(navigation image)
Home American Libraries | Canadian Libraries | Universal Library | Community Texts | Project Gutenberg | Biodiversity Heritage Library | Children's Library | Additional Collections
Search: Advanced Search
Anonymous User (login or join us)
Upload
See other formats

Full text of "Social security reform : hearings before the Task Force on Social Security of the Committee on the Budget, House of Representatives, One Hundred Sixth Congress, first session, hearings held in Washington, DC, May 4, 11, 18 & 25; June 8, 15, 22 29; July 13, 1999"

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) 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) 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- 
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 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 



II 



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 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 o