itself to that kind of pressure.
Chairman Smith. Ms. Rivers.
Ms. Rivers. I happen to agree with you. Having a number of peo-
ple come to our office for help, I have found the qualification proc-
ess to be very, very difficult, not easy. I don't know if you have had
success with writing a letter and having some sort of change of
279
heart for your constituents. That has not been my experience. I
have seen it to be a stringent process.
I want to ask you about something else though. DisabiUty is a
factor of Social Security coverage that is overlooked sometimes, as
is survivors insurance. We tend not to always consider that part of
what we get back from our Social Security dollars is this kind of
coverage.
I would be curious to know if you could compare and contrast for
me how survivors insurance or survivors benefit work under the
current system versus how they would work under a system of
privatized accounts? I am particularly interested in young families,
so where you have a breadwinner who is 30 years old, is killed in
a car accident or whatever, and now is left with a young widow
with small children.
Ms. Ross. A lot of the proposals for individual accounts haven't
been very clear about what happens in cases of either survivors or
disability, so it is hard to say exactly what various people might
have meant to put in their plan.
What you certainly could say, you could make two points. One
of them is if you are talking about yoxing survivors, then the person
who was the worker who was trying to accumulate this private ac-
count has had a relatively shorter time than if he or she had gotten
all the way to retirement age. So there would not be as much
money in that account for a young survivor as there would be for
a retiree.
Secondly, to the extent that the rest of the Social Security pro-
gram had benefit reductions of any sort in order to accommodate
the individual accounts or a transition period, then this young sur-
vivor will probably have a different kind of benefit formula; maybe
something will have happened to the CPI that would reduce it. So
they might be disadvantaged in two ways. So I think that is a real
concern. As Ms. Ford said, it is the same with disabled persons. I
will provide more information for the record.
[The information referred to follows:]
In general, widow(er)s, children and dependent parents of insured deceased work-
ers may be eligible for survivor's benefits if they meet certain eligibility require-
ments. The basic Social Security benefit amount that the survivor beneficiary re-
ceives is a percentage of the deceased worker's primary insurance amount (PIA), or
basic Social Security benefit amount. For example, a widow(er) first taking sur-
vivor's benefits at age 65 may receive up to 100 percent of the PIA, subject to any
reduction in the PIA due to the worker electing early retirement, but not less than
82V'2 percent of the PIA; a widow(er) at any age (with the worker's child under age
16 in care) receives up to 75 percent of the PIA; and children of the deceased worker
also may receive up to 75 percent of the PIA.
There is a limit to the amount of money that can be paid to a deceased worker's
family each month. The limit varies, and ranges fi^om 150 to 188 percent of the de-
ceased worker's PIA. Generally, benefits payable to the family members cannot ex-
ceed this limit.
Finally, there is a one-time payment of $255 that can be paid to a spouse or minor
children who meet certain requirements.
Chairman Smith. If the gentlewoman would yield, do some of the
programs have an offset, for every $5 you might earn in your pri-
vate investment account, you would have a reduction of $4 in your
fixed benefits program? Some proposals assume a 3.7 percent in-
crease, but it is only somehow what you earn in your private ac-
count. Most proposals would only be offset to what you earned.
280
Ms. Rivers. The question I would have about that, not to the
panel so much, but the thing that has been very frustrating to me
and difficult to understand is people come forward with plans, and
the answer to virtually every concern is we would keep that part
of Social Security. Then I am at a loss as to how the savings can
be as great or if there is as much money as sometimes is argued.
If you keep the disability section of it, if you keep the survivor sec-
tion of it, if you keep a minimum benefit, as many people argue,
essentially a floor, and you do all these things, I don't see how
there is enough money to move into a new system that is going to
have any sort of real effect on people, or people are not being rea-
sonable when they consider their transition costs.
Chairman Smith. If the gentlewoman would 3deld. But here
again, and maybe we depend too much on the actuaries at the So-
cial Security Administration, but supposedly, hopefully, all of those
issues are being taken into consideration.
Mr. Holt.
Mr. Holt. It is my understanding that there has been some spec-
ificity lacking in proposals for reform of the system when it comes
to disabilities. I want to understand just how much room there is.
It seems to me that the definition of eligibiUty, the definition of
disability, is pretty much cut and dried, and there is not a lot of
room for redefinition there. But I would like to— as it is apphed
now. Certainly in our society at large, there is a lot of room for def-
inition, a definitional range in what constitutes disability.
I would Hke to find out what— well, I guess the general question,
I am not sure how you would answer this, is how much variability
you see possible in the definition of disability. But my specific ques-
tion is how much of your effort, how much of your resources, how
much of the administrative costs goes into assessment and the de-
termination of eligibility, the determination of how someone
matches the definition, how someone's condition matches the defi-
nition?
Ms. Ross. Our disability determination is a very labor-intensive
process which requires the collecting of a great deal of medical data
and then a considerable amount of assessment of people's capacity
to continue work. So I would say a large part of our expenditures
in the disability program are to make that determination.
You mentioned something that might be important. You said the
definition is cut and dried, and I think you meant it was pretty
much settled, at least in law, that you were unable to do any work
in the whole economy.
Mr. Holt. That is right.
Ms. Ross. How you evaluate that continues to change. That is
pretty complex, and we are trying to do things like keep up with
medical advances and medical technology so that we understand
what now means the inability to work. So we continue to try and
refine our definition — no, refine our determination of are you dis-
abled, while working with the same definition.
So it is probably a very large part of those administrative costs.
Mr. Holt. Can you give me a percentage, a figure, anything clos-
er to a dollar amount or percentage?
Ms. Ross. I can't do that right now, but I would be glad to supply
it to you.
281
[The information referred to follows:]
In fiscal year 1998, it cost about $352 for the State Disability Determination Serv-
ice to process a disability case.
Mr. Holt. Thank you. That is all for the moment.
Chairman Smith. Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. I apologize for being
late. I had another engagement I had to attend. So I apologize for
missing your testimony.
But in your testimony, have any of you all explored the possibil-
ity or the efficiency or lack thereof of trying to privatize the disabil-
ity side of Social Security? We have had a lot of people come and
talk about the retirement supplement benefit and debating the po-
tential privatization, but most of the plans, if not all of the plans
we have looked at, have assumed some sort of flat disability bene-
fit.
Would that be the concurrence of the panel today, that it would
remain as a government-sponsored benefit through the pajrroU tax?
Ms. Ross. When I provided my testimony, I spoke specifically to
the comparison between the Social Security Disability Insurance
program and private long-term disability, and one of the most im-
portant things we want to emphasize is that in moving to some-
thing other than this pool where everybody can be a member re-
gardless of your prior history or your projected future, if you move
to a system where there is significant underwriting, where we look
at individuals and their risks, as would happen in a private sys-
tem, you are very likely to have much higher costs for individuals,
and you are very likely to have some people who are excluded en-
tirely.
So if you are looking for a way to insure the entire population
against the loss of income due to disability, it seems virtually im-
possible to do it with private insurance.
Mr. Bentsen. As the Chairman pointed out in his opening state-
ment, the Chairman of the Federal Reserve, Alan Greenspan, had
testified before the group, before this panel, and had discussed his
experiences as the Chair of the Greenspan Commission back in
1982 and 1983 and the recommendations they made at the last
time Social Security was adjusted, and stated one of the reasons
why he felt there were adjustments, if I interpret this correctly,
why their adjustments had not achieved a 75-year solvency level
was because of the exploding costs in the disability side of Social
Security.
Ms. Ross, based upon that and your statement, and I would be
interested in what the others have to say, is there a case to be
made — if there is really no private market system available to pro-
vide universal disability coverage, is there a case to be made that
this very well could be a program that should be underwritten
more from general government revenues rather than a specific pay-
roll tax deduction revenue stream?
Ms. Ross. I would like to go back to some of the reasons we
think that change in the disability rolls has occurred. I am not sure
they are the kinds of things that would lead you to that conclusion.
The high unemployment in the early 1990's was one of the things
that caused the most rapid increase in our roles, and that sort of
282
thing is cyclical, or recently not. But in any case, the economy goes
up and down, and we may be able to accommodate to that.
There were changes in laws and changes brought about by court
decisions in the 1980's and early 1990's that made substantial dif-
ferences in disability, and those things, I think, are things within
someone's control.
Then Ms. Ford also talked about the fact that there were medical
advances such that people who might otherwise have died now are
living longer lives, even if they have a disability.
So a lot of these things are things that can be foreseen, and we
can do something about projecting the costs of those.
I am not sure that I would give up on a social insurance system.
I think this is a huge pool. We cover everyone, and I think with
the proper kind of costing, we could do it in a social insurance pay-
roll tax environment rather than a general revenue environment.
Mr. Bentsen. Ms. Ford.
Ms. Ford. I would Kke to comment. We take the position that
it should be done as social insurance, that that is the only way it
would work. People with disabilities simply will not get private in-
surance if they already have an impairment. Many families cannot
afford it. There already is private disability insurance on the mar-
ket, and I am not sure exactly what the numbers are, but it is gen-
erally higher-income people who can afford to purchase it for them-
selves.
Social Security Disability Insurance and survivors and retire-
ment insurance are unique in that the system will also pay for the
family members, and not just the person who is disabled.
When a program is paid for out of the general revenues, it tends
to be means tested, and we are talking about people who have
worked and paid FICA taxes as essentially insurance premiums. To
means-test a program means that those folks who may have
worked for many years or their parents may have worked for many
years would be forced to impoverish themselves in order to qualify
for a means-tested program. So we are absolutely in opposition to
taking that kind of approach.
Mr. Bentsen. Let me say, and I am not necessarily advocating
this transfer, and I was just talking with the staff, in 1997, and
it is possible people may look back on the 1997 balanced budget
agreement and say it was not all that it was cut out to be, but
nonetheless, in 1997, as part of the Medicare portion of the budget,
we did transfer some of the home health care function, because
that was a spiraling cost, from Part A, the Hospital Insurance
Trust Fund, to Part B, which, as you know, includes a significant-
well, it is basically all general revenue, except for the premium and
deductible and copay of the beneficiaries. It is still a universal pro-
gram.
Now, that could be viewed two ways. That could be viewed, one,
as just a cost shift to bolster the Part A. It could also be viewed
as, and the case was made, that this was more of an outpatient
program and thus deserved to be under Part B.
The question is whether or not that sets a precedent that should
be explored with respect to disability, because even though Part B
of Medicare is an optional program, it is still — if I understand cor-
283
rectly, it is still universally available, and whether or not the same
would be said if you moved SSDI in that same type of direction.
Of course, the other side of the coin is the fear that somehow
bringing general revenues in will put the Mark of — the stigma of
welfare or public assistance onto the program. That is yet to hap-
pen in Medicare. I don't know whether the same would be the case
here or not.
Ms. Ross. The business about shifting from one revenue source
to another, it seems to me what we really want to be sure of is that
we have a program that is running appropriately, that we have it
under control, so to speak, regardless of what its revenue source is,
so that we ought to be making sure that we do things like empha-
size our return to work program so that people who can move off
do; that we do continuing disability reviews so that we make sure
that people who are no longer meeting our eligibility requirements
are removed from the roles; and that we improve our decision-mak-
ing, which is something going on now, so we are making the best
decision with the most complete information we can. I think we
want to be working on those things for sure.
Mr. Bentsen. Thank you, Mr. Chairman.
Chairman Smith. Deputy Commissioner Ross, you stated in your
testimony that 25 to 30 percent of 20-year-olds will become dis-
abled before retirement. Are you suggesting that 25 to 30 percent
of all beneficiaries are receiving benefits based on disability?
Ms. Ross. About a third of our whole beneficiary population is
either receiving disability or survivors benefits. What I am telling
you with regard to my illustration was that if you take a set of 20-
year-olds, at some time during their lives, they will have come onto
our roles and received disability benefits. Some of them may actu-
ally die and not live on to retirement. Actually about 23 percent of
our disability beneficiaries die within 5 years. But I am definitely
saying if you look at today's 20-year-olds as they are entering into
the work force, 25 to 30 percent of them will have been disability
beneficiaries before they reach retirement age.
Chairman Smith. It seems high. Maybe we should be looking at
our working conditions. Maybe we should be looking at something
to react to what seems to be a very high percentage.
Let me ask you this question, because I am not sure I know how
it works. If a worker has mentally impaired kids, and that worker
goes on Social Security at age 65 and then dies at age 70, will
those kids continue to receive Social Security benefits, and will
they be any different than if that individual had gone on disability
before retirement? Ms. Ford.
Ms. Ross. Yes, those are the people I am referring to as adult
disabled child. If you are an adult who is disabled during child-
hood, which is defined in this case up to age 22, during those devel-
opmental years, if you were severely disabled enough to qualify es-
sentially under the disability definition, you receive benefits off
your parents' history. So if the parent retires at 65 and dies at 67,
the adult disabled child is receiving benefits from that parent's
work history for life.
Chairman Smith. The benefits are the same; whether that par-
ent might have gone on disability at age 60 or whether they retire
284
at 65, the benefits ultimately after the death of the worker for
those kids are the same?
Ms. Ford. I am not sure if the calculation turns out to be the
same.
Ms. Ross. The benefits for anybody relate to the earnings of the
person who was the worker. So if a person became disabled and
had lower earnings in the years they were working, their benefit
would be lower than if they had a full healthy life and worked all
the way up to 65 at a better-paying job, for example. So it is not
just the child gets a certain specified amount. The child gets a por-
tion of whatever the worker would have gotten.
Chairman Smith. Yes, Ms. Ford.
Ms. Ford. And that becomes an issue when you look at the plans
that look at annuities. If the parent is required to purchase an an-
nuity using a private account at retirement, under a typical annu-
ity situation and as described in some of the plans, at death that
would go into the estate. You don't have the same kind of ability
to support that adult disabled child for life. Some may live 20, 30,
40 years beyond the parents, and Social Security will pay for that,
but those annuities probably won't.
Chairman Smith. Deputy Commissioner Ross said earlier that in
their reexamination of those currently on disability, they are find-
ing 6 percent that they feel now can go back to work. As a legisla-
tor I get calls on a regular basis complaining about somebody that
went on disability that is out pla5ring golf or doing other work, et
cetera, and I am sure you get some of the same complaints through
your IG.
But tell us more about Social Security's fraud hotline and other
fraud and abuse initiatives now under way.
Ms. Ross. I don't have a lot of specifics to tell you, but the em-
phasis on the integrity of our program and antifraud has been an
emphasis over the past couple of years not just of our inspector
general, but of the Social Security Administration itself, and we
have worked together with our inspector general to look especially
in the disability area for any kind of fraud. So we are quite vigilant
in that regard.
Chairman Smith. So if a person wanted to call in to the Social
Security Administration and complain about somebody they felt
was really not eligible for these benefits, how would they call your
hotline?
Ms. Ross. I bet somebody can tell me the hotline number, but
those are exactly the kind of calls that the inspector general's hot-
line is there to take.
Chairman Smith. Can they look it up in the telephone book in
some way under probably — I as a legislator should know the an-
swer as well as you.
Ms. Ross. If anybody called our usual 1-800 number and said, I
need the number for the inspector general's hotline, they could give
it to them. Actually I have it in front of me right now. But I think
going through our main 800 number would be the way to make
sure.
Chairman Smith. What is the main 800 number? You would just
call
285
Ms. Ross. What is the main number? This is the first time I
have ever had to answer this question. 1-800-SSA-1213. That is
pretty easy. So that 1-800-SSA-1213 would tell you how to get to
our hotline if you needed it.
Chairman Smith. Let me finish ofi". What are the major reasons
for going on disability?
Ms. Ross. You mean, what are the categories of impairments?
The most common impairment now is a mental impairment. That
is the largest single category of impairments. But there are a lot
of other categories which have a fair representation.
Chairman Smith. A mental impairment is the major reason for
going on disability?
Mr. Nadel. It is the single largest. It doesn't mean that most of
the people are mentally impaired. It is the single largest category.
Chairman Smith. Ms. Ford.
Ms. Ford. And a significant proportion of them, and I don't have
the number off the top of my head, of people with mental impair-
ments, have mental retardation. Mental retardation is included in
the category of people with mental impairments under Social Secu-
rity's definitions.
Chairman Smith. So these individuals had some impairment be-
fore they started their working career, if I can use that word; is
that reasonable to assume?
Ms. Ford. People with mental retardation would have, since it
occurs in childhood.
Chairman Smith. But a person that doesn't have mental impair-
ment can somehow develop mental impairment, and that is one of
the largest reasons for going on disabihty? That is interesting.
Ms. Ford. That would include significant psychiatric disorders
and other mental impairments, yes.
Chairman Smith. To the extent this is a new disorder developed
or whether it has been long-lasting, does the Social Security Ad-
ministration have any kind of statistics or records to be able to tell
how many were working with some disability before they went on
disability? Do we have anything in our records that would let us
know how many, when it is new, and when it just got to the point
when it is no longer able for that individual worker to be able to
sustain that kind of work?
Ms. Ross. One can deduce that most times mental illness, not
mental retardation, has some progress, and these are people — we
are talking about people who have mental impairments who have
worked a good deal of time and paid payroll taxes.
Chairman Smith. At least 40 months or else they would not be
eligible.
Ms. Ross. Forty quarters.
Chairman Smith. I mean, 40 quarters, yes.
Ms. Ross. So, yes, there is a very high likelihood we have people
dealing with some sort of mental impairment while they were
working.
Chairman Smith. Does that mental impairment include alcohol
and drug addiction?
Ms. Ross. Those are categories that have been excluded as a rea-
son for becoming eligible for disability.
Chairman Smith. The gentleman from Texas, Mr. Bentsen.
286
Mr. Bentsen. Thank you. I have a couple of questions. The drug
and alcohol, is that part of the SSDI reforms in 1995-1996, or was
that internal?
Ms. Ross. It was a provision of Public Law 104-121, the Contract
With America Act of 1996.
Mr. Bentsen. They defined what would not be considered. Other-
wise you were under court rulings and other reasons that you had
to expand.
Ms. Ross. Right.
Mr. Bentsen. As I recall, back when Congress passed those ad-
justments, there was also concern about expansion of the SSDI pro-
gram for things like — if I recall correctly — attention deficit dis-
order, and that there was concern for potential abuse of that. But
didn't the law try and sort of clamp down on that; is that correct?
Ms. Ross. There were changes in the SSI program that tightened
the eligibility requirements for SSI children.
Mr. Bentsen. That was SSI. We are talking about a different
program. When you are talking about mental impairment as the
largest single program, including mental retardation, when you
were talking about that, you are not talking about that as being
60, 70 percent, you are talking about that being a 25 or 30 percent
share against loss of a limb or some other type of category, right?
Is physical impairment still a majority of disability cases?
Ms. Ross. I think that mental impairments are a third or so of
the disability insurance category.
Mr. Bentsen. I am not tr5dng to discount mental impairment as
a realistic impairment. It is.
Ms. Ross. Among the DI beneficiaries, I think it is about a third,
which would lead to your conclusion that two-thirds are probably
physical impairments. I will provide more detailed impairment in-
formation for the record.
[The information referred to follows:]
OASDI CURRENT-PAY BENEFITS: DISABLED WORKERS
[Number and percentage distribution, by diagnostic group, and sex, December 1998]
Number Percentage distribution
Total Men Women
Total 4,698,560 2,737,444 1,961,116
Diagnosis available 4,568,391 2,647,721 1,920,670 100.0 100.0 100,
Infectious and parasitic diseases' 93,776 72,695 21,081 2.1 2.7 1
Neoplasms 127,174 64,436 62,738 2.8 2.4 3,
Endocrine, nutritional, and metabolic diseases .... 233,724 95,498 138,226 5.1 3.6 7.
Diseases of blood and blood-forming organs 11,349 5,579 5,770 .2 .2
Mental disorders (other than mental retardation) 1,215,373 668,245 547,128 26.6 25.2 28,
Mental retardation 243,745 166,459 77,286 5.3 6.3 4,
Diseases of the:
Nervous system and sense organs 441,016 236,198 204,818 9.7 8.9 10,
Circulatory system 526,573 368,138 158,435 11.5 13.9 8,
Respiratory system 159,869 87,592 72,277 3.5 3.3 3
Digestive system 61,541 34,657 26,884 1.3 1.3 1
Genitourinary system 74,888 46,026 28,862 1.6 1.7 1
Skin and subcutaneous tissue 11,826 5,151 6,675 .3 .2
Musculoskeletal system 1,024,053 571,058 452,995 22.4 21.6 23,
Congenital anomalies 8,719 4,722 3,997 .2 .2
Injuries 224,388 163,631 60,757 4.9 6.2 3
Other 110,377 57,636 52,741 2.4 2.2 2,
'AlOS/HIV records are counted in the Infectious and Parasitic Diseases group. Before 1990, these records were included in the Other group.
287
Mr. Bentsen. And am I right that the President proposed, as
have Members of both parties in the past, is it that people with
SSDI who went back to work, who were able to, because of
wellness or different working conditions or whatever, able to go
back to work, that they would not forfeit their Medicare benefits;
is that correct? That is what the President proposed? Or is it Med-
icaid?
Ms. Ross. If you are talking about the provision in the Kennedy-
Jeffords bill
Mr. Bentsen. Right.
Ms. Ross. There is an expansion of Medicare coverage. Over the
next several years, people will be able to get much extended Medi-
care coverage.
Mr. Bentsen. Under current law, if you have achieved disability,
and if you then go back to work, you have an income cap; is that
right?
Ms. Ross. That is right.
Mr. Bentsen. If you exceed that cap, you forfeit benefits, includ-
ing health benefits?
Ms. Ross. There is an extended period of eligibility for both cash
benefits and lasting a couple of years, 3, I believe.
Mr. Bentsen. Does the SSA — do you have any empirical data
that would lead to the conclusion that even with the 3-year cap,
that that is an impediment to people who might otherwise be able
to return to the work force from running? Does that keep them
from returning to the work force?
Ms. Ross. I am aware of a study that the General Accounting Of-
fice did talking to people who were actually working disability in-
surance beneficiaries, and they asked them what were the things
that were of major concern to them, what were they fearing even
though they were working, and it was the loss of their medical in-
surance coverage.
Knowing you are going to lose your Medicare coverage in 3 years,
without having any idea whether there is anybody who will cover
you regardless of whether you could afford it, is a real threat. You
think most of us would think twice about whether we were willing
to jump off that.
Mr. Bentsen. Unless you were 62.
Ms. Ross. True.
Mr. Bentsen. I will say this, and the gentleman is right, of
course, we get all kinds of calls, but we get calls from people that
say this is being abused. At the same time, I have to tell you, my
case-working staff" who deals with people, trying to work with con-
stituents who are trying to get their disability designation and
going through that process, they sometimes feel like they are bang-
ing their head against a wall and the time it takes to do it. I hope
that is because of SSA or whoever it is that does it is dotting their
I's and crossing their T's and making sure that somebody meets the
qualifications.
Chairman Smith. If the gentleman will yield. Deputy Commis-
sioner Ross indicated that when she gets a call from a congres-
sional office, that they don't give it undue regard.
288
Mr. Bentsen. I am not sure I understand exactly, but is that a
double or a triple negative? Does that mean we can just call your
office any time?
Ms. Ross. You are welcome to call any time.
Mr. Bentsen. You are careful to say that, I am sure.
Thank you, Mr. Chairman.
Chairman Smith. Thank you all very much. I would like to con-
clude and ask each one of you if you would have a closing comment
of something that the Task Force, the Budget Committee, Congress
should take into consideration or be aware of, or something that
might not have been said that you feel should have been said? We
will go from you, Ms. Ford, to Mr. Nadel to Ms. Ross.
Ms. Ford. I think I have probably said it. Overall the Consor-
tium for Citizens with Disabilities believes the system works, and
we have to preserve the social insurance aspect of the disability
programs.
Chairman Smith. Mr. Nadel.
Mr. Nadel. I again would reiterate the importance of the social
insurance aspects of the programs, which enjoy broad public sup-
port, where people feel that they have paid in and have a right
should terrible misfortune befall them.
Chairman Smith. Ms. Ross.
Ms. Ross. I just would suggest that when you are looking at var-
ious solvency proposals, that you look particularly at survivors and
disability benefits, what results from a change in one place, what
is the consequence for these individuals viewing it separately rath-
er than as part of the whole package.
Chairman Smith. You have an interesting comment, Mr. Bent-
sen, that maybe we should consider if an individual works only 39
quarters, then they would be going on SSI paid for out of the gen-
eral fund. Maybe there is a way to accommodate the increasing the
work quarter requirement without forcing those individuals that
were between 20 and, say, 40 work quarters to sell out everything
they had to be eligible for the SSI benefits, because it seems to be
more of a program that should be accommodated by the general
public. That was an interesting suggestion that I wrote down, and
maybe we will look at incorporating it.
Let me just announce next week we will be starting at 10 o'clock.
We will be starting with a review of some of the Social Security
proposals, and Senator Gregg and Senator Breaux will be here at
10 a.m. At 10:30, Congressman Archer will testify on his proposal;
at 11 a.m.. Congressman Kolbe and Congressman Stenholm. We
will proceed with other plans, including the one that I have devel-
oped, and this Task Force can review some of the aspects of those
different plans.
I would thank our witnesses today very much for giving your
time and coming to this hearing. The Budget Committee Task
Force is adjourned.
[Whereupon, at 1:35 p.m., the Task Force was adjourned.]
Review of Social Security Reform Plans
TUESDAY, JUNE 29, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Security,
Washington, DC.
The Task Force met, pursuant to call, at 10:07 a.m. in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Chairman Smith. The Budget Committee Task Force on Social
Security will come to order for the purpose of hearing individual re-
ports on their proposals to save Social Security.
I certainly welcome the witnesses here today as we look to spe-
cific Social Security reform proposals offered in Congress. Nothing
is more important to this country's long-term budget prospects
than resolving the funding gap in Social Security and Medicare,
and I congratulate the Members that have had enough courage to
move ahead with solutions. Solutions are not easy, they are dif-
ficult, and it takes some exceptional wisdom and statesmanship to
move ahead.
Today we will hear many different ideas about how we should re-
form Social Security. Our witnesses will undoubtedly disagree on
some of the issues with each other and with members of the Task
Force. That is only to be expected on an important issue like Social
Security. It is extraordinary, I think, to note that there is one thing
that every single witness agrees on. This is something that the
President and all the members of the Social Security Commission
also agree on, and the single point of agreement is the investment
of Social Security funds in the private securities market. We all
agree that this investment, whether held by government or by indi-
vidual workers, is necessary to increase the return on the surpluses
now coming into Social Security.
I hope that we all take note of this agreement. It is something
that did not exist up until the last couple of years. And when I first
introduced my Social Security bill and started writing it in 1993,
there was very little support and very little interest in moving
ahead. I think we have made significant progress, and I firmly be-
lieve that investment is an important part of the eventual biparti-
san compromise that will be necessary if we are going to protect
and strengthen Social Security for the future. Let's hope that we
can work together so that we can reach this compromise as soon
as possible for the sake of current and future retirees, and I look
forward to the testimony.
[The prepared statement of Mr. Smith follows:]
(289)
290
Prepared Statement of Hon. Nick Smith, a Representative in Congress From
THE State of Michigan
I welcome the witnesses here today as we look at specific Social Security reform
Proposals offered in Congress. Nothing is more important to this country's long-term
udget prospects than resolving the funding gap in Social Security and Medicare.
Today, we will hear many different ideas about how we should reform Social Secu-
rity. Our witnesses will undoubtedly disagree on various issues with each other and
with the members of the Task Force. That is only to be expected on an issue as
important as Social Security.
It is extraordinary, therefore, to note that there is one thing that every single wit-
ness today agrees on. This is something that the President and all the members of
the Social Security Commission also agree on. This single point of agreement is the
investment of Social Security funds in the private securities markets. We all agree
that this investment, whether held by the government or by individual workers, is
necessary to increase the return on the surpluses now coming into Social Security.
I hope that we all take note of this agreement. It is something that did not exist
when I started working on my first Social Security bill in 1993 and represents real
progress in the debate. I firmly believe that investment will be the basis of the even-
tual bipartisan compromise legislation that will be necessary to protect and
strengthen Social Security for the future. Let's hope that we can work together so
this compromise can take place as soon as possible.
I look forward to today's testimony.
Chairman Smith. Representative Rivers.
Ms. Rivers. Thank you, Mr. Chairman. I want to thank the two
Senators as well as all of the others who will be presenting today
and to commend you on your courage. There are a lot of people who
are talking about Social Security, but only a handful who are actu-
ally coming forward with proposals. I want to apologize, however,
because I am dealing with an especially vicious summer cold and
will not be able to stay for the entire hearing. But I look forward
to hearing from you, and I will review all of your materials very
carefully, thank you.
Chairman Smith. Senator Gregg, Senator Breaux, proceed with
whatever time you think is appropriate. Leave us some time for
questions, and please proceed.
STATEMENT OF HON. JUDD GREGG, A UNITED STATES
SENATOR FROM THE STATE OF NEW HAMPSHIRE
Senator Gregg. Thank you very much, Mr. Chairman. It is a
pleasure to have a chance to talk with you today, and I congratu-
late you, Mr. Chairman, on your efforts in the area of Social Secu-
rity. They have been a significant contributor to making this proc-
ess viable and to moving forward toward Social Security reform,
which is absolutely essential if the next generation of Americans
are to have a system which they can benefit from.
Senator Breaux and I have been working on this issue for about
2^2 years now, initially as a Chairman, Cochairman, along with
Senator — Congressmen Kolbe and Stenholm — of the CSIS Commis-
sion, which involved a large number of people interested in this
issue. From that commission we developed a bill which we felt was
an extremely positive step forward, and that bill has received a fair
amount of notoriety.
Since then, however, working with other Members of the Senate,
Senator Kerrey, Senator Grassley and a number of other Members
who have been interested in this issue, we have put together an
additional piece of legislation which has taken the original bill that
we proposed and expanded on it and I think made it much stronger
and a much more constructive piece of legislation, and I will out-
291
line what this piece of legislation does. We call it the bipartisan So-
cial Security plan because it is bipartisan with Senator Breaux and
Senator Kerrey, Democratic Members, Senator Grassley and myself
being Republican Members, and 15 cosponsors or something in that
range of bills similar to this within the Congress. And so it does
have broad interest.
The basic goal of the legislation is to accomplish a number of
things. First, we came to the conclusion that we should go for a
long-term solvency. We shouldn't have a short-range plan. The
President's plan, as you recall, really only projected through the
year 2050. Our plan goes to the end of the next century, and as
far as the eye can see beyond that for all intents and purposes, so
it makes the system solvent for not only 75 years, but perpetually,
which is very important.
Second, our plan has no major, no significant tax increases and,
in fact, represents over the term of the plan a significant tax reduc-
tion over present law; a dramatic tax reduction over present law
and significant tax reduction over what many of the other plans
which have been put forward, including the President's proposal, in
the Ways and Means plan, in our opinion.
Fourthly, the plan is concerned with intergenerational fairness.
In other words, we feel very strongly that younger people who are
already getting a rather raw deal under the Social Security System
of a very low rate of return should not have that aggravated by any
attempt to try to correct the system. We should not end up increas-
ing the tax burden of younger people. We should not end up put-
ting younger people at further disadvantages to their likelihood of
getting the Social Security benefit they are paying for, and paying
rather dearly for at this time, so our plan addresses that in a posi-
tive way. TO
Our plan doesn't touch any current beneficiaries of the Social Se-
curity system so that there is no impact on current beneficiaries.
They can participate in our savings accounts if they want to, I sup-
pose, but as a practical matter it says to current beneficiaries, you
are protected.
Fifth, our plan is very progressive. In other words, we make a
special effort to make sure that people at the low income levels get
a significant benefit, and we have a benefit which dramatically —
which is dramatically better than what present law is or than
what, as we understand, any other bill's proposals are relative to
low- and moderate-income individuals, independent of the personal
savings accounts which we have in our plans, so that even if the
personal savings accounts are not considered, our plan is extremely
progressive in its approach.
Sixth, and I think most important, is we begin the process of
prefunding the liability of the Social Security System. There are
only really three ways that you can address the insolvency of the
Social Security System. One, of course, is to raise taxes. Two is to
significantly cut benefits. Three is to prefund the liability, the con-
tingent hability, of the system. We accomplish this through per-
sonal savings accounts. Our personal savings accounts are struc-
tured much like the other ones, including the Chairman's personal
savings accounts, although we don't have it grow as aggressively as
the Chairman's does in the outyears. Our personal savings ac-
292
counts are structured so that it begins at a 2 percent level, al-
though people in lower income brackets will be able to get 4 per-
cent through a matching system with the Federal Government con-
tributing, and so that they can have a higher tax refund, almost
4 percent. And that personal savings account is then the asset of
the retiree, which is a very significant point.
In a number of plans that are floating around, the personal sav-
ings accounts and the amount of money that is earned in those per-
sonal savings accounts is essentially taken by the Federal Govern-
ment as a claw back at the time of retirement. Ours does not take
that approach. Ours you keep your personal savings account. It is
yours. If you die prior to retirement, it becomes an asset of your
estate, and you benefit from its growth.
We structured the personal savings accounts so that there is a
reduction in your benefit at retirement, actuarial reduction, which
is represented by what your personal savings account would have
generated if it had earned only the rate of T-bonds. In other words,
if you had taken the most conservative investment, that ends up
being an actuarial reduction in your benefit at retirement, but
since almost everyone will be generating more than their T-bond
rate, there is very little question that you will end up with a per-
sonal savings account at retirement that will be a significant con-
tributor to your assets and to your own personal wealth.
In addition, the way we invest the personal savings accounts is
we do it using the model of the Thrift Savings Plan so that essen-
tially the Thrift Savings Plan, which all of us in Congress are fa-
miliar with, is the same type of vehicle that you would have to use
as your investment vehicle under the personal savings accounts. So
you would have a choice every year of three our four, maybe five
or six different funds which would have been set up by the trustees
of the Social Security Administration under a Thrift Savings Plan
type of structure.
So we have three major functions here: One, we don't raise taxes,
and I think this is a critical point, one which I want to stress a
little bit further, where all of the plans out there today that are
being talked about besides this plan and the Chairman's plan end
up with a huge tax increase in the transition years because they
use the general fund to essentially support the Social Security Sys-
tem. Now, historically we have never used the general fund ac-
counts to support Social Security. And it would be, in my opinion,
a major mistake to use the general fund in an extraordinarily ag-
gressive way to support the Social Security System.
But what almost all of the plans do, especially
Chairman Smith. I am going to ask the visitors today to refrain
from moving up while testimony is proceeding to get copies. We can
take a break in a minute and let everybody come up and get an-
other copy.
Senator Gregg, excuse me. Proceed.
Senator Gregg. Under the President's plan, and the Ways and
Means plan to a great extent, you end up with the general fund
tax burden increasing significantly in order to bear the burden of
obtaining solvency in the Social Security Trust Fund, which means
that especially wage earners and younger wage earners end up
with a double hit. They end up with less benefits in many in-
293
stances than their parents. More importantly, they end up with a
much higher tax burden than their parents in order to support the
burden of the Social Security reform.
Our proposal does not do that. Our proposal maintains a tax bur-
den which is consistent with the present-day tax burden, and does
not presume any significant general fund, and, in fact, would be a
huge tax reduction in comparison to either general law or the
President's proposal or the Ways and Means proposal relative to
the use of general funds. So we see that as a very big positive.
I notice that my time is up, but let me simply highlight again
we prefund the liability. We give ownership. We don't raise taxes,
and we make the system solvent for the next 100 years, and it is
a bipartisan plan. And it has been scored by the Social Security
trustees.
[The prepared statement of Senator Gregg follows:]
Prepared Statement of Hon. Judd Gregg, a United States Senator From the
State of New Hampshire
Thank you, Mr. Chairman, for this opportunity to testify before your Task Force.
As you may know, I serve as the chair of the Budget Committee Task Force on the
Senate side, so I understand something of your current responsibilities. I want to
commend you for your leadership in holding this hearing, and also for offering a re-
form proposal of your own.
The proposal that I will discuss was negotiated over several months by a biparti-
san group of committed reformers in the Senate. It already has more cosponsors
than any other competing proposal. Those cosponsors include myself, Senator Bob
Kerrey, Senator John Breaux, Senator Chuck Grassley, Senator Fred Thompson,
Senator Chuck Robb, and Senator Craig Thomas.
Mr. Chairman, I would like to begin by stressing that our plan is not the work
of any single legislator. Each of us had to make concessions that we did not like.
But we also benefited fi-om our decision to employ the best ideas that we could find
fi-om serious reform plans presented across the political spectrum. One of these
ideas, you may have noticed, derives from a similar provision in your own proposal.
It therefore seems appropriate to begin with a description of it.
In the last Congress, I worked with Senator Breaux as well as Congressmen
Kolbe and Stenholm to develop a proposal that was actuarially sound, and would
also improve the quality of the deal provided to Social Security beneficiaries, espe-
cially today's young workers. Our calculations persuaded us that most individuals
would benefit from the reforms that we proposed, either in terms of increased bene-
fits, or decreased tax burdens, or some combination of both. Despite this, it was not
very difficult for detractors to take "pot shots" at our proposal. Critics could pick
out one provision that in isolation would reduce benefits, and ignore the provisions
that increase them. Or they could charge that the provisions to ensure fiscal respon-
sibility were made necessary only because we were determined to embrace personal
accounts at all cost. These criticisms are not persuasive to those who have analyzed
the entirety of the effects of our reforms, but they are sometimes made nonetheless,
so we needed to be sure that the benefits of our reforms were clearly understood.
In drafting this year's legislation, therefore, we sought a way to demonstrate to
people that personal accounts were not the cause of any "benefit cuts," that by con-
trast, the accumulated savings in personal accounts could be an important cushion
against the types of outlay restraints that are necessary to balance the current So-
cial Security system, much less a restructured one. We found that the provision in
your legislation that estabhshed an exact offset of benefits, equal to the interest-
compounded value of the tax refund into the personal account, was a useful means
of achieving this. In its effects, it is very similar to "bend point factor" changes that
we offered last year. But to help in presenting our proposal to the pubhc, we felt
that there was something to be gained by changing the nature of the offset.
By making the benefit offsets exactly proportional to the interest-compounded
value of the tax refunds placed in personal accounts, you can make a very straight-
forward deal with beneficiaries. If they don't want to take a risk, if they don't want
to "play the game" of stock investment, they don't have to. If they simply invest in
T-bonds with their personal accounts, then they come out exactly even. Their bene-
fits will exactly match what they would have been had the personal account never
294
been created. But if they believe that they can do better — and indeed, most of them
can — then our proposal gives them the opportunity to do so. It does not "claw back"
the proceeds of their investment success. It gives them an opportunity to improve
upon the benefits that the system could give them if reformed by traditional meth-
ods alone. But it does not force anyone to take a risk that they do not want, and
assures them that the personal account itself cannot cause any reduction in their
overall benefits.
That is one important element that our proposal has in common with your pro-
posal, Mr. Chairman. Now I would like to describe the other aspects of our plan.
It would:
• Make Social Security solvent. Not simply for 75 years, but perpetually, as far
as the Trustees can estimate. Our proposal would leave the system on a perma-
nently sustainable path.
• Increase Social Security benefits beyond what the current system can fund. I
will follow up with some details as to why and how.
• It would drastically reduce taxes below current-law levels. Again, I will provide
details as to why and how it does this.
• It will make the system far less costly than current law, and also less costly
than competing reform proposals.
• It will not touch the benefits of current retirees.
• It will strengthen the "safety net" against poverty and provide additional pro-
tections for the disabled, for widows, and for other vulnerable sectors of the popu-
lation.
• It will vastly reduce the Federal Government's unfunded liabilities.
• It would use the best ideas provided by reformers across the political spectrum,
and thus offers a practical opportunity for a larger bipartisan agreement.
• It will improve the system in many respects. It will provide for fairer treatment
across generations, across demographic groups. It would improve the work incen-
tives of the current system.
I would like now to explain how our proposal achieves all of these objectives:
Achieving System Solvency
Our system would make the system solvent for as far as the Social Security Actu-
aries are able to estimate.
How does it do this? Above all else, it accomplishes this through advance funding.
As the members of this Committee know, our population is aging rapidly. Cur-
rently we have a little more than 3 workers paying into the system for every 1 re-
tiree taking out of it. Within a generation, that ratio will be down to 2:1.
As a consequence, if we did nothing, future generations would be assessed sky-
rocketing tax rates in order to meet benefit promises. The projected cost (tax) rate
of the Social Security system, according to the Actuaries, will be almost 18 percent
by 2030.
The Trust Fund is not currently scheduled to become insolvent until 2034, but as
most acknowledge, the existence of the Trust Fund has nothing to do with the gov-
ernment's ability to pay benefits. President Clinton's submitted budget for this year
made the point as well as I possibly covild:
"These balances are available to finance future benefit payments and other trust
fund expenditures — but only in a bookkeeping sense. * * * They do not consist of
real economic assets that can be drawn down in the future to fund benefits. Instead,
they are claims on the Treasury that, when redeemed, will have to be financed by
raising taxes, borrowing ft-om the public, or reducing benefits or other expenditures.
The existence of large Trust Fund balances, therefore, does not, by itself, have any
impact on the Government's ability to pay benefits."
In other words, we have a problem that arises in 2014, not in 2034, and it quickly
becomes an enormous one unless we find a way to put aside savings today. This
does not mean simply adding a series of credits to the Social Security Trust Fund,
which would have no positive impact, as the quote fi-om the President's budget
clearly shows.
What we have to do is begin to advance fund the current system, and that means
taking some of that surplus Social Security money today out of the Federal coffers
and into a place where it can be saved, invested — owned by individual beneficiaries.
That money would belong to them immediately, even though they could not with-
draw it before retirement. But it would be a real asset in their name.
By doing this, we can reduce the amount of the benefit that needs to be funded
in the future by raising taxes on future generations. This is the critical objective,
but it allows for flippant political attacks. If you give someone a part of their benefit
today, in their personal account, and less of it later on, some will say that it is a
295
"cut" in benefits. It is no such thing. Only in Washington can giving people owner-
ship rights and real fiinding for a portion of their benefits, and increasing their total
real value, be construed as a cut. Accepting such terminology can only lead to one
conclusion — that we can't advance fund, because we simply have to be sure that
every penny of future benefits comes fi*om taxing future workers. So we need to get
out of that rhetorical trap.
Our proposal has been certified by the actuaries as attaining actuarial solvency,
and in fact it goes so far as to slightly overshoot. We are "overbalanced" in the years
after 2050, and have some room to modify the proposal in some respects and yet
still stay in balance.
I would note the consensus that has developed for some form of advance funding.
This was one of the few recommendations that united an otherwise divided Social
Security Advisory Council in 1996. The major disagreements today among policy-
makers consist only in the area of who should control and direct the investment op-
portunities created within Social Security. I believe strongly, and I believe a con-
gressional majority agrees, that this investment should be directed by individual
beneficiaries, not by the Federal Government or any other public board.
Why Benefits are Higher Under Our Plan
We have worked with the Social Security actuaries and the Congressional Re-
search Service to estimate the levels of benefits provided under our plan.
There are certain bottom-line points that should be recognized about our plan.
Among them:
1. Low-wage earners in every birth cohort measured would experience higher ben-
efits imder our plan than current law can sustain, even without including the pro-
ceeds from personal accounts.
2. Average earners in every birth cohort measured would experience higher bene-
fits under our plan than current law can sustain, even if their personal accounts
only grew at the projected bond rate of 3.0 percent.
3. Maximum earners in some birth cohorts would need either to achieve the his-
torical rate of return on stocks, or to put in additional voluntary contributions, in
order to exceed benefit levels of current law. However, the tax savings to high-in-
come earners, which I will outline in the next section, will be so great that on bal-
ance they would also benefit appreciably from our reform plan.
Under current law, a low-wage individual retiring in the year 2040 at the age of
65 would be promised a monthly benefit of $752. However, due to the pending insol-
vency of the system, only $536 of that can be funded. We cannot know in advance
how future generations would distribute the program changes between benefit cuts
and tax increases. But we do know that our plan, thanks to advance funding, would
offer a higher benefit to that individual, from a fully solvent system that would
eliminate the need for those choices.
I will provide tables that are based on the research of the Congressional Research
Service that make clear all of the above points. The CRS makes projections that as-
sume that under current law, benefits would be paid in full until 2034, and then
suddenly cut by more than 25 percent when the system becomes insolvent. CRS can
make no other presumption in the absence of advance knowledge of how Congress
would distribute the pain of benefit reductions among birth cohorts. In order to
translate the CRS figures into a more plausible outcome, we added a column show-
ing the effects that would come from the benefit reductions under current law being
shared equally by all birth cohorts.
BENEFIT TABLE NO. 1
The Bipartisan Plan's Benefits Would Be Higher for Low-Income Workers Even Without Counting Personal Accounts
[Assumes Steady Low-Wage Worker; Monthly Benefit, 1999 Dollars; Assumes Retirement at Age 65]
„ . I ,1. f. r .1 1 ■ Bipartisan plan Bipartisan plan Bipartisan plan (with
Year Current law (benefi Current law sustain- (bond rate no vol- (without account 1 percent voluntary
cuts begin in 2034) able' ^^,3^, ^g„g,its, contributions)
2000
626
517
615
606
627
2005
624
515
620
601
645
2010
652
539
698
667
738
2015
673
556
733
687
790
2020
660
545
754
691
832
2030
690
570
776
694
877
2035
512
595
798
693
926
2040
536
621
821
689
981
2050
582
678
869
710
1,051
296
BENEFIT TABLE NO. 1— Continued
The Bipartisan Plan's Benefits Would Be Higher for Low-Income Workers Even Without Counting Personal Accounts
[Assumes Steady Low-Wage Worker; Monthly Benefit, 1999 Dollars; Assumes Retirement at Age 65]
Current law (benefit Current law sustain-
Blpartisan plan Bipartisan plan Bipartisan plan (with
(bond rate, no vol- (without account 1 percent voluntary
cuts begin in 2034) able' ^^^jg'^, tienefits) contributions)
2060 611 739 920 749 U07
'The Congressional Research Service, m the left-hand column, assumes that all of the burden of benefit changes under current law will
commence in 2034. In order to produce a more realistic prediction of how the changes required under current law would be spread, the "cur-
rent law sustainable" column assumes that they have been spread equally among birth cohorts throughout the valuation period.
BENEFIT TABLE NO. 2
The Bipartisan Plan's Benefits Would Be Higher for Average-Income Workers Even if Accounts Earn Only a Bond Rate of
Return (3.0 Percent) Assumes Steady Average-Wage Worker; Monthly Benefit, 1999 Dollars; Assumes Retirement at Age 65
„. . Bipartisan plan (with
v„,. Current law (benefit Current law sustain- (hnr ntp"nn unl Bipartisan plan 1 percent voluntary
^^^' cuts begin in 2034) able' , m Li (stock rate) contributions, bond
Ullldiyj pg(g)
2000 1,032 852 1,014 1,016 1,029
2005 1.031 852 973 982 1,006
2010 1,076 889 991 1,014 1,046
2015 1,111 918 977 1,024 1,057
2020 1,090 900 1,005 1,092 1,115
2030 1,139 941 1,083 1,183 1,179
2035 845 982 1,083 1.307 1.250
2040 884 1,026 1,093 1,476 1.329
2050 961 1,119 1,157 1,672 1,442
2060 1,007 U21 1^225 1778 1^
' The Congressional Research Service, in the left-hand column, assumes that all of the burden of benefit changes under current law will
commence in 2034. In order to produce a more realistic prediction of how the changes required under current law would be spread, the "cur-
rent law sustainable" column assumes that they have been spread equally among birth cohorts throughout the valuation period.
The alternative course is that current benefit promises would be met in fiill by
raising taxes, both under current law and under proposals to simply transfer credits
to the Social Security Trust Fund. I have also provided a table that shows the size
of these tSLX costs, and will comment further upon them in the next portion of my
statement.
I would like to point out that these figures apply to individuals retiring at the
age of 65. Thus, even with the increased actuarial adjustment for early retirement
under our plan, and even though our plan would accelerate the pace at which the
normal retirement age would reach its current-law target of 67, benefits under our
proposal for individuals retiring at 65 would still be higher.
Our tables also show that the progressive match program for low-income individ-
uals will also add enormously to the projected benefits that they will receive.
Why Taxes Will Be Much Lower Under Our Plan
If there is a single most obvious and important benefit of enacting this reform,
it is in the tax reductions that will result from it.
I am not referring to the most immediate tax reduction, the payroll tax cut that
will be given to individuals in the form of a refund into a personal account.
The greatest reduction in taxes would come in the years from 2015 on beyond.
At that time, under current law — and under many reform plans — enormous outlays
from general revenues would be needed to redeem the Social Security Trust Fund,
or to fund personal accounts. The net cost of the system would begin to climb. The
Federal Government would have to collect almost 18 percent of national taxable
payroll in the year 2030, more than 5 points of that coming from general revenues.
The hidden cost of the current Social Security system is not the payroll tax in-
creases that everyone knows would be required after 2034, but the general tax in-
creases that few will admit would be required starting in 2014.
With my statement, I include a table showing the effective tax rate costs of cur-
rent law as well as the various actuarially sound reform proposals that have been
placed before the Congress. These figures come directly from the Social Security ac-
tuaries. They include the sum of the costs of paying OASDI benefits, plus any man-
datory contributions to personal accounts. (Under our proposal, additional voluntary
contributions would also be permitted. But any Federal "matches" of voluntary con-
297
tributions from general revenues would be contingent upon new savings being gen-
erated.)
Let me return to our individual who is working in the year 2025 under current
law. In that year, a tax increase equal to 3.61 percent of payroll would effectively
need to be assessed through general revenues in order to pay promised benefits. As
a low-income individual, his share of that burden would be less than if it were as-
sessed through the payroll tax, but it would still be real. Under current law, his
income tax burden comes to about $241 annually.
COMPARISON OF COST RATES OF CURRENT LAW AND ALTERNATIVE PLANS
[As a percentage of taxable payroll]
Year Current law Archer/Shaw Senate bipartisan Kolbe/Stenholm Gramm Nadler
2000 10.8 12.8 12.7 12.9 15.0 (i)10.4
2005 11.2 13.3 13.2 13.0 15.2 10.6
2010 11.9 13.9 13.4 13.4 15.6 11.2
2015 13.3 15.0 14.0 14.0 16.4 12.5
2020 15.0 16.4 14.7 14.8 17.3 12.8 (14.2)
2025 16.6 17.4 15.4 15.6 17.6 14.4 (15.8)
2030 17.7 17.8 15.7 15.7 17.1 15.5 (16.9)
2035 ... 18.2 17.3 15.5 15.2 16.4 15.9 (17.4)
2040 18.2 16.2 14.8 14.5 15.2 16.0 (17.5)
2045 18.2 14.9 14.3 13.8 14.1 16.1(17.5)
2050 18.3 13.8 13.9 13.3 13.4 16.3 (17.7)
2055 18.6 13.1 13.7 13.2 13.0 16.6(18.0)
2060 19.1 12.6 13.7 13.1 12.8 16.9 (18.5)
2065 19.4 12.3 13.6 13.4 12.5 17.1 (18.8)
2070 19.6 12.1 115 117 12.4 17.3 (19.0)
'Tax rate of Nadler plan is lower than current law not because total costs are less but because amount of national income subiect to tax
is greater. In order to compare total costs of Nadler plan to other plans, cost rate giuen in Nadler column must be multiplied by a factor
that varies through time. This factor would be close to 1.06 in the beginning of the valuation period, and would gradually decline to 1.03 at
the end. For example, the tax rate given as 11.2 percent in 2010 under the Nadler column would equate to the same total tax cost as the
11.9 percent figure in the current law column
Notes: Annual cost includes OASDI outlays plus contributions to personal accounts. Peak cost year in bold. Figures come from analyses
completed of each plan by Social Security actuaries. Archer/Shaw plan memo of April 29, 1999. Senate bipartisan plan (Gregg/Kerrey/Breaux/
Grassley et al) memo of lune 3, 1999. Kolbe/Stenholm plan memo of May 25, 1999. Gramm plan memo of April 16, 1999. Nadler plan memo
of June 3, 1999. Nadler plan total cost given m parentheses, cost estimate given on assumption that stock sales reduce amount of bonds
that must be redeemed from tax revenue Due to construction of plans, cost rates for the Archer/Shaw, Gramm, and Nadler plans would vary
according to rate of return received on stock investments.)
PART II: COMPARISON OF COST RATES OF CURRENT LAW AND ALTERNATIVE PLANS
[As a percentage of taxable payroll]
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065
2070
10.8
(1)11.1 (13.1)
11.2
11.0 (13.0)
11.9
10.9 (12.9)
13.3
11.5 (13.5)
15.0
12.2 (14.2)
16.6
13.2 (15.2)
17.7
13.8 (15.8)
18.2
14.0 (16.0)
18.2
14.0 (16.0)
18.2
14.0 (16.0)
18.3
14.2 (16.2)
18.6
14.5 (16.5)
19.1
14.7 (16.7)
19.4
14.8 (16.8)
19.6
14.9 (16.9)
' Like the Nadler plan, the Moynihan/ferrey plan would increase the share of national income subject to Social Security taxation, but to a
lesser degree Thus, tax rates will appear lower than would an equivalent amount of tax revenue collected under the Archer/Shaw, Gramm, or
Kolbe/Stenholm plans. The correction factor required to translate one cost rate into another would be between 1.03-1,06 for the Nadler pro-
posal. 1.01-1.02 for the Senate bipartisan proposal, and 1.01 1,04 for the Moynihan/Kerrey proposal.
Notes: Annual cost includes OASDI outlays plus contributions to personal accounts. Peak cost year in bold. Analysis of tifloynihan/Kerrey plan
IS based on SSA actuaries' memo of January 11. 1999, and is listed separately because it is the only projection provided here based on the
1998 Trustees' Report. 1999 re-estimates would vaiv. Unlike the other personal account proposals, the accounts in the Moynihan/Kerrey plan
are voluntary. The figure without parentheses assumes no contributions to, and thus no income from, personal accounts. The figure mside pa-
rentheses assumes universal participation in 2 percent personal accounts, for comparison with other personal account plans.
298
Under our proposal, that tax burden would drop by roughly 37 percent, from $241
to $153.
Middle and high-income workers would not experience benefit increases as gener-
ous as those provided to low-income individuals under our plan. But we have deter-
mined that by the year 2034, an average wage earner would save the equivalent
of $650 a year (1999 dollars) in income taxes, and a maximum-wage earner, $2350
a year. I want to stress that these savings are net of any effects of re-indexing CPI
upon the income tax rates. These are net tax reductions, even including our CPI
reforms.
I would also stress that 2025 is not a particularly favorable example to select. Our
relative tax savings get much larger after that point, growing steadily henceforth.
A look at our chart showing total costs reveals how quickly our proposal, as well
as the Kolbe-Stenholm proposal, begins to reduce tax burdens.
A plan as comprehensive as ours can be picked apart by critics, provision by pro-
vision. It is easy to criticize a plan's parts in isolation fi-om the whole, and to say
that one of them is disadvantageous, heedless of the other benefits and gains pro-
vided. One reason for the specific choices that we made is revealed in this important
table. The result of not making them is simply that, by the year 2030, the effective
tax rate of the system will surpass 17 percent, an unfortunate legacy to leave to
posterity.
Our Plan Protects the Benefits of Current Retirees
How would current retirees be affected by our proposal?
Only in one way. Their benefits would come fi-om a solvent system, and therefore,
political pressure to cut their benefits will be reduced. Our proposal would not affect
their benefits in any way. Even the required methodological corrections to the Con-
sumer Price Index would not affect the benefits of current retirees.
Under current law, there is no way of knowing what future generations will do
when the tax levels required to support this system begin to rise in the year 2014.
We do not know whether future generations will be able to afford to increase the
tax costs of the system to 18 percent of the national tax base by the year 2030, or
whether other pressing national needs, such as a recession or an international con-
flict will make this untenable. Current law may therefore contain the seeds of politi-
cal pressure to cut benefits. Moreover, as general revenues required to sustain the
system grow to the levels of hundreds of billions each year, there is the risk that
upper-income individuals will correctly diagnose that the system has become an
irretrievably bad deal for them, and that they will walk away from this important
program.
By eliminating the factors that might lead to pressure to cut benefits, our pro-
posal would keep the benefits of seniors far more secure.
Strengthening the Safety Net Against Poverty
Poverty would be reduced under our proposal, even if the personal accounts do
not grow at an aggressive rate. The reason for this is that our proposal would in-
crease the progressivity of the basic defined, guaranteed Social Security benefit. It
would also gradually phase in increased benefits for widows.
Moreover, our plan would protect the disabled. They would be unaffected by the
changes made to build new saving into the system. Their benefits would not be im-
pacted by the benefit offsets proportional to personal account contributions. If an in-
dividual becomes disabled prior to retirement age, they would receive their current-
law benefit.
It is important to recognize that we do not face a choice between maintaining So-
cial Security as a "social insurance" system and as an "earned benefit." It has al-
ways served both functions, and it must continue to do so in order to sustain politi-
cal support. The system must retain some features of being an "earned benefit" so
as not be reduced to a welfare program only. This is why proposals to simply bail
out the system through general revenue transfusions alone — to turn it into, effec-
tively, another welfare program in which contributions and benefits are not relat-
ed— are misguided and undermine the system's ethic.
Again, I would repeat that our proposal contains important benefits for all indi-
viduals. Guaranteed benefits on the low-income end would be increased. High in-
come earners would be spared the large current-law tax increases that would other-
wise be necessary. If we act responsibly and soon, we can accomplish a reform that
serves the interests of all Americans.
299
Our Proposal Would Reduce Unfunded Liabilities
By putting aside some funding today, and reducing the proportion of benefits that
are financed solely by taxing future workers, our proposal would vastly reduce the
system's unfunded liabilities.
Consider such a year as 2034. Under current law, the government would have a
liability from general revenues to the Trust Fund equal to an approximately 5 point
payroll tax increase. By advance funding benefits, our plan would reduce the cost
of OASDI outlays in that year from more than 18 percent to less than 14 percent.
The pressure on general revenue outlays would be reduced by more than half.
The Social Security system would be left on a sustainable course. The share of
benefits each year that are unfunded liabilities would begin to go down partway
through the retirement of the baby boom generation. By the end of the valuation
period, the actuaries tell us, the system would have a rising amoimt of assets in
the Trust Fund.
Our Plan Combines the Best Features of Many Reform Plans
We believe that our plan is indicative of the product that would result from a
larger bipartisan negotiation in the Congress. Accordingly, we believe that it pro-
vides the best available vehicle for negotiations with the President if he chooses to
become substantively involved. It was our hope to put forth a proposal on a biparti-
san basis, so that the President would not have to choose between negotiating with
a "Republican plan" or a "Democratic plan." Stalemate will not save our Social Secu-
rity system.
Other Aspects of the Bipartisan Plan
The changes effected in our bipartisan bill do not, all of them, relate solely to fix-
ing system solvency.
One area of reforms includes improved work incentives. Our proposal would elimi-
nate the earnings limit for retirees. It would also correct the actuarial adjustments
for early and late retirement so that beneficiaries who continue to work would re-
ceive back in benefits the value of the extra payroll taxes they contributed. The pro-
posal would also change the AIME formula so that the number of earnings years
in the numerator would no longer be tied to the number of years in the denomina-
tor. In other words, every year of earnings, no matter how small, would have the
effect of increasing overall benefits (Under current law, only the earnings in the top
earnings years are counted toward benefits, and the more earnings years that are
counted, the lower are is the resulting benefit formula. )
We also included several provisions designed to address the needs of specific sec-
tors of the population who are threatened under current law. For example, we
gradually would increase the benefits provided to widows, so that they would ulti-
mately be at least 75 percent of the combined value of the benefits that husband
and wife would have been entitled to on their own.
We also recognized the poor treatment of two-earner couples relative to one-earn-
er couples under the current system. Our proposal includes five "dropout years" in
the benefit formula pertaining to two earner couples, in recognition of the time that
a spouse may have had to take out of the work force.
Our proposal uses the best information available to us about how to administer
personal accounts. We have been carefol not to place new administrative burdens
upon employers. They would continue to forward payroll taxes to the Social Security
system just as they do now, with the same fi*equency. Their relationship to the proc-
ess would not change. The Social Security system would administer the new system
along lines similar to the Thrift Savings Plan that is enjoyed by so many of the peo-
ple in this room.
Our proposal also provides true ownership and control over the proceeds fi"om the
personal accounts. Beneficiaries are required to annuitize a portion of their personal
accounts, enough so that their traditional Social Security benefit and the personal
account benefit together provide a monthly stream of income that is at least at the
poverty level. But we provide flexibility regarding the use of remaining personal ac-
count balances. They can be passed on to heirs, they can be withdrawn in periodic
cash payments, and through any of a number of other options, once the individual
reaches retirement age. These are assets that would be owned and controlled by in-
dividual beneficiaries in a very real sense.
300
What Our Proposal Does Not Do
Unveiling a proposal as comprehensive as ours invariably creates misvinderstand-
ing as to the effect of its various provisions.
First, let me address the impact of our reforms on the Consumer Price Index.
Most economists agree that further reforms are necessary to correct measures of the
Consumer Price Index, and our proposal would instruct BLS to make them. Correct-
ing the CPI would have an effect on government outlays as well as revenues. This
is not a "benefit cut" or a "tax increase," it is a correction. We would take what was
incorrectly computed before and compute it correctly from now on. No one whose
income stays steady in real terms would see a tax increase. No one's benefits would
grow more slowly than the best available measure of inflation.
The proposal would instruct the BLS to make methodological reforms identified
by the Boskin Commission, in the areas of "upper substitution bias" and "product
quality improvement" that were identified and quantified in the Boskin Commission
report. The estimate that we have put in our legislation, of a 0.5 percent change
in CPI resulting from these reforms, is less than the estimate made by the Boskin
Commission. Thus, we believe it is very unlikely that any "legislated" change in CPI
would ultimately result from our legislation.
We wanted to be doubly certain that any effects of the CPI change upon Federal
revenues not become a license for the government to spend these revenues on new
ventures. Accordingly, we included a "CPI recapture" provision to ensure that any
revenues generated by this reform be returned to taxpayers as Social Security bene-
fits, rather than being used to finance new government spending. This is the reason
for the "CPI recapture" provision in the legislation.
Our proposal would not increase taxes in any form. The sum total of the effects
of all provisions in the legislation that might increase revenues are greatly exceeded
by the effects of the legislation that would cut tax levels. The chart showing total
cost rates makes this clear.
Our provision to re-index the wage cap is an important compromise between com-
peting concerns. Fiscal conservatives are opposed to arbitrarily raising the cap on
taxable wages. The case made from the left is that, left unchanged, the proportion
of national wages subject to Social Security taxation would actually drop.
Our proposal found a neat bipartisan compromise between these competing con-
cerns. It would maintain the current level of benefit taxation of 86 percent of total
national wages. This would only have an effect on total revenues if the current-law
formulation would have actually caused a decrease in tax levels. If total wages out-
side the wage cap grow in proportion to national wages currently subject to tax-
ation, there would be no substantive effect. This proposal basically asks competing
concerns in this debate to "put their money where their mouth is." If the concern
is that we would otherwise have an indexing problem, this proposal would resolve
it. If the concern is that we should not increase the proportion of total wages subject
to taxation, this proposal meets that, too. I would further add that the figure we
choose — 86 percent — is the current-law level. Some proposals would raise this to 90
percent, citing the fact that at one point in history it did rise to 90 percent. The
historical average has actually been closer to 84 percent, and we did not find the
case for raising it to 90 percent to be persuasive. Keeping it at its current level of
86 percent is a reasonable bipartisan resolution of this issue.
Conclusion
Mr. Chairman, I thank you once again for using your position of leadership to ad-
vance debate on this important issue. I am appreciative that you were one of the
first to come forward with a proposal that met the important standard of long-range
actuarial solvency, and I appreciate your courtesies in inviting us to testify. I trust
that you and the rest of this committee will look closely at the total effects of our
plan in evaluating what it would achieve. I am confident that in doing so, you will
find that it is a reasonable basis for hope that we can achieve a bipartisan agree-
ment. I thank you again and would be pleased to answer any questions that you
may have.
STATEMENT OF HON. JOHN B. BREAUX, A UNITED STATES
SENATOR FROM THE STATE OF LOUISIANA
Senator Breaux. Thank you, Mr. Chairman and members of the
committee. You all are far away in distance, but I don't think we
are that far away in ideas about how to solve this problem.
301
I think that my colleague Judd Gregg has accurately described
the overall thrust of what is now known as the Gregg, Breaux,
Grassley and Kerrey proposal. It is bipartisan. There are 15 other
Senators that have joined together in a bipartisan fashion to
present this to the Congress on our side over on the Senate side.
I think what you have done in this committee cannot be over-
stated in the sense that it is a major contribution. Just having
Democrats working with Republicans on something as sensitive as
Social Security is a major accomplishment in itself. We absolutely
have to get away from looking at Social Security as a poHtical foot-
ball whereby one election Democrats blame Republicans for not fix-
ing it, and Republicans blame Democrats for not doing anything.
That type of rhetoric on both Medicare and Social Security has
brought us to the point where nothing gets done.
I think we have a very unique opportunity and a small window
of opportunity remaining of this year to actually come together
with the surplus and the good economic times we are enjoying and
doing some real structural reform to both Social Security and the
Medicare program, and your committee over here in a bipartisan
fashion is doing it. This is something Democrats can't do by our-
selves, and Republicans can't do it by yourself. The only way it is
going to get done is by working together. So enough said on the
politics.
What we have is essentially— and I will describe two features ot
our plan which I think are some of the key parts of what we have
recommended, and Judd has done an excellent job going through
it all. The first thing is we create a 2 percent individual investment
account. We require that everybody paying Social Security takes 2
percent of it and puts it into a private savings account, just like
you have and all the other colleagues and all the people sitting be-
hind you have the opportunity in the Federal Thrift Savings Plan
to do. ,.11
They can put up to 10 percent of their money into a high-risk ac-
count, which is basically the stock market; they can put it into a
moderate, medium type of risk, which is a combination of govern-
ment bonds and the stock market; or they can choose the most safe
investment of all is just put it in bonds. That is how this has
worked for Federal retirees. It has worked very well, and what we
have suggested is that Social Security beneficiaries and people pay-
ing the payroll tax ought to have the same opportunity to create
wealth through an individual retirement account.
We don't put it all in there. We picked a number of 2 percent.
Some say, why 2 percent? Well, why not? We didn't want to do it
all and put it all into private accounts because that would have
been too risky and totally privatize the program, which I would not
support, and I think most Members would not. But we do say that
2 percent of your payroll tax would go into one of these three ac-
counts. You pick. You decide. It would be managed by a group of
professional managers much like we have for the Federal retire-
ment plan that we are all underwrite now, and they do a good job.
And we have taken your idea. Congressman, Nick, as far as how
do you account for this.
I think in the Archer-Shaw plan, what they have done through
the use of a claw-back, basically saying they create private ac-
302
counts, but whatever you make in your private account is going to
be deducted from what you would get under normal Social Secu-
rity, so there is no real incentive, I would argue, to do this if you
are going to lose it when you get your Social Security.
The way we pay for it is your idea, which you have introduced
in legislation previously, to basically say that at the end of^a per-
son's ready to be retired, you look at what they have made in the
individual retirement account, and you look at what they would
have made had they kept the money in Social Security, getting
about a 3 percent rate of return, so if they put the money into this
private account and they make 15 percent, just as an example, they
wouldn't get the whole 15 percent, but they would get all of it
minus what they would have got had they left it in Social Security.
So had they left it in Social Security, maybe they would have made
3 percent. They put it into this private account, they got 15 per-
cent. So you subtract the 3 percent from the 15. They still get a
12 percent advantage, which is very, very significant.
And they own the account. They can inherent their account. It
connects people with the concept of investing for their own future.
It makes young people more in tune to what Social Security is try-
ing to do for them. It affects no one who is 62 years of age or older.
You can go to AARP and all the other groups and tell them we are
talking about baby boomers and those in my category, making
some changes for us that is going to give us a better opportunity
to retire successfully. That is the first part, the 2 percent.
The second part is really aimed at doing more for lower-income
people, and you have — I think my staff put out a little chart about
the voluntary contributions. It is this chart right here. And this is
in addition to the 2 percent investment account. This says that we
are going to help low-income people do a little bit more than other
than their 2 percent. So an example, a person with a 20,000 and
a $30,000 salary, if the person with the $20,000 salary takes the
2 percent and puts it — that is 2 percent of 20,000 is $400 a year
they would have in their individual retirement account. If they
want to do more and they put up another $1, the government
would match that with an extra $100, giving that person 400 plus
the $101, for a total of $501 that that person could put in their in-
dividual retirement account, and then the person could continue to
contribute up to 1 percent up to the amount that they would reach
as the taxable income base, which is about $72,000 today. That
person could contribute an additional 112, so he would have $725
additional in their account that they would be able to do.
The same pattern for the person making the 30,000. The only dif-
ference is that when they put 2 percent of their 30-, obviously it
is $600, if you put another $1, the government would match it with
100. That would give you 701. You only need 12 dollars more to
get up to the maximum amount. This is extra and voluntary, but
it strengthens the whole opportunity to increase wealth for the in-
dividuals.
And I would just say that — I mean, we ought to seize the oppor-
tunity to do something. They have got a lot of variations about all
of this, as many economists as you can think of that come up with
schemes and plans and recommendations that they think would
work. But we think the 2 percent account plus the voluntary con-
303
tributions with no tax increase and no age increase for seniors. Re-
tire at 62 years of age and gradually work up to 67. We do have
a CPI adjustment, which everybody has recommended that we do,
and that is our plan.
Thank you.
Chairman Smith. Senator Grassley, welcome. I said good things
about everybody that was brave enough to proceed, so congratula-
tions, and please go ahead.
STATEMENT OF HON. CHARLES E. GRASSLEY, A UNITED
STATES SENATOR FROM THE STATE OF IOWA
Senator Grassley. Well, I can listen a long time if you have
some more things you want to repeat.
Thank you very much for the opportunity to be here with you.
I am going to just focus my remarks on a very narrow area of our
whole program of what we do to improve the situation for workers
who are in and out of the work force. For the most part women,
it is who are in and out of the work force, and probably more apt
to be that because of family responsibilities that in our society tend
to rest more on women than on men, right or wrong.
But before I do that, if I could just comment on the statement
that Senator Breaux started out with on the bipartisanship. Let me
emphasize from a historical perspective backing up what he said.
I think Social Security, being the social contract that it has been
for 63 years, has never been dramatically changed without biparti-
san cooperation. And, I don't think it will be again this year, and
probably we can suggest the changes that change somewhat the
basic format, albeit it is still a social contract. That social contract
has changed to some extent, all the more reason to have bipartisan
support.
So my colleagues have thoroughly outlined our proposal. I would
like to highlight just a few aspects. In designing our plan, we as-
sessed how changes to Social Security would affect different seg-
ments of the American population. One of my top priorities in re-
forming Social Security is ensuring that the program addresses
needs of women. This is how our bipartisan program would do that:
Women are more likely to be in and out of the work force to care
for children and elderly parents. We believe that they should not
be punished for the time that they dedicate to dependents. There-
fore, for every two-earner couple our plan provides 5 dropout years
to the spouse with lower earnings. Our proposal provides all work-
ers with an opportunity to create wealth by contributing to their
individual account, an amount equal to 1 percent of the taxable
wage base. This year that figure would be $726. Workers whose
combined 2 percent contributions equal less than 1 percent of the
taxable wage base would receive $100 from the Federal Govern-
ment when they put in the first dollar of savings. They would then
receive a dollar-for-dollar match by the government for additional
contributions up to 1 percent of the wage base. This progressive
feature will boost the contributions for low-income individuals,
many of whom, happen to be women.
Also, our proposal creates an additional bend-point to benefit for-
mula to increase the replacement rate for low-income workers.
Women live longer than men. So at age 65 men are expected to live
304
15 more years, whereas women, the case happens to be 20 years.
Our proposal addresses that reaHty by allowing money accumu-
lated in individual accounts to be passed on to surviving spouses
and children.
Furthermore, our proposal would increase the widow's benefit to
75 percent of the combined benefit that a husband and wife would
be entitled to based on their own earnings.
As many older Americans live longer, healthier lives, they are
eager to remain in the work force in various capacities. Others re-
main in the work force out of necessity. We would eliminate the
earnings test for beneficiaries 62 and older so that retirees may
continue to contribute to the economy without being penalized.
Currently, benefits are reduced for over 1 million beneficiaries be-
cause their wages exceed the Social Security earnings limit.
Furthermore, our proposal would correct the actuarial adjust-
ment for early and late retirement. Currently, individuals do not
receive back the value of payroll taxes contributed if they delay re-
tirement. Our plan increases both the early and delayed retirement
adjustments to levels appropriate to recognize additional tax con-
tributions. Retirees who remain in the work force could also con-
tribute to their individual accounts.
The first step on the road to reforming Social Security is to en-
gage the American public in the policy debate. No action could take
place without Americans making informed decisions about how to
design Social Security for their needs of the 21st century. Now,
America, after doing that for a year, seems to me to be ready for
reform. According to a recent poll conducted by Americans Discuss
Social Security, and I had the pleasure of serving with Senator
Moynihan as cochair of that group, we have our survey showing 58
percent of those surveyed believe reform should take place before
the 2000 election.
The second step in saving Social Security was to address its long-
range funding difficulties. Several proposals have now been put for-
ward that would do this. Now, we must work together in the next
step, and that is enacting Social Security — or legislation to restore
the long-term solvency of Social Security.
I want to stress the importance of saving Social Security sooner
rather than later. Do we work now to prepare for the retirement
of the baby boom and subsequent generations, or do we sit back
and leave the legacy of higher taxes and unmet benefit obligations?
According to Social Security actuaries, in the year upon 2075, and
that is the last year of our 75-year valuation period, income to So-
cial Security program will be $14 trillion, but we will owe $21 tril-
lion in benefits. It is obvious you can't take more hay out of the
barn than you put in. So plain and simple, that translates into
more Draconian measures that we will be forced to take for each
year that we fail to enact legislation to protect the program that
most older Americans rely upon and almost every pension system
uses as a basis, as a foundation.
Thank you.
[The information referred to follows:!
305
Prepared Statement of Hon. Chuck Grassley, a United States Senator From
THE State of Iowa
Thank you, Chairman Smith. I am pleased to be here today with my colleagues
to discuss our proposal to save Social Security. I want to commend you for holding
this hearing. It is an important step in reforming Social Security.
My colleagues have thoroughly outlined our proposal. I would like to highlight a
few aspects. In designing our plan, we assessed how changes to Social Security
would affect different segments of the American population. One of my top priorities
in reforming Social Security is to ensure that the program addresses the needs of
women. Let me explain how the Bipartisan Reform plan accomplishes that goal:
Women are more likely to move in and out of the work force to care for children
or elderly parents. We believe they should not be punished for the time that they
dedicate to dependents. Therefore, for every two-earner couple, our plan provides
five "drop out" years to the spouse with lower earnings.
Women, on average, earn less than men. Our proposal provides all workers with
an opportunity to create wealth by contributing to their individual accounts an
amount equal to 1 percent of the taxable wage base. For this year, that would be
$726.
Workers whose combined 2 percent contributions equal less than 1 percent of the
taxable wage base would receive $100 from the Federal Government when they put
in the first dollar of savings. They would then receive a dollar-for-doUar match by
the government for additional contributions up to 1 percent of the wage base. This
progressive feature will boost the contributions for low-income individuals, many of
whom are women.
Also, our proposal creates an additional bend point to the benefit formula to boost
the replacement rate for low-income workers.
Women live longer than men. At age 65, men are expected to live 15 more years,
whereas women are expected to Uve almost 20 more. Our proposal addresses that
reality by allowing money accumulated in individual accounts to be passed on to
surviving spouses and children.
Furthermore, our proposal would increase the widow's benefit to 75 percent ot the
combined benefits that a husband and wife would be entitled to based on their own
earnings.
As many older Americans live longer, healthier lives, they are eager to remain
in the work force in various capacities. Others remain in the work force out of neces-
We would eliminate the earnings test for beneficiaries age 62 and older so that
retirees may continue to contribute to the economy without being penalized. Cur-
rently, benefits are reduced for over one million beneficiaries because their wages
exceed the Social Security earnings hmit.
Our proposal would also correct the actuarial adjustment for early and late retire-
ment. Currently, individuals do not receive back the value of payroll taxes contrib-
uted if they delay retirement.
Our plan increases both the early and delayed retirement adjustments to levels
appropriate to recognize additional tax contributions. Retirees who remain in the
work force could also contribute to their individual accounts.
The first step on the road to reforming Social Security was to engage the Amer-
ican public in the pohcy debate. No action could take place without Americans mak-
ing informed decisions about how to design a Social Security program which would
meet their needs in the 21st Century. , r » ■
Now, America is ready for reform. According to recent poll results fi"om Americans
Discuss Social Security, 58 percent of those surveyed feel that reform should take
place before the 2000 elections.
The second step in saving Social Security was to address its long-range funding
difficulties. Several proposals have been put forward to save Social Security. Now
we must work toward the next step: enacting legislation to restore the long-term
solvency of Social Security.
I must stress the importance of saving Social Security sooner rather than later.
Do we work now to prepare for the retirement of the baby boom and subsequent
generations, or do we sit back and leave a legacy of higher taxes and unmet benefit
obligations?
According to Social Security's actuaries, in 2075— the last year of the 75-year
valuation period— income to the Social Security program will be $14 trillion, but it
will owe $21 trillion in benefits. You can't take more hay out of the bam than you
put in. Plain and simple, that translates into more Draconian measures that we will
be forced to take for each year that we don't enact legislation to protect the program
on which so many older Americans rely.
306
Thank you for the opportunity to outUne our proposal. We would be happy to en-
tertain any questions you might have.
Chairman Smith. Gentlemen, again my compliments. So many
details in your proposal have been thought out and addressed. And
I want to say something really positive because I would like the op-
portunity to ask some tough questions. One is on the CPI adjust-
ment, because that also affects the ultimate increase in income
taxes because of bracket creep and because of lower deductibles.
Senator Gregg, so it is going to have the effect of increasing those
taxes? How are taxes ultimately going to be decreased? I don't un-
derstand that.
Senator Gregg. Well, because if you look at current law, the in-
crease in taxes that would be required to fund the benefit is dra-
matic. It is about 4 percent, 4.5 percent difference from where we
are today. If you look at the Archer plan in the year 2030, I believe
the difference between our plan and the Archer plan is about 2 per-
cent of general tax revenues.
So, the CPI increase is significantly less. It is 0.78 percent as
versus 2 percent or 4.7 percent on the present law as being the dif-
ference between the increased tax burden if you don't accomplish
our plan as versus if you do take our plan.
So I think you have to look at net taxes. You can't just look at
one tax and say that goes up a little, therefore there is a tax in-
crease. I think you have to look at the effect on the net tax burden.
Under the net tax burden, under our bill, taxes are significantly re-
duced over any other bill that is out there with the exception pos-
sibly of yours.
Furthermore, the extent that the CPI does generate new tax rev-
enues in our bill, we don't let that go into the general fund. We put
it into the benefit structure to assist in paying Social Security ben-
efits. So we don't allow it to be used; any bracket creep that may
occur as a result of indexing the tax tables to CPI, we don't allow
that to flow into the general revenues. We cause it to flow into So-
cial Security Trust Fund, and so it benefits the Social Security Sys-
tem and does not end up being spent on other activities.
Chairman Smith. Chairman Greenspan and Secretary Summers
in testifying before this Task Force suggested that whatever plan
is adopted, it needs to encourage additional savings, investment.
Senator Grassley, you sort of suggested that your plan allows a 1-
percent add on. How else do you encourage savings investment?
How does that work?
Senator Grassley. Well, don't forget, if people have been in the
work force and have an individual account, that is earning growth
while they are outside the work force. So that is one way that we
enhance that opportunity. It seems to me another very fair way is
that the opportunity to pass that on as part of your estate as well
as being quite an incentive to do this, equalizing of benefits for low-
income families. Spouses who are in and out of the work force, may
be dying early, the family is losing benefit of that. There is some
of that growth that comes to the benefit of the family that way.
So the most important point is that it has growth when people
are not in the work force.
Chairman Smith. A couple of the economists suggested to the
Task Force that if you are going to replace the Social Security and
307
not touch the disabiUty portion, you need 5.4 percent of taxable
payroll as a separate investment, assuming a 7 percent real rate
of return. Did you consider, and if so, why you decided against in-
creasing it over 2 percent?
Senator Breaux. Really, what we have is a compromise between
those who would make it a lot larger. Ours in the Federal plan is
a 10 percent plan. I mean, that is more than I think is doable at
this stage in the political forum. I think 2 percent is a major step
in creating individual accounts, but it could be more. I mean, any-
thing less becomes almost insignificant in a sense of making a dif-
ference. We cited that 2 percent was about the right figure and
then added the voluntary contributions for the lower-income peo-
ple, which I think is significant. It is going to really get them down
the path of starting to save, knowing that the government is going
to match their first dollar with $100 and a 1-to-l match up to the
taxable base. You have help for lower income people and a real in-
centive for the regular people to put the 2 percent in there, but
that is a number that— any number you pick is going to be arbi-
trary to a certain extent.
Senator Gregg. That number is also controlled by actuarial sol-
vency.
Senator Breaux. That is what we needed.
Senator Gregg. If we could have afforded more, we would have
put more.
Chairman Smith. Thank you.
Congressman Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. And let me thank you
all for testifying today and also for putting together a fairly broad
and specific plan, which has not always been the case with some
who have testified before this panel.
First off, have you— has your plan been scored?
Senator Gregg. Yes, it has been scored by the actuarial trustees
of the Social Security Administration as creating solvency perpet-
ually, twice.
Mr. Bentsen. And has it been scored by — I mean, if I read the
summary correctly, there are a number of new tax provisions, some
savings enhancements beyond the 2 percent, which I assume are
pretax. I am not sure. Have those been scored by either Joint Tax
or CBO?
Senator GREGG. They are after tax, and they have not been
scored by Joint Tax or CBO.
Mr. Bentsen. Okay. And has any analysis been done that would
give you an idea of how various income groups would be affected
under this new formula going out over the next 75 years?
Senator Gregg. Yes. We have extensive analysis on that, and we
would be happy to get them to you. And I would just tell you that
what it is going to show, that low- and moderate-income groups do
extremely well as compared with present law or the President's
proposal.
Mr. Bentsen. I would be interested in seeing that. And again,
the investment requirement— or the investment requirement is
similar to the Federal Thrift Savings Plan. There is a Umitation on
what it can be invested in; is that correct?
Senator Gregg. That is correct. You get a choice.
308
Mr. Bentsen. Pooled funds or whatever.
Senator Gregg. It will probably be index funds initially.
Mr. Bentsen. A couple of specific questions. Initially you have
the claw-back provision, which, if I understand that correctly, you
take the spread between the T-bill — the annual T-bill rate and the
return on the private account and
Senator GREGG. There is no claw-back provision. Basically what
we do is reduce the benefit structure by what the T-bill rate would
be on the amount of the personal account. You own the personal
account. Whatever is in there, you get; it is yours, it is your asset.
But your benefit under Social Security would be reduced by — let's
say you put in 2 percent every year. It would be 2 percent plus the
rate of return of the T-bills, which would be about 3 percent, so
your benefit structure would be reduced by that amount, but you
actually own the asset. In addition, you don't have to credit back
to the Federal Government an amount of the money. You own the
physical asset, and to the extent you have exceeded that T-bill rate,
you have made money.
Senator Breaux. I want to make sure that we all understand. It
sounds complicated when we are talking about how do you pay for
the 2 percent, and it is not really that complicated. I mean, if you
have your private account, and say you average 15 percent return
investing it in the various private accounts, and you have got a 15
percent rate of return, what our plan suggests is that what you do
when you start collecting your Social Security is to reduce your So-
cial Security by what amount would have been credited to your So-
cial Security had you taken the 2 percent, and instead of putting
it in the private account, just kept it in Social Security, like Judd
said, that you would have gotten a 3 percent return, then you re-
duce it by 3 percent. So instead of getting 15 percent increase in
your retirement, you would have it reduced by about 3 percent.
Mr. Bentsen. But, Senator, the reduction applies to the defined
benefit portion, the remaining 10 percent or whatever at the
annualized T-bill rate, so your only risk there — I mean, generally
you should have a positive spread. Your only risk is if the market
underperforms.
Senator Gregg. Underperforms the T-bill rate.
Mr. Bentsen. Which in rare occasions happens.
Senator Breaux. Not over a 20-year period, it has never had a
negative return over the T-bill rate, which is the time which most
people would be paying into a retirement account.
Mr. Bentsen. The KidSave portion is outside of Social Security.
This is just a new program, although you could roll it into your pri-
vate account. How would that be funded, just through general reve-
nues?
Senator Breaux. That is correct.
Senator Gregg. That is correct.
Mr. Bentsen. So that would be scored.
I have two other quick questions. One is you recapture Social Se-
curity revenues currently diverted to the Hospital Trust Fund. I
understand that. What I am concerned about is do you make any
proposals for replacing the revenue taken out of the Hospital Trust
Fund in Medicare?
309
Senator Breaux. The President will announce that at 2:30 this
afternoon. No, I mean the basic premise is the fact that Social Se-
curity revenues ought to be for Social Security. And, you know, we
did it when Social Security was in good shape by kicking it into
Medicare to kind of help Medicare, but now Social Security needs
what Social Security is entitled to, and we put it back where it is,
recognizing that the Medicare problem is a legitimate problem and
has to be fixed. But this relatively small amount is not what is
needed to fix Medicare, so it should be kept for Social Security
beneficiaries.
Mr. Bentsen. Thank you, Mr. Chairman.
Chairman Smith. Congressman Collins.
Mr. Collins. Thank you, Mr. Chairman.
Gentlemen, if I believe I understand that, you are doing a 2 per-
cent carve-out rather than 2 percent additional; is that true?
Senator Breaux. Yes.
Mr. Collins. Two percent required.
Senator Gregg. It is required.
Mr. Collins. On the voluntary contribution portion of it, what
is the top annual salary that a person qualifies or is disqualified
beyond to participate in the voluntary provision?
Senator Breaux. It is approximately 35,000 is what the staff is
telling us. You can raise it or lower it, obviously, but we thought
35,000 was about the maximum that we would be able to do it.
Mr. Collins. What would be the maximum benefit of a $35,000
wage-earner contributing voluntarily?
Senator Breaux. Seven hundred twenty-five, I think. Mac, you
have that Httle chart right here. I mean, the voluntary contribution
allows you to get up to 1 percent of the taxable wage rate, which
ends up at about $707 each year, so the amount that the contribu-
tion is made available is reduced each year until you get to the
total of 725.
Mr. Collins. And the maximum general funds that would be
used to match, 725 also?
Senator Breaux. That is correct.
Senator Gregg. Wouldn't match 725. Maximum amount of the
match would be 112.
Mr. Collins. The individual is less than the general fund match
by $99; is that true? Let me ask you.
Senator Gregg. Reduce the 725 by the mandatory contribution
to get to the number that you would then be able to put a dollar
in, the Federal match would be $100 that would come out of the
general fund.
Senator Breaux. I don't know if you have that little chart that
we gave with the 20,000 and the 30,000. You see what the private
consideration would be under 20,000 and then under the 30,000.
The max goes to $725, regardless of income. You couldn't go more
than that.
Mr. Collins. Is there any provision that allows a wage-earner
above 35,000 to opt not to have their tax dollars used for this pur-
pose?
Senator Gregg. No.
Senator Breaux. Obviously the 2 percent contribution, obviously
that portion of that is 2 percent, not a significant amount.
310
Mr. Collins. You are setting up a program where you are going
to take funds from another taxpayer and deposit them into an ac-
count for another taxpayer, up to 35,000. And above that is where
you are actually taking your funds from; is that the way I read
this? That would be the entitlement to the ones that would owe
35,000. It is voluntary, but you are taking money from above 35-
to contribute to their account? But there is no volunteer opt-out for
someone from 35,001 to 75,000 or 80,000 to not participate in that
program? They just have to ante up?
Senator Gregg. Their 2 percent would get them to that 725.
Mr. Collins. We are above that. We are talking about the vol-
untary portion.
Senator Gregg. That would be funded from the general fund.
Mr. Collins. You put money in, but you also have another tax-
payer putting it in for you.
Senator Gregg. It would come out of the general fund.
Mr. Collins. There is no voluntary provision for the other tax-
payer, just the one that wants to contribute?
Senator Gregg. Right. This is the progressive part of this plan.
That is correct.
Mr. Collins. That is all I have. Thank you.
Chairman Smith. Mr. Toomey.
Mr. Toomey. I would just like to — two quick questions. One is to
understand the nature of the taxable wage base. I am a little bit
confused. There is a reference to the CPI that adjusts the tax reve-
nue side. And elsewhere in the little summary I have here it says
that the taxable wage base is maintained at 86 percent of total
wages, as we all know; currently the taxable wage base is a fixed
number. Is it your intention that this grows? And if so, how does
that work?
Senator Breaux. Well, right now it is about 86 percent. Under
current law taxes only go up to 72,600. That level is about 86 per-
cent of all wages in the country are taxed. Because wages are going
up, that amount is being reduced, obviously. And what we are sug-
gesting is that you maintained the 86 percent of the wages being
subject to Social Security taxes, therefore you would have wages
continue to go up. You would have an increase in account.
Mr. Toomey. So that would be a significant tax increase for
many earners, certainly for people who are above that cap.
Senator Grassley. Same as it is now.
Senator Breaux. It is 86 percent today, and it would be 86 per-
cent next year if wages go up. The number goes up.
Senator Grassley. It is a significant increase in taxes, but not
any more than you have under present law. It would be fair to say
it is present law.
Senator Breaux. Yes, it is 86 percent.
Mr. Toomey. The other question that I have, point number 4 of
the summary that you sent around refers to giving every child a
retirement savings account. This is funded by the government put-
ting in $1,000 into this account at birth, and then the government
puts in another $500 every year for the next several years. Is that
the way that would be funded?
311
Senator Breaux. That is the KidSave account, and that is an
idea that was crafted by Senator Bob Kerrey, and that is the way
it would work.
Senator Gregg. We wish he were here to explain it. It is a good
idea. The basic concept is to create a huge savings pool which peo-
ple would then have available to them.
Mr. TOOMEY. How do you respond to the idea that this is a whole
new entitlement and we are sending a message that everybody has
a birthright to getting a large check without having done anything
at all to earn it?
Senator Gregg. Of course Social Security could be viewed m that
way, too, to some degree. The fact is that we are basically saying
that the society should address the Social Security insolvency issue
in the later years of the next century by prefunding the hability as
versus having it be a contingent liability. That is what this all
comes down to. The whole debate over Social Security is a debate
over whether you are going to create a huge tax burden for the
next generation by running up an obligation which the next gen-
eration has to bear in order to support the retired generation be-
fore it, or whether the generation that is going to retire creates an
asset which can be used to reduce their retirement benefit needs.
And so what this is is basically carrying that concept one step fur-
ther, which is initiating the prefunding of the next generation of
liabilities.
Senator Grassley. And it seems to me if you want to deempha-
size the plague that you might call the entitlement mentahty that
we have in our economy and society today, one of the ways that
you do that is to create ownership and have people have a stake
early on in their retirement and feel a part of the system. And you
might say, well, the $1,000 is given, that is not part of the system,
but the ownership that comes with it, more importantly the eco-
nomic growth that comes from it, is something that is theirs. And
that is very important if you want to have reduced generational
gaps that we have in our system or conflict as well as promote a
concept of people having growth so that they feel a part of the econ-
omy, particularly lower-income people that feel left out today.
Senator Gregg. It makes everybody a capitalist at birth.
Mr. ToOMEY. Thank you.
Mr. Ryan. I was going to go on another line of questioning, but
I would like to expand on the KidSave accounts. Thank you for
coming, by the way. It is good to have you here.
The KidSave account, what is the score on the KidSave account?
This is a government contribution of $1,000 and then a government
contribution of $500 for 5 years after that for a total of $3,500.
What is the score of that, and is that an indexed amount?
Senator Breaux. Staff tells us that it is $14 billion a year.
Mr. Ryan. Is that indexed?
Senator Breaux. It is indexed.
Senator Grassley. Remember that is paid for in the projection
of our system.
Mr. Ryan. And the cost savings primarily from your system come
from the CPI change and the fact that you reduce the defined bene-
fit base by the bond indexed amount taken off outside of your 2
percent individual account?
312
Senator Breaux. That is how you pay for the 2 percent.
Mr. Ryan. That is basically the funding mechanism.
Senator Breaux. That is right.
Mr. Ryan. And the actuaries have scored the long-term solvency
of this account with the KidSave taken into account?
Senator Grassley. For 75 years.
Mr. Ryan. And it is 14 billion a year, and that obviously goes up
with the indexation; correct? Now every single child born gets the
KidSave account? There are no other strings? You get a Social Se-
curity number, and $1,000 and $2,500 after that, and then you can
roll your KidSave account into your Social Security account after
that period?
Senator Gregg. When you turn 18.
Mr. Ryan. When you turn 18, you roll it in.
Can you make contributions into this KidSave account other
than the money that you received from the government?
Senator Breaux. You cannot add to it, but when you roll it over
into your Social Security account, you can add to the account at
that time.
Mr. Ryan. As you could with the other Social Security rollover
provisions.
That is all for me. Thank you.
Mr. Bentsen. Will the gentleman yield?
The KidSave account, though, that is not coming from proceeds
from Social Security, the payroll tax. That is general revenues
monies that are appropriated. Okay.
Chairman Smith. Gentlemen, I am going to take the liberty of
asking you one last question. If you were betting, what do you con-
sider the odds of something coming out of the Senate?
Senator Gregg. I will defer that to my finance fellows.
Senator Breaux. The Finance Committee — Senator Grassley and
I both serve on it — I think the odds of doing something on this and
Medicare, I think, are better than 50-50 in the sense that you have
a bipartisan t3rpe of arrangement going where you have Members
on both sides that have joined together in a common proposal. And
I think that is very significant. It is not just your plan or your plan,
it is one Republican-Democratic plan together. And I think that has
greatly increased the odds of having something come out of the Fi-
nance Committee and go to the floor of the Senate which I think
would pass.
Chairman Smith. Congressman Herger.
Mr. Herger. Thank you, Mr. Chairman.
I want to thank each of you for the monumental work that you
are doing in the Senate on coming up with a bipartisan plan. I find
it sad and disheartening that the President could not have given
more support, at least a little bit of support, so that we could have
moved this process forward a little more than what it has. But that
is not to say that we are not going to be successful. We have to
be successful. I am convinced the only way we are going to solve
this monumental problem is that we work together, the Senate, the
House, the President, Republicans, Democrats, quote, liberals, con-
servatives, everyone working together. This is a challenge that
faces each and every American, certainly not one class or another.
So I want to thank you for this work that each of you has done.
313
I really don't have any more questions. I would like to urge you,
though, as we have what I feel was the first step, and that was the
lockbox proposal, which did pass out of the House by an over-
whelming vote 412 to 16. I understand there will be another clo-
ture vote perhaps on Thursday. I think essential as the first step
that at least we lock up those dollars that have been paid to Social
Security and the interest on it not be used for anything else. And
I would certainly urge each of you that we move forward with that
as well as areas that you are working on.
Senator Gregg. You have 60 percent of this panel for it.
Chairman Smith. Gentlemen, thank you very much. Any final
closing statements? It is such a good opportunity for us to lecture
Senators, so thank you again.
Representative Clay Shaw on the Shaw-Archer proposal. And
Chairman Archer. Bill, I didn't see you. Chairman Archer, just give
us 1 second — that was 17 Senate staff that apparently just left.
Chairman Archer, Representative Shaw, welcome. Thank you for
being here. Please proceed.
STATEMENT OF HON. BILL ARCHER, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF TEXAS
Mr. Archer. Thank you, Mr. Chairman. I will attempt to shorten
my oral testimony, and without objection I hope my full statement
can be entered into the record.
Chairman Smith. Yes it will be. All full statements will be in the
record without objection.
Mr. Archer. Mr. Chairman, as you have said, we have an his-
toric opportunity this year to save Social Security. If we do not do
it, it becomes exceedingly more difficult in every new Congress.
We should act now, and our greatest opportunity to do it will be
on a bipartisan basis. And to that end, I have been working with
the White House and with the Democrat leadership in the House
to see if we can come to some resolution that both sides — or all
sides, I should say, can support. Without that, it becomes far more
difficult. It becomes simply a partisan activity.
For many months, Congressman Shaw and I have been develop-
ing a plan that we believe can be passed that will save Social Secu-
rity for all time. It has been certified by the actuaries at SSA that
it will save Social Security for 75 years and get even better in the
years beyond that.
We do not raise taxes. We do not cut benefits. We maintain the
safety net for workers, and we provide new options for younger
workers.
Let me say, Mr. Chairman, that as I have worked with Social Se-
curity over the many years that I have been in the Congress, I
have over and over again said that it must be intergenerationally
fair, and we have an opportunity to make it so. If we grant benefits
to today's seniors that are not available to the next generation or
the generation beyond that, it is not intergenerationally fair. And
that is one reason why I have a great deal of difficulty in justifying
cuts in benefits.
If we increase taxes on the next generation and the generation
beyond above what this generation is paying, it is not
intergenerationally fair. So that is why Congressman Shaw and I
314
came together with no cuts in benefits, don't touch the existing So-
cial Security System, and no increases in taxes. In fact, our plan,
when implemented over the long term, will generate a unified
budget surplus, which your committee is particularly interested in,
of $122 trillion. That is a great benefit to future generations.
Now, how does it work? Very simply, 2 percent of payroll is com-
puted at the end of each year on every worker that qualifies for So-
cial Security, and they receive a refundable tax credit equal to that
amount of money out of the general Treasury. It is a tax reduction
dollar for dollar which goes into personal savings. That money is
transferred into a personal savings account, what we call a Guar-
anteed Social Security Account, for each worker, directly from the
Treasury, and that worker thereafter determines where that money
is to be invested.
I think all of the plans that you look at have some degree of gov-
ernment standards as to what qualifies as a legitimate investment,
and that is a part of our plan.
Should you die before reaching retirement, the money that is left
in your plan after providing for your widow and any survivors is
yours to will to any beneficiary that you see fit. You are not obli-
gated to retire at any particular time, but when you do retire, your
account is converted into an annuity, and that annuity guarantees
you a certain amount of money based on life expectancy for the rest
of your life. If that amount is not enough to equal the Social Secu-
rity benefit under the current system — and bear in mind we don't
change the benefits compared to what people are getting today, the
next generation and the generation following and the generation
after that gets the same benefit — if your personal account is not
enough to equal that benefit, then the Social Security Administra-
tion makes up the difference. So it keeps the safety net for work-
ers.
We, by the way, do not touch the disability program. That needs
looked at very carefully, but we see that as a separate action on
the part of the Congress.
So, Mr. Chairman, I appreciate the opportunity to come before
you. There is more that I am sure will be developed in the ques-
tion-and-answer period, and I have, I think, come close to comply-
ing with my 5-minute limitation.
Chairman Smith. I am not sure. Either I was very interested, or
that 5 minutes went very quickly.
[The prepared statement of Mr. Archer follows:]
Prepared Statement of Hon. Bill Archer, a Representative in Congress
From the State of Texas, and Hon. Clay Shaw, a Representative in Con-
gress From the State of Florida
Preserving Social Security for the future is one of the most challenging and most
important tasks we will undertake as Members of Congress. Fortunately, a strong
economy and a promising budget outlook give us an unprecedented opportunity to
address Social Security's long-term fiscal crisis.
We are seizing this opportunity by offering a proposal to save Social Security. Our
proposal, the Social Security Guarantee Plan, does not seek to radically alter the
Social Security program or change the nature of Social Security benefits. Instead,
the plan fully maintains the current program, but reforms the way benefits are fi-
nanced, making the program affordable and sustainable for future generations.
315
Guiding Principles
Five main principles guided the design of the Social Security Guarantee Plan.
1. Fully guarantee current Social Security benefits for life. According to data from
the Census Bureau, Social Security benefits alone reduce the elderly poverty rate
ft-om 48 percent to 12 percent. If Social Security benefits are cut, many elderly
Americans will be pushed into poverty, forcing them to rely on other government
programs. Consequently, our plan does not cut benefits for anyone, and it does not
change the defined benefit nature of the program.
2. Ensure fairness for all generations. Saving Social Security should not place an
unfair burden on young and future workers by forcing them to pay higher taxes or
settle for lower benefits. At the same time, imposing changes on current retirees
and those nearing retirement would be unfair because these beneficiaries and work-
ers will not have adequate time to prepare for the changes. Our plan guarantees
current law benefits without payroll tax hikes, eliminates the earnings limit that
penalizes many working seniors, and reduces the payroll tax in the long run.
3. Save Social Security forever. Any plan to save Social Security should save the
program for at least 75 years, the standard used by Social Security's actuaries be-
cause it includes the working and retirement Ufe spans of most workers. Moreover,
the plan should make the Social Security program sustainable so we are not faced
with a chff at the end of 75 years. In other words, at the end of 75 years. Trust
Fxind balances should not be dechning and the program's cash shortfalls should not
be increasing. Only by making Social Security stable in the future can we avoid the
need to constantly tinker with payroll taxes and benefits to keep the program sol-
vent.
4. Promote fiscal responsibiUty. Any plan to save Social Security must be fiscally
responsible. Our plan directly increases national savings, thus generating economic
growth, higher wages, and better living standards. Moreover, our plan pays for itself
in the long run and generates large surpluses in the unified budget. These savings
allow us to cut the payroll tax for the first time in the program's history. This is
true even under the most conservative budgetary assumptions.
5. Ensure political feasibiUty. Finally, our plan is designed to be politically fea-
sible. Realizing that Social Security reform cannot happen without bipartisan sup-
port, we are offering a plan that builds on areas of bipartisan consensus and bridges
the gaps between ideological differences. The plan fully maintains the current safety
net and ftilly shields individuals and their benefits from market risk. However, it
creates individual accounts so that benefits can be funded in advance with real sav-
ings.
How THE Guarantee Plan Works
Any plan to save Social Security shoxild be simple and transparent so that work-
ers can easily understand how the program is changing and how their retirement
income will be affected. The Social Security Guarantee Plan is simple, transparent,
and easily understandable. The plan can be described in four steps.
1. Annual Tax Credit. All workers would receive a refundable tax rebate equal
to 2 percent of their Social Security taxable wages earned in 1999 and thereafter.
(The maximum credit in 1999 woiUd be $1,452, increasing annually with average
wage growth.) The credit would be financed with general revenues so that no payroll
taxes are diverted from the current system. Proceeds from the tax rebate will be
automatically deposited into a Guarantee Account established in each worker's
name.
2. Designation of Savings Options. Workers would choose one of several pre-ap-
proved investment options that meet safety and soundness guidelines. The funds
would be required to invest their assets in a fixed mix of 60 percent equity index
funds and 40 percent fixed income funds. This portfolio provides a stable trade off
between risk and return and reduces the educational requirements of the program.
Workers who do not choose a savings option will be assigned to a comparable fund.
Earnings would accrue tax free, thus increasing the compounding power of the ac-
counts. Accounts could not be accessed or borrowed against for any reason prior to
benefit entitlement.
3. Annuity Calculation. Upon retirement, the Social Security Administration
would calculate a monthly pay out based on the account balances. This calculation
would be similar to an annuity calculation, accounting for life expectancy (based on
imisex mortality tables), expected inflation, expected returns on the account (which
would continue to be invested privately), and joint/survivor payments.
The worker's monthly benefit would equal the current law benefit or the cal-
culated monthly pay out, whichever is higher. Each month, the monthly pay out
would be transferred from the account to the Social Security Trust Funds to help
316
finance the worker's benefit, and the worker would receive a single check for their
entire benefit. Workers who outlive their account balances would continue receiving
fiill monthly benefits financed fi"om the Social Security Trust Funds. In essence,
workers accumulate savings during their careers to help finance their Social Secu-
rity benefits, which otherwise would not be payable under current law. This design
allows us to guarantee current law benefits and shield workers ft-om market risk.
4. Inheritamce. If workers die prior to collecting benefits, the account is main-
tained to support survivor benefits. If there are no aged survivors, remaining ac-
count balances can be bequeathed to heirs tax fi*ee. In contrast, if the worker dies
after collecting benefits, any remaining balances are transferred to the Trust Funds
to help pay benefits for those who outlive their account balances. This is the way
private annuities work.
The plan also creates some new benefits for both current and future retirees. The
plan would ehminate the earnings limit for all beneficiaries age 62 and over by the
year 2006. (Currently, the earnings limit reduces Social Security benefits for ap-
proximately 1.4 miUion retirees.) In addition, the plan would reduce the pa5Toll tax
rate from 12.4 percent to 9.9 in 2050. The tax rate would be further reduced to 8.9
percent by 2060.
How Does the Guarantee Plan Save Social Security?
Socied Security is facing a financing problem: the pay-as-you-go method of financ-
ing benefits is not sustainable because the population is aging. As the population
ages, there wUl be fewer workers to finance the benefits of each retiree, placing
more and more pressure on the future work force.
The Guarantee Plan alleviates this financing problem by updating the program's
Depression-era, pay-as-you-go financing mechanism. The plan uses general revenues
to finance individual accounts. The savings that accumulate in these accounts are
used to help finance future benefits. In other words, the plan creates a savings fea-
ture within Social Security so that worker's can save for their own retirements in-
stead of rel)rLng on future taxpayers. This pre-funding of benefits reduces Social Se-
curit/s unfunded habilities and reduces the program's annual costs. As a result. So-
cial Security surpluses reemerge. These surpluses allow us to reduce the payroll tax
rate from 12.4 percent to 8.9 percent by 2060. If thes- surpluses are not returned
to workers, they will accumvdate in government coffers where they will undoubtedly
be used to finance new spending initiatives.
According to Social Security's actuaries, our plan reduces Social Security's costs,
generates Social Security surpluses, allows future payroll tax reductions, and saves
the program beyond 75 years. Most importantly, the plan eliminates the cliff" effect.
In other words, the program's financing is sustainable in the long run with healthy
cash flows and growing Trust Fimd balances. Thus, the program does not fall off
a cUff in the 76th year (see graph).
317
1100
1000
BOO
800
700
600 ^
500
400
300
200
100
Trust Fund Balances under the
Social Security Guarantee Plan
[as a percent of annual costs]
payroll
desired minimum balance
o o o
cvcgtViCMCMCviWcx
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Budgetary Effects of the Guarantee Plan
Social Security has been running annual surpluses since the early 1980's. These
surpluses have been used to finance deficits in the rest of the government, thus im-
proving the unified budget. This situation will quickly reverse itself early in the
next century. According to Social Security's Trustees, program costs will exceed in-
come beginning in 2014, and the Treasury will have to come up with the cash need-
ed to draw down the Trust Funds. Between 2014 and 2034 (when the Trust Funds
are depleted), these cash shortfalls will total $7.5 trillion, placing a large strain on
the Federal budget. Unless the government defaults on future promised benefits,
the Treasury will have to come up with another $106 trillion to pay benefits for the
remainder of the 75-year period.
As explained earUer, the Social Security Guarantee Plan uses general revenues
to finance individual accounts. Account balances are used to pre-fund Social Secu-
rity benefits, thus reducing the program's future imfunded liabilities. In sum, the
plan increases General Fund costs, but reduces Social Security costs. Over time, the
savings to Social Security will outweigh the cost of financing the accounts, thus gen-
erating unified budget surpluses.
According to long-range estimates from Social Securit/s actuaries, the plan will
pay for itself on a cash flow basis by 2031. When financing costs are included, the
plan pays for itself by 2047 and generates $122 trillion of unified budget surpluses
over the entire 75-year period. These surpluses allow a 2.5 percentage point reduc-
tion in the payroll tax rate in 2050, and a further 1 percentage point reduction in
2060.
Over the first 15 years, the plan is fully financed with Social Security surpluses.
For the first time ever. Social Security surpluses will actually be set aside to pay
Socitd Security benefits. Beyond the first 15 years, the plan will be financed with
budget surpluses (if available) or with other financing mechanisms. Data from So-
cial Security's actuaries show that even if the program is financed with public debt
from day one (which won't happen because we have Social Security surpluses for
the first 15 years), the plan still saves Social Security, pays for itself in the long
run, generates $122 trillion of unified budget surpluses, and pays off any loans cre-
ated by the program. Thus, the plan works even if we never have budget surpluses
at any point in time over the next 75 years.
Moreover, the plan does not rely on historicEil rates of return to save Social Secu-
rity. A sensitivity analysis conducted by Social Security's actuaries shows that the
plan would practically eliminate Social Security's long-term deficit even if the rate
of retiim is as low as 4.35 percent. (A 4.35 percent return would reduce the long-
term deficit from 2.07 percent to 0.08 percent). Even if the rate of return is zero,
318
we woTild still be better off than under current law because cash balances would
be available to pay future benefits.
Economic Effects of the Guarantee Plan
The Guarantee Plan would primarily affect the economy by increasing national
savings. National savings is the sum of government savings and private savings.
Thus, national savings increases when the government pays down the public debt
and when businesses and households save more money.
Over the next 15 years, the Guarantee Plan uses Social Security surpluses to fi-
nance individual accounts, which are invested in private financial markets. This
money directly increases private savings and, therefore, increases national savings
as well. In essence, the Guarantee Plan has the same beneficial effects as pubUc
debt reduction: more money is channeled into the private financial markets where
it is invested in productive assets that generate economic growth. ^
However, using the surpluses to finance individufd accounts is a more effective
way of increasing national savings than public debt reduction. Surpluses can only
be used to reduce the public debt if they are not spent by politicians as they arise.
Allocating the surpluses to individual accounts ensures that the money will actually
be saved and not spent. In essence, the Guarantee Plan creates the strongest lock
box ever by taking the money out of Washington and putting it into individual ac-
counts where it can be invested productively.
Economic effects beyond the first 15 years depend on the budget outlook at that
time. To the extent that the Guarantee Plan increases national savings in the first
15 years, it is more hkely that future surpluses may materiaUze. If future surpluses
do not materialize, the government may have to borrow to finance the accounts.
However, this borrowing would not adversely affect the economy because the pro-
ceeds wiU go directly into the financial markets: government savings will fall by a
dollar, but private savings will increase by a dollar. Moreover, the return on the pri-
vate savings will outweigh the interest owed on the government debt.
Addressing Concerns
This section address two of the most common concerns about the Social Security
Guarantee Plan.
account balances are "confiscated" at retirement
Every individual account proposal has some mechanism by which Social Security's
costs are reduced. Some plans reduce Social Security's guaranteed benefit £md use
accotint balances to supplement the reduced benefit. Other plans offset Social Secu-
rity's guaranteed benefit by the amount contributed to the accounts grown at some
hjT)othetical rate of return. Still other plans use a combination. The Social Security
Guarantee Plan transfers account balances to the Social Security Trust Fvmds to
help finance workers' benefits. This method was chosen for three reasons.
First, it allows us to maintain the defined benefit nature of the program. Social
Security is a safety net — it is not, and was never intended to be, a primary source
of income during retirement. As a safety net. Social Security should provide a guar-
anteed benefit. In fact, a series of nationwide surveys found that a small majority
of Americans favor allowing workers to have personal retirement accovmts. How-
ever, when forced to choose between retirement accounts and a guaranteed, exact
benefit, 59 percent prefer the exact benefit and only 33 percent opt for individual
accoimts.2 Turning Social Security into a defined contribution plan reduces its role
as a safety net and creates direct competition with private savings and employer
pension plans.
Second, it enables us to shield individuals and their benefits from market risk.
Under the Guarantee Plan, all risk is bom by the government, not the individual.
Other mechanisms of reducing Social Security's costs place workers and their bene-
fits at risk — some people may do better than current law, but others will do worse.
Third, it allows workers to continue receiving one check from the Social Security
Administration for the fuU amount of their benefit. Providing workers with one
1 Individual accounts may cause some people to save less in other forms so that national sav-
ings does not increase doUar-for-dollar by the amount contributed to the accounts. However,
leakages occur with public debt reduction as well. For instance, some of the money that is no
longer tied up Ln Treasury securities may flow to overseas investments or be used to finance
consumption. Thus, it cannot be claimed that public debt reduction results in more national sav-
igs than financing individual accounts.
2 Americans Discuss Social Security, Report to Congress, Jime 1999
319
check for their full benefit emphasizes our commitment to maintain the program,
not dismantle it.
GENERAL REVENUES WILL BE USED TO SUPPORT THE PROGRAM FOR THE FIRST TIME
EVER
Every single individual account proposal that restores Social Security's solvency
for 75 years relies on general revenues to some extent. Some of the plans create a
permanent claim on the General Fund, and this claim increases in the future.
The important question is whether the use of general revenues increases or re-
duces the overall burden on taxpayers. As explained earher, the use of general reve-
nues in the Guarantee Plan is offset by savings to the Social Security program. Over
time, the savings to Social Security outweigh the use of general revenues, resulting
in a lower overall burden on taxpayers. The lower burden is clearly embodied in the
fact that the future payroll tax cut is larger than the cost of financing the accounts.
In the long run, the total cost of supporting the Social Security system is lower
under the Guarantee plan than it is under most of the individual account proposals
that restore 75-year solvency.
Thus, the Guarantee Plan does use general revenues, but it also reduces the tax-
payer burden significantly relative to current law. Moreover, every dollar of general
revenues goes directly to the private financial markets where it is available for busi-
ness investment. This is the most productive use of general revenues.
The plan simply pumps more money into the system without fixing the problem.
We believe that Social Security is facing a financing problem, and fixing that
problem should not equate to cutting benefits. We fix the financing problem by
using general revenues to pre-fund future benefits. This pre-funding substantially
reduces Social Security's annual costs so that the overall cost of nmning the pro-
gram (including the cost of financing the accounts) is lower than current law. For
example, under current law, the average 75-year cost of supporting Social Seciuity
is 16.64 percent of taxable payroll. Under the Guarantee Plan, the average 75-year
cost of supporting Social Security is only 14.57 percent. (The cost of paying benefits
is 12.57 percent auid the cost of financing the accounts is 2 percent.)
In fact, when all costs of supporting Social Security are taken into account (i.e.,
paying benefits, fimding individual accounts, general revenue transfers to the Trust
Fimds, etc.) the Guarantee Plan is less expensive than almost all of the individual
accoimt proposals that have been estimated as restoring 75-year solvency (see Fig-
ure 2 on the following page). Thus, the total taxpayer burden of supporting Social
Security is smaller under the Guarantee Plan than under most other proposals to
save Social Security. Figures showing otherwise exclude the general revenue trans-
fers to the Trust Fund.
320
Rgure 2. Average Cost^ of Supporting Social Security
[as a percent of taxable payroli]
20 ^...^»— ..«^_.-.,^..^..„..™ —
-fi „
r-
,
lO "
14
12
h
10
8
6
4
I m m
// / ..' / ^ ^
Source: Calcuialions based on data torn ihe Sodal Security Administration, Office of the Chief Actuary
' Includes the cost of pa>ing Social Security benefits, funding individual acocamts, and general revenue transfers t
tl»e Trust Funds.
♦Because data are not available, some ccsts associated with these plans are not included, sudi as government
iiubsidies to low-incoiTW workers md Ihe cost of fiuMJCing KidSave accounts.
Chairman Smith. Mr. Shaw.
STATEMENT OF HON. E. CLAY SHAW, JR., A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF FLORIDA
Mr. Shaw. Thank you, Mr. Chairman, members of the commit-
tee. I will be very, very brief. I think Chairman Archer adequately
described where we are. Our joint full statement is a part of the
record of this hearing.
There are many good plans out there. Mr. Chairman, you have
one. You will be hearing others coming in for the balance of the
day. All of these are improvements over existing law. We have got
to do something, and I think that has to be underscored.
Mr. Archer and I decided at the early moment that we were not
going to touch the existing Social Security System, and I think that
is very, very important. The law that eventually goes on the books,
if it is anywhere near the Archer-Shaw bill, will leave Social Secu-
rity totally alone. We do not touch it, and I think that is very im-
portant to remember. It sets up a refundable tax credit that will
be scored wonderfully in regards to all taxpayers. It will set this
fund up to rescue Social Security.
When you look at the funding over 75 years, you find only one
plan is less expensive than the Archer-Shaw bill, and that is the
Smith bill, and it is only by a very small amount. Politically, there
321
is no way that this Congress on either side of the aisle is going to
raise FICA taxes. So that is simply not going to happen.
I think also you will find a great reluctance by either political
party to step out in front on interfering with the benefits.
It is a must that we do something. What you have before you
right now with the Archer-Shaw plan is a centrist approach. It is
certainly not the most liberal, and it is not the most conservative.
We have been abused from both sides of the political spectrum, and
I think that once we have an opportunity to go over this with both
of our conferences on the Republican and the Democrat side, I
think our plan will provide the basic roots of the plan that the Con-
gress will eventually adopt.
I hope that this does happen. It is going to be more difficult to
do it in 2 years than it is in this Congress. It is going to be more
expensive the longer we wait. The prospect of doing nothing is ab-
solutely frightening, and it would be a disgraceful mark in history
if this Congress fails to take care of the next generation and allows
this thing to go the way it is going.
It is important to remember that when Social Security was first
put together, there were 42 workers for each retiree. Now there are
three. Soon there will be two. This is a huge burden that the next
generation cannot handle. It is important that we act, and act now.
We have lead time. And it is important that we enact this legisla-
tion, and I think that the bill that is before you is certainly the
most politically doable, and I would hope that we move ahead with
it.
Thank you, Mr. Chairman.
Chairman Smith. Gentlemen, thank you. And my compliments,
because I think the Chairman of the Ways and Means Committee
and the Chairman of the subcommittee overseeing Social Security
introducing a bill is part of the reason that we have generated
more interest in this problem, part of the reason that there are
more individuals offering their proposals. So you have moved the
debate much further ahead than it would otherwise have been.
Do I understand the proposal to just use surpluses coming into
the unified budget, or does it mandate that some of this money
come out of the general fund regardless of surpluses?
Mr. Archer. Depends what your projections are, Mr. Chairman.
We have not seen a run-out of the latest projections that 0MB has
made relative to the surplus, and we don't know and will not know
until the end of this week or at least Thursday what CBO will do
in that regard, and we will have to overlay that new projection on
the plan.
Chairman Smith. But would the legislation itself provide for this
kind of 2 percent of taxable payroll funded regardless of surpluses?
Mr. Archer. Well, Mr. Chairman and members of the committee,
because you deal with the very arcane aspects of how we budget,
I will take a moment to get into that, if I may. It is not understood
too much by the average citizen outside the Beltway.
The money that goes into Social Security is immediately invested
in Treasury bonds. It cannot be spent for anything else. Because
we have, I think inappropriately over the years, assumed that that
can be double-counted and create another surplus, we are dealing
today with those kind of semantics and that sort of an approach.
322
I think it is inappropriate, personally, but the entire budgeting con-
cept double-counts the Social Security surplus.
If you have already invested it in Treasury bonds, it cannot be
used for anything else. And you say, oh, but we still have it again,
and we can spend it. That is basically not true.
So all of the monies that become a part of any one of the Social
Security plans that you are holding your hearing on involve the use
of general Treasury money. They have to. And I just think that
needs to be made clear, and ours does, too.
Most all of the plans, and perhaps all of them, have some sort
of personal retirement accounts as a part of their proposal. Those
personal retirement accounts are funded out of general Treasury
money. If they are funded out of reduction in the payroll tax, and
more money has to be put out of the general Treasury into the So-
cial Security fund in order to make up that difference, you create
bankruptcy at an earlier date.
So I think we need to cut through an awful lot of this in a way
that members of this committee can do, and understand, yes, every
plan uses general Treasury money, and ours is no different.
Chairman Smith. I was just wondering, Mr. Chairman, if it is
mandated in the proposal or whether it is somewhat dependent on
whether or not there is a surplus. But you don't predicate it in your
legislation that you are working on the draft
Mr. Archer. No, and I assume that every one of the proposals
that has been put before you does not mandate a surplus because
we cannot predict in the future what our economic conditions are
going to be. And yet if every one of them is going to solve the Social
Security problem, which I think we must do, no one can predict for
sure whether there will be enough surplus to take care of it or not.
Chairman Smith. Have you calculated if there is any income
level or any age level where that 2 percent investment would ever
totally replace the fixed benefit portion of Social Security?
Mr. Archer. Mr. Chairman, based on the Social Security actuar-
ies' projections, and they picked the rate of return, we did not, they
said that under our plan the rate of return would be 5.3 percent
in real terms. If that were to go up in reality, then it is possible
some of the accounts could be in excess of the Social Security bene-
fit. But if it does not over the 75-year period exceed the 5.3 percent,
then none of the accounts would be in excess of the Social Security
benefit.
Chairman Smith. We had some medical futurists guess that
within 40 years, it is reasonable to expect life expectancy between
100 and 120. How would that affect your plan? A great deal, prob-
ably?
Mr. Archer. No, all — I think the only standard that we can use,
Mr. Chairman, is Social Security actuaries. And we can project or
have personal predictions as to what we think might happen. But
when you judge these plans, they have to all stand side by side
based on the evaluation of the Social Security actuaries.
Chairman Smith. Congressman Collins.
Mr. Archer. And you are young enough to both enjoy that life
expectancy.
323
Mr. Collins. Might live to be 100, but the question is will you
know that you are at 100? I think the mind is the first thing to
go.
I just want to say I commend the two gentlemen. This is the sec-
ond time I think in 3 weeks that Wally Herger and I have had the
opportunity to sit up here and look down at them. They both sit
above the dais from us on Ways and Means. It is a privilege to
work with both and serve with Chairman Shaw on the Social Secu-
rity subcommittee.
I have heard a great deal about this plan, so I have no more
questions. We have discussed it in detail personally. But I do want
to say that back in December when we were at the White House
for the White House Conference on Social Security, it was empha-
sized then by the Commissioner of Social Security that the admin-
istration needs to move forward not just with a plan of how to re-
form or save the retirement system or retirement security system,
but also to move forward with a plan that would establish trust be-
tween the administration and the Congress.
Because as Chairman Archer has stated, until we have trust,
until we have a situation where we know that we can talk about
the situation seriously and with an intent to move forward with re-
form, we will never get anywhere with this. And so therefore I ap-
preciate these two gentlemen, I appreciate the work that they have
done. They have put theirs on the table. They trust. They trust the
American people, and they trust the Members of Congress, and I
know they trust the administration or they would not reveal their
wares. I just wish the administration had the same initiative and
the same trust for us as we have for him. Thank you.
Chairman Smith. Congressman Toomey.
Mr. Toomey. Thank you, Mr. Chairman. I would just like to re-
flect for a moment on what I think you have accomplished with
this plan, which is a very interesting approach. It seems that this
is a strategy designed to save Social Security in essentially its cur-
rent form by eliminating the funding liability problem, but without
making profound changes in the nature of the program. And I say
that because it seems to me that there is really quite httle flexibil-
ity in investment options for these personal accounts. There is little
or no upside, as I can see it, in terms of the return on that invest-
ment for— certainly for most workers that are currently in the work
force. And you don't have a complete ownership in the accounts be-
cause you force an annuitization whereby the moment after retire-
ment, the value of one's entire savings is turned over to the govern-
ment.
Did you consider an alternative approach which would give
greater flexibility to workers, the freedom to make various invest-
ment decisions, and ask people to live with the consequences of
those decisions, either greater returns or lesser as the case may be?
Mr. Archer. Well, you have. Congressman Toomey, and you
have asked, I think, a very good question. You have to weigh risk
against gain. Clearly, if you happen to be lucky and you take a big-
ger risk, you are going to have a bigger gain, but you also have a
greater risk of loss, and that has always got to be considered. I
don't believe we can leave the workers with an account that is
funded by the taxpayers, which all of these programs provide in
324
one way or other, with the free opportunity to invest in Uncle Joe's
automobile repair shop or whatever else. And if you are referring
to that, no, I don't think we can ever reach that point in any one
of these plans.
Now, I don't know what the limitations are in the Chairman's
plan, and I will say this, the Chairman comes forward and says,
look, we are going to abolish Social Security ultimately, and we are
going to rely totally on personal retirement accounts, and his plan
stands apart from the rest of the plans in that regard. I personally
do not think that is politically doable.
As far as whether you have personal ownership, if you do not re-
quire conversion to an annuity at the time of retirement, you will
have those people who live beyond actual life expectancy having ex-
hausted their retirement account, and they will become a ward of
government potentially. So it seems to me that any plan is going
to have to have a requirement that there be an annuitization at the
time of retirement to eliminate the winners and the losers.
I don't know how else you can validly look at the future. Once
you annuitize, you have nothing left to leave to your heirs in any-
bodys plans. If you annuitize an IRA today, you have nothing left.
You have turned over your property ownership to a third party
that has agreed to pay you a certain amount of money for the rest
of your life per month, and that is all this we do in our plan.
Mr. TOOMEY. One of the alternatives, for instance, that is imple-
mented in Chile is that the amount that is required to be
annuitized is such that you provide a relatively minimal benefit
and give flexibility with any savings above and beyond that. That
would be an alternative.
Mr. Archer. But we are, number one, not Chile. And even Jose
Pinera, whom I have gotten to know very well, does not say that
what he has designed for Chile is appropriate for the United
States.
I think we have reached the area importantly that will accom-
plish the end result. Let workers, if they die prior to retirement,
leave that money to their heirs if they want to keep it through re-
tirement. They don't have to retire. They can then leave it to their
heirs at the time of their death if they do not elect to annuitize and
to retire and on to get the coverage of the safety net of the Social
Security System.
So I believe that we have given property rights to people. That
money continues to be theirs. It continues to stay in their account.
The title is theirs, not the Federal Government's. But they are re-
quired, if they are going to retire, to annuitize, and that is not very
different than many other systems.
Of course, I don't know what Chairman Smith does relative to
the long range once Social Security is no longer there, but, of
course, Chile guarantees a minimum benefit, which is the equiva-
lent of guaranteeing a Social Security benefit for all time to work-
ers so that if their account falls below an amount that is enough
to be able to pay that minimum benefit, the government still has
to reach in. It has that continuous obligation for all time. It is not
funded, but it is there. And there are variations to all of these sys-
tems.
325
Chairman Smith. The gentleman's time has expired. I would just
like to say
Mr. Shaw. Mr. Chairman, could I comment briefly on that an-
swer?
Chairman Smith. Yes. Let me just say very briefly that my pro-
posal never goes above 8.4 percent that would ever go into the pri-
vate savings accounts to make sure that there is adequate money
there for the disability, and we do have a safety net.
Mr. Shaw.
Mr. Shaw. With regard to the very nature of Social Security and
the very nature of it, it can be described as the greatest antipoverty
program ever put in place here in this country. Lower-wage people
may not have the sophistication to do investments, and those are
the ones we have to be most concerned about. We have to be sure
that the investments are made in a sensible way — that they are
widespread, and that they are done by capable people.
There are elements of ownership included in our plan. As the
Chairman said, you have property rights in your individual retire-
ment account. If you die before retirement, you can will it away if
it is not necessary to take care of survivor benefits. So there are
some very strong ownership rights. By case law right now, none of
us have a vested interest that we can enforce in Social Security if
Congress decides to change the system. This would be an absolute
property right, and we have drawn the bill up in such a way so
that future Congresses, although they can change the law, but they
cannot take away what is in your individual retirement account.
Also it is important to understand that you pick your time of re-
tirement. If you decide you do not want to retire, and you want to
leave the individual retirement account to your heirs, you can do
it, and it passes along estate-tax-free — no estate tax. Also we do
away with the earnings limit, which has not been mentioned here,
which is a position that is immensely popular among our seniors.
Right now it makes absolutely no sense for us to penalize the guy
who has to bag groceries down at the grocery store in order to sup-
plement his income and not penalize the guy who has $100,000 a
year coming in in interest and dividends.
Chairman Smith. Mr. Ryan.
Mr. Ryan. Thank you very much for coming. I wanted to ask you
a few budgetary questions fi'om the Budget Committee's perspec-
tive.
When you first gave us your original briefing 2 months ago, it
was my understanding that you were rel5ring mostly on the off-
budget surplus to fund the beginning part of the plan, then the on-
budget surplus in the outyears. Right now our projections show us
that we have an off-budget Social Security surplus of $1.8 trillion,
and on-budget is $778 billion. Those numbers are going to be
changed to our benefit in the next few days, and we eagerly await
those numbers.
But now looking at the summary, it looks like that you are rely-
ing solely on on-budget surpluses to fund the annual tax credit. Is
that correct? Is that a change in the plan from its inception?
Mr. Archer. The answer to that is no, Mr. Ryan. There is not
a change.
Mr. Ryan. So you are relying on
326
Mr. Archer. We are living within — when we budget, as you
know, we budget only out 10 years in the Congress.
Mr. Ryan. Right.
Mr. Archer. And in that 10-year period we are living totally
within the walled-off lockbox Social Security surpluses which are
put there for the purpose of saving Social Security.
Mr. Ryan. So you are relying exclusively on the $1.8 trillion off-
budget surplus; not going into the on-budget surpluses of $778 bil-
lion?
Mr. Archer. That is correct. And let me also add, one of the tre-
mendous advantages of our plan is that it establishes with certifi-
cation from SSA the ability to save Social Security for all time, im-
proving in the outyears rather than hitting a cliff, and that is
something that we should always be concerned about on the basis
of $1.3 trillion over the next 10 years. Now, that includes
Mr. Ryan. Freeing up 500?
Mr. Archer. That includes the interest. Actual outlays are $900
billion to save Social Security, but because you are no longer put-
ting all of that money to pay down the debt, you have to recapture
the interest charges, and that gets you up to $1.3 trillion, that is
included in that surplus of $1.8 trillion. So we have a half trillion
dollars available for other purposes after having saved Social Secu-
rity.
Now, with the new projections, and we don't know what CBO is
going to do, but under OMB's projections we will have roughly an
additional $150 billion over that 10-year period.
Mr. Ryan. Now, as you know, the mix of surpluses between on-
budget and off-budget surpluses, the proportions change fairly
drastically over the next 10 years. Right now it is entirely — before
we find out in the next few days we are going to have an on-budget
surplus, but right now the surplus is almost entirely off-budget. So-
cial Security. And that begins to go down very rapidly over the
next 10 years, and the on-budget surplus starts from basically
nothing now and then gets very large and basically is the entire
surplus at the end of our 10-year window.
Does your plan at any time on its year-to-year basis go into the
on-budget surplus for its $1.3 trillion calculation? The reason I am
asking this is because if we are reserving our on-budget surpluses,
income tax overpayments, for the t£ix bill that you will be marking
up in committee, will your plan dip into your ability to provide that
on-budget surplus tax cut? Are we running into each other on this
thing?
The tax bill that the Ways and Means Committee has to produce
will be solely from the on-budget surplus and hopefully all of the
on-budget surplus. But this plan relies on a $1.3 trillion stream
which is in the outyears of our 10-year window. I assume that the
annual revenue that you require for your plan is fairly substantial.
Does that begin to eat into the on-budget surplus?
Mr. Archer. Well, first — that is an excellent question. Under the
projections prior to the update which we expect this week, we do
go slightly for a few years into the on-budget surplus. But you have
got to also remember that we are not dealing in a vacuum. We are
not using all of what has been locked up in the off"-budget sur-
327
pluses, and that extra money is going to be available on an amor-
tized basis to go out into those years that begin 15 or 20 years out.
And the interest on that money is also available, coupled with
the fact that, as I mentioned over the 75-year basis, and I believe
that our program does a better job on this than anybody else's, we
generate a unified budget surplus of $122 triUion. And I know the
gentleman from Wisconsin looks at things long term, because I
have talked to you too many times. And there is no doubt that even
if we went into the on-budget surplus temporarily, in a relatively
small amount in a transition number of years, that even if we had
to borrow the monoamortizeable bonds, we would come out way
ahead by virtue of the $122 trillion unified budget surplus that
comes under our plan. And to me, that is what we have got to do
more of, is look at the long term and not simply the short term.
Mr. Ryan. So you don't see our goals as mutually exclusive of
fashioning a tax bill out of the Ways and Means Committee that
relies on the on-budget surplus and passing your plan?
Mr. Archer. I do not. But again I think we have to look at the
new projections and see what they show for those intervening years
at the same time. And then we have got to throw in the interest
that will be on the amount of the off-budget surplus that we have
not used that literally can be attributed to that period of time
which otherwise would not be there.
Mr. Ryan. I think Gene Sperling said today that it was going to
be $107 biUion over 10 years interest savings we will have accom-
plished.
Mr. Shaw. It is important to realize that we don't go into on-
budget financing until after 2015. Our plan is completely funded
from the Social Security surplus until that time. Chairman Archer
spoke about going into it for a relatively short time. This generates
$43 trillion of Social Security surpluses after 2044, which allow the
payroll taxes to actually be reduced from 12.4 percent to 8.9. That
is huge.
It is important to realize here that we are legislating for the next
generation. We are going to have a completely funded pension sys-
tem for American workers. But you have got to get over the transi-
tion.
Mr. Ryan. That is your chart on page 4, right?
Chairman Smith. The gentleman's time has expired.
Mr. Archer. Mr. Chairman, would you indulge me just to jump
in a little bit and tie together what Congressman Ryan and what
Congressman Toomey were saying. In Chile, there had to be added
debt. They had to take on added debt in order to make their pro-
gram work. And it was amortized over a period of years for them
to be able to come out with their final result.
I hope we will not have to do that, but if we did it in a program
that was the right kind of program where we are putting money
to work and creating wealth and more personal savings for a tem-
porary period of time in order to be able to get to the long-term tre-
mendous benefits, that is not bad fiscal policy.
Mr. Ryan. Thank you very much, gentlemen.
Chairman Smith. Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman. I want to thank both of
the gentlemen, our two Chairmen, Chairman Archer and Chairman
328
Shaw, for the courage you have taken. I was present in several of
our Ways and Means meetings when we were discussing whether
or not you would move forward, whether or not it was wise to move
forward or not, and I know at that time there was a lot of discus-
sion about the possible repercussions, that maybe this was not the
time to come out with a plan. And I want to thank you for having
the courage to move forward as you have with a plan that I think
is very beneficial, and so I thank the two Chairmen, and I know
we have Chairman Kasich coming up. I will end with that. But
thank you very much for what you have offered.
Chairman Smith. A final comment?
Mr. Archer. Yes, Mr. Chairman, very briefly, and we could prob-
ably go on for several hours with the comparison of plans. To legis-
late a CPI fix, which is part of many of these plans, shows a benefit
to the Social Security outflow, a reduction in the Social Security
benefit outflow, but it also is a hidden tax on middle-income Ameri-
cans when applied to the income tax. It is a sword that has two
edges. It helps on Social Security; it hurts middle-income people by
raising the amount of their income taxes which are now indexed for
inflation. And I don't think we can be oblivious to that.
Finally, I would say, Mr. Chairman, we have an analysis here of
the various plans that we know about today, of which there are
eight, as to their total cost in order to create a saving of the Social
Security system. And I would like to insert that in the record, if
I might.
And let me just refer to the year 2074, which is the end of the
75-year period, the total cost of the Archer-Shaw 12.11 percent of
pa5rroll. The total cost of the Sanford plan is 18.38 percent of pay-
roll. And the total cost of the Chairman's plan, which is one of the
least costly, is 13.23 percent of payroll.
So in that final year, and those projections will work out in the
following years, our plan costs 1 percent of payroll less than the
next least costly plan. And actually, that is John Kasich's plan,
which is 13.08 percent of payroll. So, if I may, I would like to insert
this data into the record.
Chairman Smith. Mr. Shaw.
Mr. Shaw. Mr. Ryan was making the comment regarding his
concern about whether the tax dollars or general revenue on-budg-
et comes in to have to pay these benefits. It is important that all
of us not lose sight of the fact that in the year 2014, tax dollars
are going to have to start cashing in these Treasury bills. That is
when the Social Security surplus dries up. We don't have until
2032 or 2055. Building up more Treasury bills within the Social Se-
curity Trust Fund is not going to in any way delay the Congress'
having to appropriate revenue in order to have to take care of the
benefits. 2014 is our drop-dead date. That is the date we have to
be very concerned about.
Chairman Smith. Absolutely. Gentlemen, thank you very much
again.
Mr. Kasich, who was written up today in the Wall Street Journal
as being a brave soul in coming ahead with legislation to save So-
cial Security.
[The information referred to follows:]
329
[From the Wall Street Journal, Jiine 28, 1999]
How TO Save Social Security
BY JOHN R. KASICH
Most Americans know that Social Security is headed toward bankruptcy. Nothing
makes the point better than the poll taken a couple of years ago in which young
people said they had a better chance of spotting a UFO than receiving Social Secu-
rity benefits. , x i j i i
But many may not know why the system is threatened. In order to develop a solu-
tion-one that meets my goal of saving Social Security for today's retirees and those
near retirement, the baby boomers and their children-we need to understand the se-
rious difficulties facing Social Security. . .
Beheve it or not, in 1945 there were about 42 workers for each person receiving
Social Security benefits. By 1960, that ratio had shrunk to about 5 to 1. Today, it's
3.4 to one and by 2030, there will be just 2.1 workers for each beneficiary.
At the same time, Americans are living longer. That's good news. But it means
retirees will receive benefits for a longer period. Americans are also having fewer
children, which means relatively fewer workers paying Social Security payroll taxes.
It is those taxes that finance current benefits.
Aside ft-om these demographic trends, first-time Social Security benefits are grow-
ing far faster than inflation. These benefits now rise with overall wage growth, and
wages are rising faster than prices. The result: over the next 75 years, benefits will
increase more than 20 times, while prices wiU go up at half that rate. A retiree m
2060, for example, has been promised annual benefits starting at over $140,000.
The result is a system that would require people in the future to work longer
hours and pay more in taxes to support retirees. By 2034, payroU taxes would need
to be increased by 50% to pay promised benefits or benefits would need to be
slashed. Between now and 2070, benefits will exceed payroll taxes by a cumulative
$120 trillion. o • , o • o
Is it any wonder young people don't expect to receive their Social Security.''
We must do better, and we can. Every generation of Americans has left a legacy
of prosperity for its children. We cannot let our legacy be a Social Security system
drowning in a sea of red ink.
My plan does not affect current retirees and those neanng retu-ement-benehts tor
those now 55 or older would be untouched. Neither would it increase the retirement
age above current law, increase payroU taxes or reduce annual cost-of-Uving adjust-
ments (COLAs), now or in the future.
We save Social Security by making two fundamental changes to the system for
those now under 55. First, this plan changes the way first-time benefits will be cal-
culated. These benefits now rise with overall wage growth. Under my plan, growth
in initial benefits would be linked to the consumer price index. Initial benefits would
still rise over time, only at a slower rate. Instead of rising 20 times over the next
75 years, they will increase by a factor of 10. ,. ■■ j ,• ui
Switching from wage indexing to price indexing will ehmmate the unfunded liabil-
ity of the Social Security system and allow us to avoid increasing the payroll tax
for young workers. At the same time, future workers could count on receiving then-
benefits. r. i o. • »*
Second, workers currently contribute 6.2% of their wages to Social Security. My
proposal allows workers under 55 the option of establishing their own personal sav-
ings accounts. Contributions into these accounts would range from 3.5% of wages
for low income workers to 1% for those at high income levels. Workers who choose
to contribute to these accounts would have a variety of investment options and could
withdraw proceeds upon retirement. But as they will be paying less into Soci^ Se-
curity, their Social Security benefit will be slightly reduced. The basic Social Secu-
rity benefit will be reduced by 25 cents on the dollar for each dollar they receive
from their personal savings account. . .
Nonetheless, the private investment account option should offer most recipients
the opportunity for greater returns than Social Security alone could generate.
Yes, we are asking some in the baby boom generation to insure the solvency of
Social Security by making a sacrifice in terms of accepting a slightly lower imtial
benefit. An average 45-year-old male, for example, would receive about 1.7% less
under my plan, but look what happens in return. First, he is assured of receiving
benefits because the solvency of Social Security is assured. More important, his chil-
dren will receive far more in benefits. Under my plan a 25-year-old male who takes
advantage of the personal savings account option should receive 19% more in bene-
fits than promised under the existing system, based on historical averages for con-
servative investments.
330
Toda/s retirees and those nearing retirement will receive their benefits just as
they expected. Younger workers can not only count on receiving benefits, they will
not have to worry about the prospect of working longer hours and pa5dng increased
payroll taxes that would otherwise be needed to keep the current system afloat. If
they take advantage of the personal savings account option, they'll have more con-
trol over their own retirement resources and the opportunity for greater overall ben-
efits than under our current Social Security system-even if it could pay all their
promised benefits.
Finally, and most important, my plan is honest and realistic. The problems facing
Social Security have built up for so long and become so mammoth that everyone
must realize they cannot just be wished away. This plan makes clear the costs and
benefits, and it avoids false promises.
If we are truly concerned about saving Social Security, there is no better plan
than this one and no better time to start than today. If we face the challenge now,
we can provide for our retirement security without sacrificing our children's and
grandchildren's standard of living.
STATEMENT OF THE HON. JOHN KASICH, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF OHIO
Mr. Kasich. I want to thank Mr. Stenholm for letting me slide
in here. I want to just basically lay out precisely what we are
doing. As I know you have had a number of hearings and the full
committee is going to start having hearings very soon, there are
really fundamentally, as you know, three things I hope you know,
three things that are driving Social Security to bankruptcy. One,
of course, is demographics which we all know about; the second
issue is that people obviously are living much longer, which is
great news, which also contributes to the fiscal situation with So-
cial Security; but the third reason is the way in which we create
initial benefits for Social Security, which is based on a wages and
prices program that was designed to replace wages of people when
most Americans were fundamentally below poverty. In fact, many
years ago, the Social Security program represented a percentage of
poverty and now we are providing money well above the poverty
rate.
That is all good. In fact, what has happened is senior citizens
have been able to systematically move out of poverty. But here is
what I get down to in this program:
First of all, this is not sustainable. And it is not sustainable be-
cause of this large factor of growth in these initial benefits, this ini-
tial starting point. If what we were to do was to — I don't finish, you
know, the complicated factor whereby benefits are initially estab-
lished, but in the year you turn 60, they take the average wage of
every American and they divide it by the average wage of your
other 34 years in the workplace, because they come up with this
initial benefit based on 35 years' worth of work.
They take the average wage when you are 60, divide it by the
average wage of your other 34 years, multiply times your income,
which gives you a yearly number. Then they break it down into 12
months and then they replace the first amount of income with 90
percent of your income at the low levels. It is a very complicated
formula. And it is a factor of wages and prices that establish your
initial benefit.
I think that first of all, it is essential that we make Social Secu-
rity balance, flat out; that we need to make sure that the program
is not just based on economic factors that are removed from Social
Security. I think we need to make Social Security balance in £ind
331
of itself and then create the individual retirement accounts that
allow us to have more growth than what the benefits provide.
Now, Mr. Herger, if we were to establish the initial benefit in
this complicated formula on the basis of prices, which is exactly
how our seniors today have their benefits determined, Eind we ex-
clude wages, what we will do is we will balance the Social Security
program. Period. Flat out. It will balance. In a number of years,
but it will balance.
And then what we do in this program is to then permit you to
have a part of your payroll tax for investing in the private econ-
omy. Now if you are a 45-year-old man under my program, over
your lifetime you will receive 1.7 percent less than what you were
promised by the government, but your 25-year-old son would be
able to earn 20 percent more than what the current system prom-
ises.
You would have an individual retirement account established
under your name. It would be an individual retirement account
that you could have as part of your estate. The government would
not recapture it. The government doesn't own it, you own it. And
it is amazing when you stop and think that for a 45-year-old man
to give up a total of 1.7 percent in benefits over a lifetime in ex-
change for having his son or his daughter in a position of where
they can earn at least 20 more than what Social Security promises,
and we know that Social Security promises are empty promises,
you will have balanced the system forever. It will not be based on
just the theory of how fast the economy grows; it will be based on
the fact that we brought Social Security into balance and add on
top of it an individual retirement account that we control.
It does nothing beyond that. It does not affect the cost of living
increases, it doesn't affect anymore the CPI. It essentially says we
balance Social Security by slowing that starting point and in ex-
change giving Americans the freedom and the security to be able
to have individual retirement accounts out of their current payroll
taxes that would provide for a very secure system.
I maintain that in this whole debate on Social Security, the issue
of wages and prices have never emerged before, I have never heard
it discussed before. The beauty of this is it doesn't mean we have
to go in and change anybody's COLAs. It doesn't mean we have to
monkey around with the CPI.
But I want to commend my friends, Mr. Kolbe and Mr. Stenholm,
because I think frankly they have been the leaders on this. No
question. And every time I look at how you can get there, you try
to build a better mousetrap. I believe that if we can slow the start-
ing point, politically it is the best way to go.
Secondly, economically, it is the best way to go, and thirdly, not
only will it balance the system, but it will guarantee retirement se-
curity for every American based on the notion that the long-term
rate of return is at 5.3 percent with 60/40 investment in stocks and
bonds. I mean, think about this.
The other thing I want to make is that nobody knows what their
starting point is with Social Security anyway. Nobody sits around
and calculates the 35 years and the replacement wage. Nobody
knows that. So if we just tell the baby boomers that you have got
to take a little bit less — and the other final point is, if you are
332
under the age of 45, you don't lose anything because the power of
compound interest makes up for those benefits that you have fore-
gone in terms of your starting point.
So virtually everybody in Ainerica wins and we have balanced
the system. Do you understand what I am suggesting? If we do not
slow the growth in the starting point of benefits, you cannot fix this
problem. You cannot guarantee a fix of this problem. That is why
it is necessary to do both things: To slow the growth and starting
point of the benefits while at the same time giving people the eco-
nomic freedom to invest in our economy.
Mr. Chairman, thank you for giving me the opportunity to be
here and I hope you will take a very good look at this approach to
this problem that needs to be resolved.
[The information referred to follows:]
Saving Social Security...
...for three
generations of Americans
"A law that will give some measure of
protection to the average citizen and to hts
family against the loss of job and against
poverty ridden old age. . ."
"President Frankiin D, Roosevelt
333
Why is Social Security
going bankrupt?
Americans are living longer and having
fewer children. Fewer workers support each
beneficiary.
1
1960 (5.1 to 1 ) Today (3.4 to 1) 2030 (2.1 to 1)
Initial benefits are growing faster than inflation.
2500
334
The Q and A's
Q: Are young people going to see a Social Security
check when they retire?
^ii:-.
A: fn a recent poll, more young people
believed in UFOs than fjelieve ^^
in the future of Soda I Security. ^-----'t^-
To save the system, we must restore the
freedom to secure one's own retirement.
V^
Q Won't strong economic growth save Social Security
from bankruptcy?
A: No. Under the current law, the fa&ter the economy
grows, the faster the benefits grow. The gap between
taxes and benefits is never closed.
In the new millennium, Social Security will face a tidal wave of red
ink! Benefits will exceed payroll taxes by $120 trillion!
$1,000
$0
-$1,000
-$2,000
-$3,000
-$4,000
-$5,000
2000 2010 2020 2030 I 2040 2050 2060 2070
$200 4666 -$1,116 -$1,732 -$3,002 -$4,993
335
The promise of Social
Security is about to be
broken.
X By 2014, promised benents
will outstrip taxes collected.
X By 2034, tlie Trust Fund will
be depleted, leaving only
etmugh revenue to pay 7(M
oftienefits.
X Unless payroll taxes are
inci^ased by 50%, the
promise of Social Security
will be broken.
336
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$150,000
$100,000
$50,000 -
Initial Annual Benefit for Average Wage Worker at Normal Retirenfient ^e
Under this combined approach...
Most people will do as well or better under the Kasich Plan
Combined Benefits of Social Security and Personal Accounts
Are we ready?
Under the Kasicti plan, a 45 year-old member at the baby boom generation mi^t
gve up 1 7 percent of t^rs retirement
But in exchange, he will allow his kids to earn almost 20 percent more for their
retirement
Chairman Smith. Chairman Kasich, I think this is our 12th Task
Force meeting and I would just hke to point out the bill that I
wrote in 1995 did exactly what your bill does, but we only changed
it from wage inflation to CPI inflation for the second and third
bend points. You also change it for the first bend point. Let me ask
you, why did you consider or rule out any change in the CPI in de-
veloping your solution to Social Security?
Mr. Kasich. Well, because the CPI has already been significantly
adjusted. And if you take a look at what the — I can't remember the
guy's name, who was the guy that did — the Boskin Report, we have
already made significant adjustments in the CPI. Now I am sure
338
you can make the argument that we can squeeze some more out
of it, but I just think it is unUkely we are going to pass that. I
think — and I don't even know if it is going to be accurate.
In terms of change in CPI, it is very, very difficult. And as you
know, Mr. Smith, this committee struggled mightily with the issue
of CPI with the Bureau of Labor Statistics, and we were able to
move them to a large degree to upgrade the CPI calculation. I just
am not convinced that there is a whole lot left to wring out. And
frankly, that starts affecting your benefits on almost a yearly basis.
I mean, if you can remove this significant cost driver from the
initial stages of the formula, you don't — ^you never have to go back
and look at CPIs or COLAs or anything else. The benefit flows
straight out.
Chairman Smith. Is your plan voluntary?
Mr. Kasich. Yes.
Chairman Smith. Does your plan have any special provisions for
women?
Mr. Kasich. No. But what we do is we maintain the progres-
sivity of the system so if you are at the top end you will get 1 per-
cent of payroll tax into an account, but if you are at the lowest end
you will get up to 3.5 percent. So we wanted to make sure that So-
cial Security replacement concept progressivity was maintained in
this plan. And the reason why, if you take a look at the benefit life
of women in some categories, it appears as though women don't
make out as well as men. It has to do with the total period in
which the loss of benefits are calculated because women live longer.
But we have no special provisions affecting anybody else other than
this progressivity factor retained.
Chairman Smith. Explain how the personal retirement savings
accounts are offset for any reduction in fixed benefits.
Mr. Kasich. You would lose 25 cents on every dollar that you
earned from your private account. So not only would you begin
your Social Security at a lower starting point, but for every dollar
you earn in your private account, you lose a quarter, you make out
75 cents. The amazing thing about this approach is that virtually
the entire public benefits.
Mr. Archer's plan, you don't get your private account. You don't
have the potential to earn more than what Social Security prom-
ised. Under my program, you can earn an immense amount more
than what Social Security promised at the same time that Social
Security comes into balance.
And remember, when you say that a 25-year-old son or daughter
can make 20 percent more, that is based on a 60/40 ratio. If you
were at 80/20 ratio, stocks to bonds, then your potential to earn far
more than even the 20 percent is there.
Chairman Smith. Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman. And thanks for joining
us today, Mr. Chairman. A couple of questions. Does your plan con-
template forced annuitization at the point of retirement? That the
savings be required to be converted into annuity?
Mr. Kasich. No, they do not.
Mr. Toomey. So the person continues to have true ownership?
Mr. Kasich. Absolutely. This actually becomes part of your es-
tate. This is your accoxuit.
339
Mr. TOOMEY. Before and after retirement?
Mr. Kasich. Absolutely.
Mr. ToOMEY. How about investment options? Do you contemplate
giving individuals a considerable degree of latitude, or would do
you as Archer does and say equity funds
Mr. Kasich. No, I would do it the same way we do our Federal
program. I mean, what we anticipate, that we would have compa-
nies that would seek contracts to be able to provide the menu list
of choice, because I know there would be a lot of people that would
want to do better than 60/40. So we want to give people a lot of
flexibility. Maximum flexibility.
Frankly, I would like to be able to give them their money, but
my concern is then that people would put all of their money in aii
IPO. And Social Security is a contract that we have made in this
country that is going to be a bedrock of the way our government
works. So I think that to give them the maximum flexibility, like
we have in thrift sa^/ings, is the way to go. And I imderstand thrift
savings will be offering us even more investment opportunities.
Mr. TooMEY. So there are certain restrictions. You presumably
cannot leverage the funds and get involved in very risky invest-
ments, but otherwise you would advocate a great deal of latitude.
Mr. Kasich. Without question; yes, absolutely.
Mr. ToOMEY. Did you consider a different approach in the consid-
erations of the personal accounts? It suggests that it ranges 1 per-
cent to 3.5 percent and that is a function of a person's income. De-
pending on the trade-off, the reduction in fixed benefits, could we
not accomplish as much, maybe even more, by allowing more peo-
ple to have a greater contribution to their personal account?
Mr. Kasich. Well, as you know, Mr. Toomey, this is a matter of
filling various holes. I mean, I would love to give 8 percent, but
how are you going to handle the transition period? How do you
handle the people who are retired today? But what I try under my
program is after — ^you see, what happens is you start running a
surplus in Social Security as a result of estabUshing initial benefits
based on prices, and not prices and wages. And you run a huge sur-
plus that can be used to do two things. One is to cut pajn-oll taxes
or, two, to allow larger private accounts that will be a decision for
our children to make, because I believe that Social Security for our
children is going to look dramatically different than it looks today,
but we have got to get started in this process, and those surpluses
would allow people to have more in a private account.
But you know, what I suspect is that our children would rather
have their payroll taxes cut and take their money and put it in
Ebay. That is what I suspect because I think the younger genera-
tion is distrustful of government and they have concluded that
there is not a wizard behind the curtain; there is just a tired old
man.
Mr. Toomey. And given the average return that the market has
consistently returned over the entire history of this Nation and
comparing that to that which Social Security promises and cannot
deliver, I think there is a lot of truth to that wisdom.
I will yield the balance of my time, but I would like to say that
I congratulate the Chairman. I think this is a tremendous contribu-
tion to this debate and a huge step forward in terms of freedom,
340
in terms of solving the fiscal problems and making Social Security
very different and better for the next generation.
Mr. Kasich. I think that it is the most reasonable approach,
would not force us to come to this floor and start adjusting COLAs
or whatever, which is what we always do around here. It gets it
solved. It balances the system. It creates private accounts that are
yours, that go to your estate, that give you the ability to earn far
more than the current system. To me, it is a lay-down, it is a
"gimme pot." The next President ought to put it in.
Chairman Smith. Mr. Collins.
Mr. Collins. Was that last statement a campaign statement?
Mr. Kasich. It wasn't, Mr. Collins.
Mr. Collins. And why not? Let me ask you this, Mr. Chairman;
3.5 percent is the opt-out figure for low-income wage earners;
right?
Mr. Kasich. That is the amoimt that you would be permitted to
put in your account; right. Everybody is going to want to be in this.
I can't imagine anybody not wanting to be in this.
Mr. Collins. What is the range of wages that apply to 3.5?
Mr. Kasich. I don't have those figures in front of me, but they
are obviously the lowest-income workers.
Mr. Collins. The highest would be 1 percent?
Mr. Kasich. One percent, correct.
Mr. Collins. Why is there a variation?
Mr. Kasich. Because the system was created to be progressive.
It was created to provide the greatest amount of replacement
wages for people at their first dollar of earnings because we wanted
to try to rescue people from poverty. And the people at the very
top, their 1 percent gives them more money and they also have a
lot of other investment opportunities. And the people at the very
bottom are putting just a little smaller amount into their fund.
So I think you could take issue with the progressive nature of it,
but I just think it is the fairest way to go on a program like Social
Security.
Mr. Collins. Is there a ceiling on the wages earned for the 1
percent?
Mr. Kasich. Well, it is that $72,000 or wherever those numbers
go to ultimately.
Mr. Collins. Would there not be a greater incentive to opt-out
for the higher income through $72,000 if the percentage was more?
Mr. Kasich. No. When you do the numbers you find out that
anybody under the age of 45 wins. You either — you do better than
what you would do under the promised program of Social Security
at all income levels. I think there are a couple — I think that is ac-
curate in and of itself. Yes, everybody would win, so everybody
would want to opt into this program.
What I worry about is that — you see, the surplus on Social Secu-
rity is so important because what it allows you to do is to start
these private retirement accounts, and what I get concerned about
is that we enact some kind of a program on Social Security that
really does not force Social Security to balance in and of itself and
is based on theory. That is my greatest concern.
341
But in terms of the 1 percent, the 3 percent, I mean, I can't
imagine any American that would not want to opt into this pro-
gram since the numbers turn out so well for everybody.
Mr. Collins. What you are getting around to, then, is anybody
45 or under is a winner. They would receive total retirement or
benefit from their personal account, none from Social Security?
Mr. Kasich. No, they would get both. You put the two together.
They would get their Social Security benefits but they would be es-
tablished on the basis of prices and not prices and wages. And you
take that amount and you combine it with your private retirement
account measured at what we are all assuming, the 5.3 percent is
what you would get from the 60/40, ratio and that is how we cal-
culate how you would do under the program. And people who are
45 years old could actually not lose their money if they invested 80/
20.
Mr. Collins. Well, your program doesn't give you the option to
entirely opt out of Social Security.
Mr. ICasich. Oh, no; no, it does not.
Mr. Collins. Have you looked at that approach?
Mr. Kasich. Well, I don't think that that is a manageable pro-
gram if you buy into the fundamental basis as to why we estab-
lished Social Security, Mr. Collins. I think that that is a very inter-
esting discussion and debate that can occur probably a couple gen-
erations down the road. But I don't think that is where we ought
to be today and it is not where I am today. I see Social Security
as something — see, my problem with it is if you give everybody a
total opt-out and you make sure that we are going to have some
kind of a survivor benefit for people who invest their money in
Uncle Joe's pork bellies and lose everything, then we have to create
a welfare program for our seniors that lost all of their money,
which is why I believe you have to have a program like this.
One other point I would like to make is that there is a notion
that if the economy grows fast, that we can grow our way out of
the Social Security problem. And it is simply not true. You don't
make any headway based on strong economic growth. But I think
your question is a legitimate one and our children are going to
have that debate, and probably it is going to be pretty fierce if we
can take the first few steps.
Mr. Collins. Thank you.
Chairman Smith. Except, John, with your proposal and my pro-
posal, an expanding economy is going to be much more significant
as we change it to a CPI inflation rather than wage inflation.
Mr. Kasich. I am saying if the economy is growing strong, this
thing is gangbusters. What I am saying, Mr. Smith, is that there
are a lot of people who think that the current Social Security prob-
lem can be solved if we just have rapid economic growth. But the
system is set up that the more rapidly wages grow, the more bene-
fits you pay, so you can't get out of it. And the other problem is,
of course, the longer we delay on this, look, everybody in this room
who is here obviously, and particularly the young people, have an
interest in this program. Providing it for young people is essential
to, I think, restoring a little confidence. Every year you delay com-
pound interest is every year that you lose a chance to get ahead.
That is why you have got to do this soon.
342
Chairman Smith. Mr. Ryan.
Mr. Ryan. Thank you. Thank you very much, John, for coming.
And I had the opportunity of visiting with your staff, Steve Robin-
son, to go over this plan last week. And what I think your plan
does is highlight a really important issue that we have been talk-
ing about a little bit, which is the wage peg and the price peg. One
of the newspapers recently just brought that out as well.
Can you shed some more light on the wage peg versus the price
peg, when and how that change is scheduled to occur, and how
chemging from the wage peg to the price peg is not a cut in bene-
fits— it is actually still increasing benefits? How does it also help
us solve the huge liability in the outyears?
Mr. Kasich. Well, the first thing we have to realize is that it is
the price peg that our seniors now are geared to when it comes to
their cost-of-living increase. So what we would be doing is essen-
tially saying that our benefits would have growth, but the growth
would not exceed
Mr. Ryan. Prices.
Mr. Kasich. It would not exceed prices and it would not exceed
that indexing which occurs with our senior citizens today. So you
would have a slowing of the starting point, yet you wouldn't be
going backwards. I hate to get into this slowing the growth, but I
suppose that is how you would argue this. You slow the growth in
the establishing of benefits.
But once it is established, of course, then you get the juice on the
other side, which is the ability to invest in the economy at a far
faster rate than what the rate of return is on a government invest-
ment. And I mean, it has got to be astounding to everybody to find
out if you are under the age of 45, you win. The only people who
have to pay are people like me. I stood on my parents's shoulders
to get where I am. I don't want to stand on my kids' shoulders to
get out of this. I can give up a little of this. Frankly, most Ameri-
cans don't think they are going to get any of it anyway. It is a rea-
sonable approach to being able to solve this.
And, Paul, it has got to be wages and prices because in the early
years, essentially, we were trjang to get people really out of pov-
erty. And the wages and the prices were a way to try to make this
system equitable. If we don't change wages and prices, we will
grind down. All the plans at some point have to borrow from the
general fund. Mine, fortunately, becomes totally self-financing.
The other programs — I don't want to comment on Mr. Kolbe's be-
cause his and Mr. Stenholm's both do as well, which is why I take
my hat off to them. But the inability to deal with the benefits side
means we will not fix this and we will keep robbing from the gen-
eral fund or driving up huge, huge — not minor, huge borrowing
costs.
So what you get with this program, I mean, think about it, a lit-
tle lower starting point where virtually all Americans benefit. We
have more retirement security, we have private accounts that we
control, that we can pass on to our families. That allows us to earn
more than what the current system provides. And I understand
Mr. Archer's plan does not even permit that. You don't have an op-
portunity to earn more than what the government program pro-
vides.
343
Mr. Ryan. I am glad you brought the Archer plan up. He was
just here. I asked him as a Budget Committee member about the
score, the cost for our purposes of budgeting. And he is supposed
to prepare a tax bill using all on-budget surpluses for that tax bill.
I was unsure as to whether his bill eats into that tax bill, that on-
budget surplus. As the Chairman of the Budget Committee, I know
you are acutely aware of off-budget surpluses going to debt reduc-
tion and on-budget going back to the taxpayer who produced it.
What is the score of your bill? What does it do with respect to
the off-budget surplus? How much would it take of that? Is it to-
tally self-funding?
Mr. Kasich. The off-budget, all of it goes into creating the ac-
counts; and at some point when this program starts nose-diving
into the ground, you have to incur some debt from the on-budget
side. But the beauty of this is that it becomes self-enforcing be-
cause at some point the payroll taxes collected will be much greater
than the benefits that are passed out, and at that point you can
reduce payroll taxes or you can create larger private accounts.
Under the other plans that I am aware of, look, I don't know
about all of these plans, I haven't studied them all, but I know that
programs that do not in some way, shape, or form impact benefits
are programs — I mean we all know intuitively that if you do not
slow some of this benefit growth, you are not going to make it, and
that your borrowing costs are going to be enormous.
And I think if we were trying to ratchet somebody down and
clobber somebody, it would be unacceptable. But if I am going to
tell you that a 45-year-old guy loses less than 2 percent in ex-
change for an amazing benefit for everybody else in our society that
will probably also drive up the savings rate in America, it is a very,
very small price to pay for making this program solvent.
What I fear, Paul, is that we are going to go ahead and pass
something and we are not going to get to the nub of the problem.
Mr. Ryan. And just delay the problem. I just wanted to clarify
with you, your plan doesn't eat into our on-budget surplus and
therefore take away from the tax reduction that we are hoping to
achieve in this budget in this Congress?
Mr. Kasich. It would not.
Mr. Ryan. That is an important point. Some plans do. As a gen-
tleman under 45
Mr. Kasich. You need to know that at some point when the ofiF-
budget surplus doesn't provide enough money to finance the private
retirement accounts, there will be a borrowing cost on the general
revenue side. But at some point it ends because mine is self-enforc-
ing.
Now, remember, we also found out presumably that we have got
about a trillion dollars more in surplus. Now, I must tell you that
that then means that our borrowing costs for financing the Social
Security plan would be reduced, but it also gives us perhaps a
great opportunity to fix Medicare. I want to bring to your attention
that Medicare is a far more acute problem than Social Security.
That is why it is so important we don't flatter away this surplus
on more government spending, but use that surplus to be able to
address these huge entitlement challenges that we have for the
next generation.
344
Chairman Smith. The gentleman's time has expired.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. Let me say at the out-
set, some specificity fi'om a candidate for the RepubUcan nomina-
tion for the presidency is increasingly uncommon and I commend
you for that. And I know the Chairman has thought long and hard
about all of these issues. And I apologize for not being here for your
opening testimony. I was caught up in another meeting.
Let me also reference the comment made by my young colleague
on the other side with respect to the previous speakers, that that
is a critical element, that you can only spend the on-budget surplus
once — ^you can spend it twice, but we are only supposed to spend
once or we get into the problem that we have been in before.
With respect to the wage — first of all, have you had your pro-
gram scored by
Mr. Kasich. That is all worked out.
Mr. Bentsen. By the trustees and all? With respect to the wage
peg, if I understand this correctly, for future or new retirees, you
would just eliminate the wage peg so that the initial average bene-
fit woiild be whatever it is, $740 a month today or something hke
that, and it would just stay there, flat
Mr. Kasich. No, the initial establishment would be on that com-
phcated formula that takes your average wage at 60 and divides
it by your average wage in the other 34 years, times your income,
to give you a yearly total and breakdown into 12-month totals, and
then there is a factor applied that includes both wages and prices —
that initial factor would be based on prices and not wages. But
then beyond that, you would grow, because we don't affect CPI or
an3rthing else.
Mr. Bentsen. Right, you would grow based on the annual COLA.
Mr. Kasich. Correct.
Mr. Bentsen. But initially
Mr. Kasich. And you would receive a lesser amount.
Mr. Bentsen. No adjustment going forward for adjusting the
wage base in effect.
Mr. Kasich. Correct.
Mr. Bentsen. How did the Social Security actuaries score that
over the 75-year period in terms of — did they make any projections
as to what the net reduction would be?
Mr. Kasich. Yes, they did. I don't have those numbers in front
of me, but in about 30 or 40 years, the system balances itself and
then starts to run a huge surplus. And then that surplus, of course,
can be used either to reduce payroll taxes or to increase the
amount in the personal account. Mr. Bentsen, I would argue that
your children probably would rather have a lower payroll tax so
they could have the freedom to invest as opposed to staying in
the
Mr. Bentsen. Mine would like to have the freedom to spend, has
been my experience so far. But nonetheless, if you could provide my
staff with
Mr. Kasich. Yes, we will get you all the details of this program.
Mr. Bentsen. That is what I would be interested in.
Mr. Kasich. The inability to be candid on these major issues is
not Hmited to certain classes of people. I have talked to my own
345
Republican colleagues who, when they find out that you may not
be giving everybody a chicken in every pot, probably all the way
down to the school board level people are Hke, oh, that is the "third
rail."
I have to tell you I think the public is ready for changes in this,
and I think they are ready for some straight talk; and frankly, this
is not any different than what we did with tr5dng to balance the
budget. As you know, we had to make choices and a lot of times
those choices meant that some people would get less. But look at
what the result has been, not that that is the reason that the econ-
omy has done so well, but if you take a look at the stock market,
and if we keep going like this we will be at 20,000. I am not so
sure that that is not an accurate projection.
I think the beauty of this plan is that for people under the age
of 45, they are a winner in every single way. And it just takes such
a small give on the part of a limited number of people in order to
make this whole thing work. I don't think it takes any great cour-
age at all to do this. I think it is like falling off of a log. I think
it is pretty simple. And I think you are the kind of person that
says, I didn't come here to waste my time either, I might as well
just get some things done. I think it is the nature of the individual
in this. But I think that our Congress needs to reaUze that I think
on this issue, it is time for it to be done.
Mr. Bentsen. Well, I would just tell the gentleman, generally I
would concur with you. And I think that being up front — and I
know our next panel has done this as well, and the first panel we
had today in getting into specifics. And where the adjustments are
made, where the cuts are made, is important because I think what
the American people want more than an3rthing else is honesty.
They are willing, I think ultimately, to take the tough medicine if
they think you are being honest with them. We may have disagree-
ments on how we get there, but we need to deal in specifics, not
broad generalities, which as the Chairman will tell you in some
cases has been the case with some groups that have come up here
£ind said, we will take care of that later. And we all know what
that means: It never gets taken care of.
Mr. Kasich. Thank you. I thank you, Mr. Chairman. I apologize
to Mr. Kolbe and Mr. Stenholm for getting their time, and I appre-
ciate it very much.
Chairman Smith. Mr. Herger has a question.
Mr. Kasich. Oh.
Mr. Herger. Mr. Chairman, I want to thank you for your in-
volvement, for taking the effort to put forward a plan to help save
Social Security. I guess my question is in this area of 45, what is
it, 45 to 54, would be receiving something less than what they
would be receiving now. And I know you are one of those who
would be very wilUng to sacrifice that.
Mr. Kasich. Yes; just barely made the cutoff.
Mr. Herger. I think of my town hall meetings and we all have
these notch babies that come up, whether or not it is correct.
Mr. Kasich. Well, we know it is not correct.
Mr. Herger. In their eyes. I still have them come forward, and
I hope you have been more successful than I have.
346
Mr. Kasich. What I tell them is if you are a notch baby and you
are complaining, we can treat you like everybody after the notch,
and you will get less because you got phased in with a higher
amount than is reflected in your wages. I just don't dabble around
it. They are mad and I say, well, you know, you have got to get
un-mad.
Mr. Herger. Bless you for taking that head-on. I hope you have
been more successful with those notch babies than I have been. My
concern is that this group that we are setting up, do you feel that
other than yourself and myself and some others, that this would
be a political liability?
Mr. Kasich. Let me say something about the notch-year people.
The reason why the notch-year people are so upset is that they
think they literally got shafted, and there were people that wrote
articles and drove this and drove this, and then folks out here mak-
ing money by writing to these notch-year people and telling them
what a terrible rip-off it is.
And people are fundamentally not selfish. You talk to the people
who were the notch-year people, they are very concerned about
their grandchildren, there is no question about it. And so you have
to tell them the fact is that the system was going bankrupt. We did
a phase-in period for you. And when they understand that and —
see, the problem is I am a politician, so whatever I tell them, they
don't believe me to begin with. If you tell them enough times, they
start thinking about it and I think they can accept it. But the prob-
lem is they read it in the paper and then they listen to a politician,
and there is a big gap there. That is the first thing.
The second thing is, do I think that people between 45 and 54
would be willing to do something? Let me tell you, Wally, Mr.
Herger, I would be astounded if we were not. I would be absolutely
astounded if we said, no, we would very much like to stand on the
shoulders of our kids. I don't believe it. And I can tell you that
when I travel and people know about this plan, they are very posi-
tive about it. They are glad somebody is laying out the facts and
somebody is trying to do something.
And remember, even for people who are 45, look how many more
retirement tools we have right now. And so we are not asking any-
body to take a bludgeoning here. This is a tiny little give for signifi-
cantly fixing the system and improving the quality of our children's
lives. So would somebody write that somebody is a notch-year in
2025? Yeah, probably, if they are still having town hall meetings,
and we might still have to go and explain this. And I will be old
enough to be able to hobble into that room and say, let me tell you
what I really meant to be doing here.
And I think it is something that this generation would be willing
to do. I hope. If not, you tell me what the alternative is. The alter-
native is to whack everything or melt this program down or con-
tinue to put off what we know needs to be done? That is not accept-
able.
Mr. Herger. And that is certainly what the great debate is, and
thank you very much. I yield to Mr. Collins.
Mr. Collins. This is a volunteer program; right?
Mr. Kasich. Correct. You can stay under the current system.
347
Mr. Collins. If you are not willing to give it up, you don't have
to opt into this program?
Mr. Kasich. That is correct. Thank you, Mr. Chairman.
Chairman Smith. Thank you, Mr. Chairman.
Mr. Kolbe and Mr. Stenholm, let me just say that in addition to
the thank-yous for being here and developing a proposal, these two
gentleman have headed up the Public Pension Reform Caucus for
the last 5 years and probably have been the catalyst and burr
under the saddle to move the discussion forward. So congratula-
tions and please proceed.
STATEMENT OF THE HON. JIM KOLBE, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF ARIZONA
Mr. Kolbe. Thank you, Mr. Chairman. I also want to commend
Mr. Kasich, who has already left, for the contribution he has made.
I think his plan and ours share a lot in common. They are both fis-
cally responsible and I think the Chairman of the Budget Commit-
tee has done a great deal to advance this debate.
Mr. Chairman, I appreciate your kind remarks about our efforts
with the Public Pension Reform program because I hope it has
helped to educate Members of both the House, Republican and
Democratic Caucuses, and our staffs about it.
Congressman Stenholm and I have been working on this a long
time, as have you Mr. Chairman, on your own proposal. And I am
delighted that this Task Force is looking at this issue and recogniz-
ing the need for comprehensive Social Security reform.
We remain steadfast in our belief that comprehensive reform is
possible in this Congress and this year. Now, the window of oppor-
tunity for doing it is closing very fast. And we respectfully submit
to the committee that our legislation, though not perfect, we think
can form a foundation for legislation which might be considered by
Congress. You have a written copy of our statement. You also I be-
lieve have received a briefing book about our plan.
There are four specific issues that I think that I would like you
to focus on with regard to our plan. One, how the Kolbe-Stenholm
plan reduces Social Security's program costs to sustainable levels;
second, why the Kolbe-Stenholm plan is a better deal for women
than the current Social Security law; third, the property rights and
opportunities for wealth creation under the Kolbe-Stenholm plan;
fourth, why a carveout is absolutely necessary.
Because of the time constraints, I am only going to be able to ad-
dress the first two of these issues. First, on the issue of sustainable
costs. While restoring actuarial balance to the Social Security Trust
Fund is an important step, it is only one measure of the financial
stability of the Social Security reform plan. A truly responsible So-
cial Security plan has to control the costs of the Social Security
program over the long run, and it has to address the cash shortfalls
that begin in 2014.
And I cannot emphasize that last point enough, Mr. Chairman.
Not one plan, not yours, not ours, not Mr. Archer's not Mr. Ka-
sich's, none of them deal entirely with the cash shortfall that exists
in the year 2014 because the cash shortfall is so large. I think it
is very important to keep that in mind.
348
And if you think the budget caps are tough now, imagine the
budget pain that we will experience when the growth in Social Se-
curity and Medicare programs forces Congress to cut programs like
NIH, cancer research grants, Pell grants, Meals on Wheels, any of
those worthy programs that we all know about, by 15 percent or
more, and that is what we are looking at. The day that that would
happen is not that far in the future and that is why we have to
act now. If we don't act now, the future is the present.
There are three ways to measure the financial stability of a So-
cial Security reform plan: The impact on program costs; the plan's
impact on annual cash flow deficits; the plan's impact on the na-
tional debt.
First, on the program costs, briefly. You have a chart and it is
also in the packet of information up there. What are the average
costs? We haven't been able to put the Kasich plan up there yet.
Current law versus the Kolbe-Stenholm and the Archer somewhat,
and you can see that ours is, over the 75 years, is better than any
certainly current law. And Archer-Shaw and the peak costs — and
this is important in terms of the incredible pain that you would
suffer — under current law it is going to go to 19.6 over the next 7
years and then it just keeps on going, it keeps on rising; whereas
ours levels off and we have a lower, much lower peak cost.
Cash flow deficits: No plan, as I mentioned, can eliminate that
cash flow directly, but ours does more about doing that. Current
law, cash deficit would be over $814 billion by the year 2030. Ours
would be at $272 billion.
And finally on the national debt, during the years that Social Se-
curity is running cash flow deficits, the government is going to
have to borrow money to pay benefits. The current law, there is no
figure because it is bankrupt, so there is no limit on it. And ours
is much, much less than that which has been proposed by some of
the other plans.
Let me very briefly in my remaining time focus on the impact on
women, because there are several provisions that are especially
beneficial to women, and I don't think other plans have addressed
that. The most notable is the minimum benefit provision which
would provide a more robust benefit than is currently provided by
current law. If you work for 40 years, you get a benefit that is 100
percent of poverty level. Under that provision alone, 50 percent of
women will do better under our plan than current law. It allows
for voluntary contributions, as I think you know. You can contrib-
ute, like an IRS, up to $2,000 additional in the account. So women
who take time out to raise children can make voluntary contribu-
tions before and after the hiatus to catch up.
And women who are at the lower end of the economic scale, and
more single women are in that category, there is a savings subsidy.
For each dollar of a voluntary contribution you put in, you get a
$150 match by the Federal Government, and each additional dollar
is matched 50 percent, up to a cap of $600. And we provide a mech-
anism for doing that through the earned income tax credit.
One last thing about why women are going to do better under
ours is the changing nature of divorce. Current law stipulates that
a woman gets a benefit if her marriage lasts 10 years. She is enti-
tled to 50 percent of her spouse's Social Security benefit. But di-
349
vorce and marriage is changing. Whereas it used to be that mar-
riages lasted longer and divorce occurred after 15 to 20 years of
marriage, today it is most likely to occur in the fourth to seventh
year of marriage, so a woman is not going to get any benefit today.
I think our plan does more in terms of helping women than the
other plans have done. There is much more to be said about our
plan, and I will turn to Mr. Stenholm to talk about some of those.
[The information referred to follows:]
Prepared Statement of Hon. Jim Kolbe, a Representative in Congress From
THE State of Arizona, and Hon. Charles W. Stenholm, a Representative in
Congress From the State of Texas
Chairman Smith, Congresswoman Rivers and Members of the House Budget Com-
mittee Social Security Task Force, we appreciate the opportunity to appear here
today to discuss Social Security reform and present our legislation for your consider-
ation. We've spent several years working together on this issue and we are delighted
that the Budget Committee recognizes the need to address the financial and demo-
graphics problems that threaten our nation's most successful anti-poverty program.
A few weeks ago, we testified before the Ways and Means Committee. Chairman
Archer invited all sponsors of plans with 75-year solvency to address the Committee.
We think 75-year solvency is a critical element of this debate. Groups on and off
the HiU have suggested that this goal may be too ambitious, and that incremental
reform may be a better solution. We disagree. It is for good reason current law man-
dates that the Social Security Trustees evaluate the health of the Trust Fund over
a 75-year horizon. This period encompasses the entire future life span of all current
workers and beneficiaries, including newborn babies — the beneficiaries of tomorrow.
Also, the projection period is sufficient to evaluate the full effect of changes to the
Social Security program.
In fact, we would like to see the Budget Committee set the bar even higher. We
believe the Members also should consider the impact of reform proposals on the an-
nual operating cash flow of the Federal Government, and on the Trust Fund balance
at the end of the 75-year forecast horizon. Solvency alone is an incomplete standard
for determining whether legislation truly strengthens Social Security. Solvency is
not sufficient if we leave the Social Security system in a deteriorating condition at
the end of the period, or if the Federal budget incurs massive cash deficits in the
interim years.
The difference between a plan that leaves in place a strong and growing Trust
Fund at the end of seventy-five years, and a plan that extends solvency for a finite
period of time but leaves the system with a depleted Trust Fimd, is fundamental
and significant. The issue should not be 50 years versus 75 years, it should be
whether a reform plan offers a complete solution that puts the Social Security sys-
tem on a permanent, sustainable fiscal course.
A "partial" solution will only exacerbate the C3micism among yoimg people that
Social Security won't be there for them. A "partial" solution will require continuous
"tinkering" and adjustment, impeding the ability of Americans to plan for retire-
ment with a degree of certainty. Any credible reform plan must put the Trust Ftmd
on a permanent path of financial stability that will ensure the system remains fis-
cally sound throughout the valuation period and beyond. Genuine solvency is
achieved only if the cash flow is balanced, and the Trust Fund is stable and getting
stronger at the end of the forecast period.
We Were Country When Country Wasn't Cool
To paraphrase the country emd western song, we were Social Seciuity reformers
before Social Security reform was cool. Three years ago, we came together to form
the Public Pension Reform Caucus and begin a discussion in Congress. Today, the
PPRC has a bipartisan membership of 75 members. Our goal was to educate our-
selves and our colleagues about the issues and challenges facing Social Security.
Perhaps just as importantly, we sought to demonstrate the type of centrist, biparti-
san approach to the substance and politics of Social Security reform necessary to
resolve the impending crisis.
Two years ago, we joined Senators Judd Gregg (R-NH) and John Breaux (D-LA)
to serve as Congressional cochairmen of the CSIS National Commission on Retire-
ment Policy (NCRP). The NCRP was a 24-member commission comprised of leaders
fi"om the business community and experts on retirement policy. Our goal was to de-
velop a plan to strengthen America's retirement programs, including employer-pro-
350
vided pensions, personal savings and, finally, Social Security. Fifteen months aft;er
the panel's creation, we disproved the notion that all commissions must end in dis-
agreement or irrelevance. In a unanimous vote, our commission agreed on the 21st
Century Retirement Security Act.
We introduced legislation last Congress (H.R. 4824, 105th Congress) based on the
NCRP report. That legislation generated considerable interest and praise for rep-
resenting a fiscally responsible approach to strengthen the Social Security program.
Since then, we have talked with many of our colleagues on both sides of the aisle,
met with Administration's staff to discuss our proposal and listened to constructive
criticisms of our plan. The legislation we bring before you today is a revised version
of the NCRP plan — a "new and improved" plan that we believe addresses many of
the concerns that have been brought to our attention over the last year.
H.R. 1793: The 21st Century Retirement Security Act
We still adhere to the same guiding principles as our previous legislation: a bal-
anced, actuarially sound plan that reduces the $7.4 trilhon imfunded liability, im-
proves rates of return and strengthens the safety net. We accomplish this by using
personal accounts to advance-fund future obligations and by implementing much
needed structural reforms. We've softened some of the tough choices in last year's
bill and included some new provisions aimed at improving the retirement income
of the working poor. What we don't do, however, is rely on double counting, cost-
shifting, uncertain budget surpluses and accounting gimmickry to hide the true
costs of reform — unlike some "free lunch" plans that have been offered by the right
and left.
Our legislation. The 21st Century Retirement Security Act, provides a payroll tax
cut for all working individuals under the age of 55 by diverting 2 percent of FICA
taxes into personal Individual Security Accounts. Workers also would be allowed to
make additional voluntary contributions of up to $2,000 a year to their individual
account. The legislation also provides a savings match for voluntary contributions
to help low-income workers build their individual accounts.
The individual accounts in our plan would be modeled on the Federal Govern-
ment's Thrift Savings Plan. In the TSP, individuals personally choose investment
options, including a stock index fund, a bond index fund and a Treasury securities
index fund. Unlike other proposals, our plan would provide individuals with owner-
ship and control over their retirement assets, including the freedom to invest in
safe, risk-free Treasury securities. We don't force anyone to invest their Social Secu-
rity monies in the stock market — it's your money, your choice.
Our biU also strengthens traditional Social Security's safety net by creating a
more substantial guaranteed minimum benefit that ensures stronger poverty protec-
tions than currently provided for low-income workers. Moreover, this benefit is given
regardless of any other factors. Consequently, any income from the individual ac-
counts would supplement the enhanced guaranteed Social Seciirity benefit for low-
income workers.
Our plan makes changes in the defined benefit program, but in a progressive
manner that insulates vulnerable populations. Changes to the defined benefit large-
ly affect mid-to-high income individuals who will benefit disproportionately from the
individual accoimts. We implement additional reforms that reduce the cost of the
Social Security program. For example, our plan makes chsmges to reflect the in-
creases in life expectancy and longer working lives, provides for a more accurate in-
flation adjustment, and rewards work. While these provisions involve some pain, it
is necessary to make tough choices to ensure that future governments will have re-
sources to deal with other problems in addition to Social Security.
We have never claimed that our plan is perfect. Every one of you could go through
our plan and select individual items in the plan to criticize — either we went too far
or not far enough. We remain open to constructive suggestions about how our ^plan
can be improved. However, we encourage you to look at the plan "holistically" — to
examine what the proposal accomplishes in it's entirety, rather than focus on one
or two provisions. If everyone determines the acceptability or unacceptability of var-
ious proposals based on a single element, we'll never achieve the bipartisan consen-
sus necessary to pass a bill and save Social Security.
Kolbe-Stenholm is a Foundation Plan
We respectfully suggest to this committee that the bipartisan work embodied by
this legislation offers a foundation for you to commence negotiations and create
meaningfijl, comprehensive reform that can be enacted in to law this year. There
are several elements in our proposal that we believe are essential to reaching a bi-
partisan consensus on Social Security reform:
351
1. Bipartisan. Our proposal is a truly bipartisan solution that balances the objec-
tives of different political perspectives.
2. Solvent. The legislation we introduced has been scored by the actuaries of the
Social Security Administration as restoring solvency to the Social Security program
for the next 75 years and beyond.
3. Fiscally responsible. Our legislation tackles the tough choices that are nec-
essary to control cost and reduce the pressures on future general revenues. It does
not use cost shifts or other accounting gimmickry and does not rely on projected sur-
pluses to create new general fund liabilities.
4. Empowers all Americans. The legislation establishes individual accounts that
provide all Americans the opportunity to create wealth, and provides individuals
with ownership of and control over their retirement assets.
5. Enhances the safety net. Our legislation contains several provisions in both the
defined benefit program and individual accounts that provide stronger poverty pro-
tections and greater assistance to low-income workers than are contained in current
law.
6. Rewards work. The legislation makes several reforms to enhance the work in-
centives in the current system.
7. Improves Social Security for all Americans. Our proposal proxddes all future re-
tirees with a better rate of return than the current system can afford, and protects
all taxpayers from the increased tax burden created by the existing general fund
obligations to the Social Security system.
The Kolbe-Stenholm Plan is Bipartisan
An agreement on legislation to strengthen Social Security will require bipartisan
cooperation. We must put party affiliations aside and think about the future genera-
tions who will be affected by the decisions we make today.
The Kolbe-Stenholm plan is a model for building this bridge. The Social Security
reform debate has been characterized as an either-or choice between two ideological
poles— "status quo" or "full privatization." Defenders of the status quo argue that
any reform that includes a market-based component will undermine the current
safety net features and expose workers to dangerous risks. Advocates of full privat-
ization suggest that the creation of privately managed personal accounts will pain-
lessly solve every challenge while, in fact, they ignore existing long-term liabilities
and the needs of special populations. Both extremes make for good, albeit myopic,
rhetoric and fail to acknowledge the virtue of hybridization. The complete solution
to the Social Security problem can and must combine the best of the traditional pro-
gram with new market-based options.
Our plan attempts to balance three competing objectives we think are necessary
to achieve a responsible consensus that can win the support of the left, right and
middle of the Social Security debate. It establishes individual accounts to improve
rates of return for all retirees— the key objective of most Republicans. At the same
time, it maintains and strengthens the important protections that the Social Secu-
rity system provides for low-income retirees, survivors and the disabled — the key ob-
jective of most Democrats. Last, but definitely not least, it honestly deals with the
financial challenges of Social Security, the key concern of those of us in the radical
center.
The Kolbe-Stenholm Plan is Fiscally Responsible— or "Show Me the Money!"
Our plan sets the standard for a credible, responsible solution to Social Security.
The 21st Century Retirement Act ensures the Social Security program will oper-
ate on a solid, sustainable fiscal path well into the next millennium. It does this
by honestly and responsibly addressing the unfunded liabilities of the program.
Three distinguishing characteristics separate this plan fi-om other prominent pro-
posals. First, unlike the President's proposal, our plan restores the Social Security
Trust Fund to 75-year actuarial balance. Second, unlike several "fi-ee lunch" propos-
als, our plan addresses the cash deficits that begin in 2014 (when benefit costs ex-
ceed payroll tax revenues), by reducing the pressure on general revenues and pre-
serving the flexibility of future governments to meet other critical budget needs.
Third, the 21st Century Retirement Security Act does not depend on projected budg-
et surpluses, cost shifts or accounting gimmicks to balance the Social Security pro-
gram.
The 21st Century Retirement Security Act restores solvency of the Social Security
Trust Fund by eliminating the entire projected cash shortfall in the Trust Fund over
the next 75 years. Moreover, it does so using conservative economic assumptions.
Just as importantly, the 21st Century Retirement Security Act makes structural re-
forms to the Social Security system that help restore the traditional program to a
352
path of long-term solvency that does not deteriorate over time. The Kolbe-Stenholm
plan puts Social Security revenues and outlays on a sustainable course over the en-
tire 75-year period. The Trust Fund ratio — the amount of cash reserves in the Trust
Fimd relative to projected benefits — is rising at the end of the 75-year period. Thus,
there is no "cliff effect."
While restoring actuarial balance to the Social Security Trust Fund is an impor-
tant step, it is only one measure of the financial stabiUty of a Social Security reform
plan. A truly responsible Social Security plan must control the costs of the Social
Security program over the long term and address the cash shortfalls that will create
tremendous liabilities on general revenues beginning in 2014. Controlling the costs
of the Social Security system is essential to the fiscal health of our government. If
we do not address the pressures on the rest of the budget caused by the growth in
the costs of Social Security, future Congresses will be forced to cut other important
government programs or raise additional taxes to meet the obligations to our senior
citizens. Not only will there be no room for any domestic initiatives; we will have
to cut back on existing programs to make room for growth in spending on Social
Security
According to the Congressional Budget Office long-term budget projections, which
assume that we will use 100 percent of projected surpluses to reduce our national
debt. Social Security will consume an ever growing portion of the Federal budget,
creating tremendous budgetary pressures. Between now and 2030, the percentage
of our national income consumed by Social Security will increase by 50 percent.
Spending on Social Security consumes slightly less than 20 percent of total Federal
revenues today. CBO projects that Social Security will grow to 23.5 percent of total
revenues by 2015 and nearly 30 percent of total revenues by 2030.
The tough choices we struggle with in the current appropriations cycle are mild
compared to the problems we will leave for future Congresses if we do not take ac-
tion now to control the costs of the Social Security program. By 2025, spending on
programs other than Social Security and Medicare wiU have to be reduced by nearly
9 percent below current levels if we do not take action. By 2030, spending on pro-
grams other than Social Security and Medicare will have to be reduced by 16 per-
cent below current levels.
Under current law, the U.S. Treasury must find $7.4 trillion in cash fi-om general
revenues between 2014 and 2034 to convert the lOUs in the Social Security Trust
Fund into cash benefits for Social Security recipients. These general fund liabilities
will be more than $200 billion a year by 2020 and more than $800 billion in 2030
alone. After adjusting for inflation, the amount of general revenues that will need
to be provided to the Social Security system in 2030 to provide promised benefits
wiU be greater than total non-defense discretionary spending last year.
The 21st Century Retirement Security Act restores the costs of the Social Security
system to sustainable levels. According the Social Security Administration actuaries,
the costs of the Social Security system wiU average 14.0 percent of payroll over the
75-year period imder our plan, compared to 16.4 percent under current law. The
costs of the Social Security system will never exceed 15.7 percent of payroll under
our plan. Under current law, the costs of the Social Security system will reach 19.6
percent of pajrroU by 2075 and will continue growing. Our proposal and the Senate
bipartisan proposal will do more to control the costs of the Social Security system
than any other proposal. In fact, several prominent proposals that have been put
forward would actually result in higher costs for the Social Security system than
the projected costs under current law (see Table 1).
TABLE 1.— COMPARISON OF COST RATES OF CURRENT LAW AND ALTERNATIVE PLANS
[As a percent of Taxable Payroll]
Year
Current law
Archer-Shaw
Senate bipartisan
Kolbe-Stenholm
Gramm
Stark
2000
10.8
12.8
12.7
12.9
15.0
10.8
2005
11.2
13.3
13.2
13.0
15.2
11.2
2010
11.9
13.9
13.4
13.4
15.6
11.9
2015
13.3
15.0
14.0
14.0
16.4
13.3
2020
15.0
16.4
14.7
14.8
17.3
15.0
2025
16.6
17.4
15.4
15.6
17.6
16.6
2030
17.7
17.8
15.7
15.7
17.1
17.7
2035
18.2
17.3
15.5
15.2
16.4
18.2
2040
18.2
16.2
14.8
14.5
15.2
18.2
2045
18.2
14.9
14.3
13.8
14.1
18.2
2050
18.3
13.8
13.9
13.3
13.4
18.3
2055
18.6
13.1
13.7
13.2
13.0
18.6
353
TABLE 1.— COMPARISON OF COST RATES OF CURRENT LAW AND ALTERNATIVE PLANS— Continued
[As a percent of Taxable Payroll]
Year Current law Archer-Shaw Senate bipartisan Kolbe-Stenholm Gramm Stark
2060 19.1 12.6 13.7 13.2 12.8 19.1
2065 19.4 12.3 13.6 13.4 12.5 19 4
2070 19.6 12.1 13.5 13.7 12.4 19.6
Minimum 10.8 12.1 12.7 12.9 12.4 10.8
Maximum 19.B 17.8 15.7 15.7 17.6 19.6
Average 16.4 R6 HA RO R9 1M
Source- Office of the Actuary, Social Security Administration. Archer-Shaw plan memo dated April 29, 1999; Senate Bipartisan plan memo
dated June 3, 1999; Kolbe-Stenholm plan memo dated May 25, 1999; and Gramm plan memo dated April 16, 1999. Nadler plan memo un-
available on date of publication.
Because our plan advance-funds future liabilities and addresses tough choices, it
will dramatically reduce the general fund liabiUties that exist under current law.
By contrast, the leading plans proposed from the left and the right leave this habil-
ity in place and actually increase these general fund liabilities for the next fifty
years. According to estimates prepared by the Social Security administration actuar-
ies, the 21st Century Retirement Security Act would reduce the $7.4 trillion liabihty
facing general revenues between 2014 and 2034 by approximately $3.8 trillion, a re-
duction of more than 50 percent. It would reduce the amount that the Federal Gov-
ernment will have to come up with from general revenues in 2025 from $420 bilhon
to $217 billion. In 2030, our plan would reduce the burden on general revenues by
more than half a trilhon dollars, reducing a $814 billion Hability to just $272 billion.
These reductions represent resources that will be available for other priorities, in-
cluding programs for education, training, health care, debt reduction or teix cuts.
The tough choices that are contained in our plan to control program costs must be
viewed in context of the resources that would be freed for other priorities. Likewise,
any evaluation of "free lunch" plans that claim to save Social Security without tack-
ling tough choices must consider the problems these plans shimt onto the rest of
the budget— problems that will be left for future Congresses. We can responsibly
tackle some tough choices today or we can leave a fiscal time bomb for future gen-
erations. A plan that restores the Social Security Trust Fund to 75-year actuarial
balance, but does not address the budgetary pressures created by these growing
costs and general fund liabilities, does no favors for future generations.
Unlike other Social Security reform plans that are dependent upon funding from
projected surpluses, the 21st Century Retirement Security Act is entirely self-fi-
nanced and will achieve its goals whether or not current surplus projections are ac-
curate. Although our plan relies on general revenue transfers, all of the general rev-
enue transfers in our plan are paid for by savings in the non-Social Security budget
fi-om the CPI recapture provision. Plans which rely on general revenue transfers fi-
nanced by projected surpluses either place the solvency of the Social Security Trust
Fund in jeopardy, or create problems in the non-Social Security budget if the sur-
pluses are not as large as currently projected. Under our plan, if the surpluses do
materialize, they would remain available for debt reduction, strengthening Medi-
care, tax cuts, or spending on other priorities.
The 21st Century Retirement Security Act does not rely on double-countmg, opti-
mistic assumptions or other gimmicks to make the plan appear balanced on paper.
The plan does not mask the costs of the program by shifting costs to other areas
of the budget or the private economy. All payroll taxes are used only once, either
to fund current benefits, fiind individual accounts, or credit the Trust Fund. Unlike
other plans, the Kolbe-Stenholm plan does not use Social Security surpluses already
credited to the Social Security Trust Fund to justify a second roimd of credits to
the Trust Fund. Nor does the plan pay for individual accounts with funds that al-
ready have been credited to the Trust Fund, like some "free lunch" plans do.
We learned a long time ago that if something sounds too good to be true, it prob-
ably is. There is no free limch. We cannot afford to meet all of the promises in cur-
rent law without finding additional resources elsewhere. Proponents of plans that
claim to preserve benefits at levels promised under current law, or even suggest
that benefits will be increased above current law, must answer the call "Show me
the money!" Where does the money come from to fund these promises? These so-
called "free lunch" plans which suggest it is possible to save Social Security without
any pain actually have tremendous hidden costs that will require very real pain.
They will drain the Federal budget and U.S. economy of resources that are needed
for other government programs. They will result in higher tax burdens and lower
national savings. Congress and the President must honestly address the fiscal chal-
354
lenges posed by the Social Security system, instead of ignoring hidden costs and pre-
tending that we can meet these challenges without tough choices.
H.R. 1793 Empowers All Americans With Freedom and Control Over Their
Retirement Assets
H.R. 1793 creates individual accounts based on the Federal employees' Thrift Sav-
ings Plan. This model combines the benefits of individual ownership with the protec-
tions offered by a quasi-private board governing fund managers. The TSP model of-
fers a straight-forward, low-cost retirement savings mechanism safeguarded against
fraud and abuse. The Thrift Savings Plan has been an extremely successful program
for all Federal employees, including Members of Congress. The burden of record-
keeping for each individual account would be assumed by the Board. Employer bur-
dens and administrative costs would be kept to a minimum. The administrative
costs would be spread across accounts proportionally based on account balances to
limit the impact of administrative charges on small accounts.
Under our legislation, every worker would be able to choose from among a number
of investment options selected by a quasi-private Board based on a competitive bid-
ding process. Workers would have the opportunity to choose between options with
higher risk and the potential of a commensurate higher return and those that are
safer, with lower rates of return. The options would include a stock index fund, a
bond index fund, and a government securities fund. No worker would be forced to
put his or her retirement funds in the stock market. Workers would have the oppor-
tunity to select their own risk profile, including the freedom to invest in safe, risk
free Treasury securities. Conversely, workers who want to take advantage of stock
market returns could place all or most of their account in stock funds. The individ-
ual accounts under our plan are based on a simple philosophy: it's your money, your
choice.
Opponents of individual accounts highlight examples of poorly implemented indi-
vidual account systems in other countries that resulted in high administrative costs.
There are legitimate administrative cost concerns about purely privatized individual
account plsms involving dozens of private account managers. However, these con-
cerns can be addressed without eliminating individual control and turning invest-
ment decisions over to the government. Our legislation demonstrates that it is pos-
sible to give individuals control over their retirement income while also providing
government safeguards that address legitimate risk concerns.
Federal Reserve Board Chairman Alan Greenspan and others have made a per-
suasive case about the risks of social investing, government interference in the mar-
ket and conflicts of interest inherent in having the Trust Fimd invested by the gov-
ernment in the stock market. Most significantly, though, the collective investment
approach doesn't address the central impetus behind calls for individual accounts:
taxpayers want their own stake in the economy and more control over their retire-
ment benefits.
Critics argue that individual accounts are too risky for lower-income individuals.
We believe that it is more risky, and certainly unfair, not to give lower-income indi-
viduals the opportunity to realize the benefits of accumulating assets. It is precisely
this lack of investment opportunity that has left too many Americans on the fringe
of the economy. Our legislation gives low-income workers the same opportunities to
have savings for their retirement and reap the benefits of investment earnings that
are already available to higher earning workers who benefit from 401 (k) plans and
other private savings vehicles. For low-income people, the individual security ac-
counts are a pure bonus above and beyond the strengthened safety net provided by
the guaranteed minimum benefit provision included in our legislation.
Why a Carve-Out is Necessary
H.R. 1793 creates individual accounts within the existing payroll tax structure in-
stead of creating individual accounts above the current 12.4 percent payroll taxes.
Some plans "add on" personal accounts through explicit or implicit tax increases or
by diverting revenues from other programs. Diverting a portion of payroll taxes to
create individual accounts — sometimes referred to as a "carve-out" — has been criti-
cized as weakening the financial status of the Social Security system and requiring
deeper benefit cuts than othei-wise would be necessary. This argument completely
ignores the benefits of using individual accounts funded with current payroll taxes
to replace a portion of future unfunded liabilities instead of building up Trust Fund
By placing a portion of current payroll taxes into individual accounts that will be
available to provide retirement income for future retirees, our legislation would sig-
nificantly reduce future unfunded benefit promises without reducing retirement in-
355
come for these retirees. Under our plan, a portion of retirement income for future
retirees will come from pajToll taxes collected today and placed in individual ac-
counts, instead of leaving the entire burden of funding retirement income to future
taxpayers. The large reductions in future liabilities on general revenues that we out-
lined earlier in our statement are possible because of the advance funding from cre-
ating individual accounts with existing payroll taxes.
WTiile there has been a lot of discussion about the transition costs of creating indi-
vidual accounts, the transition costs resulting from advance funding future benefits
must be viewed in context of the reductions in future liabilities that are achieved
by this advance fiinding. Proposals which rely on increasing the balances of the So-
cial Security Trust Fund to meet future benefit promises — instead of creating indi-
vidual accounts — effectively leave the financial burden of providing retirement in-
come for future retirees to future taxpayers. The transition costs of creating individ-
ual accounts out of existing payroll taxes are much smaller than the liabilities that
future taxpayers will face in redeeming trust fund balances imder current law.
Those who criticize plans to advance fund future benefits with individual accounts
because of the transition costs resulting fi'om diverting a portion of current payroll
taxes should be asked to explain how they plan to meet the general fund liabilities
that would be reduced imder our plan. Our legislation takes responsibility for itself
and preserves the flexibility of future Americans to address other national needs.
There have been some suggestions that creating individual accounts outside of the
existing payroll taxes — sometimes referred to as an "add-on" — would represent a
compromise on the issue of individual accounts. We strongly disagree with that sug-
gestion. In fact, creating individual accounts above the existing payroll tax would
actually exacerbate the concerns that we have outlined about the budgetary pres-
sures that will be created by retirement programs under current law. That would
represent a major step backwards from current law, not a compromise.
Since there is very little willingness to explicitly require additional contributions
above the current 12.4 percent payroll tax rate to fund individual accounts, most
proposals that create individual accounts outside of the current pa)Toll tax are fund-
ed with general revenues from projected surpluses. This approach presents some
very serious problems in terms of fiscal responsibility, future tax burdens and re-
sources available for other needs. Even if projected surpluses materialize as cur-
rently estimated — an uncertain prospect at best — they will not last indefinitely.
However, the obligation to fund individual accounts from general revenues would be
permanent.
A Congressional Budget Office analysis of one such plan to create individual ac-
counts with general revenues warned that this approach would result in higher im-
plicit tax burdens, increased budgetary pressures and a higher national debt. The
Social Security Actuaries have found that creating individual accounts of 2 percent
funded with general revenues could increase the national debt by more than $10
trillion above current projections over the next thirty years. Creating individual ac-
counts outside of the existing 12.4 percent payroll tax means higher tax burdens on
future generations, less resources available for all other government priorities, and
higher debt. We cannot afford to ignore the very serious fiscal consequences that
this approach would have in the future in order to meet political needs of today.
The real question isn't whether or not a plan has individual accounts, it is wheth-
er the plan uses the individual accounts to address future liabilities to taxpayers.
Unlike plans which use current payroU taxes to prefund future benefits instead of
building lOUs in the Trust Fund, individual accounts funded outside of the current
pa3rroll tax would allow the Trust Fund to continue to accumulate lOUs. These
lOUs are merely claims against future general revenues. Using current payroll
tEixes to create individual accounts and advance fund future benefits will substan-
tially reduce the liabilities on future general revenues. By contrast, individual ac-
counts added on top of the current system take funds from general revenues today
and leave in place the future liabilities on general revenues. This is a fundamental
difference fi-om a fiscal perspective that must not be brushed aside to reach a politi-
cal compromise.
The Kolbe-Stenholm Plan Strengthens the Government Safety Net
The 21st Century Retirement Security Act restores the solvency of the Social Se-
curity Trust Fund in a way that not only protects low-income workers fi^om any re-
duction in benefits, it actually strengthens the safety net provided by the Social Se-
curity program. It contains a new minimum benefit provision that offers stronger
poverty protection than provided under current law. The plan also provides a sub-
sidy to supplement the individual accounts of low-income workers. Finally, by ad-
dressing the unfunded liabilities of the Social Security without shifting new obliga-
356
tions onto general revenues, our plan reduces the pressure to cut funding for other
government programs that benefit low-income populations.
One of the innovative features of our bill is a minimum benefit provision that pro-
vides a much stronger safety net for low and moderate-income workers when they
retire than is contained in current law. An individual who has worked for 40 years
and quahfied for 40 years of coverage will be guaranteed a Social Security benefit
equal to 100 percent of the poverty level. Workers would be eligible for a minimum
benefit equal to 60 percent of poverty after 20 years of work, and the minimum ben-
efit would increase by 2 percent of the poverty level for each additional year of work.
This minimum benefit level is calculated without regard to any other change in the
benefit formula under our legislation. Any income ft-om the individual accoimts
would supplement this guaranteed benefit. Widows would be covered by the mini-
mvmi benefit guarantee based on his or her spouse's work history.
The new minimum benefit provision will enable Social Security to lift more of the
elderly out of poverty than current law. Currently, nearly 8 million seniors receive
benefits that are less than the poverty level. According to the Social Security Ad-
ministration actuaries, 50 percent of women and 10 percent of men would receive
higher guaranteed Social Security benefits as a result of the minimum benefit provi-
sion in H.R. 1793. For a low-wage worker, defined by the Social Security Adminis-
tration as a worker with lifetime earnings equal to 45 percent of the national me-
dian, the minimum benefit provision increases retirement income by more than 10
percent (see Table 2) — not including any balances that would accrue in the worker's
personal account. We say to all Americans — if you work all your life and play by
the rules, you won't retire into poverty.
The Kolbe-Stenholm plan also incorporates the concept from the President's USA
proposal of helping low-income workers save for their retirement by providing sub-
sidies for workers. The individual accoimts in the 21st Century Retirement Security
Act will give low and moderate income workers the opportunity to benefit fi"om in-
vestment opportunities that higher income workers already have with 401(k) plans,
IRAs and mutual funds. To help low-income workers take advantage of this new
savings vehicle the Kolbe-Stenholm plan provides a savings subsidy, or "match" for
low-income workers who make voluntary contributions to their individual account.
A maximum of $600 per individual is allowed per year. To qualify for the subsidy
in any given year, an individual must earn less than $30,000 per year and make
at least $1 in volimtary contributions to their personal account. The subsidy for low
income workers will help increase retirement savings for lower income workers who
do not have access to private pensions and have little or no other savings for retire-
ment.
TABLE 2.— IMPACT OF THE MINIMUM BENEFIT PROVISION ON A LOW-WAGE WORKER
Low-wage worker earning 45% of the National Average Wage (per year) $12,600
CURRENT LAW SOCIAL SECURITY BENEFIT
Social Security Benefit at Normal Retirement Age: $568
Plus: Spousal Benefit (if applicable): $284
Equals: Total Monthly Social Security Benefit: $852
SOCIAL SECURITY BENEFIT UNDER KOLBE-STENHOLM
Poverty Level for a single-person household over age 65 (per year) $7,525
Translated into a monthly benefit (divide by 12) $627
Plus: Spousal Benefit (if applicable) $314
Equals: Total Monthly Social Security Benefit' $941
Kolbe-Stenholm increase over current law benefits (per month) 10.4% / $89
' Ttiis amount does not include any balances that accrue In tfie worliers personal account. Consequently, total benefits will be higher.
We've discussed in detail the reduction in the unfunded liabilities of the Social
Security system under our proposal. This effect is substantial for low-income indi-
viduals as well, because the budgetary pressures that will occur under current law
threaten deep cuts in other safety net programs that benefit low-income populations.
By honestly addressing the budgetary pressures created by the unfunded liabihties
of the Social Security system, our plan ensures that future governments will have
resources available to preserve funding for discretionary spending and other pro-
grams that benefit low-income families in addition to providing Social Security bene-
fits.
357
Instead of focusing on rhetoric about what Social Secuiity reform could do to vul-
nerable populations, we encourage you to look closely at what our plan actually
does. The 21st Century Retirement Security Act demonstrates that a fiscally respon-
sible plan to strengthen the Social Security system and create individual accounts
with existing payroll taxes can actually preserve and strengthen the safety net pro-
vided by Social Security.
The Kolbe-Stenholm Plan Increases National Savings
It is a basic rule of economics that increasing national savings is vital to main-
taining a strong and growing economy. Comprehensive Social Security reform, done
properly, could be the most significant action the government could take to increase
national savings. Estelle James, a World Bank Economist who has studied retire-
ment systems and across the world and served on the NCRP, wrote in a study of
public pension reforms around the world that:
"* * * a change fi-om the old traditional pay-as-you-go, defined-benefit type of So-
cial Security system to a system that includes more funding, more individual ac-
counts, and a closer Unk between benefits and contributions is good for the overall
economy * * * It helps all countries develop their long-term saving, which seems
to be linked to economic growth."
The 21st Century Retirement Security Act contains several features that will help
increase national savings. By advance fimding a portion of future benefits and tack-
ling the tough choices necessary to control the cots of the Social Security system,
our plan dramatically reduces the unfunded liabilities that will place a tremendous
drain on national savings in the future. The individual accounts in our plan create
a new vehicle for increased retirement savings by allowing workers to make vol-
untary contributions of up to $2000 a year to their individual accounts. The savings
match for low-income workers wiU provide low-income workers with an incentive
and assistance to save for their own retirement. The reductions in the defined bene-
fits for the middle and upper income workers who have the means to save for their
own retirement will encourage these workers to increase their private retirement
savings. The Congressional Budget Office and several economic studies have foimd
that the existence of high guaranteed benefit levels for higher income workers has
the effect of reducing private savings among these workers.
The Kolbe-Stenholm Plan is a Better Deal for All Americans
When all of the provisions of the 21st Century Retirement Security Act are taken
into consideration, it offers a much better deal for all Americans than current law.
Our plan will put into place a Social Security system that will remain financially
strong for the next 75 years and beyond, and reduces the tax burdens that will be
necessary to support the system. At the same time, the legislation we have intro-
duced will provide a better rate of return than can be provided under current law
and strengthens the safety net for low-income workers. The individual accoimts in
our plan will allow all workers to create wealth and benefit fi-om market forces. Per-
haps most importantly, our plan will help restore public confidence in the future of
the Social Security system.
Our legislation increases the rate of return for all workers compared to what cur-
rent law can fund. Comparing the benefits under our plan to the benefits promised
under current law is extremely misleading, because we cannot afford the benefits
promised under current law. Today, the gocial Security system faces a funding gap
that must be closed if beneficiaries are to be protected. Eliminating the funding
shortfall under current law through a traditional package of benefit reductions or
tax increases would exacerbate the bad deal that Americans receive fi-om Social Se-
curity.
Under cvirrent law, benefits will have to be cut by more than 25 percent after
2034 imless we raise payroll taxes. If the burden of closing this funding gap were
spread evenly among all generations, benefit levels would be cut by nearly 16 per-
cent beginning immediately. To accurately compare our plan to the benefits prom-
ised under current law, it is necessary to consider the substantially higher tax bur-
dens that will be necessary to fund the benefits promised imder current law. To the
extent that current law promises higher benefit levels than our plan can deliver for
some middle and upper income retirees, it can only meet those promises by impos-
ing much higher taxes on those workers. When the benefits promised under current
law are viewed in context of the taxes that must be raised to fund those benefit
promises, the deal offered by current law is not nearly as attractive for toda/s
workers. When all of the benefits under 21st Century Retirement Security Act are
compared to what current law can actually deliver, future retirees will get a much
better deal under our legislation than they would under current law.
358
Our legislation establishes the opportunity for all Americans to create wealth and
benefit fi-om the market forces to increase their retirement income. Individual ac-
counts will extend to low and moderate income workers the investment opportuni-
ties that higher income workers with 401(k) plans and mutual funds already enjoy.
Unlike the current system and some other individual account plans, H.R. 1793 will
provide individuals with ownership of and control over their retirement assets.
Finally, the 21st Century Retirement Security Act will improve public confidence
in the future of the Social Security system. The Social Security system has a well-
deserved reputation as one of the most successful government programs in history,
and has enjoyed strong public support. However, the financial problems facing the
system and the low-rate of return that current workers can expect to receive on
their payroll taxes threatens to undermine this support. The plan we have intro-
duced offers a message of reassurance to seniors and a message of hope to younger
generations.
Our plan reassures seniors that the long-term challenges facing Social Security
can be addressed without threatening the benefits they have been promised. Our
bill restores the solvency of the Social Security system while preserving existing
benefit promises for current and near-retirees. Current retirees woiild continue to
receive their existing benefits, with full increases for inflation, accurately measured.
By putting the Social Security system on a sustainable fiscal path, our plan protects
current retirees from the threat of benefit changes that may be necessary if the So-
cial Security system continues to face financial problems.
While it is important that Social Security reform protect the interests of current
retirees, it is just as important that we address the concerns of younger generations
that doubt that the Social Security system will be there for them. The Social Secu-
rity system has always been based on an implicit generational contract that workers
will pay taxes to fund benefits for current retirees in the expectation that they will
receive similar benefits when they retire. This generational contract is threatened
by the growing skepticism among younger workers about the future of the Social
Security system. Requiring workers to pay taxes to support a system that they do
not expect to benefit from will create discord that can only jeopardize the political
legitimacy of the Social Security program.
The 21st Century Retirement Security Act will give younger generations much
greater confidence in the Social Security system. Our plan reassures younger gen-
erations that the Social Security program will be there for them when they retire
by putting the system on a long-term, sustainable fiscal path. In addition, our legis-
lation wiU give younger workers ownership of and control over a portion of their re-
tirement income, providing them with concrete assurance that the Social Security
system will provide them with retirement income. Our legislation will modernize the
Social Security system to ensure that it can earn the support of yovmger generations
that will be necessary to preserve the program.
Congress Must Not Shirk Its Responsibilities in Exchange for Political
Expediency
We realize that reaching agreement on an honest solution to the long-term chal-
lenges facing Social Security will be difficult, but the difllculty of the task must not
prevent us fi-om confi-onting it. Social Security reform will require us to tackle tough
choices. We were elected to make tough choices, and our constituents deserve no less
from us.
We hope that the suggestions contained in the legislation we have presented to
you will help create a foundation to build a bipartisan agreement on Social Security
reform. While our legislation may not be perfect, it does offer all of the elements
that will be necessary for a responsible bipartisan deal to strengthen the Social Se-
curity system.
We do not agree with those who say that the issue of Social Security reform is
dead. These hearings are evidence that the issue remains very much alive. More im-
portantly, those of us who have the honor of serving in public office have an obliga-
tion to keep this issue alive for the sake of future generations that are counting on
this system. As we tackle the tough choices that will be necessary to enact credible
Social Security reforms, we must look beyond current polls and think about how our
children and grandchildren will look back at the decisions we make today. We look
forward to working with this Committee to create a future for the Social Security
system that will make future generations grateful for the decisions we make today.
359
STATEMENT OF THE HON. CHARLES W. STENHOLM, A
REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS
Mr. Stenholm. I too, Mr. Chairman, thank you for your efforts
and leadership on this subject on which you hold the hearings
today. And I also commend Chairman Kasich for the approach
which he has taken, which Jim has mentioned bears some similar-
ities to the program and the proposal that he has briefly described
part of, and I want to concentrate on the fiscal responsibility side
of the question today, being fitting that this is the Budget Commit-
tee.
The hallmark of our plan is honestly addressing the financial
problems facing Social Security and tackling the tough choices that
are necessary. And we don't do all of what needs to be done, but
we do a heck of a lot more than most of the other plans.
Restoring solvency of the trust fund is important, but simply re-
storing solvency over 75 years is not enough. There are some basic
questions that all of us need to ask who care about fiscal respon-
sibility that should be asked of any Social Security plan being put
forward.
One, does the plan put the Social Security System on a perma-
nent sustainable course that will continue to remain strong at the
end of the estimating period? Or does it leave the trust fund in a
deteriorating condition at the end of the period? Does the plan deal
with the tremendous liabilities on general revenue that will
squeeze the rest of the budget beginning by 2014? And here I
would emphasize very strongly, unless we as a Congress are pre-
pared to deal with the 2014 problem, we had better be extremely
conservative in the amount of taxes that we cut, and spending that
we increase that just happen to begin at the end of a 15-year esti-
mating window.
We have been through this. I served on this committee with Mr.
Kolbe for many years, and we were always a little skeptical and
very critical of administrations that were always estimating in the
sixth year of a 5-year plan, or were estimating 5 years but not mov-
ing forward and looking at what would happen in the sixth and
seventh.
I would encourage this committee to spend a considerable
amount of time looking at the 2014 problem. And using that, first
off", as you look at our chart — I assume we have got the one up that
shows the red area here — we would have that amount of money
available for cutting taxes if you do that which we suggest.
If you cannot do that which we suggest, then you had better
come up with another way of dealing with that red area, because
between now and 2032, the percentage of our national income con-
sumed by Social Security will increase by 50 percent.
According to CBO's long-term budget projections, spending on So-
cial Security consumes slightly less than 20 percent of total budget
revenue today. It will grow to 30 percent by 2030. There will be no
room for any domestic initiatives and we will have to cut back on
existing programs or borrow the money beginning in 2014 if we do
not make some additional choices that both Mr. Kasich and we talk
about today.
There is no free lunch. The promised benefit under Social Secu-
rity will cost $20 trillion more than we can afford over the next 75
360
years. That money will have to come from somewhere. Comparing
the benefits of any reform plan to the benefits promised under cur-
rent law is unfair because current law makes promises we cannot
keep. Plans which suggest we can save Social Security without any
tough choices depend on taking funds away from other government
priorities in order to provide promised Social Security benefits.
Our plan does more than any other plan to reduce the long-term
budgetary problems facing Social Security. Our plan makes some
tough choices today that will require some sacrifices. We either
make the tough choices today to honestly deal with the financial
challenge facing Social Security or we leave a fiscal time bomb for
future generations to deal with.
Our plan reduces the liability that Social Security will place on
general revenues between 2014 and 2034 by more than 50 percent,
reducing a $7.4 trillion liability by more than $3.8 trillion. Reduc-
ing those liabilities will provide future generations with the flexi-
bility to deal with other problems in addition to preserving the So-
cial Security system.
I point out again, the area in the red on the chart is money that
will be available for other programs, whether it is money for edu-
cation or agriculture or health care or defense or tax cuts or any
other priorities that we may have in the future, but only if we
make the decisions that we are talking about today.
And the final thing I would want to emphasize is what we be-
lieve is one of the strong points of our plan, is the changes we
make to strengthen the safety net for those in the lower income
levels. Our plan restores the solvency of the Social Security Trust
Fund in a way that not only protects low-income workers from a
reduction in benefits, but actually strengthens the safety net pro-
vided by the Social Security program.
The benefit changes in our plan primarily affect middle- and
upper-income workers who will benefit from individual accounts.
The new minimum benefit provision of our plan will enable Social
Security to lift more of the elderly out of poverty than current law.
As you heard, 50 percent of women and 10 percent of men would
receive higher guaranteed Social Security benefits as a result of the
minimum benefit provision in our bill. A low- wage earner, defined
by the Social Security Administration as a worker with earnings
equal to 45 percent of the national average, would have a 10 per-
cent increase in guaranteed benefits from our minimum benefit.
Under our proposal, no individual who works a full career will
have to retire in poverty. Currently, nearly 8 million seniors re-
ceive benefits that are less than the poverty level. We say to all
Americans, if you work all of your life and play by the rules, you
won't retire into poverty.
Thank you, Mr. Chairman.
Chairman Smith. Gentlemen, thank you very much. I guess one
concern that I have is the unpredictable nature of demographics.
We have had witnesses before this Task Force that suggested that
within 40 years you would almost have the option of whether you
wanted to live to 100 or 120, so I criticized the scoring for only 75
years. And the more that your plan is based on promising fixed
benefits rather than fixed contributions, the more danger there is
361
in future insolvency, depending on demographics and depending on
a lot of the other issues that might face our economy.
So my question is: Have you considered the possibility, and why
have you ruled out never going above a 2 percent private savings
account?
Mr. KOLBE. Well, my answer would be I would never say never
to that. But let's get this system in place and see how something
in the future might change to be able to phase that in. As far as
the demographics are concerned, I recognize that medical tech-
nology and other things are changing. But I don't know how else
you can go about scoring a plan if you don't use a common base
of data and information; and ours, of course, does use both the So-
cial Security actuarial information and the Congressional Budget
Office scoring mechanisms.
Chairman Smith. But the problem with the 75-year scoring is
that you take advantage of the existing 800 billion in the Social Se-
curity Trust Fund now and assume that that is going to come in
and make the program more safe for retirement.
Mr. KOLBE. I will let Charlie respond, but ours really does not
do that. Although we don't attempt to go beyond 75 years, our pro-
jections are that ours continues on a level, stable basis after 75
years. And certainly, there is far more volatility to go with the
parts of scoring a Social Security plan in terms of wages and in-
comes and economic growth than — that is far more unstable than
anything dealing with the demographics would be.
Mr. Stenholm. I would just say that under the scoring that we
have, and I believe our charts show that the Social Security Trust
Fund is actually improving in its solvency at the end of our 75-year
projection, and you will find that many others, that is not the case.
But your point is very relevant.
I am uncomfortable with projecting 2 years, much less 75 years,
with any kind of accuracy. And that is why we will continue to em-
phasize, both in this forum and others, being conservative with the
utilization of 15-year estimates for purposes of making short-term,
politically very popular decisions, whether it be in Social Security
or otherwise.
And the reason we came up with 2 percent, it was the number
that we could fit within what we believed to be a fiscally respon-
sible approach, but it doesn't say it can't go up. If it works as well
as we hope it does, there can be future adjustments and changes
made. But we think you need to crawl before you walk before you
run. And this one fits and others have a difficult time fitting within
the fiscal responsibility criteria that we put upon our plan.
Chairman Smith. I just want to make sure that you know I am
a cosponsor of this. It moves us ahead. It has got tremendous
value.
Mr. KOLBE. And we appreciate that.
Chairman Smith. I am somewhat concerned and don't under-
stand the full impact of the additional income tax that would be
paid over the next 75 years, considering that the change in the CPI
becomes compounded in terms of its total effect on the bracket
creep and on deductions. Comments?
Mr. Stenholm. Well, yeah, CPI change is not a tax increase or
a benefit cut. It is a decrease in the rate of growth in Federal ex-
362
penditures by making adjustments for inflation accuracy. The pur-
pose of indexing benefits under Social Security and other programs
in the provision of the Tax Code is to hold folks harmless from in-
flation. Our bill simply provides that we do so with accurate meas-
ures of inflation. And for those who argue this is a tax increase,
show me where we change the tax rate and show me where we ex-
pand the base or increase the rate, because I can't find them in my
bill, Mr. Chairman.
Chairman Smith. The actuaries credit some of that money from
tax savings going back into Social Security for your plan. So there
is some tax benefit that is credited back to your plan as I read the
actuaries's report.
Mr. Stenholm. But it is based on an accurate estimation of what
cost of living is. And how can you argue against trying to make it
accurate, whether it is on spending increases or tax cuts?
Mr. KOLBE. Because I would note that it would also affect, for
example, your Medicare premiums which would not rise as rapidly,
so there is that factor too.
Chairman Smith. Mr. Colhns.
Mr. Collins. Mr. Chairman, I don't really have any questions
but I do want to thank the two gentlemen for coming forward with
a plan. Once again we have demonstrated that Members of Con-
gress are willing to step up to the plate and offer an idea and pro-
posal and put it forth for the American people to see. That is more
than I can say about some folks in this town. Thank you.
Mr. KOLBE. Thank you very much.
Chairman Smith. Jim, Charlie, do you have any specific sugges-
tions on any other efforts that we might take, or your evaluation
of moving this debate forward to increase the possibility or prob-
ability, that we can accomplish a bill?
Mr. KOLBE. Well, Mr. Chairman, I still believe, despite the rosy
news yesterday about budget surpluses being better than anybody
had anticipated over the next several years, I still believe we are
clearly up against a budget caps problem this fall. And as Members
of Congress become aware of that, and they then link that to the
lockbox legislation that we passed here in the House not too long
ago, I think they are going to come to the realization that the only
way to solve our dilemma, both politically and economically, is to
unlock that lockbox by doing something with Social Security. Once
we solve Social Security, we free up the surplus that is in there for
whatever spending we need this year, the tax cuts we need this
year. We can do that. We cannot do it until we resolve Social Secu-
rity.
Our goal as members of our Task Force and your Task Force,
and our bill and all the other bills, should be to convince our col-
leagues that they need to deal with this now, because it is the key
to solving the other political dilemmas that they face this fall. Oth-
erwise we are headed for one heck of a massive train wreck this
fall.
Mr. Stenholm. Mr. Chairman, if I might add to that, I think we
don't pretend that this plan is the perfect plan, and we stand ready
to work with any individuals on both sides of the aisle and the ad-
ministration to continue to develop a plan that can get the required
number of votes and support. Our plan has one thing that only one
363
other plan — and you heard from it earlier today — and that is the
Senate plan that Senator Gregg and Senator Breaux brought for-
ward, but ours is the only one that has bipartisan support, and
nothing will happen except with bipartisan support.
So anything, Mr. Chairman, that you can do to continue to pro-
mote the bipartisanship and moving forward will be very helpful.
One of the things that we didn't mention, but we have asked
CBO to score our plan on a 10-year basis, which is the longest that
CBO scores things of this nature. And we don't have those numbers
as yet, but I would hope, I would add, that in any actions that we
take — ^because I happen to agree with Mr. Kolbe's statement re-
garding the caps problem this year, and the fact that the consider-
ably more rosy scenario that we heard yesterday, it is all very good.
But one of the best things we can do with these surpluses until we
deal with Social Security and Medicare in a very rational way is
apply it to the debt. Avoid the temptation to spend this money we
have for tax cuts that explode in 2014 and create tremendous prob-
lems for Social Security, and by the same token avoid the tempta-
tion to spend more on the spending side. That is what we can do
and what this committee can continue to provide the leadership to
do.
Chairman Smith. Gentlemen, thank you very much. Mr. Collins
will preside, and I will go to that table to make a presentation of
my Social Security bill.
Mr. Collins [presiding]. Mr. Smith — that is Mr. Chairman, the
committee will now "endure" your testimony. So if you will begin
and pay real close attention to the lights, sir.
STATEMENT OF THE HON. NICK SMITH, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF MICHIGAN
Chairman Smith. Yes, sir. This is the third scored Social Secu-
rity bill that I have introduced. I started writing it in 1994, and
it takes into account several, what I think are dynamic ideas about
our future economy and to the survival of the Social Security sys-
tem.
First, let me say that we cannot just deal with Social Security
alone, without considering Medicare and what we do on Medicare,
because both of these problems are important; and to take one
without the other means that the eventual retirement security is
going to be less secure.
This legislation, number one, allows workers to own and invest
a portion of their Social Security taxes by creating these personal
retirement savings accounts. I start at 2.6 percent — Mr. Chairman,
gosh, that seemed so quick.
Mr. Collins. Glad you are pajdng attention to the lights.
Chairman Smith. I start at 2.6 percent of payroll and that 2.6
percent of taxable pa3rroll increases over the next 60 years to 8.4
percent. In other words, I move Social Security — except for the 4.2
percent that is reserved for the safety net and the disabled and
their dependents, into a private system.
The 2.6 percent eventually can go as high as 8.4 percent. It only
takes 5.4 percent over a period of 30 years to have a return on
those investments greater than what current Social Security prom-
364
So under all of these plans, an individual that is able to invest
in their own accounts for over 25 years has a significant advantage
over current promises of Social Security.
I come up with funding in several ways. One is I take on-budget
surpluses for 8 years, not to exceed Social Security surplus reve-
nues, to help support investment in those early years. Secondly, I
index the retirement age to life expectancy after the person reaches
the retirement age of 67 under current law.
The PRSAs, the personal retirement savings accounts, in my first
bill were given the same restrictions as IRAs. A lot of individuals
need to know more about investing, because we have failed in edu-
cating our young people and we need to start doing that. My legis-
lation simplifies the investment choices by limiting participants to
about the same options you have under the thrift savings program,
index stocks, index bonds, index small cap funds and index global
funds. It uses the surpluses coming into the Social Security Trust
Fund to finance these. There is no increase in taxes or government
borrowing. The PRSA accounts can be taken out for individuals
that want to retire early, so anybody that has enough PRSA sav-
ings or other savings and can buy an annuity to guarantee tax-
payers that they are not going to come back on taxpayers later on
for welfare benefits or other Social Security benefits, can retire at
any time.
So we are suggesting that the age of retirement with PRSAs is
much more flexible. Workers are encouraged to invest by allowing
an individual to invest with the same tax benefits as Social Secu-
rity; in other words, only taxing half of it. They can put up to an
additional $2,000 a year in their PRSA account. The tax incentives,
I think, will help spur additional savings.
This proposal gradually slows down the benefits for high-income
workers by changing the bend points. John Kasich suggested the
problem of indexing the bend points and indexing what retirees are
going to get. Under the current law it is indexed to wage inflation
that is higher than CPI. So for our first bill in 1994, when we were
writing it, we brought this back to CPI inflation rather than wage
inflation, which slows down the increase in benefits for the higher
income, precisely because we only change the second and third
bend points. We don't change the wage inflation index for the first
bend point. Therefore, it slows down benefits for higher-income re-
cipients.
We have several advantages to women in our bill. One, we divide
the personal savings account equally between husband and wife. In
other words, we add both spouses individual contributions together,
then divide by two, so both the wife and the husband can invest
in their own personal retirement savings account the exact same
amount of dollars. Also, we increase the minimum benefit for sur-
viving spouses to 110 percent over the 100 percent that is now in
current law. This has been scored by the Social Security Adminis-
tration to keep Social Security solvent, but because we gradually
over the years increase the amount allowed to go into that personal
retirement savings account, it is going to stay solvent forever, not
just the 75 years calculated by the SSA actuaries. It maintains a
trust fund reserve continually, so we always have at least one-half
year's Social Security benefits in that trust fund.
365
I think it is the kind of proposal that faces up to the challenges
ahead of us. I would be glad to respond to any questions.
[The prepared statement of Mr. Smith follows:]
Prepared Statement of Hon. Nick Smith, a Representative in Congress From
THE State of Michigan
As a member of the 104th Congress, I introduced the first reform plan in the
House this decade that provided private retirements savings accounts and was
scored to keep Social Security solvent. That bill, "The Social Security Solvency Act
of 1996," was updated and re-introduced as "The Social Security Solvency Act of
1997." Shortly, I will introduce "The Social Security Solvency Act of 1999."
Today, I would like to use the lessons we have learned during our months of fact-
finding on the Task Force to argue in favor of my "Social Security Solvency Act of
1999," which I will introduce shortly. Although there are some important refine-
ments, this Act is patterned on the "Social Security Solvency Act of 1997" that I
introduced previously. Like the 1997 bill, it has been scored by the actuaries as re-
storing the solvency of America's most popular public program. The development of
my plan follows fi-om what I consider to be the Ten Commandments oi Social Secu-
rity reform.
The Ten Commandments for Social Security Reformers
The first commandment is that time is our enemy and we must move without
delay. Alan Greenspan informed us in March that OASDI has an unfunded open
liability of $9 trilUon 1999 dollars. This means that an outside party would require
an up-front payment of $9 trillion now, plus the legal right to 12.4 percent of 85
percent of the nation's payroll forever just to honor the promises we have made to
present and future retirees, survivors, and disabled individuals. This obligation is
very real, and it exceeds by almost three times the size of the national debt held
by the public. Evei-y year we delay, this unfunded liability goes up by hundreds of
bilhons of dollars as we grow closer to the day when Social Security's temporary
positive cash flow first halts, then stops forever.
Put another way, to keep Social Security solvent for just the next 75 years, it
would take an across-the-board cut in Social Security benefits of 14 percent for cur-
rent or all future beneficiaries to make up the shortfall if we act now. Alternatively,
a 16 percent increase in Social Security taxes would also eUminate the shortfall.
These representative figures will get larger the longer we delay.
In 1983, the Congress felt an urgent need to act when Social Security had an un-
funded liabihty of - 1.82 percent of taxable payroll. The system now has an un-
funded Uability of - 2.07 percent, a problem that is 15 percent larger than the one
in 1983! With the danger so high, we must act with at least the same sense of ur-
gency. Anyone who says we have the luxury of time to tackle this difficult subject
is committing the nation to wrenching changes later rather than less dramatic cor-
rections now.
The second commandment is that we must reform the system to take into account
the growing probabihty of a significant rise in life expectancy. Dramatic increases
in life spans is wonderful news. Dr. Kenneth Manton, one of America's most re-
spected demographers, told the Task Force to expect to see many of our next genera-
tion celebrating their 100th birthday. Dr. William Haseltine, a recognized expert on
aging and regenerative biology and President of a company that expects to complete
mapping the human genome in the next few years, thinks that science will make
even greater advances. He believes that many of our children will live to 120. As
life expectancy increases, we must create opportunities for our elderly popiilation to
remain productive and active long into that period of life we now call "retirement."
Third, we should move prudently but boldly. Our actions must equal the scope
of the problem before us. Fortunately, it is now possible to solve our problems by
making gradual and continual Solvency. It took 60 years to create the current crisis.
We can resolve it in steady measured steps over 40 years.
The fourth commandment is that the burden of adjustment must fall equitably.
Any change should hold current retirees harmless. They should receive full cost-of-
living increases. Those near their retirement years and low income workers should
also be protected. Meanwhile, better paid workers should contribute more than
those with moderate incomes.
The fifth commandment states that no tax increases should be adopted to elimi-
nate Social Security's unfunded liability. Medicare has very difficult problems, and
added revenue will be needed to resolve them. Its unfunded liabiUty is twice that
of Social Security. Social Security reformers who use new tax revenue to solve their
366
problems complicate efforts to resolve Medicare's difficulties — where lives, not dol-
lars, are at stake.
The sixth commandment holds that every worker should enjoy the benefits of sav-
ing and investing. A primary reason why the rich are outpacing the lower and mid-
dle classes is their ability to invest in thriving corporations that yield returns that
significantly exceed those received by putting funds in banks. Professor Roger
Ibbotson, the nation's foremost historian on stock and fixed income markets, pre-
dicted in 1974 that the Dow would rise ft-om 1,000 to 10,000 by the year 2000. He
now projects that the Dow will reach 100,000 before 2025. A way must be found
so that everyone can get a share of this $140 trillion in new wealth that will be
created.
The seventh commandment dictates that investments made for retirement must
be prudent. Prudent risk-taking does not reqviire that every investment turn out
brilliantly. It does require that no matter what happens every retiree have adequate
funds from Social Security to remain above the poverty level.
The eighth commandment declares that professional money managers should not
earn excessive fees from carrying out an essential national mission. The Task Force
heard from William Shipman, a Principal of State Street Global Research, who pre-
sented the firm's detailed administrative cost model. Workers can have access to
broadly diversified stock and bonds portfolios for only pennies a day. The GAO is
confirming these findings, and will publish its report before the end of the month.
The ninth commandment compels us to redesign social security so that it com-
mands full public confidence. Currently, many workers have so little faith in the
System that they view their payroll taxes, not a contributions for their own retire-
ment but, as sacrifices. While they support helping seniors, they don't personally ex-
pect to receive checks when they become seniors themselves. Social Security will
never be free from political peril until all workers view participation as a valuable
fringe benefit from going to work.
The tenth commandment requires us to maintain our lead in a competitive global
economy. Other nations are modernizing their national retirement systems. If we
fail to improve ours, it will hurt our national economic performance and our stand-
ing in the world. Countries that have prepared themselves for the coming demo-
graphic changes will have strong economies that vault them ahead of their global
competitors. I want the U.S. to be among that group of world economy leaders.
If you agree with these principles, you will like my plan. It is derived from them.
The Most Essential Step: Creating Personal Retirement Savings Accounts
(PRSAs)
The central element of my plan is to provide all workers with Personal Retire-
ment Savings Accounts (PRSAs) that they own and are professionally invested sole-
ly for their benefit. For the next 36 years aU workers will contribute 2.6 percent
of their pay, up to the maximum Social Security wage base, into their accounts. In-
dividuals will choose where to invest these funds but will be offered attractive low
cost, high reward, equity and fixed income index funds as well as more specialized
programs if they so choose. After 2036, the actuaries say the contribution rate can
rapidly climb, reaching 11 percent by 2074.
Here are some examples of PRSAs in action. A 20-year old worker earning
$20,000 will deposit $520 the first year. Assuming a 2.5 percent inflation rate and
she earns a pay raise 3.5 percent annually, the annual contributions will grow over
time reaching $3,944 forty-five years from now. Over 45 years, she will place a total
of $62,800 in her account. Assuming her funds were placed in an equity index fund
that earned a 6.5 percent real rate of return, this $62,800 will grow to $422,000—
4.6 times her final salary. By converting this sum into an annuity, she can expect
to receive $34,500 a year for 19 years after her retirement. I choose that time period
because it is how long the actuaries assume in their Social Security projections.
The amount that better-off workers will have in their accounts is proportionate.
A teacher starting at $30,000 will see her account grow to $633,000, and her annual
benefits for 19 years will be $51,750. A young attorney graduating from a fine law
school who lands a job at $60,000 will retire a millionaire, having $1,266,000 in her
account, and see annual benefits of $103,500 for 19 years.
Here are representative figures for 40 year old workers. A worker earning $20,000
today will have $59,200 in her PRSA account at 65. A $30,000 per year bus driver
will have $88,800. The 40 year middle management executive will hold $177,600.
These workers will see their annual retirement incomes supplemented by $5,000,
$7,500, and $15,000 when the PSRAs are converted into annuities good until the
anticipated time of death.
367
Finally here are figures for 55 year old workers. The grocery clerk earning
$20,000 now will acquire a $9,000 PRSA in 10 years. The bank teller earing $30,000
now will have $15,600 while the successful architect earning $60,000 now will have
$27,000 in 2010. „ , . ■ r
The point of these examples is that PRSAs grow very rapidly under the magic ot
compound interest. The biggest beneficiaries of PSRAs are the young and future
generations. It makes sense, therefore, to take this into account when aUocating
costs across generations for restoring the System.
Investment Risk Can Be Managed
Fears about sudden stock market tumbles are overblown. It will be 20 years or
more before the amoimts at risk represent significant sums as a percentage of the
resources needed to ensure a secure retirement. Put another way, even with a 2.6
percent "carve out" of Social Security payroll taxes, it will be far into the future be-
fore the monthly private retirement check exceeds the check received from Social
Security. We will have time to evaluate investment returns and account for une^
pected events that jeopardize workers retirement security long before they could
happen. These fears should not prevent us from instituting needed reforms today.
I am exploring ways to reassure workers who may not have had experience with
401(k) plans or mutual funds. Although the number of happy investors has reached
an all time high along with the DOW, the process may seem fi-ightening to those
who haven't personally benefited fi-om the Reagan-Bush-Clinton bull market. One
idea that I would encourage the Committee to explore is a formal guarantee that
anyone 45 or imder will be guaranteed a retirement income equal to current law
benefits provided they invest their PSRAs in equity investments. We know from 200
years of stock market history that equity returns over long periods outperform all
other prudent investments. Consequently, the government can offer guarantees to
long term investors with confidence that there is at least a 200 to 1 chance it will
never be called upon to honor them. I haven't had this provision scored by the actu-
aries. Therefore, I cannot present it to you in a formal way.
There are other ways cautious investors can avoid risk. First, they can transfer
the risk of market downturns to others who accept it voluntarily. There are many
life insurance and annuity products that do just that. Insurance companies are pro-
fessional risk takers, and are quite successful at it. Many annuity investors give up
the chance for large gains, but they avoid losses in exchange. Here's another exam-
ple Right now, a large investment house offers the public for a fee a bundle of equi-
ties with the right to sell it back to them at the price you paid for it 5 years from
now. As Will Rogers once said, "Sometime the important thing isn't the return on
capital. It's the return of capital."
When introduced, my bill will include an eUmination of the earnings test for retir-
ees. I believe the benefits of encouraging Americans to stay in the work force will
strengthen Social Security in the long run.
Paying for It
An important issue that any reformer must confront is how to finance the ta*ansi-
tion to a modem system. We start deep in the hole with a $9 trillion unfunded li-
abihty. The problem becomes harder when 2.6 percent or more of taxable payroll
is channeled into PRSAs, the earnings test is repealed, and widows benefits ex-
panded by 10 percent as I propose. , ^ „ j •!.« j
Fortunately, the problem can be resolved under a policy of easy does it and
"steady as she goes.^' My answer is to slow down the growth of benefits by a smaL
amount each year for a long time. Under currently law, OASDI benefits will m-
crease by 90 percent, after inflation, over the next 75 years. If we agree that real
benefits should grow at a slower rate, then we can solve this problem.
My bill does this by amending the benefit formula. Before presentmg my amend-
ments, I wish to first review how initial Social Security benefit checks are deter-
mined. Under current law, a worker at normal retirement age earns a monthly ben-
efit check known as the "primary insurance amount" or PLA. The PIA is calculated
in steps. First, a worker's entire earnings record, fi-om teenage years to retirement,
is updated for inflation. Then, only the highest earning 35 years are isolated. Next,
these best earning years are averaged to get an average annual earnings level. Fi-
nally this total is divided by 12 to get "Average Indexed Monthly Earmngs or
AIME. ^ ^ ,.
Social Security is often described as a progressive program. The reason for ttus
belief is that the PIA is derived fi"om AIME in a progressive way. In 1999, anyone
with an AIME of $505 or less, the equivalent of only $6,060 in year, will receive
90 percent of this amount annually. Anyone with an AIME of $3,043 will receive
368
90 percent of the first $505 of AIME, then 32 percent of the remaining amount. Any-
one with an AIME in excess of $3,043 will receive 90 percent of the first $505 of
AIME, 32 percent of the next $2,538, and only 15 percent of any remaining
amounts. As you can see. Social Security provides 90 percent of the earnings of a
very low paid worker's historic pay while only 42 percent of workers who averaged
earnings of $36,000. The wage replacement percentage dips lower for the best off
participants. The 1999 dollar thresholds of $505 and $3,043 where the benefit rates
shift are known as "bend points." Under current law, they are annually increased
by changes in average nominal wages.
I propose to make the Social Security system more progressive by slowing down
the growth rate of benefits for those in the 32 percent and 15 percent benefit brack-
ets. I do this first by phasing in a 5 percent bracket over 5 years that only the high-
est paid workers would face. It would start at AIME above $3,720 if fully in effect
today. Next, I propose that the 5 percent and 15 percent brackets gradually decline
at a 2.5 percent rate. In the first adjustment year for example, they would be 4.875
(5 x 0.975) and 31.2 percent (32 x 0.975). Five years out they would be 4.41 (5 x
0.985 X 0.985 x 0.985 x 0.985 x 0.985) and 28.2 percent ( 32 x 0.985 x 0.985 x 0.985
X 0.985 x 0.985). I propose that the 32 percent rate also decline but by only 2 per-
cent a year, not 2.5 percent. I want the lowest paid workers to be unaffected or un-
ambiguously better off from my changes. Consequently, the 90 percent rate is not
subject to reduction.
As a further way to slow down the growth rate in real benefits, I proposed that
the 15 percent and 5 percent bend points, and their future derivative rates, be in-
dexed to changes in the CPI, not nominal wages. The bend point that defines the
90 percent AIME credit level will continue to rise with nominal wages.
I believe the mechanism under my bill, which generates a very gradual change
annual change over a long period of time is a fair way to allocate the costs across
generations and income levels. It's true that high school kids and young workers
today wovild make the largest contributions to solvency. However, as we saw earher,
they have the time to benefit from the magic of compound interest. The two pay-
ment streams, one from Social Security, the other fi^om PRSAs, together will exceed
the amount of benefits projected under current law just fi"om Social Security.
It's worth remarking that our youngest workers have the least faith that they wiU
ever receive a Social Security benefit. In one famous poll, a larger number said they
believed in UFOs than they would collect Social Security. Young workers will espe-
cially like having a binding property right in their own privately managed PRSA
while giving up only some of a Social Security benefit many never expect to see in
the first place.
Gradually Raising the Retirement Age as Life Expectancy at
Age 65 Rapidly Improves
There are two other reforms required to restore Social Security to long-term
health. The first requires thinking through a pleasant subject, increasing life expect-
ancy during our retirement years. The actuaries predict that newborn children
today who reach 65 years of age will live 3 years longer than those who reach that
age now. The difference in life expectancy works out to about 1/2 additional month
of life for every passing year. This means an infant bom today who reaches his 65th
birthday can expect to live until 85.5, compared to 82.5 today.
I propose that we all share our good fortune of living longer with the taxpayers.
After all, we'll have more time to prepare for it! I propose eliminating the 11 year
hiatus in current law between 2005-16 where the retirement age remains at 66 be-
fore increasing in 2 month increments in 2017 to 2021. Instead, I recommend rais-
ing it to 67 by 2010, then indexing it to life expectancy. The indexing provision may
be the most important idea in the bill if the Task Force experts prove prescient and
our children and grandchildren are destined to led much longer lives than we. Re-
flecting on the age of this Committee's venerable Chairman and my upcoming 65th
birthday, I think the vast majority of future workers, who can be expected to be in
better shape than we are today, are up to the task. For those who are not, we
should update the disability program. For those who want to retire early, we should
let them do so, as is now done, with actuarially fair reduced benefits.
Sharing the PRSA Bounty With the Taxpayers
As the size of PRSAs grows, the need for taxpayer assistance declines. We can
ask for an especially large contribution from that young attorney who will have a
PRSA worth over $1,000,000 for example. I propose that PRSA accounts be offset
by the future value of contributions made into PRSA assuming a 3.7 percent real
rate of return. In effect, a worker who gets a 6.5 percent real rate of return from
369
equity investments will keep 2.8 percent. The remaining 3.7 percent is returned to
the Trust Funds so they balance. A 2.8 percent real rate of return is much higher
than the 1 percent or less experts now predict on future OASDI payroll tax pay-
ments if, and it's a big if, Congress finds a way to honor all benefit promises under
current law. I wish it could be higher. But as Billy Joel sang, "We didn't start the
fire. It's been burning since the world been turning." We have to eUminate the $9
triUion shortfall we've been handed or leave a more difficult challenge to future
leaders who will lead if we refuse the challenge.
Actuarial Scoring of the Social Security Solvency Act
Here is the summary table the Social Security actuaries.
ESTIMATED LONG-RANGE OASDI FINANCIAL EFFECT OF PROPOSAL OF
REPRESENTATIVE NICK SMITH
Estimated
change in long-
range OASDI ac-
tuarial balance'
201 Raise the NRA by 2 months per year for those age 62 in 2000 to 2011, then index to maintain a
constant ratio of expected retirement years to potential work years 0.50
202 Provide a third PIA bend point in 2000 with a 5 percent percent factor; index the second and
third bend points by the CPI and gradually phase down the 32, 15 and 5 percent factors after
2000 2.89
203 Annual statement for workers and beneficiaries (^)
205 Cover under OASDI all State and local government employees hired after 2000 0.21
206 Increase benefit payable to all surviving spouses by 10 percent beginning 2001 -0.30
207 SSA study the feasibility of optional participation (^)
Subtotal for sections 201, 202, 203, 205, 206, 207 3.21
101 Set up PRSA accounts starting 2001.
102 Redirect 2.6 percentage points of OASDI payroll tax to PRSAs for 2001-2036. After 2036, redirect
to PRSAs any OASDI income in excess of the amount needed to cover annual program costs
and maintain a minimal contingency reserve trust fund. Transfer specified amounts from the
Treasury to OASDI for years 2001-9 (based on current CBO surplus est).
103 Reduce OASI benefit levels by the amount of lifetime PRSA contributions, accumulated at the
yield on trust fund assets plus 0.7 percent - 1-15
Total for proposal ^
' Estimates for individual provisions exclude interaction.
2 Negligible, i.e., less than 0.005 percent of payroll
Notes: Based on the intermediate assumptions of the 1999 Annual Trustees Report, Office of the Chief Actuaiy, Social Security Administra-
tion, June 5, 1999.
The Impact of the Plan on the Unified Budget
The Social Security Solvency Act has a very salutary effect on the long run unified
budget. Under current law, the nation will experience a dramatic swing in the uni-
fied budget over the next sixty years. Until most of the baby boomers retire around
2020, the nation can expect to run unified budget surpluses. For the fifty years or
longer that follow 2020, the unified budget will plunge into the red with accelerating
speed. My bill helps to stabilize the unified budget over the long run by reducing
the size of surpluses now and reducing the size of the deficits that appear afler
2020. The bill principally reduces unified surpluses now by channeling a portion of
payroll receipts into PSRAs. By amending the benefits formula, it reduces unified
budget deficits significantly later on. Overall, my bill makes the government small-
er. Both taxes and spending as a share of GDP fall significantly in the middle of
the next century.
My bill's primary impact in the early years is to reduce revenues by 2.6 percent
of taxable payroll, starting in 2001. Table II F7 of the Social Security 1999 Trustees
Report specifies how much revenue, by year, 12.4 percent of taxable payroll tax
raises for the several years. By calculating what fraction 2.6 is of 12.4, then mul-
tiplying by projected taxable payroU receipts its possible to calcvdate how much the
bill reduces revenues. We estimate these revenue reductions will be offset by $12
billion annually by 2008 by bringing newly hired state and local government work-
ers under Social Security.
My bill provides for a 10 percent increase in widows/widower benefits, which will
increase Social Security outlays. Short term outlays also will increase because less
370
Federal debt will be retired due to the revenue reductions and outlays increases,
resulting in higher interest expenses.
Gradual reduction in benefits, due to indexing the bend points to the CPI rather
than nominal wages, and gradual phasing down the 32 percent, 15 percent, and 5
percent benefit factors, will reduce outlays by growing amounts. Benefits are further
reduced through the 3.7 percent offset formula described above.
The combined impact of all these changes is shown in the following table:
IMPACT OF THE MAJOR PROVISIONS OF THE SOCIAL SECURITY SOLVENCY ACT
ON THE UNIFIED BUDGET
[Dollars in billions]
Year
Debt
Widow/Widower
Benefits
Total outlays
Revenues
Impact on unified budget
2001
+$5
+$9
-$1
+$13
-$95
-$108
2002
+9
+9
-3
+15
-97
-112
2003
+14
+9
-4
+19
-100
-119
2004
+19
+9
-6
+22
-104
-126
2005
+24
+10
-9
+25
-109
-134
2006
+29
+10
-14
+25
-113
-138
2007
+34
+10
-19
+25
-117
-142
2008
+39
+10
-25
+24
-122
-146
Total
+205
-857
- 1,025
To comply with reconciliation instructions, the Committee could elect to defer
some contributions into PRSA accounts from 2001^ until 2005-8. Additional reve-
nue would have to be found since estimated revenue losses total $857 billion from
2000 to 2008 while the instruction hmits reductions to $778 billion from 2000 to
2009. Spending offsets will be needed to pay for the widow's benefit.
The Act Prevents Dangerous Future Unified Budget Deficits
PERCENT OF TAXABLE PAYROLL
Current law income Current law cost
Smith bill income
Smith bill Cost rate
2010
12.75
11.91
.84
10.13
11.30
-1.18
2020
12.91
15.03
-2.12
10.22
11.86
-1.63
2030
13.09
17.71
-4.62
10.33
11.98
-1.65
2040
13.17
18.18
-5.00
9.62
9.85
-0.23
2050
13.22
18.28
-5.06
7.10
7.26
-0.17
2060
13.29
19.05
-5.77
5.02
5.14
-0.12
2070
13.34
19.63
-6.29
3.09
3.18
-0.09
After 2015, my bill substantially reduces future unified budget deficits. The pre-
cise amounts are difficult to calculate 15, 25, or 50 years out. However, their mag-
nitude can be suggested from the actuaries' scoring. Under current law, the 1999
Trustees Report found that OASDI would run deficits starting in 2015 by growing
amounts. By 2040, OASDI will run deficits equal to 5.00 percent of taxable payroll
and growing. Under my plan, OASDI will run only a minor deficit of 0.23 percent
of taxable payroll, and it will be falling. Here is a comparison of the two actuarial
projections. It proves that my bill avoids the creation of massive unified deficits for
most of the 21st century. It therefore stabilizes long-run fiscal policy.
Impact on the Social Security Trust Funds
Instead of exhausting the Trust Funds in 2035, my plan keeps them in the black.
Year
Trust fund ratio
Year
Trust fund ratio
Year
Trust fund ratio
2005
2015
2025
241
267
159
2035
2045
2055
54
45
45
2065
2074
49
68
Note; The Trust Fund Ratio equals the amount of assets on hand divided by that year's disbursements.
371
Use of General Revenues
I believe solving Social Security's problems is so important we should apply the
proceeds from of on-budget surpluses from 2000 until 2008 to achieve it. Impor-
tantly, the plan still provides room for tax reUef, improving Medicare's unstable fi-
nancing, or a reduction in the national debt.
SMITH PLAN REDUCES, BUT DOES NOT ELIMINATE, SHORT-TERM UNIFIED BUDGET SURPLUSES
[Dollars in billions]
Year 2001 2002 2003 2004 2005 2006 2007 2008
Off-Budget $145 $153 $161 $171 $183 $193 $204 $212
On Budget 6 55 48 63 72 113 130 143
Smith Plan -107 -111 -118 -125 -132 -137 -141 -146
Remaining Surplus +44 +98 +91 +109 +123 +169 +193 +209
Every day of delay leaves us vnth fewer resources to bring solvency tc Social Secu-
rity. Right now, the system is enjoying robust surpluses. In fifteen years, these stir-
pluses will be gone, replaced by deficits that grow larger each year. We must act
now for the baby boomers' retirement.
Congressman Nick Smith's Social Security Solvency Act: A Tax Cut for
Workers
• Allows workers to own and invest a portion of their Social Security taxes by cre-
ating Personal Retirement Savings Accounts (PRSAs).
• PRSA investment starts at 2.5 percent of wages (20 percent of Social Security
taxes) and gradually increases.
• PRSA limited to a variety of safe investments.
• Uses surpluses coming into the Social Security Trust Fimd to finance PRSAs.
• No increases in taxes or government borrowing.
• PRSA account withdrawals may begin at 59^2, while the eUgibility age for fixed
benefits is gradually increased by 2 years over current law.
• Tax incentive for workers to invest an additional $2,000 each year.
• Gradually slows down benefit increases for high income retirees.
• Divides PRSA contributions between couples to protect non-working spouses.
• Widows or widowers benefit increased to 110 percent of standard benefit pay-
ment.
• Scored by the Social Security Administration to keep Social Security solvent.
• Maintains a Trust Fund reserve.
Mr. Collins. Is this an option, or does this 2.6 percent apply to
all?
Chairman Smith. It is optional when you go into the prograrn.
But here again if you are expecting to receive a return on your pri-
vate investments of 4 percent or more, then in the long run it is
going to be an advantage to go into the program. So the way it is
scored by Social Security is assuming that everybody is going into
the program, but in our legislation it is optional.
Mr. Collins. How about age? Is there any age limitation to opt
into it?
Chairman SMITH. No age limitation. In fact, what we do, Mac,
is we also require the Social Security trustees to start looking at
ways individuals can totally opt out of Social Security if they want
to. That is going to be somewhat expensive, but at least it seemed
reasonable for younger people to have some way of opting out of
Social Security if they wanted to, except we wouldn't allow them
to opt out of the disability insurance portion of the program.
Mr. Collins. Do I understand that someone age 61 could opt
into this?
Chairman Smith. Yes, any age can opt into it. Of course, the peo-
ple who are really going to benefit are those who can keep that pri-
372
vate investment in there for 20 years or 25 years. Then the magic
of compound interest is going to give you a much higher benefit in
relation to what you can now get luider Social Security.
Mr. Collins. What age maximum is the least benefit to opt into
it; 55, 60?
Chairman Smith. If you can get a 5 or 6 percent real return,
then you should opt into it at any age because, No. 1, it becomes
your account. If you happen to die before retirement, you are get-
ting all of that personal retirement savings, unlike the current So-
cial Security system that leaves you with nothing. In terms of what
future Congresses might do, because the Supreme Court has ruled
twice now that there is no entitlement for benefits regardless of
what you pay in Social Security taxes, then I think once people un-
derstand the consequences, most everybody is going to opt into the
program unless they are ready to retire in the next year or two.
So maybe, if I were answering your question specifically, I would
say anybody that was under 60 might find an advantage in coming
into this program.
Mr. Collins. You have two spouses working, both the husband
and wife. The wife makes $30,000 a year. The husband makes
$60,000. You mentioned something about you treat them equal?
Chairman Smith. Yes. I take 2.6 percent to start out. In the
early years it is 2.6 percent. Ultimately it gets to 8.4 percent. In
the early years 2.6 percent times 30,000 plus 2.6 percent times
60,000 are added together, so each spouse, each husband and wife,
would have the exact same amount to invest in their personal re-
tirement account. It might reduce some of the business for attor-
neys in case there is ever a divorce because it has been equally di-
vided while they are married. Then the division and equal invest-
ment would, of course, stop, but it is all accounted for in terms of
if there is a divorce or something else happens plus the fairness of
having it equally in both names.
Mr. Collins. Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman.
Mr. Smith, a couple of questions. First I want to start by sa5dng
I think this is a tremendous plan, extremely thoughtful in detail,
and it accomplishes a number of things. Is it fair to say that the
goal of your plan is to gradually transition to a fully funded, fully
prefunded system of personal savings accounts, and with respect to
the retirement portion of Social Security, that is your goal to pro-
foundly transform the nature of this system?
Chairman Smith. That is the goal. And if you can get a real re-
turn of more than 3.7 percent, then you are going to be ahead of
fixed benefits. What we did do is we saved out almost 4 percent in
the current plan. I am not sure what is going to happen to the dis-
ability insurance portion of the program. Since that has grown so
tremendously, we wanted to save enough aside there to make sure
it is covered.
Mr. Toomey. By using 4 percent you are using more than twice
of what it would currently cost to finance that part of it?
Chairman Smith. The financing now is 1.7 percent.
Mr. Toomey. As far as ownership of the plans go, does your plan
contemplate complete ownership, by which I mean — first of all, do
you force annuitization?
373
Chairman Smith. Yes, we force annuitization so that the fixed
portion of benefits plus the annuity would equal ultimate Social Se-
curity benefits.
Mr. TOOMEY. So the forced annuitization would only apply to
that amount of the savings account which is necessary to generate
that minimum savings; is that correct? Anything above and beyond
that a person would be free to do with as they please?
Chairman Smith. Correct.
Mr. ToOMEY. As far as investment options, do I understand you
correctly to say that you would limit them to index funds?
Chairman Smith. Yes. We limit them to four choices. Now, we
add sort of a fifth option directing the Secretary of Treasury to add
any other investment account allowances that he thinks is appro-
priate that are less risky investments.
Ultimately it seems to me that we have got to start training our
young kids about investment if they are going to be able to enjoy
the wealth creation that investment can accomplish. I would like
to incorporate in my bill, but I can't very well do it, that we start
training these kids in high school to excite them about the magic
of compound interest and investments, but eventually I think it is
important that we expand that to a broader range of investments.
Mr. TooMEY. Right. I agree with that sense.
As far as the reduction in fixed benefits, if I understand cor-
rectly, you apply a calculation equivalent of a theoretical
annuitization based on 3.7 percent assumed return to the savings
account, and that is the amount by which you would reduce the
fixed benefit portion?
Chairman Smith. Technically in the bill we add what Treasury's
30-year treasuries are getting plus 0.7 percent. That amounts to
3.7 percent. Your offset of your fixed benefits would equal 3.7 per-
cent of your personal retirement savings account.
Mr. TooMEY. That is a fixed amount. You don't contemplate that
fluctuating with respect to some market index or anything?
Chairman Smith. No, I don't.
Mr. TooMEY. The administration of accounts like this we have
heard a lot of discussion over the course of our hearing. Some be-
lieve that it is absolutely impossible. Some have made reasonably
compelling arguments that they have got a system for this. Do you
advocate using an approach similar to what State Street rec-
ommended using?
Chairman Smith. Yes, we include the State Street type of ap-
proach in our bill.
Mr. ToOMEY. Last question. The— using CPI versus wages to de-
termine initial benefits, you mention you do that with an applica-
tion of two out of the three bend points, not the first, as Chairman
Kasich approaches it, with all three of the bend points. Is that pri-
marily to keep the system more progressive, or does that have the
net effect of keeping the system more progressive or less, or does
it not
Chairman Smith. It has the effect of keeping the system more
progressive so the low- and moderate-wage individuals would con-
tinue to have their benefits grow faster than the higher-income re-
cipients.
374
Mr. TooMEY. If you applied it to all three bend points, as Chair-
man Kasich does, there would still be an element of progressivity
in the program, correct?
Chairman Smith. There would be some progressivity. Mr. Ka-
sich, as I understand his proposal, offsets the disadvantage of
changing the bend point for — the first bend point by allowing a
higher percentage of investment for those low income.
Mr. ToOMEY. Thank you very much.
Mr. Collins. One other question, Chairman Smith. If I under-
stand your proposal here, you don't have any transfer payments
built into this as was presented by the memos from the other end
of the hall; is that correct?
Chairman Smith. I do have transfer payments. I call on general
fund surpluses not to exceed Social Security surpluses to help in
the transition. Also, what we will be doing in the bill is we are
using the Social Security surplus to pay down the debt and to re-
duce any negative effects for any recipients regardless of their age.
We are going to look for the general ftmd to contribute the amount
of interest savings to try to make sure that nobody is disadvan-
taged, even that vulnerable age group from 45 to 60.
Mr. Collins. But by transfer payment, you are not setting up,
you are not requiring above the current tax rate any additional
funds? I know it is going to take general funds to bail out any
Chairman Smith. No.
Mr. Collins. You are not setting up a kitty account; you are not
setting up a personal account that takes money beyond the current
tax system?
Chairman Smith. No, except we do call on money coming in from
the general fund to a certain extent.
Mr. Collins. You have a safety net?
Chairman Smith. And then we have a safety net, yes.
Mr. Collins. Thank you.
Chairman SMITH. Thank you.
Mr. Collins. Any further questions for this gentleman?
Mr. ToOMEY. Not at the present time.
Mr. Collins. Stand in reserve in case some question comes up,
please.
Chairman Smith. You may mail me questions.
Mr. Collins. We expect a full answer, too.
Chairman Smith. Mr. DeFazio, I think, is next.
Mr. Collins. Mr. DeFazio.
Chairman Smith [presiding]. Mr. Roscoe Bartlett.
Mr. Bartlett. Mr. Markey should be here to testify with me. We
are checking to see if he is on his way.
Chairman SMITH. We will stand in ease for the next 4 minutes
while the members of the Task Force eat lunch.
[Recess.]
Chairman Smith. Congressman Bartlett, thank you for your will-
ingness to go ahead of time, and we will have Representative Mar-
key join you when he gets here.
375
STATEMENT OF HON. ROSCOE G. BARTLETT, A REPRESENTA-
TIVE IN CONGRESS FROM THE STATE OF MARYLAND
Mr. Bartlett. Thank you very much. Mr. Chairman and mem-
bers of the Social Security Task Force of the House Budget Com-
mittee, I want to thank you for the opportunity to testify before you
this afternoon. I appreciate the opportunity to discuss H.R. 990, the
Social Security Investment Fund Act of 1999, with the Task Force.
H.R. 990 was written to achieve a simple goal: putting the excess
Social Security taxes to their highest and best use. We beheve that
the surplus taxes collected for Social Security should get a rate of
return comparable to what a fund manager would get for a private
retirement program. With that in mind, the Social Security Invest-
ment Fund Act was written to allow surplus payroll taxes to take
advantage of the historically higher rates of return reaUzed in the
United States equities market. To accomphsh this, our bill would
authorize the managing trustee of the Social Security Trust Fund
to transfer specific portions of the trust fund surplus to an inde-
pendent agency which will broadly invest in the United States eq-
uity market.
The Federal Government has extensive experience with investing
of this sort under the Thrift Savings Plan, the TSP. Because of the
positive experience of the TSP, we chose to closely model the Social
Security Investment Board after the Thrift Savings Board. I would
like to point out that we are all members of the Thrift Savings
Plan, and I cannot recall in my 7 years as a Member anyone taking
to the well of the House to question the management of the Thrift
Savings Plan. Not only can government manage broad-based stock
investments, but it has been doing so for a number of years.
After the Social Security Investment Board receives the surplus
Social Security revenue, the taxes will be invested in broad-based
index funds. Index funds are passively managed funds which rep-
licate the performance of the market as a whole, not individual
stocks. The funds envisioned by H.R. 990 would be similar to the
C-Fund in the Thrift Savings Plan. In all likelihood, the indices se-
lected would be similar to the popular Standard and Poor 500 or
the Willshire 5000. I believe it is important to point out that pri-
vate sector professionals, such as those at the widely respected
Standard and Poor's, will determine what companies are included
in the Social Security Investment Fund by the criteria they estab-
lish to govern inclusion of stocks in their indices. Under our bill,
there cannot be a room full of government bureaucrats picking and
choosing what companies get included in an index.
I understand that there are some Members who have concerns
about our bill. Many Members may be concerned that our bill will
unduly involve the Federal Government in the affairs of national
businesses. I had the same concern when I first started working on
this bill. Mr. Markey and I went to great pains to include a number
of provisions in this bill that would address these concerns.
As I mentioned earlier, the surpluses would be invested in broad-
based private sector investment funds. This effiectively prevents the
fund managers from picking and choosing winners and losers. The
companies that are included in the Social Security Investment
Fund will be included because they are already a constituent com-
pany in a widely used private sector index.
376
Secondly, we prevent the manager of the fund from influencing
corporate decision-making by requiring them to mirror vote their
shares. This means that the managers are exphcitly instructed to
vote last and cast their votes in the same proportion as the votes
were cast in the company as a whole. This will effectively eliminate
any possibility of government managers having an effect on the se-
lection of members of the corporate boards or on the formulation
of corporate policy.
We have also included extensive reporting requirements so that
the Congress will be able to closely monitor the management of the
funds. Since the surplus would be invested in funds that track
widely available private sector indices, it will be fairly simple to
monitor whether or not the funds are tracking the indices or not.
Since the members of the board will be regularly reporting to Con-
gress, there will be ample opportunity to publicly address an incon-
sistency should it arise.
We also have included language in the bill which prohibits com-
panies from being included or excluded from an index for social, po-
litical, or religious reasons. Although I may personally object to the
policies of various companies in a fund, the only criteria that can
be used for the inclusion or exclusion is whether or not they would
otherwise be included in the index.
Finally, there have been some concerns that while our bill may
be well crafted and left untouched would prevent the government
from acting irresponsibly or imprudently, its provisions could be
changed. I will be the first to concede that our bill can in no way
prevent a future Congress from altering its provisions in breaking
down the firewalls that we have constructed, but I have rarely
heard Members retreat from passing good legislation because a fu-
ture Congress could undo their good work. Should we abandon tax
cuts because a future Congress may increase tax rates? Should we
forsake Medicare reform because a presently unelected Congress
would scuttle our changes? Of course not. What we have to do is
pass prudent reform and remain vigilant in the future so the safe-
guards will not be undone.
Our bill represents a common-sense proposal that Members from
both sides of the aisle can support. The bill will add at least 6
years to the life of the Social Security program without raising
taxes or cutting benefits. It will get the Social Security surplus out
of Washington and put it to work for Social Security beneficiaries.
Most importantly, the bill will give the Congress the opportunity
to craft a proposal that addresses the underlying demographic and
unfunded liability problems that exist within the Social Security
program.
Task force members, our bill is a modest proposal, but we believe
the right proposal for the 106th Congress. I believe that com-
prehensive reform is not possible in this Congress. Early next year
Presidential politics will take center stage. Considering the House
has only passed three appropriations bills, we have a $788 billion
tax bill pending, and it is nearly the 4th of July. I am unsure when
we will have time for the national debate necessary to reach the
consensus required for fundamental Social Security reform. With
that in mind, I believe Congress should act while times are good
377
and embrace the Bartlett-Markey bill and bide some time for Social
Security while Congress works out a more comprehensive solution.
I thank the Task Force for its time and welcome any questions.
[The prepared statement of Mr. Bartlett follows:]
Prepared Statement of Hon. Roscoe G. Bartlett, a Representative in
Congress From the State of Maryland
Mr. Chairman and members of the Social Security Task Force of the House Budg-
et Committee, I want to thank you for the opportunity to testify before you this
afternoon. I appreciate the opportunity to discuss H.R. 990, the Socisd Security In-
vestment Fimd Act of 1999, with your Task Force.
H.R. 990 was written to achieve a simple goal; putting the excess Social Security
taxes to their highest and best use. We believe that the surplus taxes collected for
Social Security, should get a rate of return comparable to what a private sector fund
manager would get for a private retirement program. With that in mind, the Social
Security Investment Fund Act was written to allow "surplus" pasToU taxes to take
advantage of the historically higher rates of return realized in the United States eq-
uity market. Estimates are that investing a portion of the surplus in the equities
market alone will add at least 6 years to the hfe of Social Security.
To reaUze this goal we estabhsh an independent Federal agency which will be re-
sponsible for investing portions of the projected Social Security surplus in broad
based private-sector index funds.
Advantages of Investment in an "Index Fund"
At regular intervals, a portion of the surplus Social Security taxes that are not
necessary to pay current beneficiaries will be transferred to the Social Secvuity In-
vestment Board to be invested for their benefit in broad-based stock index funds.
"Index funds" are passively managed funds which repUcate the performance of the
market as a whole, not individual companies.
By investing in widely used indices the Social Security Investment Fund will be
able to take advantage of the traditionally higher rates of return available in the
equities market, effectively giving the taxpayer, "more bang for their buck."
The General Accounting Office (GAO) estimates that indexed investment in the
stock market will have a long-term real rate of return of 7 percent, as opposed to
the 2.5 percent real rate of return the Social Security Trust Fund currently receives
on government securities. In addition to having a higher rate of return than the gov-
ernment securities, stocks are real assets that can be hquidated to pay beneficiaries,
without having to resort to another government revenue stream. Indices are also a
prudent choice, because they perform well when compared to actively managed pri-
vate sector funds. The Standard and Poor's 500 (S&P 500), an index of the "large-
cap" companies, out-performs over 75 percent of the actively managed mutual funds.
The funds envisioned by H.R. 990 would be similar to the C-Fund currently avail-
able in the TSP and administered by Wells Fargo. It is anticipated that the indices
selected would be similar to the popular S&P 500 or the Willshire 5000. By selecting
indices which only use value-neutral criteria, market-weighting in the case of the
S&P 500, we will be vesting the market professionals, such as Standard and Poor's,
with the responsibility for selecting what companies are included in the funds in the
Social Security Investment Fund.
Finally by investing a portion of the Social Security Trust Fund in the American
market, there will be tangible assets available for Social Security benefits when So-
cial Security outlays surpass revenues in 2014.
Administration of the Fund and the Soclal Security Investment Board and
Executive Director
The Social Security Investment Board will be composed of five members who will
serve staggered 10 year terms. One of the members will be elected chairmem. All
of the members of the board will be required to have extensive private sector experi-
ence in the management of large investment portfolios. The members will be ap-
pointed by the President and require Senate ratification. The Speaker of the House
and the Senate Majority Leader shall each recommend one member.
The Board develops policies to be carried out by the Executive Director. The
Board is prohibited, however, from directing any investment in any specific stock.
The Executive Director will be responsible for overseeing the investment of surplus
Social Security revenue by qualified private-sector managers. The private sector
managers will be chosen on a competitive basis consistent with Federal procurement
378
policies. The managers will have to be presently engaged in the management of
large portfoUos in the private-sector. Because the surplus will be invested in exist-
ing indices, the managers will be competing only to provide the Board with adminis-
tration of the funds for the lowest possible cost, not to sell the Board the "best" per-
forming fund. It is anticipated that because there will be a small nimiber of ac-
counts to manage that the administrative costs of the Fund will be extremely low.
Safeguards to Prevent Political Manipulation
There have been a number of legitimate concerns raised about government di-
rected investment. One of the most prominent concerns is that our bill will unduly
involve the Federal Government in the affairs of national businesses. I had the
same concern when I first started working on this bill. Mr. Markey and I went to
great lengths to include a number of provisions in this bill that would address this
concern.
As outlined earlier, the surpluses would be invested in broad-based private sector
investment funds. This effectively prevents the fund managers ft-om "picking and
choosing^' "winners and losers." The companies that are included in the Social Secu-
rity Investment Fund will be included because they are already a constituent com-
pany in a widely used private sector index.
Secondly the bill prevents the members of the board, the Executive Director or
the managers of the funds from influencing corporate decision making by requiring
them to mirror-vote their shares. This means that the managers are exphcitly in-
structed to vote last and cast their votes in the same proportion as the votes were
cast in the company as a whole. This will effectively eliminate any possibility of the
government managers having an effect on the selection of members of the corporate
boards or on the formulation of corporate policy.
We have also included extensive reporting requirements so that Congress will be
able to closely monitor the management of the fiinds. The Board and the Executive
Director will be required to appear before the House Ways and Means Committee
and the Senate Finance Committee semi-annually. The Board will also be required
to file quarterly reports with Congress detailing the management of the fund. Addi-
tionally the Board will be subjected to an annual audit. These provision provide for
a significant degree of transparency which is not required of many of the agencies
Congress currently oversees.
In addition to the reporting requirements, the natm-e of the indices lends them
to easy monitoring. Because the composition of the S&P 500 and the Willshire 5000
is widely known, and closely monitored in the markets, it would be difficult for the
Board to inappropriately drop a company without eliciting the attention of Congress.
Moreover, one would expect that if a company felt that it had been inappropriately
excluded from an index, they would bring it to the attention of their Congressman.
Because of the rigorous reporting and testimony requirements, there will be ample
opportunity to publicly address an inconsistency should it arise.
Additionally, we have included language in the bill which explicitly prohibits com-
panies fi-om being included or excluded from an index for social, political or reUgious
reasons. Although a Member or an interest group may object to the policies of var-
ious companies in an index and desire their exclusion, the only criteria that can be
used for their inclusion or exclusion is whether or not they would otherwise be in-
cluded in the index.
Lastly there have been some concerns, that these safeguards are insufficient be-
cause they can be changed by a future Congress. I will be the first to concede that
our bill can in no way prevent a future Congress fi-om altering its provisions and
breaking down the firewalls that we have constructed. But I have rarely heard
members retreat ft-om passing good legislation because a future Congress could
undue their good work. Should we abandon tax cuts because a future Congress may
increase tax rates? Should we forsake Medicare reform, because a presently
unelected Congress would scuttle our changes? Of course not. What we have to do,
is pass prudent reform and remain vigilant in the future so the safeguards will not
be undone.
Political Reality Makes Bartlett/Markey the Common-Sense Solution
Our biU represents a common-sense proposal that members fi"om both sides of the
isle can support. The bill will add at least 6 years to the life of the Social Security
program without raising taxes or cutting benefits. It will get the Social Secvuity
Surplus out of Washington and put it to work for Social Security beneficiaries. Most
importantly, the bill will give the Congress the opportunity to craft a proposal that
addresses the underling demographic and unfunded liability problems that exist
within the Social Security Program.
379
Task Force Members, our bill is a modest proposal, but we believe the right pro-
posal for the 106th Congress. I believe that comprehensive reform is not possible
this Congress. Early next year, Presidential politics will take center-stage. Consider-
ing the House has only passed three appropriations bills, we have a $788 Billion
tax bill pending and it is nearly the forth of July, I am xmsure when we will have
time for the national debate necessary to reach the consensus required for fun-
damental Social Security Reform. With that in mind, I believe Congress should act
while times are good and embrace the Bartlett/Markey bill and bide some time for
Social Security while Congress works on a more comprehensive solution.
I thank the Task Force for its time and attention.
Chairman Smith. Roscoe, it might be the plan that we move
ahead with. I agree with you, it is important that we proceed with
doing something to get some of the money out of town because the
danger is you use it for something else, tax cuts or expanded
spending. But your bill only extends the solvency for 6 years. Have
you looked at or thought about what ultimately might be a way to
keep it solvent forever or for at least 75 years?
Mr. Bartlett. What this does it gives us 6 more years to have
that debate and reach that conclusion. But the earlier we have the
debate and reach the conclusion, the easier it will be to solve the
problem.
Obviously there are only two things you can do. One is to in-
crease revenues, and the other is to decrease expenses. I think that
increasing revenues is unacceptable already. The FICA payroll tax
is the largest tax on many working people's pay stub, so I don't
think we can raise that percentage tax.
I don't think also that it is acceptable to reduce the benefits that
current beneficiaries get. There are many of our senior citizens that
live on the edge, and reducing these benefits would, I think, be un-
conscionable for them.
We might means test, and that is something we need to talk
about. If, in fact, this is a trust fund, then we shouldn't means test.
If it is an insurance fund, and you have invested your money in
it, you ought to get back what you have put in, but after you have
gotten back what you put in, I don't see any problems in mean test-
ing beyond that.
I know that the President's Commission on Social Security Sol-
vency has recommended that we simply increase the retirement
age. It is now 67 for all bom after 1960, I think. If we were to in-
crease that to 70, most people believe that that would solve our So-
cial Security solvency problem. And the truth is today at 70, we are
healthier and will live longer than we would have at 65 when So-
cial Security went into effect. As a matter of fact, when Social Se-
curity first went into effect, the average male did not live to be 65.
The average female lived a bit longer. But today the average male
will live longer after 70 than he would have lived after 65 when
Social Security was put into effect. There are many seniors that do
not want to be forced out of the job market at 65 or 67 in the fu-
ture. They are very vital. They feel they have something to contrib-
ute, and so I do not find seniors adverse to increasing the retire-
ment age to 70. It is my understanding that for the long haul this
would solve the problem, but for the short term, we think that our
bill, which I think addresses all of the concerns that Alan Green-
span had.
The government managers cannot pick and choose stocks. They
can't even vote the stocks. They are mirror voting the stocks, and
380
all we are doing is using the same prescription we have in the
Thrift Savings Plan, which has been in operation for a number of
years. We all are a part of this, and nobody complains about it. The
amount of money that our plan would invest in the market is less
than the amount of money that State and local retirement plans
invest in the market, so it is not a really large share of the market.
Chairman Smith. How long does your proposal extend the cash
flow, positive cash flow, of Social Security? In other words, does it
go beyond 2013 in terms of cash flow?
Mr. Bartlett. CBO said it extended it 6 years.
Chairman Smith. Six years would be the total solvency, assum-
ing that all of the trust fund is paid back, so it takes it to 2039,
as I understand it, but in terms of cash flow, right now there is
going to be less taxes coming in than would accommodate pay-
ments by the year 2013, I think is the current date. Does your bill
extend that?
Mr. Bartlett. Six years on the front end means 6 years on the
back end. It is my understanding it extended it from 2013 to 2019.
Of course, all of this depends on your assumptions as to what the
economy is going to do, but extended the date when the income and
the expenses were going to be equal for 6 years, which gives us 6
more years to solve the problem.
Chairman Smith. Has anybody calculated the administrative
cost?
Mr. Bartlett. The administrative cost should be very small.
They are the same as administrative costs in the Thrift Savings
Plan, and this, of course, was a part of the computations that CBO
did. The Thrift Savings Plan had to be subtracted from the total
increased revenues to reach the 6 years. I do not know what the
percentage of the administrative costs are, but they are very, very
much less than if you had an individual account and you were pay-
ing an individual ftind manager to manage it for you.
Another good thing about our bill is that this would provide a
mechanism so that when we move it — and I hope we do move to
individual savings account — that when we move to individual sav-
ings account, that there will already be there a mechanism with
very low administrative cost that you could choose to buy into, like
now when you have the Thrift Savings Plan, you don't do that on
your own. You are a participant with a large number of other peo-
ple, so the administrative costs are very low. If you do an equiva-
lent thing on your own, the administrative cost would be relatively
very high.
Chairman Smith. Currently thrift savings is working under two
basis points, I believe.
Mr. Bentsen.
Mr. Bentsen. No questions.
Chairman Smith. Mr. Herger.
Mr. Herger. I have no questions.
Chairman Smith. Roscoe, I don't believe we have any more ques-
tions. Any final comments? And we can still allow Mr. Markey
when he comes to give his testimony.
Mr. Bartlett. Just a word about how we got here. We had pre-
pared a bill, and when Mr. Markey's staff saw the bill, they called
and asked us if we would like to participate with them. Mr. Mar-
381
key is pretty much on the left of the political spectrum, I am pretty
much on the right of the political spectrum, and I thought it was
interesting that two people from the two ends of the political spec-
trum had similar notions as to how we might craft a bill that
would meet some of the challenges that we have in Social Security.
We worked very hard. Mr. Pomeroy was a part of that, who pre-
viously was a State manager of this kind of fund, and he worked
with us in crafting a bill that we thought met all of the objections
that people might have and the objective of extending Social Secu-
rity solvency.
We start out, by the way, with investing only about 15 percent
of the funds. As time goes on, more and more of the funds are in-
vested until near the end. Essentially 100 percent of the surpluses
are invested here. This was intentional so that we would have ex-
perience; if it wasn't going well at any time, the Congress could
change that, and we have ample opportunities to monitor this
through the reporting requirements of the bill. But initially it is
only about 15 percent of the surplus that would be invested. You
could increase that 6 years to more years, and I don't know how
many more years if you started investing all of the funds imme-
diately. We thought that that was a step that Congress would not
be willing to take; that this Httle demonstration, if you will, of 15
percent was something that would be acceptable, and then it grows
as we gain experience with it to ultimately be essentially all of the
funds that would be invested.
As you know, this market yields about three times more than
has traditionally been yielded by the non-negotiable U.S. Securi-
ties, which by law now is the only place that these funds can be
invested. The average investor, if he were retiring today, had in-
vested his funds in the market, would have the equivalent of over
$800,000 of investment. Social Security gives him about $180,000
of investment, the income from an investment, about a fourth of
what it would be had he invested in the market. This is not ac-
crued to the individual investor. It accrues to the fund, unlike a
personal savings account where the increased income would accrue
to the individual investor. This accrues to the Social Security Trust
Fund, which extends it for the 6 years.
Thank you very much.
Chairman Smith. Roscoe, thank you very much. Our com-
pliments for your willingness to move ahead in this — down these
tough roads.
Congressman DeFazio.
STATEMENT OF HON. PETER A. DeFAZIO, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF OREGON
Mr. DeFazio. Thank you, Mr. Chairman. Mr. Chairman, I have
a prepared statement. I would enter it in the record and make
some brief comments.
Chairman Smith. It is entered into the record.
Mr. DeFazio. Thank you, Mr. Chairman.
Mr. Chairman, a bit in common with the previous gentleman, so
I don't need to explain it, is I would take part of the surplus, 40
percent, and invest it, but invest it in an aggregate manner, but
with the same protections as mentioned by the previous speaker.
382
In addition, what I adopted was an objective of 75-year solvency,
no decrease in benefit, no increase in retirement age, and no im-
pact on the general fund. And I did that through both the invest-
ment and through a lifting the cap on the ages upon which one
pays pa3a-oll tax, and then since that provides more revenue than
is needed for 75-year solvency, I provide a $4,000 exemption on
FICA taxes. And as the previous gentleman said, more than 40 per-
cent of workers in America pay more than FICA than they do in
income tax. So my proposal would reduce taxes for 95 percent of
wage-earners in America; that is, everyone who earns less than
$76,600 per year. So 95 percent of the workers would come out
ahead with a tax reduction. They would have no increase in — no
decrease in benefits, no increase in age relative to full eligibility or
partial eligibility with reductions.
I would also increase benefits for people over age 85, because the
current system shows that people over age 85 are more likely to
be in poverty when they are relying upon Social Security, and
would provide for five child care dropout years; that is, parents
should not be penalized if they stay home to raise their children.
So I meet the objectives of the trustees, 75-year solvency, and
provide tax relief to 95 percent of working Americans.
Chairman Smith. Thank you very much.
[The prepared statement of Mr. DeFazio follows:]
Prepared Statement of Hon. Peter A. DeFazio, a Representative in Congress
From the State of Oregon
Thank you, Mr. Chairman, Ms. Rivers and members of the Task Force for giving
me the opportunity to testify today on my proposal to insure the future health of
the Social Security program.
Social Security is one of the most popular and successful New Deal programs. It
was created in 1935 and today provides essential retirement, survivors and disabil-
ity benefits to 44 million Americans. Before Social Security was approved by Con-
gress, more than one-half of America's elderly citizens lived in poverty.
Thanks to Social Security, fewer than 11 percent of today's seniors fall below the
poverty Une. Social Security provides more than half of the retirement income for
two out of every three people over 65 years of age. Social Security benefits make
up 90 percent or more of the income for about one out of three seniors.
It is important to understand that the Social Security Trust Fund is not bankrupt,
nor will it be. According to the 1999 Social Security Trustees Report, Social Security
is financially sound until at least 2034-35 years from now. Even if Congress does
nothing to reform the program, Social Security will continue to provide 75 percent
of current benefits for an additional 40 years— until the year 2073. With the rel-
atively modest reforms that I am proposing, the Social Security system should be
able to provide promised retirement benefits for many generations to come.
In fact, my proposal cuts taxes for 94 percent of working Americans, increases So-
cial Security benefits for the most needy, and saves Social Security. My proposal
amends the Social Security Act to restore 75 year solvency by:
• Providing a FICA payroll tax exemption for first $4000 of income, cutting taxes
for 94 percent of all workers. This exemption would cut Social Security taxes by
more than 11 percent for an individual earning $35,000 a year. Approximately 40
percent of American taxpayers pay more in FICA taxes than they pay in Federal
income tax!
• Investing 40 percent of the future Social Security surplus in broadly indexed eq-
uity funds. Many state retirement plans already invest a portion of their surplus
in the stock market.
• Making all earnings subject to payroll tax for both employer and employee be-
ginning in 2000. Retain the cap for benefit calculations. This affects only those who
earn more than $72,600 a year— less than 6 percent of wage earners.
• Increasing benefits at age 85 by 5 percent. Women over the age of 85 are more
thgin twice as likely to live in poverty than men of the same age. There are more
than twice as many women as men over the age of 85.
383
• Allowing up to 5 child-care drop-out years. Parents should not have reduced So-
cial Security benefits because they chose to stay home to raise their children.
The Social Security program is the most successfiil government program ever un-
dertaken. With these changes it can remain so. Thank you, Mr. Chairman. I would
welcome questions fi"om you or other members of the Committee.
Memorandum
Date: June 8, 1999
To: Harry C. Ballantyne, Chief Actuary
From: Stephen C. Goss, Deputy Chief Actuary; Ahce H. Wade, Actuary
Subject: Estimates of Long-Range OASDI Financial Effect of Proposal for Represent-
ative Peter DeFazio
Information
This memorandum provides long-range estimates of the effect on the financial sta-
tus of the OASDI program of a proposed plan to change several provisions of the
program. This analysis has been produced at the request of Aaron Deas of Rep-
resentative DeFazio's staff. All estimates are based on the intermediate assumptions
of the 1999 Trustees Report.
The comprehensive proposal is described in Table A, attached. Table A provides
estimates of the change in the long-range OASDI actuarial balance that would re-
sult from the enactment of the total proposed package, as well as fi-om each individ-
ual provision of the proposed package.
If all modifications are implemented, the resulting long-range actuarial balance
for the 75-year period (1999-2073) is estimated to be +0.07 percent of taxable pay-
roll. This is a change of +2.14 from the long-range actuarial balance vmder present
law of -2.07 percent of taxable payroll. The combined OASDI Trust Fund would
rise to a peak of 579 percent of annual cost for 2021, declining thereafter, and reach-
ing a level of 217 percent of annual cost at the end of the long-range period.
Stephen C Goss
Alice H. Wade
TABLE A.
-ESTIMATED LONG-RANGE OASDI FINANCIAL EFFECT OF REFORM PROPOSAL
(REPRESENTATIVE DEFAZIO)
Estimated change in
long-range OASDI actuar-
ial balance (percent of
taxable payroll)
Invest a portion of the OASDI Trust Funds in stocks beginning in 2000, reactiing 40 percent
of assets in stocks for 2014 and later
For earnings in years after 1999, change the OASDI contribution and benefit base to be a
benefit base only. Subject all covered earnings to OASDI payroll taxes, but use the base
to establish the maximum annual amount of earnings that is credited for the purpose of
benefit computation
Beginning in 2000, establish an exempt amount for a worker's annual taxable earnings. The
exempt amount would be set at $4,000 in 2000, and would serve to exempt the first
$4,000 of each worker's annual taxable earnings from the 6.2 percent employee's tax. For
self-employed individuals, the provision would exempt the first $4,000 of self-employment
income from one half of the 12.4 percent self-employed tax rate. The $4,000 would be in-
cluded in determining benefit amounts. For years after 2000, the exempt amount would
be indexed by growth in the SSA average wage index
In 2020, increase the level of benefits for all beneficiaries who are age 85 or older by 5
percent. This increase is phased in beginning in 2001. Benefit payments for beneficiaries
meeting this age requirement would increase by 0.25 percent for 2001, 0.5 percent for
2002, etc., reaching 0.5 percent for 2020 and later
Increase the benefit computation period by up to 5 additional years for new eligibles (by one
additional year for new eligibles in each year 2005, 2007, 2009, 2011, 2013)
Provide up to 5 child-care drop-out years. These years will be granted to a parent who has
$0 earnings during the year and is providing care to his/her child under the age of 12 or
to his/her disabled child. Drop-out years are phased in by one additional year for new eli-
gibles in each year 2005, 2007, 2009, 2011, 2013. (This provision reflects interaction
with provision 5a.)
1.03
■0.05
0.35
384
TABLE A.— ESTIMATED LONG-RANGE OASDI FINANCIAL EFFECT OF REFORM PROPOSAL
(REPRESENTATIVE DEFAZIO)— Continued
Estimated change in
long-range OASDI actuar-
ial balance (percent of
taxable payroll)
Note: Based on ttte intermediate assumptions of the 1999 Trustees Report under present law, the long-range actuarial balance for the 75-
year period (1999-2073) is -2.07 percent of taxable payroll.
Source: Social Security Administration, Office of the Chief Actuary, June 8, 1999.
Chairman Smith. Alan Greenspan and Secretary Summers sug-
gested to our Task Force that it is important to encourage addi-
tional savings. Do you see your plan as having an effect of encour-
aging additional savings and investment?
Mr. DeFazio. Well, since you would be providing much-needed
tax relief to 95 percent of Americans if you made available an op-
tional, you know, either — 401(k)-type plan, as has been proposed by
some, could be administered through Social Security, or you could
enhance their capability of participating in IRAs or Roth IRAs on
the other hand, that would certainly be money that would be avail-
able to them which is not now available.
Chairman Smith. Peter, as I understand your proposal, it takes
the cap off of the maximum amount that can be taxed under Social
Security and has no increase in benefits over the current cap in
terms of the calculation of benefits. Is that right? In other words,
it adds another bend point of zero over $74,000.
Mr. DeFazio. That is correct. As indexed in the future, anticipat-
ing the indexation in the future of the capped amount of wages, the
benefits would only rise with what is currently projected under —
with the formulas in place today. So those nionies, you know,
would in effect go to relieve the burden of the entire fund.
The analogy goes to Medicare, of course, although there the bene-
fits are uniform for all income levels. But we have lifted the cap
on Medicare, so people are paying Medicare on their entire income,
so it is a precedent.
Chairman Smith. As you move Social Security— you can say it ei-
ther way — in the direction of a welfare program or at least more
progressive, do you think there is additional justification to have
some of the funding come out of the general fund rather than the
tax on wages that tends to be somewhat less progressive on lower
income?
Mr. DeFazio. Well, I mean, that is a very interesting question.
I mean, you could look at a progressive tax for Social Security. I
did not go that far. What I thought, since people are accustomed
to the existing flat tax, and 95 percent of Americans pay it on all
their wages, you know, that the plan I proposed would mean for
95 percent of the people, you know, they would get the $4,000 ex-
emption, some tax reduction, and for everybody over $76,600, they
would be paying on all their income which they are now paying on
the first $72,600. So it was less radical of a change in terms of peo-
ple's thinking about Social Security. Certainly you could look at
something closer to our income tax system where you have brack-
ets at different income levels. That would be another way to go. I
haven't seen anyone propose that yet.
385
Chairman Smith. Any suggestions when we hit payback time of
what is now estimated to be 2013 or 2014 when there is less Social
Security taxes coming in that can accommodate benefits? In fact,
your proposal probably would bring that back a year or so. I don't
know
Mr. DeFazio. I think a little more than that. We have the num-
bers at the office. I could certainly provide them to the committee,
but what I would like to see is — which goes beyond the scope of
this hearing — but for my mind, if the surplus does indeed arrive,
as many pundits and economists and others are suggesting, rather
than use it for general tax reductions or additional spending, I
would use it to pay down the debt, which would enhance our capa-
bility to cash in those lOUs or bonds starting in 2015 or so. In fact,
the President said yesterday, although I don't quite see the math,
that current projections could show us at zero debt by 2017 or so;
2015, I believe he said.
Chairman Smith. This would be zero public debt.
Mr. DeFazio. Right.
Chairman Smith. The debt for what we would owe Social Secu-
rity Trust Fund and other trust funds would continue.
Mr. DeFazio. Is that what he said? I was wondering about the
math there, how it — with a trillion dollars additional surplus. But
at any point if indeed — you know, we have to honor the lOUs, but
if indeed, you know, we did get into some unexpected problems in
the future, paying down our public debt would give us more flexi-
bility to borrow if need be to meet hard and fast obligations to the
Federal Treasury.
Chairman Smith. That is an area that it is easy not to pay a
great deal of attention. It is assumed in most of these proposals
that what is owed to the trust fund is somehow automatically going
to be paid back. Have you thought once we hit about 2022, 2025
that it is going to be substantial, and somehow we have got to in-
crease borrowing or taxes or reduce other government expenditures
to pay back what we owe the trust fund.
Mr. DeFazio. That has bothered me a long time. When I came
to Congress and met Dorcas Hardy, then the Social Security Ad-
ministrator, I said, what is going to happen when Social Security
owns the entire debt of the United States, which at that point it
was projected to be around 2005, and, of course, things have
changed. She said, what do yoii mean? I said, wouldn't a future
Congress be tempted to say, gee, why are we paying ourselves all
this interest on this debt which we owe for this program? Let's can-
cel the debt and find some other way to finance it.
I have worried about that for a long time, which is why a long
time ago I became interested in diverting some of the incoming So-
cial Security Trust Fund money into other investments other than
lOUs, which is why I have gone with the 40 percent proposal here
as opposed to 15 of the President and I think 20 with Nadler and
others, is to at least move 40 percent of that money that is coming
in on an annual basis, and this year I believe it is — Social Security
surplus is projected this year at 120, I believe.
Chairman Smith. 127 maybe.
Mr. DeFazio. If 40 percent of that were diverted, we would have
real assets and real income stream out there, and if we did that
386
every year between now and 2015 or so, we would have a substan-
tial income stream and assets even. If the stock market or the
broadly diversified investments didn't do really well, would you
still have something other than paper lOUs to pay the money?
Chairman Smith. And Mr. Bentsen and I have talked about it.
Now that we have proven that Congress is capable of wiping out
some of that indebtedness to trust funds like we did in the High-
way Trust Fund, we know what can happen.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Mr. DeFazio, I will say this, though. Certainly you can have
terms of an agreement where the debtor — the creditor and the
debtor can cancel debt, and that doesn't necessarily undermine the
value of the debt. But you raise an interesting point, if the only
public — the only debt outstanding is nonpublic intergovernmental
debt, and whether or not you try and get out from under it, I still
think in a large-scale — a large-scale attempt to do that would have
detrimental impact on future ability to raise debt in the capital
markets. And I think you are right, Mr. DeFazio, that the Presi-
dent— I don't know that you are endorsing the President's proposal,
but the idea of using some of the surplus to pay down the publicly
held debt does put the Nation in a better fiscal position in the fu-
ture to the extent you need to raise debt or raise capital in the debt
markets. Your proposal, if I understand it, would invest 40 percent
of the future cash flow stream from the Social Security payroll tax
in the private markets
Mr. DeFazio. Forty percent of that, which exceeds need for cur-
rent benefits, yes.
Mr. Bentsen. Of the surplus.
Mr. DeFazio. Right.
Mr. Bentsen. In private markets in the same capacity as we do
now with the Federal employees' thrift plan?
Mr. DeFazio. Actually very similar. It would be a broadly based
index fund without voting rights. It would be very similar.
Mr. Bentsen. And avoid any political tampering that might
occur?
Mr. DeFazio. That is correct.
Mr. Bentsen. But much more narrow than, say. States or local-
ities invest their pension funds or the pension funds of teachers or
State employees, where in some cases they invest in actual stocks,
particular stocks, or capital projects or things like that.
Mr. DeFazio. Yeah, I did not go down that path. There is cer-
tainly an argument to be made. In fact, the PERS fund in my
State, PubUc Employees Retirement System, had a rate of return
to more than two times that of what Social Security gets on its
fixed equities in a broadly diversified investment base which in-
cludes both individual equities, index equities and bonds and real
property. So, I mean, there is certainly some case to be made for
that. I just didn't — this was the least controversial route.
Mr. Bentsen. Your construct is one that is the least political as
well that the government is all of a sudden in the business of man-
aging capitalism through stock ownership or something like that.
Mr. DeFazio. Right. Although in my State, again, they have-
Fred Meyer, for instance, was one of their major equities because
387
it was a Northwest-based corporation, and when it was bought out
by a New York firm, even though they had substantial voting
rights, you know, they did not exercise those to try and keep the
headquarters in the Pacific Northwest. You know, the State has
been — since they are required as fiduciaries to basically do things
in the best interests of returns for the fund, we haven't found that
kind of political manipulation because very infrequently does a po-
litical objective optimize returns. So in voting, they do have voting
rights. They have voted as pretty much, you know, as people who —
well, all the time as someone to optimize their income, not to opti-
mize their political objectives.
Mr. Bentsen. This wasn't where I was going, but you raise an
interesting point that throughout the country. State and local gov-
ernments invest in private markets like Fred Meyer, and they op-
erate with the fiduciary responsibility as opposed to a political re-
sponsibility, and I think it is fair to say that we haven't seen a re-
treat to socialism as a result of this occurring.
Let me ask you this: Based upon your analysis or the analysis
that has been done then, you invest 40 percent of the future Social
Security surplus in private market index funds or whatever, and
then you lift the cap on the payroll tax, and those two measures
alone are sufficient to meet the needs of Social Security over the
next 75 years?
Mr. DeFazio. No, they exceed the need.
Mr. Bentsen. And furthermore, you are able to credit back
$4,000— $4,000 tax credit for our payroll.
Mr. DeFazio. $4,000 of income would be exempt. So in fact, the
total would be 2.0 — would be 3.03 would be from those two assump-
tions. The lifting the cap is 2.02, and investing, the assumption
used by the actuaries for 40 percent is 1.01, and the total need is
2.07. So we are considerably over and then
Mr. Bentsen. I am sorry, what were those again?
Mr. DeFazio. I can provide the table for the committee. They do
it as a
Mr. Bentsen. So a httle less than
Mr. DeFazio. — percent of taxable payroll.
Mr. Bentsen. A little bit less than half out of the return on in-
vestment and the other from the payroll.
Mr. DeFazio. Right. In fact, lifting the cap almost meets the
total need. If you just lifted the cap, you would come very close to,
within the margin of error, obviously, 75 years out, meeting the 75-
year need if you made no other changes in the program.
Mr. Bentsen. Finally, do you make any recommendation or pro-
posal for what you do if investment of the 40 percent doesn't pan
out; does that have any — can that affect your future cash flow
needs in any given year, and to the extent that it does, does the
government just underwrite any shortfall at that point in time?
Mr. DeFazio. Well, pretty conservative assumptions were used
for rate of return and economic growth by the actuaries in project-
ing returns in a broadly based equity fund less than historic over
the last 25 years. So certainly if we entered into another Great De-
pression, we are going to be in trouble with that portion of the
fund's investments, but we would be in trouble with a whole bunch
388
of other things. I haven't accommodated that, nor did I put in any
special device.
You know, generally you just find that these things over time av-
erage out. That is the problem in the criticism of individual funds;
if you happen to retire in a down year, or it may be in the middle
of 5 down years, and the market was an individual fund, you are
kind of out of luck in terms of annuitizing or whatever you have
to do when you withdraw your money. But if you are part of a
broad group which has a tail behind you and ahead of you, that all
tends — ^you can maintain the benefit.
Mr. Bentsen. If I might, back on the tax exemption or deduction,
does that apply across the board?
Mr. DeFazio. That would be to the first $4,000 of income for all
workers who work for wages and pay FICA taxes. That is correct.
So essentially that would mean that with the current cap at
$72,600, that means everybody who earns less than $76,600 would
get a tax break, obviously skewed toward people at the bottom in
terms of percentage.
Mr. Bentsen. Thank you.
Thank you, Mr. Chairman.
Chairman Smith. During the apartheid controversy in the State
of Michigan, we had a law that our pension program decisions
could not be influenced by political decisions, with independent in-
vestors making the decision on how and where to invest the money.
But on the apartheid controversy, we simply passed another law
that was signed by the Governor saying regardless of all other pro-
visions, it couldn't be invested in any company that was doing busi-
ness with South Africa at the time. So I am still a little nervous
of ways that we might insulate, protect those investments enough.
Let me ask you
Mr. DeFazio. Mr. Chairman, that is a very valid concern. As I
recall, my State, the State legislature passed that, but then they
were sued because the fiduciary responsibility was embedded in the
Constitution for the trustees, and to tell the truth, I don't remem-
ber the resolution, but the other point I would make is that those
sorts of restrictions on investment are now GATT-illegal, and since
a majority of people here in Congress are great fans of GATT and
the WTO, which I am not, we could not have those sorts of restric-
tions in the future under GATT and the WTO.
Chairman Smith. One final question. Have you considered the
danger — along this same line of discussion, have you considered the
possibility that Congress and the President are going to look on in-
vestment revenues — the money coming in from capital investments,
once we hit a crucial year of problems with cash flow, that govern-
ments might start looking at the returns on that capital invest-
ment to use for financing other government programs which would
significantly reduce the benefits of long-term investment in terms
of compound interest?
Mr. DeFazio. Well, the language that I have adopted would basi-
cally leave the — for instance, if any of the investments were to be
terminated, those decisions are up to the board of trustees, and
they are to manage only in the best interest of the fund. So, you
know, you would have to somehow convince the board of trustees
that it would be a better return for the fund to cash in some invest-
389
merits and divert that money to the Treasury that would replace
it with lOUs at a lower rate of return, and so then the trustees
would be immediately in violation of their responsibility.
Mr. Smith. Thank you very much for your being here today and
your willingness to move ahead for a solution to a tough problem.
The next witness to testify, I think, is Mr. Nadler, who is sched-
uled to be here in 3 minutes, and so we will stand at ease for 3
minutes and see if Mr. Nadler shows up.
[Recess.]
Mr. Smith. Mr. Nadler has indicated that he is unable to be
here, so the Budget Task Force on Social Security is adjourned.
[The prepared statement of Mr. Nadler follows:]
Prepared Statement of Hon. Jerrold Nadler, a Representative in Congress
From the State of New York
Thank yoH, Mr. Chairman, for your invitation to testify before this committee.
EarUer this year, I introduced H.R. 1043, legislation which would make Social Se-
curity solvent for at least 75 years without raising the retirement age, without cut-
ting benefits, without shifting the risk onto individuals through private accounts
fUnded by FICA taxes, and without raising tax rates.
This plan also would not adjust the CPI, would not force all new state and local
government employees into Social Security, would not increase the benefit computa-
tion period above 35 years, and would not cut benefits by adjusting the bend points.
This plan does not rely on general fund transfers beyond an initial 15-year period.
It has been scored by the Social Security Actuaries as completely eliminating the
long-range OASDI actuarial deficit. In fact, it would improve the long-range OASDI
actuarial balance by an estimated 2.55 percent of taxable payroll, replacing the ac-
tuarial deficit of 2.07 percent under present law with an positive actuarial balance
of 0.48 percent of taxable pa5Toll.
In addition, at the end of the 75-year period, Social Security would remain strong.
In fact, the trust fimd ratio would then be 793 percent. The current trust fund ratio
is approximately 194 percent.
This plan would maintain Social Security as a guaranteed, life-long, cost-of-hving-
adjusted, defined benefit plan. That is the heart and soul of Social Security, and
that is why I have fought so hard to preserve this vital program.
So, how does this legislation work?
Essentially, the bill would transfer 62 percent of the projected budget surplus to
the Social Security Trust Fund for a period of 15 years, would provide for the invest-
ment of a portion of the funds in broad stock index funds, and would raise the wage
cap above the current $72,600.
Surplus Transfer
The bill would implement the President's proposal to authorize the transfer of 62
percent of the projected budget surplus to the Social Security Trust Fund for a pe-
riod of 15 years. It expresses this figure as a percent of taxable payroll, and is not
dependent on actual budget surpluses to materialize. If the economy does better
than predicted over the 15-year period, more funds would be allocated to Social Se-
curity. If the economy does worse, less funds would be transferred, and there would
be correspondingly less pressure on other government spending.
The Independent Soclal Security Investment Oversight Board
The bill would create the Independent Social Security Investment Oversight
Board — members of which would have long, staggered terms — which would then
hire several competing private managers to invest small portions of the Trust Fund
in broad index funds which track the market based on a fixed formula. Some people
incorrectly describe this as "government investment in the market". This is terribly
misleading. There would be no picking and choosing of stocks by the President, Con-
gress, or anyone else in government. The investments would follow a fixed formtila
and not the whims of some investment genius. No geniuses need apply imder this
plan.
The investment is completely private and fully insulated from political influence
by several layers of protection. Federal employees currently invest in the market
through the Thrift Savings Plan. I am not aware of anyone who has accused Con-
390
gress of tampering with the market due to this t)T)e of collective investment. In fact,
several of the plans that include individual accounts have similar restrictions on in-
vestments which would essentially require the same type of protections to be in-
cluded in their plans. Individuals would be severely restricted in their investment
decisions and in some cases only allowed to invest in broad index funds approved
by the government.
Many state and local governments invest up to 60 percent of their assets in the
stock mtirket. This bUl would authorize half of that amount and would prohibit in-
vesting more than 30 percent of total Trust Fund assets in the market. In order to
extend the projected solvency of the Social Security system for 75 years, the bill in-
vests a larger, but still prudent, amount of the Trust Funds in index funds than
the President's proposal which extends the projected solvency for 56 years.
Keep in mind, under this legislation most of Social Security's funding will still
come from payroll taxes and interest from government bonds. The Actuaries inform
us that imder current law in 2034, payroll taxes will still be sufficient to cover about
75 percent of benefit payments. The other 25 percent is from the Trust Fund. Only
30 percent of this Trust Fund is invested in the market. That means that only 7
1/2 percent is at any market risk at all. It has been estimated that if the market
coUapsed, and only held 50 percent of its current value, the ability of Social Seciuity
to pay benefits would only be reduced by about 2 percent. So the risk to the system,
under this bill, is quite small.
The real difference between this approach and private accounts is that this ap-
proach is a lower cost, more efficient, and more prudent way of increasing the rate
of return on Social Security assets. There are staggering administrative costs for
setting up 150 milUon individual accounts and tracking them year by year for 40
years with allowances made for annual adjustments to each account. This is an in-
credible burden that is completely unnecessary and wasteful.
Increase, and Then Index, the Cap on Taxable Wages
This legislation, starting in fiscal year 2000, also incrementally increases the cap
on taxable wages above the current $72,600. Currently, approximately 86 percent
of all wages are subject to FICA contributions. This has slipped in recent years fi"om
the historic 90 percent due to the dramatic rise in disparity of wages. The Social
Security Actuaries inform us that 93 percent percent of wage earners earn less than
the current cap, and, therefore, pay FICA taxes on all of their earnings. About 7
percent of wage earners do not pay FICA taxes on all of their income. My bill would
require the wealthiest 7 percent to pay the same FICA tax rate on a slightly greater
portion of their earnings. It would not eliminate the cap completely. To ensure fair-
ness, these individuals' Social Security benefit levels would increase as well.
Keep in mind this plan makes the system solvent even under the Actuaries ex-
tremely pessimistic intermediate assumptions. Many of their predictions are ques-
tionable especially the fact that they predict economic growth to average 2.0 for the
years 2000-2007, despite economic growth of 3.4 percent in 1996, 3.9 percent in
1997, and 3.9 percent in 1998. They then predict economic growth to take a signifi-
cant downturn to average 1.4 fi-om 2020-2040 and 1.3 percent in 2050-2070. They
further predict that the economy will do even worse after that. To put these num-
bers in some perspective the economic growth rate was 4.6 percent fi-om 1960-64,
5.4 percent in 1976, 7.0 percent in 1984. So H.R. 1043 restores solvency even in
light of these extremely pessimistic predictions. If the Actuaries are wrong, and the
economy does better than predicted. Social Security wiU be in even better shape.
The legislation that I have proposed, H.R. 1043, is also supported by Americans
for Democratic Action, OWL (the Older Women's League), and the 2030 Center. A
large national organization, a women's organization, and an organization primarily
concerned with protecting the interests of young people.
[The prepared statement of Senators Moynihan and Kerrey fol-
lows:]
391
Social Security Solvency Act of 1999 (S.21), Introduced on January 19, 1999,
By Senators Moynihan and Kerrey
BRIEF description OF PROVISIONS
/. Reduce Payroll Taxes and Return to Pay-As-You-Go System with Voluntary Per-
sonal Savings Accounts
A. Reduce Payroll Taxes and Return to Pay-As-You-Go
The bill would return Social Security to a pay-as-you-go system. That is, payroll
tax rates would be adjusted so that annual revenues from taxes closely match an-
nual outlays. This makes possible an immediate payroll tax cut of approximately
$800 billion over the next 10 years, with reduced rates remaining in place for the
next 30 years. Payroll tax rates would be cut from 12.4 to 10.4 percent for the period
2002 to 2029, and the rate woiild not increase above 12.4 percent until 2035. Even
in the out-years, the pay-as-you go rates under the plan will increase only slightly
above the current rate of 12.4 percent. Based on estimates prepared last year the
proposed rate schedule is:
2002-2029 10.4%
2030-2034 12.4%
2035-2049 12.9%
2050-2059 13.3%
2060 and thereafter .... 13.7%
To ensure continued solvency, the Board of Trustees of the Social Security Trust
Funds would make recommendations for a new pay-as-you-go tax rate schedule if
the Trust Fxmds fall out of close actuarial balance. The new tax rate schedule would
be considered by Congress under fast track procedures.
B. Personal Savings Accounts
Beginning in 2002, the bill would permit voluntary personal savings accovmts
which workers could finance with the proceeds of the 2 percentage point cut in the
payroll tax. Alternatively, a worker could simply take the employee share of the tax
cut (one percent of wages) as an increase in take-home pay. In addition, KidSave
accounts, of up to $3,500, would be opened for all children bom in 1995 or later.
C. Increase in Amount of Wages Subject to Tax
Under current law, the Social Security payroU tax applies only to the first $72,600
of wages in 1999. At that level, about 85 percent of wages in covered employment
are taxed. That percentage has been falling because wages of persons above the tax-
able maximum have been growing faster than wages of persons below it.
Historically, about 90 percent of wages have been subject to tax. Under the bill,
the taxable maximum would be increased to $99,900 (thereby imposing the tax on
about 87 percent of wages) by 2004. Thereafter, automatic changes in the base, tied
to increases in average wages, would be resumed. (Under current law, the taxable
maximum is projected to increase to $84,900 in 2004, with automatic changes also
continuing thereafter.)
//. Indexation Provisions
A. Correct Cost of Living Adjustments by One Percentage Point
The bill includes a 1-percentage point correction in cost of Uving adjustments. The
correction would apply to all indexed programs (outlays and revenues) except Sup-
plemental Security Income. The Bureau of Labor Statistics has made some improve-
ments in the Consumer Price Index, but most of these were already taken into ac-
count when the Boskin Commission appointed by the Senate Finance Committee re-
ported in 1996 that the overstatement of the cost of living by the CPI was 1.1 per-
centage points.^ Members of the Commission believe that the overstatement will av-
erage about 1 percentage point for the next several years. The proposed legislation
would also establish a Cost of Living Board to determine on an annual basis if fiir-
ther refinements are necessary.
B. Adjustments in Monthly Benefits Related to Changes in Life Expectancy
Under current law, the so-called normal retirement age (NBA) is scheduled to
gradually increase from age 65 to 67. In practice, the NRA is important as a bench-
1 A number of improvements announced by the BLS after this legislation was first introduced
in 1998 would lower the reported change in prices. The authors are considering what modifica-
tions, if any, should be made to the bill as a result of the BLS announcements. They are also
discussing, with the Social Security actuaries, the effects of this change on the long-run projec-
tions made by the actuaries.
392
mark for determining the monthly benefit amount, but it does not reflect the actual
age at which workers receive retirement benefits. More than 70 percent of workers
begin collecting Social Security retirement benefits before they reach age 65, and
more than 50 percent do so at age 62. Under the bill, workers can continue to re-
ceive benefits at age 62 and the provision in the 1983 Social Security amendments
that increased the NRA to 67 is repealed. Instead, under this legislation, if life ex-
pectancy increases the level of monthly benefits payable at age 65 (or at the age
at which the worker actually retires) decreases.
These changes in monthly benefits are a form of indexation that mirrors the pro-
jected gradual increase in life expectancy over a period of more than 100 years. For
example, persons who retired in 1960 at age 65 had a life expectancy, at age 65,
of 15 years and spent about 25 percent of their adult life in retirement. Persons re-
tiring in 2060, at age 70, are projected to have a Ufe expectancy at age 70 of more
than 16 years, and thus would also spend about 25 percent of their adult life in re-
tirement.
///. Program Simplification— Repeal of Earnings Test
The so-called earnings test would be eliminated for all beneficiaries age 62 and
over, beginning in 2003. (Under current law, the test increases to $30,000 in 2002.)
Under the earnings test benefits are withheld (reduced) for one milhon beneficiaries
because wages are in excess of the earnings Umit. This is an unnecessary adminis-
trative burden because beneficiaries eventually receive all of the benefits that are
withheld. Indeed, Social Security Administration actuaries estimate that the long-
nm cost of repealing the earnings test is zero.
IV. Other Changes
All three factions of the 1994-96 Social Security Advisory Council supported some
variation of the following common sense changes in the program.
A. Normal Taxation of Benefits
Social Security benefits would be taxed to the same extent private pensions are
taxed. That is. Social Security benefits v,ould be taxed to the extent that the work-
er's benefits exceed his or her contributions to the system (currently about 95 per-
cent of benefits would be taxed). This provision would be phased-in over the 5 year
period 2000-2004.
B. Coverage of Newly Hired State and Local Employees
Effective in 2002, Social Security coverage would be extended to newly hired em-
ployees in currently excluded State and local positions. Inclusion of State auid local
workers is sound pubUc policy because most of the five million State and local em-
ployees (about a quarter of all State and local employees) not covered by Social Se-
curity in their government emplojonent do receive Social Security benefits as a re-
sult of working at other jobs — part-time or otherwise — that are covered by Social Se-
curity. Relative to their contributions these workers receive generous benefits.
C Increase in Length of Computation Period
The legislation would increase the length of the computation period from 35 to
38 years. Consistent with the increase in life expectancy and the increase in the re-
tirement age we would expect workers to have more years with earnings. Computa-
tion of their benefits should be based on these additional years of earnings.
SUMMARY OF BUDGET EFFECTS
The legislation provides for long-nm solvency of Social Security, with little or no
effect on the budget surplus. In its latest (March, 1999) baseline, the Congressional
Budget Office (CBO) projected that for the 5-year period FY 2000-2004, the cumu-
lative surplus would be $953 biUion, and $2,604 triUion for the 10-year period FY
2000-2009. Preliminary estimates, based on these budget projections, indicate that
this legislation, while preserving Social Security, reduces payroU taxes by almost
$800 billion, and only reduces the 10-year cumvdative surplus by about $150 bilUon.
In no year is there a budget deficit and, starting in 2007, the legislation increases
the annual unified budget surplus.
[The prepared statement of Senator Gramm follows:]
Prepared Statement of Hon. Phil Gramm, a United States Senator From the
State of Texas
The attached summary provides a section-by-section analysis of the Social Secu-
rity Preservation Act, an Investment-based Social Security reform plan authored h>^
Senator Phil Gramm. According to estimates prepared by the Social Security Ad-
393
ministration, "the plan would eliminate the long-range OASDI actuarial deficit, esti-
mated at 2.07 percent of taxable payroll under present law. The OASDI trust fund
would be substantial and rising at the end of the long-range 75-year period." In ad-
dition to providing permanent solvency, the plan guarantees each worker 100 per-
cent of the benefits promised by the current system, plus a onus equal to percent
of the benefits funded by their investments.
The Social Security Preservation Act allows each worker to set aside 3 percent
of their 12.4 percent Social Seciirity payroll tax, which will be owned by the worker
and invested in stocks and bonds by a professional money manager in a "Social Se-
curity Savings Accovmt for Employees" or "SAFE Account. The worker can choose
from any privately-managed SAFE Account fund certified for safety and soundness
by a Federal board.
Upon retirement, any worker can opt out of the investment-based system and re-
ceive I 00 percent of the Social Security benefits guaranteed to them under current
law. However, it is expected that most workers will choose to remain in investment-
based Social Security and will use the funds in their SAFE Account to purchase a
"Savings Annuity For Ehgible Retirees" or "SAFER Annuity." The SAFER Annuity
will be guaranteed for Ufe and supplemented by the Social Security system if it does
not produce a retirement benefit at least equal to 100 percent of the benefits prom-
ised under the current system, plus a bonus equal to 20 percent of the payments
fiinded by the SAFER Annuity. ,„.„^^. -u i.
Private companies offering SAFE Accounts and SAFER Annuities will charge all
participants a single uniform investment fee, not to exceed 0.3 percent of assets.
SAFER Annuities will provide workers of the same age the same monthly benefit
relative to the size of their SAFE Account, regardless of sex, race, health status, etc.
Over the next 10 years, the Congressional Budget Office projects a Social Security
surplus of about $1.78 triUion, while SAFE Accounts funded at 3 percent of OASDI
wages would cost about $1.35 trilhon, leaving $430 bilUon in Social Security sur-
pluses. The Social Security Preservation Act uses these remaining surpluses to tar-
get additional investment for those aged 35-55 in the year 2000, allowuig these
workers to invest an extra 2 percent of their wages. These extra investments v?ill
begin to fund Social Security benefits at the height of the baby boom retirement,
providing additional resources in the critical years of the transition. The extra 2 per-
cent will not be counted in calculating the worker's 20 percent bonus, but will be
used entirely to fund the benefits they receive fi-om the existing Social Security sys-
tem.
SEC. 1 — SHORT TITLE AND TABLE OF CONTENTS
SEC. 2 — FINDINGS
SEC. 3— ESTABLISHMENT OF INVESTMENT-BASED OPTION FOR SOCIAL SECURITY
BENEFITS
Amends the Social Security Act to preserve all existing Social Security provisions
(OASDI) in a new Part A and creates a new Part B providing an Investment-Based
Social Security option for those workers who voluntarily choose to participate m the
investment-based alternative.
SEC. 250 GUARANTEE OF PROMISED BENEFITS
Those opting into the Investment-Based system are guaranteed never to have a
benefit less than that promised under the current system, plus a bonus of 20 per-
cent of the benefits paid by their Part B investments.
SEC. 251 DEFINITIONS
SEC. 252 SOCIAL SECURITY SAVINGS ACCOUNTS FOR EMPLOYEES (SAFE ACCOUNTS)
Each current worker may choose to establish a Social Security Savings Accoxint
for Employees or SAFE Account. All individuals who will join the work force in 2000
or later will enter the investment-based system. The worker shall choose the invest-
ment fund to professionally manage his SAFE Account from among those invest-
ment funds quahfied by high standards of safety and soundness, and may change
funds once every year. The Account will be the property of the investing worker.
SEC. 253 SAFE INVESTMENT FUNDS
SAFE Accounts will be managed by qualified SAFE Investment Fimds, which will
be certified and regulated for safety and soundness by the new Social Security In-
vestment Board. Under the parameters set by the Board, the Funds will invest the
394
assets of the SAFE Accoiints in stocks, bonds, bank deposits, insurance instruments,
annuities and other earnings assets. The Funds will provide an annual report to
each participant showing the dollar value of investments over the last quarter, the
last year and the life of the SAFE Account. The report shall also project how much
each worker will have at retirement if contributions and earnings continue at the
same rate during the remainder of his or her working life. Each Fund shall accept
all eligible workers requesting to join such Fimd. The Fimd shall charge all partici-
pants a single uniform investment fee as a percent of the investment, not to exceed
0.3 percent of assets.
SEC. 254 SOCIAL SECURITY INVESTMENT BOARD
Establishes a Social Security Investment Board which will set the general safety
and soiuidness parameters of investments held as part of SAFE Accounts but will
be prohibited from requiring or denying the purchase of any specific stock, or in any
way dictating which individual investments are made. The Board will protect the
safety and soimdness of SAFE Investment Funds with the power to order compli-
ance and, where appropriate, decertify and shut down any Fund found to be in vio-
lation of Board standards. The Board shall annually provide information on all
qualified Funds to workers. The annual report shall include data on the rate of re-
turn achieved by each SAFE Investment Fund.
The Board will be comprised of the Secretary of the Treasury, the Chairman of
the Federal Reserve Board, the Chairman of the Securities and Exchange Commis-
sion and two outside experts with substantial experience in financial matters, who
will be appointed by the President and confirmed by the Senate. One of the outside
Members will be nominated and confirmed as Chairman.
SEC. 255 SAFE ACCOUNT CONTRIBUTIONS
Workers participating in the investment-based system will initially invest 3 per-
cent of their wages into their individual SAFE Account. The remaining 9.4 percent
of the current 12.4 percent paid in Social Security taxes would continue to be used
to pay benefits under the current Social Security system. The 3 percent investment
rate will automatically increase in the future as Investment-based Social Security
becomes self-financing. In addition, workers age 35-55 in the year 2000 will invest
an extra 2 percent of their wages to provide additional resources in the critical years
of the transition. The extra 2 percent will not be counted in calculating the worker's
20 percent bonus, but will be used entirely to fund the benefits they receive from
the existing Social Security system.
An entry on participating workers' paycheck stubs wiU show exactly how much
money was invested in their SAFE Accounts for that pay period. The payment into
the workers' designated accoimt will be made directly fi"om the Social Secvirity Ad-
ministration at least once a quarter. The Board is empowered to require that invest-
ments are made on a more timely basis if more fi-equent investment is deemed to
be feasible.
SEC. 256 SOCIAI, SECURITY SAVINGS ANNUITIES FOR ELIGIBLE RETIREES (SAFER
ANNUITIES)
Upon retirement, a worker participating in investment-based Social Secvirity will
use the funds in his SAFE Account to purchase a Savings Annuity For Eligible Re-
tirees or SAFER Annuity. Under the investment-based system, the SAFER Annuity
will be guaranteed for life and supplemented by the Social Security system if it does
not produce a retirement benefit at least equal to a) 100 percent of the benefits
promised imder the current system plus b) a bonus equal to 20 percent of the pay-
ments fi-om the SAFER Annuity. This benefit will be fully protected against infla-
tion. Each SAFER Annuity Fund must accept all eligible retirees requesting to join
such Fund. SAFER Annuity Fimds shall charge all participants a single uniform in-
vestment fee, not to exceed 0.3 percent, and shall provide each worker of a particu-
lar age the same monthly benefit relative to the size of their SAFE Account, regard-
less of sex, race, health status, etc.
Early Retirement Option
Workers can retire at any age and draw their Investment-Based Social Security
benefits once they have built up a SAFE Account large enough to fund a SAFER
Annuity equal to at least 120 percent of the Social Security benefit promised at the
early retirement age and fund any survivor, spousal or other benefits that might
be triggered by their retirement.
395
Unrestricted Right to Use Remaining SAFE Account Assets
Workers who have built up enough funds in their SAFE Account to finance more
than 120 percent of the benefits promised under Social Security and fund any other
benefits their family might receive under the current Social Security system may
use any remaining SAFE Accovmt funds as they see fit.
Bequests
If a worker dies prior to retirement, the worker's SAFE Accoimt, minus the
present value of benefits promised to the surviving family members imder the cur-
rent Social Security system, will become part of the worker's estate.
sec. 257 MONEY BACK GUARANTEE
Upon retirement, any worker may choose to opt out of the Investment-Based sys-
tem and instead receive 100 percent of the benefits he would have received had he
stayed in the current Social Security system. Those opting for this money back guar-
antee will receive monthly benefit checks directly fi-om Social Security. Workers who
opt upon retirement to return to the existing Social Security system will forfeit all
their SAFE Account assets directly to the Social Security Administration to be de-
posited into the Social Security Trust Fund.
SEC. 258 guarantee OF PROMISED BENEFITS
A worker whose SAFE Accoimt is not sufficient to purchase a SAFER Aimuity
which will pay a monthly benefit equal to that promised under the current system
plus a bonus of 20 percent of any payments fi-om their SAFER Aimuity will receive
a supplemental payment fi-om the Social Security Administration. Because this
guarantee is based on the inflation-adjusted benefit a worker is promised under the
current system, the guarantee fuUy covers the effects of inflation.
sec. 259 investment rate increases
Social Security Surplus Investment
In any year the Social Security Investment Board certifies that the aimual Social
Security surplus is greater than the amount needed to finance the 3 percent invest-
ment rate (and the temporary 2 percent additional investment to help cover the
transition), the Board shall automatically increase the investment rate in incre-
ments of 1/10 of 1 percent, up to a maximum of 8 percent. If, in any year, the an-
nual Social Security surplus is less than the amount needed to fund the 3 percent
investment rate, the Social Security Commissioner shall redeem assets of the Trust
Fund to ensure that benefits are fully paid and that the investment rate shall never
drop below 3 percent.
Social Security Reserve
The Social Security Investment Board shall ensure that a suitable reserve is
maintained in the OASDI Trust Funds. ^
sec. 260 TAX TREATMENT OF INVESTMENT BASED SOCIAL SECURITY
SAFE Accounts and SAFER Annuities will build up tax-free until withdrawal. At
retirement, payments from a SAFER Annuity up to 120 percent of benefits promised
by the current system will be taxed in the same manner as Social Security benefits.
Any additional payment, or any Ivmap sum withdrawal, would be taxed as any aimu-
ity payment would be taxed under the Internal Revenue Codf The amount of SAFE
Account contributions must be shown on a worker's W-2 as well as the worker's pay-
roll receipt.
SEC. 4 — PAYROLL TAX REDUCTION RESULTING FROM INVESTMENT-BASED SOCIAL
SECURITY
After the investment rate has risen to 8 percent and the necessary portion of the
remaining payroll tax is dedicated to fully fund disability insurance, the payroll tax
rate shall drop fi-om 12.4 percent to 8 percent plus the rate required to fund disabil-
ity insurance.
396
SEC. 5 FINANCING OF INVESTMENT-BASED SOCIAL SECURITY
Recapture of Federal Corporate Income Taxes Arising from SAFE Account
AND SAFER Annuity Investments
The Secretary of Treasury, in consultation with the Social Security Investment
Board, will annually estimate the amount of corporate income tax revenues that can
be attributed to the contributions and accumulated capital bviildup in the SAFE Ac-
counts and SAFER Annuities. Within 3 months after the end of each fiscal year,
the Secretary of Treasury shall transfer to the OASDI Trust Funds the amount of
Federal corporate income taxes attributable to the assets held in SAFE Accounts or
SAFER Annuities.
In calculating the recapture rate during 2000 and 2001, the Secretary of Treasury
shall assume that 80 percent of the total SAFE Accoxmt and SAFER Annuity assets
are net additions to national investment, that 10 percent of that amount will be in-
vested abroad and not subject to Federal taxes, and that 5 percent will be invested
domestically but outside the corporate sector. Thus 68.4 percent of the profits fi-om
SAFE Account and SAFER Annuity assets shall be assumed to be net additions to
taxable corporate income, resulting in an effective tax rate of 23.9 percent which
will be credited to Social Security.
Dedication of Part B Savings to Social Security Trust Fund
Any other savings resulting from Investment-Based Social Security that flow to
the Federal Government, including increased revenues resulting fi"om Federal tax-
ation of SAFER Annuity bonuses and excess SAFE Account distributions, shall be
credited to the OASDI Trust Funds.
Dedication of Budget Surplus to Saving Social Security
Each quarter beginning in the year 2000, the Secretary of Treasury shall reim-
burse the OASDI Trust Funds fi-om the unified budget surplus an amount equal to
the actual investments made in SAFE Accounts in that quarter. This reimburse-
ment will be permanently reduced in any year that a reduction can be made without
creating a future cash shortfall in OASDI, until the reimbursement is eventually
ehminated. To ensure that these budget surpluses materialize, the discretionary
spending caps in place under current law are extended through 2009.
[Whereupon, at 1:48 p.m., the Task Force was adjourned.]
The Cost of Transitioning to Solvency
TUESDAY, JULY 13, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social Secitrity,
Washington, DC.
The Task Force met, pursuant to call, at 12:10 p.m. in room 210,
Cannon House Office Building, Hon. Nick Smith [chairman of the
Task Force] presiding.
Chairman Smith. The Social Security Task Force of the Budget
Committee will come to order today for the purpose of hearing wit-
nesses testifying on the cost of transitioning to solvency.
Today will be the last official meeting of this Task Force unless
it is renewed. We have held 14 different meetings. I hope that we
can come to some common bipartisan agreement on some findings
in terms of outlining our goals on how we might proceed with solv-
ing Social Security, such as the finding that time is not on our side,
and the longer we put the solutions off, the more drastic those solu-
tions are going to have to be.
So without objection, we will reconvene this meeting at the call
of the Chair probably this Thursday, and also, without objection,
each individual Member may submit a statement by the 30th of
this month that will be included in the final report and also, minor-
ity and majority views in that report. Hearing no objection, it is so
ordered, and we will set the target date as of now for the 30th of
this month to have those individual or minority/majority reports in.
Today's hearing focuses on transition costs. This topic is an es-
sential element of the Task Force's mission to review the long-term
budget ramifications of the various Social Security reform propos-
als and work toward a bipartisan solution of the impending insol-
vency of our Nation's retirement system.
We all know that there are only three ways to eliminate Social
Security's $9 trillion debt in a closed system and estimated $4 tril-
lion unfunded liability in an open system. Our choices are to raise
taxes, to cut benefits or increase the rate of return that is earned
on the taxes that are now coming in. The comprehensive reform
plans that have been proposed use some or all of these three ways.
Our witnesses have reviewed the various reform proposals under
consideration and will tell us how each brings financial stabiUty to
Social Security.
We have an extraordinary opportunity, I think, to soften the im-
pact of transition costs by using the Federal surplus to strengthen
Social Security. Let us hope that we can work together and make
(397)
398
this happen. Let us hope that there are some areas where we as
a Task Force can have bipartisan agreement.
After witnesses have testified, we will open it for any individual
Member that wants to make a comment today, and hke we have
already agreed to, those individual written comments and then ma-
jority/minority reports will be due by the 30th of this month.
And I would call on our ranking member, Lynn Rivers, for a
statement.
Ms. Rivers. No statement.
Chairman Smith. Let me introduce our witnesses today. Dr. Ru-
dolph Penner holds the Arjay and Frances Miller Chair in Public
Policy at the Urban Institute. He directed the Congressional Budg-
et Office from 1983 until 1987, highly respected by both Repub-
licans and Democrats. He served as a senior government official at
the Council of Economic Advisers and the Department of Housing
and Urban Development. Dr. Penner has directed fiscal research
programs at the Urban Institute and the American Enterprise In-
stitute.
David John is a Senior Policy Analyst for Social Security at the
Heritage Foundation, a 20-year veteran of Washington policy de-
bates, and David has worked on Capitol Hill and in the private sec-
tor as well. We look forward to the testimony from Heritage.
And William Beach, of course, is Director of the Center for Data
Analysis for the Heritage Foundation and has developed various
econometric and computer models used by policy analysts. And we
are very happy that within the last couple years the Heritage
Foundation has taken on Social Security as a priority venture for
them in terms to arrive at a solution.
And, Dr. Penner, we will start with you. All written testimony
will be included in total in the record, and if you would keep your
remarks to 5 or 8 minutes, we would appreciate it.
Prepared Statement of Hon. Nick Smith, a Representative in Congress From
THE State of Michigan
Today's hearing focuses on transition costs. This topic is an essential element of
the Task Force's mission to review the long-term budget ramifications of the various
Social Security reform proposals and work toward bipartisan solution to the impend-
ing insolvency of our nation's retirement system.
We all know that there are only three ways to eliminate Social Securit/s $9 tril-
Uon unfunded liability and return the system to solvency: raise taxes, cut benefits,
or increase the rate of return earned on the taxes workers pay. The comprehensive
reform plans that have been proposed use some or all of these three ways. Our wit-
nesses have reviewed the various reform proposals under consideration, and will tell
us how each brings financial stability to Social Security.
We have an extraordinary opportunity to soften the impact of transition costs by
using the Federal surplus to strengthen Social Security. Let's hope that we can
work together to make this happen.
After witnesses have testified. Members will be invited to make closing state-
ments. Finally, I want to propose Task Force findings review what we have learned
during the past 4 months that we have been meeting.
STATEMENT OF RUDOLPH PENNER, ARJAY AND FRANCES
MILLER CHAIR IN PUBLIC POLICY, THE URBAN INSTITUTE
Mr. Penner. Well, Mr. Chairman, members of the Task Force,
thank you for the opportunity to testify. As we all know, the cur-
rent pay-as-you-go Social Security system is in trouble. Adverse de-
mographics will force tax increases and benefit cuts in the future
399
and the rate of return on tax payments will be far lower for future
retirees than they have been in the past.
As a result, many believe that we should reduce our reliance on
the current pay-as-you-go system and move toward a funded sys-
tem in which real investments would provide income to fund pen-
sions in the future. The rate of return on payments to pension ac-
counts is then ultimately determined by the real return on invest-
ments rather than by demographic developments, and as a result,
the expected rate of return will be much higher.
As I explain in my complete testimony, funding can be accom-
plished publicly or privately. Here I shall concentrate on private
approaches, since I deem them to be highly preferable.
Fimding involves a sacrifice. The money going into personal ac-
counts could have been used for immediate consumption of goods
and services. At the same time, people already retired or who are
approaching retirement will not receive much benefit fi-om funded
pension accounts. They will have to be supported by the working
population, and that will be an additional sacrifice.
The problems involved in moving toward funding are complicated
by the fact that we start with a system in which the earmarked
payroll tax is insufficient to fund future benefits and either benefit
growth will have to be slowed or taxes raised to solve this problem.
Solving this problem, therefore, also involves sacrifice.
The sacrifices involved in the financial problems of the current
system will have to be faced whether or not we move toward a
funded system. In policy discussions, the sacrifices involved in mov-
ing toward funding are often merged and muddled with the sac-
rifices involved in solving the system's financial problem. It is use-
ful conceptually to keep the two problems distinct.
Both types of sacrifices can be distributed across generations and
within generations in a multitude of ways. Both the transition
problem and the actuarial problem can be mitigated by slowing the
future growth of benefits. Here we face a difficult trade-off. The
more quickly benefits are reduced, the smaller the necessary reduc-
tion. But quick benefit reductions are only possible if they affect
those already retired or those near retirement. It is generally be-
lieved that this is undesirable because such people do not have
much time to adjust their private saving or work efforts to change
this in the rules, but if benefit cuts are phased in over a long pe-
riod, they have to be much larger in the end.
My own feeling is that the sacrifice should be spread broadly and
that the currently retired should not be spared some small cut.
Tiny cuts now mean significantly less cutting in the future.
The sacrifice can be spread within generations in a variety of
ways. Plans like the Smith plan and the Kolbe-Stenholm plan cut
higher earners more than lower earners. Kolbe-Stenholm provides
a new benefit equal to the poverty line for those who have worked
40 years.
The President's USA plan and Kolbe-Stenholm private accoxmts
subsidize contributions to individual accounts by lower income
e£imers to reduce the sacrifice that they have to bear. Such provi-
sions show that reforms can be accomplished in a highly progres-
sive manner if that is deemed desirable.
400
With all the talk of sacrifice, it should be emphasized that most
plans do not impose much of a transition cost because they do not
contain much transition. If we were talking about replacing the en-
tire pay-as-you-go system with a Chilean-type reform, the transi-
tion costs would be quite enormous, but that is not politically plau-
sible in the United States, and most plans from the political middle
replace a relatively small portion of the current pay-as-you-go sys-
tem.
Were it not for the actuarial problem, the total sacrifice of lost
consumption would be less than 2 or 3 percent of total income im-
mediately, and much less than that in the very long run.
Even the actuarial problem can be solved without huge sacrifice.
It must be remembered that a considerable part of the actuarial
problem comes from the fact that current promises involve provid-
ing average benefits that constantly rise faster than the inflation
rate. Keeping the retired population at the current absolute living
standard can help solve a considerable portion of the problem.
The current surplus can also be used to ease the immediate sac-
rifice because it means that we can fund contributions to individual
accounts without reducing consumption below recent levels. True,
we give up the potential of a tax cut or spending increases, but I
think, as you said, Mr. Chairman, the existence of the surplus
makes this all very, very much easier than it would be otherwise.
So it should not be as hard to solve the Social Security problem
as it seems to be. I think people are reluctant to contemplate even
small changes in the system because Social Security has been so
popular and has worked so well in the past, but adverse demo-
graphics will keep it from working as well in the future, and there-
fore, it has to be changed.
Thank you very much, Mr. Chairman.
Chairman Smith. Dr. Penner, thank you.
[The prepared statement of Mr. Penner follows:]
Prepared Statement of Rudolph Penner, Arjay and Frances Miller Chair in
Public Policy, the Urban Institute
The views expressed in this testimony are those of the author and do not nec-
essarily reflect the views of the trustees and employees of The Urban Institute.
Mr. Chairman and members of the Task Force, thank you for the opportunity to
testify. The current pay-as-you-go (PAYGO) Social Security system is in trouble.
Revenue growth will slow because the rate of growth of the labor force is declining.
Meanwhile, the number of beneficiaries will grow rapidly because of increases in ex-
pected life and the retirement of the baby boomers. The cost of benefits will outrun
the revenues provided by the payroll tax, and either benefit growth will have to be
reduced, payroll taxes raised, or general revenues used to finance the system. Re-
gardless of the option chosen, the rate of return to taxes paid will be much lower
for future retirees than for current and past retirees.
This has led many to support reduced reliance on the traditional PAYGO system
and more reliance on a funded system in which contributions would be invested in
a mixture of public and private securities, the return on which would be used to
finance future pensions. The low rate of return created for the traditional system
by adverse demographics would be replaced by a higher rate of return associated
with investments in real capital. Both rates of return are associated with consider-
able risk, but given the current demographic outlook, the expected return on a fund-
ed system far exceeds that on a PAYGO system.
In theory, a funded system can be managed using either pubhc or private ac-
counts. Conceptually, the fundamental economic effects of the two approaches can
be made to be identical. The dispute over which approach is preferable is therefore
not a matter of economic theory. Instead, it involves different political forecasts as
to how the two approaches would function in practice. Those of us who favor a pri-
401
vate approach doubt that the government could resist dipping into the reserves of
a pubUc account in the long run in order to fund deficits emerging in the rest of
government. We also worry that the government would use its investment policy to
achieve pohtical ends rather than investing in an optimum portfolio for future retir-
But forgetting these problems for the moment, one can imagine diverting an
amount of current tax revenue, say equal to 2 percent of payroll to a funding ac-
coimt that could be invested in stocks and bonds by either the government or pri-
vate individuals. This approach is often called a "carve out" approach and essen-
tially uses the current surplus to finance the move toward funding. The diversion
of revenues can be fi-om payroll taxes or any other taxes. The choice of an approach
will have distributional and other consequences that are important, but the choice
does not change the fundamental natiu-e of the transition problem to be discussed
at this hearing.
The important point is that the poUcy imposes a sacrifice. It the revenues were
not diverted into a funded account, they could be used to finance a tax cut or some
spending increase that would allow taxpayers to increase their consumption of goods
and services immediately.
A different approach would either increase taxes to fund a public account or man-
date that individuals invest a certain portion of their earnings in a personal retire-
ment accoimt. Assuming that individuals did not evade the mandate, consumption
would have to be reduced immediately compared to levels enjoyed in the recent past.
The two approaches are meaningless unless they reduce consumption below what
it would be otherwise. This is the same as saying that the reform must uicrease
national saving, thus providing additional national wealth which can be used to fi-
nance the pensions of the future. . , i- ^ «i i
These approaches to increasing saving should be differentiated from recent lock
box" proposals that strive to increase national saving by running a unified budget
surplus at least equal to the surplus in the Social Security trust fund. The lock box
approach only increases national saving while the trust fund surpluses last, whereas
true funding would go on indefinitely. Moreover, the amoimt of increased saving re-
sulting fi-om the lock box proposal is not directly related to future pension needs.
The language surrounding lock box proposals is more than a Uttle confusmg, but
that does not mean that the goal of a lock box is a bad idea. If adhered to, it will
increase national saving as long as trust fund surpluses contmue. This is appro-
priate, since most economists agree that current American saving levels are woe-
fully inadequate. ^ i- l r ■
When people speak of a transition problem related to funding, they are retemng
to the fact that consumption must be forgone immediately to finance the fiuided ac-
coimt, but the funded accoimts will be of no help to the currently retired and of little
help to those soon to retire. These potential beneficiaries of the traditional system
will have to be supported somehow by the working population and that will mvolve
an additional sacrifice. The amount of the sacrifice can be reduced by reducing
promised benefits, but it is pohtically unreahstic to assume that promises can be
cut back radically. , , „ ^ •
The problem is intensified by the fact that the current earmarked payroU tax is
inadequate to finance future promised benefits. Therefore, some benefit reductions
or tax increases will be necessary, even if we do not move toward a funded system.
Put another way, any sacrifice involved in moving toward a funded system will be
on top of that involved in fixing what remains of the current PAYGO system.
In current pohcy discussions, the problems of fixing the current system are often
merged and muddled with the problems involved in moving toward funding. The
two problems are distinct and should be separated conceptually. But it is desirable
to solve both simultaneously, and it is necessary to consider this twofold burden
when analyzing reforms.
The sacrifices involved in solving both can be spread in different ways across dit-
ferent age cohorts in the population and within each cohort. Plans oft«n strive to
provide about the same retirement income as is promised by the current system.
This can be done in two ways. Reductions in traditional benefits can be phasedin
slowly and designed to match the growth in income fi-om individual accounts. The
designer must make explicit assumptions about the rates of return to individual in-
vestments and this is a risky business. Of course, if such a reform were imple-
mented, individuals could maJse their own assumptions about rates of return and
if they preferred to assume lower returns on a safer portfoUo, they could compensate
by saving more than the mandated amount in order to replace traditional benefits.
That is to say, they could choose to lower their risk by reducing immediate con-
sumption by a larger amoimt. The second approach is to directly link the reduction
in traditional benefits to the amount earned on individual accoimts as in the Feld-
402
stein and Archer-Shaw plans. Then government bears a considerable portion, or all,
of the risks of the investment and it is certainly not appropriate to refer to this as
privatization. (Privatization is not a good word for any mandated highly regulated
fdan involving individual accounts.) Such guarantees make the approach more simi-
ar to pubUc funding of benefits in that the general taxpayer bears some or all of
the risk of the investment in private seciirities. In Congressman Smith's plan, the
reduction in future benefits is linked to the amount contributed and not to the
amount earned on the individual account. This approach leaves the general tax-
payer with a lower contingent liability and is preferable in my view.
Benefit Reductions
To the extent that benefit reductions are used to ease the transition burden on
futtire workers and to bring the existing system into actuarial balance, reformers
face a difficiilt tradeoff. It is generally agreed that any benefit reductions should be
phased in slowly, so that people have time to adjust to changes in the rules by alter-
ing their work effort and private saving. But if changes are phased in slowly, the
ultimate reduction in benefits must be greater than if the changes are implemented
immediately. This suggests that those currently retired should not be totally ex-
empted from making sacrifices to help insure that future cohorts will have adequate
retirement income. A very small current sacrifice can mean less significant cuts in
traditional benefits for fixture retirees.
Many reforms cut taxes immediately to finance contributions to individual ac-
coxints while traditional benefit reductions are phased in slowly. An example of such
a plan has been put forward by Representatives Kolbe and Stenholm. The effects
of this class of plan on the unified budget balance are negative at first as the reve-
nue loss exceeds the outlay savings from the benefit reductions. The negative impact
grows for a time and in the Kolbe-Stenholm plan reaches a peak about 2012. But
the outlay savings eventually catch up with the revenue loss and eventually exceed
it, so that such plans viltimately improve the budget balance. Put another way, such
plans first reduce the amount of debt that can be redeemed, all else equal, and de-
pending on fiscal policy choices and economic developments between now and the
time that their net cost reaches a peak, may require some net borrowing from the
pubUc.
Such plans probably would not be contemplated were it not for the current siir-
plus. But the fact that such plans may temporarily result in a small deficit should
not be considered a major problem. (The maximum negative effect of the Kolbe-Sten-
holm plan on the unified budget balance never exceeds 0.8 percent of the GDP.) To
the extent that future Congresses decide to nm deficits, it is equivalent to passing
some of the costs of reforms to future generations. Those future generations will
benefit from the reform in that they face a reduced burden associated with paying
for traditional benefits. In other words, the explicit liability associated with govern-
ment debt will replace some of the implicit liaDihty associated with promised bene-
fits. Unlike some, I do not beUeve that the two liabilities should be regarded as
being equivalent on a dollar for dollar basis, but there is room for some tradeoff be-
tween the two types of liability. Alternatively, it may be decided 20 or 30 years from
now that economic conditions do not warrant running a deficit and that taxes
should be raised or spending cut. The issue again involves which age cohorts should
bear the costs of reform and that need not be decided immediately for all future
time.
There is a multitude of options for spreading the burden of benefit cuts within
cohorts. Traditional benefits can be cut progressively by altering the benefit formula
appropriately or by using means testing, although the latter runs the risk of de-
stroying incentives for privately saving for retirement. The sacrifice imposed by
mandated accoimts can also be made progressive by subsidizing the contributions
of low-income individuals as in the President's USA accounts and in the accounts
estabUshed by the Kolbe-Stenholm plan.
Tax Increases
Tax increases can also be used to fund a pubhc account or to reduce the actuarial
imbalance in the current system. Whether one uses tax increases or benefit cuts to
reform the system depends on what portion of the nation's resovirces one wants to
convey to the retired population. Today, slightly more than half the noninterest ci-
vilian budget goes to the elderly. Those of us who emphasize benefit cuts as a solu-
tion rather than tax increases are concerned that elderly programs are already
crowding out programs for children, defense, infrastructure and other things out of
the budget, and unless benefits are reformed, the problem will intensify rapidly in
the fiiture.
403
If traditions are maintained and payroll taxes continue to be the main sources of
income for the traditional system, revenue-increasing options are limited to rate or
tax base increases. Roughly speaking, it takes a doubling of the t£ix base to produce
revenues equivalent to a 1-percentage point increase in the tax rate. Base increases
concentrate the pain of reform on the upper middle class and affluent two earner
famiUes while rate increases afflict all who have earnings. If the burden of a rate
increase is examined relative to total income, the highest percentage burden tends
to be on lower income famiUes who do not have much income other than from earn-
ings. However, the effects of a rate increase extend far up the income scale — far be-
yond the wage base, because affluent famiUes often attain high incomes because
they contain more than one worker. At the very bottom, the effects of a rate increase
are mitigated somewhat on average, because the very poor are often at the bottom
because they have no earnings.
The Severity of the Transition Problem
With all the above discussion of sacrifices and burdens, there is a danger of great-
ly exaggerating the pain involved in meaningful Social Security reform. Transition
problems are very severe if a PAYGrO system is entirely replaced with a funded sys-
tem as in Chile, but such a radical reform does not seem politically plausible in the
United States. Because the traditional American PAYGO system has been so popu-
lar, it is likely to continue to be a very large component of our public retirement
system. A move toward funding is only feasible in my judgment if it is relatively
small. Most plans for individual accounts from the political center convey the equiv-
alent of only two or 3 percentage points of the current payroll tax into individual
accounts. Were it not for the perceived need to simultaneously cure the actuarial
imbalsmce in the traditional system, the pain of reform would be quite small. The
immediate forgone consumption in many plans would initially be less than 2 percent
of income and would be less than that in the very long run.
The existence of the current budget surplus provides a golden opportunity to fur-
ther reduce the pain of partially funding the system. It allows a portion of revenues
to be saved either pubUcly or privately without having to reduce consumption below
current levels. It is true this approach sacrifices the opportunity for tax cuts or
spending increases, but that is much easier than having to accept the reduction in
consimaption that would be necessary if a tax increase was necessary to fund a pub-
Uc account, or a mandated contribution to an individual account was imposed on top
of the current tcix burden.
Although the problems of the actuarial imbalance and of any move toward fund-
ing will have to be solved simultaneously, they should not be confused conceptually.
Because the cvurent system is not sustainable under current law, some sacrifice wiU
be necessary even if we do not move toward funding. It is therefore illusory to com-
pare reform plans to the current system as though cvirrent benefit and tax laws can
be sustained forever. The Congressional Research Service (CRS) has done a good job
analyzing different reforms under two scenarios — one in which benefits are lowered
to payroU tax receipts and another in which taxes are raised to finance promised
benefits. If adverse assmnptions are made — retirement at age 65, bond rate of re-
turn on individual accounts, no retirement saving that is not mandated — monthly
retirement income tends to be lower than that under current law in plans like Moy-
nihan-Kerrey or H.R. 4256 for most of those retiring before the trust fund empties,
but much higher after, if it is assvmaed that benefits are lowered to tax receipts. If
taxes Eire raised to finance promised benefits, the burden on futiire taxpayers wiU
be higher than vmder the reform plans.
The sacrifice will be even less if the move toward funding is successful in increas-
ing saving and enhancing economic growth. The CRS study is inconsistent in this
regard in that the projections of future retirement income impUcitly assume that
people truly increase their saving by the amount of any mandate, but it does not
teike account of any increase in incomes that might resxilt from enhanced economic
growth.
This is a tricky issue whether funding is done publicly or privately. It was noted
previously that pubhc funding will not work if surpluses in any retirement fund
allow deficits to be larger in the rest of government. Mandates to save privately can
also be evaded if people respond by reducing other retirement saving or by borrow-
ing more. However, any plan cutting the growth of benefits provides a powerful in-
ducement for people to save more privately in order to replace those benefits. Con-
sequently, it is my judgment that a mandate combined with a benefit reduction
would be very effective in increasing saving. Saving should also rise, even though
individual accounts are voluntary and also in the case where no special provision
has been made for private saving to offset benefit cuts. However, mandates may be
404
useful in encouraging people to exercise the self-discipline that they should be exer-
cising in any case when confronted by lower Social Security benefits than they origi-
nally expected.
To the degree that saving is increased as the result of Social Security reform,
growth should be enhanced. This does little to reduce the proportionate economic
biirden imposed by the Social Security system, because faster growth means higher
wages and higher wages mean higher benefits. However, more growth makes reform
less painfiil, because it reduces any loss of consumption compared to past history.
Indeed, it should be noted that today's system promises each successive cohort of
retirees a higher real benefit. Simply, keeping traditional benefits constant in real
terms would solve a significant portion of the financing problem without at all re-
ducing the absolute living standard of average retirees.
Conclusions
It is necessary to contemplate two types of Social Security reform, both of which
are highly desirable. First, we have to adjust to the fact that under current law pay-
roll taxes are not sufficient to finemce promised benefits in the long nm. Second,
it would be useful to fund part of the system, so that the rate of return to tax pay-
ments is dependent on the real return to capital rather than on demographic vari-
ables. Both types of reform will impose sacrifices in the sense that someone's con-
sumption will have to be lowered below what it could be otherwise, either now or
in the future. However, the total sacrifice is not large in size, because most politi-
cally feasible reforms fund only a small portion of the public retirement system and
if we act quickly, the financing problem under current law is small relative to total
income. Moreover, the sacrifice can be spread in an infinite number of ways among
and within the generations. The neediest in society can be easily protected against
any drop in absolute living standards.
Consequently, Social Security reform should not be as hard as it is. Part of the
problem is due to a lack of understanding of the current system and of the implica-
tions of specific reform proposals. More important, Social Security is hard to reform
because it has been so popular and has worked so well in the past. But it cannot
work as well in the future because of adverse demographics. Leaving it the same
is not a viable option in the long run.
Chairman Smith. Mr. John and Mr. Beach, do you have a pref-
erence on who goes first? Mr. John.
STATEMENT OF DAVID C. JOHN, SENIOR POLICY ANALYST
FOR SOCIAL SECURITY, HERITAGE FOUNDATION
Mr. John. We appreciate the opportunity to appear before you
today to discuss the cost of transitioning to a solvent Social Secu-
rity system.
High transition costs will be a fact of life for Social Security re-
gardless of whether the program is radically reformed or just left
as it is. As a result, the transition costs of the various reform pro-
posals should be measured against the costs associated with doing
nothing at all.
We define the transition costs for Social Security retirement pro-
grams as the total amount of money that must come from sources
other than Social Security pa)n*oll taxes at the current level.
The easiest way to measure this cost is to look at the annual
cash flow deficit of the OASDI trust funds under both the existing
program and the various proposals that have been made. We have
used the cost estimates made by the SSA's Office of the Chief Actu-
ary with only one change. While SSA measures these amoimts in
percentages of taxable pa3rroll, we have translated them into con-
stant 1999 dollars in order to make them more understandable.
Increased pa3n'oll taxes, whether by raising the wage cap or in-
creasing the tax rate or other revenues that are used to fill the op-
erating deficit, count as part of the transition costs under this defi-
nition. This is true regardless of whether or not the general fiind
405
revenues come from a budget surplus. In either case, they rep-
resent additional resources that are used to pay Social Security
benefits.
Three quick examples for the year 2020 show how this definition
applies to the existing system and the various reform plans. Look-
ing at SSA's intermediate prediction for the existing program in
2020, the OASDI trust fund is estimated to take in $634 billion in
taxes and pay out $737 billion in benefits. Even if this $104 billion
operating deficit is covered by liquidating some of the assets in the
OASDI trust fund, that money comes from sources other than the
payroll tax and should be considered part of the transition cost.
This is not to imply that the special issue Treasury bonds held
in the trust fund are worthless or will not be repaid on schedule.
However, the Analytical Perspectives volume of President Clinton's
fiscal year 2000 budget accurately characterized the assets in the
trust fiind when it said:
"These balances," I quote, "are available to finance future benefit
payments only in a bookkeeping sense. They do not consist of real
economic assets that can be drawn down in the future to fiind ben-
efits. Instead, they are claims on the Treasury that, when re-
deemed, will have to be financed by raising taxes, borrowing from
the public, or reducing benefits, or other expenditures," end quote.
Looking at the Kolbe-Stenholm plan, in 2020, by comparison,
afl:er adjusting the traditional benefit, SSA foimd that $57 billion
will be transferred from general revenues to cover the operating
deficit. A further $27 billion will be brought in from the effect on
the income tax collections of reestimating the CPI, Consumer Price
Index, for a total transition cost of $84 bilhon in 2020.
The Archer-Shaw plan makes no change in the existing payroll
tax rate or to the existing benefit structure. However, it funds indi-
vidual accounts with an amount of general revenues equal to 2 per-
cent of income and requires general revenue funds to pay a portion
of Social Security benefits during its transition period. Thus, in
2020 the transition cost for Archer-Shaw includes both $98 billion
for the amount that goes into the personal accounts and $72 billion
that is used to pay some benefits for a total transition cost of $170
bilUon.
The source of the money for general revenue transfers to pay So-
cial Security benefits is extremely important. In short, no matter
where the money comes from. Congress will always face oppor-
tunity costs.
The phrase, "There is no free lunch," has never been truer than
in this situation. To the extent that the money is borrowed, future
generations will bear a significant interest cost that will be in addi-
tion to the base transition cost.
The other alternatives are to cut spending or raise pajn-oU taxes.
Future Congresses may face the choice between paying Social Secu-
rity benefits or paying for education or defense programs.
It is easy to assimie that this money can be repaid out of sur-
pluses, but there is a catch to the recent good news on that front.
Over the last 6 months, the White House's estimate of the cumu-
lative 15-year budget surplus has gone up by $1.1 trillion. How-
ever, the beginning of an economic downturn, which is inevitable
at some point, could cause a downward revision of an equal
406
amount. It is a fallacy to assume that these surpluses are inevi-
table.
There is no easy solution to Social Security. No matter what, fu-
ture taxpayers will bear a significant additional burden to pay the
benefits of that time's retirees. The only question is when the an-
nual deficits begin, how big they are and how long they last.
The benefits of individual accounts would take some time to de-
velop. Even if a taxpayer is allowed to begin them tomorrow, the
accounts will not grow large enough to offset any significant
amount of the traditional benefits for a good 20 to 30 years.
If Congress does nothing, the annual cash flow deficits for Social
Security begin in 2014. They reach $516 bilHon in 1999 dollars by
2070. It appears that the annual deficits continue and grow in size
as long as they can be measured. On the other hand, most reform
plans start to run overall deficits sooner, but they tend to be small-
er over time, and in a few cases they actually end.
Plans that finance individual accounts with part of the existing
Social Security taxes must begin to run deficits almost imme-
diately, for obvious reasons. There is less money going to Social Se-
curity. While these plans adjust the traditional benefit that is fi-
nanced solely from payroll taxes, these reductions only begin to re-
duce costs after the individual accounts have had a chance to grow
for a number of years. This necessary delay in cost reduction
causes these plans to run significant deficits that grow for about
30 years and then begin to steadily decline.
Of course, there is more to be considered in Social Security re-
form than just aggregate costs. The simple fact is that for millions
of low- and moderate-income families Social Security is the only re-
tirement plan that they have. Unfortunately, for most of them, to-
day's Social Security is not a good investment. At a time when the
S&P 500 has gone up 20.5 percent in the last 12 months. Social
Security earns the equivalent of only about 1.3 percent.
The objective of Social Security reform must be more than just
restoring the financial health of the system. It is time to allow
every American family, no matter what their income level, to have
the opportunity to fully participate in our economy. Social Security
reform must also improve the retirement income of low- and mod-
erate-income individuals.
The real question is how responsible this Congress and the one
following wants to be to future generations. It can do nothing and
place a significant burden on our children or grandchildren, or it
can act responsibly and reduce that burden.
Chairman Smith. Thank you.
[The prepared statement of Mr. John and Mr. Beach foUowsil
Prepared Statement of David C. John, Senior Policy Analyst for Social Se-
curity, AND William W. Beach, Director, Center for Data Analysis, the
Heritage Foundation
We appreciate the opportunity to appear before you today to discuss the costs of
transitioning to a solvent Social Security system. At the outset, let me state that
the views that are expressed in this testimony are our own, and should not be con-
strued as representing any official position of the Heritage Foundation.
High transition costs will be a fact of life for Social Security regardless of whether
the program is radically reformed or just left as it is. While some consider transition
costs to apply only to proposals that would reform Social Security, this is not the
case. Since the existing program will begin to run cash flow deficits in 2014, the
407
transition costs of various reform proposals should be measured against the costs
associated with doing nothing at all. In fact, it would probably be more accurate to
talk about "preservation costs" instead of transition costs.
'Transition Costs" Defined
We define the transition costs for Social Security retirement program as the total
amount of money that must come from sources other than Social Security payroll
taxes at the current level and the small portion of the income tax on benefits paid
to certain higher income retirees. Thus, increasing the payroll taxes would count as
part of the transition costs as would any general revenue that is transferred to the
program.
The easiest way to measure this cost is to look at the annual cash flow deficits
of the Old-Age, Survivors and DisabiUty Insurance (OASDI) trust funds under both
the existing program and the various proposals that have been made. For this anal-
ysis, we have used estimates made by the Social Security Administration (SSA) Of-
fice of the Chief Actuary with only one change. While SSA measures these amounts
in percentages of taxable payroll, we have translated them into constant 1999 dol-
lars in order to make them more understandable.
When considering the various reform plans, we compared the operating deficits
(if any) that would result after subtracting trust fimd income (mainly payroll tax
revenues) fi-om trust fund costs (the aggregate benefits that would be paid under
the reformed system). However, let me emphasize once again that our definition
only considers payroll taxes at the current level. Increased payroll taxes, whether
by raising the wage cap or increasing the tax rate or other revenues that are used
to fill the operating deficit covmt as part of the transition cost. This is true regard-
less of whether or not the general fund revenues come from a budget surplus. In
either case, they represent additional resources that are used to pay Social Seciirity
benefits. .
This analysis is Umited to measuring the effect of various poUcy options on boaal
Security revenue and outlays, and by extension on the government's budget. It does
not measure changes in the retirement benefits received by individuals. For in-
stance, both the existing system and the Archer-Shaw plan assume that benefits
will be paid at levels called for under current law, while the Gramm plan assiimes
that the combination of traditional benefits and individual accounts will equal at
least 120 percent of that amount. On the other hand, the Kasich plan assumes that
retirement benefits will remain at the current level instead of growing in real terms
as is called for under existing law. Kolbe-Stenholm, meanwhile, assumes that Social
Security retirement benefits from traditional sources will gradually decline as the
amount available from individual accoimts grows. These effects on the individual
can only be measured indirectly in a discussion of transition costs.
Applying This Definition to the Existing System and Various Reform Plans
Three quick examples show how this definition apphes to the existing system and
various reform plans. Looking at SSA's intermediate prediction for the existing pro-
gram in 2020, the OASI trust fund is estimated to take in $634 biUion in taxes and
pay out $737 bilhon in benefits. Even if the $104 biUion operating deficit is covered
by liquidating some of the assets in the OASI trust fund, that money comes from
sources other than the payroll tax, and should be considered part of the transition
This is not to imply that the special issue Treasury bonds held in the trust fund
are worthless or will not be repaid on schedule. However, the Analytical Perspec-
tives volume of President Clinton's FY2000 budget accurately characterized the as-
sets in this trust fund when it said:
These balances are available to finance future benefit payments * * * only in a
bookkeeping sense. They do not consist of real economic assets that can be drawn
down in the future to fund benefits. Instead, they are claims on the Treasury that,
when redeemed, will have to be financed by raising taxes, borrowing from the public,
or reducing benefits, or other expenditures." (P.337 — ItaUcs added for emphasis)
On the other hand, the Kolbe-Stenholm plan diverts an amount of the Social Se-
curity tax equal to 2 percent of income to individual accounts and adjusts the tradi-
tional benefits to reflect the gradual ability of individual accounts to pay some por-
tion of Social Security benefits. In 2020, after making these adjustments, Kolbe-
Stenholm assumes that $57 billion will be transferred from general revenues to
cover the operating deficit. A further $27 bilhon will be brought in from the effect
on income tax collections of re-estimating the Consumer Price Index (CPI), for a
total of $84 biUion.
408
The Archer-Shaw plan makes no changes to the existing pa5Toll tax rate or to the
existing benefit structure. However, it fiinds individual accounts with an amount of
general revenues equal to 2 percent of income and requires general revenue funds
to pay Social Security benefits. Thus, in 2020 the transition cost for Archer-Shaw
includes both $98 bilhon for the personal accounts and $72 bilhon to pay benefits
for a total of $170 billion.
Where Does the Money Come From?
The source of the money for general revenue transfers to pay Social Security bene-
fits is extremely important. In short, no matter where the money comes fi'om, Con-
gress must always face opportunity costs. They range fi"om foregoing expansion of
a non-Social Security program in order to pay the interest on borrowed money to
being forced to raise taxes to support Social Security outlays rather than spending
those funds on urgent needs in education or defense. Depending on a variety of fac-
tors, there also could be an effect on the growth rate of the entire domestic economy.
The phrase "There is no free lunch" has never been truer than in this situation.
To the extent that the money is borrowed, future generations will bear a significant
interest cost that will be in addition to the base transition cost. If the Federal Gov-
ernment borrows a significant amount for Social Security, under some cir-
cumstances this could cause an increase in interest rates for the overall economy.
This in turn could lower economic growth, thus reducing pajrroU tax collections
below anticipated levels.
Congress also needs to consider the effects on the rest of the budget that stems
fi"om increased general revenue spending to meet Social Security's challenges. . It
is easy to assume that this can be paid out of surpluses, but there is a catch to the
recent good news on that front. Over the last 6 months, the White House's estimate
of the cvunulative 15-year budget surplus has gone up by $1.1 trilhon. However, the
beginning of an economic downturn, which is inevitable at some point, could cause
a downward revision of an equal amount. It is a fallacy to assume that these sur-
pluses are inevitable.
In that case, future Congresses may face the choice between tax increases and sig-
nificant reductions in other programs. If there is no surplus, where will the $104
biUion come from that will be required to redeem assets of the trust fund in 2020?
Win the 115th Congress sitting in 2020 be forced to reduce spending for education,
highways, defense, or other programs to pay Social Security benefits? When consid-
ering transition costs, it will be important to consider aggregate deficits, how long
they wiU last, and how large the individual annual deficits are. To a very real de-
gree, the actions of this Congress and the next one will limit the ability of future
Congresses to meet national needs.
You Can Pay Me Now or You Can Pay Me Later
As it will become clear from looking at both the forecast for the current system
and various reform options, there is no easy solution to Social Security. No matter
what, future taxpayers will bear a significant additional burden to pay the benefits
of that time's retirees. The only question is when the annual deficits begin, how big
they are, and how long they last.
The benefits of individual accounts would take some time to develop. Even if a
t£txpayer is allowed to begin them tomorrow, the accoimts will not grow large
enough to offset any significant amount of the traditional benefits for a good 20 to
30 years.
If a portion of the existing Social Security tax is diverted to individual accounts,
there is a direct relationship between the amount that can go into an individual ac-
count, the size of the initial deficits, and how soon the deficits can end. Diverting
part of the tax reduces Social Security's income and causes almost immediate defi-
cits. On the other hand, the more that goes into the individual accounts, the faster
they grow to a significant size and can replace much of the traditional benefit. How-
ever, since the early deficits can be so large, most reform plans initially hmit indi-
vidual accounts to an amount equal to 2 percent of income.
If Congress does nothing, annual cash flow deficits begin in 2014. They amoimt
to about $21 bilhon in 2015, $252 billion in 2030, and reach $516 bilhon in 2070.
It appears that the annual deficits continue and grow in size as long as they can
be measured. On the other hand, most reform plans start to run overall deficits
sooner, but they tend to be smaller over time, and in a few cases they eventually
end.
As expected, plans such as Kolbe-Stenholm, Kasich and the Senate bipartisan
plan that finance individual accovmts with part of the existing Social Security taxes
begin to run deficits almost immediately. While these plans adjust the traditional
409
benefit that is financed solely fi-om payroll taxes, these reductions only begin to re-
duce costs after the individual accounts have had a chance to grow for 20 to 30
years. This necessary delay in cost reduction causes these plans to run significant
deficits that grow for about 30 years and then begin to steadily decUne.
For instance, Kolbe-Stenholm reaches a maximum annual deficit of $133 billion
in 2030, but by 2070, the deficit has declined to only $38 bilUon. In several years
in between, there is actually a surplus. The Kasich plan also reaches a maximum
deficit of $187 bilUon in 2030, but deficits essentially end afl«r 2065. This pattern
is also true for the Senate bipartisan plan, where deficits reach $130 biUion in 2030,
but end in 2065.
Because our definition includes all outside revenues other than the existing level
of payroll taxes, this pattern is also true for the Archer-Shaw plan. Even though
under Archer-Shaw, the Social Security trust fund does not begin annual cash flow
deficits until 2014, the level of general revenues that are necessary to fund the add-
on individual accounts causes an almost immediate aggregate deficit. Thus, while
Social Security runs a surplus in 2000 of $69 bilUon, the $74 billion for general reve-
nues that goes into the Archer-Shaw accounts causes a $5 bilUon aggregate deficit.
This deficit climbs to $255 bilUon in 2030, before declining to $185 bilUon in 2070.
Thus, what this Congress does wiU have a major impact on the future. In 2000,
this country could face a Social Security surplus if Congress does nothing. Passing
Kolbe-StenhoUn, Archer-Shaw, the Senate bipartisan plan, or Kasich wiU result in
a deficit of about $5 billion.
By the time a child bom in 2000 reaches the age of 30 in 2030, the annual deficit
will cUmb to $252 billion under the existing system. Under Kolbe-Stenholm, it
would be $133 bilUon, while the Archer-Shaw deficit would be $255 bilUon. That
same year, the Senate bipartisan plan would run a deficit of $130 billion, and the
Kasich plan deficit would be $187 biUion.
In 2070, the existing system will run a $516 bilUon deficit. For Kolbe-Stenhohn,
it will be $38 bilUon, for Archer-Shaw $185 bilUon. However, for both the Senate
bipartisan plan and the Kasich plan, there will be no Social Sec\irity deficit.
Of course, there is more to be considered than just aggregate costs. The simple
fact is that for inilUons of low and moderate-income famiUes, Social Security is the
only retirement plan that they have. Unfortunately, for most of them today's Social
Security is not a good investment. At a time when the S&P 500 has gone up 20.5
percent in the last 12 months. Social Security "earns" the equivalent of only 1.3 per-
cent.
The objective of Social Security reform must be more than just restoring the fi-
nancial health of the system. It is time to allow every American family— no matter
what their income level — to have the opportunity to fully participate in our econ-
omy. Social Security reform must also improve the retirement income for low and
moderate-income workers.
The real question is how responsible this Congress and the one foUowing want
to be to ftiture generations. It can do nothing and place a significant burden on our
children and grandchildren, or it can act responsibly and reduce that burden. Your
decision will have an even greater impact on our children's grandchildren. What
kind of a legacy do we as a people want to leave to the futxire?
410
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411
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[-H>-Kasidi]
Chairman Smith. Did you have a comment, Mr. Beach?
Mr. Beach. Just a very quick comment, first, to explain why I
am here. I am Robin to this man, Batman, today, so I don't have
formal remarks.
Secondly, I would like to point out to the committee that this
country has faced significant transition costs before, and there is
in these hallowed halls, actually across the street, good history
coming out of our own Revolution. As you may know from your his-
tory, this country faced a significant amount of debt which was
413
going to significantly constrain the ability of the country to grow
economically. Many of our creditors in Europe simply had given up
on the United States when Alexander Hamilton funded the debt.
That funding of the debt was done over a long period of time with
long-term bonds — they didn't have income taxes at the time be-
cause it was not part of the Constitution — and it was successful.
Sometimes when we think about the challenges of funding our
transition to a Social Security system that works from a trust fund
standpoint and it works from a retirement standpoint, they seem
like large obstacles, but we can keep in mind what many times we
have done in this past.
Mr. Chairman, David and I have before you graphic material
that shows various plans, just a selection of plans. I have brought
with me a number of documents from Social Security to answer
questions. All of these data are data from Steve Goss and his fine
deputy actuaries over at the SSA.
Chairman Smith. Dr. Penner, let me start with you. In an article
published by Investors Business Daily last April, you stated: "By
focusing the Nation's attention on solvency while ignoring the se-
vere fiscal imbalances underlying both Social Security and Medi-
care the President does the nation a great disservice." That is
somewhat aggressive. Do you still feel that way? And please elabo-
rate.
Mr. Penner. Yes, Mr. Chairman, I certainly still feel that way.
I do feel that the President's proposal probably has a negative ef-
fect on the prospects for Social Security reform. By a bookkeeping
entry, he makes it seem as though the problem is solved, but he
did nothing to real benefits. He did nothing to the payroll tax, and
I think it shows the problem of focusing on the solvency of the trust
fund. That can be cured by the stroke of a pen, as he did it, but
that in no way reduces the real economic burden of having to pay
people benefits; and that burden, in my judgment, is much better
measured by the ratio of those benefits to our total income or our
gross domestic product. And that burden is going to start rising
and rises quite rapidly after we get past the first decade of the next
century. The total increase in that burden is roughly 2 percent of
the GDP by 2030 or so. That is not a lot and wouldn't be much of
a problem except that it is also combined with a much bigger rise
in the Medicare burden caused by the same sort of demographics,
plus the increase in the relative price of medical care.
So unless we focus on these real burdens, it seems to me that
we miss the total problem. So while the President has made some
proposals on Medicare, and I believe that those should be taken
very seriously, his proposals on Social Security are an empty box
as far as I am concerned.
Chairman Smith. There seem to be several empty boxes from an-
other perspective. Almost all of the Social Security proposals, there
may be nine that have now been evaluated by the actuaries, as-
sume that the Social Security trust fund indebtedness is going to
somehow be paid back. That is technically a legal obligation, but
the trust fund is not a financial asset until we find some way to
pay it back. How should we be looking at plans to pay that back?
And I will go across, with each of you making a comment on that.
414
Mr. Penner. Well, I think that is exactly right, Mr. Chairman.
The President has essentially just put a lot more debt into the
trust fund. Some people refer to that as general revenue financing
of Social Security, but I think that is a misnomer. It would be gen-
eral revenue financing if he had said that in the future, maybe in
2020, he would like to see an increase of 10 percent in income taxes
and 20 percent in the corporate tax in order to pay off that debt,
but he has not given any indication of how that debt should be paid
off in the future. So I would refer to it as general debt financing
as opposed to general revenue financing.
Chairman Smith. Mr. Beach.
Mr. Beach. Yes, I agree with that. The source of all government
revenues comes from the productivity of households, individual
workers, and that productivity is taken from them in a sense
through the tax system. Income taxes is a source for rolling over
debts and other source. If we operate in a fashion to raise taxes on
those households that are most covered by the Social Security sys-
tem, we are doing a double disservice. Unless we reform Social Se-
curity to increase the savings in those households, we are doing a
disservice. If we say we are going to balance on the basis of in-
creased payroll taxes, increased aid to retirement and so forth, we
are doing another disservice to those households, so we have to be
very careful. But that repaying of existing debt must come, in some
fashion or another, ultimately out of the tax sources.
Chairman Smith. Mr. John.
Mr. John. Well, as Bill said, the bottom line here is that we have
our choice. We can raise taxes, we can reduce other government
spending. There is not a whole lot else on the menu here. The big-
gest cost that is going to come up here is if we do nothing.
Chairman Smith. Ms. Rivers.
Ms. Rivers. Thank you, Mr. Chairman. I have several questions,
but the first one I want to start with is, I know you have got your
materials from the Heritage Foundation that you gave to us today.
Would you be amenable to having the actuaries from Social Secu-
rity take a look at them and put their comments in the record with
yours?
Mr. Beach, By all means, Congresswoman. The materials that
we have today, in fact, are all taken from, except our comments,
of course, from Social Security. So we would be more than happy
to supply your staff with an exact duplicate of the materials I have
in front of me.
Ms. Rivers. Wonderful. A lot of the proposals that I have heard
rely on either the on-budget surplus or the Social Security surplus
as a source of funds for transition; and I have a couple questions
about that. The first is, if you use any portion of the Social Security
surplus, don't you exacerbate the problem that we were just dis-
cussing, which is the 2012, or I guess it is 2013 problem now,
where we have to draw down on the trust fund; and then in 2034,
you have got a gap between income and outgoing. So doesn't any
proposal to use trust funds today, to plan transition to another pro-
gram, intensify the existing liability of the existing program or
make it worse?
Mr. Penner. I think that if you want to retain the traditional
characteristics of the Social Security system, that is to say, have
415
the benefits largely funded by the earmarked payroll tax, then you
are right that reducing the payroll tax to fund private accounts, as
in the Kolbe-Stenholm plan, for example, means you have to make
a sacrifice in the sense that you could have used those payroll
taxes for something else in the first place. But also, you have a
double burden. You have got to reduce future benefit growth suffi-
ciently to fund the 2 percent diversion first of all, and then you also
have to fund the 2 percent actuarial deficit in the system. So you
must have substantial benefit cuts in the program.
If you are willing to go outside the system and use some general
revenue financing, then obviously you will have to reduce benefits
as much, but that leaves you with a bigger burden in the future,
because benefits will be higher relative to our total income.
Ms. Rivers. Do either of you want to speak to the issue of using
the Social Security surplus?
Mr. Beach. Yes, I would be happy to. Before you today are the
drafts that I have already referred to, based on what the Office of
the Chief Actuary has told us about the plans which are rep-
resented on the graphs. If I could answer your question by pointing
to the baseline first, the baseline assumes that those Social Secu-
rity surpluses remain available for current law use, and as we
know from a couple of months ago when the trustees made their
report on the Old- Age, Survivors and Disability Insurance trust
fund, they predicted that by 2035, in that year, with the absence
of assets now in the trust fund, that they would only be able to pay
71 percent of current law benefits; and that absent any other
change by 2075, only 66 percent of current law benefits.
Now, as you notice from looking at the graph, the Office of the
Chief Actuary has followed the plans in their detail and said, using
the surplus in the way that each plan uses it and making the ap-
propriate changes to current law, then points to COLAs and so
forth, that in point of fact each of those plans results in a better
actuarial balance by the end of that period of time.
So I guess my answer is, if we use the surpluses occurring to
those plans, the actuary
Ms. Rivers. But these plans don't all rely exclusively on Social
Security revenues. Archer-Shaw looks for general revenue funds.
Mr. Beach. Exactly right, and you will see in each of these plans
in some cases a very large use of general revenue funds, in some
cases a more prudent use of general revenue funds. They all re-
quire some kind of funding outside of the system.
Ms. Rivers. The other question I have regarding surpluses is
about the general funding surplus, which people are only beginning
to understand is predicated on the idea that we are going to see
real cuts in domestic discretionary spending, about a 20 percent cut
in real spending. What happens to these plans if these surpluses
don't materialize, if we agree to make changes today, like Wimpy,
I will pay you for a hamburger on Tuesday if I can have it today,
what happens; and what we have seen in the 5 years since the Re-
publican revolution is that even a Republican majority is not will-
ing to make these kinds of cuts in the budget.
Mr. Penner. As I explained in my complete testimony, the typi-
cal plan of this type lowers the growth of benefits very slowly, and
on the other side you have an abrupt fall in tax revenues because
416
they are conveyed to individual accounts. So all such plans sub-
stantially reduce the surplus in the short run. That reduction in
the surplus tends to grow with most of these plans over time. I
think with Kolbe-Stenholm it reaches a peak about 2012 and then
eventually the cut in benefits catches up, and ultimately the plan
is beneficial to the unified budget surplus in the very long run.
Now, if, in fact, our projections are far too optimistic, these plans
can cause actual deficits in the future. At that time the Congress
should ask itself, is this deficit permissible or should we do some-
thing to prevent it? You don't have to decide that now. Some deficit
may be considered permissible because that is just a way of convey-
ing some of the transition cost to future generations. We are, after
all, relieving future generations of the burden of paying as high
benefits in the future as under current law.
So you might say it is a fair trade, but again, I don't think the
Congress has to decide that at this moment. They can decide that
depending on how the surplus and economic conditions evolve in
the long run.
Mr. John. If I understand your question correctly, what you are
asking is, if these overall budget surpluses fail to appear, how does
that affect these charts. The answer is that it doesn't really affect
them at all because these charts show essentially a hole that has
to be filled from some form of resources in order to pay Social Secu-
rity benefits under these different scenarios. Now, if there is a
budget surplus at that point, then some of that budget surplus can
be used to fill the hole. If there is no budget surplus at that point,
then essentially either taxes go up or we have got to make other
spending cuts.
Ms. Rivers. Have you heard many people put that as part of
their proposal? I mean, has anybody said, we will use the budget
surplus, but of course, if there is a problem with the budget sur-
plus, we are going to raise your taxes or cut your benefits?
Mr. John. I haven't heard it said explicitly, but the simple fact
is that this is true regardless of whether Congress does nothing or
whether it passes Kolbe-Stenholm or Mr. Smith's plan or any of the
others.
Ms. Rivers. Thank you, Mr. Chairman.
Chairman SMITH. Thank you.
Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman.
A couple of questions, gentlemen. First, in evaluating the cost of
a transition, assuming we were to engage in one from the current
system to one that is more prefunded through a system of savings
accounts, would you evaluate — aside from the politics of it, but
looking at the economics of it, would you suggest that there is an
advantage to minimizing the present value of the transition costs,
and that rather than looking at given years, year after year, of
what that deficit may be — or as you put it, the hole that needs to
be filled with other resources — that it is most useful to discount ev-
erything back to a present value and to compare apples to apples
by having that tool available.
If so, then I guess my real question is, does it help to divert more
money sooner from, say, the payroll tax into personal accounts to
start the benefit from the greater returns of investing in real eco-
417
nomic assets; and while that may create a greater shortfall in the
earlier years, does that lead to a lower total transition cost?
Mr. Beach. Yes. In my view, it does, and I think that that is
standard operating procedure in the private sector when you are
looking at large investments and payoffs down the line, to size the
problem up, begin quickly and move forward; and I think that that
would be a prudent move in this particular case for yet another
reason. This is not the major transition cost this Congress is going
to have to face and that — of course, that major transition cost will
be Medicare. It is there. The insurance pool is adverse to big
changes.
So Social Security, I think you need to look at all — give me a dis-
count factor, and we will come back to this table with those calcula-
tions based on Social Security's own estimates, and you can size it
up at that point. Begin that process now. I think the sooner you
get it started, the better. The economy will certainly benefit.
The earlier question about the economy is highly relevant to your
particular question. If the economy doesn't perform based on the
intermediate assumptions of SSA, but in fact below that— and it
would have to be a pretty poor economy to be below the intermedi-
ate assumption— then the problem worsens, and it worsens rapidly
sooner rather than later.
If there is an economic benefit from reform that does rely upon
personal saving accounts, it will be able to reaHze that as soon as
we begin to see the benefit offsets for the first retirees, and that
should be in about 20-years, and that would be a good thing to get
started soon, yes.
Mr. Penner. I would agree that it is very useful to look at the
present value numbers on these things, but I would suggest that
under usual circumstances the choices you have to make are more
choices of political values as opposed to economics in that regard.
Assuming the deficit or the surplus that evolves is not really
large relative to GDP, then you have a lot of choices, and the more
you borrow to fund the hole that David talked about, the more you
are passing this burden on to future generations. So it is really a
question of intergenerational equity: How much do we do for those
who aren't born yet and not voting yet, and how much of a burden
do we leave them?
Mr. TooMEY. Thank you. One other question on a different line.
I am looking at the graphic presentation that you provided us with.
A question comes to mind, in particular if I look at the way you
have depicted the Archer-Shaw plan.
Am I correct in concluding from that graph that what you are
suggesting is that the Archer-Shaw plan essentially locks in a per-
manent hole that has to be filled from sources outside of Social Se-
curity? What I see is a graph that goes up and then it iterates a
bit but seems to sort of level off somewhere over $200 billion. So
is that a permanent deficit in the Social Security system that that
reform plan would create.
Mr. Beach. That is what Social Security has in fact concluded.
That line rises to about $200 billion a year and that is what you
were pointing to. In about 2050, under the plan, you have a reduc-
tion in the payroll tax rate; so that difference is not being replaced
418
except through general funding or through the debt instrument
funding.
Mr. Penner. There is a bit of a problem with the analysis here,
and frankly, as an analyst, I am not sure how to solve it. But many
of the analyses of these various plans for the purpose of computing
people's future income assume that people really increase their sav-
ing by whatever is mandated, or sometimes by the amounts in vol-
untary accounts.
On the other hand, that increased saving is not allowed to affect
the future growth of the economy and the future growth of income.
Now, there is a lot of uncertainty as to how you would do that,
but there is this basic logical inconsistency in the way much of the
analysis proceeds.
Mr. TOOMEY. Thank you very much.
Chairman Smith. Representative Clayton.
Mrs. Clayton. I am just wondering, as we look at the transi-
tional costs, should I assume that we could have some efficiencies
as they relate to savings, but in the public policies some of the
transitional costs could be amassed but yet would come up later
on? Let me give you an example.
If indeed, as I understood the gentleman from the Urban Insti-
tute to say, in terms of our beneficiaries, if we change the structure
of our benefits, to see — one way of changing that is to structure it
in a way that we wouldn't cover the disability, we would have that
from another source, but at the same time, it is conceivable not to
structure a finance resource for that would translate into a cost for
Medicare and/or Medicaid that would not be accounted for here.
In other words, there are some public purposes in society, wheth-
er you fund it out of the payroll tax roll or fund it out of another
source, it is going to be funded one way or another.
And another one would be — I don't know if you said it, but I have
heard others say it — one way to look at the benefit coverage is not
to be so generous to widows and to dependent children, so we
would restructure this in such a way that it wouldn't be as gener-
ous; but again, the transitional costs could conceivably not antici-
pate the full costs until a dependent became 18 years of age, or do
very much like similar retirement funds.
Could you speak to that? Could either of you or all of you speak
to all the public purposes which Social Security now is providing
in the transitional costs, because regardless of which model we
went to support, assuming we are going to either do something
with the source of income or the structure, am I to assume that you
have anticipated all of those public goods that we are doing in your
transitional costs?
Mr. Penner. Well, I was negligent, I guess, in writing my testi-
mony. I implicitly assumed that the disability system would go on
as it is defined in current law, but I must admit I did not explicitly
say that in my testimony.
Mrs. Clayton. I misunderstood you then.
Mr. Penner. But with regard to particular social problems af-
flicting retirees, certainly old widows are among the poorest mem-
bers of society, and I think if we can solve the big-picture problem,
there would be a good reason to look at the possibility of increasing
the benefits of that subset of the population.
419
In the Kolbe-Stenholm plan that I was involved in developing,
there is a special new benefit, a minimum benefit equal to the pov-
erty line for people who have worked 40 years. The basic message
I wanted to get at in my testimony is that you have a lot of choices
in how you design the rate of reduction of benefits or how the pay-
ments to individual accounts are designed. The President's and
Kolbe-Stenholm plans actually subsidize contributions to individual
accounts. So if you perceive social problems out there, I think intel-
lectually at least it is very easy to address them in a reform pro-
posal. Politically it might be more difficult, but I think there is a
potential solution to almost every problem.
Mrs. Clayton. I was just wondering whether your assumption
was in the transitional costs or in the restructuring?
Mr. Penner. In those remarks, I am combining the two problems
we face, transition and the actuarial deficit.
Mr. Beach. Right. The data displayed before you. Congress-
woman, is for the combined trust funds, Old-Age and Survivors In-
surance and Disability Insurance. So we are working with 12.4 per-
cent of the payroll tax and these numbers represent the spending
gap, the outgo gap between revenues and expenditures associated
with both programs. So this would be a combined situation.
As you know from studying this problem, the Disability Insur-
ance trust fund is forecasted to have negative cash flows sooner
than the Old-Age and Survivors Insurance trust fund; and also con-
tained in these numbers are estimates by the actuaries of what
transfers will have to occur from Old-Age and Survivors Insurance
to Disability Insurance in order for that particular fund to be pay-
ing out benefits when its assets are essentially zero. So that is all
contained in here, as well as the preretirement survivors insurance
program which is funded through the Old-Age and Survivors Insur-
ance program.
I point out to you that many of these plans do have significant
changes in benefits. One of the major common elements, not in all
plans but in many, is to adopt the rebased CPI, which has you
know through the Boskin Commission is saying, has argued CPI
has been too high for too long, let us bring it down a point. That
is part of Moynihan-Kerrey, the old bill. That is part of the Senate
bipartisan plan, Kolbe-Stenholm.
In the Kasich plan, he in fact moves the balance-point calcula-
tions which are important for flaring what that income will be
during retirement away from the average wage index, which is
growing at about a 4.4 percent rate to the CPI All Workers Series,
which is growing at a much lower rate, so he has an implicit
growth rate reduction in benefits, and that is one of the ways he
gets to his actuarial balance points.
In point of fact, personal retirement accounts, while they are im-
portant to these plans, are only one of many of the important de-
tails and they are making a transition to get away from a negative
actuarial balance of minus 2.07 percent to something closer to the
zero line that you see going across. So I believe that Social Security
has captured all of the related Social Security programs in their
analysis.
You have raise a fascinating point: What are the spillover effects
from Social Security reform to the non-Social Security entitlement
420
programs, which are part of the package of work that Congress and
the Federal Government does with older Americans; and of course,
a big one is Medicare. A less large one is Medicaid for those who
have reached retirement survivor situations. Clearly, that has to be
addressed in looking at the full ramifications of reform.
Chairman Smith. I think we will have time for a second round.
Mr. Herger.
Mr. Herger. Thank you.
Mr. Beach and perhaps anyone else who would like to comment,
regrettably it would seem that Congress many times only makes
changes when it has to, when we are confronted with it imme-
diately in front of us, as opposed to 15 years out, if you will.
Mr. Beach, if you would make a comment, what is the impact —
you have already spoken on this somewhat, but maybe if you would
care to comment a little bit more — what is the impact of choosing
now versus over time, and should we put reforms in place now that
prepare Social Security for projected cash flow deficits 15 years in
the future or should we make incremental changes to the system
over time as they are needed?
Mr. Beach. Well, thank you very much for that question.
One thing I have learned over the last several years in working
on the Social Security reform agenda in the debates is that this is
very much a generational program. People who are working today
may not be saving for their retirement because of their income sta-
tus because Congress has said there will be a viable Social Security
retirement program for you in 30 years. So their time horizon is
their entire working life. If you are a — well, take my family that
grew up around Newton, Kansas. We are all Lithuanian immi-
grants despite my name. He was a foreigner who came into the
family.
We were not in a position. Congressman, to save for our retire-
ment. We did, but we did it as a family, as a community. We had
a long time horizon.
What I am suggesting to you is this, that because of the long
time horizons that the covered workers have with respect to their
retirement, you should do this now to single people, that, yes, you
do need to supplement your retirement income; or, yes, you do need
to put, when you are 25, aside 2 percent and let it grow and be
prudent in your investment. That is a key.
Can you make incremental changes along the way? Of course you
can and you will. There are certain things, though, that you need
to signal now so that workers who are 25 years of age know that
that is coming in 30 years or 40 years when they retire.
Again, back to my original comment, the sooner you do that, the
better off your chances are of success. If we had made changes in
1983 of the type that are envisioned in these plans that we have
before you, we would no doubt be holding a different kind of hear-
ing today, and I think we have the evidence of other countries and
the success with which they have been able to fund much of their
retirement overhang as a guide here.
So I wish we had done that. I hope that you will be doing this
very soon for that reason.
421
Mr. Herger. I think that is a very good point. I beheve that even
when Social Security was originally set up it was never set up to
be a complete, as I understand it, retirement.
Mr. Beach. You are right.
Mr. Herger. You have people who tend to look at it that way,
and perhaps Congress has oversold this.
Mr. Beach. In fact. Congressman, the original first administrator
of the Social Security system said that it is only one of a three-
legged stool, that you have private savings or personal savings,
that is one leg. You have something from your place of work; I wish
we all had that now, but that was the second leg. And the third
leg was Social Security. And he also said, once Social Security
crowds out either of the other two legs, it is important to look at
Social Security because it is supplemental.
Now, we have grown Social Security since that time, and it is a
very large tax on low- and moderate-income households, and it has
got to work for them as a retirement program. That is part of the
mission here, not just to save the trust fund but to save a retire-
ment program for people that are totally dependent on it.
Mr. Penner. I think Bill made a really important point, and that
is, it is so much better if you can give people advance notice of a
change in the rules. When the later normal retirement age was
phased in in the 1983 reforms, no one was affected that was older
than 45 at the time. It is too late now to give that kind of notice.
If I am correct, Mr. Chairman, your plan doesn't affect anyone over
58, but that is older. We had the luxury before of being able to give
more notice, but now you have to move more quickly. So next year
is not too early to do something about the problem.
Mr. Herger. Thank you.
Chairman Smith. Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Mr. Penner, your testimony, there are a new questions about it.
I appreciate your comments on page 6 regarding the Feldstein and
Archer-Shaw plans, which I read to say that privatization, those
plans aren't just privatization because you call it that. It is just try-
ing to privatize the system for the sake of calling it privatization,
but otherwise it doesn't really do much.
Mr. Penner. I didn't mean to imply it didn't do much. It is not
done privately.
Mr. Bentsen. It doesn't seem to accomplish what the stated goal
is.
I do take issue, if I understood you correctly, that the President
is just debt financing because the question of how future obliga-
tions would be paid will be determined at that point in time,
whether it is paid through existing revenues or through further
taxes; and what you are saying in your testimony— you talk about
the various carve-out plans, and in one case you use the current
surplus to finance the move toward funding which, in effect, would
be debt financing, as well, I presume, because any use of an on-
budget surplus has some effect of possibly debt financing in the
long run.
But more importantly, you make a comment that says the choice
of an approach will have distributional and other consequences
422
that are important, but the choice does not change the fundamental
nature of the transition problems to be discussed at this hearing.
I know we are talking about transitional, and I think you get
into great detail or at least conceptual detail about how you would
deal with that, but what I am interested in is the first part of that
sentence. In going to a carve-out, can you, for the benefit of the
members of the panel, tell us what is the trade-off, what are the
distributional and other consequences that exist, forgetting about,
you know, holding harmless those who are not affected by the tran-
sition, but the retiree of the future that is under a carve-out? Be-
cause I think that is an area where we have heard what the poten-
tial upside is; we haven't heard what the potential downside is.
And there is skepticism among, I think, more Members than just
Democrats, but I think there is some skepticism that were this to
really happen and were this to really work, whose ox gets gored or
does everybody come out ahead?
And I am skeptical because I don't think there are plans where
everybody comes out ahead. That is sort of, you know, the "free
lunch" theory. And so I would like, given your expertise and experi-
ence on this, I would like to hear what you have to say.
Mr. Penner. Well, first of all, differentiating the President's plan
from the plans that are mentioned explicitly in my testimony, all
of the plans I mentioned do real things to benefits one way or the
other. The President's plan does not.
With regard to the distributional implications of having a carve-
out versus an add-on, much of one's analyses of these different
plans depends on political as opposed to economic forecasts. But if
you think that you are not affecting future tax and spending deci-
sions by what you do, you will obviously retire less debt imme-
diately with the carve-out than if you had some sort of add-on plan.
So, from a distributional point of view, you could say if that was
the end of the analysis, the carve-out puts more of the burden and
sacrifice on future generations, than would an add-on tax, say, to
finance a funded account.
Mr. Bentsen. Or not even an add-on, the chairman's indulgence,
but just current law, trying to maintain a current benefit structure.
Because you also say in your testimony, you talk about the reform
and actuarial balance are not necessarily the same thing. So as-
suming you figure out a way to address actuarial balance, absent
reform, and it may not be possible, but absent a change in the
overall structure, what is the distributional effect of that?
Mr. Penner. Well, just to finish my other point on carve outs
first, I think what seems so appealing about them right now is po-
litical. I think it is a lot easier to have a reform that lets consump-
tion go on at recently experienced levels as opposed to having a tax
increase which actually makes people lower their living standard.
So that is why the surplus presents a golden opportunity but, of
course, the lower the surplus, the more burden you are passing
onto the future.
Can you move to more funding and reform the system without
changing the benefit structure at all? It is theoretically possible,
but then you get to a question of values. Already more than half
of the non-interest, non-defense budget of the United States goes
to people over 65. So the question really is how much of the Na-
423
tion's resources do you want to continue to convey to those people
as opposed to conveying them to children and defense and high-
ways and all sorts of other things.
If you don't reform the structure, the proportion of the Federal
budget going to the elderly is just going to grow and grow and
grow. But deciding the proper portion is a value judgment. Do you
really want to spend that much resources supporting people in
longer and longer retirements, many of those people being very af-
fluent people? So that is the value judgment you have to make.
Siu-e you can do it without reforming benefits, but it means a big
burden on the taxpayer in the future.
Chairman Smith. The gentleman's time has expired. Mr. CoUins.
Mr. Collins. Mr. Greenspan testified before the Ways and
Means Committee several months ago that in order to address the
Social Security situation, the current pay as you go system should
be ending. In your review of plans that have been proposed, does
any plan or, if so, which plan or plans will actually terminate the
pay as you go system as we know it today?
Mr. Beach. Congressman, none of the plans we have before you
eliminate the pay as you go system in its entirety. I would suggest
that perhaps Senator Gramm's plan comes closest because of the
higher personal account percentage that you can put aside. But
then again, all of these plans take a portion of the payroll tax and
use that for retirement. The remaining portion is still pay as you
go. It still supports the system as it currently is structured.
What they are trying to do — just close on this — what they are
trjdng to do is fill a hole. It is not the hole that David referred to.
It is a demographic hole. As you know, Social Security is based on
pay as you go so it is based on workers. Those workers are going
to be fewer in number relative to retirees in the future than they
are today. That is a certainty, unless, of course, we have some mi-
raculous thing hatch.
Mr. Penner. There are plans like the Cato Institute's plan that
I believe has been put into legislation by Congressman Porter that
really do scrap the current system entirely. But even those very
radical plans typically keep a minimum benefit of some sort that
is financed on a pay as you go basis.
Mr. Collins. What you are saying is that there will be a social
insurance program of some type that will exist for those who some
way fall through the traps.
Mr. Penner. I think, in my judgment and most peoples', it is not
politically plausible to think that something as radical as the Cato
Institute has proposed can pass.
Mr. Beach. We have made a commitment that is not likely to be
repudiated in the absence of complete economic chaos toward a so-
cial insurance system on many fronts. So at the Heritage Founda-
tion while we don't have a plan yet that we are promoting as the
Heritage plan, we nevertheless have five principles. One of those
principles, I think principle number three, is that we have a two-
tiered system, one tier made up of personal accounts and the sec-
ond tier made up of this safety net. And a substantial safety net
it will be in order to replace the demographic hole that is out there
and maintain some kind of a minimum floor that everybody will
have access to, no matter what their condition.
424
Mr. Collins. Thank you. That is all I have,
Mr. Chairman.
Chairman Smith. We will briefly entertain a second round of
questions which gives me the opportunity for a couple more. In
coming up with a solution now that would keep Social Security sol-
vent forever, there is some question on whether we should try to
address the problems of reaching 75 years and the problems we
face after 75 years. Maybe each one of you can give me your com-
ments and evaluations of solving part of the problem and moving
toward a solution in incremental steps as we proceed into a future
where there is less money coming in than is needed to pay Social
Security benefits estimated around 2014. Coming up with a total
plan now versus incremental changes. Any comments?
Start with you, Mr. Penner.
Mr. Penner. I think that it would be highly preferable to come
up with a comprehensive plan now for the reason we have already
discussed. Then people will know what the rules are in the future.
After all, retirement planning is a matter of 20 or 30 years for most
people. And it would be good to have the rules stable so you aren't
always twesiking them incrementally and forcing everybody to ad-
just to new rules all the time.
Chairman Smith. Bill.
Mr. Beach. I will defer to David.
Chairman Smith. David.
Mr. John. Actually also to address one of the points Mr. Collins
raised, the one problem that you face with a wholesale restructur-
ing of Social Security — a complete replacement of the pay-as-you-
go system — is that you have a huge Social Security deficit that hits
almost immediately. And while it does end sooner rather than later
because the individual accounts build up fairly quickly, there will
be a 20- or 30-year period with monster deficits.
As far as what is to be done, realistically, Congress could pass
probably a 2, 3, or 4 percent account individual account. Preferably
ft-om our point of view, a carve-out from the existing tax would be
the way to go. We also agree that the sooner that that is done, the
easier the transition is going to be. Although under no cir-
cumstances is it going to be an easy situation.
There is also going to be a fair amount of education that is going
to have to be undertaken before people can take responsibility for
investing a certain amount of their Social Security money. And
that is something that is also going to take time. Realistically, if
we could start to put something in the schools at a fairly early date
to teach people how to invest, that would be a very fine move to
start out with.
Also, it is going to take a fair amoimt of time to develop the in-
frastructure whether we have an individual account that is run on
a TSP model or an individual account where you basically go out
and choose your provider. But no matter what, there is going to be
a fairly healthy infi-astructure that will have to be built. And it is
something that doesn't really exist now, although it is certainly not
impossible to develop. The sooner that Congress starts to lay down
the marker and indicate which direction it is going to go, the soon-
er we will be able to work out details on that kind of plan.
425
Chairman Smith. Representative Rivers, did you have additional
questions?
Ms. Rivers. Thank you. On page 8 of your testimony from the
Heritage Foundation, the last paragraph gives numbers regarding
annual deficits under the various systems for the year 2030. Is
there an assumption within these numbers that none of the bonds,
none of the treasury bonds will be redeemed?
Mr. John. No, as a matter of fact what we are pointing out here
and the reason that we chose 2030 was that that is within the time
that the trust fund is being redeemed to pay benefits. The question
comes how much money is going to have to be used to retire those
bonds. Now, those bonds, as was mentioned in the paragraph from
the 0MB, President Clinton's
Ms. Rivers. So what you are presenting is you are presenting
the debt owed in the form of the Treasury bonds as a deficit on the
system.
Mr. John. Yes. Because the thing is money is going to have to
come in from outside the system, from outside the payroll tax in
order to repay the bonds in the trust fund.
Ms. Rivers. Okay. Which leads me to my second question, I will
add, I asked questions earlier about the on-budget surplus and my
concerns about the fact that it is predicated on real cuts in the
budget, 20 percent in discretionary spending including defense.
Given that, given that we have a Federal debt approaching 6 tril-
lion and we have Medicare problems, that we have Social Security
problems here, how much harder are these tasks going to be to ad-
dress if we give a substantial tax cut at the current time?
Mr. Beach. We made the point Congresswoman, that these num-
bers we presented today are based on various assumptions, demo-
graphic assumptions, economic growth assumptions and so forth, so
that is one of the realities that we have to face. Tax cuts are impor-
tant for reasons beyond Social Security, some would argue, and I
would argue, that they are good for the economy, that there is a
level of tax cuts which is important for economic purposes, equity
purposes. We have
Ms. Rivers. I understand the reasons for it. My question is did
it make the job easier or harder to deal with Social Security and
our existing obligations if we give a tax cut right now?
Mr. Beach. No, I think that you can separate the two one from
another now. Now, you can't do that 10 years from now. Because
10 years from now this problem is a much worse problem than it
is now.
Ms. Rivers. But 10 years from now, tax cuts — if they are predi-
cated on cuts that never exist, that never happen, don't we have
an even worse problem not just with Social Security but with ev-
erything else that we are dealing with?
Mr. Beach. No, I don't think so. I think if you have the kinds
of tax cuts that a number of people across the spectrum are rec-
ommending, the capital gains, and on second earner bias, that you
have a bigger economy, you have more jobs and have you a bigger
tax base. i'Gid that is part of the policy judgment you have to bring
to this issue.
Ms. Rivers. I didn't bring this today for this reason, I brought
it because I am looking for something else. But I have read this
426
about four or five times. It is David Stockman's book. He tells us
that what happened in 1981 is that a tax cut was predicated on
the idea that the budget was going to be cut. The budget cuts never
materialized. There was a hope that a tax decrease would, in fact,
increase economic activity just like what you are talking about.
And, in fact, none of those things happened, and we moved into the
largest period of deficit spending that we have experienced as a
Nation.
And my question, and I really want to address this in terms of
problem solving, is we have some huge tasks in front of us, some
real heavy lifting economically. We have to deal with redeeming
the bonds and, as you say, the money has to come from somewhere.
We have to deal with restructuring Social Security, we have to deal
with Medicare. We are basing a surplus projection on cuts that this
body has not been willing to make in the past.
How reasonable, how responsible — you are from the midwest,
you are from Kansas, I am from Michigan, my training says to me,
my upbringing says you don't spend money you don't have. You
don't spend the same dollar twice. How reasonable is it to talk
about doing all of these things with the same budget surplus?
Mr. Beach. And my training also tells me that there is not a gov-
ernment program on the face of the earth that can't be made more
efficient and better for the people that it is supposed to serve. Now,
Social Security is a — as a retirement program has got to be fixed.
It just has to be fixed. And by fixing it now, and then doing things
to grow your tax base at the same time, you may be able to avoid
major financial problems 2020 to 2050 period that are stemming
from other things besides the issues that we are talking about
today. We have $22 trillion worth of anticipated revenues over the
next 10 years, counting Social Security revenues. We are talking
about tax cuts between 300 billion and 800 billion over that time
period that should be directed to help this problem and not hinder
it.
Ms. Rivers. With the Chair's indulgence I would like Mr. Penner
to speak to it then I will finish.
Mr. Penner. I tend to agree with you, Congresswoman. I don't
think this is the time for tax cuts. I wouldn't say that were it not
for the huge demographic problem that we face starting around
2010. But I would like to get the debt, the GDP ratio down a lot
lower than it is today before I started talking about tax cuts. Espe-
cially tax cuts that would be promised for the year 2003 or so.
There is just no reason to have to do that.
If the Congress follows its goal of trying to keep the unified
budget surplus at least as large as the Social Security surplus with
some kind of lockbox proposal, there is no room for tax cuts in the
next few years even if you abide by the spending caps, which al-
most certainly you won't. I don't disagree with Bill that we could
probably all go into a room together and find enormous amount of
government waste that we could cut out.
Ms. Rivers. But we all go into a room together, and we can't
come up with things that can be cut. Congress.
Chairman Smith. And that is our experience. Our experience is
that government tends to grow. Right now taxes as a percentage
of GDP are at the highest point they have ever been at in peace-
427
time. And we have already got many proposals out there suggest-
ing that we spend some of the surplus for other government pro-
grams that are so much needed. And so the argument is: should
we get this money out of town to the extent that a surplus is an-
other way of defining overtaxation. Is it reasonable at this time, to
give some of that money back to the individuals that earn it? Can
we do it in such a way that is going to be conducive to an expanded
economy and a growing economy? That ultimately is going to be
the solution.
If we simply take a larger piece of a smaller economic pie that
might exist 30 years from now, and say these are our Social Secu-
rity benefits, the system will shortchange younger workers. It is
better for our retirees if we take the kind of actions that are nec-
essary to expand the economy and enlarge the economic pie when
they retire.
And did you have a statement, Mac, that you want to close on?
Then I will ask each one of these individuals to summarize for a
couple minutes if they would like to.
Mr. Collins. Well, Mr. Chairman, we talk about spending and
talk about tax relief here for working folks around this country.
You know, the budget resolution that the Congress passed was a
resolution, it was the work of the Congress. It was a blueprint laid
out by the Congress, no other branch of government was involved,
just the Congress.
Now, if Members of Congress will follow the philosophy that our
dear colleague on my left has just stated, then we will be able to
follow through with that blueprint, that resolution, that will control
spending, much different than is reported by Mr. Stockman's writ-
ing in his book of 1981. And in doing so, then we have fallen
through with managing the people's business. And we will be able
then to also pass and give tax relief to working people to leave
more of their income to them, and they will spend it. And when
people spend money, that has a tendency to increase and enhance
the economy.
There are also some provisions in this tax proposal that Mr. Ar-
cher released just this morning that encourage divesting of assets
and then reinvesting. And why is that important? It is important
because — and I like to refer to a story of when I was campaigning
in 1992, I walked in a little, small TV rental shop in Bamesville,
GA, and the shop itself was about a third the size of this room. One
lady was working in there. And I told her who I was and what I
was doing. She says I want to talk to you about taxes. I said — I
was a candidate; I would talk to her about anything.
She says I got this little piece of property out here at the edge
of town that I could have sold three times. But I haven't sold it,
and I am not going to sell it because I don't want to give a large
part of the money to the government. I said, lady you are talking
about capital gains. She says I don't know what you call it, she just
said I know if I sell my property I have to give a lot of it to the
government, and I am not going to do that.
Well, the gist of the story is this, she didn't sell that property.
When she didn't sell that property, there were no profits made, no
tax liability at all generated. So the Federal Government got no tax
from it. The local system, the local government there got no money
428
because there was no transfer tax on it, neither did the State re-
coup any kind of income tax because there was no sale, no tax U-
abihty.
So there are provisions of tax reUef that can enhance the econ-
omy and grow the economy and help the situation that we face by
creating more jobs and creating more revenue. And as we sit
around, it is as 430 people on this end of the hall, 100 on the other
end trying to make these decisions about how we are going to man-
age the people's money, the people's business, how we are going to
by law force them to pay a portion of their income, they are sitting
around a hundred million plus kitchen tables in this country trying
to figure out their budget based on their income and the deductions
from their income and the needs for the balance of that income
that is left and how they are going to provide for their family.
So I think we can follow suit, and we can do exactly what we laid
out in the resolution. And then once we do that, we send it down
to the other end of the street. Then we bring into play the execu-
tive branch. And this executive branch then has the opportunity to
either agree or disagree with what the legislative branch has done,
and that is the work of the people's business.
Thank you, Mr. Chairman.
Chairman Smith. Mr. Herger.
Mr. Herger. Well, I want to thank the Chairman for having this
hearing. I want to thank each of you for being here. I want to say
that I sit on the same committee that my colleague Mr. Mac Col-
lins serves on, the Ways and Means, tax writing committee. I don't
know how anyone could say it more eloquently than he just said.
The fact is we are being taxed at the highest rate in peacetime
history. When we allow working people to be able to keep more of
their money, and we have done that several times under the Ken-
nedy administration, under the Reagan administration, again a few
years ago, I believe we have found out conclusively that very, very,
very few people take that extra money and go bury it in the back
yard. They go, and they pay off debts. They purchase things that
they weren't able to before. And the multiplier effect, we end up
having more than we did before, be able to take care of Social Secu-
rity, particularly at the high rate we are being taxed now.
So I really can't add anything to that. I think it says it very well,
the example he gave. I believe we could give a hundred other ex-
amples in other areas as well. So, again, this Social Security is an
issue that we can't wait 15 years to take care of. It is something
that we have to begin taking care of right now. And whether it be
the thinking that those who are receiving it have or whether it be
those of us as elected officials, we have to make the tough decision
now, and it is a decision we have to make on a bipartisan basis.
It is a decision we have to make, Senate, House, the President.
I am more encouraged now than I was before, it sounds like per-
haps the President is moving more and more this way and others.
And I believe probably only through the pressure of the American
public are we going to do something. But I believe it is something
we have to do right away. And again, Mr. Chairman, I understand
this is the last of the hearings. I want to thank you for what I feel
are very, very productive hearings. And I want to thank each of our
participants for contributing. Thank you.
429
Chairman Smith. And in summary, Mr. Herger, the Task Force
decided earUer that we are going to recess today at the call of the
Chair. A business meeting is tentatively scheduled for 1 p.m. this
coming Thursday or at another time that will be appropriately an-
nounced. Any statements that individuals would like to have in-
cluded in the Task Force report should be in by the 30th of this
month. And the minority and majority statements likewise. And I
would like to ask each of the witnesses today if they would have
a concluding statement.
Mr. Penner. Well, Mr. Chairman, I think all the important
points have been made. But maybe the one that needs repeating
is that this, combined with the Medicare problem, is the most im-
portant fiscal problem facing the Nation. It would be so much easi-
er if we acted earlier rather than waiting until later. So I urge you
on.
Mr. Beach. About a year ago I was in south-central LA address-
ing a congregation of African and Methodist Episcopal ministers
and church leaders on Social Security. Social Security reform for
them is a problem of capital in their community. We toured the
area several times Crenshaw, south-central LA, the place where
Reginald Denny was pulled from the truck. The problem that these
people have really isn't the glass sealing of civil rights. Congress,
the President, the courts have provided the tools necessary to fight
the civil rights problems, plenty of racism left in this country. The
problem is the sticky floor of economic opportunity.
We need to find ways of using Social Security, the main way peo-
ple say save for their retirement in those communities, to build
capital in those communities through personal savings accounts.
That is doing something inside Social Security. If you could do that,
the economic benefits would be rather immediate, tangible in ex-
actly the places where they need to be. So I urge this Congress to
keep one thing in mind as you go forward, as Dr. Penner has said
repeatedly, solving the trust fund problem is a couple of handles
moved here and there and little bit of paint and basically you have
got something done. Generational effects are going to be important.
The real objective here should be solving the retirement program
for low and moderate income Americans, restructuring, changing
that program to make it work for them.
Chairman Smith. David.
Mr. John. I have a 13-year-old daughter who is going to be retir-
ing, with luck, about 2050 or so. If this Congress, or if the next
Congress acts, she basically could be retiring at a time when the
Social Security or deficit, is somewhere between $25 billion and
maybe $8 billion. If you do nothing, the deficit is going to be $342
billion. Now what is that going to mean to her quality of life and
the quality of life my grandchildren and, with luck, my great
grandchildren?
Basically if you act now and if you act responsibly, and if you
bite the bullet, there can be some sort of a reform that will make
a tremendous amount of difference not just in terms of an operat-
ing deficit but in terms of the quality of life that she will face. As
Bill was saying, allowing all Americans to participate in the econ-
omy through some sort of an individual retirement account gives
people an opportunity that they never had. This is possibly the
430
most important decision that is going to be facing this Congress or
the next one.
Chairman Smith. Well, again I thank each one of you for all the
work that you have contributed to this effort. The Chairman hand-
ed out 14 potential findings that should be considered for Social Se-
curity changes. And without objection, those suggested findings will
be included in the record. And with that, this Task Force is re-
cessed for next Thursday at 1 or at the call of the Chair.
[The information referred to follows:]
Budget Committee Social Security Task Force 14 Findings We Might Be Able
TO Agree On
1. The current demographic projections may very well underestimate future life
expectancy.
2. Investment in the capital markets is an important part of restoring Social Se-
curity 's solvency.
3. The investments should be limited strictly for retirement.
4. Guaranteed return securities and annuities can be used with personal ac-
counts to ensure an investment safety net.
5. Social Security reform should encourage savings and overall economic growth.
6. Congress should consider paying for a portion of disability benefits for work-
ers who have been in the system a short time out of the general fund.
7. Private or other capital investments can be managed to minimize administra-
tive costs to avoid substantial reductions rates of return on investment.
8. We can learn from the experiences of other countries to more effectively de-
velop Social Security reforms.
9. Any reform must consider the effects on all generations of workers and retir-
10. The Social Security Trust Fund is a legal entity, but only becomes a financial
asset when General Fund provides actual funding.
11. Time is the enemy of Social Security reform and we should move without
delay.
12. Change should be gradual to allow workers to adjust their retirement plans
and any change for current or near-term retirees should be minimal.
13. No payroll tax increase.
14. Social Security surpluses should only be spent for Social Security.
Prepared Statement of Hon. Kenneth F. Bentsen, Jr., a Representative in
Congress From the State of Texas
Mr. Chairman, I want to start by thanking you for your leadership on this panel
and for holding these hearings. They have been, if anything, informative and in-
sightful. I personally have learned more about Social Security, its successes, its
problems, and potential solutions to achieve solvency.
I would like to spend the next few minutes laying out what I think are some key
principles that all of us can take away from this Task Force.
First, I sensed that there is widespread agreement on the need to keep the Dis-
abihty Insiu-ance and Survivors' Insurance programs intact. If government shoiild
do anything at all, it should help those who cannot help themselves and protect wid-
ows and their children from poverty. No private insurance program would assume
the disabled or those unable to work— children— as beneficiaries. They represent a
perfect example of the problem of adverse selection. The Disability Insurance and
Survivors' Insurance program is a sound safety net that should be maintained in
its present form.
Second, it is also clear that Social Security is the most successful social program
of the 20th Century. It, along with Medicare, has brought the poverty rate among
our senior citizens down to 13 percent from almost 50 percent before its inception.
That in and of itself is a tremendous accomplishment.
In spite of the program's achievements, it is also clear what is broken. The cur-
rent program is fiscally unsustainable. Social Security is a pay-as-you go system
where payroll taxes on current workers and their employers fund current bene-
ficiaries. The basic problem is this: Social Security in its current form reqviires that
the nimiber of workers and the economy's payroll tax base expand faster than the
number of beneficiaries and the size of their benefits. But demographic and eco-
nomic trends have made this virtually impossible.
431
In about 10 years, 76 million baby boomers will begin to retire, and they are ex-
pected to live longer than their parents. The number of Social Security beneficiaries
will double over the next four decades. Let me repeat that. The number of bene-
ficiaries will double over the next four decades. At the same time, the number of
workers will grow by only 17 percent. In 1950, there were forty workers for every
retiree. In 1997, there were only 3.3 workers for each retiree. And that ratio is ex-
pected to fall to two to one in 2020. Under these conditions we cannot maintain cur-
rent benefit levels with this kind of retirement boom.
So a proportionately smaller pool of workers — primarily younger workers and em-
ployers who pay the 12.5 percent payroll tax — will have to support a larger pool of
retirees. Payroll contributions will only be able to cover 75 cents on the dollar of
current benefits after 2055. The big question is how do we make up those 25 cents
on the dollar or 2 percent of payroll?
Yet, this Task Force and the Congress should work to pierce the myth that the
Trust Fiind is an accounting fiction. Indeed, it is not. The Treasury Bonds invested
in the Trust Fund are backed by the full faith and credit of the United States Gov-
ernment. The United States has never defaulted on its debt. In fact, Alexander
Hamilton made debt repayment a significant part of his agenda as om nation's first
Treasiiry Secretary. Since then, this nation has not backed down fi:'om debt repay-
ment. To do so is unthinkable and irresponsible.
The problem with the Trust Fund is that while the dollars deposited in the fund
are to be spent on general operations, they are credited to the Trust Fund and spent
on general operations. Then, this increases in annual obligations ultimately in-
creases debt and results in macroeconomic consequences in the future as total per
capita debt grows and must be repaid. This puts additional pressure on fiscal policy.
But while this practice has consequences for the general economic well-being of the
U.S., it should be strongly noted that no obligation to the Social Security Trust
Fvmd has been diminished.
Third, there are some credible plans that exist. Mr. Stenholm and Mr. Kolbe's
plan, while I do not agree with all of its features, it is honest in that it meets fiscal
considerations, such as transition costs and balanced budgeting. It also says there
is no fi-ee lunch. Mr. Kasich's plan too is rather straightforward, although I may
not agree with everything that is in there. Other plans, such as Mr. Archer's and
Mr. Shaw's, show how difficult it is for a plan to be driven by ideology. Their plan
does not differ much from the President's in the near term because all they do is
commit future general revenues to the Social Security Trust Fvmd. Even worse,
some have appeared before this Task Force with plans that promise ever lasting eco-
nomic growth and higher than average returns on equity investments. While invest-
ments in equities have generated higher returns on average when compared with
T-bUls, there have been some periods of time when there have been negative re-
turns. Seven times in the 1970's and 1980's the real value of the S&P 500 was at
least 40 percent below what it had been in the previous 10 years. What is really
a tragedy is when private interest groups put forth plans without saying how they
are going to pay for them and do not take into account transition costs. Those plans
are just not credible.
Finally, I want to emphasize again what Mr. Greenspan said privately to the Task
Force. He favors a more privatized system or, at least, if I can read into what he
said, individual accounts, because he is a conservative. He believes the value of plac-
ing a greater burden on an individual tq save for his or her retirement makes for
a better society; it does not necessarily make for a better retirement program. In
fact, a private system does not have to be pre-funded and can have the same liabil-
ities as our current system. Just because a system is privatized does not mean that
it will not have the same habilities as a pay-as-you-go system. Solvency is not the
same as reform and just because a system is reformed does not mean that it is sol-
vent. His preference for a private system is based, in large part, on macroeconomic
theory and he clearly stated that a system of private accounts is no more solvent
or sustainable if the current the current pubhc system.
For example, a privatized but imfunded pension system has recently been estab-
lished in Latvia, where payroll teixes are collected by the government, which then
credits workers' so-called "notional" accounts with paper returns on contributions.
Singapore, on the other hand, has a public retirement benefit that is pre-funded
where the central government collects taxes sufficient to generate substantial as-
sets, which it then invests on the systems behalf ^
^This paragraph is extrapolated from a paper by John Geanakoplos, Olivia S. Mitchell, and
Stephen P. Zeldes. "Would A Privatized Social Security System Really Pay a Higher Rate of Re-
turn?" (Latest draft, August 3, 1998).
432
The bottom line is that a plan to extend the solvency of the system is needed and
such a plan should be enacted sooner rather than later. Solvency may include, but
does not have to include, radical overhaul of the current system. Any system should
mEiintain the basic characteristics of the existing system with respect to the prin-
ciples of universEility and progressivity. And, any reform plan, must indicate upfront
how it is paid for and on whom the burden falls. Mr. Chairman, our work is cut
out for us. There are hard decisions that have to be made and I hope we can do
this in a bipartisan, constructive maimer. Thank you.
Prepared Statement of Hon. Eva M. Clayton, a Representative in Congress
From the State of North Carolina
Mr. Chairman, preserving Social Security is one of the most important issues that
we face today. We finally have a balanced budget which gives us an opportunity to
save and strengthen Social Security. It is the obUgation of this Congress to protect
the financial sectirity and promised benefits that so many of this nation's retirees
are depending on when they retire within the next 10 to 15 years. Additionally, it
is through Social Security that we must ensure the economic fiiture for our children
and grandchildren.
Social Security has been one of the country's most successful social programs. It
is largely responsible for the dramatic reduction in poverty among elderly people.
Half of the population aged 65 and older would be living in poverty if it were not
for Social Security and other government programs. Social Security alone lifted over
11 million seniors out of poverty in 1997, reducing the elderly poverty rate from
about 48 percent to about 12 percent. Social Security has become more effective in
reducing poverty over time.
Strategies for saving Social Seciuity for future generations is probably the most
significant debate facing us. We want to make sure that the future of Social Secu-
rity is secure for our children and grandchildren, but we also want to protect the
financial security and promised benefits of retirees. It is important for Congress to
remember that while Social Security was not designed as a retirement program,
many Americans have paid into the system in good faith and feel justified in relying
on these benefits to survive in their retirement years.
The Social Security system is projected to have long-range funding problems.
Therefore, we must find a way to reform this system. The House Budget Committee
Social Security Task Force was formed with the intent to look at the various reform
proposals, problems that different generations and genders have, and possible solu-
tions to these problems. We have held hearings, and as a result, have defined eight-
een bipartisan statement findings.
Mr. Chairman, one particular area that I would like to focus on is consideration
of the effects reform will have on all generations, genders, and minorities. Social Se-
curity is particularly important to people of color. Elderly African Americans and
Hispanic Americans rely on Social Security benefits more than white elders rely on
the program. Social Security benefits make up 43 percent of the income received by
elderly African American people and their spouses and 41 percent of income re-
ceived by elderly Hispanic Americans, compared to 36 percent of the income of el-
derly whites.
Social Security is also an important source of income for women. The program
made up 61 percent of the total income received by elderly women in 1997 and it
was the only source of income for one out of five elderly women. Women have fewer
resources to draw upon in their older years than do men. Only 30 percent of women
65 and older had pension coverage in 1994 while 48 percent of men were covered.
While Social Security is intended to be only one source for retirement income, the
lack of pension coverage and Umited resources for savings places greater weight on
Social Security as a reliable, guaranteed source of income for minorities.
Mr. Chairman, thank you for holding these hearings since ensuring that Social
Security remains intact is so important to the livelihood of many people. The ques-
tions and problems surrounding Social Security, as well as the impact on every U.S.
citizen, certainly justifies a close examination by Members of Congress.
Prepared Statement of Hon. Rush D. Holt, a Representative in Congress
From the State of New Jersey
Mr. Chairman, it has been a pleasure to serve with you and other members of
the Social Security Task Force throughout the past several months. Preparing for
the retirement of the baby boom generation looms as one of our nation's most dif-
ficult challenges, and I commend the efforts being made here to develop a long-term
solution.
433
Social Security — the nation's largest and most successful domestic program — has
reached a critical juncture in its development. When Social Secvirity was passed, to
be old was usually to be destitute — Social Security changed that. People in the U.S.
believe it is a fundamental value to help workers save for retirement.
As its creators anticipated, nearly every wage earner now pays taxes into the sys-
tem. In principle, all citizens may be eligible for entitlements at some point in their
lives. Yet senior citizens worry that their benefits will be cut; younger Americans
are skeptical about their own benefits upon retirement.
If the government were to do absolutely nothing to Social Seciirity, the Social Se-
cvuity Trust Fund woiild still be solvent for about 35 more years. There is no imme-
diate Social Security crisis. But because the issue concerns every American, it is
critical that the debate on Social Security reform be based on a deep understanding
of the economic and social underpinnings of the system. This Task Force has aug-
mented my personal learning process and for that I am appreciative.
Although the Social Security system is now nmning surpluses, its board of trust-
ees projects that its trust funds will be depleted in 2034 and only 71 percent of its
benefits will then be payable with incoming receipts. The trustees project that, on
average, over the next 75 years, the system's cost will be 15 percent higher than
its income; by 2075 it would be 49 percent higher. The primary reason is demo-
graphic: the post-World War II baby boomers will begin retiring in a decade and
life expectancy is rising. By 2025, the number of people age 65 and older is pre-
dicted to grow by 75 percent. In contrast, the number of workers supporting the sys-
tem is expected to grow by only 13 percent. As a result, the ratio of workers to re-
cipients is expected to fall fi-om 3.4 to 1 today to 2.0 to 1 in 2035.
Trustees project that the surplus Social Security taxes now being collected will
cause the Social Security Trust Fluids — comprised exclusively of Federal bonds — ^to
grow to a peak of $4.5 trillion in 2021. The system's outgo would thereafter exceed
its income and the trust funds would fall until their depletion. However, the trust-
ees also project that the system's taxes (ignoring interest income) would fall below
its outgo in 2014. Interest paid to the funds is simply an exchange of credits among
government accounts. It is not a resource for the government — only the system's
taxes are. Hence, it is in 2014 that other Federal receipts would be needed to help
pay for benefits. If there are no other receipts, we would have three primary options:
raise taxes, cut spending, or borrow the needed money.
Public opinion polls show that fewer than 50 percent of Americans are confident
that Social Security can meet its long-range commitments. We have also heard testi-
mony that Social Security may not be as good a value in the future as it is for to-
day's retirees. These concerns and a belief that the remedy lies partly in increasing
national savings have led to proposals to completely revamp the system.
Some witnesses suggest that the system's problems are not as serious as some-
times portrayed. They argued that the system is now running surpluses, that the
public still values the program, and that there is risk in some of the new reform
ideas. They contend that only modest changes are necessary.
In our Social Security Task Force, we have considered ideas ranging fi-om restor-
ing solvency with minimal alterations to totally replacing the system with some-
thmg modeled after IRAs or 401(k)s.
I agree with the Committee for Economic Development that there are three pri-
mary goals for reform that address the central problems of Social Security — fiscal
imbalance, declining returns, and the resulting loss of confidence among yoimg
workers. When crafting solutions to achieve basic reforms, we must keep in mind
the key principles of restoring the system's solvency, preserving Social Security as
a safety net, reducing inequities in the system, and raising the national saving rate.
We Americans have made Social Security one of our most useful and basic com-
mitments to younger and future generations. We cannot let the Social Security sys-
tem slide toward insolvency and allowing confidence in the system to erode, espe-
cially among young workers. To do so would xmdermine one of the most successful
and important programs of the 20th Century.
The nation can — and should — keep its commitment to future workers as well as
to today's retirees. Social Security provides reliable income that is critical to millions
of retirees in this country; it is the primary means of cash support for nearly aU
retired low-income workers. To abandon Social Security would be to cast millions
of future retirees adrift to fend for themselves. Sensible reforms, building on exist-
ing structures and drawing on the productive power of this coimtr/s private econ-
omy, can ensure a healthy Social Security system for America.
But the nation must act promptly. Delay is unwise and dangerous. It wiU raise
the cost of reform and is unfair to future generations. The most compelling reason
to act soon, however, is to reverse the alarming erosion in popular support for Social
Security, especially among younger workers.
434
It is well within the resources of our country to provide support for our retirees
and other who receive payments under disability. It is no secret that at this time,
our nation is enjoying a budget surplus. I believe that every penny of the entire
budget surplus, not just the Social Security surplus, should be saved until legisla-
tion is enacted to strengthen and protect Social Security first.
Spending any projected budget surpluses before protecting and strengthening So-
cial Sectority would be wrong. Projected budget surpluses over the next decade offer
a once-in-a-lifetime opportunity for addressing the challenges that Social Security
faces. This hard-won achievement resulted from responsible steps that were taken
in the past. We should not deviate fi-om the path of responsibility now, with prob-
lems looming over the horizon for Social Security.
Mr. Chairman, Social Security is the most important and successful program of
the 20th Century. We must not forget that it provides vitally important protections
for American seniors. A majority of workers have no pension coverage other than
Social Security, and more than three fifths of seniors receive most of their income
fi-om Social Security.
Let's put the need of America's current and future retirees first. Thank you.
Prepared Statement of Hon. Paul Ryan, a Representative in Congress From
THE State of Wisconsin
I want to take this opportunity to provide my conclusions on the work of this Task
Force in the past few months and congratulate the Chairman of the House Budget
Committee Social Security Task Force, Mr. Nick Smith, for his leadership on Social
Security and this special Task Force. The hearings we held have provided a good
opportunity to facilitate the dialogue on both sides of the aisle. The bottom Une for
Social Security, however, is that Social Security cannot and will not survive in its
current form. It faces the grave reality of insolvency within the next few years if
we do nothing.
On the other hand Congress and this Administration now have the opportimity
to address this pending insolvency. One of my highest priorities in Congress is So-
cial Security. There are many important steps that need to be met in order to, first,
protect the Social Security Trust Fund, and second, improve Social Security for cur-
rent retirees and fiiture generations. In addition, before any changes are made to
Social Security, I believe it is important to guarantee current benefits to current and
future beneficieiries.
First, to guarantee these benefits, earlier this year, I introduced the Social Secu-
rity Guarantee Initiative, H.J.Res. 32, which would guarantee benefits to current
and fiiture retirees as we work to improve Social Security. It passed overwhelmingly
in the House. This needs to be a fundamental ingredient to any initiative to save
Social Security.
Second, I introduced and cosponsored Social Security "Lock box" legislation which
would change the rules of the House of Representatives to help us stop Congress
fi-om passing legislation that dips into Social Security. For years, the Federal Gov-
ernment has been taking money fi-om the Social Security Trust Fund to pay for no-
related government programs.
In addition, I, along with the Chairman of the House Budget Committee, Con-
gressman John Kasich, have introduced the Social Security Surplus Preservation
and Debt Reduction Act, H.R. 1803, which would establish a new enforceable limit
on the amoimt of debt held by the public. The debt ceiling would be reduced as the
debt is paid off. A point of order would lie against any legislation, in the House or
the Senate, which would increase the public debt limit or provide borrowing author-
ity that exceeds the debt held by the public.
Finally, I am still in the process of evaluating each Social Security reform pro-
posal. I have heard fi-om many of my constituents in the District and will be looking
very carefully to see whether each proposal would:
• Increase the rate of return for payroll taxes paid into the Social Security Trust
Fund.
• Not increase the Federal Government's role in Social Security.
• Continue to provide a safety net for retirement income.
• Not decrease benefits.
• Not increase taxes.
Again, reforming Social Security is a priority for me this Congress. I look forward
to working with my constituents and my colleagues to improve Social Security for
the current and future generations.
[Additional resource on Social Security privatization submitted
by the Budget Committee minority staff follows:]
435
Internet Link to National Bureau of Economic Research Working Paper,
"Would a Privatized Social Security System Really Pay a Higher Rate of
Return?"
http: 1 1 www .nber.org I papers I w6713
[Additional resources on Social Security reform submitted by Mr.
Smith follow:]
Prepared Statement of William G. Shipman, Principal, State Street Global
Advisors
Chairman Smith, Congresswoman Rivers and Members of the Task Force, I thank
you for giving me the opportunity to submit testimony to the House Budget Com-
mittee Task Force on Social Security concerning administrative costs in a reformed
Social Security system. I come before you as an interested citizen who has spent
his career in the financial services industry. I am a Principal of State Street Global
Advisors, an investment management firm that is part of the State Street Corpora-
tion.
Founded in 1792, the State Street Corporation is committed by our corporate plan
to "Participate in the governmental process, and contribute our efforts and resources
to serving the common good." In that spirit, we have participated in the national
debate over ways to strengthen and revitalize America's Social Security System. In
response to numerous requests, we have examined the technical and administrative
costs and challenges that would arise in creating a national system of individual in-
vestment accounts. Our analysis, based upon our extensive experience in admin-
istering pension funds and 401(k) plans, does not advocate any specific proposal or
its financing.
Moving to an individual account system is a significant and unprecedented under-
taking. To put it into perspective, at year-end 1994, the latest government data
available, there were about 200 thousand 401(k) plans, and about 21 million individ-
ual participants. Given the growth since then it is presently estimated that 25.4 mil-
lion individuals now have 401(k) accounts. ^ The individual account system we are
discussing here would be more than five times the size.
Many, if not most, analyses of administrative costs have approached the issue by
looking at what other countries have done, estimating their costs, and then project-
ing that those costs reasonably would be borne by the United States, as well, if we
were to move to a market-based structure. We took a different tack. We looked at
individual accoimt systems in our coxmtry and wondered if they could be applied to
this challenge. We concluded that they could.
This testimony is in four parts. The first is a description of the objective of a mar-
ket-based system. The second is the summary of a model currently in use that
meets the objective. The third is the significant challenge in appl3ring that model
to Social Security reform given present accounting and record-keeping systems. And
the fourth is a solution that overcomes the challenge.
The feasibility analysis conducted by State Street is just that — a feasibility
study — and does not advocate one course of action over another.
The Objective: An Individual Account, Market-Based Social Security Option
The objective is to develop an investment and administrative plan that:
• Creates individual accounts with assets owned by the account holder;
• Ensures reasonable costs for all participants, low- as well as high-income work-
ers;
• Minimizes employers' administrative burden;
• Provides the opportimity for workers of all incomes to invest in capital markets;
• Ensures that inexperienced investors will not suffer poor returns relative to ex-
perienced investors;
• Provides investment choice;
• Offers a solution for workers who make no investment choice;
• AutomaticaUy adapts to changing technology and services offered by the finan-
cial services industry.
These objectives are considered important because they have been central in the
debate on Social Security reform. They are also integral to the most popular defined
' Spectrum Group, San Francisco, CA.
436
contribution system in the United States, the 401(k) plan.i Indeed, the 401(k) plan
structure is often referenced as a potential model for an individual retirement ac-
count plan for Social Security. It should be noted that even though the 401(k) plan
may be a useful model, it is unlikely that it would be appUed precisely.
The Model: The 401(k) Plan
Since the late 1970s, defined contribution systems have increased in popularity
among American companies and workers. And just since 1985 those that have spon-
sored as well as those that have participated in 401(k) plans have increased several
fold.
Under 401(k) programs, a plan sponsor, usually a company or union, oversees ad-
ministration of a savings and investment program for its employees. Under such
plans:
• Employees opting to participate in the program designate the amoimt they wish
deducted fi-om their pay;
• Employees select investment options prescribed by the plan sponsor;
• The plan sponsor deducts the specified funds fi-om the employee's pay and in
many cases invests the funds as of that day in the designated investment vehicles;
• Deductions are made on a pre-tax basis;
• Investment earnings grow on a tax-deferred basis;
• Benefits are subject to tax when taken out;
• In many plans, the employer provides some level of matching contribution to
the employee's accoimt;
• Account holders normally can call an 800 number voice response vmit or individ-
ual accoimt representative and change their portfolio holdings and receive that day's
closing price for each asset traded.
In the early years of 401(k) plans investment options were often limited to a sta-
ble value fund, a diversified fund and company stock. In recent years, however,
there has been a significant increase in investment choice. Many plans now include
a large number of investment options as well as self-directed brokerage accoimts.
These accoimts provide access to a large universe of institutional and mutual funds
as well as individual securities. With all of the choice available, individuals can now
create portfoUos that are appropriate for their age, their risk tolerance, and their
wealth objectives.
The Challenge: The Government's Record-Keeping and Accounting System
The major challenge in creating a 401(k) model of individual accounts linked to
Social Security is the timely posting of individuals' savings contributions. This is not
possible given the present Social Security record-keeping system.^ Although the
Treasury Department has built a comprehensive system for the collection of PICA
taxes from employers, there is no detailed record of individual taxes paid at the time
they are collected and sent to Treasury. This information is not communicated to
the government until the following year.
Companies remit FICA taxes in lump sums throughout the calendar year, but do
not forward to the government at the same time the names of the individual em-
ployees who paid those taxes or the amount each paid. That information isn't pro-
vided to the government until the next calendar year when the employer sends W-
2 forms to both the government and the employee. Treasury knows throughout
1998, for instance, that a company has paid a sum of FICA taxes for its employees,
but the Social Security Administration will not update its records until late June
of 1999, and possibly a few months later, with the names of the individual workers
who paid those taxes and how much each worker paid. The government never
knows when during the year the individual paid the taxes. This recordkeeping proc-
ess, although workable in Social Security's defined benefit structure, is unworkable
in a daily environment defined contribution structure. But it is all that currently
exists for identifying individual payroll taxes.
2 Profit Sharing/401(k) Council of America. "Helping Americans to Help Themselves: The Role
of Profit-Sharing/40 l(k) Plans in the Retirement-Income Security Framework." http://
www.psca.org/role.html.
3 See, for example, Kelly A. Olsen and Dallas L. Salisbury, "Individual Social Security Ac-
counts: Issues in Assessing Administrative Feasibility and Costs." EBRI Special Report and
Issue Brief #203.
437
The Solution: A Three-Level Approach
A solution is to structure investment options, not all of which require timely and
detailed contribution data. This approach involves three investment levels.
At the first level, workers' savings are deducted from payroll and invested m a
collective money market fund. Workers own the assets of the fund although the ac-
coimting at the individual level is not completed until the following year. This rec-
onciliation is accomplished with the fihng of the W-2 form. When the individual's
assets are accounted for, units in the money market fund, which include earned in-
terest, are then posted to each worker's account. The fund is dollar priced which
means each unit is valued at one dollar.
The units are then invested in one of four funds— three balanced funds and a
money market accoimt— selected by the worker. Individuals who do not or choose
not to make a selection have their assets invested in a default option.
The accoimt holder has the option— after a startup of about three years, a period
required to successfully build up assets to achieve economies of scale — to transfer
some or all of his balance to an appropriate retail retirement account
Level One Investment: A Pooled Money Market Account
This pooled account would be a conservative fund similar to a large institutional
money market fund. The funds would be held in this pool earning interest for all
participants. Given that the timing of an individual's contribution is not known, all
participants are assumed to invest on Jime 30th. The effect of this accommodation
is that interest earned is one half of what it would be if one started investing m
January. The loss, or gain for those that start working in the latter part of the year,
is not significant in most cases. For example, an average wage worker making about
$28,000 and contributing 4 percent of wages throughout the year and earning 5 per-
cent interest incurs a loss of about $13. For average wage workers who work inter-
mittently during the year the loss is most Ukely less. High-mcome workers, how-
ever, effectively subsidize low-income workers because high-income workers contrib-
ute a disproportionate amount of their income during the early part of the year.
Each worker would know during the year how much is invested because it is the
same as the year-to-date reduction in the FICA tax that goes to savings, often re-
ferred to as the carve-out. The carve-out may be itemized as a separate line item
on the pay stub. Interest would always accrue, so the account balance would be m
excess of the contribution. All workers, regardless of income, would receive an iden-
tical rate of return. Funds would remain in the money market account until the rec-
onciliation of how much each worker contributed, about August of the following
year.
Level Two Investment: Balanced Funds
When the individual account balance is determined it is converted to units in one
of three balanced funds that the worker chooses. Balanced funds are diversified
portfolios that are generally invested in stocks, bonds and cash. The combined as-
sets imderlying very successful private employer-sponsored defined benefit plans are
essentially balanced funds. One of the Level Two balanced funds may have an allo-
cation that closely approximates these plans. This allows all workers, if they wish,
to maintain an asset allocation similar to that provided to the employees of many
sophisticated corporations in the world. There would be another fund on each side
of this fund: one for younger workers that would be weighted more toward equities,
while the other would be weighted more toward bonds for those closer to retirement.
Although workers could choose their balanced fund, some may not. In this case,
they would default to the middle fund. In other words, a worker— perhaps low in-
come and financially unsophisticated— would be invested in a well diversified bal-
anced portfolio suited for retirement saNangs. The portfolios would be managed by
professional asset managers chosen through an open and competitive bidding proc-
ess. Index fund investment management fees most likely would be less than two
basis points (bps): two one-hundredths of one percentage point. The balanced funds
would be valued daily and prices would be pubhshed in the popular press. Workers
only need multiply their units by the daily price to monitor their accoimt balance.
Level Three Investment: Rollover Option
After a period of perhaps three years, a period required to successfully build up
the assets in the Level Two account system to realize economies of scale, investors
seeking more investment choice would have the option of rolling their investment
438
funds out of the Level Two asset allocation funds and into any qualified retirement
investment account.
Those choosing Level Three would transfer assets to a qualified account Avith a
financial services company meeting reasonable and specified standards.^ While in-
vestors would have a wider range of choice within Level Three, there still would be
reasonable investment guidelines. In Level Three investment managers would act
as the fiduciary for their product offerings and be subject to Department of Labor
oversight. This is consistent with many employer-sponsored plans, both defined con-
tribution and defined benefit. ^
Level Three might well suit those workers who have a high degree of confidence
in a particular money manager, a particular firm or a particular style of investing.
It will also serve investors seeking a type of investment unavailable in the Level
Two asset allocation funds. An investor, for example, may wish a greater concentra-
tion of equity investments than is available in the asset allocation funds. Should a
worker find a particular Level Three provider or product unsatisfactory, the worker
could transfer to another provider or move back to Level Two. This assures competi-
tion across Level Three as well as competition between Levels Two and Three. Com-
petition will ensure the lowest cost and best service for the entire system.
Record-Keeping and Administration
The administration of an individual account system will require the development
of a large-scale, customized record-keeping system with the capabihty to produce a
highly efficient service solution. The efficiency of the service application will be de-
pendent upon the design and execution of the system. There is no existing applica-
tion that meets all the requirements.
The requirements to support a national individual account system will be com-
plex, large-scale and capital intensive. As noted above, this is a challenge of unprec-
edented scope. , T^ ,
Nonetheless, the application itself is relatively straightforward. Development time
can be minimized to allow focus on sizing and scaUng the network and building the
necessary interfaces to the Social Security Administration (SSA). Unlike mutual
fund or 401(k) record-keeping systems, there will not be many unique product fea-
tures or functions, thus significantly reducing complexity and cost. It is reasonable
to assume a system could be developed in 12-18 months to support these require-
ments.
The greatest challenge in building a record-keeping system to support the require-
ments of an individual account system is not the complexity of the application, but
the need to support the high volume of participant inquiries, transactions, transfers
and report generation. To keep costs low, it is critical that most participants utiUze
voice and Internet technology to obtain information and transact business. The
greater the percentage of calls that requires a customer service agent the higher the
administrative cost.
The volume of calls will be driven by the fi-equency of transactions and state-
ments, as well as average account size and market volatility. Assuming 140 miUion
accounts and the plan described, participant call volumes are projected to range
ft-om 175 million to 350 million annually. In addition, the system will issue 140 mil-
lion statements, process fund transfers and distributions. This approach assumes
the funds are priced daily and accounts updated nightly. u o • i
Whether the record keeping is done by a government entity such as the Social
Security Administration or out-sourced to the private sector, this task will require
the formation of a large service organization to support these requirements. The
service firm would need call centers in multiple locations around the country and
would need to hire between three and seven thousand employees. For the purpose
of this analysis, it is assumed that the Social Security individual account system
will incur volumes between 0.5 and 1.0 calls per participant per annum.
Another important factor in projecting costs is determining what percentage of the
participant's call volume will be processed by voice response and Internet technology
versus requiring the sei-vices of a call center representative. The cost to handle calls
using the technology is a fraction of the cost to process through a representative.
Therefore, to achieve an efficient solution it is critical that high levels of automation
4 This process should be fully automated and driven by a third party, such as the National
Securities Clearing Corp. At the individual account holder's instructions the Level Three pro-
vider should be able to initiate the transfer and cause the money to be moved from Level Two
to Level Three without having to provide any papei-work. ^ .,«,.,> ™
5 Department of Labor Pension and Welfare Benefits Administration. Study of 401(k) Plan
Fees and Expenses." April 13, 1998.
439
are achieved. The analysis assumes 85 percent of the call volume will be handled
through voice and Internet technology, comparable to the levels currently achieved
in many large defined contribution plans. Estimated first year expenditures will
range ft-om $473 to $922 million.
Cost Model
Based on the plan design defined above, a cost model has been developed to
project the administration costs under a range of assumptions. The unit cost factors
are based on experience in the 401(k) business and have been adjusted in some
cases to account for the scale of the individual account option. The requirements of
a national system of individual accounts are unique and, therefore, extrapolations
fi-om 401(k) experience pose some risks. Unlike the 401(k) structure we assume that
in a timely fashion the Social Security Administration will provide the individual
account recordkeeper an accurate, automated transmission of earnings' histories
that will be used to calculate annual contribution data. These and any other ex-
penses associated with reconciling W2 records are to be borne by Social Security and
are not included in this cost model. It is also assumed that Social Security, at its
cost, will maintain accurate and up to date employee address files, as will be nec-
essary anyway with the annual mailing of Social Security statements starting in
2000. We envision that one's investment account statement would be included in
this mailing.
Another cost not included in this model is the expense associated with commu-
nicating this program to employees. The assumption is that the government would
bear these expenses. Therefore, they expressly are not included in the asset based
fees reported below. There is precedent for this in that the government pays directly
some of the commimication expense of the Federal Thrift Plan.
Cost Sxjmmary
Based on the design criteria outlined and our unit cost assumptions, it is pro-
jected that the first year's administrative expenses to support an individual account
system will range ft-om $473 to $922 million. Assuming 140 milUon accounts this
translates to a cost per account range of $3.38 to $6.58 in the first year. Although
costs would be expected to increase annually driven primarily by employee com-
pensation and benefits, assets would increase more rapidly. Costs as a percent of
assets, therefore, would fall. We project that steady-state asset based costs would
range ft-om 19 to 35 basis points.
These costs are competitive with other investment products. For example, the
Federal Thrift Plan, which is often used as an example of an efficient retirement
plan, had an expense ratio of 65 bps in its second year. Another benchmark is a
portfolio of individual mutual funds representing different asset classes and weight-
ed to approximate a Level Two balanced fund. Such a portfolio is presently available
for a total cost of about 40 basis points.
Final Comments
Although many approaches to the administrative challenges inherent in an indi-
vidual account system hnked to Social Security may be expensive, not all need to
be. Under reasonable assxmiptions, a welt thought out plan that meets our nation's
retirement needs is affordable.
440
Presentation on Individual Accounts by EBRI
lA's:
Administrative Cost
Dallas L Salisbury
The Employee Benefit Research Institute
www.EBRi.org
March 11, 1999
indlviciual Accounts Will
Have Substantially Higher
Administrative Costs Than
SSA - And Costs Matter
SSA is now $10 per covered life per year, of
wtiicli $9.30 relates to the annuitization and
benefit payment function.
Studies from advocates have presented rates
of up to $55 to $117 per covered life per year,
with no cost included for education or
annuitization.
lA Cost Is From Five Areas:
Employer
Deducts and
Transmits $
(5.5 million on
paper)
Financial
Unit Gets ■
Funds
Benefits
Paid
Administrator
Gets Report and
Creates Account
Record
Education is
Provided and
Account
Serviced by
phone
www, etc
What Cost Estimate ?
• 140 million voice calls
• 140 million voice calls
at $4
at $13
- $560 million
- $1,820 million
• Voice Response at .10
• Voice Response at $1
- $14 million
- $140 million
• Staffatl per 100,000
• Staffatl per 1000
participants
participants
- 1400 people
- 140,000 people
Copyright E8RI !999 4
442
Estimated Cost
70,000 fte's at $50,000 or $3.5 billion total
Employee questions at mid cost or $1.3
billion
$31 dollars per participant per year
Worker investment education at $30 or $4.2
billion
Start up system and software - three years
and $500 million or $3.57 per
EBRI DC Plan $;72§.Btonvestment fees ,
Small Employers and Low
Income Workers Key Issues
Small employers want no added
administrative burden and are willing to pay
little in added cost.
Small employers want no added dollars
added, they want reallocation of exisitin
payroll taxes
There are a lot of low income workers
Copynght EBRI 1999
443
Administrative Costs Matter
percentage reduction in male's benefits going from
low to high cost by birth cohort, S. 2313-NCRP
25%
20%
10%
5%
r-~-'^y?V»'f<-?^''Sg'"'~-'y5>''#9-,'"]^ "^'f' ""''
1953 1963 1973 1983 1993 20O3 2013 2023
CopynghlEBRII999
How is Social Security
Different from DC Plans?
1. It's Bi99^''=^ covers more
than 7x the # of k participants
2. Covers different people and
employers
3. benefits vs
4. Technology Differences —
5,5 million report on paper
to SSA,
Copyright EBRI 1999
444
Workers and K by Income
ALL WORKERS
# of workers
% of workers
Offered k
Rarticieate
Total 143,193.461
100%
36.8%
23.8%
annual eaminnqs
19%
8.1%
1.6%
less than 5000 27,150,605
5000 to 9999 14,253,227
10%
13.1%
4.4%
10000 to 14999 15,098,961
11%
22.7%
10.0%
15000 to 19999 13,771,471
10%
35.7%
19.5%
20000 to 24999 1 3,535,457
9%
43.9%
26.7%
25000 to 29999 11.212,714
8%
46.5%
46.5%
30000 to 49999 29,455.411
21%
57.1%
57.1%
50000 or more 18,715,615
13%
67.6%
67.6%
Copyright EBRI 1999
Linking Contributions to
Workers - W-2 Reports
How Social Security Works:
Jan. '98. You Earn $700 in January 1998
Employer Schedule. Employer sends PICA tax on $700
to Treasury along with income taxes for you and all
your coworkers on employer's schedule
Jan-Feb.'99. W-2 reports that $700 reported to SSA by.
Julv-Sept.'99. Wage credit posted to your record
(at earliest)
Copyright EBRU 999
EBRI Issue Brief. November 1998.
445
Thousands of Employers by Tax Deposit
Schedule, 1997
13,800 :
IZZIZZZIZZI
— «. ■ — i
MM
Daily
Monthly Quarterly Annually
Seml-
weeidy
Source: Unpublished Data, Social Security Administration, 1998.
Copyright EBRl 1999 II
EBRI Issue Brief, Novcmbcf 1998.
Trade-Offs
o Employer Burdens
o Worker Liability
o Government
Involvement / Liability
Copyrig)uEBRn999
446
1998 Survey of Small Employers
on Social Security Individual
Accounts
Knowledge of Social Security Individual
Account Proposals
How knowledgeable do you feel you are about reform proposals
that would allow individuals to divert a portion of their Social
Security taxes into individual accounts?
Don't know
W
Not loo
29%
Copyright EBR I 1999
447
Reasons for Favoring Social
Security Individual Accounts
Why do you favor this type of reform?
Uaves choice to tfufnidual
Sglier retumsfmora for fe&enient
Sodai Security future uncertain/tuiuijfts o*d of ntofley
Generally favor in<jjyjdtial accounts
l^r -. ■--• -
!38%
1^; -
■~^'25%
^^Hi^^
^mn
. r-
Ni
0% 10% 20% 30% 40%
Copyright EBRI 1999
Reasons for Being Neutral About
Social Security Individual Accounts
Why do you say you are neutral about this type of reform?
Qnough infofiration
"
|S3%
Uniieci(ie<i
|l9^/o
People wiiimisnana^
the? funds
1 K-
[ ^
Mi
0% 10% m 30% «% 50%
Copyrighi EBR! 1999
60%
448
Reasons for Opposing Social
Security Individual Accounts
Why do you oppose this type of reform?
People will nisirenage
their funds
Generally oppose
individu^%o}unts
^«
Copyrigh!EBRli999
Thought About Administering Social
Security Accounts
Some of these proposals would involve setting up an individual
Social Security account for each worker
and employers might be required to help administer the
individual Social Security accounts system.
Have you thought about this?
rfi
Copyright EBRI 1999
449
Feelings About Administering Social
Security Accounts
As an employer, how would you feel about helping to administer this
individual Social Security account system?
60%
20%-
40%
48$
M
5%
Neutral Negatively Don't know
IBMJ
Co|>yri^iEBRI>999
Comparison of the Three Approaches
to Implementation
Support for the Three Approaches
General support
Onceavesr
4tiinesayea'
401(k) model
rz]
glKP^^ij^^M I
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
M\
■ Fswr i Lean towards favomg iNeuIra! D lean towards opposing DOppose DDonlknow
Copyright EBRl 1999
450
Opposition to Employer Administration
Suppose the only way an individual Social Security accounts
system could pass Congress was If employers were required to
help administer it. Is there any type of system that you, as an
employer, would favor?
Yes
Don't know
24%
59%
Ni
CopyrighlEBRn999
Amount Small Employers
Are Willing to Spend
What is the maximum amount of money you would be willing
to spend on an annual basis in additional
payroll processing costs and still favor this system?
40%
30%
20%
10%
0%
18%.
28%
29%
18% 17%
22%
18%
23%
15%
401(k).iTK)del
%
iNoawg B<$SOO a$500-$999 O$1.000-^.000 0>$S.OOO ODonlknow]
H
Copyrigbt EBR! 1999
451
Amount Small Employers Are
Willing to Spend (cont'd.)
Would you still favor this proposal if, in addition,
Social Security taxes went up from 15.3% of taxable payroll to 17.3%?
80%
60%
33=
40%
20% H
0%
^fi
60%
54%
55%
37%B| 38r<H|
Hh9% Ib^
Once a year
(n=141)
Four times a
year
(n=113}
401 (k) mode!
(n=141)
Yes ® No D Don't know
Copyrigh«EBRn999
Amount Small Employers Are
Willing to Spend (cont'd.)
Would you favor this system if the additional processing costs
were offset by a reduction in Social Security taxes from 15.3%
of taxable payroll to 13.2%?
90%
year
(n=39)
2% 8%
401(k) model
(n=48)
Yes @ No D Don't know
Copyright EBRi 1999
452
Support for individual Accounts
Reconsidered (cont'd.)
Would you say you are now more liiceiy or less likely to favor it?
^fi
More likely
32%
Copyright EBRl 1999
EBRI
www.ebri.org (202) 659-0670
• Health, retirement, economic security issues.
• Objective, unbiased research since 1978.
• Nonadvocacy — does not lobby.
Copyrighi EBRI 1999
453
[Whereupon, at 1:36 p.m., the Task Force was adjourned, subject
to the call of the Chair.]
O
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780160"593734
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