<DOC>
[106th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:56994.wais]
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
__________
Serial No. 3-1
Printed for the use of the Committee on the Budget
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U.S. GOVERNMENT PRINTING OFFICE
56-994 WASHINGTON : 1999
SOCIAL SECURITY REFORM
COMMITTEE ON THE BUDGET
JOHN R. KASICH, Ohio, Chairman
SAXBY CHAMBLISS, Georgia, JOHN M. SPRATT, Jr., South
Speaker's Designee Carolina,
CHRISTOPHER SHAYS, Connecticut Ranking Minority Member
WALLY HERGER, California JIM McDERMOTT, Washington,
BOB FRANKS, New Jersey Leadership Designee
NICK SMITH, Michigan LYNN N. RIVERS, Michigan
JIM NUSSLE, Iowa BENNIE G. THOMPSON, Mississippi
PETER HOEKSTRA, Michigan DAVID MINGE, Minnesota
GEORGE P. RADANOVICH, California KEN BENTSEN, Texas
CHARLES F. BASS, New Hampshire JIM DAVIS, Florida
GIL GUTKNECHT, Minnesota ROBERT A. WEYGAND, Rhode Island
VAN HILLEARY, Tennessee EVA M. CLAYTON, North Carolina
JOHN E. SUNUNU, New Hampshire DAVID E. PRICE, North Carolina
JOSEPH PITTS, Pennsylvania EDWARD J. MARKEY, Massachusetts
JOE KNOLLENBERG, Michigan GERALD D. KLECZKA, Wisconsin
MAC THORNBERRY, Texas BOB CLEMENT, Tennessee
JIM RYUN, Kansas JAMES P. MORAN, Virginia
MAC COLLINS, Georgia DARLENE HOOLEY, Oregon
ZACH WAMP, Tennessee KEN LUCAS, Kentucky
MARK GREEN, Wisconsin RUSH D. HOLT, New Jersey
ERNIE FLETCHER, Kentucky JOSEPH M. HOEFFEL III,
GARY MILLER, California Pennsylvania
PAUL RYAN, Wisconsin TAMMY BALDWIN, Wisconsin
PAT TOOMEY, Pennsylvania
------
Task Force on Social Security
NICK SMITH, Michigan, Chairman
WALLY HERGER, California LYNN N. RIVERS, Michigan,
MAC COLLINS, Georgia Ranking Minority Member
PAUL RYAN, Wisconsin KEN BENTSEN, Texas
PAT TOOMEY, Pennsylvania EVA M. CLAYTON, North Carolina
RUSH D. HOLT, New Jersey
------
Professional Staff
Wayne T. Struble, Staff Director
Thomas S. Kahn, Minority Staff Director and Chief Counsel
C O N T E N T S
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Page
Hearing held in Washington, DC, May 4, 1999: How Uniformity
Treats Diversity: Does One Size Fit All?....................... 1
Statement of:
Laurence J. Kotlikoff, Professor of Economics, Boston
University, and Research Associate, the National Bureau
of Economic Research................................... 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. Kotlikoff............................................ 4
Ms. Olsen................................................ 18
Ms. Kijakazi............................................. 29
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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 Institution.................................. 58
Roger Ibbotson, Professor of Finance, Yale University
School of Management................................... 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
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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
David Harris, Research Associate, Watson Wyatt Worldwide. 173
Prepared statement of:
Mr. Crippen.............................................. 161
Mr. Thompson............................................. 170
Mr. Harris............................................... 175
Additional information supplied for the record by:
Mr. Crippen.............................................. 198
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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
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Hearing held in Washington, DC, June 15, 1999: Secure Investment
Strategies for Private Investment Accounts and Annuties........ 229
Statement of:
Steve Bodurtha, First Vice President, Customized
Investments, Merrill Lynch & Co., Inc.................. 230
Mark Warshawsky, Director of Research at the TIAA-CREF
Institute.............................................. 236
James Glassman, De Witt Wallace-Reader's Digest Fellow in
Communications in a Free Society, American Enterprise
Institute for Public 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
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Hearing held in Washington, DC, June 22, 1999: The Social
Security Disability 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 Administration................................ 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
OASDI Current-Pay Benefits: Disabled Workers (table)..... 286
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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 from 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 Moynihan and Kerrey............................... 391
Summary of Social Security Preservation Act authored by Hon.
Phil Gramm, a United States Senator from the State of Texas 392
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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 Public
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 Policy Analyst for Social Security
and William W. Beach, Director, Center for Data
Analysis, the Heritage Foundation...................... 406
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?
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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
witness 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
Economics 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 Economic Association. He served on the President's
Council of Economic Advisors, and as a consultant to the
International Monetary Fund, the World Bank, and the
Organization for Economic Cooperation 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
Institute working on Social Security, child care, education,
health care and welfare. In particular, she studies the ways of
entitlements 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 Regulation Magazine.
She is a frequent guest on television and radio programs
nationwide and has appeared on the Today Show, NBC Nightly
News, and CNN. Her articles and editorials have been published
in a variety of newspapers, magazines and journals. Ms. Olsen
holds a bachelor's degree from the School of Foreign Service at
Georgetown 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 Policy 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 University. 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 benefits 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
payroll contributions they make because they are eligible for a spousal
benefit based on their husbands' wages. In addition, women live longer
than men, and the Social Security retirement 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 status 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 payments 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
included 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 ECONOMICS,
BOSTON UNIVERSITY, AND RESEARCH ASSOCIATE, THE NATIONAL BUREAU
OF ECONOMIC RESEARCH
Mr. Kotlikoff. Chairman Smith and other distinguished
members of the House Budget Committee's Task Force on Social
Security, I am honored by this opportunity to discuss with you
Social Security's treatment of postwar Americans and the
system's contribution 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 treatment of different groups in society born since
1945. The study compares 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 simulation 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 together to get an actuarial assessment of how they
are being treated. 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 better than the middle class, women are being
treated better than men, whites are being treated better than
nonwhites, and the college-educated are being treated better
than the noncollege-educated. 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 contributions. 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 inflation-indexed U.S. Government
bonds. Those groups that do better 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, despite 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 Security 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' intermediate 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 generations pay the same share as
current generations of their lifetime labor income in taxes net
of transfer payments received.
If we were to raise income tax rates to make sure that our
children pay the same tax rates on net as we do, we'd need an
immediate 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 situation 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,
Boston University; Research Associate, the National Bureau of Economic
Research
Chairman Smith and other distinguished members of the House Budget
Committee'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.\1\ The study finds that Americans born 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 benefits. 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.
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\1\ See Caldwell, Steven B., Melissa Favreault, Alla Gantman,
Jagadeesh Gokhale, Thomas Johnson, and Laurence J. Kotlikoff, ``Social
Security's Treatment of Postwar Americans,'' forthcoming, Tax Policy
and the Economy, NBER volume, Cambridge, Ma.: MIT Press, 1999.
---------------------------------------------------------------------------
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 detailed 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 increase of two-fifths in the
system's tax rate is needed to meet benefit payments on an ongoing
basis. The magnitude of this tax adjustment is more than twice as large
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 horizon, 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 Americans. As a group, Americans born this year
would receive only a 1 percent real return on their OASI contributions.
Generational Accounting\2\
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.\3\
---------------------------------------------------------------------------
\2\ This section draws on ``Generational Accounting Around the
World,'' a coauthored paper with Berndt Raffelheuschen forthcoming in
the May 1999 American Economic Review.
\3\ See Auerbach, Alan J., Laurence J. Kotlikoff, and Willi
Leibfritz, eds., Generational Accounting 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.
---------------------------------------------------------------------------
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 policy
imply for future generations? Second, is fiscal policy sustainable
without major additional sacrifices on the part of current or future
generations or major cutbacks in government purchases? Third, what
alternative policies would suffice to produce generational balance--a
situation in which future generations face the same fiscal burden as do
current generations when adjusted 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
accounting 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\4\, 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 from academic and government
economists.
---------------------------------------------------------------------------
\4\ The European Commission has an ongoing project to do
generational accounting for EU member nations under the direction of
Bernd Raffelhueschen, Professor of Economics at Freiburg University.
---------------------------------------------------------------------------
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 expected, under current policy, to pay over
their remaining lifetimes. Adding up the generational accounts of all
currently living generations gives the collective contribution 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 generations must be
paid by future generations. This is the hard message of the
government's intertemporal budget constraint--the basic building block
of modern dynamic 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, valued to the present, B is the sum of the
generational accounts of those now alive, 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 payments of those now
alive, the larger is A, the net payments of those yet to be born.
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 accounts of these two sets of
parties are directly comparable 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 intertemporal budget constraint. The same is true
if future generations face a smaller growth-adjusted lifetime 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 born in the future. But it
delivers a clear message about the need for policy adjustments. Once
such a need is established, interest naturally turns to alternative
means of achieving generational balance that do not involve foisting
all the adjustment 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 government's fiscal labeling--how it
describes its receipts and payments. The same, unfortunately, is not
true of the government's official debt. From the perspective of
neoclassical 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 alternative 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 payments increase by $100, and there is an additional 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 repayment 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 government, 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 1's language, using the language in the other
cases will generate the following: case 2: a $800 larger deficit, and
case 3: a $4,000,000,900 smaller deficit. Although the government's
reported deficit is dramatically different depending on how it labels
the additional $100 pounds it gets this year from Nigel, Nigel's
economic circumstances are unchanged. Regardless of which language the
government 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 liquidity constrained in choosing how much to consume and
save.\5\
---------------------------------------------------------------------------
\5\ 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(1+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.
---------------------------------------------------------------------------
Unfortunately, the ability to avoid hard policy decisions by
manipulating the reported 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 surpluses. 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 deficit limit while
maintaining these companies' major liabilities--their unfunded pension
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 countries could
achieve generational balance. The alternatives are cutting government
purchases, cutting government transfer payments, increasing 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 adjustment needed. The magnitudes of these alternative
adjustments provide an indirect measure of countries' generational
imbalances.
The four different policies are considered under two definitions of
government purchases and transfer payments. 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 countries--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 including 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 billion larger than is currently the case.\6\
---------------------------------------------------------------------------
\6\ 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 incorporate the latest
CBO projections of Federal Government spending and receipts and,
therefore, of Federal surpluses.
---------------------------------------------------------------------------
Not all 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 projections. 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 Kingdom, with zero or moderate
generational imbalances as measured by the spending adjustment needed
to achieve perfect balance. What explains these tremendous cross-
country differences? Fiscal policies and demographics differ
dramatically across countries. The U.S., for example, suffers from
rampant Federal health care spending. Japan's health care spending is
growing 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 dealing with the ongoing costs of
reunification.
One alternative to cutting spending is cutting transfer payments.
In Japan, education, health care, Social Security benefits,
unemployment benefits, disability benefits, 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 countries 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 all
types (value added, payroll, corporate income, personal income, 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 relatively 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 action 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 percent 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 number
of countries around the world. Notwithstanding its shortcomings,
generational accounting has four major advantages over deficit
accounting: It's forward looking. It's comprehensive. 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. An array of countries,
including the United States, Germany, and Japan, have severe
generational imbalances.\7\ This is true notwithstanding the fact that
the United States is currently reporting an official 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
industrialized countries. The imbalances in these and the majority of
the other countries considered in Table 6 place future generations at
grave risk.
---------------------------------------------------------------------------
\7\ The Congressional Budget Office and the Federal Reserve Bank of
Cleveland are in the process 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.
---------------------------------------------------------------------------
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 imbalance in generational policy. Hence,
fixing Social Security's long-term financial problems once and for all
should be of the highest priority.
TABLE 1.--AVERAGE LIFETIME OASI NET TAX RATES
[Lifetime Labor Earnings in 1997 Dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
0-120k 120k-240k 240k-360k 360k-480k 480k-600k 600k-720k 720k-840k 840k-960k 960k-1.08m 1.08m+ Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
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
Cohort 85............................. -1.2 4.1 5.7 6.3 6.7 6.8 7.0 7.4 7.6 4.4 5.1
Cohort 90............................. -1.2 4.0 5.5 6.3 6.7 6.8 7.0 6.9 7.6 4.7 5.3
Cohort 95............................. -1.8 3.8 5.3 6.1 6.4 6.4 6.7 7.3 7.3 4.9 5.3
Men 45................................ 4.7 6.3 7.2 7.3 7.5 7.3 6.9 6.1 6.6 3.9 5.9
Men 50................................ 3.6 5.4 6.3 6.5 6.7 6.8 7.0 6.5 6.2 3.7 5.5
Men 55................................ 4.0 5.9 6.5 6.9 6.9 7.5 7.7 7.9 7.0 4.0 5.6
Men 60................................ 4.2 6.2 7.2 7.3 7.6 7.6 8.2 7.7 7.7 3.9 5.6
Men 65................................ 4.4 6.1 6.9 7.5 7.4 7.3 7.7 7.5 7.4 4.6 5.9
Men 70................................ 4.4 6.0 6.9 7.0 7.5 7.3 8.0 8.0 7.9 4.6 5.9
Men 75................................ 4.0 5.8 6.7 7.1 7.2 7.5 7.6 8.0 8.1 4.6 5.9
Men 80................................ 4.3 5.3 6.5 7.1 7.1 7.4 7.2 7.8 7.6 5.0 5.8
Men 85................................ 3.4 5.1 6.4 6.8 6.9 6.9 7.4 7.8 8.1 4.4 5.4
Men 90................................ 2.8 4.9 6.1 6.8 6.8 7.1 7.0 7.2 7.9 4.9 5.7
Men 95................................ 1.9 4.6 5.8 6.2 6.8 6.4 6.9 7.5 7.3 5.0 5.6
Women 45.............................. -0.6 4.9 6.0 5.9 6.1 6.1 6.5 5.2 4.1 2.7 4.4
Women 50.............................. -4.3 3.3 4.7 5.3 5.7 6.4 5.6 5.7 6.0 3.3 3.8
Women 55.............................. -3.0 3.6 5.3 5.6 6.1 6.4 6.7 6.4 5.8 3.7 4.3
Women 60.............................. -2.0 4.2 5.7 6.5 6.5 6.9 6.6 7.0 6.9 3.8 4.7
Women 65.............................. -1.8 4.3 5.5 6.7 6.5 6.7 7.3 7.4 7.0 3.9 4.9
Women 70.............................. -2.0 3.9 5.6 6.3 6.6 6.9 7.3 7.3 6.5 3.7 4.6
Women 75.............................. -2.3 3.7 5.5 6.1 6.5 6.1 6.5 6.7 7.2 4.2 4.7
Women 80.............................. -3.3 3.8 5.1 5.9 6.3 6.8 6.8 7.2 7.3 3.9 4.5
Women 85.............................. -3.1 3.4 5.1 5.8 6.3 6.7 6.3 6.7 6.3 4.2 4.6
Women 90.............................. -2.9 3.5 4.9 5.8 6.5 6.6 7.0 6.3 6.9 4.5 4.7
Women 95.............................. -3.3 3.2 4.8 6.0 5.9 6.4 6.5 6.8 7.4 4.7 4.8
White 45.............................. 0.3 5.5 6.6 6.9 7.1 7.1 6.9 5.8 5.9 3.7 5.4
White 50.............................. -2.6 4.0 5.5 6.0 6.3 6.7 6.6 6.3 6.2 3.6 4.8
White 55.............................. -1.1 4.5 5.9 6.4 6.5 7.2 7.4 7.3 6.6 3.9 5.1
White 60.............................. -0.3 5.0 6.3 7.0 7.1 7.3 7.7 7.4 7.6 3.9 5.2
White 65.............................. -0.2 5.0 6.3 7.1 7.0 7.0 7.5 7.5 7.5 4.3 5.5
White 70.............................. -0.2 4.6 6.1 6.7 7.2 7.1 7.7 7.9 7.5 4.4 5.4
White 75.............................. -0.3 4.5 6.0 6.7 6.8 6.9 7.1 7.4 7.8 4.4 5.3
White 80.............................. -1.4 4.3 5.8 6.6 6.8 7.1 7.0 7.7 7.5 4.5 5.2
White 85.............................. -1.5 3.9 5.5 6.2 6.7 6.9 6.9 7.4 7.4 4.3 5.0
White 90.............................. -2.0 3.8 5.3 6.3 6.8 6.8 7.0 7.1 7.6 4.7 5.3
White 95.............................. -2.2 3.4 5.1 6.0 6.3 6.3 6.6 7.2 7.3 4.8 5.2
Nonwhite 45........................... 1.3 5.3 7.0 6.4 7.4 6.4 6.2 6.6 7.0 3.8 5.8
Nonwhite 50........................... -0.3 4.8 5.9 6.0 6.9 7.0 6.4 6.5 6.3 4.1 5.4
Nonwhite 55........................... 0.2 5.3 6.5 6.2 7.1 7.2 7.7 7.6 7.9 4.3 5.6
Nonwhite 60........................... 1.3 5.8 7.0 7.0 7.4 7.5 6.5 8.1 6.9 3.5 5.1
Nonwhite 65........................... 1.9 5.7 6.1 7.2 7.4 7.3 8.1 7.4 5.3 4.8 5.8
Nonwhite 70........................... 1.7 5.4 6.6 6.7 7.1 7.4 7.8 7.4 7.4 4.0 5.4
Nonwhite 75........................... -0.7 5.1 6.5 6.9 7.3 7.2 7.8 7.7 8.0 4.9 5.9
Nonwhite 80........................... 0.7 5.1 5.9 6.7 6.7 7.4 7.3 7.3 7.9 5.5 6.0
Nonwhite 85........................... -0.1 5.1 6.3 6.8 6.5 6.6 7.3 7.1 8.3 4.7 5.5
Nonwhite 90........................... 1.3 5.1 6.0 6.4 6.2 6.9 7.3 6.1 7.6 4.7 5.5
Nonwhite 95........................... -0.5 5.0 6.0 6.5 6.9 6.9 7.0 7.6 7.6 5.5 5.9
Noncollege 45......................... 0.6 5.7 6.9 7.0 7.2 6.8 6.8 5.7 6.4 3.8 5.7
Noncollege 50......................... -2.0 4.4 5.7 6.2 6.5 6.8 6.5 6.5 6.1 4.0 5.1
Noncollege 55......................... -0.4 4.7 6.0 6.4 6.5 7.4 7.6 7.3 7.0 4.2 5.4
Noncollege 60......................... 0.3 5.3 6.6 6.8 7.2 7.5 7.6 7.8 7.9 4.2 5.6
Noncollege 65......................... 0.5 5.2 6.4 7.3 7.0 7.2 7.7 7.8 7.6 4.7 5.8
Noncollege 70......................... 0.3 5.0 6.5 6.9 7.2 7.2 7.5 8.0 7.4 4.7 5.7
Noncollege 75......................... 0.3 4.8 6.2 6.5 7.0 7.3 7.2 7.7 8.0 4.8 5.7
Noncollege 80......................... -0.4 4.8 6.0 6.4 7.0 7.0 6.9 7.6 7.9 5.0 5.6
Noncollege 85......................... -0.9 4.5 5.9 6.3 6.8 6.9 7.0 7.5 7.4 4.6 5.3
Noncollege 90......................... -0.5 4.2 5.5 6.4 6.9 6.9 7.1 6.9 7.8 5.2 5.6
Noncollege 95......................... -0.9 3.9 5.4 6.2 6.7 6.8 7.1 7.6 7.3 5.6 5.7
College 45............................ -0.2 4.7 6.1 6.5 7.1 7.4 6.9 6.1 5.5 3.6 5.1
College 50............................ -3.0 3.5 5.2 5.6 6.3 6.6 6.7 6.2 6.3 3.3 4.6
College 55............................ -2.2 4.2 5.9 6.4 6.7 6.8 7.1 7.3 6.2 3.6 4.8
College 60............................ -1.0 4.8 6.1 7.2 7.1 7.1 7.6 7.0 7.1 3.6 4.8
College 65............................ -0.6 5.0 6.1 6.9 7.0 6.9 7.4 6.8 6.9 4.1 5.2
College 70............................ -0.3 4.5 5.9 6.4 7.1 7.1 7.9 7.7 7.6 4.1 5.1
College 75............................ -1.4 4.3 6.0 6.9 6.8 6.8 7.2 7.2 7.7 4.3 5.2
College 80............................ -1.8 4.1 5.7 6.9 6.6 7.3 7.1 7.6 7.2 4.4 5.1
College 85............................ -1.8 3.6 5.4 6.3 6.5 6.8 7.0 7.3 7.8 4.2 5.0
College 90............................ -2.6 3.8 5.5 6.2 6.5 6.8 7.0 6.8 7.4 4.4 5.1
College 95............................ -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]
--------------------------------------------------------------------------------------------------------------------------------------------------------
0-120k 120k-240k 240k-360k 360k-480k 480k-600k 600k-720k 720k-840k 840k-960k 960k-1.08m 1.08m+ Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cohort 45............................ 3.47 53.28 67.05 70.61 73.71 75.72 76.88 75.34 77.60 77.20 67.59
Cohort 50............................ -26.22 46.35 61.26 67.68 70.62 74.54 76.04 76.79 77.60 76.09 64.58
Cohort 55............................ -9.75 48.31 62.48 67.29 70.36 75.23 77.78 77.98 78.33 78.05 67.03
Cohort 60............................ -0.98 51.24 63.52 70.26 71.37 73.61 77.41 78.73 79.98 78.64 68.47
Cohort 65............................ 1.06 49.97 61.27 69.79 70.99 72.95 74.64 75.55 79.69 80.18 68.63
Cohort 70............................ 0.93 46.66 60.48 66.49 70.57 71.81 75.41 79.06 77.97 79.79 67.94
Cohort 75............................ -3.30 45.08 59.98 66.39 68.40 70.07 73.59 74.61 78.97 79.49 67.35
Cohort 80............................ -9.44 44.24 57.80 65.20 67.69 70.57 70.54 75.24 77.74 79.43 67.47
Cohort 85............................ -12.13 40.98 55.36 61.82 66.03 68.79 69.75 74.32 77.09 78.42 66.04
Cohort 90............................ -12.35 39.59 54.43 62.28 66.35 68.66 70.75 71.62 75.37 77.61 65.83
Cohort 95............................ -18.17 37.01 52.67 59.67 64.04 64.27 67.29 71.66 74.78 78.88 66.19
Men 45............................... 45.08 64.52 72.91 74.38 76.26 77.25 78.26 77.27 79.79 78.88 75.55
Men 50............................... 39.84 60.11 68.09 71.81 73.25 76.40 78.36 78.58 78.47 77.35 73.41
Men 55............................... 42.23 60.71 68.15 71.79 72.59 77.61 80.32 80.63 79.43 79.09 74.47
Men 60............................... 42.02 62.40 69.39 73.47 74.07 75.66 80.79 81.37 80.98 79.42 75.16
Men 65............................... 42.84 59.83 68.20 72.94 74.66 75.39 75.20 76.51 80.69 81.51 75.16
Men 70............................... 43.57 57.88 66.42 69.87 73.43 73.20 77.11 80.16 79.31 80.91 74.42
Men 75............................... 40.64 55.47 66.30 69.74 70.84 73.75 76.65 78.30 80.53 80.74 74.06
Men 80............................... 42.03 53.42 63.66 69.60 70.56 73.49 71.50 76.42 78.38 80.65 73.78
Men 85............................... 33.47 50.42 62.03 65.93 68.60 70.18 73.25 76.36 79.56 79.29 72.43
Men 90............................... 27.90 47.71 60.74 66.78 67.32 70.64 70.66 73.57 76.43 78.43 71.39
Men 95............................... 19.22 44.74 57.40 60.57 67.64 64.90 68.21 72.05 74.81 79.40 70.84
Women 45............................. -4.81 46.40 59.63 62.72 66.80 68.41 71.56 68.99 68.15 69.04 51.73
Women 50............................. -49.48 36.76 53.37 60.08 64.38 70.05 69.71 70.60 75.27 71.90 48.64
Women 55............................. -32.25 39.12 55.87 60.42 66.46 69.48 71.78 73.50 75.42 75.24 54.80
Women 60............................. -20.21 42.28 56.96 65.64 67.16 70.62 71.68 74.70 77.08 76.74 58.33
Women 65............................. -17.16 42.11 53.68 65.39 65.55 68.54 73.65 74.14 77.12 76.40 58.23
Women 70............................. -20.04 37.78 54.54 61.68 65.97 69.38 72.32 76.50 74.62 77.08 57.67
Women 75............................. -22.28 36.71 54.04 61.30 64.02 64.12 68.67 69.65 74.80 76.52 56.98
Women 80............................. -32.32 36.91 50.44 58.81 63.70 66.74 69.17 72.42 76.14 76.21 56.95
Women 85............................. -30.44 33.72 49.90 57.00 62.56 66.56 64.07 70.68 70.75 76.31 56.26
Women 90............................. -28.78 33.94 48.30 57.10 64.96 66.12 70.95 68.01 72.94 75.76 57.31
Women 95............................. -32.35 31.31 47.67 58.51 59.41 63.19 65.87 70.64 74.72 77.63 58.60
White 45............................. 2.54 53.13 66.23 70.95 73.58 76.24 76.88 74.98 76.83 77.38 67.50
White 50............................. -28.90 45.14 60.65 67.78 70.41 74.64 75.99 76.97 77.88 75.94 64.29
White 55............................. -11.44 47.29 61.94 67.43 69.79 75.18 77.66 77.34 77.95 78.31 66.99
White 60............................. -3.23 50.26 62.64 70.03 71.55 73.68 77.61 78.46 80.29 78.61 68.34
White 65............................. -1.91 48.55 61.65 69.86 71.23 72.53 74.45 75.69 80.66 80.27 68.77
White 70............................. -2.15 45.26 59.79 66.13 70.58 71.51 75.84 79.87 77.45 80.12 67.95
White 75............................. -2.61 44.05 59.57 66.13 67.92 70.11 72.94 74.21 78.61 79.82 67.35
White 80............................. -13.27 43.06 57.36 64.93 67.70 70.47 70.60 74.84 78.32 79.40 67.40
White 85............................. -14.73 38.77 54.10 61.06 66.07 68.67 69.46 74.68 76.68 78.68 65.95
White 90............................. -19.68 36.96 53.10 61.65 66.87 68.13 70.18 71.97 75.04 77.40 65.59
White 95............................. -21.39 33.28 50.53 58.36 62.96 63.45 67.03 71.57 74.11 78.48 65.58
Nonwhite 45.......................... 13.72 54.41 72.40 68.73 74.74 69.83 76.80 78.40 83.03 74.74 68.36
Nonwhite 50.......................... -3.94 53.60 64.67 67.12 71.95 73.68 76.33 75.26 75.66 77.54 66.59
Nonwhite 55.......................... 2.24 54.60 65.80 66.33 73.71 75.64 79.03 84.84 82.59 75.41 67.33
Nonwhite 60.......................... 12.48 57.34 68.66 71.64 70.27 73.08 75.68 80.86 76.90 78.83 69.37
Nonwhite 65.......................... 17.81 56.51 59.55 69.42 69.39 75.43 76.06 74.64 69.28 79.53 67.77
Nonwhite 70.......................... 16.53 52.47 63.42 68.70 70.51 74.00 73.30 72.84 80.71 77.82 67.92
Nonwhite 75.......................... -6.62 49.04 62.22 67.61 70.31 69.85 76.90 76.53 80.23 77.63 67.39
Nonwhite 80.......................... 7.10 49.41 59.86 66.52 67.65 71.05 70.30 77.05 75.84 79.61 67.82
Nonwhite 85.......................... -0.90 50.00 60.94 65.70 65.86 69.32 71.10 72.17 79.03 76.89 66.48
Nonwhite 90.......................... 12.45 49.15 59.38 65.35 63.90 70.38 73.12 70.28 77.13 78.91 66.93
Nonwhite 95.......................... -5.03 48.21 59.91 64.50 67.43 67.70 68.24 72.12 78.05 80.71 68.65
Noncollege 45........................ 5.30 55.97 68.32 71.98 73.80 74.90 76.55 74.51 79.60 76.15 66.91
Noncollege 50........................ -23.05 48.72 62.25 68.82 71.36 74.19 75.64 77.49 78.61 76.68 63.79
Noncollege 55........................ -4.37 49.96 62.51 66.98 69.63 76.85 78.78 77.81 79.76 78.56 66.41
Noncollege 60........................ 3.22 53.02 65.74 70.13 71.97 74.26 76.40 79.92 82.37 79.11 68.09
Noncollege 65........................ 4.74 50.49 61.92 71.15 70.54 73.41 75.49 76.93 80.62 80.74 68.23
Noncollege 70........................ 3.12 48.40 62.88 68.33 70.92 71.82 73.64 80.33 77.96 79.67 66.97
Noncollege 75........................ 3.03 47.40 60.77 65.72 69.45 72.18 73.82 75.25 79.22 80.96 66.98
Noncollege 80........................ -4.33 46.66 59.38 64.92 69.60 69.13 71.49 74.45 78.55 80.10 66.45
Noncollege 85........................ -8.61 44.36 57.80 62.14 67.30 68.95 70.01 74.43 75.83 78.92 65.09
Noncollege 90........................ -4.56 41.00 54.62 63.23 66.67 69.00 72.59 73.48 75.26 77.34 64.69
Noncollege 95........................ -8.71 38.65 52.97 61.95 67.04 66.61 69.68 72.27 75.79 79.71 65.59
College 45........................... -1.56 45.80 63.13 67.65 73.51 76.61 77.35 76.38 74.40 78.18 68.76
College 50........................... -34.74 40.43 59.09 65.23 69.49 75.13 76.52 75.91 76.47 75.48 65.84
College 55........................... -23.64 44.81 62.43 67.86 71.66 73.11 76.22 78.26 76.07 77.50 68.00
College 60........................... -10.29 48.18 59.28 70.48 70.54 72.76 79.21 77.07 76.74 78.23 68.97
College 65........................... -6.10 49.09 60.19 67.88 71.57 72.32 73.57 72.93 78.32 79.67 69.16
College 70........................... -2.58 44.11 57.27 64.35 70.11 71.80 77.07 77.99 77.99 79.88 68.93
College 75........................... -14.28 41.74 59.05 67.17 67.13 68.45 73.37 73.93 78.73 78.35 67.73
College 80........................... -17.13 40.94 55.97 65.51 65.59 72.25 69.64 75.99 76.94 78.99 68.40
College 85........................... -17.89 36.44 52.20 61.43 64.75 68.65 69.55 74.25 78.31 78.05 66.92
College 90........................... -25.19 37.64 54.19 61.20 65.98 68.33 69.21 69.66 75.49 77.81 66.92
College 95........................... -34.41 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]
--------------------------------------------------------------------------------------------------------------------------------------------------------
0-120k 120k-240k 240k-360k 360k-480k 480k-600k 600k-720k 720k-840k 840k-960k 960k-1.08m 1.08m+ Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cohort 45............................. 0.7 5.8 7.0 7.2 7.5 7.5 7.2 6.3 6.4 3.9 5.8
Cohort 50............................. -1.8 4.6 6.1 6.6 7.0 7.3 7.3 7.0 6.8 4.0 5.4
Cohort 55............................. -0.1 5.4 6.9 7.3 7.6 8.1 8.4 8.3 7.6 4.5 5.9
Cohort 60............................. 1.1 6.3 7.8 8.4 8.5 8.8 9.1 8.8 9.0 4.6 6.3
Cohort 65............................. 1.8 6.9 8.2 9.1 9.0 9.0 9.7 9.5 9.2 5.5 7.1
Cohort 70............................. 2.4 7.3 9.0 9.3 9.9 9.9 10.6 10.6 10.2 5.7 7.5
Cohort 75............................. 2.8 7.9 9.5 10.1 10.4 10.4 10.5 10.8 11.3 6.4 8.1
Cohort 80............................. 2.9 8.3 9.7 10.5 10.6 11.0 10.8 11.4 11.2 6.8 8.4
Cohort 85............................. 2.6 7.9 9.5 10.2 10.5 10.6 10.8 11.1 11.3 6.5 8.0
Cohort 90............................. 2.6 7.9 9.3 10.2 10.5 10.6 10.8 10.5 11.4 7.1 8.4
Cohort 95............................. 2.0 7.6 9.2 10.0 10.2 10.2 10.5 11.1 11.0 7.3 8.4
Men 45................................ 5.2 6.6 7.5 7.6 7.9 7.7 7.3 6.5 7.1 4.2 6.3
Men 50................................ 4.3 6.0 6.9 7.1 7.3 7.5 7.7 7.2 6.9 4.1 6.0
Men 55................................ 5.0 7.0 7.5 8.0 8.0 8.5 8.8 9.0 8.0 4.6 6.4
Men 60................................ 5.7 7.6 8.7 8.8 9.1 9.2 9.8 9.2 9.3 4.6 6.7
Men 65................................ 6.3 8.2 9.1 9.6 9.5 9.3 10.0 9.6 9.4 5.7 7.5
Men 70................................ 7.0 8.8 9.8 9.7 10.4 10.2 10.9 10.9 10.8 6.1 8.1
Men 75................................ 7.3 9.3 10.1 10.7 10.6 11.1 11.1 11.5 11.6 6.6 8.6
Men 80................................ 8.2 9.1 10.3 11.0 10.9 11.2 11.0 11.6 11.3 7.3 8.8
Men 85................................ 7.2 8.8 10.3 10.7 10.7 10.6 11.3 11.6 12.0 6.6 8.3
Men 90................................ 6.7 8.7 9.9 10.7 10.7 10.8 10.8 10.9 11.8 7.2 8.7
Men 95................................ 5.7 8.5 9.7 10.0 10.6 10.2 10.7 11.4 11.0 7.4 8.6
Women 45.............................. -0.3 5.2 6.3 6.3 6.6 6.5 6.9 5.6 4.5 2.9 4.8
Women 50.............................. -3.8 3.7 5.2 5.8 6.3 7.0 6.3 6.3 6.6 3.7 4.3
Women 55.............................. -2.2 4.4 6.2 6.4 6.9 7.3 7.6 7.3 6.7 4.3 5.1
Women 60.............................. -0.9 5.3 6.8 7.7 7.7 8.2 7.9 8.3 8.2 4.5 5.7
Women 65.............................. -0.2 5.9 7.3 8.5 8.2 8.5 9.2 9.3 8.7 4.9 6.4
Women 70.............................. 0.2 6.2 8.1 8.7 9.1 9.4 9.9 9.9 8.9 4.9 6.6
Women 75.............................. 0.7 6.9 8.8 9.3 10.0 9.4 9.7 10.0 10.4 6.0 7.4
Women 80.............................. 0.5 7.6 8.8 9.7 10.1 10.7 10.5 10.9 10.9 5.8 7.5
Women 85.............................. 0.8 7.2 8.9 9.6 10.2 10.6 10.0 10.3 9.7 6.2 7.7
Women 90.............................. 0.9 7.3 8.8 9.6 10.3 10.3 10.7 9.9 10.5 6.7 7.9
Women 95.............................. 0.6 7.0 8.6 9.9 9.7 10.2 10.2 10.5 11.1 7.0 8.0
White 45.............................. 0.6 5.8 6.9 7.3 7.5 7.5 7.3 6.2 6.3 3.9 5.7
White 50.............................. -2.0 4.5 6.0 6.6 6.9 7.3 7.3 7.0 6.8 4.0 5.4
White 55.............................. -0.2 5.3 6.8 7.3 7.5 8.1 8.4 8.3 7.5 4.4 5.9
White 60.............................. 0.9 6.2 7.7 8.4 8.5 8.7 9.2 8.8 9.1 4.6 6.3
White 65.............................. 1.5 6.8 8.2 9.1 8.9 9.0 9.6 9.5 9.4 5.4 7.0
White 70.............................. 2.1 7.2 8.8 9.3 9.9 9.9 10.5 10.7 10.2 5.8 7.5
White 75.............................. 2.8 7.8 9.4 10.1 10.3 10.3 10.4 10.8 11.3 6.3 8.0
White 80.............................. 2.5 8.1 9.7 10.5 10.6 10.9 10.7 11.5 11.0 6.7 8.2
White 85.............................. 2.3 7.7 9.4 10.1 10.5 10.7 10.7 11.2 11.1 6.4 7.9
White 90.............................. 1.8 7.6 9.2 10.2 10.7 10.6 10.7 10.9 11.4 7.1 8.3
White 95.............................. 1.7 7.2 9.0 9.9 10.0 10.0 10.4 11.0 11.0 7.2 8.2
Nonwhite 45........................... 1.5 5.6 7.3 6.8 7.7 6.8 6.6 6.9 7.4 4.0 6.1
Nonwhite 50........................... 0.0 5.3 6.5 6.6 7.6 7.6 7.0 7.2 6.9 4.4 5.9
Nonwhite 55........................... 0.9 6.1 7.4 7.2 8.1 8.3 8.8 8.6 8.9 4.9 6.5
Nonwhite 60........................... 2.5 7.0 8.4 8.3 8.9 9.0 7.8 9.6 8.3 4.1 6.2
Nonwhite 65........................... 3.6 7.6 8.1 9.3 9.6 9.2 10.3 9.4 7.0 5.9 7.5
Nonwhite 70........................... 4.0 8.1 9.5 9.2 9.8 10.1 10.6 10.2 10.1 5.4 7.5
Nonwhite 75........................... 2.7 8.6 9.9 10.5 10.9 10.7 11.3 11.2 11.4 7.1 8.9
Nonwhite 80........................... 4.7 9.0 9.7 10.5 10.5 11.3 11.2 10.9 11.8 8.1 9.4
Nonwhite 85........................... 3.8 8.9 10.2 10.8 10.3 10.3 11.1 10.8 12.2 6.9 8.7
Nonwhite 90........................... 5.2 9.0 9.9 10.1 9.9 10.6 11.0 9.4 11.4 7.0 8.6
Nonwhite 95........................... 3.3 8.9 9.9 10.3 10.7 10.7 10.8 11.6 11.3 8.1 9.2
Noncollege 45......................... 0.9 6.0 7.2 7.3 7.5 7.2 7.2 6.1 6.8 4.1 6.0
Noncollege 50......................... -1.5 4.9 6.3 6.8 7.1 7.4 7.2 7.1 6.7 4.4 5.7
Noncollege 55......................... 0.5 5.6 6.9 7.3 7.5 8.4 8.7 8.3 8.0 4.8 6.2
Noncollege 60......................... 1.6 6.6 8.0 8.2 8.5 9.0 9.1 9.2 9.3 5.0 6.8
Noncollege 65......................... 2.2 7.1 8.4 9.3 9.0 9.2 9.8 9.9 9.5 5.8 7.5
Noncollege 70......................... 2.7 7.6 9.2 9.6 9.9 10.0 10.3 10.8 10.1 6.2 7.9
Noncollege 75......................... 3.5 8.2 9.6 9.9 10.5 10.7 10.5 11.2 11.5 6.8 8.5
Noncollege 80......................... 3.4 8.6 9.8 10.2 10.7 10.8 10.6 11.5 11.7 7.4 8.8
Noncollege 85......................... 3.0 8.3 9.7 10.2 10.6 10.6 10.8 11.3 11.1 6.8 8.4
Noncollege 90......................... 3.3 8.1 9.3 10.3 10.8 10.7 10.8 10.5 11.7 7.8 8.9
Noncollege 95......................... 3.0 7.8 9.2 10.1 10.4 10.7 10.9 11.6 10.9 8.2 9.0
College 45............................ 0.1 5.0 6.4 6.8 7.4 7.8 7.3 6.5 5.9 3.8 5.4
College 50............................ -2.5 3.9 5.7 6.2 6.9 7.2 7.3 6.8 6.9 3.7 5.1
College 55............................ -1.4 5.1 6.8 7.3 7.7 7.8 8.1 8.2 7.1 4.2 5.5
College 60............................ 0.0 5.9 7.4 8.6 8.5 8.5 9.0 8.4 8.5 4.2 5.8
College 65............................ 1.0 6.7 8.0 8.8 8.9 8.7 9.5 8.8 8.7 5.2 6.6
College 70............................ 2.0 7.0 8.6 9.0 9.9 9.8 10.8 10.5 10.3 5.4 7.1
College 75............................ 1.5 7.6 9.3 10.4 10.3 10.1 10.6 10.4 11.1 6.1 7.8
College 80............................ 2.1 7.9 9.5 10.9 10.4 11.2 11.0 11.4 10.8 6.5 8.0
College 85............................ 2.0 7.4 9.3 10.2 10.3 10.6 10.8 11.0 11.5 6.3 7.8
College 90............................ 1.3 7.7 9.3 10.0 10.2 10.6 10.8 10.6 11.1 6.6 7.9
College 95............................ 0.3 7.3 9.1 9.8 9.9 9.6 10.1 10.8 11.2 6.8 7.8
--------------------------------------------------------------------------------------------------------------------------------------------------------
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]
--------------------------------------------------------------------------------------------------------------------------------------------------------
0-120k 120k-240k 240k-360k 360k-480k 480k-600k 600k-720k 720k-840k 840k-960k 960k-1.08m 1.08m+ Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cohort 45............................. 3.1 6.7 7.5 7.6 7.8 7.7 7.4 6.4 6.5 3.9 6.1
Cohort 50............................. 0.4 5.3 6.4 6.8 7.1 7.3 7.1 6.8 6.6 3.9 5.6
Cohort 55............................. 1.6 5.8 6.9 7.2 7.3 7.8 8.0 7.8 7.1 4.2 5.8
Cohort 60............................. 2.4 6.3 7.4 7.7 7.9 8.0 8.1 8.0 8.0 4.1 5.8
Cohort 65............................. 2.7 6.4 7.3 7.9 7.7 7.7 8.2 8.1 7.8 4.6 6.2
Cohort 70............................. 2.6 6.2 7.3 7.5 7.9 7.9 8.4 8.3 8.0 4.6 6.0
Cohort 75............................. 2.3 6.0 7.1 7.6 7.8 7.7 7.8 8.1 8.4 4.8 6.1
Cohort 80............................. 1.9 5.9 6.9 7.6 7.6 7.9 7.8 8.2 8.1 4.9 6.0
Cohort 85............................. 1.6 5.6 6.8 7.3 7.5 7.6 7.8 8.0 8.2 4.7 5.8
Cohort 90............................. 1.6 5.6 6.7 7.3 7.6 7.6 7.8 7.6 8.2 5.1 6.0
Cohort 95............................. 1.2 5.4 6.6 7.2 7.3 7.3 7.5 8.0 7.9 5.3 6.0
Men 45................................ 6.2 7.2 7.9 7.9 8.1 7.9 7.4 6.6 7.1 4.2 6.4
Men 50................................ 4.9 6.3 7.1 7.1 7.3 7.4 7.5 7.0 6.7 4.0 6.0
Men 55................................ 5.4 6.9 7.3 7.6 7.6 8.1 8.2 8.4 7.5 4.3 6.1
Men 60................................ 5.7 7.2 8.0 8.0 8.3 8.2 8.7 8.2 8.2 4.1 6.0
Men 65................................ 5.9 7.2 7.8 8.2 8.0 7.9 8.4 8.1 7.9 4.8 6.4
Men 70................................ 5.8 7.1 7.8 7.7 8.2 8.0 8.6 8.5 8.5 4.9 6.4
Men 75................................ 5.5 6.9 7.6 7.9 7.9 8.2 8.2 8.6 8.6 4.9 6.4
Men 80................................ 5.8 6.5 7.4 8.0 7.9 8.1 7.9 8.4 8.2 5.3 6.4
Men 85................................ 5.1 6.3 7.4 7.7 7.7 7.6 8.1 8.4 8.7 4.7 6.0
Men 90................................ 4.7 6.2 7.1 7.7 7.7 7.8 7.8 7.9 8.5 5.2 6.2
Men 95................................ 3.9 6.0 7.0 7.2 7.6 7.3 7.7 8.2 7.9 5.4 6.2
Women 45.............................. 2.4 6.3 7.0 6.8 6.9 6.8 7.1 5.8 4.6 3.0 5.5
Women 50.............................. -1.1 4.6 5.8 6.2 6.5 7.1 6.2 6.3 6.6 3.6 4.8
Women 55.............................. 0.1 5.1 6.4 6.5 6.9 7.1 7.4 6.9 6.3 4.0 5.2
Women 60.............................. 1.0 5.7 6.8 7.3 7.3 7.6 7.2 7.6 7.5 4.0 5.5
Women 65.............................. 1.3 5.8 6.8 7.6 7.3 7.5 8.0 8.1 7.5 4.2 5.8
Women 70.............................. 1.0 5.5 6.8 7.3 7.5 7.6 8.0 7.9 7.1 4.0 5.5
Women 75.............................. 0.9 5.3 6.7 7.1 7.5 7.0 7.3 7.5 7.8 4.5 5.6
Women 80.............................. 0.1 5.4 6.3 7.0 7.3 7.7 7.6 7.9 7.9 4.2 5.4
Women 85.............................. 0.2 5.1 6.4 6.9 7.3 7.6 7.2 7.4 7.0 4.5 5.5
Women 90.............................. 0.4 5.2 6.2 6.9 7.4 7.4 7.7 7.1 7.6 4.8 5.6
Women 95.............................. 0.1 4.9 6.1 7.1 7.0 7.3 7.3 7.6 8.0 5.1 5.7
White 45.............................. 3.1 6.7 7.5 7.6 7.8 7.7 7.4 6.3 6.4 3.9 6.1
White 50.............................. 0.3 5.2 6.4 6.8 7.0 7.2 7.2 6.8 6.6 3.9 5.5
White 55.............................. 1.5 5.7 6.8 7.2 7.3 7.8 7.9 7.8 7.0 4.2 5.7
White 60.............................. 2.2 6.3 7.3 7.7 7.8 8.0 8.3 7.9 8.1 4.2 5.9
White 65.............................. 2.4 6.3 7.3 7.9 7.7 7.7 8.2 8.1 8.0 4.6 6.1
White 70.............................. 2.4 6.1 7.2 7.5 7.9 7.9 8.3 8.4 8.0 4.6 6.0
White 75.............................. 2.3 5.9 7.1 7.5 7.7 7.7 7.7 8.0 8.3 4.7 6.0
White 80.............................. 1.6 5.8 6.9 7.6 7.6 7.9 7.7 8.3 8.0 4.8 5.9
White 85.............................. 1.4 5.4 6.7 7.3 7.6 7.7 7.7 8.0 8.0 4.6 5.7
White 90.............................. 1.0 5.4 6.6 7.3 7.7 7.6 7.7 7.8 8.2 5.1 6.0
White 95.............................. 0.9 5.0 6.4 7.1 7.2 7.2 7.5 7.9 7.9 5.2 5.9
Nonwhite 45........................... 3.5 6.5 7.7 7.2 8.0 7.1 6.6 7.0 7.4 4.1 6.5
Nonwhite 50........................... 1.7 5.9 6.7 6.7 7.6 7.6 6.9 7.0 6.8 4.3 6.1
Nonwhite 55........................... 2.3 6.4 7.3 7.0 7.8 7.8 8.2 7.9 8.3 4.6 6.3
Nonwhite 60........................... 3.5 6.9 7.9 7.7 8.2 8.2 7.0 8.6 7.4 3.7 5.7
Nonwhite 65........................... 3.9 6.8 7.2 8.0 8.2 7.9 8.7 8.0 5.9 5.1 6.5
Nonwhite 70........................... 3.8 6.6 7.6 7.5 7.8 8.1 8.5 8.1 7.9 4.3 6.1
Nonwhite 75........................... 2.1 6.5 7.5 7.8 8.1 8.0 8.4 8.3 8.5 5.3 6.6
Nonwhite 80........................... 3.2 6.4 7.0 7.6 7.6 8.1 8.0 7.9 8.5 5.9 6.7
Nonwhite 85........................... 2.5 6.3 7.3 7.7 7.4 7.4 8.0 7.7 8.8 5.0 6.2
Nonwhite 90........................... 3.6 6.4 7.1 7.3 7.1 7.6 7.9 6.8 8.2 5.0 6.2
Nonwhite 95........................... 2.2 6.3 7.1 7.4 7.7 7.7 7.8 8.4 8.2 5.8 6.6
Noncollege 45......................... 3.2 6.9 7.7 7.7 7.8 7.4 7.3 6.2 6.8 4.1 6.4
Noncollege 50......................... 0.6 5.6 6.6 7.0 7.1 7.4 7.1 7.0 6.5 4.3 5.9
Noncollege 55......................... 2.0 5.9 6.9 7.2 7.3 8.0 8.1 7.8 7.4 4.5 6.1
Noncollege 60......................... 2.7 6.5 7.5 7.6 7.9 8.1 8.2 8.3 8.3 4.5 6.3
Noncollege 65......................... 2.9 6.5 7.4 8.1 7.8 7.9 8.3 8.4 8.1 4.9 6.5
Noncollege 70......................... 2.8 6.3 7.5 7.7 8.0 8.0 8.2 8.5 8.0 5.0 6.4
Noncollege 75......................... 2.8 6.2 7.2 7.4 7.8 8.0 7.8 8.4 8.5 5.1 6.4
Noncollege 80......................... 2.3 6.1 7.1 7.3 7.8 7.8 7.6 8.3 8.4 5.3 6.4
Noncollege 85......................... 1.9 5.9 7.0 7.3 7.6 7.7 7.8 8.1 8.0 4.9 6.0
Noncollege 90......................... 2.2 5.7 6.7 7.4 7.8 7.7 7.8 7.6 8.4 5.6 6.4
Noncollege 95......................... 1.9 5.5 6.6 7.2 7.5 7.7 7.8 8.3 7.8 5.9 6.5
College 45............................ 2.8 6.1 7.0 7.3 7.7 8.0 7.4 6.6 6.0 3.8 5.7
College 50............................ -0.1 4.8 6.1 6.4 7.0 7.1 7.2 6.7 6.8 3.6 5.2
College 55............................ 0.7 5.5 6.9 7.2 7.4 7.5 7.7 7.8 6.7 3.9 5.4
College 60............................ 1.7 6.0 7.1 8.0 7.9 7.8 8.1 7.5 7.6 3.8 5.3
College 65............................ 2.1 6.4 7.2 7.8 7.7 7.5 8.1 7.5 7.3 4.4 5.8
College 70............................ 2.4 6.0 7.0 7.3 7.9 7.8 8.5 8.2 8.1 4.3 5.7
College 75............................ 1.4 5.8 7.1 7.8 7.7 7.5 7.9 7.8 8.2 4.6 5.8
College 80............................ 1.3 5.6 6.8 7.8 7.5 8.1 7.9 8.2 7.8 4.7 5.7
College 85............................ 1.2 5.2 6.6 7.3 7.4 7.6 7.7 7.9 8.3 4.5 5.6
College 90............................ 0.6 5.4 6.6 7.2 7.3 7.6 7.7 7.6 8.0 4.8 5.7
College 95............................ -0.1 5.1 6.5 7.1 7.1 6.9 7.2 7.8 8.1 4.9 5.6
--------------------------------------------------------------------------------------------------------------------------------------------------------
TABLE 5.--OASI INTERNAL RATES OF RETURN
[Lifetime Labor Earnings in 1997 Dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
0-120k 120k-240k 240k-360k 360k-480k 480k-600k 600k-720k 720k-840k 840k-960k 960k-1.08m 1.08m+ Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cohort 45............................. 4.91 3.00 1.99 1.53 1.21 0.88 0.78 0.92 0.52 0.53 1.84
Cohort 50............................. 5.63 3.27 2.27 1.73 1.46 0.97 0.79 0.54 0.56 0.70 1.98
Cohort 55............................. 5.25 3.17 2.21 1.81 1.49 0.93 0.62 0.52 0.47 0.54 1.81
Cohort 60............................. 5.03 3.03 2.19 1.54 1.47 1.19 0.63 0.46 0.29 0.57 1.73
Cohort 65............................. 4.97 3.10 2.38 1.64 1.53 1.27 1.07 0.97 0.34 0.39 1.74
Cohort 70............................. 4.98 3.29 2.44 1.92 1.57 1.40 1.06 0.40 0.57 0.43 1.80
Cohort 75............................. 5.09 3.38 2.48 1.95 1.73 1.61 1.20 1.12 0.47 0.52 1.87
Cohort 80............................. 5.24 3.42 2.61 2.09 1.79 1.53 1.56 0.97 0.52 0.52 1.85
Cohort 85............................. 5.31 3.57 2.79 2.36 2.00 1.70 1.65 1.14 0.75 0.66 1.99
Cohort 90............................. 5.31 3.63 2.83 2.29 1.94 1.68 1.47 1.42 0.96 0.69 1.97
Cohort 95............................. 5.45 3.73 2.89 2.39 2.10 2.03 1.78 1.33 0.93 0.41 1.87
Men 45................................ 3.35 2.07 1.29 1.11 0.92 0.62 0.55 0.65 0.07 0.26 0.88
Men 50................................ 3.45 2.27 1.55 1.21 1.08 0.64 0.35 0.21 0.27 0.48 0.99
Men 55................................ 3.40 2.19 1.60 1.20 1.13 0.49 0.11 -0.01 0.17 0.35 0.91
Men 60................................ 3.36 2.09 1.45 1.04 1.00 0.83 -0.09 -0.13 0.00 0.38 0.85
Men 65................................ 3.41 2.26 1.62 1.14 0.92 0.83 0.89 0.74 0.09 0.11 0.90
Men 70................................ 3.35 2.46 1.72 1.43 1.10 1.13 0.72 0.22 0.31 0.17 0.99
Men 75................................ 3.50 2.64 1.85 1.50 1.40 1.07 0.68 0.51 0.06 0.27 1.07
Men 80................................ 3.47 2.74 2.06 1.53 1.42 1.06 1.34 0.73 0.35 0.25 1.09
Men 85................................ 3.82 2.96 2.17 1.88 1.63 1.47 1.10 0.74 0.17 0.47 1.25
Men 90................................ 4.08 3.12 2.21 1.77 1.74 1.38 1.41 1.12 0.70 0.48 1.32
Men 95................................ 4.37 3.23 2.44 2.16 1.62 1.87 1.54 1.20 0.81 0.25 1.29
Women 45.............................. 5.11 3.42 2.63 2.24 1.84 1.80 1.47 1.63 1.81 1.52 3.06
Women 50.............................. 6.06 3.77 2.89 2.45 2.15 1.61 1.65 1.41 1.16 1.31 3.15
Women 55.............................. 5.73 3.69 2.77 2.50 2.00 1.73 1.50 1.21 1.09 0.99 2.82
Women 60.............................. 5.47 3.57 2.80 2.12 2.04 1.63 1.50 1.15 0.97 0.96 2.65
Women 65.............................. 5.42 3.59 2.99 2.19 2.21 1.90 1.37 1.27 0.90 1.03 2.67
Women 70.............................. 5.48 3.77 2.97 2.48 2.17 1.83 1.57 0.79 1.14 0.95 2.71
Women 75.............................. 5.51 3.82 2.95 2.49 2.24 2.28 1.85 1.74 1.26 1.02 2.75
Women 80.............................. 5.72 3.82 3.15 2.70 2.23 2.02 1.83 1.46 0.87 1.11 2.75
Women 85.............................. 5.69 3.94 3.19 2.82 2.41 2.03 2.32 1.73 1.76 1.05 2.80
Women 90.............................. 5.65 3.92 3.29 2.76 2.20 2.01 1.59 1.88 1.47 1.10 2.72
Women 95.............................. 5.74 4.02 3.27 2.64 2.59 2.28 2.09 1.65 1.11 0.76 2.59
White 45.............................. 4.94 3.02 2.06 1.51 1.24 0.81 0.78 0.97 0.63 0.48 1.84
White 50.............................. 5.69 3.33 2.33 1.71 1.46 0.93 0.77 0.52 0.52 0.72 2.00
White 55.............................. 5.29 3.22 2.25 1.79 1.55 0.93 0.62 0.62 0.50 0.50 1.82
White 60.............................. 5.08 3.09 2.26 1.56 1.45 1.19 0.58 0.49 0.24 0.56 1.74
White 65.............................. 5.05 3.18 2.34 1.65 1.51 1.30 1.10 0.93 0.17 0.37 1.73
White 70.............................. 5.06 3.36 2.50 1.95 1.56 1.42 1.01 0.26 0.65 0.37 1.80
White 75.............................. 5.07 3.43 2.50 1.98 1.78 1.61 1.25 1.19 0.51 0.47 1.87
White 80.............................. 5.33 3.47 2.64 2.10 1.80 1.56 1.54 1.03 0.44 0.53 1.86
White 85.............................. 5.37 3.68 2.88 2.42 2.01 1.72 1.67 1.09 0.79 0.62 2.00
White 90.............................. 5.47 3.75 2.92 2.34 1.90 1.72 1.51 1.39 0.99 0.72 1.99
White 95.............................. 5.52 3.89 3.02 2.48 2.17 2.10 1.77 1.33 1.01 0.47 1.92
Nonwhite 45........................... 4.64 2.91 1.47 1.69 0.93 1.60 0.67 0.48 -0.36 1.11 1.78
Nonwhite 50........................... 5.11 2.88 1.91 1.82 1.44 1.27 0.90 0.69 0.80 0.51 1.83
Nonwhite 55........................... 4.94 2.81 1.96 1.88 1.05 0.89 0.61 -0.90 0.05 0.91 1.78
Nonwhite 60........................... 4.62 2.69 1.72 1.42 1.59 1.15 1.01 0.18 0.73 0.64 1.65
Nonwhite 65........................... 4.43 2.69 2.55 1.61 1.66 1.07 0.85 1.18 1.61 0.51 1.81
Nonwhite 70........................... 4.52 2.98 2.20 1.76 1.61 1.30 1.28 1.27 0.05 0.75 1.83
Nonwhite 75........................... 5.17 3.18 2.37 1.80 1.53 1.65 0.91 0.69 0.33 0.76 1.86
Nonwhite 80........................... 4.81 3.15 2.48 2.05 1.74 1.37 1.61 0.67 0.76 0.43 1.81
Nonwhite 85........................... 5.02 3.08 2.38 2.07 1.96 1.61 1.54 1.44 0.51 0.86 1.94
Nonwhite 90........................... 4.65 3.15 2.47 2.03 2.13 1.53 1.28 1.51 0.78 0.53 1.88
Nonwhite 95........................... 5.13 3.20 2.41 2.00 1.86 1.71 1.81 1.32 0.45 0.16 1.67
Noncollege 45......................... 4.86 2.83 1.85 1.39 1.15 0.97 0.77 1.01 0.19 0.61 1.89
Noncollege 50......................... 5.57 3.12 2.18 1.59 1.38 1.04 0.78 0.46 0.33 0.62 2.04
Noncollege 55......................... 5.12 3.06 2.20 1.83 1.55 0.66 0.37 0.50 0.25 0.47 1.85
Noncollege 60......................... 4.91 2.90 1.97 1.53 1.39 1.00 0.77 0.28 -0.09 0.47 1.73
Noncollege 65......................... 4.87 3.02 2.27 1.44 1.56 1.19 0.98 0.79 0.12 0.29 1.74
Noncollege 70......................... 4.91 3.17 2.23 1.68 1.54 1.41 1.25 0.14 0.56 0.47 1.87
Noncollege 75......................... 4.92 3.23 2.36 1.97 1.61 1.33 1.14 0.96 0.48 0.21 1.86
Noncollege 80......................... 5.11 3.28 2.47 2.08 1.56 1.69 1.43 1.12 0.41 0.39 1.92
Noncollege 85......................... 5.22 3.39 2.60 2.30 1.86 1.65 1.58 1.11 0.94 0.59 2.04
Noncollege 90......................... 5.12 3.55 2.78 2.20 1.86 1.64 1.27 1.25 0.98 0.70 2.05
Noncollege 95......................... 5.23 3.65 2.84 2.20 1.83 1.86 1.56 1.22 0.76 0.30 1.92
College 45............................ 5.04 3.44 2.36 1.81 1.33 0.79 0.78 0.81 0.97 0.46 1.75
College 50............................ 5.78 3.60 2.45 1.99 1.57 0.83 0.80 0.63 0.78 0.77 1.88
College 55............................ 5.55 3.38 2.25 1.77 1.37 1.24 0.95 0.55 0.78 0.61 1.75
College 60............................ 5.25 3.24 2.57 1.57 1.57 1.40 0.34 0.69 0.73 0.65 1.72
College 65............................ 5.16 3.22 2.54 1.90 1.50 1.38 1.19 1.27 0.62 0.47 1.73
College 70............................ 5.07 3.46 2.70 2.18 1.61 1.40 0.87 0.59 0.57 0.39 1.74
College 75............................ 5.34 3.57 2.61 1.92 1.87 1.81 1.24 1.26 0.46 0.73 1.88
College 80............................ 5.40 3.59 2.76 2.09 2.01 1.32 1.67 0.82 0.62 0.60 1.79
College 85............................ 5.43 3.79 3.02 2.44 2.13 1.74 1.69 1.17 0.55 0.71 1.93
College 90............................ 5.58 3.74 2.90 2.38 2.04 1.72 1.62 1.59 0.94 0.68 1.89
College 95............................ 5.77 3.85 2.95 2.56 2.36 2.21 1.98 1.41 1.10 0.49 1.83
--------------------------------------------------------------------------------------------------------------------------------------------------------
TABLE 6.--INTERNATIONAL COMPARISONS OF GENERATIONAL ACCOUNTING ALTERNATIVE WAYS TO ACHIEVE GENERATIONAL BALANCE
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cut in government Cut in government Increase in all Increase in income
purchases transfers taxes tax
Country -----------------------------------------------------------------------------------------
A B A B A B A B
--------------------------------------------------------------------------------------------------------------------------------------------------------
Argentina..................................................... 24.6 29.1 16.8 11.0 10.7 8.4 97.1 75.7
Australia..................................................... 8.8 10.2 12.1 9.1 5.1 4.8 8.5 8.1
Austria....................................................... 56.8 76.4 25.0 20.5 20.1 18.4 60.7 55.6
Belgium....................................................... 11.2 12.4 6.0 4.6 3.7 3.1 11.7 10.0
Brazil........................................................ 23.8 26.2 21.3 17.9 12.4 11.7 78.9 74.0
Canada........................................................ 0.0 0.1 0.0 0.1 0.0 0.1 0.0 0.2
Denmark....................................................... 9.9 29.0 4.7 4.5 3.4 4.0 5.8 6.7
Finland....................................................... 47.6 67.6 26.5 21.2 20.6 19.4 54.1 50.8
Germany....................................................... 21.1 25.9 17.6 14.1 9.5 9.5 29.5 29.5
Ireland....................................................... -2.1 -4.3 -2.5 -4.4 -1.1 -2.1 -2.5 -4.8
Italy......................................................... 37.0 49.1 18.0 13.3 12.4 10.5 33.3 28.2
Japan......................................................... 26.0 29.5 28.6 25.3 15.5 15.5 53.6 53.6
Netherlands................................................... 21.0 28.7 21.4 22.3 8.5 8.9 14.9 15.6
New Zealand................................................... -1.0 -1.6 -0.8 -0.6 -0.4 -0.4 -0.8 -0.8
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
colleagues, 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 immediately 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 brother--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 income, 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 determine what this Nation's future
retirement system should look like. Substandard returns,
whether they are shared equally or unequally, 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 Social 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 system and don't get a dime back in benefits based on all
the years 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
higher than the benefits that they earned in their own right.
So while 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 nothing in direct return. Let me give you an
illustration.
What it means is this: You can have a wife who has never
entered the paid labor force or paid a dime in payroll 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 system.
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 preference, they wouldn't need that favoritism.
Instead, every single dollar they earned would work toward
their retirements and improve 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 retirement accounts. We studied a cohort of women who
actually retired 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
majority 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 another example. You can look at
different groups of men and consider the African-American man
compared to the Caucasian male. Upon reaching age 65, the
average African-American male can expect to live 2 years less,
die 2 years earlier than the average Caucasian 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 around 1960, regardless of their
gender, their marital status, their ancestry or their incomes,
can expect rates of return on their payroll 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 significantly increase the retirement incomes of
every worker, no matter what their retirement income--excuse
me, no matter what their income, 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 payroll 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 studying the impact of
the current system on women. The bottom line is that while Social
Security does not differentiate 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 benefit is little 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 percent.
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 during 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
Security, 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 acceptable 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 accounts.
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. 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 continue 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 born 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.
Today's average 20-year-old male can expect to pay $182,000 more in
Social Security taxes than he will receive in benefits.
So while men may be ``better off'' than women under Social
Security, neither group fares well.
The most important thing for this task force to consider is that a
redesigned system 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 Americans favor some amount of privatization.
Democratic and Republican legislators have introduced bills that would
privatize the system to varying degrees. And experts of various
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 women'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. Unfortunately, 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 improvement.
In contrast, research shows that virtually every woman--single,
divorced, married, or widowed--would probably be better off financially
under a system of fully 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 typically earn
less, work fewer years, and live 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 benefits 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 husband'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.
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 husband's earnings--she receives no
credit or benefits based on the payroll taxes she has paid. A woman who
never worked at all receives exactly the same benefits.
The second inequity that results under Social Security's dual-
entitlement rule is that a couple with two breadwinners may get fewer
benefits than a couple with one breadwinner and identical lifetime
earnings. Table 1 illustrates this point.
TABLE 1.--COUPLES BENEFITS UNDER DUAL ENTITLEMENT
------------------------------------------------------------------------
Monthly earnings Monthly benefit
($) ($)
------------------------------------------------------------------------
Couple A:
Husband........................ 1,000 573
Wife (no income)............... 0 287
Total........................ 1,000 860
Couple B:
Husband........................ 500 413
Wife........................... 500 413
Total........................ 1,000 826
Couple C:
Husband........................ 667 467
Wife........................... 333 300
Total........................ 1,000 767
------------------------------------------------------------------------
Source: Adapted from Ekaterina 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 indexed
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 breadwinners. During 1 year, couple A will receive $1,116 more
than couple C. After 10 years, couple A will have received more than
$11,000 more in retirement benefits than couple C. As men and women who
reach age 65 are expected to live to age 80 or beyond, that inequity
can have a significant impact on a couple's quality of life for many
years.
While the dual-entitlement rule has a negative impact on many two-
earner couples during their retirement years together, its most
pernicious impact is often felt after a husband dies. Social Security's
survivor benefit rules can leave widows with up to 50 percent less
income than the couple was receiving when the husband was alive. That
is one reason why the poverty rate among widows is 19.2 percent, two
times greater than among widowers. And, in general, the more of the
couple's earnings the widow earned, the smaller the share of the
couple's retirement benefit she receives after her husband dies. Table
2 illustrates this point.
TABLE 2.--WIDOWS' BENEFITS UNDER DUAL ENTITLEMENT
----------------------------------------------------------------------------------------------------------------
Monthly Earnings Couple's Benefit Widow's Benefit
($) ($) ($)
----------------------------------------------------------------------------------------------------------------
Couple A:
Husband.............................................. 1,000
Wife (no income)..................................... 0 860 573
Total.............................................. 1,000
Couple B:
Husband.............................................. 500
Wife................................................. 500 826 413
Total.............................................. 1,000
Couple C:
Husband.............................................. 667
Wife................................................. 333 767 467
Total.............................................. 1,000
----------------------------------------------------------------------------------------------------------------
Source: Adapted from Ekaterina Shirley 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 indexed 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 found 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 difference of $408 per month.
The Social Security Administration reports that 24 percent of
married and widowed 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
system 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 handful 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 private 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
revenue 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 Security. 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 from Social Security,
according to the nonpartisan Tax Foundation. And, as the American
Association of Retired Persons has pointed out, women would suffer most
under reform proposals that reduce retiree 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 similar to individual retirement accounts or
401(k) plans. Would private accounts increase the overall level of
women's retirement benefits? Would private accounts address 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 analyses. 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 Security benefits with
the benefits that hypothetically would have accrued under a private
plan with a 7 percent contribution rate, a 6.2 percent rate of return,
and 50-50 earnings sharing between spouses where applicable. Earnings
sharing lets married 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 difference appears small,
it is significant relative to total benefits from Social Security.
Overall, the median value of the accrued difference between benefits
from Social Security and benefits from 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
percent for widows.
In the second analysis, Shirley and Spiegler conducted a
prospective simulation 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 lifetime 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
Social 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 would
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 \2/3\ of the poverty rate. As they did in the
retrospective analysis, the researchers 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 security in retirement. Thus, the fully private system
generates significantly higher retirement benefits than does the partly
private, two-tiered system. The partly private system provides only
slightly greater benefits than Social Security. The results 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 benefits 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 interrupted 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 national mean wage level of women. Figures 3
and 4 show that women with low to moderate incomes (with full or
interrupted earnings histories) would do far better under a fully
private system than under either Social Security or the partly private
system.
figure 1.--accrued retirement income of mean-income women with full
earnings histories
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Adapted from Ekaterina Shirley and Peter Spiegler, ``The
Benefits of Social Security Privatization for Women,'' Cato Institute
Social Security Paper no. 12, July 20, 1998, p. 12.
figure 2.--accrued retirement income of mean-income women with
interrupted earnings histories
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Adapted from Ekaterina Shirley and Peter Spiegler, ``The
Benefits of Social Security Privatization for Women,'' Cato Institute
Social Security Paper no. 12, July 20, 1998, p. 12.
figure 3.--accrued retirement income of low-income women with full
earnings histories
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Adapted from Ekaterina Shirley and Peter Spiegler, ``The
Benefits of Social 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
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Adapted from Ekaterina Shirley and Peter Spiegler, ``The
Benefits of Social 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 private 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
privatization 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; under
the fully 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
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Adapted from Ekaterina Shirley and Peter Spiegler, ``The
Benefits of Social Security Privatization for Women,'' Cato Institute
Social Security Paper no. 12, July 20, 1998, p. 12.
figure 6.--money's worth to low-income women with interrupted earnings
histories
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Adapted from Ekaterina Shirley and Peter Spiegler, ``The
Benefits of Social 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 dollar than would either
Social Security or the partly private plan.
The money's worth calculations demonstrate that, even taking into
account 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-dollar calculations show how a fully private system with a
contribution rate of 10 percent would be able to bring all women--
single, married, divorced, or widowed with low to moderate 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 important concerns should alleviate much
uneasiness about personal accounts.
Low-Income Women as Investors
``Because women are more likely to be living in low-income
households, they generally 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 undoubtedly 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 pension benefits to experienced
investors who, for the most part, have fulfilled their
responsibilities. 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 Advisors 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 retirement system have regulatory elements that restrict
investment strategies that are either too risky or that would be
insufficiently aggressive to provide needed retirement benefits.''
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 under 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 Social Security
benefit with an initial balanced-fund (60 percent equities, 40 percent
bonds) benefit for low-income workers born in 1950 and 1970. The low-
income worker born in 1950 could expect a monthly Social Security
benefit of $668; the balanced-fund benefit would be $1,514. The low-
income worker born 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 from
Social Security. If, however, the worst-case scenario arose leaving a
worker with insufficient benefits upon retirement, the government could
finance a safety net from general revenues. Moreover, if one believes
the market-based system is inferior to Social Security, most
privatization 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-income 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 control 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 potential returns are more likely to invest more than those who do
not receive such information. Investment companies compete vigorously
to educate and attract female clients. For example, OppenheimerFunds
has distributed a 160-page booklet called ``A Woman's Guide to
Investing.'' Merrill Lynch, PaineWebber Group Inc., and Smith Barney
have similar marketing strategies. In addition, women who have been
investing 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 investors. Finally, in a
well-structured private system, women, as well 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 earnings sharing can address the shortcomings of the current
Social Security system. First, both the retrospective and the
prospective analysis show that fully private accounts would
significantly improve the retirement incomes of women--single, married,
divorced, 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
without 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 constructive comments, to Carrie Lips for her expert
research assistance, and to Michael Tanner for his support and
direction. I take full responsibility for all errors.
Chairman Smith. Dr. Kijakazi.
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
Security'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 Americans 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
disproportionately 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, guaranteed 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 Social Security provides for African Americans and
low-wage workers. Three aspects of Social Security help to
compensate African Americans 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 disproportionately from the
disability and survivors components of the system.
A study by employees of the Treasury Department found that
African 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 average, 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 Security 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 received 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 payroll 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 reduction in Social
Security benefits than otherwise would be necessary.
The recently introduced Archer-Shaw proposal would also
have disadvantages for people of color and women. Funding for
the individual accounts would likely come from funding for
nondiscretionary 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?
Several 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 administrative costs or risks of individual
accounts.
Finally, the plan would create USA accounts, an individual
account system outside of the Social Security system. It would
be progressive and would be targeted to low-wage and moderate-
wage workers. Solvency can be restored without putting at risk
the guaranteed benefit and the features of the program that are
most beneficial 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 from about 48
percent to about 12 percent. Additionally, Social Security has become
more effective in reducing 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 payments 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 individuals.
The Importance of Social Security to People of Color and Women
Social Security is particularly important to people of color.
Elderly African Americans and Hispanic Americans rely on Social
Security benefits more than white elders rely on the program. Social
Security benefits make up 43 percent of the income received by elderly
African American people and their spouses and 41 percent of income
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 income. Moreover,
people of color are disproportionately represented among low-wage
workers. It is, therefore, more difficult to set aside savings for
retirement to supplement 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 percent 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 participation 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 from poverty.
In 1997, three of every five elderly people lifted out of poverty by
Social Security were women.
While Social Security is intended to be one leg of a ``three-legged
stool'' for retirement 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
life expectancy than the general population. Based on this premise, an
African American worker would contribute payroll taxes, but would not
live long enough to receive Social Security benefits sufficient to
achieve the same rate of return as non-African American beneficiaries.
This reasoning is faulty, however, as it overlooks important
protections Social Security provides for African-American and low-wage
workers including disability 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
Security's benefit formula is progressive. Benefits replace 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
compensate 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 retirees 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 retirees 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 mortality among African Americans is the comprehensive nature of
the program. Social Security is not solely a retirement program, but
also an insurance system that protects against risks that are
unforeseen or for which workers are not sufficiently prepared. 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 civilian labor force, they comprise 18
percent of the workers receiving Social Security disability benefits in
1996. When a worker becomes disabled, the worker's dependents 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 Americans
also accounted for 21 percent of the spouses with children who received
survivors benefits. Benefits for non-aged survivors are one of the
aspects of Social Security most favorable to African-American workers.
Some studies have attempted to estimate Social Security's rate of
return for African Americans. The Social Security Administration's
(SSA) Office of the Chief Actuary has assessed some of these estimates,
such as those used by The Heritage Foundation, 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 information is confidential and
is not released to the public so that the privacy of workers 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 conducted by employees of the Treasury Department (Duggan,
Gillingham, and Greenlees). These researchers found that African
Americans had a slightly higher 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 African
Americans 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 benefit, early
retirement and comprehensive insurance, offset the effects of higher
mortality rates for this community.
Social Security's Protections for Hispanic Americans
Social Security also is of particular value to Hispanic Americans
for another reason. Hispanic retirees live longer, on average, than
other Americans. The average American who reaches 65 (including both
men and women) will live an additional 17\1/2\ years, while the average
Hispanic reaching 65 lives an additional 20\1/2\ years. Those with a
longer life span receive more monthly benefit checks from Social
Security. 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 Hispanic 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
expected, 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 benefit 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 determination 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 eliminated 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 compensation 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 receive a survivors benefit
that is based on her own earnings history or she can receive 100
percent of her deceased husbands benefit, whichever is larger.
Approximately 74 percent of elderly widows receive benefits based on
their deceased husbands' 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.
Finally, the annual cost-of-living adjustment particularly benefits
women due to their longer life span. Without this annual increase in
benefits, the buying 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 benefits.
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 percent. There also will be a decline in the rate of
growth of the working-age population. 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 population.
Social Security payroll tax revenues currently exceed benefit
payments and the trust funds are accumulating assets. The demographic
changes that lie ahead, however, will result in substantial increases
in benefit payments 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 beneficiaries 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. Policymakers 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 accounts 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 government's
obligation to pay Social Security benefits to current retirees and
those nearing retirement. Robert Reischauer, a senior fellow at the
Brookings Institution, addressed 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 promised
to today's elderly and near elderly. Dealing with the unfunded
liability inescapably 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 benefits of current and soon-to-be
retirees. As senior researcher Paul Yakoboski of the Employee Benefit
Research Institute has testified, ``Because the current Social Security
system is largely pay-as-you-go, most of what workers pay into the
system funds today's benefits. . . . [O]n top of paying current
benefits, workers moving to a privatized system would have to pay
'twice' for the benefits going to today's beneficiaries and again to
their own [personal] accounts.''
A study conducted by the Employee Benefit Research Institute
incorporated transition costs into its calculations. It found that for
workers who are 21 today and receive 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. Accounts 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. Research
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 African-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 additional 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 General
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
accounts centrally managed similar to the Federal employees Thrift
Savings Plan, the cost would still be significantly higher than the
administrative cost for Social Security.)
In addition to the costs of these individual accounts, there are
some risks. Retirees 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
convert 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 investment
experience and would be more likely to invest in an overly conservative
manner because they could not afford to expose the funds in their
accounts to much risk. 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 limitations 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 remain
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 surplus. 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 payments 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
individual 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 from 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 financing the
individual accounts is likely to entail substantial tax increases or
program 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 guaranteed, 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 increases 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
annuity payment from 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 Social 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 universal 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
account 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 accounts. 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 benefits to previous
generations of workers, pay for disability and survivors insurance, 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 Security 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
maintaining 150 million 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 equities. These investments would be overseen by a new
independent institution outside the executive branch that would be
designed to be insulated from political pressures. 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 necessary.
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 inefficient. The plan would transfer general revenues to
individual accounts 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
accounts then transferred back to the Social Security trust funds to
help pay Social Security benefits. Based on the actuaries' assumptions
regarding these costs, the administrative 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 preserve the guaranteed benefit that is the
cornerstone of the Social Security system and would not divert any
revenue from the trust funds. Furthermore, the USA accounts 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 progressive 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-dollar 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 from an increase in their retirement 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.
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
economist 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 insurance 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
government, which is calculated on a progressive basis. So you
can have as much progressivity under our plan as you would
like. All account 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
children of the poor end up not receiving any inheritances when
their parents die because all of the earnings of the parents
are completely covered by Social Security and they are not able
to accumulate 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 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
margin, but everybody gets their accrued benefits, and in the
aggregate, there is no new accrual of benefits under the old
system. Now paying off the old accrued benefits means paying
off this time path of benefits, which, declines to zero. How
would we do this? The answer 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 system for American
workers that would be yielding a terrific rate of return on the
marketplace.
Chairman Smith. Ms. Olsen, do you have any specific
suggestions 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
``earnings 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 Social 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 percent 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 paying
for the system 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 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
progressive structure, both Ms. Olsen and Dr. Kotlikoff spoke
to it. Because at some point, Mr. Kotlikoff, you talked about
the fairer system, 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 system built in when people were getting
three times or four times what people put in. From the very
beginning, there has been a progressive 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
government 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
government 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 accounts. 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
continue to provide matching for lower income, paying fully for
disabled, 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 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
saving 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 paying 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 purchasing 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
margin, 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 benefit or average benefit, but it is inequitable in
terms of the incentives that people face to work. You are
telling women, if you work, you lose this part of your wages
and you get nothing back in return.
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 interest 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 believe is a positive thing, but I believe it is only a
part of the equation.
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 negating 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
securities 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 generate 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.
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 additional 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 generation 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 creating 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, I 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
percentage than some of the others are receiving. Is that
correct?
Ms. Kijakazi. 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 Social 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
running 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 percent of Social Security would be saved or lock-boxed or
however you 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 recommendation 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 surplus to fund these individual accounts.
Estimates show that the cost for the Archer-Shaw plan would
exceed 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 accounts 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 Security. If, as the plan is designed, Social Security
benefits are reduced by $1 for every dollar that is in these
individual accounts, then individuals who have the largest
accounts, which would be the high-wage earners, would be
getting back very little from Social Security, while lower-wage
earners who have smaller accounts would be getting back the
bulk of their retirement income from Social Security.
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 accounts. 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
consumption tax?
Mr. Kotlikoff. We'll see some good economic news and some
fiscal 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 contribute anything, there would be no matching
contribution. But the government would contribute on behalf of
the disabled. The government would also require people who are
unemployed to contribute 8 percent of their unemployment checks
to the program.
But to return to your question, if you are a low-income
worker and you put in your contribution, the government is
going to provide a matching contribution, which is going to be
a larger percentage 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 benefit 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
global----
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 contributor 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 progressive benefit structure. If it is to redistribute
income, then I understand where you are coming from.
Mr. Bentsen. Let me interrupt real quick, because that is
an important 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
actually 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 insurance plan.
In the sense that you are allowed to diversify your
portfolio and get returns from the market, you are also
increasing rates of return, which is also met by the plan
obviously.
Can I go back really quickly to say that if your goal is to
redistribute income, I understand why you want a progressive
benefit structure; but if the goal of a progressive benefit
structure is to ensure that nobody lives in poverty or to lift
the lot of the lower-income workers, Social Security does a
terrible job of that, and what 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 ineptitude? 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
Friedman 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 in 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 saying that our surplus
streams are different. The surplus stream is very big from
Social Security surpluses 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 permanent funding structure for a 2 percent
private account system, as you suggested, that may dip into the
on-budget surplus.
Is that what you suggested? Is that correct?
Ms. Kijakazi. My statement was that the budget resolution
envisions 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 discretionary programs will be cut to fund the
individual accounts.
Mr. Ryan of Wisconsin. You have to have the money somewhere
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
speculation?
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
Social Security's treatment of women and minorities, and
different reform 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 apples-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
progressive 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 Security benefits longer--with cost of living
adjustments.
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 workers 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 system--well, it is really probably going to be 1
percent if we continue to go along the way we are going and
have a payroll 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 Security is treating different groups under current law.
To brag just a little bit, I think this is the most extensive
study of Social Security's treatment of America's workers that
has ever been done, because it is the only one that has been
done based on a microsimulation analysis. It takes into account
all of the various benefits under OASI--survivor, mother,
father, children's benefits, earnings testing, early retirement
benefits, etc. We nearly bugged the Social Security actuaries
to death getting all the details right.
What you find is that women do do a lot better in terms of
internal rate of return than men, but even the women are
earning less than the 3.9 percent you could earn buying a long-
term Treasury bond protected against inflation.
You find that nonwhites do slightly worse in terms of rate
of return than do men. That is a difference with Dr. Kijakazi's
perspective, that nonwhites do appear to be doing worse in
terms of rate of return, even taking into account the
progressivity and other features of the system.
The noncollege educated do not do as well as the college
educated.
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 Clayton.
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
benefit data, so they could look at the actual rate of return
received by workers. These researchers did not 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 husband's retirement, other than his life 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.
Kotlikoff's 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 deducted
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 saying, 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 system 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 everybody, 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
generation 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 trying 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 disabled; there is progressivity in terms of matching
contributions; 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 Security thinks is essential to
maintain.
Mrs. Clayton. How much does your plan cost? Have you
estimated?
Mr. Kotlikoff. The real cost is that you are having a
consumption 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. Kijakazi. There is one other point that I would like to
address 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 disability insurance to make up the
difference.
Chairman Smith. I don't think Dr. Kotlikoff would agree
that those benefits--just 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 from Minnesota and a member of the Budget
Committee.
Mr. Gutknecht. Thank you, Mr. Chairman.
I really haven't heard enough of the testimony to ask a
particularly 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 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. And 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 better 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 Security 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
figure 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
better 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
hearing 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 President's plan does, and that, in fact,
the President's plan leaves us with a resulting budget debt,
debt held by the public, or debt subject 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 toward 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
getting 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 protects women from poverty and protects low-income
people from poverty. That could not be further from the truth.
Thirty percent of African-American women in our country live in
poverty while collecting 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 acknowledging 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 investment opportunity together, and divided 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.
Mr. Bentsen. In Texas we call it community property.
Fortunately, 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
anybody, but it failed.
And 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
offered 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 account, 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 benefit.
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 assumed 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 IOUs 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 paying 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 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
ultimately 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 completely an 8 percent consumption
tax, particularly when they--at the lower end they will be
consuming more of their disposable income 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
impacts 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 simulating 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, regardless, 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 imbalance in a substantive way, you end up with a
worse economy in the long run.
So sweating the transition is incredibly important and the
consumption tax is the way to finance a transition in terms of
getting the best bang for the buck with respect to economic
performance.
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 debatable.
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 trying 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 economy 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 considerations 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 Social 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 increase 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 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 increase 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 administrative 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 politically 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
disfavor 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 individually 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 investments 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 Security 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
advice 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
trillion 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, corporate stocks have given investors an average of
11.2 percent return, 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
benefits of higher investment returns to provide greater
retirement income 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 workers pay Social Security taxes
for 40 years or more, they can use this long-term investment
strategy and the magic of compound interest 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 investment. That is the purpose of our hearing today.
[The prepared statement of Mr. Smith follows:]
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:
<bullet> Cut benefits
<bullet> Raise taxes
<bullet> Increase the rate of return earned on workers'
contributions
The current Social Security program gives the average worker a 1.8
percent investment return on their payroll taxes. In contrast,
corporate stocks have given investors 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 investment 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 offices.
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
Associates, 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 already 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 Security and social welfare protection. Return on
investment has become an important issue in thinking about how
this kind of insurance and social protection can be made
available to people.
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 Security of 1.8 percent, which is, I think,
approximately what people retiring 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 common 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
various 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 earlier, and then calculate the average annual return.
Figure 1 shows that there has been an enormous 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 disappear. The purpose of my calculations in
this testimony is to show how 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 constantly 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
payroll; is that what you are saying?
Mr. Burtless. Yes, yes.
Mr. Smith. OK. Go ahead.
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 retiring 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 earnings. So there is a huge
difference in the value of the annuity people 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 inflation 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 proposal is to establish a new
system of individual, privately managed retirement accounts 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 financing 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 individual accounts, but there are
efficiency advantages to accumulating reserves in a single collective
account, 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 recipients). Under a system of individual
accounts, 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 workers 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 mandatory 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 from individual investment accounts.
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 defined-contribution pension accounts.
Such accounts could be run independently of traditional Social Security
or as an additional element in the existing system. Advocates of
individual accounts claim three big advantages from establishing
individual accounts:
<bullet> It can lift the rate of return workers earn on their
retirement contributions
<bullet> It can boost national saving and future economic growth
<bullet> It has practical political advantages in comparison with
reforms in existing public programs that rely on higher payroll taxes
or a bigger accumulation of public pension reserves
Individual account plans differ from traditional Social Security in
an important way. The worker's ultimate retirement benefit depends
solely on the size of the worker's contributions and the success of the
worker's investment plan. Workers who make bigger contributions get
bigger pensions; workers whose investments earn better returns receive
larger pensions than workers who invest poorly.
The most commonly mentioned advantage of individual accounts is
that they would permit workers to earn a much better rate of return
than they are likely to achieve on their contributions to traditional
Social Security. I have heard it claimed, for example, that workers
will earn less than 0 percent real returns on their contributions 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 returns on their Social Security
contributions, but on average future returns are expected to be between
1 percent and 1\1/2\ percent, even if taxes are increased and benefits
reduced to restore long-term solvency.
Second, workers will not have an opportunity to earn the stock
market rate of return on all of their retirement contributions, even if
Congress establishes an individual account system in the near future.
As noted above, workers' overall rate of return 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 current return on Social Security
contributions than it is to 8 percent.
Investment risk. Advocates of individual retirement accounts often
overlook the investment 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 types 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 returns
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 reinvested 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.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Some people mistakenly believe the annual ups and downs in stock
market returns 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 depended on
stock market investments.
We can evaluate the financial market risks facing contributors to
individual retirement accounts by considering the hypothetical pensions
such workers would have obtained between 1910 and 1997. The 88
hypothetical contributors are assumed 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 accumulated
retirement savings into a level annuity. To make the calculations
comparable across time, all contributors are assumed to have an
identical career path of earnings and to face the same mortality risks
when they reach age 62. Contributors differ 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 system, 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 market performance, interest
rates, and inflation dating back to 1871.\1\ 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 accounts. Workers' earnings typically rise throughout their
careers until they reach their late 40's or early 50's, and then wages
begin to fall. I assume that the age profile 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 percent a year.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
While it would be interesting to see how workers' pensions would
vary if we altered 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 holdings are
immediately invested in stocks, too. Optimistically, I assume that
workers incur no expenses buying, selling, trading, or holding stocks.
(The average mutual fund that holds a broadly diversified stock
portfolio annually charges shareholders a little 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-life 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 selling costs, or impose extra charges to protect
itself against the risk of adverse selection in its customer pool.
(These assumptions are all unrealistic. Annuity companies typically
charge an amount that is between 10 percent and 15 percent of the
selling price of annuities to cover these items.) My assumptions
therefore yield an overly optimistic estimate of the pension that each
worker would receive.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 reflected 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 individual
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 replacement 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
replacement 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.)
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 percent and almost 10 percent.
The average rate of return was 6.4 percent.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
The principal lesson to be drawn from these calculations is that
defined-contribution retirement accounts offer an uncertain basis for
planning one's retirement. Workers fortunate enough to retire when
financial markets are strong obtain big pensions; workers with the
misfortune to retire when markets are weak can be left with little 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 Administration, 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, rising
from 21 percent to 35 percent. Social Security pensions have been far
more predictable 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 pension 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.''
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 return 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 realized 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 average, workers would have received real annuities that are
less in value than was anticipated when they first began their
retirements.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Conclusion
The debate about reforming Social Security should not rest on
exaggerated claims about the potential gains workers can obtain from a
shift to privately managed individual retirement accounts. Social
Security provides workers with crucial protections against financial
market risks. It is worth remembering that when the system was
established in 1935, many industrial and trade union pension plans had
collapsed 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 Government, was preferable to
sole reliance on individual retirement plans.
Financial market fluctuations continue to make private retirement
incomes uncertain. Workers who invest in financial market assets, such
as common stocks, bonds, and annuities, are exposed to three kinds of
risks: The risk that asset prices will decline around the time workers
begin to retire; The risk that annuities will be expensive 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
seriously 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 benefits of current retirees, and the problem we are
in that I guess probably everybody here recognizes is that the
changing demographics are changing the mix of workers to
retirees. We are having 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 partially by design the system is not in balance. The
individual account, 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
system 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 benefits 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 suggesting 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
returns, higher returns, we have to talk about making an
investment, 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
statement, 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. Government bonds have returned 5.3 percent. So
there is about a 6 percent differential between stocks and
bonds. That 6 percent differential 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 inflation.
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 starting 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 downside 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 higher 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 U.S. economy, and when times are at their
worst, perhaps the government will be there for us. So we
recognize that we are concerned 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 advocate 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 retirement benefits of current retirees. The system is
mostly unfunded, and to the extent 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 demographics of our workforce, with ever larger proportions of
the population being retired.
Also, the Social Security system, partially by design and partially
by its very nature, has not paid out individual benefits that are
aligned with that same individual'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 merely 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 offset 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 percent per year, while U.S. Government bonds returned 5.3 percent
per year. One dollar invested 73 years ago in common stocks grew to
$2,351 versus only $44 in bonds. 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 outperformed 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, individual 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 capable 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 studying 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 underestimating this time as he did in 1974, or do you
think he is overestimating?
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 percent 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 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
forecasting 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 between stock and bond returns
may be lower just because the valuation 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 Security trust fund to manage the investment in
stocks.
Mr. Smith. This means we have 1-minute to go for my time.
Explain how individual workers could minimize risk if we had
personal 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 individuals do manage their money in 401(k)
accounts, they manage their money in accounts; they learn to
manage their money. I recognize 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.
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
someone 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 someone 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 annuity 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, annuities 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
vehicle. You can buy one. Because the insurance companies have
an expected life span that they use, they can offer annuities
that last until death. For every 1,000 people that come in to
buy the annuity, 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 talking 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 surplus 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 President 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 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 retirement, 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 perhaps--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 invested 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.
Chairman?
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
managers, Mr. Burtless, who charge two basis points would know
something 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
guarantee 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 taxpayers 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 savings and loans associations. The owners of
the savings and loans were looking at a situation where if they
invested in a very reckless 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 investments they can make. But if you restrict
the nature of the investments 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, everyone 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 advantage 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 wonder, well, why are you offering this option when
you could easily have the Federal Government invest 60 percent
in stocks and 40 percent in bonds, and you would vastly reduce
the administrative costs.
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
parameters. 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 anyway, there are
parameters there.
Let's say we set something up like that which would be in
addition 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
certainly 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 payroll 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 guarantee. The guarantee in this system is
still the traditional Social Security pension, perhaps scaled
back some. Then people must indeed 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 system.
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 criticizing this are saying 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.
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 investment vehicle like bonds and perhaps
100 percent being invested 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 retirement 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 assume 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
simply 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 assurance 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 example, 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 kind of assets, in pretty short periods of time, if they
are entirely invested just in one kind of asset, they can face
very drastic reductions in the amount that they can afford to
live on when they retire. That is simply a fair description of
financial markets in the United States.
Mrs. Clayton. So the time you invest would remove the
vulnerability 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?
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 volatility. 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 periods. 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. Probably 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
father 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 pretty well on their investments.
Dr. Ibbotson, did I misunderstand you? You feel the value
of investing 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 resolution 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 whatever 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.
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 people 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
second 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 investments 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 investments 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
purchased. 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.
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 public discussions of
alternatives to Social Security, 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
comparison 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 different, 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 accounts 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
industry 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 typically 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. You want to match the risk
preferences to the people if it is a privately-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 something 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 distribution, 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 letting 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 benefits 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 better at these sorts of things,
too.
Ms. Rivers. Dr. Burtless.
Mr. Burtless. I think one reason we have a Social Security
system is the fact that in the 1930's the private retirement
system failed so conspicuously for such a large proportion of
the aged population. The other reason we have it is the view,
both among workers and voters, that maybe individually we are
not completely to 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 advantages for us. We see this in unionized
companies. Almost all unionized 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 decisionmakers to allocate the investment funds.
They don't trust the government 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
individual 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 politically the safest thing to do.
I do not agree with this view. I have a fundamental
disagreement with it. The Federal Reserve Board's retirement
plan and the Thrift Plan covering Federal employees have shown
that it is perfectly possible to make apolitical decisions
about how to invest retirement funds. So I fundamentally
disagree with the critics of public control over the retirement
investments. I do recognize, however, 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
decision. That is, right now, within the political system,
there is a bias on the return for low-income people. They do
better under the system than higher-income people do. If we
create a privatized system or a somewhat privatized system
where people are investing a percentage of wages, we are going
to see people who already have money doing much better than
people who are in low-income positions. 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.
Mr. Ibbotson. They invest more, they take more risk, they
end up with more, and I am sure that is likely to be true,
given choices here, that they would be the ones more likely 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 function. 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
redistribution in the Social Security system in favor of low-
lifetime-earnings 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 careers. 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, because 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 account, but still that could be an individually owned
investment accounts?
Mr. Burtless. My view is that if you are going to have
individual 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 investment options. The Treasury or the
Social Security Administration could collect people's
contributions. It could use a bidding process 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 distribute 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
Fidelity and a thousand other investment companies only becomes
feasible if contributions represent a big percentage of
people's pay, 1 or 2 percent is just not enough.
Mr. Smith. Mr. Herger.
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 running 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 addition 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 type of investment that we, as Federal workers, have I
think is exciting.
I serve on the Ways and Means Committee. We had an
individual 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 Congress, 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 interest--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 particularly 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 something 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
guaranteeing, if not stated, at least very explicitly implied
that we are guaranteeing that in the form of Social Security
that we currently have.
Mr. Ibbotson. We are guaranteeing it, we have been
guaranteeing 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----
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
exciting 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
percent 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 option 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 investments. 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 government 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, Director, 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
Evaluating Social Security Reform with Dr. Robert Reischauer
from The Brookings Institution and Steve Entin from the
Institute for Research on the Economics of Taxation.
So, gentlemen, again, thank you very much for your time and
effort to be here today. Your testimony will be entered in
total in the record, as well as your comments. Thank you very
much for helping 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 worrying 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 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 ``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 recommendations of the Greenspan Commission were enacted by
Congress 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.
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--Representative 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 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 recommendations of the
Greenspan Commission were enacted by Congress 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'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 important 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 Administration. I left between Mr. Baker and Mr.
Brady. Two Secretaries 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 important in mind. This is not just about
Washington and it is not just about the Federal budget. It is
primarily about a better retirement system for Americans and a
more productive working life for Americans.
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 the people as they work and retire.
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. Retirees 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
numerous 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 transition 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
expanded economic capacity.
You can make workers more willing to work by letting them
divert a portion of their payroll tax to personal accounts, and
allowing 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 would 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
substitute for other saving. It may displace some foreign
capital inflows, or it may flow abroad (and should be free to
do so if workers 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.
Consequently, to ensure a good outcome, please combine the
Social 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 extend 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 retirement 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 assets 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
investment 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 system, the better the retirement income picture is
going to be.
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 effort 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 improves 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 realistic dynamic assumptions about its
impact during 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 improve as
well. Meanwhile, however, benefits to current retirees would still have
to be paid. If payroll taxes were diverted to personal accounts, the
government would 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
consequences for the economy should be given more attention in
designing an alternative 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 annually as of 1999, rising to $45 billion by 2004. These
figures assume no economic gains and revenue reflows from the reduction
in the payroll tax. Thus, to leave budget deficit or surplus
projections unchanged, cutting the payroll tax rate by, for example, 5
percentage points would require trimming Federal spending, increasing
borrowing, or raising other taxes by about $180 billion to $225 billion
per year, under static economic assumptions.
The authors of a number of reform proposals have incorporated
specific amounts of Federal borrowing, tax increases of a particular
level and duration, and reductions 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 employing 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
Advisory 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.
Budget Surpluses to the Rescue?
Projected budget surpluses might eliminate the requirement of
budget neutrality and allow 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 recent quarters, nor throw off large revenue
increases, unless some of the rising revenue stream is ``reinvested''
in the expansion through growth-enhancing tax rate reductions on
capital and labor inputs. Fundamental tax reform is an attractive
competing 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 investment, reduced double taxation
of corporate income and capital gains, expanded IRA and pension
eligibility and contribution limits, and lower tax rates on labor
income.
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 the national 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 enhanced if
the reform were coupled with reductions in the taxation of domestic
investment and saving.
Needed: A Broader Objective--Enhanced Saving, Productivity, Investment,
and Income
Various alternatives to the Social Security System and the various
means of financing the transition would have important effects on
individual and business behavior 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 productive 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 standards of future 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 productivity 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 demands on future
workers for support. Their saving will add to capital formation
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 increasing 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
Security 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 increase all four.
If a switch to private saving were done in a manner that improves
the performance of the economy, it would reduce the net cost of the
transition, and reduce the amount of transition funding that would be
required. These dynamic revenue effects should be considered when
formulating the reform program.
Labor Market Effects of Reform
Diverting a portion of the payroll tax to personal accounts, and
allowing the saving to build tax-deferred, as in an IRA, would increase
the amount of retirement income available to workers. The returns would
exceed those possible under Social Security. Workers would 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. Labor force participation and hours worked would
rise.\1\
---------------------------------------------------------------------------
\1\ See, for example, the labor market discussion in Martin
Feldstein, ``The Missing Piece in Policy Analysis: Social Security
Reform,'' American Economic Review (May 1996).
---------------------------------------------------------------------------
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 saving. 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 national output.
Higher employment would result in additional income and payroll
taxes. Increased availability of labor would boost the return on
capital, and induce some additional investment and yield some
additional business taxes.
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 worker benefits
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.
Freedom to Choose
Workers will place the maximum value on the new system if they have
significant freedom 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 free 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 limited to three investment options as under 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 ``contributions'' to Social Security would not yield the same
gains in work incentives as a carve-out of the payroll tax. Under
mandatory saving, individuals retain their ownership of the income, and
have access to it at a later date, with interest. However, 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 freely. It is a ``tax'' to the extent that it reduces their
utility. The inconvenience may be substantial for low income wage
earners who have little room to reduce 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 generations. For
generations working prior to the payroll tax cut, it would make Social
Security, 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 because 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 retirement. The stated objective is to protect the
worker from outliving his retirement income. 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 asking 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 virtually nothing back on his annuity;
nearly all his assets will go to someone else in the annuity pool who
lives 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 support the destitute. At most, a
safety-net level annuity should be all that is required. Alternatively,
require that a minimum balance be maintained in the account, according
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 declines very slowly
as the quantity rises. However, positive effects on investment may
depend critically on how the reform is structured, and are not a sure
thing.
Some studies\2\ have assumed that most of the saving in the
personal saving accounts set up under reform would represent an
increase in total saving by Americans, and that the additional saving
would translate almost dollar for dollar into additional investment by
businesses in the United States. The additional investment is assumed
to earn the current rate of return, yielding higher levels of taxable
business income, and generating significant revenue reflows to help pay
for the transition.
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\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.
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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 likely to
save more due to the new accounts. Absent better tax treatment of
ordinary saving, however, other savers might substitute the required
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 displace 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 ineffective 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 businesses to borrow, it may discourage other saving by
Americans or discourage capital inflows from 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 reduce
domestic employment, income, and tax reflows.
Finally, if additional investment were to occur, the higher capital
stock would depress the rate of return on capital, depressing profit
and government revenue reflows below levels that might otherwise be
anticipated.
For all these reasons, there would be no cause to expect the saving
in personal retirement accounts to result 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 predicted
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 investment in the United States. In
particular, faster depreciation or expensing (immediate 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 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 decline, and more incentive for businesses to
use additional saving to expand their operations in the United States
as opposed to abroad.
Further steps to increase domestic saving, such as easing
contribution limits and eligibility requirements for IRAs and pensions,
reducing the double taxation of dividends and the taxation of capital
gains, and ending the estate tax, would all increase the incentive to
save.\3\ In effect, Social Security reform would be greatly assisted 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 income 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.
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\3\ Ideally, all saving, whether mandated by the Social Security
reform program or done in addition to the required amounts, and whether
for retirement or not, should receive pension treatment. 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.
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Financing Options for the Transition and How They Stack Up in
Furthering Saving, Investment, and Work Incentives
There will be many specific proposals for dealing with the Federal
budget implications of the transition, with many variations as to
details. 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 reduce the amount of funding required by recognizing
the positive budget effects of Social Security reform as the higher
levels of saving, growth, income, and employment it generates raise
revenues and reduce social safety net outlays (dynamic scoring).
The choice of transition financing will have important consequences
for personal saving, national saving, and domestic investment. Assuming
a budget neutral approach, one can describe the possible outcomes as
follows: On- or off-budget cuts in Federal spending would permit the
transfer 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 transition would reduce incentives to work and invest,
depress private saving, and would cancel out potential increases in
national saving and growth. Federal borrowing 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 investment 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 saving could be
directed toward additional capital formation. Furthermore, if the
government 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 public 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 require 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 offsets to a payroll tax reduction be made within the
confines of OASDI, rather than by means 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 Johnson (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 reduction.)
People would have to choose between the government spending or the
tax relief, retirement income increases, and improved job opportunities
that people could get from additional 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
payroll taxes with private saving.
It would be difficult to cut Social Security benefits for current
recipients or people close to retirement. Current Social Security
beneficiaries will get relatively little of the economic and personal
financial gains of the switch to a funded personal retirement 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 little 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 Social
Security benefits (a rough 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 reform were not undertaken.
Borrowing
Federal borrowing could be increased (or debt reduction reduced) to
pay for a portion of the transition costs. However, additional Federal
borrowing of an amount equal to the deposits in personal retirement
accounts would effectively divert the additional saving to financing
the deficit rather than increasing private investment. Savers would
either purchase the additional Federal bonds directly for their
retirement accounts, or they would 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 finance 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 management of the Federal budget, not the economic
``cost'' of the transition. In terms of real economic 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 taxes 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 willing to increase 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 would 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 current workers to save. Individual
and corporate income tax rate 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 effect 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 assets, 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 national 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 private sector would provide current revenue for the
government, but would reduce future 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 subsidy, 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 from 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 payment of future
benefits. Treasury must pay benefits from current taxes or borrowing
whenever benefits are due. The trust funds represent past tax revenue
that the Treasury ``borrowed'' from OASI and DI and spent on other
government outlays. To acquire the money to ``redeem'' the Federal
``bonds'' in the trust funds to pay future benefits, Treasury would
have to borrow additional money from 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 current 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 future financing of future
Social Security benefits. Treasury would just have to borrow the money
back from 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\4\
The baseline projections reflect current law and use economic
assumptions similar to those in the budget forecasts of the
Congressional Budget Office and the Office of Management and Budget.
Fiscal Associates extended the baseline to accommodate 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 Insurance (OASI) program were reduced to eliminate the
program's long-run deficit.
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\4\ The scenarios presented here were developed with the assistance
of Gary and Aldona Robbins and simulated using the Fiscal Associates
general equilibrium model. For more on the 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.
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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 depending 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.\5\
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\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'' described 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.
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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
return.\6\
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\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 will change. They assume a perfectly
integrated world financial system, in which people supplying marginal
saving regard domestic and foreign assets as perfect substitutes.
---------------------------------------------------------------------------
A third case is illustrated in some charts. It assumes the weak
saving and investment response, but adds a tax change--a shift from
depreciation to expensing of investment outlays--to ensure that the
reform generates the additional saving and investment 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. residents. However,
U.S. workers benefit from capital located in the United States,
regardless 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 from 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 from
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 investment responds strongly. It is
smaller--about 2 percent of GDP--where the investment response in
lower. There is still a beneficial effect from the labor market
response to higher retirement income from personal saving accounts. The
chart illustrates 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.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 alternative approaches to financing
the payroll tax cut and the transition--cutting government spending,
borrowing, and raising other taxes.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 returned to the government to finance added government
debt, in which case the additional 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 borrowing, year after year, reduces GNP below the
baseline. Workers earn more than under the baseline 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.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 response case.
Employment and real after-tax wages would fall relative to the
baseline. 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 payroll 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 entitled to the interest or dividend payments,
which absorb the added GDP made possible 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.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
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 income would 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'' rather than an ``add-on'' approach to
obtaining money for the required saving accounts. Workers must have
real ownership of their retirement savings, and the flexibility to use
it as they see fit.
Care must be taken to finance the transition to the new system
without damaging the economy. One cannot count on economic growth to
make the transition painless. There will 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 treatment. Tax increases must be avoided. To
ensure a substantial increase in domestic investment, depreciation
should be replaced with immediate expensing of investment outlays, or,
at the very least, asset lives should be shortened.
If these steps were taken, future generations would enjoy
significantly higher incomes 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 anyway, this
is a payback 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 unstable 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 position 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.
Is the distribution of benefits fair? Fair, of course, is
in the eye of the beholder, but generally, our society has
viewed that basic retirement 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 equitable distribution of risk. Any long term contract
inevitably involves 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 suggested 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
compliance. We have a system now which is very efficient. It is
worth reflecting when we think about changing that system how
much additional administrative costs are going to be imposed.
Virtually all of the proposals that have been put forward keep
the Survivors Insurance 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 often 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 employers 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 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 different 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
individual 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 worthwhile 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
national 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:]
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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 current 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, cutting 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 categories 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 beginning you talk about that none of the studies, or all
of the studies 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 productivity for
sociological reasons related to control of your investments and
things like that.
With respect to the former, is that only true and I ask
this because I do not know, is that only true at a time when
you are running 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 swapping--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 paying down a little
debt (or not borrowing a little) more productive 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 investment 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 economic 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 Steve has been talking about. They are things like
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 importance 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 misleading 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
system 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 forward, remained in balance. The plan that Henry
Aaron and I proposed 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
suggesting 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
commitment 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 retirement 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 affordable 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 promised. The three ways as I see them is you do more
public borrowing, 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 because there is no money in the trust fund and cannot be.
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 device.
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 Security 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 increased 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 opposed 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 IOUs 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 IOUs or not real IOUs or whatever) and
we came to the point where payroll tax receipts and interest
payments on these reserves were insufficient to pay benefits,
then it strikes me it would be inconceivable to say to
beneficiaries we are going to reduce your benefits or even to
payroll taxpayers, workers that we are going to raise the
payroll 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 workers 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 personal account system would crowd out savings
that are already occurring. 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 expensing that
would, I agree, encourage capital investment and therefore
encourage the likelihood of a greater net increase in savings,
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
option 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
businesses and American capital, and that corporate income tax
receipts 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 likely 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
rather 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.
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 assuming that they are behaving in a rational
fashion, is it not therefore still safe to assume that this
capital generates the same kind of return, although it may
happen outside of our borders and therefore there is that added
economic activity and taxable income to the government?
Mr. Entin. That is very true. There are several things to
distinguish 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 income taxes of the higher-paid
workers, and from their higher payroll 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 reform so much as proposals to address the funding deficit
of the system. 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 transforming 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 pressure that will come from the general populace to
seek benefits that are closer to the highest yield benefits
that the more successful investors are getting? In other words,
we can easily talk about putting 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 everyone trying to
receive returns that are comparable to the highest returns that
the shrewd investors are receiving. I see that as a fundamental
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 limited 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
benefits 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 returns are higher at the bottom, but the
difference in dollar benefits is quite sharp. You have got
benefits of around $11,000 for the average 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
accounts, they generally do not find out what their neighbor is
getting. 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 saying, ``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 comfortable with risk than
he is. He is happy because he is less comfortable with risk
than I am.
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 complaint. 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
effects 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 redeemed 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 earlier 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
Security reform plan. Can you comment on that, each of you?
Mr. Reischauer. I strongly favor paying down debt and
reserving, 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 situation 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 economic 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 airplane or machine. By refraining from
consumption, you are transferring real resources to the private
sector for private sector expansion, 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, however. It will not trigger a huge burst of private
sector investment just because of the change in government
finances. It may help private sector growth because of the
resource transfer, but not because 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 borrowing money at that time. And it won't matter much
whether you have been borrowing a lot or not borrowing a lot,
whether the government is big or small as a share of the
economy; the incremental damage by issuing that piece of paper
30 years from now, and taking 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, assuming 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 paying 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
legislation in both the House and the Senate--Domenici has it
in the Senate 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 public 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
Department? 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.
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
forward, 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
recession, 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,
uncontrollable 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 percent 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 government 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 oversimplifying--easier to be re-elected if we are
spending than if we are saying no, tightening our belts. At
least that is undoubtedly oversimplification 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 Congress, 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 anymore. 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 Congress to spend money which really is not ours
to spend or at least that is the way many of us look at it.
I was just wondering if you would comment, your support or
opposition 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
government 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
perceive things that way. They look at that number, and if we
gave them a different number to look at, they would see
something different. The best thing, however, is to give them a
thorough education 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 everybody. The workers would be more productive and have
higher wages. And it is really the only way to address this
problem without 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 retirement income, and be able to do it by setting
aside only 5 percent 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 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 Member 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 reduction, 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.
Anyway, 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
benefits to CPI minus half a percentage point, then what you
are basically 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 retirement 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 developed a lot of respect for the technicians in the
various departments when it comes to number gathering. I think
to second guess the Bureau of Labor Statistics on the CPI would
be a major mistake.
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 unchanged 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 income, subject to the income tax,
you would be watering down income tax indexing. The tax
brackets, in real terms, would narrow 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
hidden 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 several decades of the Social Security system
that system was asked to perform a welfare function. We boosted
benefits very significantly over what the original law called
for in an effort to raise incomes of the elderly and by doing
so we reduced old age assistance payments.
However, that aside, I am not a big fan of using general
revenues to strengthen the system. I think the system through
some judicious and rather small benefit reductions and some
expansion of the tax base by bringing in new employees of state
and local governments and an investment policy that
collectively invested a portion 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
infusions if they were being used in a transition to a system
where the Federal role in the retirement side of Social
Security were substantially reduced, if it were temporary and
leading to a great shrinkage 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 because 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 accounts out of general revenue, if they
cannot contribute enough while they are working. Alternatively,
when they get ready to retire, 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.
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 buying 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 paying down publicly held debt is basically encapsulated
in this legislation 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 do it?
Mr. Reischauer. Well, I will be glad to look at the revised
version of your bill, but I would be more comfortable if the
Congress, in its budget process, began to focus on the non-
Social Security portion 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 recessions, when this is unavoidable. But we are not going
to consider tax cuts or spending increases to the extent that
they might tip that balance into the negative. I am not sure
debt ceiling legislation 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
surpluses I thought were interesting. With the budget
resolution, we make a pretty strong difference between on-and-
off-budget surpluses and with the on-budget surpluses as you
well know, we dedicate that toward tax reduction. I would like
each of you to comment on the economic benefits toward
dedicating on-budget surpluses toward tax reduction.
Specifically, we want to make sure that these surpluses do
materialize 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 highly 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 discretionary spending caps this year. I see no way
you are going to stay within those caps over the next 3 years.
To make a commitment on the tax side which would tend to be
irrevocable, I think, is quite frankly irresponsible, given
that situation when the Chairman of your Appropriations
Committee is saying there is no way we can live within these
caps.
The Chairman of the Senate Appropriations Committee is
saying there is no way we can live within the caps. And
everybody is sitting 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
surpluses 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
difference 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
economic growth than paying 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 carefully.''
In reality, what you are faced with, however, is the very
open political hurly 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 type ceiling
because I remember from the Reagan years that when the economy
slowed down, the ceiling was adjusted. You have a projected
surplus. 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 sympathize with your need to do it. I
understand where you are coming from. I just wish you did not
have to.
Mr. Smith. If the gentleman will yield with your time up
anyway. 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 private 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
future Congresses----
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
danger.
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
reflecting 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
overwhelming 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 potholes 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 actually 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?
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 outlays 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 responsibility 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 unreliable 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 charging 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 airports 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
willing 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.
Mr. Reischauer. People drive from Michigan to visit
Northern California. 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 resources, that the obligations that have been made,
will for all practical 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 controllers 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 question on USA accounts.
Mr. Ryan. Earlier in your testimony, Steve, you talked
about possible crowding out that might occur from a private
Social Security 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
inception 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 businesses 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 treatment. 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 income, 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 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 marginal 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
consumption 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 government 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 accounts might lead to some slight
reduction in other private saving, but at the same time, the
matching component of this should encourage slightly some
saving by individuals. The fact that the Administration has
allowed 401(k) contributions to be used as the individual'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 consideration 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
action 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, they are capturing the public's feelings). I
think the public may be ahead of the Washington establishment.
People want private accounts. They trust them more than a
system they know is underfunded and may not be there for them.
They may not realize 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
personal 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 reduction plan would do it. He had an investment tax
credit, and he had marginal rate cuts, and the recession in the
late Eisenhower administration 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 welfare 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 momentum 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 insurance program aimed at eliminating poverty among
the elderly. Germany introduced its first plan in 1889, and now
is still having a tremendous imposition of taxes on its
citizens to fund its retirement 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 demographic 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 tax 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
implementing 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 partners 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
reform 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.
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
Congressional 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 majority 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 Promote Growth.
Mr. Lawrence Thompson is a Senior Fellow at the Urban
Institute, 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 Assistant Comptroller General at the GAO from
1989 through 1993.
Mr. David Harris is Research Associate at Watson Wyatt
Worldwide and advises and examines major international Social
Security systems in Europe, Asia/Pacific, North and South
America, certainly Australia. David was awarded the 1996 AMP
Churchill Fellowship to research what influences public
confidence in life insurance 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
comments 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 Monetary Fund (IMF), and was released by CBO
in January, just before I arrived.
The aging of the population, as you stated in your opening
remarks, Mr. Chairman, is not unique to the United States. Most
developing countries are experiencing growing retirement
populations that we supported by fewer workers. Those facts
mean, in part, 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 future 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 questions: 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
practicality, 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 national 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
examined here, but we are all bound by one truth: the larger
the economy, 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 reformed their Social Security systems at least in
part through privatization.
The retirement of the baby-boom generation in the United States
will put our Social 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 amounts 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 immediate. 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 comparisons should therefore be made cautiously.
The Congressional Budget Office (CBO) released in January a paper
that reviews the experience of five countries--Chile, the United
Kingdom, Australia, Argentina, and Mexico--that have introduced
individual accounts to fully or partly replace their public retirement
system.\1\ 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.
---------------------------------------------------------------------------
\1\ See Congressional Budget Office, Social Security Privatization:
Experiences Abroad, CBO Paper (January 1999).
---------------------------------------------------------------------------
All five countries 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 accounts from 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 burden 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 system.
<bullet> 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 continue to support retirees under the old
system while saving for their own retirement. That issue is obviously
not unique to privatization and must be faced in any reform of Social
Security that moves toward a prefunded system.
<bullet> Some countries have required workers to shift to a new
system of private accounts, 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 additional administrative
problems. But it can also help workers accept the change, particularly
older workers who have substantial accrued benefits.
<bullet> 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.
<bullet> Countries 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 annuities
would be mandatory, are also important. However, regulations also limit
an individual'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 establish private retirement accounts. The
United Kingdom allowed its workers to choose between the old pension
system and the new system. Australia based its system 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 accounts 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 contributions. To
encourage switching, the government compensated workers who did so with
``recognition bonds'' that would be paid into a worker's account at
retirement. Workers with sufficient 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 who have contributed to both
systems may choose to receive benefits from 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, people whose employer offered a pension
were allowed to opt out of part of the government'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. Unlike the other four countries, Australia
never had a Social Security-like system funded 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 will 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 decisions. 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 from sellers of the private accounts--including, apparently,
some fraud--some workers made poor decisions. The United Kingdom
responded to that problem with more careful regulation. Sellers of
private accounts now have to provide enough information 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 taxpayers, 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, therefore, that systems
that guarantee a minimum benefit would tend to have more regulation,
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 qualify) would have to rely on a basic pension that was not
means-tested. The basic pension 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 expected returns--
the worker reaps all the benefits if the gamble pays off and can rely
on the basic means-tested pension if it does not. Taxpayers in those
countries thus have a greater interest in ensuring that returns on the
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, Mexico, and Australia but not in the United Kingdom or
Argentina. One would therefore expect the United Kingdom and Argentina
to have little 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 ``prudent
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 accounts, 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 from the accounts at retirement and spending it, for
instance, by paying down their mortgage or buying a new house. Housing
receives special treatment under 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 government's costs for retirement. Australia's experience suggests
the importance of establishing 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 retirement.
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 different fee mechanisms
preclude any direct comparison, particularly since most of the reforms
are recent and the plans 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 funds charge for individual accounts in
the United States. In Chile, account fees and commissions are about 1
percent of the assets held in Chilean 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 \1/3\ 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
example, 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 individuals, which leads to relatively high sales costs and
little bargaining power for purchasers. 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 accounts. All
those factors increase total administrative costs. In Australia, by
contrast, 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).
Because of limited information on what the governments and workers
would have done had the pension systems not been reformed, estimating
the reforms' exact impact on national saving is difficult. In the
United Kingdom, the fiscal tightening associated 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
government saving probably offset only a portion of the increased
private saving. As a result, 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
percent 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 from the countries we studied is the
difficulty of funding a retirement system controlled by a national
government. Several of the countries 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
privatization 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 programs for retirees
will be strained. Other countries have undertaken, and the United
States is considering, reforms to those programs to help ensure future
benefits.
Judging the desirability of reform--indeed, judging the results of
other countries' reforms--depends 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 determines our ability to support a growing elderly
population with fewer workers. Increasing national saving should
enhance productivity and thereby economic growth. Increased saving
results from funding a heretofore unfunded system with real assets, not
with increases in government debt.
The second question addresses considerations of practicality, ease
and cost of administration, protection against severe losses, and the
extent of regulation.
Our comparisons of the five countries suggest that:
<bullet> None of the five countries successfully maintained
permanent prefunding of their government-run, defined benefit pension
system.
<bullet> Prefunding through privatization offers an opportunity to
increase national saving and economic growth.
<bullet> 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 administrative 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 consequences 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 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 reform.
2. These countries 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 transition 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 privatization 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 percentage 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.
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 something 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 bidding 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
watching carefully to see how that actually works.
So the lesson is that how you set up the individual account
system 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 administrative 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 almost 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 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 several 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
European 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 administrative costs in the Latin American systems,
and I think she has probably given accurate figures with
respect to the costs of managing 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 position 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 likely to get
burned either way, or you run the chance of being burned either
way.
Secondly, we want to make sure that the contributions are
handled 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, matching 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 carefully.
Third, we want to provide workers with choice. In the UK
system, although it is terribly expensive, it does do a good
job of providing workers with choice. The Latin American
systems don't do a very good job of providing workers with
choice because for a complex set of reasons they end up
producing a set of choices in which everybody is offering the
same portfolio, or almost the same portfolio. 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 unreasonable 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 annual 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
multiplying 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 workers 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
interference. 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 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 experience suggests that this is a dangerous
assumption. No country has yet successfully 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
details if they want to avoid another catastrophic health fiasco.
One of the most contentious elements of the current debate about
refinancing Social 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, benefit
predictability, rates of return to Social Security contributions, the
progressivity of the retirement income system, the behavior of future
political office holders, competing 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 creating mandatory individual accounts
must also focus on the practical aspects of how such accounts 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 belief 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 devised 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 objectives 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 objectives 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 keeping 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 decentralized individual
account systems currently in operation around the world. In the Latin
American systems, roughly one-quarter of the money that goes into the
funds is lost to administrative fees. In the U.K., administrative
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 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 operational.
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
respective 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 studied) 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 paychecks. 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 investments 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 contrast, 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 result
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. Australia 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
operating the system than many of the designers of systems in other
countries 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 country I know. Many countries require all
employers to file information electronically; those that do not require
electronic filing at least require employers 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 employers. It is
doubtful that we would adopt a system that relied on monthly reporting
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 annual 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 transferred 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 suffer from time lags
like these. In this respect, it is not possible to build a system of
individual accounts 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 portfolio of assets could give government undue influence over
the economy through the influence it could exert on corporate
management. Such concerns also helped convince the Swedes to adopt a
more decentralized approach, more or less as a replacement 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 mandates 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 accounts, it will have to also develop an administrative
strategy for organizing the system 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 likely
not be something that looks like today's 401(k) plans. Indeed, we will
probably have to create an entirely new institution to implement an
approach that had never before been tried anywhere 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 American 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
----------------------------------------------------------------------------------------------------------------
Latin
Plan America\1\ Switzerland Australia UK Sweden CSIS \2\
(Chile)
----------------------------------------------------------------------------------------------------------------
General Characteristics:
Is Participation Compulsory?.. Yes Yes Yes No Yes Yes
Contribution Rate............. 13% 7-18% 9% 4.8-5.8% 2.5% 2%
Budget Financing?............. Transition No No Partial No Partial
Who Collects?................. Pension fund Pension fund Pension fund Tax Tax Tax
authority authority authority
(IRS)
Who Remits?................... Employer Employer Employer Employer Employer Employer
Who Maintains Records?........ Pension fund Pension fund Pension fund Investment Government Government
mgr
Employer Reporting Frequency.. Monthly Monthly Monthly Annual Annual Annual
Investment Management:
Who Selects Investment Worker Social Employer Worker Worker Government
Manager?. Partners
Who Selects Investment Investment Investment Investment Worker Worker Government
Strategies?. 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 fund Worker Worker Government Government
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 Yes Yes No No No Implicitly
Company?.
----------------------------------------------------------------------------------------------------------------
\1\ 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
Australian, 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 mentality 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.
What is striking about the Australian system is that
political pressures are the reverse of those in the United
States. It was a Federal labor government, if you like it, a
democrat leaning government, that largely introduced the system
in 1987 and then reformed 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 version 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
superannuation which had been narrowly confined, if you like,
to a relatively 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
distinct pillars. The first pillar is a means tested, pay-as-
you-go, unfunded 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 voluntarily contributing today,
as in tomorrow, 4 percent of their salary on a voluntary basis
into these accounts. Largely these accounts exist on an
employer sponsored, defined contribution basis, but it is
important to note that individuals can seek and do purchase
individual superannuation retirement accounts from life
insurance 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
superannuation approach is that it doesn't involve government
control to any great extent with regard to investing monies on
behalf of individual account holders as seen possibly in Chile.
Except for the normal standards of regulation associated with
disclosure and prudential solvency, fierce and effective
competition between industry participants has effectively
driven down the fees and increased returns, 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 system matures.
Contrary to what is often argued in the United States, even
the small account holders in Australia can minimize charges and
maximize returns. For women and disadvantaged groups
especially, responsive superannuation accounts have developed
that take account 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 individual 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 protection or minimizing consumer protection
risks had to be enshrined 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 Kingdom, 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 development as has been described by Estelle
James with regard to the capital markets, I think it has been
very, very strong and very effective. 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 provisioning.
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
countries 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.
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 Australia, Chile and the United Kingdom. All
three countries have shared since the beginning of the 1980's a
political and economic will to ``grasp the thorny nettle of Social
Security reform.'' The successes and otherwise of these international
Social Security models provides a useful ``blueprint'' for the United
States in its ongoing discussions over the future of Social Security
reform. My testimony will largely concentrate 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 looking 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
realities of an increasingly aging ``baby boomer'' population in the
United States, will help solidify the need for individual retirement
accounts.
Australia
developing and nurturing an individual retirement system
For Australia, a country 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 alike
realized that the current Old Age Pension could not be sustained with
the rapid aging of the population. Simply 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 from 15 percent of the population, 2.9 million, to 23
percent by 2030, that is, 5 million people. The percentage aged over 85
is expected to more than double from around 2 percent to more than 5
percent amounting to 650,000 Australians over 85.''\1\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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
Federal Government began the process of ensuring 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
interaction 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 Australia's case,
more through coincidence and luck a popular Federal Government, through
trade union support was able to convey to the nation the impending
problems Australia would confront, if it did nothing about addressing
its aging population. This theme of the realization and admittance of a
future 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 living consistent with that experienced
whilst in the workforce.''\2\
---------------------------------------------------------------------------
\2\ Senate Select Committee on Superannuation: ``Safeguarding
Super,'' June 1992, p.7, Canberra, Australia.
---------------------------------------------------------------------------
For trade unions, which had strongly supported the election of a
Federal Labor government in 1983, increasing superannuation coverage
was seen as a major priority. 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
counterparts in the United Kingdom and Denmark but yet diametrically
opposes the position adopted by the AFL-CIO in the United States with
regard to Social Security reform. By 1986 circumstances were ideal for
the introduction of a widespread employment based retirement incomes
policy. Continuing wages pressure 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
employer as part of centralized 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 compulsory contributions of 3 percent to be made into
individual superannuation accounts, award (employment conditions)
superannuation was born. In the years that would proceed its actual
implementation in 1987, individual superannuation account balances
would gradually increase. The trade union movement and the Federal
Government 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
operations of superannuation funds was directed principally toward
industry funds. These funds generally gravitate around an occupation or
industry and are sponsored by employer and employee organizations.
Fundamentally they were established to receive the 3 percent mandated
award contribution. As at June 1996 there were 159 industry funds with
5.8 million accounts (35 percent of total accounts) and $17.6 billion
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 Australia'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 saving.
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:
<bullet> a major extension of superannuation coverage to employees
not currently covered by award superannuation;
<bullet> an efficient method of encouraging employers to comply
with their obligation to provide superannuation to employees; and
<bullet> 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.\3\
---------------------------------------------------------------------------
\3\ Senate Select Committee on Superannuation: ``Safeguarding
Super,'' June 1992, p.13, Canberra, Australia.
---------------------------------------------------------------------------
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 Australia's population and the need for compulsory savings for
retirement:
``Australia, unlike most other developed countries, meets its age
pension from current 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.
``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 savings.
``* * * 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 community that
something has to be done now to meet our future retirement needs.''\4\
---------------------------------------------------------------------------
\4\ The Hon John Dawkins, MP, Treasurer: ``Security in Retirement,
Planning for Tomorrow Today, 30 June 1992, pp1-2, Canberra, Australia.
---------------------------------------------------------------------------
The Superannuation Guarantee Charge Act 1992 requires all employees
to contribute to a complying superannuation fund at a level, which
increased from 3 percent 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
payroll. 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 obligations under Act the employer will not receive
favorable taxation treatment in regard to contributions made by them on
their employees' behalf.
At the present time the levy is currently at 7 percent which will
increase progressively 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 Howard. It had been the intention of the Australian
Labor Party, with trade union blessing 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 approximately 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 design and the overall rate of taxation applied.
Based on Andrew Dilnot's model developed at the Institute of Fiscal
Studies in London, Australia's taxation of superannuation can be
described as TTT. Taxation of contributions at a rate of 15 percent,
along with possible additional taxation of 15 percent for members'
contributions 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 diversity and adequacy of return that reflects strong
and vigorous competition among the financial services industry in
Australia. Through a trustee structure, superannuation funds are
managed in the most efficient and effective manner for members. 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 administrative 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 contained 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 accounts, Sylvester J. Schieber, Vice President, Watson
Wyatt Worldwide and John B. Shoven, Charles R. Schwab, Professor of
Economics, Stanford University made the following conclusions about
Australia's cost structure:
``The Association of Superannuation Funds of Australia estimates
that the average 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, administrative 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
Australia's as it is being phased in, as Australia's is now.'' \5\
---------------------------------------------------------------------------
\5\ Schieber SJ & Shoven JB: ``Administering a Cost Effective
National Program of Personal Security Accounts'' (Draft), NBER,
Cambridge MA, December 4, 1998, p.16.
---------------------------------------------------------------------------
Further evidence of the relatively low cost structure associated
with superannuation accounts in Australia is highlighted in Table 4
prepared by the Financial Section of the Australian Bureau of
Statistics, on behalf of Watson Wyatt Worldwide.
TABLE 2.--ADMINISTRATIVE COSTS AS A PERCENT OF ASSETS UNDER MANAGEMENT
IN AUSTRALIAN INDIVIDUAL ACCOUNT SUPERANNUATION FUNDS DURING 1996 AND
1997 \6\
------------------------------------------------------------------------
Number of members in 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 superannuation 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 decisions and strategies are developed solely
between 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 fund but rather through regulation stresses the need for
a sensible and sustainable investment strategy. Regulations 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 superannuation assets of A-$377 billion or US-$234.07 are
invested in equities & units in trust and overseas assets. Clearly this
level is deemed appropriate by government, trustees and superannuation
fund members alike. A concise overview of the Australian superannuation
industry as at December 1998, is provided in Table 3.
---------------------------------------------------------------------------
\6\ Ibid., p.17.
TABLE 3.--OVERVIEW OF THE AUSTRALIAN SUPERANNUATION INDUSTRY--DECEMBER 1998
----------------------------------------------------------------------------------------------------------------
Number of
Type of fund Total assets funds (June Members
(billions) 1998) (thousands)
----------------------------------------------------------------------------------------------------------------
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 management 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, annuity and allocated pension
vehicles are increasing in popularity.
I would like to now turn briefly to the mechanics associated with
selling, distribution and withdrawal of benefits from the
superannuation account. One of the reasons 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 information 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 consumer will enter
into in their life, effective disclosure should be provided to
encourage 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 Government will force employers to
offer choice of funds. Consequently effective consumer 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 offsetting the transitional risks linked with nurturing a
more fully funded retirement system. In a recently published chapter of
the book Consumer Protection of Financial Services, edited by Mr. Peter
Cartwright and published by Kluwer Law International, 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 delivered between 1995-1996 by Federal Government
agencies. To build a better understanding 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-$11 million in 1995 or the equivalent US-
$159 million on a per capita basis. When devising the elaborate and
integral public education 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 undergoing a period of reform for over twenty years. The UK
pension system is structured effectively in two tiers. The first is a
benefit provided by the state, which consists 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 government's state provision responsibilities. Currently
10.6 million individuals receive the benefit at a cost of
<brit-pound>32 billion (4.7 per cent of GDP). This compares favorably
with other major OECD countries, as noted in Table 4.
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 11.5 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 <brit-pound>66.75 a
week for a single pensioner, which equates to 15 per cent of average
earnings. An additional dependant addition of <brit-pound>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 and evolving private pension 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 comparatively generous with today'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 compulsory. 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 earning years formula, were especially advantageous to some
groups. Employees earning more than the Lower Earnings Limit (LEL) for
National Insurance Contributions (NICs) <brit-pound>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 <brit-pound>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 pension 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 all 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 payments 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 <brit-pound>24 billion in 2035, compared with a basic pension
cost in 1985 of about <brit-pound>15 billion.'' \7\
---------------------------------------------------------------------------
\7\ Budd, A. & Campbell, N.: ``The Roles of the Public and Private
Sectors in the UK Pension System''--1996, HMSO London, United Kingdom,
p.7.
---------------------------------------------------------------------------
A significant change to SERPS took place in the second half of the
1980's when the Social Security Act 1986 provided that from 1999
onwards, SERPS 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 SERPS would provide 20 percent of average
earnings over the whole working life of the individual. The current
cost of SERPS is only around two billion pounds per annum, due to
relatively few retired people having significant entitlements. By 2030
in contrast, these entitlements will have grown to its maturity point.
In summary SERPS payments in the future will progressively diminish
as a percentage 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 from 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 SERPS pension of only
10 percent of average male earnings.
contracting out of serps
As indicated previously, when SERPS 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 average lifetime earnings. This
rebate was initially set at 7 percent of earnings (between LEL and UEL
for National Insurance contributions). The current rate, applying 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 involved in pensions provisions
for the second tier. More likely was that advice provided by the
Treasury and Government 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
SERPS 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 pensions (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 declined 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 SERPS entitlements
and transfer from 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 female employees
had contracted out and were in personal pensions.
Concern in Treasury and other areas of Government was that these
new retirement vehicles were only being used to receive the rebate
provided through transferring out of SERPS. In 1991, 24 percent of
employees had contracted-out into personal pensions yet about three-
fifths of these personal pensions had been established simply to
receive the associated rebate and incentives provided by the
Government. Such a situation led or induced the mis-selling of
pensions, which has continued 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 from 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.
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. C.D. Daykin, the United Kingdom's Government Actuary in his report
to the European Commission.
`` Personal pensions at the minimum level for contracting-out are
unlikely to provide a very inadequate income in retirement. A major
challenge for education (and marketing) is, therefore, to persuade
people that they must make additional voluntary contributions and that
the responsibility for ensuring an adequate retirement 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 dependence 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
institutions. The preferred option of organized labour is the final
salary occupational pension scheme, if possible with full price
indexation of pensions, both in payment and in deferment.'' \8\
---------------------------------------------------------------------------
\8\ Daykin, C.D.: ``Pension Provision in Britain--Report on
Supplementary Pension Provision in the United Kingdom,'' 1994, HMSO,
London, United Kingdom.
---------------------------------------------------------------------------
Chile
Chile was the first South American country to move toward adopting
a mandatory, 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 functioned in Chile since 1924 and by
the mid 1970's symptoms of its long term weakness, in providing
benefits for recipients was increasingly becoming pronounced.
In effect the reforms meant that from May 1 1981, new workers were
eliminated from having the option of becoming a member of the complex
unfunded national defined 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
linkage between the amount of benefits and contributions to the system.
This flaw can often lead to irresponsibility and unaccountability, a
trend complicated by the fact that the impact of inappropriate 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 workers/retirees ratio of the old system. While the system's
ratio was 8.6 in 1960, it declined 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
structured to provide benefits that surpassed its ability to pay.'' \9\
---------------------------------------------------------------------------
\9\ Larrain, L.A.: ``A Bold Step in Chile's Reforms: Privatization
of the Pension System,'' Instituto Libertad y Desarrollo, Center for
International Private Enterprise, 1993, Santiago, Chile, p.2.
---------------------------------------------------------------------------
To assist workers in making contributions to the new defined
contribution accounts, the dictatorship mandated that employers raise
wages by 18 percent for existing workers and new labor force entrants.
Clearly the advantage of introducing such reforms under a military
dictatorship was highlighted in this aspect or transition of the
Chilean Social Security system. Today the first pillar of the Chilean
Social Security system can be described as a minimum benefit funded
from consolidated 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 of the system's
tiers. If workers do not accumulate enough in their defined
contribution accounts, they must forfeit their balance and receive the
minimum benefit.'' \10\
---------------------------------------------------------------------------
\10\ EBRI Notes: ``Chilean Social Security Reform as a Prototype
for Other Nations,'' EBRI, Vol.18 Number 8, August 1997, Washington,
United States, p.2.
---------------------------------------------------------------------------
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 will
occur where their pension produces a monthly income 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 from time to time.
Under the system all benefits are provided through the AFP (pension
fund administration 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
investments. The assessment of the likely benefits to be provided by
the annuity that is purchased from a life insurance company, via
accrued contributions was estimated by the Instituto Libertad y
Desarrollo:
``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 income, 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.'' \11\
---------------------------------------------------------------------------
\11\ Larrain, L.A.: ``A Bold Step in Chile's Reforms: Privatization
of the Pension System,'' Instituto Libertad y Desarrollo, Center for
International Private Enterprise, 1993, Santiago, Chile, p.6.
---------------------------------------------------------------------------
All covered or ``dependent'' workers must lodge 10 percent of their
monthly earnings 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 function of the AFP is also to provide survivors and
disability insurance, according to rules prescribed by the government.
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 affiliate to purchase the annuity from a life
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. Unlike 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
evaluating the possibilities for developing supplementary retirement
benefits.
The major drawbacks associated with the Chilean model is the
overall costs associated 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 industry, 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, withdrawal, account
statements.
In summary there is no doubt that the Chilean model has some
ambiguous characteristics which are seen to detract from the overall
system. The Chilean system's high administrative costs, relative to
other government systems, pose a large problem for the Superintendency.
The major historical statistics of the system are noted in Table 5.
TABLE 5.--CHILEAN PENSION FUND SYSTEM--MAJOR HISTORICAL STATISTICS, 1981-1996
----------------------------------------------------------------------------------------------------------------
Total Assets (MM Annual Number of
US$) Return Number of Affiliates Contributors
----------------------------------------------------------------------------------------------------------------
1981............................... 291.82 12.7 1,400,000 NA
1982............................... 919.50 26.5 1,440,000 1,060,000
1983............................... 1670.24 22.7 1,620,000 1,230,000
1984............................... 2177.54 2.9 1,930,353 1,360,000
1985............................... 3,042.00 13.4 2,283,830 1,558,194
1986............................... 3986.09 12.0 2,591,484 1,774,057
1987............................... 4,883.07 6.4 2,890,680 2,023,739
1988............................... 5954.12 4.8 3,183,002 2,167,568
1989............................... 7,358.64 6.7 3,470,845 2,267,622
1990............................... 9,758.30 17.7 3,739,542 2,642,757
1991............................... 13,810.67 28.6 4,109,184 2,486,813
1992............................... 15,399.57 4.0 4,434,795 2,695,580
1993............................... 19,788.07 16.7 4,708,840 2,792,118
1994............................... 23,925.72 17.8 5,014,444 2,879,637
1995............................... 25,433.17 (2.5) 5,320,913 2,961,928
1996............................... 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 return
requirements, and management fee limitations place an indirect cost on
the associated 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 percent more or less than the all AFP average. In
addition, AFP commissions are subject 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 domestic (Chilean) equity holding was 30
percent of the fund's portfolio, while the foreign equities cap was 10
percent (later lifted to 20 percent), and government bonds can
constitute no more than 45 percent of the AFP portfolio.'' \12\
---------------------------------------------------------------------------
\12\ Mitchell, O.S. & Barreto, F.A.: ``After Chile, What? Second-
Round Pension Reforms in Latin America,'' NBER, Cambridge, United
States, p. 4-5.
---------------------------------------------------------------------------
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 returns generated on
individual retirement accounts but moreover through the harnessing 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 infrastructure, all three countries 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.
Mr. Herger [presiding]. Thank you very much. I want to
thank each of our witnesses for, I believe, 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 anyway, 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 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 alleviate 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 mechanisms, 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 because it is sitting in some account some place waiting
to be processed.
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
centralized 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
period----
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 system 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.
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
desires 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 opting 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
investing 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 accounts. 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 handling that problem.
Mr. Harris. Can I just make an additional comment, just
quickly, on the experience of administrative costs and handling
of accounts in Australia? I think it is important to note that
Australia has 19.7 million individual accounts for a workforce
of about 9 million workers, and it is important to note that
people say that individual accounts can't operate but when I
hear these statements I cast mine back to when we were
regulators and developing the system. We envisaged that
companies would become specific administrative costs or
administrative companies. The Fidelities and the Vanguards in
the United States operate in Australia very effectively 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, administrative
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 administrative cost was incredibly high then, I think even
much higher percentage wise than what we are talking about
here.
We have about 6 minutes on a vote.
Mrs. Clayton. I will retain my questions.
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
before 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 accounts 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
report, 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 government 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.
Chairman Smith. I hear you saying it might reduce other
savings but probably there is going to be a net increase in
overall savings 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 Government 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 national 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 return, this might induce them to cut back on private
voluntary saving. On the other hand, in the U.S. people do so
little private voluntary 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 increase 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 tax
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 government would spend the surplus.
Those are all ways that you could have additional saving
relative to what you would have without the individual
accounts. But ultimately it has to mean less public or private
consumption if you want to have more saving.
Chairman Smith. I am going to take the liberty of being
somewhat 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 setting up here except staff, and then we will
be in recess for approximately 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 respect to the impact on the growth of financial markets,
and less strong with respect to whether savings would be
increased. Improving financial markets is a very important goal
the transition economies 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
Australia. 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 counterfactual. 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 increase 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 accounts 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
superannuation 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 saving more for their
retirement.
I think the challenge, though, that has been encountered in
Australia 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 services.
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 within Australia was relatively small and
limited. Today, it is very aggressive with major U.S. players,
Merrill Lynch and other providers, Vanguard and Fidelity,
entering the market and being very aggressive 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 nation traditionally that doesn't save a heck of
a lot of money, and more importantly what you are seeing is
that the government is relying increasingly on the
superannuation saving to do funding of infrastructure and
privatization programs.
Thank you.
Ms. James. I could just add that when I look at the various
proposals that are floating around in the U.S., and many of
them involve 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
proposals 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
statement you raise the issue of reduced political risk of
private accounts. 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 percentage, and it is the same dilemma that
politicians have confronted 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 return on average in 1997 was something like over 12
percent, about 12.2 percent; and market failure with regard to
individual retirement accounts has largely been minimized in
Australia through effective regulation.
So, in summary, I think what is, I think, relieving for an
Australian is to know that their retirement responsibility is
largely engaged with a financial firm, whether it be a life
insurance company or a mutual provider, rather than being tied
to the whims of political change possibly, as being confronted
by a Frenchman or somebody living in Germany, for example.
Chairman Smith. In terms of other countries using their
retirement pension program safety net, if you will, as a
welfare program, give me your analysis of what other countries
are doing in this regard.
Mr. Harris. Sure. I think with Australia what is important
is to make a distinction with the U.S. program--is that the
old-age pension or the first pillar is essentially a welfare
payment, that is, it is a flat rate 25 percent of that whole
total average weekly earnings, 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
Germany 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
percentage 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 extent that it becomes more of a welfare program.
Ms. James. Well, I think that you have to make a basic
distinction, basic choice, about whether you want to have one
contribution that does both the redistribution and the savings
part of old-age security or whether you want to split those
two; and many of the reforming 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
finance. 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 considered less distortionary because
you don't have a high tax levied 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 nobody 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 trying 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 somewhat more efficient by reducing the Social
Security benefit and having SSI come in as an offset to pick up
more of the income support 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
including 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
percentage 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 aspects of this. As people's superannuation or retirement
accounts are increasing, their eligibility for this old-age
benefit is declining.
So, in other words, the long-term projections by the
commonwealth treasury are that the actual cost of the public
spending associated with the old-age program will be largely
contained. It will increase slightly, but if they hadn't
brought in the mandated superannuation 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 industry 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
countries, 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
industry 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 importing workers. That gives you a very dramatic
example of how 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 floating 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 papering over the problem by moving a
lot of money around and hoping nobody noticed that its all a
shell game, and creating a guarantee 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
pensioners; 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 convinced 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 McHale 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 debate and
discussion about raising the retirement age or cutting benefits
or raising contribution rates. That is the unfortunate part of
this political 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
system 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,
Germany and France, are certainly in the grips of an enormous
problem, 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 reform 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 politicians that I would talk to in Australia, and
certainly in the United Kingdom, they feel benefit in that they
are seeing the system 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 future destiny in terms of
retirement, but at the same time don't avoid the requirement to
provide a basic safety net or basic requirement 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 theoretical structures. You need to be very careful in
that in analyzing those structures, because if you buy into one
of these, you are putting your name on how it is going to
operate.
And the experience around the world is that there are very
serious 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 designing 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 defined-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 savings 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 control 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 personal, purely personal, opinion is that if you have
centrally managed funds, it is impossible to totally insulate
it from political manipulation; 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
accounts, 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
information. 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.
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 Committee'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
response 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: Experiences Abroad (January 1999), has little
relevance to the United States--yet ironically, 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. Policymakers 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,
Argentina, and Mexico] differ considerably from those of the United
States' and ``comparisons 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 testimony, 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 nations indicated above. First,
those countries explicitly intended to create prefunded trust funds--
and actually began the process. Nevertheless, they ultimately failed in
their objective.\1\ Second, after they established their retirement
systems, the countries 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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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 current-law Social Security revenues will
exceed benefits until 2014, some observers believe that pressures will
inexorably mount to use the resulting Social Security surpluses 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 reform that the proposed transfers from the general
fund to the Social Security trust funds be recorded as outlays. That
proposed change in budgetary accounting would redefine--and reduce--the
size of the measured unified budget. In the Administration's view, the
redefinition would limit temptations to spend the surplus.
Congressional interest in establishing a Social Security ``lockbox''
arises from precisely the same concerns about the likely failure to
save the Social Security surpluses.
In that context, the CBPP critique raises an interesting issue that
I did not discuss 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 surpluses that accumulated in the
Social Security trust funds were spent on other items in the budget.
(Although that is literally 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 hypothesis, 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 apparent 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 Government 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 successfully prefunded their retirement systems, CBPP
does not provide them in its critique.
I hope this letter clarifies the issues noted above. Feel free 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 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 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 Social 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 response, 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 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 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 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 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 expenditures 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
approximately $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 studying the pressures on its
pay-as-you-go financing system 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 taxes. 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, Social Security stood on the brink of default. In response,
Congress passed the recommendations 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 expenditures 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. Anyway, 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 secretary/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.
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
testimony? 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/TREASURER, AARP; AND DAVID
KOITZ, CONGRESSIONAL RESEARCH 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 association. I live in a little town called Whitesboro,
Texas, 3,250 people, in north central Texas, and we have a lot
of Social Security recipients in that area.
AARP appreciates the opportunity to present its views
regarding the Social Security Trust Fund. We know there is
widespread confusion 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 benefits 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 additional debt. The government in times
of deficit utilizes the funds that it receives from selling
bonds to Social Security and other investors to help pay
expenses. As we begin to move toward budget surpluses, Social
Security's annual surplus would not be needed for 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 sufficient 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 IOUs. However, this is not so. Mr. Chairman, Chairman
Bill Archer stated in a November 20, 1998, interview with
AARP's Bulletin staff, and let me quote, he said, ``We are
talking about a Social 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 anything 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 Security first faces financial difficulty in
2014 or 2034 or whether the Trust Funds hold worthless IOUs.
Rather on the eve of the 21st century, what really counts is
that we make the necessary decisions to put Social Security on
sound financial footing for the future. This solution should
maintain the program's guiding principles, ensure income
adequacy, and achieve solvency in a fair and timely manner.
AARP looks forward to working with our elected officials on
a bipartisan basis to ensure Social Security's continuing role
as a foundation of income security for current, as well as
future, beneficiaries.
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 Security trust funds. Our own experience, supported by public
opinion polls, suggest that there is widespread confusion about the
size and use of the trust funds. As our elected officials broaden their
dialogue with the American people about the Social Security program and
its future, AARP hopes for improvement in the public's understanding 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 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, government 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 families 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 responsible
for their own and their family's financial security upon the
retirement, disability, or death of a breadwinner. The program provides
a near universal, defined 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 commitment 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
funds 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 Government had used the Social Security trust funds
for other purposes. (Only 13 percent did not). Similarly, this March, a
Rasmussen Research poll showed that by more than 3 in 1 (60 percent to
19 percent) respondents believed that if the government 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 reasons 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 remained 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 Security's history, the program
operated on a pay-as-you-go basis. Most revenue was immediately spent
to pay benefits with only a modest trust fund reserve to cushion
against an economic downturn. Starting in 1977, Social Security shifted
toward partial 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 indicate 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 estimated in1997. The
trust funds will continue taking in 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
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 interest obligations to all its current
bondholders, and it has never reneged on its debts. Starting in 2022,
incoming revenue and interest earnings will not fully cover benefits,
and the trust funds reserves will be gradually drawn down until they
are exhausted 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 from the view that the trust funds have been stolen and/or the
trust funds hold worthless IOUs. 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 securities, 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
expenditures 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 private 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 Security's government
bonds are worthless IOUs. 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 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 account.
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 securities, 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 financial 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 financial footing for the
future. Earlier remedial action is desirable to strengthen the fiscal
health of the program, improve public confidence, and maximize the
opportunity for individuals to adjust their plans.
The Association looks forward to participating on a bipartisan
basis with our nation'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 adequacy, and achieve
solvency in a fair and timely manner. Social Security must continue its
role as the foundation of lifetime income security for tomorrow's
beneficiaries.
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.
Perhaps 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 deposited into the Social Security Trust
Funds. They flow into depository accounts across the country
and always have. Along with many other forms of revenue, these
taxes become part of the operating cash pool or what is
commonly referred to as the U.S. Treasury. In effect, once
these taxes are received, they become indistinguishable 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 obligations 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 Social
Security benefits, the government will obtain resources
equivalent 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 IOU 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 certainly establishes claims against the
government 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.
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 financial 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 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 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 expenditures 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, 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 receipts,
including both payroll taxes and income taxes 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
period as a whole, the shortfall would be about 22 percent,
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 governmental 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 expenses, are 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 deposited into the
Social Security trust funds. They flow each day into thousands of
depository accounts maintained by the government with financial
institutions across the country. Along with many other forms of
revenues, these taxes become part of the government's operating cash
pool, or what is more commonly referred 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 Federal securities to the Social
Security trust funds--which basically involves a series of bookkeeping
entries by the Treasury Department--but the trust funds themselves do
not receive or hold money.\1\ 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.
---------------------------------------------------------------------------
\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 electronically.I74Does This Mean That the Government Borrows
Surplus Social Security Taxes?
---------------------------------------------------------------------------
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 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 obligations 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 Social Security benefits, the
government will obtain resources in the future equal to the value of
the securities.
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. government. 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
established 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 IOU 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 government 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 represent ``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 it 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 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 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 anything but Social Security 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 sufficient to
finance all Social Security costs through 2034, they estimate that the
system's tax revenues would fall below its expenditures in 2014. In
effect, at that point the government would be paying a portion of the
system's benefits with general funds, i.e., monies it would owe the
system then from prior Social Security surpluses. 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 receipts, 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 period as a whole, the shortfall would be about
22 percent, meaning that only 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'' 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 system 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
estimated 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 Transportation 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 payments
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 generation 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 percent. 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
spending.
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 surpluses, 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 entitlements? 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 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 statement 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 System 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 basically the same question that you asked me to address in
my testimony, only it occurs 20 years later. At that point,
based on the actuary's projections, we would have the revenues
to pay the equivalent 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 encourage 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.
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 suggesting 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
important. AARP is the leading senior organization. Their
reaction to go against politicians that come up with proposals,
make it so important 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 yielding?
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 people 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 concern, 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 develop 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 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''--it seems to me the exact opposite 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 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 Security's government bonds are worthless IOUs.''
Mr. Huff. Let me see if I can find it.
Mr. Toomey. Under Roman numeral IIB, 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
government bonds are worthless IOUs. 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 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
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 replace 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 account 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
conversations 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 depend on that and know that when we need
the money to pay the benefits that accrue, that we can draw on
that.
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 deposits 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:]
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
[The letter referred to follows:]
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, requesting 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 Federal government.
Section 201(f) of the Social Security Act states that ``The
interest on, and the proceeds 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 Insurance 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 borrower and the lender, correct?
Mr. Koitz. Sure.
Mr. Bentsen. So there is a legal obligation that exists. I
am trying 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 Security 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 marketable 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.
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
transaction where you go out and issue debt and you--under a
trust indenture, 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 withdrawals 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 oranges with the issues. The fact that the government has
given a commitment to Social Security is a form of asset for
Social Security, 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 python. 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 opinion, 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.
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
conditions for payment of Social Security are defined under
benefit payment 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 Department to make good on the benefit commitments
that are prescribed 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 benefits 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
payments of the Trust Funds--if we got to that point, the
Treasury Department would delay payments.
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 decide 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 taxation on those same people, going up to an 85-
percent rate. That money is credited to the Hospital Insurance
portion of the system.
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 income 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, taxes were increased or benefits cut before
it became time, Mr. Bentsen, to really 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, rather than paying back, rather than digging
deeper into the Trust Fund, we have increased taxes. In fact,
we have increased taxes something like 36 times 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 decision 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 increase 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 injurious than it would be if we wait several
years to make the fix.
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 smaller 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 financial 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 comment 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
actuaries 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 IOU 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 imposition 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 interest, 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
IOU to the Trust Fund?
Mr. Koitz. I am trying to distinguish between two levels.
One is how do you deal with the imbalance of the numbers that
the trustees have projected over the last 12 years? You could
deal with that simply by crediting the Trust Funds with that
amount of government 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 saying pouring into the general revenues a System that has
been a dedicated source of funds coming in. That is, in part,
what the administration 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
hearing 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 incapable 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 defaulted 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 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 billion. 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
important 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 committee.
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 generations 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.
Accomplishing 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
statement. When I was writing my first Social Security bill
that included some private investing back in 1994, there was a
tremendous misunderstanding of Social Security. When I met with
the AARP specialists, they understood the problem and the
consequences 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
memorandum, 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,
Congressional 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 eligibility 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-86-45,
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
Contributions Act (SECA), respectively, to the general fund of the
Treasury rather than to the OASDI Trust Funds.
Social Security benefits are paid from the general fund of the
Treasury. On the payment date, usually the third day of the month, a
portion of the Treasury securities 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 revenues 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 surplus 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 revenues 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. Sec. 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 Medicare (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 born
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 insolvent in 2032. Koitz, David, and Kollman, 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).
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 depend 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 raising 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 regarding 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. Sec. 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 disability insurance benefits for the
month preceding the month in which he attained
retirement age (as defined in section 216(1)(l)),
shall be entitled to an old age benefit for each month
* * *
Entitlement authority has been defined as:
[a]uthority to make payments (including loans and grants) for
which budget authority is not provided in advance by
appropriation acts to any person or government if, under the
provisions of the law containing such authority, the government
is obligated to make the payments to persons or governments who
meet the requirements established by law.
2 U.S.C. Sec. Sec. 622(9) and 651(c)(2)(C), quoted in General
Accounting Office, Accounting 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. Sec. 622(2), quoted in Glossary at
21.
The definition of entitlement authority emphasizes the obligatory
nature of benefit 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 Social Security
Act:
Broadly speaking, eligibility for benefits depends on
satisfying statutory conditions as to (1) employment in covered
employment or self-employment (see Sec. 210(a), 42 U.S.C.
Sec. 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 Sec. Sec. 213-215, 42 U.S.C. Sec. Sec. 413-415); and (3)
attainment of the retirement age (see Sec. 216(a), 42 U.S.C.
Sec. 416(a)). * * *
Of special importance in this case is the fact that
eligibility for benefits, and the amount 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 degree to which he was
called upon to support the system of taxation. It is apparent
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 benefits 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 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 awareness 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. Sec. 1104, 49 Stat. 648, 42 U.S.C. Sec. 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 developments, 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. Sec. 1304.
In addition to its power to adjust Social Security eligibility
requirements and revenues, 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 sufficient to meet benefit
payments. Section 201(a), 42 U.S.C. Sec. 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 general fund, but any amount borrowed must be repaid. It
appears to be stopgap authority designed to deal with temporary
conditions that may prevent timely investments in nonmarketable
government securities. Insolvency of the OASDI Trust Funds 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 between a beneficiary's legal right to receive the full
amount of an entitlement payment 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 subsequent funding options. * * *
[E]ntitlement 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 payment
but does not authorize the administering 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
payments, but such actions 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 borrowing 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 interest. 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 billion, $4.5 from the DI Trust
Fund and $9.0 billion from the HI Trust Fund, on December 31, 1982.
Recommendations of the National Commission 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 Richard S.
Schweiker, Secretary of Health and Human Services).
The Secretary added that, ``Since the borrowing authority has
expired [it expired on January 1, 1983], 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 extinguish 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, section 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 an 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 fund 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 the
Trust Funds and the amount being credited to them. If the Funds should
become insolvent, it appears that the Social Security Administration
would be able to pay only an amount of benefits equivalent to Social
Security receipts from 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.
Sec. 401(a) appropriates Social Security taxes. Section 201(d), 42
U.S.C. Sec. 401(d) makes interest on and proceeds from the sale or
redemption of government securities held by the OASDI Trust Funds a
part of the Funds 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 employee who violates the Act's
prohibitions subject to appropriate administrative discipline,
including, when circumstances warrant, suspension from duty without 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 difference. If the status
of the Social Security Trust Funds should allow payment of only 75
percent of benefits, for example, could a beneficiary sue for the
difference, the remaining 25 percent? If a beneficiary may file such a
suit, what would be 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 Security Act, 42 U.S.C. Sec. 405(g),
grants a right of judicial review to any individual, after a final
decision of the Commissioner of Social Security made following a
hearing to which he was a party, irrespective of the amount 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 judgment affirming, modifying, or reversing the decision of
the Commissioner. Findings of the Commissioner as to any fact, if
supported by substantial evidence, are conclusive. 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 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 benefit. Subsection (h)
of section 205 of the Social Security Act, 42 U.S.C. Sec. 405,
captioned ``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 Security,
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 Constitution, 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. Sec. 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, however, 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 Federal 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 Vincent'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 Social 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
beneficiary 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.(11 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 announced in the Reeside case where a court orders an expenditure
for a constitutional 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, appropriated 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 (f) of the
Social Security Act, 42 U.S.C. Sec. 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.
Sec. 401(h). Consequently, it appears that unless Congress changes the
law, a beneficiary would not be likely to obtain 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 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
payment is ``not otherwise provided for.'' 31 U.S.C. Sec. 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
defendant may have insufficient funds at the particular time
does not make the judgment appropriation available. 66 Comp.
Gen. 157, 160 (1986); Department of Energy Request to Use the
Judgment Fund for Settlement of Fernald Litigation, 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.
III 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 Social Security Act, 42 U.S.C.
Sec. 401(h), states that benefits shall be paid ``only'' from amounts
credited to the Trust Funds. As a result, it does not appear that a
beneficiary, 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 from the Judgment Fund.
Conclusion
This memorandum has addressed whether insolvency of the Social
Security Trust Funds may prevent a beneficiary from receiving the full
amount of benefits prescribed 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 amount 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 percent 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 challenge payment 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, section 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 amount sufficient to cover 75 percent of
benefits would represent the full amount that Congress has appropriated
and made available for benefit 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 Funds.
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
appear.
The next meeting of the Task Force will be next Tuesday,
and the subject matter will be investments, the cost of those
investments, 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 annuities 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 Lynn and I and the other Members to go vote.
It seems to me public understanding is one of the keys to
successful 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 encourages 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 protectionism from seniors, from near retirees,
certainly from young people that already have expressed their
concern and skepticism of whether 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 investment 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 representative from TIAA-CREF will tell us about the
life annuity program used for investors.
Steve Bodurtha is in charge of Merrill Lynch's Customized
Investment Group. He has 15 years of Wall Street experience in
applying financial innovation to investment products. He has
pioneered 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
organization and pension system for workers in U.S. educational
and research institutions. Dr. Warshawsky has authored numerous
publications on pensions and retiree health benefit plans,
individual annuities 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
columnist for the Washington Post and host of the
TechnoPolitics weekly PBS program on science and public policy.
Mr. Glassman's articles have appeared in the New York Times,
the Wall Street Journal, Forbes, and many other publications.
Chairman Smith. And Lynn, would you have an opening
comment?
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
objection, 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 WALLACE-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 because of my knowledge of and experience in developing
secure financial products that protect principal and provide
investors the opportunity for significant growth potential. My
testimony is limited to that subject.
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 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 financial goals.
To help with this problem, we at Merrill Lynch have
pioneered the concept of protected growth investing, which
combines participation 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 listed, protected growth assets have been issued to
meet varying investor needs. While each has its own unique set
of terms, most protected growth assets share certain common
features. When you buy a protected growth asset, you are
purchasing an asset at an offering price that typically ranges
between $10 and $1,000.
Protected growth investors will receive all or
substantially all of their initial principal at maturity.
Protected growth assets generally 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 institutions 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
Exchange. Protected growth assets such as equity link deposits
and annuities generally will not be exchange listed, however.
An illustration may provide a better idea of how protected
growth investing works. I will use the example of one of our
protected growth investment products called a MITTS for
marketed index target-term security.
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 appreciation 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
example, 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
supplemental payment equal to 100 percent of the index's price
appreciation, if any, between the original offering date and
the maturity date. Let's look at three scenarios to understand
what an investor will earn when they purchase such an
investment. If the stock index is up, for example, 50 percent
at maturity, an investor's return at maturity is the $10
principal amount plus a $5 supplemental payment.
The total final payment at maturity is $15. If the index is
unchanged over the life of the investment, an investor's return
at maturity is again the $10 principal amount plus no
supplemental payment. As a result, the total final payment at
maturity is $10. And if the index is down, for example, 50
percent at maturity, an investor's return at maturity will be
$10 principal plus no supplemental payment. The total final
payment in that case is $10 simply reflecting 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 underlying 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 participation rate of 100
percent. It is possible that some of these investments 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, perhaps 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 investor 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
submitted 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 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 in the context of Social
Security reform. Rather, I have been invited because of my knowledge
of, and experience in, developing secure financial products that
protect principal and provide investors the opportunity for significant
growth potential. My testimony is limited to that subject.
We at Merrill Lynch applaud the Task Force's ongoing efforts to
meet the challenge of reforming Social Security in a manner that
guarantees the long-term solvency 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.
Pursuing Investment Growth While Limiting Risk
Growth-oriented investments, such as stocks, historically have
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 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 financial goals.
To help with this problem, Merrill Lynch has pioneered Protected
Growth<SUP>SM</SUP> investing, which combines participation in the
long-term appreciation potential of growth assets, such as stocks, with
protection of principal.
The purpose of Protected Growth<SUP>SM</SUP> investing is simple:
to allow the pursuit of growth with limited risk.
The Advantages of Protected Growth<SUP>SM</SUP> Investing
Protected Growth<SUP>SM</SUP> assets are financial instruments with
features of both stocks and bonds. The benefits of Protected
Growth<SUP>SM</SUP> assets include protection of principal, growth
potential of stocks, opportunity for diversification, low minimum
investment and liquidity.
Protected Growth<SUP>SM</SUP> assets promise to repay all or
substantially all of their principal amount at maturity, even in the
event of dramatic stock market price declines. The ability of a
Protected Growth<SUP>SM</SUP> 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 referred to as ``market
measures.''
diversification
Because Protected Growth<SUP>SM</SUP> 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 equities.
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 Lynch's Protected Growth<SUP>SM</SUP> 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 Growth<SUP>SM</SUP> assets, as well as monitor daily price
quotations published in the financial pages of major newspapers.
Protected Growth<SUP>SM</SUP> Assets Key Features
In recent years, an array of exchange-listed Protected
Growth<SUP>SM</SUP> assets have been issued to meet varying investor
needs. While each has its own unique set of terms, most Protected
Growth<SUP>SM</SUP> assets share certain common features.
When you buy a Protected Growth<SUP>SM</SUP> asset, you are
purchasing an asset at an offering price that typically ranges between
$10 and $1,000.
Protected Growth<SUP>SM</SUP> investors will receive all or
substantially all of their initial principal at maturity--making
principal protection a key feature of Protected Growth<SUP>SM</SUP>
investing.
Protected Growth<SUP>SM</SUP> assets generally are structured as
debt obligations or bank deposits. Some, however, may be in the form of
a fund, or annuity. Because Protected Growth<SUP>SM</SUP> assets are
issued or backed by financial institutions or other companies, the
payment of principal at maturity and the return, if any, depend upon
such issuers' creditworthiness.
Protected Growth<SUP>SM</SUP> investing typically offers the
opportunity to participate in the growth of a particular market
measure. This participation is usually stated in percentage terms and
is referred to as a ``participation rate.'' As an example, a 100
percent 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 until the market measure has appreciated above a specific
minimum level, sometimes referred to as a ``minimum threshold.'' Also,
participation rates may specify a maximum return level or ``ceiling.''
Protected Growth<SUP>SM</SUP> assets usually are offered with a
final maturity date. Maturities can range from one to 5 years or more.
Protected Growth<SUP>SM</SUP> assets typically do not make regular
interest or dividend payments to investors, and purchasing a Protected
Growth<SUP>SM</SUP> asset does not constitute ownership of the
underlying securities or index comprising the market measure. As a
rule, the market measure to which Protected Growth<SUP>SM</SUP> assets
are linked is specified at the time they are originally issued.
Most of Merrill Lynch's Protected Growth<SUP>SM</SUP> 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<SUP>SM</SUP>
assets such as equity-linked deposits and annuities generally will not
be exchange-listed, however.
Protected Growth<SUP>SM</SUP> Investing Hypothetical Example
An illustration may provide a better idea of how Protected
Growth<SUP>SM</SUP> 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 hypothetical 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 supplemental 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 Up--ABC Index is up 50 percent at maturity. An investor's
return at maturity is the $10 principal plus a $5 supplemental payment.
The total final payment is $15.
2. Index Unchanged--ABC Index is unchanged at maturity. An
investor's return at maturity is the $10 principal plus no supplemental
payment. The total final payment 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
payment. The total final payment is $10.
Reasons To Consider Protected Growth<SUP>SM</SUP> Investing
Protected Growth<SUP>SM</SUP> investing allows investors to
participate in growth opportunities that otherwise may be too volatile
for their risk tolerance. The result is preservation 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 buying stocks or other
investments, Protected Growth<SUP>SM</SUP> 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<SUP>SM</SUP> assets to maintain appreciation
potential while limiting downside exposure as the child's college 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 market gains by reducing their existing direct equity
holdings and using Protected Growth<SUP>SM</SUP> investing to continue
participation in potential future market advances.
benefit from index-based investing
Even professional money managers may find it difficult to
outperform market indices consistently over the long term. Committing a
portion of assets to index-linked Protected Growth<SUP>SM</SUP>
instruments can be a sensible strategy, particularly in volatile
markets when stock selection can be more challenging.
enhance investment performance
Protected Growth<SUP>SM</SUP> investing may be an effective method
of boosting potential returns on money investors may have idle in low-
earning bank accounts and money market investments without greatly
increasing their risk. Protected Growth<SUP>SM</SUP> investing 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 from the long-term growth potential of stocks. The principal
protection available with Protected Growth<SUP>SM</SUP> investing can
make it easier to stay with a well-planned investment strategy 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<SUP>SM</SUP>
investing may offer a sound choice.
Other Important Features
Protected Growth<SUP>SM</SUP> investing was created for investors
willing to accept a specified level of participation in a growth
opportunity in exchange for a known degree of principal risk. Investors
who are willing to assume greater risk may want to invest directly into
stocks and other growth investments for potentially higher long-term
returns. In addition, Protected Growth<SUP>SM</SUP> Investing usually
is not appropriate for investors seeking current income.
no dividends participation or voting rights
Protected Growth<SUP>SM</SUP> 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<SUP>SM</SUP>
assets do not convey any voting rights.
different terms and features
Each Protected Growth<SUP>SM</SUP> instrument has its own
particular structure. While most pay only at maturity, some make annual
payments or provide a minimum yield on 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
Growth<SUP>SM</SUP> assets are offered with original maturities of one
to 5 years or more.
creditworthiness of issuer
The timely payment of principal at maturity and the market-linked
return, if any, depend on the issuer's or backing institution's ability
to pay. Protected Growth<SUP>SM</SUP> assets typically are backed by
highly creditworthy financial institutions or companies, most of which
are rated A or better. Keep in mind that Protected Growth<SUP>SM</SUP>
notes and deposits are not mutual fund investments, and investors have
no ownership rights in the underlying market measure.
liquidity
While Protected Growth<SUP>SM</SUP> 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 until maturity,
their principal is protected according to the terms of the issue.
market price fluctuations
Remember that Protected Growth<SUP>SM</SUP> 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 Growth<SUP>SM</SUP> issue.
understanding the principal protection level
If investors purchase a Protected Growth<SUP>SM</SUP> 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 will 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, giving the investor a
minimum return of $2 per unit.
taxation
Investors should consider the tax consequences of Protected
Growth<SUP>SM</SUP> investing. For Protected Growth<SUP>SM</SUP> notes
or deposits issued after August 12, 1996, any 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 annually on imputed income, even though the return,
if any, is typically paid at maturity.
opportunity cost
Investors who purchase Protected Growth<SUP>SM</SUP> assets
typically give up interest or dividend payments. Protected
Growth<SUP>SM</SUP> assets may protect only some or all of the original
investment and should be purchased by investors who do not require
current 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 members
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 Actuary, in 1998, a woman age 62 could expect to live to
age 84 while a 62-year-old man could expect to live 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 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
until 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 Security, 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 scientists. 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. The mandatory
provision of life annuities is judged to be necessary because
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
actuaries and economists. This problem occurs if individuals
with higher 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 widespread, insurance companies will
price annuities with the truncated market in mind, and life
annuities would be priced less attractively. 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 financial products. Marketing costs which can
include massive advertising 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
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 index bonds by
the Treasury and other borrowers and the nascent formation of
derivatives markets 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, again referring to TIAA-CREF's experience, have also
devised several types of annuities that provide for increases
in income as the annuitant 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 pension system, providing defined contribution
pension plans to almost 2 million workers 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
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. 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 research 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 traditional 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 income 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 could expect to live 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 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. 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 program, 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 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 voluntarily through the private market. These
arguments maintain that there are problems in the operation of a
voluntary 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 necessary
because it is thought that ultimately public support programs will be
widely utilized, and to maintain the dignity of the aged.
The second problem that a mandatory system is suggested to solve is
adverse selection. This problem occurs if individuals with higher than
average mortality 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 expectancy individuals, insurance companies
will price annuities with a truncated market in mind, and life
annuities would be priced less attractively to those expecting
relatively 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. Marketing 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
inflation indexation. Unlike Social Security since 1972, individuals
covered exclusively by fixed annuities purchased in the private market
would have been exposed to unexpected increases in the rate of
inflation.
Before I introduce some evidence on these problems, a general
consideration can be posed against these arguments. 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
quickly to new ideas and financial technologies. In my papers, I have
devoted several sections 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 innovations 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 because they take lump-
sum or periodic distributions from their retirement plans and fail to
purchase life annuities as they age, individuals use up their financial
resources and rely solely on public retirement income programs.
Similarly, because individuals 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 premium 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 employer sponsors of TIAA-CREF plans
historically required annuitization of all assets accumulated through
their pension plans, and TIAA-CREF still recommends annuitization as
appropriate for most of its participants.
On the question of whether adverse selection is a problem, there is
evidence from studies which I have authored or co-authored that there
is a difference in the mortality experience of the general population
and annuity purchasers and that the difference imposes a not
insignificant cost on individual annuities.
As I mentioned earlier, 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 and issue inflation-sensitive life annuities. For
example, CREF recently introduced an inflation-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.
STATEMENT OF JAMES K. GLASSMAN
Mr. Glassman. Thank you, Mr. Chairman. Mr. Chairman,
Congresswoman Rivers, and members of the Task Force, I am
honored that you have asked me to testify here today on this
very important subject.
My name is James Glassman. I am the DeWitt Wallace-Reader's
Digest Fellow in Communications at the American Enterprise
Institute 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
reform Social Security. I am a strong supporter of allowing all
Americans 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 participate 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 opportunity to
participate is that many of the dollars that could be saved or
could have gone into stock market investing have been diverted
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 insulate 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 investment is entirely risk-free, not even Treasury bonds.
Treasury bonds can lose their value, lose their buying 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 insulation 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 making 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 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 statistics.
I know that Roger Ibbotson has testified in front of this
committee. From 1925 to 1997, an investment of $1 in large
company stocks rose to $1,828 while investment of $1 in long-
term government bonds rose to just $39. So it is important that
people are invested 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 investors seem to be aware of them. Paine
Webber, Solomon Smith Barney, Lehman Brothers and other firms
also provide similar vehicles. The point about MITTS is very
simple. There is no downside risk or very, very little downside
risk. It is kind of like 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 Standard &
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
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 downside in a trade-off
for trimming slightly the gains on the upside. It is a deal
that many Americans would gladly accept.
In summary, Mr. Chairman, and members of the Task Force,
complete insulation from risk is impossible but the kind of
risk reduction 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 Communications 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
will be published by Times Books this September.
You asked that I specifically address the question of how to
insulate personal retirement account holders from losses and provide
adequate retirement income--when and if the current Social Security
system changes from a defined-benefit system of government-guaranteed
annuities to a defined-contribution system in which individuals own
their own retirement accounts and are allowed broad choice in deciding
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 found 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 Government 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 secure 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 bills, 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 annually, roughly twice the returns 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 especially 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 retirement 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 additional 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 excellent 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 difference of
$158,000.
But there are interesting alternative equity investments that
provide guarantees against 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 launched 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.
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 public 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 investment.
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 increase 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
return 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 contingent, 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 limit of $100,000.
Second, an investor gets no dividends from the index. Even in the
current 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.
Third, 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 receive 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 rolling 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 will 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 downside in a tradeoff
for trimming gains on the upside. It is a deal that many will gladly
accept.
In summary, complete insulation from risk is impossible, but the
kind of risk reduction 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 Lynch in this role is functioning a little bit
like an insurance 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 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 trading, 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
generally 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 return on the index stocks. Roger Ibbotson said and I
didn't quite understand it, Mr. Glassman, but I think he said
that a 20-year period 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 market 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 deciding how we make Social Security secure.
Some have suggested government should control the
investments. 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 introduced 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 limitation on
investments.
Can I get each of your reactions to your feelings or
thoughts on what kind of capital investments should be
incorporated in Social Security reform?
Mr. Glassman. Well, I can answer that. First of all, I
think that--unfortunately I think investments have to be
mandatory and I think people must be fully invested during the
entire period, until whenever their retirement starts. I don't
think that the government should mandate particular
investments. I think it is perfectly reasonable to have some
kind of requirements for investment companies 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 fund, 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 are involved 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--particularly 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 truly 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 extent 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 ability 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
questions. 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
addressing in my comments are life annuities in terms of the
payout phase. In other words, they are not what is typically
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
depends. It depends on where the annuity comes from, whether it
is 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 represents 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 insurance products and I think it
is comparable.
Ms. Rivers. 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 yields as the basis
for determining whether or not moving to a privatized system is
better than having the current system.
What are the yields 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
investments that I am involved in is that they are really
contractual commitments. 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 minimum in 5 years' time, plus 80 percent of whatever
the stock market'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.
Ms. Rivers. When you made the analogy of--you made an
analogy 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 overall 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 type 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 some 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 government 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 technology or the
capability of this--that this type of investment 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
fascinating 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
Security are receiving now, which isn't a lot, which really is
a piddly little when you look at it for what they were putting
into it, but somehow transferring over into something else that
would be actuarially 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,
somehow guarantee it at the level that they would be receiving
from Social 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 determined 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 International 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.
Chairman.
Chairman Smith. We will start a second round. Maybe
following up, Wally, on how we can devise a safety net. A
safety net is politically very popular because if you end up
not having anything, then you would be more likely to go on
Medicaid or other more desperate welfare programs.
The proposal that we are developing in our bill looking for
a safety 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 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 discretion. 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 accounts, that
may solve a lot of the problems.
Chairman Smith. The current Social Security offers
inflation indexing 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
program, the inflation index bonds that itself offers, unfolds.
One of the MITTS that we offered combines a degree of inflation
protection 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.
Currently in the United States there are no, strictly speaking,
true inflation indexed annuities. However, in the United
Kingdom there are such products.
Of course, in the United Kingdom they have had much more
experience with inflation indexed bonds issued both by the
Government, 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.
So I think theoretically, and more than theoretically, it
certainly is technologically possible. Our company, as I
mentioned in my testimony, 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 possibility 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
optimistic 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
enormous deficiencies simply because it costs something in the
transition stage is a good reason to keep it.
It is true of almost every Federal program. It was true,
for example, of the Freedom to Farm Act, that if you want to
make a change and there are people benefiting from the current
system, then unfortunately 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
absolutely would not deny that it is expensive. Well, it
appears to be expensive, at any rate. But you said it exactly
right in your question. 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 something that is real and
tangible. As you know, there have been lots of proposals
including one from my colleague at the American Enterprise
Institute, Carolyn Weaver, who was part of the Social Security
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 situation 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 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 unfunded 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 dollar 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 survivors 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
actually gave some testimony to the Senate Aging Committee in
February 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 annuities be on a unisex basis. And
that would strike me as to be somewhat 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 safety net currently is not just Social Security
benefits upon retirement, it is disability if one becomes
injured during their preretirement 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 invest? I guess that I am trying to put
this whole package together. Low-risk investment plus survivors
benefits plus disability 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 analyst looks only at the portion of payroll taxes that
involve the retirement portion of Social Security. Sloppy
people may do the other, but----
Ms. Rivers. There are a lot of sloppy people on Capitol
Hill.
Mr. Glassman. Life insurance, survivorship benefits, and
disability 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 construct a life insurance policy where you
wouldn't have to make very much in the way of premium payments.
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
between an annuity and a no-risk investment. Should we consider
annuities as part of the investment guidelines? Right now, in
my draft legislation, we say that if a person wants to retire
at an earlier 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 themselves don't necessarily have to be guaranteed.
As I indicated before, that you can have such a thing as a
variable annuity where the payments reflect the underlying
investment, 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 return based on the
guarantee of the insurance company that is underwriting the
annuity. That is an alternative investment as well. It is more
conservative, the returns are lower, but they are guaranteed by
the insurance company.
Chairman Smith. So roughly, if you are looking at a fixed
annuity or variable annuity or a guarantee no-loss provision
under the programs that Merrill Lynch has developed compared to
an indexed 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
conditions. 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 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 investor, 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
Government'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
institutions. 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 future 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
investment 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 competitiveness. One issue as we
significantly expand investment opportunities, possibly through
Social Security reform, is that the more flexibility 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
encourage 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 others.
I think there is a tradition in the private sector and the
public sector with the administration of public pension funds
for establishing minimum standards of investment suitability.
Creditworthiness, 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 anything 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 individual 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 appropriateness. 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 introduces markets which they have never had
before. This is certainly 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 limit it in ways that I think make people feel
much more comfortable 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 higher 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 economic 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
certainly 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 participating in
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 participated, 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
perspective, 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
limiting of risk. Whether you choose to accept the Merrill
Lynch formula for delivering that, the point is the financial
markets have the capability 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
discussion 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 security.
Certainly, reforms in Social Security are one approach, but
then there are also other approaches which include widening the
availability of individual retirement accounts and a pension
reform proposal 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.
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 objection that statement will go into the record.
Let me say that I think today's meeting on Social Security
disability program is important. DI is too often overlooked as
we develop 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 workers in 1998, plus another 1.6 million that
were family members of those disabled in 1998.
Social Security disability benefits are becoming a more
significant part of the cost of Social Security. Reforms that
restore solvency 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 expenses 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 disability
trust fund will be depleted at that time.
It was interesting that Federal Reserve Chairman Alan
Greenspan has told this Task Force that the main reason that
the actuarial estimates of the 1983 changes that were costed
out to keep Social Security solvent for the next 75 years were
wrong is the increased 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
insurance program.
Lynn, I was just saying 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
program. I have asked today's speakers to help us understand
the details of the disability program. This way, Congress can
design reforms that keep the disability program strong and
protect its beneficiaries.
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
overlooked, 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 Commissioner for Disability and Income Assistance.
Marty Ford is Assistant 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 GOVERNMENTAL
AFFAIRS FOR ARCUS, ON BEHALF OF THE CONSORTIUM FOR CITIZENS
WITH DISABILITIES
Ms. Ford. 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.
We believe that the title II Old Age, Survivors and
Disability Insurance programs are insurance programs, not
investment programs, 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 insure dependents and survivors of workers who become
disabled, retire or die.
In fact, more than one-third of all Social Security benefit
payments 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 benefits from the retirement and survivors programs
based on the work history of their parents.
The definition of disability is uniform across these
programs and across the country. Administration of the programs
includes determination 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 programs 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 building private accounts would be devastating
for people with disabilities, and we oppose them.
We believe that Social Security is a system that works. 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 programs
of disability, survivors, and retirement, guarantees benefits
with inflation adjustments, 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 program. In addition, 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 significantly 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 proposals that could have a negative impact on people
with disabilities. 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 and 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 individual retirement accounts. Third, issues of
privatization of retirement and survivors only and the use of
annuities which may seriously affect people who are adult
disabled children and need to depend on their parents' work
history and earnings, perhaps well beyond their parents'
lifetime.
The impact of these and other components must be judged in
combination with all other components of any plan under
discussion. 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 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 budgetary 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
Disabilities
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.
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.
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 families 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 successful domestic government program, providing economic
protections for people of all ages. It works because it speaks to a
universal need to address family uncertainties 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 multiple
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 insure against disability
limiting a person's ability to work; and they insure dependents 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 Administration, 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 retirement age.
People with disabilities benefit from the Title II trust funds
under several categories 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
retirees; 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 16.7 million people who are non-retirees, including almost 4.7
million disabled workers, nearly 1.5 million 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
dependents. For the average wage earner with a family, Social Security
insurance benefits are equivalent to a $300,000 life insurance policy
or a $200,000 disability insurance policy.
Beneficiaries with disabilities depend on Social Security for a
significant proportion of their income. Data from the Census Bureau's
Current Population Survey indicates that, in 1994, the poverty rate for
working age adults with disabilities was 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 harmful 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 currently insured against in Title II from the Federal
Government back to the individual. This could have a devastating impact
on people with disabilities and their families 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 from 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 benefits with inflation
adjustments; and preserves the Social Security trust funds to meet the
needs of current and future beneficiaries. Certainly, changes will be
necessary 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 privatization 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 elements
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
proposals resulting in cuts of 24 to 30 percent. Reducing the PIA would
force more people with disabilities further into poverty.
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 retirement benefits. At this point, disabled
workers could find their individual accounts are inadequate because the
proceeds from individual accounts would necessarily 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,
earnings 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 minimal 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, surviving spouses, and former spouses. Under
individual account proposals, those accounts 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
eligibility 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. Essentially, 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 people
with disabilities may experience prior to eligibility for disability
benefits would have 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 adjusted 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 reduction in the COLA would
result in a 20 percent reduction in benefits after 20 years. For people
with disabilities who must rely on benefits from 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 (NRA)--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 reduction 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 program)
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 protection alone. There would be no intended direct
effect on the disability insurance program. However, the systems are
not so easily separable: those adult disabled children 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 themselves dependent on
the private accounts for any length of time before death) and 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 account proceeds (as some plans require), no funds would be
available for the surviving 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 system is unknown; currently, there is no
insurance comparable to Social Security disability benefits which
includes indexing for inflation and coverage of family members. In
addition, as the disability community well knows, disability insurance
(or for that matter, health or other insurance) is essentially non-
existent for most people 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 protection
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 everyone. 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
cognitive impairments, such as mental retardation, or mental illness,
when the impairment creates substantial barriers to the individual's
ability to make wise and profitable decisions over a lifetime. In many
cases, the person may be unable to make any financially significant
decisions. Privatization removes the shared-risk protection of social
insurance and places these individuals at substantial personal risk.
Again, we strongly recommend that Congress 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 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 Committee hearing to request a beneficiary
impact statement from 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 families 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 analysis and
solution development.
Chairman Smith. Without objection, the full written
testimony of all the witnesses will be entered into the record.
Commissioner Ross.
STATEMENT OF JANE ROSS, DEPUTY COMMISSIONER FOR POLICY, SOCIAL
SECURITY ADMINISTRATION; ACCOMPANIED 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 proceeding to do that.
The Social Security disability insurance program is truly
irreplaceable 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 individuals 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 disabled enough to draw out
benefits.
Last year, Social Security paid benefits to almost 5
million severely disabled workers and about 2 million members
of their families. 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
program 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 payments 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 disabled 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
Social Security disability program is financed by a payroll tax
of 1.7 percent on covered earnings, half paid by the employer
and half by 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
disability 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 disabled 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 employers 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
insurance is provided.
It is also important to note that Workers' Compensation
programs integrate with Social Security if the worker is
sufficiently severely disabled for a lengthy period of time and
there is a maximum amount of combined benefits, which is 80
percent of predisability earnings.
Then moving from the Workers' Compensation to private
disability plans, there are generally two categories of private
disability insurance, 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 replace about half to three-quarters of earnings
and last for about 6 months.
A somewhat smaller percentage of American workers have
employer sponsored long-term disability insurance. However,
employees 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
provided by employers are also available. They tend to be plans
that are purchased only by high wage earners or self-employed
individuals. So this private long-term disability most times
has a broader definition of disability than we have in the
Social Security disability 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 definition.
One final point I would like to make: 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 of becoming disabled or persons
whose income stream is not consistent over time would be deemed
unlikely to be insurable by the providers of this private
disability insurance. In this environment, it is highly
unlikely that a market for private disability 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 beginning of my testimony: Can private disability insurance
provide the same level of protection to all workers at the same
low cost of Social 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
insurance program. Private insurers are selective, excluding
those individuals 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 premiums, 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
purpose today by providing additional financial protection to
those who can afford it and who qualify, but only Social
Security provides coverage 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 discuss 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
compensation 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
dependents. 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 general, the SSDI program
provides an extra measure of protection for lower-wage workers. Due to
the progressive nature of the program, the benefits formula replaces 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 severely 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
workers, 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 extremely important. This is
especially true for young families often struggling to afford adequate
private insurance. For a young, married, average worker with two
children, Social Security is the equivalent of a $233,000 disability
income insurance policy. 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 individuals who have been eligible for disability benefits for
24 months. These benefits provide health care coverage that to many
SSDI beneficiaries is simply irreplaceable, 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
substantial 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 disability. 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 responsible 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 disability
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
because of the cost of obtaining medical evidence and the need for a
thorough evaluation by a physician or other highly trained professional
reviewer.
While the Social Security eligibility criteria are very strict, we
also have a very structured system to ensure that applicants' rights
are protected and that those applicants 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 administrative 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 reconsideration 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 vocational 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 beneficiaries 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 introducing the concept of
consumer choice in obtaining employment services. Similar legislation
overwhelmingly passed in the House in 1998 and has now evolved into the
Work Incentives Improvements Act that passed the Senate by a vote of 99
to 0 on June 16, 1999. The President's budget provides full funding
support for this legislation.
I would like to turn now to a discussion of the range of workers
compensation and private disability benefits available.
Workers Compensation
While SSDI covers workers with severe disabilities regardless of
how the disability was developed, the workers' compensation (WC) system
is designed to provide reimbursement for lost wages and medical
expenses for workers who become disabled 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
compensation 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
weekly payments that are based on the degree of disability sustained as
a result of the injury, and such medical care as the nature of the
injury or process of recovery may require. Benefit payments totaled
$42.6 billion in 1996.
Workers compensation is not a stand-alone system. It is the first
payor, but integrates with Social Security. In most States if workers
go on the Social Security disability rolls, the Social Security payment
is reduced, so that the combined Social Security/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 tailored to integrate with it.
There are many different types of private disability insurance 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 employer-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 impairments as well as
pregnancy. Employer-sponsored long-term disability plans usually 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 requires 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 entire 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 return 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 disability plans and Social Security. Ideally, employer sponsored
long-term disability plans begin paying when SDT short-term disability
benefits end. The earnings replacement rate for these long-term
disability plans is about 60 percent of pre-disability 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 presumably need the protection the most-are less likely to have
long-term disability plans.
Ideally, employer sponsored LTD plans begin paying 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 government, small private firms (under 100 employees) and medium/
large firms with employer sponsored LTD by job type 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 benefits 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 intervention 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 Compensation. 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 disability 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 disability 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 participation is quite limited
because they tend to be very expensive. Participation is mostly 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, payments 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. Assuming 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 payments 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 insurance is viewing it in terms of value to the
beneficiary. This value can be determined by looking at the proportion
of the premium dollar that is returned as benefits to policyholders. We
can determine this proportion by looking at the cost structure 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 dollar 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 enterprises 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
processing costs in this example are estimated at 3 percent. But
administrative costs are also embedded in other categories, such as
acquisitions (which represents items 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 insurance
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 from 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 additional degree of financial security for the minority
of the workforce that enjoys coverage. However, Social Security
Disability Insurance and private plans serve different purposes
However, the operative word is additional. Though Social Security
provides nearly universal and portable coverage, only the most severely
disabled individuals receive benefits. For those found to be disabled,
benefits are also extended to dependents. Only Social Security provides
coverage to all workers and their dependents. 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 disability 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 programs 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.
sources
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 from the Vocational
Rehabilitation /Social Security Administration Experience, in
Disability,Work and Cash Benefits, ed. Mashaw, Reno, Burkhauser, M.
Berkowitz, Upjohn Institute for Employment Research, Kalamazoo,
Michigan, 1996.
Owens, Patricia M, Insurance Issues and Trends: A Focus on
Disability Management including Rehabilitation, in Private Sector
Rehabilitation: Insurance Trends & Issues for the 21st Century, ed.
Perlman and Hansen, National Rehabilitation Association, 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 increase of people going onto disability? We have
seen the rate of disability among the total number of covered
workers increase 300 percent over the last 30 years. Is the
Social Security Administration aware of why that number has
grown so rapidly? Not in terms 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 ordinary economy, but if they
should lose their job, then it is extremely difficult for them
to find another one. So the high unemployment 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:
<bullet> Age of disabled workers. The average age of disabled
workers is declining. Younger beneficiaries mean fewer conversions to
retirement benefits and fewer deaths (i.e., longer on the DI rolls).
<bullet> Business cycle. Job losses during recessions encourage
individuals to file for disability and discourage those on the rolls
from seeking employment. Recent data indicate that a 1-percent increase
in the unemployment rate translates into a 4-percent increase in DI
applications.
<bullet> Increased participation of women in the workforce.
Increased labor participation by women increases the percentage of the
population insured for disability. This increase 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.
<bullet> 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. Second, medical
improvements--the standard of review for termination of disability
benefits. Third, benefits continued during appeal of termination
decision in a disability review.
<bullet> Impact of court decisions. Federal court decisions on
appeals of our disability determinations have often resulted in a more
generous interpretation of SSA's regulatory 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 mismanagement. 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 reviews. 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.
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 recovered. 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
determinable 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
accountability series states only 1 in 500 DI beneficiaries
return to work after receiving benefits. GAO recommended that
SSA put together emphasis on return to work efforts.
Has this been done? How can we improve the return to work
efforts?
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 Congress right now, has a variety
of provisions in it which the administration supports which
ought to help with people at least attempting to return to
work.
For example, there is a ``ticket to independence,'' which
gives people who are disabled a much broader range of
vocational rehabilitation 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 initiatives 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 otherwise 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.
Chairman Smith. Ms. Ford, your comments?
Ms. Ford. Yes, I would like to comment on a couple of the
questions you just raised. Back on the issue of why there are
more people 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 earlier death. That is another reason for
the increase in the roles.
The disability community has supported maintaining the
integrity 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 beginning 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 applies to many of the people I represent through
The Arc of the United States, people with mental retardation.
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 savings from changing the retirement age. I
think our estimate is something like 20 percent of the savings
from changing the retirement 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 disability program, as well as the old age and
survivor program, is facing financial challenges and will
actually run out of money sooner.
Ms. Rivers. Which brings me to another question that I want
to ask Ms. Ford. Given that we know that complicates 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 disabled 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 percent of the parent's
benefits, depending on whether the family maximum 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
benefit 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 message 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 already supplementing many people, it is an
indication that the benefits 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
Administration's plan as we move toward the future and see an
increased demand 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
survivors. 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 earlier. In regard to the question,
can private 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.
The next sentence is that if private disability 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 higher, 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 administering 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 accounted 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 already 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 insurance, 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.
But the people that would be paying 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 condition 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
insurance for many kinds of risks, and there are people who are
more prone to those risks than others, and, nevertheless, the
large majority 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 appropriate 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 significant proportion of those are people with
disabilities or their dependents.
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
administrative costs between the Federal program and private
programs.
In the 3 percent administrative costs that you point to for
Social Security disability, is there anything 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 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 percent, 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 disabilities. So we are pretty
comfortable that this is a very good reflection 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
suggested the Americans with Disabilities Act has resulted in
more individuals 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 disability.
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 dealing 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 people 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
financed and paid for out of the general fund with all of the
tax revenues 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.
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 disabilities 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 information 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 receiving SSI, and that is, for instance, in your
ability to retain your resources and your assets. If someone is
not entitled to Title II benefits, 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 Congress 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 sequence 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
people come to our office for help, I have found the
qualification process 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 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. Disability
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 young survivors, then
the person who was the worker who was trying to accumulate this
private account 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 program had benefit reductions of any sort in order to
accommodate the individual accounts or a transition period,
then this young survivor 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 workers may be eligible for survivor's benefits if they meet
certain eligibility requirements. The basic Social Security benefit
amount that the survivor beneficiary receives 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
survivor'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 82\1/2\ 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 from
150 to 188 percent of the deceased worker's PIA. Generally, benefits
payable to the family members cannot exceed 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 private investment account, you would have a reduction of
$4 in your fixed benefits program? Some proposals assume a 3.7
percent increase, but it is only somehow what you earn in your
private account. Most proposals would only be offset to what
you earned.
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 section 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 reasonable when they
consider their transition costs.
Chairman Smith. If the gentlewoman would yield. But here
again, and maybe we depend too much on the actuaries at the
Social 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
specificity 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 eligibility, 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 applied now. Certainly in our society at
large, there is a lot of room for definition, a definitional
range in what constitutes disability.
I would like 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 question is how much of your effort, how much
of your resources, how much of the administrative costs goes
into assessment and the determination of eligibility, the
determination of how someone matches the definition, how
someone's condition matches the definition?
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 disabled, 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
closer 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.
[The information referred to follows:]
In fiscal year 1998, it cost about $352 for the State Disability
Determination Service 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
possibility or the efficiency or lack thereof of trying to
privatize the disability side of Social Security? We have had a
lot of people come and talk about the retirement supplement
benefit and debating the potential privatization, but most of
the plans, if not all of the plans we have looked at, have
assumed some sort of flat disability benefit.
Would that be the concurrence of the panel today, that it
would remain as a government-sponsored benefit through the
payroll 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 important things we want to emphasize is
that in moving to something other than this pool where
everybody can be a member regardless 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 system, you are very
likely to have much higher costs for individuals, and you are
very likely to have some people who are excluded entirely.
So if you are looking for a way to insure the entire
population against the loss of income due to disability, it
seems virtually impossible to do it with private insurance.
Mr. Bentsen. As the Chairman pointed out in his opening
statement, 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 provide 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 payroll 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 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 differences 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 payroll tax environment rather than a general
revenue environment.
Mr. Bentsen. Ms. Ford.
Ms. Ford. I would like 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 insurance if they already have an impairment.
Many families cannot afford it. There already is private
disability insurance on the market, and I am not sure exactly
what the numbers are, but it is generally higher-income people
who can afford to purchase it for themselves.
Social Security Disability Insurance and survivors and
retirement 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 program.
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 correctly, 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 happen 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 emphasize 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-
making, 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 disabled 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 actually 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 childhood, which is defined in this case up to age 22,
during those developmental years, if you were severely disabled
enough to qualify essentially 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
parent might have gone on disability at age 60 or whether they
retire 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 portion 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 annuity using a private account at retirement,
under a typical annuity 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 finding 6 percent that they feel now can go back to work.
As a legislator I get calls on a regular basis complaining
about somebody that went on disability that is out playing 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 emphasis 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 hotline 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
answer 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----
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 off. 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 impairments, have mental retardation. Mental retardation
is included in the category of people with mental impairments
under Social Security's definitions.
Chairman Smith. So these individuals had some impairment
before 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
impairment can somehow develop mental impairment, and that is
one of the largest reasons for going on disability? 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 Administration 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 reason for becoming eligible for disability.
Chairman Smith. The gentleman from Texas, Mr. Bentsen.
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.
Otherwise 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
adjustments, there was also concern about expansion of the SSDI
program for things like--if I recall correctly--attention
deficit disorder, 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 trying 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 information 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
Diagnostic group -----------------------------------------------------------------
Total Men Women Total Men Women
----------------------------------------------------------------------------------------------------------------
Total................................... 4,698,560 2,737,444 1,961,116 ....... ....... .......
Diagnosis available....................... 4,568,391 2,647,721 1,920,670 100.0 100.0 100.0
Infectious and parasitic diseases\1\.......... 93,776 72,695 21,081 2.1 2.7 1.1
Neoplasms..................................... 127,174 64,436 62,738 2.8 2.4 3.3
Endocrine, nutritional, and metabolic diseases 233,724 95,498 138,226 5.1 3.6 7.2
Diseases of blood and blood-forming organs.... 11,349 5,579 5,770 .2 .2 .3
Mental disorders (other than mental 1,215,373 668,245 547,128 26.6 25.2 28.5
retardation).................................
Mental retardation............................ 243,745 166,459 77,286 5.3 6.3 4.0
Diseases of the:
Nervous system and sense organs........... 441,016 236,198 204,818 9.7 8.9 10.7
Circulatory system........................ 526,573 368,138 158,435 11.5 13.9 8.2
Respiratory system........................ 159,869 87,592 72,277 3.5 3.3 3.8
Digestive system.......................... 61,541 34,657 26,884 1.3 1.3 1.4
Genitourinary system...................... 74,888 46,026 28,862 1.6 1.7 1.5
Skin and subcutaneous tissue.............. 11,826 5,151 6,675 .3 .2 .3
Musculoskeletal system.................... 1,024,053 571,058 452,995 22.4 21.6 23.6
Congenital anomalies.......................... 8,719 4,722 3,997 .2 .2 .2
Injuries...................................... 224,388 163,631 60,757 4.9 6.2 3.2
Other......................................... 110,377 57,636 52,741 2.4 2.2 2.7
----------------------------------------------------------------------------------------------------------------
\1\ AIDS/HIV records are counted in the Infectious and Parasitic Diseases group. Before 1990, these records were
included in the Other group.
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 Medicaid?
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 Medicare 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,
including 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
Office did talking to people who were actually working
disability insurance 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 insurance 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 constituents who are trying to get their
disability designation and going through that process, they
sometimes feel like they are banging 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
Commissioner Ross indicated that when she gets a call from a
congressional office, that they don't give it undue regard.
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
conclude 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
Consortium 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 support, 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 various 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 rather than as part of the whole package.
Chairman Smith. You have an interesting comment, Mr.
Bentsen, that maybe we should consider if an individual works
only 39 quarters, then they would be going on SSI paid for out
of the general 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 developed, 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 reports on their proposals to save Social Security.
I certainly welcome the witnesses here today as we look to
specific 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 difficult, and it takes some exceptional wisdom and
statesmanship to move ahead.
Today we will hear many different ideas about how we should
reform 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 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 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 believe that investment is
an important part of the eventual bipartisan 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:]
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 budget prospects than resolving
the funding gap in Social Security and Medicare.
Today, we will hear many different ideas about how we should reform
Social Security. 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 witness 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 eventual 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 actually 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
congratulate you, Mr. Chairman, on your efforts in the area of
Social Security. They have been a significant contributor to
making this process 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\1/2\ years now, initially as a Chairman, Cochairman,
along with Senator--Congressmen Kolbe and Stenholm--of the CSIS
Commission, 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 outline what this piece of legislation
does. We call it the bipartisan Social 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 reduction 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 increasing the tax burden of
younger people. We should not end up putting 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 positive way.
Our plan doesn't touch any current beneficiaries of the
Social Security system so that there is no impact on current
beneficiaries. They can participate in our savings accounts if
they want to, I suppose, 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 contingent liability, of the system.
We accomplish this through personal savings accounts. Our
personal savings accounts are structured 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 accounts
are structured so that it begins at a 2 percent level, although
people in lower income brackets will be able to get 4 percent
through a matching system with the Federal Government
contributing, 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
savings accounts and the amount of money that is earned in
those personal savings accounts is essentially taken by the
Federal Government 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 personal savings account
at retirement that will be a significant contributor 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 essentially the Thrift Savings Plan, which all of us in
Congress are familiar 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 System. Now,
historically we have never used the general fund accounts to
support Social Security. And it would be, in my opinion, a
major mistake to use the general fund in an extraordinarily
aggressive 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 another 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
instances 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
burden 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 reform
proposal of your own.
The proposal that I will discuss was negotiated over several months
by a bipartisan 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 from our
decision to employ the best ideas that we could find from 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, especially today's young
workers. Our calculations persuaded us that most individuals would
benefit from the reforms that we proposed, either in terms of increased
benefits, 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 responsibility 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 contrast, the accumulated savings in personal
accounts could be an important cushion against the types of outlay
restraints that are necessary to balance the current Social Security
system, much less a restructured one. We found that the provision in
your legislation that established 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 public, 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 straightforward 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
benefits will exactly match what they would have been had the personal
account never 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
methods 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 proposal, Mr. Chairman. Now I would like to describe the other
aspects of our plan. It would:
<bullet> 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 permanently sustainable path.
<bullet> Increase Social Security benefits beyond what the current
system can fund. I will follow up with some details as to why and how.
<bullet> It would drastically reduce taxes below current-law
levels. Again, I will provide details as to why and how it does this.
<bullet> It will make the system far less costly than current law,
and also less costly than competing reform proposals.
<bullet> It will not touch the benefits of current retirees.
<bullet> It will strengthen the ``safety net'' against poverty and
provide additional protections for the disabled, for widows, and for
other vulnerable sectors of the population.
<bullet> It will vastly reduce the Federal Government's unfunded
liabilities.
<bullet> It would use the best ideas provided by reformers across
the political spectrum, and thus offers a practical opportunity for a
larger bipartisan agreement.
<bullet> It will improve the system in many respects. It will
provide for fairer treatment across generations, across demographic
groups. It would improve the work incentives 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 Actuaries 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. Currently we have a little more than 3 workers paying into the
system for every 1 retiree 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 skyrocketing 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 government's ability to pay benefits. President
Clinton's submitted budget for this year made the point as well as I
possibly could:
``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 from 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 from 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 withdraw 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
``cut'' in benefits. It is no such thing. Only in Washington can giving
people ownership rights and real funding 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 from 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 policymakers consist only in the area of who
should control and direct the investment opportunities created within
Social Security. I believe strongly, and I believe a congressional
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 Research 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 benefits under our plan than current law can sustain, even
without including the proceeds from personal accounts.
2. Average earners in every birth cohort measured would experience
higher benefits 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 historical 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-income earners, which
I will outline in the next section, will be so great that on balance
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 insolvency 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 assume 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 showing 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]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bipartisan plan
Current law Current law Bipartisan plan Bipartisan plan (with 1 percent
Year (benefit cuts sustainable\1\ (bond rate, no (without account voluntary
begin in 2034) voluntary) benefits) 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
2060..................................................... 611 739 920 749 1,107
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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 ``current 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
Current law Bipartisan plan (with 1 percent
Year (benefit cuts Current law (bond rate, no Bipartisan plan voluntary
begin in 2034) sustainable\1\ voluntary) (stock rate) contributions,
bond rate)
--------------------------------------------------------------------------------------------------------------------------------------------------------
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 1,063 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 1,221 1,225 1,778 1,531
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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 ``current 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 full 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 tax 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 individuals 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 increases that everyone knows would be required after 2034,
but the general tax increases that few will admit would be required
starting in 2014.
With my statement, I include a table showing the effective tax rate
costs of current 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 actuaries. They include the sum of
the costs of paying OASDI benefits, plus any mandatory contributions to
personal accounts. (Under our proposal, additional voluntary
contributions would also be permitted. But any Federal ``matches'' of
voluntary contributions from general revenues would be contingent upon
new savings being generated.)
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 assessed 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 (\1\)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 13.5 13.7 12.4 17.3 (19.0)
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Tax rate of Nadler plan is lower than current law not because total costs are less but because amount of national income subject to tax is greater.
In order to compare total costs of Nadler plan to other plans, cost rate given 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 June
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
in 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]
------------------------------------------------------------------------
Moynihan/
Year Current law Kerrey
------------------------------------------------------------------------
2000.................................... 10.8 (\1\)11.1
(13.1)
2005.................................... 11.2 11.0 (13.0)
2010.................................... 11.9 10.9 (12.9)
2015.................................... 13.3 11.5 (13.5)
2020.................................... 15.0 12.2 (14.2)
2025.................................... 16.6 13.2 (15.2)
2030.................................... 17.7 13.8 (15.8)
2035.................................... 18.2 14.0 (16.0)
2040.................................... 18.2 14.0 (16.0)
2045.................................... 18.2 14.0 (16.0)
2050.................................... 18.3 14.2 (16.2)
2055.................................... 18.6 14.5 (16.5)
2060.................................... 19.1 14.7 (16.7)
2065.................................... 19.4 14.8 (16.8)
2070.................................... 19.6 14.9 (16.9)
------------------------------------------------------------------------
\1\ Like the Nadler plan, the Moynihan/Kerrey 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 proposal, 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 Moynihan/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 vary. 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 inside parentheses assumes universal participation in 2 percent
personal accounts, for comparison with other personal account plans.
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 generous as those provided to low-income individuals under
our plan. But we have determined 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 provision. It is easy to criticize a plan's parts in
isolation from the whole, and to say that one of them is
disadvantageous, heedless of the other benefits and gains provided. 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 from 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 Consumer 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 conflict will make this untenable. Current law may
therefore contain the seeds of political 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 proposal 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 increase 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 impacted by the benefit offsets
proportional to personal account contributions. If an individual
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 Social Security as a ``social insurance'' system and as an
``earned benefit.'' It has always served both functions, and it must
continue to do so in order to sustain political 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, effectively, another welfare program in which contributions and
benefits are not related--are misguided and undermine the system's
ethic.
Again, I would repeat that our proposal contains important benefits
for all individuals. Guaranteed benefits on the low-income end would be
increased. High income earners would be spared the large current-law
tax increases that would otherwise be necessary. If we act responsibly
and soon, we can accomplish a reform that serves the interests of all
Americans.
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 amount 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 provides 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 bipartisan
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 Security system.
Other Aspects of the Bipartisan Plan
The changes effected in our bipartisan bill do not, all of them,
relate solely to fixing system solvency.
One area of reforms includes improved work incentives. Our proposal
would eliminate 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 receive back in benefits the
value of the extra payroll taxes they contributed. The proposal 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
denominator. 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 sectors of the population who are threatened under current
law. For example, we gradually would increase the benefits provided to
widows, so that they would ultimately 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-earner 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 careful 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 frequency. Their relationship to the process 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
people in this room.
Our proposal also provides true ownership and control over the
proceeds from 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 account 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 individual
beneficiaries in a very real sense.
What Our Proposal Does Not Do
Unveiling a proposal as comprehensive as ours invariably creates
misunderstanding 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. Correcting 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 benefits, 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 competing 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 concerns. 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 outside the
wage cap grow in proportion to national wages currently subject to
taxation, 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 advance 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 agreement. 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.
I think that my colleague Judd Gregg has accurately
described the overall thrust of what is now known as the Gregg,
Breaux, Grassley and Kerrey proposal. It is bipartisan. There
are 15 other Senators that have joined together in a bipartisan
fashion to present this to the Congress on our side over on the
Senate side.
I think what you have done in this committee cannot be
overstated in the sense that it is a major contribution. Just
having Democrats working with Republicans on something as
sensitive as Social Security is a major accomplishment in
itself. We absolutely have to get away from looking at Social
Security as a political football whereby one election Democrats
blame Republicans for not fixing it, and Republicans blame
Democrats for not doing anything. That type of rhetoric on both
Medicare and Social Security has brought us to the point where
nothing gets done.
I think we have a very unique opportunity and a small
window of opportunity remaining of this year to actually come
together with the surplus and the good economic times we are
enjoying and doing some real structural reform to both Social
Security and the Medicare program, and your committee over here
in a bipartisan fashion is doing it. This is something
Democrats can't do by ourselves, and Republicans can't do it by
yourself. The only way it is going to get done is by working
together. So enough said on the politics.
What we have is essentially--and I will describe two
features of our plan which I think are some of the key parts of
what we have recommended, and Judd has done an excellent job
going through it all. The first thing is we create a 2 percent
individual investment account. We require that everybody paying
Social Security takes 2 percent of it and puts it into a
private savings account, just like you have and all the other
colleagues and all the people sitting behind you have the
opportunity in the Federal Thrift Savings Plan to do.
They can put up to 10 percent of their money into a high-
risk account, which is basically the stock market; they can put
it into a moderate, medium type of risk, which is a combination
of government bonds and the stock market; or they can choose
the most safe investment of all is just put it in bonds. That
is how this has worked for Federal retirees. It has worked very
well, and what we have suggested is that Social Security
beneficiaries and people paying the payroll tax ought to have
the same opportunity to create wealth through an individual
retirement account.
We don't put it all in there. We picked a number of 2
percent. Some say, why 2 percent? Well, why not? We didn't want
to do it all and put it all into private accounts because that
would have been too risky and totally privatize the program,
which I would not support, and I think most Members would not.
But we do say that 2 percent of your payroll tax would go into
one of these three accounts. You pick. You decide. It would be
managed by a group of professional managers much like we have
for the Federal retirement plan that we are all underwrite now,
and they do a good job. And we have taken your idea,
Congressman, Nick, as far as how do you account for this.
I think in the Archer-Shaw plan, what they have done
through the use of a claw-back, basically saying they create
private accounts, but whatever you make in your private account
is going to be deducted from what you would get under normal
Social Security, so there is no real incentive, I would argue,
to do this if you are going to lose it when you get your Social
Security.
The way we pay for it is your idea, which you have
introduced in legislation previously, to basically say that at
the end of--a person's ready to be retired, you look at what
they have made in the individual retirement account, and you
look at what they would have made had they kept the money in
Social Security, getting about a 3 percent rate of return, so
if they put the money into this private account and they make
15 percent, just as an example, they wouldn't get the whole 15
percent, but they would get all of it minus what they would
have got had they left it in Social Security. So had they left
it in Social Security, maybe they would have made 3 percent.
They put it into this private account, they got 15 percent. So
you subtract the 3 percent from the 15. They still get a 12
percent advantage, which is very, very significant.
And they own the account. They can inherent their account.
It connects people with the concept of investing for their own
future. It makes young people more in tune to what Social
Security is trying to do for them. It affects no one who is 62
years of age or older. You can go to AARP and all the other
groups and tell them we are talking about baby boomers and
those in my category, making some changes for us that is going
to give us a better opportunity to retire successfully. That is
the first part, the 2 percent.
The second part is really aimed at doing more for lower-
income people, and you have--I think my staff put out a little
chart about the voluntary contributions. It is this chart right
here. And this is in addition to the 2 percent investment
account. This says that we are going to help low-income people
do a little bit more than other than their 2 percent. So an
example, a person with a 20,000 and a $30,000 salary, if the
person with the $20,000 salary takes the 2 percent and puts
it--that is 2 percent of 20,000 is $400 a year they would have
in their individual retirement account. If they want to do more
and they put up another $1, the government would match that
with an extra $100, giving that person 400 plus the $101, for a
total of $501 that that person could put in their individual
retirement account, and then the person could continue to
contribute up to 1 percent up to the amount that they would
reach as the taxable income base, which is about $72,000 today.
That person could contribute an additional 112, so he would
have $725 additional in their account that they would be able
to do.
The same pattern for the person making the 30,000. The only
difference is that when they put 2 percent of their 30-,
obviously it is $600, if you put another $1, the government
would match it with 100. That would give you 701. You only need
12 dollars more to get up to the maximum amount. This is extra
and voluntary, but it strengthens the whole opportunity to
increase wealth for the individuals.
And I would just say that--I mean, we ought to seize the
opportunity to do something. They have got a lot of variations
about all of this, as many economists as you can think of that
come up with schemes and plans and recommendations that they
think would work. But we think the 2 percent account plus the
voluntary contributions with no tax increase and no age
increase for seniors. Retire at 62 years of age and gradually
work up to 67. We do have a CPI adjustment, which everybody has
recommended that we do, and that is our plan.
Thank you.
Chairman Smith. Senator Grassley, welcome. I said good
things about everybody that was brave enough to proceed, so
congratulations, and please go ahead.
STATEMENT OF HON. CHARLES E. GRASSLEY, A UNITED STATES SENATOR
FROM THE STATE OF IOWA
Senator Grassley. Well, I can listen a long time if you
have some more things you want to repeat.
Thank you very much for the opportunity to be here with
you. I am going to just focus my remarks on a very narrow area
of our whole program of what we do to improve the situation for
workers who are in and out of the work force. For the most part
women, it is who are in and out of the work force, and probably
more apt to be that because of family responsibilities that in
our society tend to rest more on women than on men, right or
wrong.
But before I do that, if I could just comment on the
statement that Senator Breaux started out with on the
bipartisanship. Let me emphasize from a historical perspective
backing up what he said. I think Social Security, being the
social contract that it has been for 63 years, has never been
dramatically changed without bipartisan cooperation. And, I
don't think it will be again this year, and probably we can
suggest the changes that change somewhat the basic format,
albeit it is still a social contract. That social contract has
changed to some extent, all the more reason to have bipartisan
support.
So my colleagues have thoroughly outlined our proposal. I
would like to highlight just a few aspects. In designing our
plan, we assessed how changes to Social Security would affect
different segments of the American population. One of my top
priorities in reforming Social Security is ensuring that the
program addresses needs of women. This is how our bipartisan
program would do that:
Women are more likely to be in and out of the work force to
care for children and elderly parents. We believe that they
should not be punished for the time that they dedicate to
dependents. Therefore, for every two-earner couple our plan
provides 5 dropout years to the spouse with lower earnings. Our
proposal provides all workers with an opportunity to create
wealth by contributing to their individual account, an amount
equal to 1 percent of the taxable wage base. This year that
figure would be $726. Workers whose combined 2 percent
contributions equal less than 1 percent of the taxable wage
base would receive $100 from the Federal Government when they
put in the first dollar of savings. They would then receive a
dollar-for-dollar match by the government for additional
contributions up to 1 percent of the wage base. This
progressive feature will boost the contributions for low-income
individuals, many of whom, happen to be women.
Also, our proposal creates an additional bend-point to
benefit formula to increase the replacement rate for low-income
workers. Women live longer than men. So at age 65 men are
expected to live 15 more years, whereas women, the case happens
to be 20 years. Our proposal addresses that reality by allowing
money accumulated in individual accounts to be passed on to
surviving spouses and children.
Furthermore, our proposal would increase the widow's
benefit to 75 percent of the combined benefit that a husband
and wife would be entitled to based on their own earnings.
As many older Americans live longer, healthier lives, they
are eager to remain in the work force in various capacities.
Others remain in the work force out of necessity. We would
eliminate the earnings test for beneficiaries 62 and older so
that retirees may continue to contribute to the economy without
being penalized. Currently, benefits are reduced for over 1
million beneficiaries because their wages exceed the Social
Security earnings limit.
Furthermore, our proposal would correct the actuarial
adjustment for early and late retirement. Currently,
individuals do not receive back the value of payroll taxes
contributed if they delay retirement. Our plan increases both
the early and delayed retirement adjustments to levels
appropriate to recognize additional tax contributions. Retirees
who remain in the work force could also contribute to their
individual accounts.
The first step on the road to reforming Social Security is
to engage the American public in the policy debate. No action
could take place without Americans making informed decisions
about how to design Social Security for their needs of the 21st
century. Now, America, after doing that for a year, seems to me
to be ready for reform. According to a recent poll conducted by
Americans Discuss Social Security, and I had the pleasure of
serving with Senator Moynihan as cochair of that group, we have
our survey showing 58 percent of those surveyed believe reform
should take place before the 2000 election.
The second step in saving Social Security was to address
its long-range funding difficulties. Several proposals have now
been put forward that would do this. Now, we must work together
in the next step, and that is enacting Social Security--or
legislation to restore the long-term solvency of Social
Security.
I want to stress the importance of saving Social Security
sooner rather than later. Do we work now to prepare for the
retirement of the baby boom and subsequent generations, or do
we sit back and leave the legacy of higher taxes and unmet
benefit obligations? According to Social Security actuaries, in
the year upon 2075, and that is the last year of our 75-year
valuation period, income to Social Security program will be $14
trillion, but we will owe $21 trillion in benefits. It is
obvious you can't take more hay out of the barn than you put
in. So plain and simple, that translates into more Draconian
measures that we will be forced to take for each year that we
fail to enact legislation to protect the program that most
older Americans rely upon and almost every pension system uses
as a basis, as a foundation.
Thank you.
[The information referred to follows:]
Prepared Statement of Hon. Chuck Grassley, a United States Senator From
the State of Iowa
Thank you, Chairman Smith. I am pleased to be here today with my
colleagues to discuss our proposal to save Social Security. I want to
commend you for holding this hearing. It is an important step in
reforming Social Security.
My colleagues have thoroughly outlined our proposal. I would like
to highlight a few aspects. In designing our plan, we assessed how
changes to Social Security would affect different segments of the
American population. One of my top priorities in reforming Social
Security is to ensure that the program addresses the needs of women.
Let me explain how the Bipartisan Reform plan accomplishes that goal:
Women are more likely to move in and out of the work force to care
for children or elderly parents. We believe they should not be punished
for the time that they dedicate to dependents. Therefore, for every
two-earner couple, our plan provides five ``drop out'' years to the
spouse with lower earnings.
Women, on average, earn less than men. Our proposal provides all
workers with an opportunity to create wealth by contributing to their
individual accounts an amount equal to 1 percent of the taxable wage
base. For this year, that would be $726.
Workers whose combined 2 percent contributions equal less than 1
percent of the taxable wage base would receive $100 from the Federal
Government when they put in the first dollar of savings. They would
then receive a dollar-for-dollar match by the government for additional
contributions up to 1 percent of the wage base. This progressive
feature will boost the contributions for low-income individuals, many
of whom are women.
Also, our proposal creates an additional bend point to the benefit
formula to boost the replacement rate for low-income workers.
Women live longer than men. At age 65, men are expected to live 15
more years, whereas women are expected to live almost 20 more. Our
proposal addresses that reality by allowing money accumulated in
individual accounts to be passed on to surviving spouses and children.
Furthermore, our proposal would increase the widow's benefit to 75
percent of the combined benefits that a husband and wife would be
entitled to based on their own earnings.
As many older Americans live longer, healthier lives, they are
eager to remain in the work force in various capacities. Others remain
in the work force out of necessity.
We would eliminate the earnings test for beneficiaries age 62 and
older so that retirees may continue to contribute to the economy
without being penalized. Currently, benefits are reduced for over one
million beneficiaries because their wages exceed the Social Security
earnings limit.
Our proposal would also correct the actuarial adjustment for early
and late retirement. Currently, individuals do not receive back the
value of payroll taxes contributed if they delay retirement.
Our plan increases both the early and delayed retirement
adjustments to levels appropriate to recognize additional tax
contributions. Retirees who remain in the work force could also
contribute to their individual accounts.
The first step on the road to reforming Social Security was to
engage the American public in the policy debate. No action could take
place without Americans making informed decisions about how to design a
Social Security program which would meet their needs in the 21st
Century.
Now, America is ready for reform. According to recent poll results
from Americans Discuss Social Security, 58 percent of those surveyed
feel that reform should take place before the 2000 elections.
The second step in saving Social Security was to address its long-
range funding difficulties. Several proposals have been put forward to
save Social Security. Now we must work toward the next step: enacting
legislation to restore the long-term solvency of Social Security.
I must stress the importance of saving Social Security sooner
rather than later. Do we work now to prepare for the retirement of the
baby boom and subsequent generations, or do we sit back and leave a
legacy of higher taxes and unmet benefit obligations?
According to Social Security's actuaries, in 2075--the last year of
the 75-year valuation period--income to the Social Security program
will be $14 trillion, but it will owe $21 trillion in benefits. You
can't take more hay out of the barn than you put in. Plain and simple,
that translates into more Draconian measures that we will be forced to
take for each year that we don't enact legislation to protect the
program on which so many older Americans rely.
Thank you for the opportunity to outline our proposal. We would be
happy to entertain any questions you might have.
Chairman Smith. Gentlemen, again my compliments. So many
details in your proposal have been thought out and addressed.
And I want to say something really positive because I would
like the opportunity to ask some tough questions. One is on the
CPI adjustment, because that also affects the ultimate increase
in income taxes because of bracket creep and because of lower
deductibles.
Senator Gregg, so it is going to have the effect of
increasing those taxes? How are taxes ultimately going to be
decreased? I don't understand that.
Senator Gregg. Well, because if you look at current law,
the increase in taxes that would be required to fund the
benefit is dramatic. It is about 4 percent, 4.5 percent
difference from where we are today. If you look at the Archer
plan in the year 2030, I believe the difference between our
plan and the Archer plan is about 2 percent of general tax
revenues.
So, the CPI increase is significantly less. It is 0.78
percent as versus 2 percent or 4.7 percent on the present law
as being the difference between the increased tax burden if you
don't accomplish our plan as versus if you do take our plan.
So I think you have to look at net taxes. You can't just
look at one tax and say that goes up a little, therefore there
is a tax increase. I think you have to look at the effect on
the net tax burden. Under the net tax burden, under our bill,
taxes are significantly reduced over any other bill that is out
there with the exception possibly of yours.
Furthermore, the extent that the CPI does generate new tax
revenues in our bill, we don't let that go into the general
fund. We put it into the benefit structure to assist in paying
Social Security benefits. So we don't allow it to be used; any
bracket creep that may occur as a result of indexing the tax
tables to CPI, we don't allow that to flow into the general
revenues. We cause it to flow into Social Security Trust Fund,
and so it benefits the Social Security System and does not end
up being spent on other activities.
Chairman Smith. Chairman Greenspan and Secretary Summers in
testifying before this Task Force suggested that whatever plan
is adopted, it needs to encourage additional savings,
investment. Senator Grassley, you sort of suggested that your
plan allows a 1-percent add on. How else do you encourage
savings investment? How does that work?
Senator Grassley. Well, don't forget, if people have been
in the work force and have an individual account, that is
earning growth while they are outside the work force. So that
is one way that we enhance that opportunity. It seems to me
another very fair way is that the opportunity to pass that on
as part of your estate as well as being quite an incentive to
do this, equalizing of benefits for low-income families.
Spouses who are in and out of the work force, may be dying
early, the family is losing benefit of that. There is some of
that growth that comes to the benefit of the family that way.
So the most important point is that it has growth when
people are not in the work force.
Chairman Smith. A couple of the economists suggested to the
Task Force that if you are going to replace the Social Security
and not touch the disability portion, you need 5.4 percent of
taxable payroll as a separate investment, assuming a 7 percent
real rate of return. Did you consider, and if so, why you
decided against increasing it over 2 percent?
Senator Breaux. Really, what we have is a compromise
between those who would make it a lot larger. Ours in the
Federal plan is a 10 percent plan. I mean, that is more than I
think is doable at this stage in the political forum. I think 2
percent is a major step in creating individual accounts, but it
could be more. I mean, anything less becomes almost
insignificant in a sense of making a difference. We cited that
2 percent was about the right figure and then added the
voluntary contributions for the lower-income people, which I
think is significant. It is going to really get them down the
path of starting to save, knowing that the government is going
to match their first dollar with $100 and a 1-to-1 match up to
the taxable base. You have help for lower income people and a
real incentive for the regular people to put the 2 percent in
there, but that is a number that--any number you pick is going
to be arbitrary to a certain extent.
Senator Gregg. That number is also controlled by actuarial
solvency.
Senator Breaux. That is what we needed.
Senator Gregg. If we could have afforded more, we would
have put more.
Chairman Smith. Thank you.
Congressman Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. And let me thank you
all for testifying today and also for putting together a fairly
broad and specific plan, which has not always been the case
with some who have testified before this panel.
First off, have you--has your plan been scored?
Senator Gregg. Yes, it has been scored by the actuarial
trustees of the Social Security Administration as creating
solvency perpetually, twice.
Mr. Bentsen. And has it been scored by--I mean, if I read
the summary correctly, there are a number of new tax
provisions, some savings enhancements beyond the 2 percent,
which I assume are pretax. I am not sure. Have those been
scored by either Joint Tax or CBO?
Senator Gregg. They are after tax, and they have not been
scored by Joint Tax or CBO.
Mr. Bentsen. Okay. And has any analysis been done that
would give you an idea of how various income groups would be
affected under this new formula going out over the next 75
years?
Senator Gregg. Yes. We have extensive analysis on that, and
we would be happy to get them to you. And I would just tell you
that what it is going to show, that low- and moderate-income
groups do extremely well as compared with present law or the
President's proposal.
Mr. Bentsen. I would be interested in seeing that. And
again, the investment requirement--or the investment
requirement is similar to the Federal Thrift Savings Plan.
There is a limitation on what it can be invested in; is that
correct?
Senator Gregg. That is correct. You get a choice.
Mr. Bentsen. Pooled funds or whatever.
Senator Gregg. It will probably be index funds initially.
Mr. Bentsen. A couple of specific questions. Initially you
have the claw-back provision, which, if I understand that
correctly, you take the spread between the T-bill--the annual
T-bill rate and the return on the private account and----
Senator Gregg. There is no claw-back provision. Basically
what we do is reduce the benefit structure by what the T-bill
rate would be on the amount of the personal account. You own
the personal account. Whatever is in there, you get; it is
yours, it is your asset. But your benefit under Social Security
would be reduced by--let's say you put in 2 percent every year.
It would be 2 percent plus the rate of return of the T-bills,
which would be about 3 percent, so your benefit structure would
be reduced by that amount, but you actually own the asset. In
addition, you don't have to credit back to the Federal
Government an amount of the money. You own the physical asset,
and to the extent you have exceeded that T-bill rate, you have
made money.
Senator Breaux. I want to make sure that we all understand.
It sounds complicated when we are talking about how do you pay
for the 2 percent, and it is not really that complicated. I
mean, if you have your private account, and say you average 15
percent return investing it in the various private accounts,
and you have got a 15 percent rate of return, what our plan
suggests is that what you do when you start collecting your
Social Security is to reduce your Social Security by what
amount would have been credited to your Social Security had you
taken the 2 percent, and instead of putting it in the private
account, just kept it in Social Security, like Judd said, that
you would have gotten a 3 percent return, then you reduce it by
3 percent. So instead of getting 15 percent increase in your
retirement, you would have it reduced by about 3 percent.
Mr. Bentsen. But, Senator, the reduction applies to the
defined benefit portion, the remaining 10 percent or whatever
at the annualized T-bill rate, so your only risk there--I mean,
generally you should have a positive spread. Your only risk is
if the market underperforms.
Senator Gregg. Underperforms the T-bill rate.
Mr. Bentsen. Which in rare occasions happens.
Senator Breaux. Not over a 20-year period, it has never had
a negative return over the T-bill rate, which is the time which
most people would be paying into a retirement account.
Mr. Bentsen. The KidSave portion is outside of Social
Security. This is just a new program, although you could roll
it into your private account. How would that be funded, just
through general revenues?
Senator Breaux. That is correct.
Senator Gregg. That is correct.
Mr. Bentsen. So that would be scored.
I have two other quick questions. One is you recapture
Social Security revenues currently diverted to the Hospital
Trust Fund. I understand that. What I am concerned about is do
you make any proposals for replacing the revenue taken out of
the Hospital Trust Fund in Medicare?
Senator Breaux. The President will announce that at 2:30
this afternoon. No, I mean the basic premise is the fact that
Social Security revenues ought to be for Social Security. And,
you know, we did it when Social Security was in good shape by
kicking it into Medicare to kind of help Medicare, but now
Social Security needs what Social Security is entitled to, and
we put it back where it is, recognizing that the Medicare
problem is a legitimate problem and has to be fixed. But this
relatively small amount is not what is needed to fix Medicare,
so it should be kept for Social Security beneficiaries.
Mr. Bentsen. Thank you, Mr. Chairman.
Chairman Smith. Congressman Collins.
Mr. Collins. Thank you, Mr. Chairman.
Gentlemen, if I believe I understand that, you are doing a
2 percent carve-out rather than 2 percent additional; is that
true?
Senator Breaux. Yes.
Mr. Collins. Two percent required.
Senator Gregg. It is required.
Mr. Collins. On the voluntary contribution portion of it,
what is the top annual salary that a person qualifies or is
disqualified beyond to participate in the voluntary provision?
Senator Breaux. It is approximately 35,000 is what the
staff is telling us. You can raise it or lower it, obviously,
but we thought 35,000 was about the maximum that we would be
able to do it.
Mr. Collins. What would be the maximum benefit of a $35,000
wage-earner contributing voluntarily?
Senator Breaux. Seven hundred twenty-five, I think. Mac,
you have that little chart right here. I mean, the voluntary
contribution allows you to get up to 1 percent of the taxable
wage rate, which ends up at about $707 each year, so the amount
that the contribution is made available is reduced each year
until you get to the total of 725.
Mr. Collins. And the maximum general funds that would be
used to match, 725 also?
Senator Breaux. That is correct.
Senator Gregg. Wouldn't match 725. Maximum amount of the
match would be 112.
Mr. Collins. The individual is less than the general fund
match by $99; is that true? Let me ask you.
Senator Gregg. Reduce the 725 by the mandatory contribution
to get to the number that you would then be able to put a
dollar in, the Federal match would be $100 that would come out
of the general fund.
Senator Breaux. I don't know if you have that little chart
that we gave with the 20,000 and the 30,000. You see what the
private consideration would be under 20,000 and then under the
30,000. The max goes to $725, regardless of income. You
couldn't go more than that.
Mr. Collins. Is there any provision that allows a wage-
earner above 35,000 to opt not to have their tax dollars used
for this purpose?
Senator Gregg. No.
Senator Breaux. Obviously the 2 percent contribution,
obviously that portion of that is 2 percent, not a significant
amount.
Mr. Collins. You are setting up a program where you are
going to take funds from another taxpayer and deposit them into
an account for another taxpayer, up to 35,000. And above that
is where you are actually taking your funds from; is that the
way I read this? That would be the entitlement to the ones that
would owe 35,000. It is voluntary, but you are taking money
from above 35- to contribute to their account? But there is no
volunteer opt-out for someone from 35,001 to 75,000 or 80,000
to not participate in that program? They just have to ante up?
Senator Gregg. Their 2 percent would get them to that 725.
Mr. Collins. We are above that. We are talking about the
voluntary portion.
Senator Gregg. That would be funded from the general fund.
Mr. Collins. You put money in, but you also have another
taxpayer putting it in for you.
Senator Gregg. It would come out of the general fund.
Mr. Collins. There is no voluntary provision for the other
taxpayer, just the one that wants to contribute?
Senator Gregg. Right. This is the progressive part of this
plan. That is correct.
Mr. Collins. That is all I have. Thank you.
Chairman Smith. Mr. Toomey.
Mr. Toomey. I would just like to--two quick questions. One
is to understand the nature of the taxable wage base. I am a
little bit confused. There is a reference to the CPI that
adjusts the tax revenue side. And elsewhere in the little
summary I have here it says that the taxable wage base is
maintained at 86 percent of total wages, as we all know;
currently the taxable wage base is a fixed number. Is it your
intention that this grows? And if so, how does that work?
Senator Breaux. Well, right now it is about 86 percent.
Under current law taxes only go up to 72,600. That level is
about 86 percent of all wages in the country are taxed. Because
wages are going up, that amount is being reduced, obviously.
And what we are suggesting is that you maintained the 86
percent of the wages being subject to Social Security taxes,
therefore you would have wages continue to go up. You would
have an increase in account.
Mr. Toomey. So that would be a significant tax increase for
many earners, certainly for people who are above that cap.
Senator Grassley. Same as it is now.
Senator Breaux. It is 86 percent today, and it would be 86
percent next year if wages go up. The number goes up.
Senator Grassley. It is a significant increase in taxes,
but not any more than you have under present law. It would be
fair to say it is present law.
Senator Breaux. Yes, it is 86 percent.
Mr. Toomey. The other question that I have, point number 4
of the summary that you sent around refers to giving every
child a retirement savings account. This is funded by the
government putting in $1,000 into this account at birth, and
then the government puts in another $500 every year for the
next several years. Is that the way that would be funded?
Senator Breaux. That is the KidSave account, and that is an
idea that was crafted by Senator Bob Kerrey, and that is the
way it would work.
Senator Gregg. We wish he were here to explain it. It is a
good idea. The basic concept is to create a huge savings pool
which people would then have available to them.
Mr. Toomey. How do you respond to the idea that this is a
whole new entitlement and we are sending a message that
everybody has a birthright to getting a large check without
having done anything at all to earn it?
Senator Gregg. Of course Social Security could be viewed in
that way, too, to some degree. The fact is that we are
basically saying that the society should address the Social
Security insolvency issue in the later years of the next
century by prefunding the liability as versus having it be a
contingent liability. That is what this all comes down to. The
whole debate over Social Security is a debate over whether you
are going to create a huge tax burden for the next generation
by running up an obligation which the next generation has to
bear in order to support the retired generation before it, or
whether the generation that is going to retire creates an asset
which can be used to reduce their retirement benefit needs. And
so what this is is basically carrying that concept one step
further, which is initiating the prefunding of the next
generation of liabilities.
Senator Grassley. And it seems to me if you want to
deemphasize the plague that you might call the entitlement
mentality that we have in our economy and society today, one of
the ways that you do that is to create ownership and have
people have a stake early on in their retirement and feel a
part of the system. And you might say, well, the $1,000 is
given, that is not part of the system, but the ownership that
comes with it, more importantly the economic growth that comes
from it, is something that is theirs. And that is very
important if you want to have reduced generational gaps that we
have in our system or conflict as well as promote a concept of
people having growth so that they feel a part of the economy,
particularly lower-income people that feel left out today.
Senator Gregg. It makes everybody a capitalist at birth.
Mr. Toomey. Thank you.
Mr. Ryan. I was going to go on another line of questioning,
but I would like to expand on the KidSave accounts. Thank you
for coming, by the way. It is good to have you here.
The KidSave account, what is the score on the KidSave
account? This is a government contribution of $1,000 and then a
government contribution of $500 for 5 years after that for a
total of $3,500. What is the score of that, and is that an
indexed amount?
Senator Breaux. Staff tells us that it is $14 billion a
year.
Mr. Ryan. Is that indexed?
Senator Breaux. It is indexed.
Senator Grassley. Remember that is paid for in the
projection of our system.
Mr. Ryan. And the cost savings primarily from your system
come from the CPI change and the fact that you reduce the
defined benefit base by the bond indexed amount taken off
outside of your 2 percent individual account?
Senator Breaux. That is how you pay for the 2 percent.
Mr. Ryan. That is basically the funding mechanism.
Senator Breaux. That is right.
Mr. Ryan. And the actuaries have scored the long-term
solvency of this account with the KidSave taken into account?
Senator Grassley. For 75 years.
Mr. Ryan. And it is 14 billion a year, and that obviously
goes up with the indexation; correct? Now every single child
born gets the KidSave account? There are no other strings? You
get a Social Security number, and $1,000 and $2,500 after that,
and then you can roll your KidSave account into your Social
Security account after that period?
Senator Gregg. When you turn 18.
Mr. Ryan. When you turn 18, you roll it in.
Can you make contributions into this KidSave account other
than the money that you received from the government?
Senator Breaux. You cannot add to it, but when you roll it
over into your Social Security account, you can add to the
account at that time.
Mr. Ryan. As you could with the other Social Security
rollover provisions.
That is all for me. Thank you.
Mr. Bentsen. Will the gentleman yield?
The KidSave account, though, that is not coming from
proceeds from Social Security, the payroll tax. That is general
revenues monies that are appropriated. Okay.
Chairman Smith. Gentlemen, I am going to take the liberty
of asking you one last question. If you were betting, what do
you consider the odds of something coming out of the Senate?
Senator Gregg. I will defer that to my finance fellows.
Senator Breaux. The Finance Committee--Senator Grassley and
I both serve on it--I think the odds of doing something on this
and Medicare, I think, are better than 50-50 in the sense that
you have a bipartisan type of arrangement going where you have
Members on both sides that have joined together in a common
proposal. And I think that is very significant. It is not just
your plan or your plan, it is one Republican-Democratic plan
together. And I think that has greatly increased the odds of
having something come out of the Finance Committee and go to
the floor of the Senate which I think would pass.
Chairman Smith. Congressman Herger.
Mr. Herger. Thank you, Mr. Chairman.
I want to thank each of you for the monumental work that
you are doing in the Senate on coming up with a bipartisan
plan. I find it sad and disheartening that the President could
not have given more support, at least a little bit of support,
so that we could have moved this process forward a little more
than what it has. But that is not to say that we are not going
to be successful. We have to be successful. I am convinced the
only way we are going to solve this monumental problem is that
we work together, the Senate, the House, the President,
Republicans, Democrats, quote, liberals, conservatives,
everyone working together. This is a challenge that faces each
and every American, certainly not one class or another. So I
want to thank you for this work that each of you has done.
I really don't have any more questions. I would like to
urge you, though, as we have what I feel was the first step,
and that was the lockbox proposal, which did pass out of the
House by an overwhelming vote 412 to 16. I understand there
will be another cloture vote perhaps on Thursday. I think
essential as the first step that at least we lock up those
dollars that have been paid to Social Security and the interest
on it not be used for anything else. And I would certainly urge
each of you that we move forward with that as well as areas
that you are working on.
Senator Gregg. You have 60 percent of this panel for it.
Chairman Smith. Gentlemen, thank you very much. Any final
closing statements? It is such a good opportunity for us to
lecture Senators, so thank you again.
Representative Clay Shaw on the Shaw-Archer proposal. And
Chairman Archer. Bill, I didn't see you. Chairman Archer, just
give us 1 second--that was 17 Senate staff that apparently just
left.
Chairman Archer, Representative Shaw, welcome. Thank you
for being here. Please proceed.
STATEMENT OF HON. BILL ARCHER, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF TEXAS
Mr. Archer. Thank you, Mr. Chairman. I will attempt to
shorten my oral testimony, and without objection I hope my full
statement can be entered into the record.
Chairman Smith. Yes it will be. All full statements will be
in the record without objection.
Mr. Archer. Mr. Chairman, as you have said, we have an
historic opportunity this year to save Social Security. If we
do not do it, it becomes exceedingly more difficult in every
new Congress.
We should act now, and our greatest opportunity to do it
will be on a bipartisan basis. And to that end, I have been
working with the White House and with the Democrat leadership
in the House to see if we can come to some resolution that both
sides--or all sides, I should say, can support. Without that,
it becomes far more difficult. It becomes simply a partisan
activity.
For many months, Congressman Shaw and I have been
developing a plan that we believe can be passed that will save
Social Security for all time. It has been certified by the
actuaries at SSA that it will save Social Security for 75 years
and get even better in the years beyond that.
We do not raise taxes. We do not cut benefits. We maintain
the safety net for workers, and we provide new options for
younger workers.
Let me say, Mr. Chairman, that as I have worked with Social
Security over the many years that I have been in the Congress,
I have over and over again said that it must be
intergenerationally fair, and we have an opportunity to make it
so. If we grant benefits to today's seniors that are not
available to the next generation or the generation beyond that,
it is not intergenerationally fair. And that is one reason why
I have a great deal of difficulty in justifying cuts in
benefits.
If we increase taxes on the next generation and the
generation beyond above what this generation is paying, it is
not intergenerationally fair. So that is why Congressman Shaw
and I came together with no cuts in benefits, don't touch the
existing Social Security System, and no increases in taxes. In
fact, our plan, when implemented over the long term, will
generate a unified budget surplus, which your committee is
particularly interested in, of $122 trillion. That is a great
benefit to future generations.
Now, how does it work? Very simply, 2 percent of payroll is
computed at the end of each year on every worker that qualifies
for Social Security, and they receive a refundable tax credit
equal to that amount of money out of the general Treasury. It
is a tax reduction dollar for dollar which goes into personal
savings. That money is transferred into a personal savings
account, what we call a Guaranteed Social Security Account, for
each worker, directly from the Treasury, and that worker
thereafter determines where that money is to be invested.
I think all of the plans that you look at have some degree
of government standards as to what qualifies as a legitimate
investment, and that is a part of our plan.
Should you die before reaching retirement, the money that
is left in your plan after providing for your widow and any
survivors is yours to will to any beneficiary that you see fit.
You are not obligated to retire at any particular time, but
when you do retire, your account is converted into an annuity,
and that annuity guarantees you a certain amount of money based
on life expectancy for the rest of your life. If that amount is
not enough to equal the Social Security benefit under the
current system--and bear in mind we don't change the benefits
compared to what people are getting today, the next generation
and the generation following and the generation after that gets
the same benefit--if your personal account is not enough to
equal that benefit, then the Social Security Administration
makes up the difference. So it keeps the safety net for
workers.
We, by the way, do not touch the disability program. That
needs looked at very carefully, but we see that as a separate
action on the part of the Congress.
So, Mr. Chairman, I appreciate the opportunity to come
before you. There is more that I am sure will be developed in
the question-and-answer period, and I have, I think, come close
to complying with my 5-minute limitation.
Chairman Smith. I am not sure. Either I was very
interested, or that 5 minutes went very quickly.
[The prepared statement of Mr. Archer follows:]
Prepared Statement of Hon. Bill Archer, a Representative in Congress
From the State of Texas, and Hon. Clay Shaw, a Representative in
Congress From the State of Florida
Preserving Social Security for the future is one of the most
challenging and most important tasks we will undertake as Members of
Congress. Fortunately, a strong economy and a promising budget outlook
give us an unprecedented opportunity to address Social Security's long-
term fiscal crisis.
We are seizing this opportunity by offering a proposal to save
Social Security. Our proposal, the Social Security Guarantee Plan, does
not seek to radically alter the Social Security program or change the
nature of Social Security benefits. Instead, the plan fully maintains
the current program, but reforms the way benefits are financed, making
the program affordable and sustainable for future generations.
Guiding Principles
Five main principles guided the design of the Social Security
Guarantee Plan.
1. Fully guarantee current Social Security benefits for life.
According to data from the Census Bureau, Social Security benefits
alone reduce the elderly poverty rate from 48 percent to 12 percent. If
Social Security benefits are cut, many elderly Americans will be pushed
into poverty, forcing them to rely on other government programs.
Consequently, our plan does not cut benefits for anyone, and it does
not change the defined benefit nature of the program.
2. Ensure fairness for all generations. Saving Social Security
should not place an unfair burden on young and future workers by
forcing them to pay higher taxes or settle for lower benefits. At the
same time, imposing changes on current retirees and those nearing
retirement would be unfair because these beneficiaries and workers will
not have adequate time to prepare for the changes. Our plan guarantees
current law benefits without payroll tax hikes, eliminates the earnings
limit that penalizes many working seniors, and reduces the payroll tax
in the long run.
3. Save Social Security forever. Any plan to save Social Security
should save the program for at least 75 years, the standard used by
Social Security's actuaries because it includes the working and
retirement life spans of most workers. Moreover, the plan should make
the Social Security program sustainable so we are not faced with a
cliff at the end of 75 years. In other words, at the end of 75 years,
Trust Fund balances should not be declining and the program's cash
shortfalls should not be increasing. Only by making Social Security
stable in the future can we avoid the need to constantly tinker with
payroll taxes and benefits to keep the program solvent.
4. Promote fiscal responsibility. Any plan to save Social Security
must be fiscally responsible. Our plan directly increases national
savings, thus generating economic growth, higher wages, and better
living standards. Moreover, our plan pays for itself in the long run
and generates large surpluses in the unified budget. These savings
allow us to cut the payroll tax for the first time in the program's
history. This is true even under the most conservative budgetary
assumptions.
5. Ensure political feasibility. Finally, our plan is designed to
be politically feasible. Realizing that Social Security reform cannot
happen without bipartisan support, we are offering a plan that builds
on areas of bipartisan consensus and bridges the gaps between
ideological differences. The plan fully maintains the current safety
net and fully shields individuals and their benefits from market risk.
However, it creates individual accounts so that benefits can be funded
in advance with real savings.
How the Guarantee Plan Works
Any plan to save Social Security should be simple and transparent
so that workers can easily understand how the program is changing and
how their retirement income will be affected. The Social Security
Guarantee Plan is simple, transparent, and easily understandable. The
plan can be described in four steps.
1. Annual Tax Credit. All workers would receive a refundable tax
rebate equal to 2 percent of their Social Security taxable wages earned
in 1999 and thereafter. (The maximum credit in 1999 would be $1,452,
increasing annually with average wage growth.) The credit would be
financed with general revenues so that no payroll taxes are diverted
from the current system. Proceeds from the tax rebate will be
automatically deposited into a Guarantee Account established in each
worker's name.
2. Designation of Savings Options. Workers would choose one of
several pre-approved investment options that meet safety and soundness
guidelines. The funds would be required to invest their assets in a
fixed mix of 60 percent equity index funds and 40 percent fixed income
funds. This portfolio provides a stable trade off between risk and
return and reduces the educational requirements of the program. Workers
who do not choose a savings option will be assigned to a comparable
fund.
Earnings would accrue tax free, thus increasing the compounding
power of the accounts. Accounts could not be accessed or borrowed
against for any reason prior to benefit entitlement.
3. Annuity Calculation. Upon retirement, the Social Security
Administration would calculate a monthly pay out based on the account
balances. This calculation would be similar to an annuity calculation,
accounting for life expectancy (based on unisex mortality tables),
expected inflation, expected returns on the account (which would
continue to be invested privately), and joint/survivor payments.
The worker's monthly benefit would equal the current law benefit or
the calculated monthly pay out, whichever is higher. Each month, the
monthly pay out would be transferred from the account to the Social
Security Trust Funds to help finance the worker's benefit, and the
worker would receive a single check for their entire benefit. Workers
who outlive their account balances would continue receiving full
monthly benefits financed from the Social Security Trust Funds. In
essence, workers accumulate savings during their careers to help
finance their Social Security benefits, which otherwise would not be
payable under current law. This design allows us to guarantee current
law benefits and shield workers from market risk.
4. Inheritance. If workers die prior to collecting benefits, the
account is maintained to support survivor benefits. If there are no
aged survivors, remaining account balances can be bequeathed to heirs
tax free. In contrast, if the worker dies after collecting benefits,
any remaining balances are transferred to the Trust Funds to help pay
benefits for those who outlive their account balances. This is the way
private annuities work.
The plan also creates some new benefits for both current and future
retirees. The plan would eliminate the earnings limit for all
beneficiaries age 62 and over by the year 2006. (Currently, the
earnings limit reduces Social Security benefits for approximately 1.4
million retirees.) In addition, the plan would reduce the payroll tax
rate from 12.4 percent to 9.9 in 2050. The tax rate would be further
reduced to 8.9 percent by 2060.
How Does the Guarantee Plan Save Social Security?
Social Security is facing a financing problem: the pay-as-you-go
method of financing benefits is not sustainable because the population
is aging. As the population ages, there will be fewer workers to
finance the benefits of each retiree, placing more and more pressure on
the future work force.
The Guarantee Plan alleviates this financing problem by updating
the program's Depression-era, pay-as-you-go financing mechanism. The
plan uses general revenues to finance individual accounts. The savings
that accumulate in these accounts are used to help finance future
benefits. In other words, the plan creates a savings feature within
Social Security so that worker's can save for their own retirements
instead of relying on future taxpayers. This pre-funding of benefits
reduces Social Security's unfunded liabilities and reduces the
program's annual costs. As a result, Social Security surpluses
reemerge. These surpluses allow us to reduce the payroll tax rate from
12.4 percent to 8.9 percent by 2060. If these surpluses are not
returned to workers, they will accumulate in government coffers where
they will undoubtedly be used to finance new spending initiatives.
According to Social Security's actuaries, our plan reduces Social
Security's costs, generates Social Security surpluses, allows future
payroll tax reductions, and saves the program beyond 75 years. Most
importantly, the plan eliminates the cliff effect. In other words, the
program's financing is sustainable in the long run with healthy cash
flows and growing Trust Fund balances. Thus, the program does not fall
off a cliff in the 76th year (see graph).
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Budgetary Effects of the Guarantee Plan
Social Security has been running annual surpluses since the early
1980's. These surpluses have been used to finance deficits in the rest
of the government, thus improving the unified budget. This situation
will quickly reverse itself early in the next century. According to
Social Security's Trustees, program costs will exceed income beginning
in 2014, and the Treasury will have to come up with the cash needed to
draw down the Trust Funds. Between 2014 and 2034 (when the Trust Funds
are depleted), these cash shortfalls will total $7.5 trillion, placing
a large strain on the Federal budget. Unless the government defaults on
future promised benefits, the Treasury will have to come up with
another $106 trillion to pay benefits for the remainder of the 75-year
period.
As explained earlier, the Social Security Guarantee Plan uses
general revenues to finance individual accounts. Account balances are
used to pre-fund Social Security benefits, thus reducing the program's
future unfunded liabilities. In sum, the plan increases General Fund
costs, but reduces Social Security costs. Over time, the savings to
Social Security will outweigh the cost of financing the accounts, thus
generating unified budget surpluses.
According to long-range estimates from Social Security's actuaries,
the plan will pay for itself on a cash flow basis by 2031. When
financing costs are included, the plan pays for itself by 2047 and
generates $122 trillion of unified budget surpluses over the entire 75-
year period. These surpluses allow a 2.5 percentage point reduction in
the payroll tax rate in 2050, and a further 1 percentage point
reduction in 2060.
Over the first 15 years, the plan is fully financed with Social
Security surpluses. For the first time ever, Social Security surpluses
will actually be set aside to pay Social Security benefits. Beyond the
first 15 years, the plan will be financed with budget surpluses (if
available) or with other financing mechanisms. Data from Social
Security's actuaries show that even if the program is financed with
public debt from day one (which won't happen because we have Social
Security surpluses for the first 15 years), the plan still saves Social
Security, pays for itself in the long run, generates $122 trillion of
unified budget surpluses, and pays off any loans created by the
program. Thus, the plan works even if we never have budget surpluses at
any point in time over the next 75 years.
Moreover, the plan does not rely on historical rates of return to
save Social Security. A sensitivity analysis conducted by Social
Security's actuaries shows that the plan would practically eliminate
Social Security's long-term deficit even if the rate of return is as
low as 4.35 percent. (A 4.35 percent return would reduce the long-term
deficit from 2.07 percent to 0.08 percent). Even if the rate of return
is zero, we would still be better off than under current law because
cash balances would be available to pay future benefits.
Economic Effects of the Guarantee Plan
The Guarantee Plan would primarily affect the economy by increasing
national savings. National savings is the sum of government savings and
private savings. Thus, national savings increases when the government
pays down the public debt and when businesses and households save more
money.
Over the next 15 years, the Guarantee Plan uses Social Security
surpluses to finance individual accounts, which are invested in private
financial markets. This money directly increases private savings and,
therefore, increases national savings as well. In essence, the
Guarantee Plan has the same beneficial effects as public debt
reduction: more money is channeled into the private financial markets
where it is invested in productive assets that generate economic
growth.\1\
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\1\ Individual accounts may cause some people to save less in other
forms so that national savings does not increase dollar-for-dollar by
the amount contributed to the accounts. However, leakages occur with
public debt reduction as well. For instance, some of the money that is
no longer tied up in Treasury securities may flow to overseas
investments or be used to finance consumption. Thus, it cannot be
claimed that public debt reduction results in more national savings
than financing individual accounts.
---------------------------------------------------------------------------
However, using the surpluses to finance individual accounts is a
more effective way of increasing national savings than public debt
reduction. Surpluses can only be used to reduce the public debt if they
are not spent by politicians as they arise. Allocating the surpluses to
individual accounts ensures that the money will actually be saved and
not spent. In essence, the Guarantee Plan creates the strongest lock
box ever by taking the money out of Washington and putting it into
individual accounts where it can be invested productively.
Economic effects beyond the first 15 years depend on the budget
outlook at that time. To the extent that the Guarantee Plan increases
national savings in the first 15 years, it is more likely that future
surpluses may materialize. If future surpluses do not materialize, the
government may have to borrow to finance the accounts. However, this
borrowing would not adversely affect the economy because the proceeds
will go directly into the financial markets: government savings will
fall by a dollar, but private savings will increase by a dollar.
Moreover, the return on the private savings will outweigh the interest
owed on the government debt.
Addressing Concerns
This section address two of the most common concerns about the
Social Security Guarantee Plan.
account balances are ``confiscated'' at retirement
Every individual account proposal has some mechanism by which
Social Security's costs are reduced. Some plans reduce Social
Security's guaranteed benefit and use account balances to supplement
the reduced benefit. Other plans offset Social Security's guaranteed
benefit by the amount contributed to the accounts grown at some
hypothetical rate of return. Still other plans use a combination. The
Social Security Guarantee Plan transfers account balances to the Social
Security Trust Funds to help finance workers' benefits. This method was
chosen for three reasons.
First, it allows us to maintain the defined benefit nature of the
program. Social Security is a safety net--it is not, and was never
intended to be, a primary source of income during retirement. As a
safety net, Social Security should provide a guaranteed benefit. In
fact, a series of nationwide surveys found that a small majority of
Americans favor allowing workers to have personal retirement accounts.
However, when forced to choose between retirement accounts and a
guaranteed, exact benefit, 59 percent prefer the exact benefit and only
33 percent opt for individual accounts.\2\ Turning Social Security into
a defined contribution plan reduces its role as a safety net and
creates direct competition with private savings and employer pension
plans.
---------------------------------------------------------------------------
\2\ Americans Discuss Social Security, Report to Congress, June
1999
---------------------------------------------------------------------------
Second, it enables us to shield individuals and their benefits from
market risk. Under the Guarantee Plan, all risk is born by the
government, not the individual. Other mechanisms of reducing Social
Security's costs place workers and their benefits at risk--some people
may do better than current law, but others will do worse.
Third, it allows workers to continue receiving one check from the
Social Security Administration for the full amount of their benefit.
Providing workers with one check for their full benefit emphasizes our
commitment to maintain the program, not dismantle it.
general revenues will be used to support the program for the first time
ever
Every single individual account proposal that restores Social
Security's solvency for 75 years relies on general revenues to some
extent. Some of the plans create a permanent claim on the General Fund,
and this claim increases in the future.
The important question is whether the use of general revenues
increases or reduces the overall burden on taxpayers. As explained
earlier, the use of general revenues in the Guarantee Plan is offset by
savings to the Social Security program. Over time, the savings to
Social Security outweigh the use of general revenues, resulting in a
lower overall burden on taxpayers. The lower burden is clearly embodied
in the fact that the future payroll tax cut is larger than the cost of
financing the accounts.
In the long run, the total cost of supporting the Social Security
system is lower under the Guarantee plan than it is under most of the
individual account proposals that restore 75-year solvency.
Thus, the Guarantee Plan does use general revenues, but it also
reduces the taxpayer burden significantly relative to current law.
Moreover, every dollar of general revenues goes directly to the private
financial markets where it is available for business investment. This
is the most productive use of general revenues.
The plan simply pumps more money into the system without fixing the
problem.
We believe that Social Security is facing a financing problem, and
fixing that problem should not equate to cutting benefits. We fix the
financing problem by using general revenues to pre-fund future
benefits. This pre-funding substantially reduces Social Security's
annual costs so that the overall cost of running the program (including
the cost of financing the accounts) is lower than current law. For
example, under current law, the average 75-year cost of supporting
Social Security is 16.64 percent of taxable payroll. Under the
Guarantee Plan, the average 75-year cost of supporting Social Security
is only 14.57 percent. (The cost of paying benefits is 12.57 percent
and the cost of financing the accounts is 2 percent.)
In fact, when all costs of supporting Social Security are taken
into account (i.e., paying benefits, funding individual accounts,
general revenue transfers to the Trust Funds, etc.) the Guarantee Plan
is less expensive than almost all of the individual account proposals
that have been estimated as restoring 75-year solvency (see Figure 2 on
the following page). Thus, the total taxpayer burden of supporting
Social Security is smaller under the Guarantee Plan than under most
other proposals to save Social Security. Figures showing otherwise
exclude the general revenue transfers to the Trust Fund.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Chairman Smith. Mr. Shaw.
STATEMENT OF HON. E. CLAY SHAW, JR., A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF FLORIDA
Mr. Shaw. Thank you, Mr. Chairman, members of the
committee. I will be very, very brief. I think Chairman Archer
adequately described where we are. Our joint full statement is
a part of the record of this hearing.
There are many good plans out there. Mr. Chairman, you have
one. You will be hearing others coming in for the balance of
the day. All of these are improvements over existing law. We
have got to do something, and I think that has to be
underscored.
Mr. Archer and I decided at the early moment that we were
not going to touch the existing Social Security System, and I
think that is very, very important. The law that eventually
goes on the books, if it is anywhere near the Archer-Shaw bill,
will leave Social Security totally alone. We do not touch it,
and I think that is very important to remember. It sets up a
refundable tax credit that will be scored wonderfully in
regards to all taxpayers. It will set this fund up to rescue
Social Security.
When you look at the funding over 75 years, you find only
one plan is less expensive than the Archer-Shaw bill, and that
is the Smith bill, and it is only by a very small amount.
Politically, there is no way that this Congress on either side
of the aisle is going to raise FICA taxes. So that is simply
not going to happen.
I think also you will find a great reluctance by either
political party to step out in front on interfering with the
benefits.
It is a must that we do something. What you have before you
right now with the Archer-Shaw plan is a centrist approach. It
is certainly not the most liberal, and it is not the most
conservative. We have been abused from both sides of the
political spectrum, and I think that once we have an
opportunity to go over this with both of our conferences on the
Republican and the Democrat side, I think our plan will provide
the basic roots of the plan that the Congress will eventually
adopt.
I hope that this does happen. It is going to be more
difficult to do it in 2 years than it is in this Congress. It
is going to be more expensive the longer we wait. The prospect
of doing nothing is absolutely frightening, and it would be a
disgraceful mark in history if this Congress fails to take care
of the next generation and allows this thing to go the way it
is going.
It is important to remember that when Social Security was
first put together, there were 42 workers for each retiree. Now
there are three. Soon there will be two. This is a huge burden
that the next generation cannot handle. It is important that we
act, and act now. We have lead time. And it is important that
we enact this legislation, and I think that the bill that is
before you is certainly the most politically doable, and I
would hope that we move ahead with it.
Thank you, Mr. Chairman.
Chairman Smith. Gentlemen, thank you. And my compliments,
because I think the Chairman of the Ways and Means Committee
and the Chairman of the subcommittee overseeing Social Security
introducing a bill is part of the reason that we have generated
more interest in this problem, part of the reason that there
are more individuals offering their proposals. So you have
moved the debate much further ahead than it would otherwise
have been.
Do I understand the proposal to just use surpluses coming
into the unified budget, or does it mandate that some of this
money come out of the general fund regardless of surpluses?
Mr. Archer. Depends what your projections are, Mr.
Chairman. We have not seen a run-out of the latest projections
that OMB has made relative to the surplus, and we don't know
and will not know until the end of this week or at least
Thursday what CBO will do in that regard, and we will have to
overlay that new projection on the plan.
Chairman Smith. But would the legislation itself provide
for this kind of 2 percent of taxable payroll funded regardless
of surpluses?
Mr. Archer. Well, Mr. Chairman and members of the
committee, because you deal with the very arcane aspects of how
we budget, I will take a moment to get into that, if I may. It
is not understood too much by the average citizen outside the
Beltway.
The money that goes into Social Security is immediately
invested in Treasury bonds. It cannot be spent for anything
else. Because we have, I think inappropriately over the years,
assumed that that can be double-counted and create another
surplus, we are dealing today with those kind of semantics and
that sort of an approach. I think it is inappropriate,
personally, but the entire budgeting concept double-counts the
Social Security surplus.
If you have already invested it in Treasury bonds, it
cannot be used for anything else. And you say, oh, but we still
have it again, and we can spend it. That is basically not true.
So all of the monies that become a part of any one of the
Social Security plans that you are holding your hearing on
involve the use of general Treasury money. They have to. And I
just think that needs to be made clear, and ours does, too.
Most all of the plans, and perhaps all of them, have some
sort of personal retirement accounts as a part of their
proposal. Those personal retirement accounts are funded out of
general Treasury money. If they are funded out of reduction in
the payroll tax, and more money has to be put out of the
general Treasury into the Social Security fund in order to make
up that difference, you create bankruptcy at an earlier date.
So I think we need to cut through an awful lot of this in a
way that members of this committee can do, and understand, yes,
every plan uses general Treasury money, and ours is no
different.
Chairman Smith. I was just wondering, Mr. Chairman, if it
is mandated in the proposal or whether it is somewhat dependent
on whether or not there is a surplus. But you don't predicate
it in your legislation that you are working on the draft----
Mr. Archer. No, and I assume that every one of the
proposals that has been put before you does not mandate a
surplus because we cannot predict in the future what our
economic conditions are going to be. And yet if every one of
them is going to solve the Social Security problem, which I
think we must do, no one can predict for sure whether there
will be enough surplus to take care of it or not.
Chairman Smith. Have you calculated if there is any income
level or any age level where that 2 percent investment would
ever totally replace the fixed benefit portion of Social
Security?
Mr. Archer. Mr. Chairman, based on the Social Security
actuaries' projections, and they picked the rate of return, we
did not, they said that under our plan the rate of return would
be 5.3 percent in real terms. If that were to go up in reality,
then it is possible some of the accounts could be in excess of
the Social Security benefit. But if it does not over the 75-
year period exceed the 5.3 percent, then none of the accounts
would be in excess of the Social Security benefit.
Chairman Smith. We had some medical futurists guess that
within 40 years, it is reasonable to expect life expectancy
between 100 and 120. How would that affect your plan? A great
deal, probably?
Mr. Archer. No, all--I think the only standard that we can
use, Mr. Chairman, is Social Security actuaries. And we can
project or have personal predictions as to what we think might
happen. But when you judge these plans, they have to all stand
side by side based on the evaluation of the Social Security
actuaries.
Chairman Smith. Congressman Collins.
Mr. Archer. And you are young enough to both enjoy that
life expectancy.
Mr. Collins. Might live to be 100, but the question is will
you know that you are at 100? I think the mind is the first
thing to go.
I just want to say I commend the two gentlemen. This is the
second time I think in 3 weeks that Wally Herger and I have had
the opportunity to sit up here and look down at them. They both
sit above the dais from us on Ways and Means. It is a privilege
to work with both and serve with Chairman Shaw on the Social
Security subcommittee.
I have heard a great deal about this plan, so I have no
more questions. We have discussed it in detail personally. But
I do want to say that back in December when we were at the
White House for the White House Conference on Social Security,
it was emphasized then by the Commissioner of Social Security
that the administration needs to move forward not just with a
plan of how to reform or save the retirement system or
retirement security system, but also to move forward with a
plan that would establish trust between the administration and
the Congress.
Because as Chairman Archer has stated, until we have trust,
until we have a situation where we know that we can talk about
the situation seriously and with an intent to move forward with
reform, we will never get anywhere with this. And so therefore
I appreciate these two gentlemen, I appreciate the work that
they have done. They have put theirs on the table. They trust.
They trust the American people, and they trust the Members of
Congress, and I know they trust the administration or they
would not reveal their wares. I just wish the administration
had the same initiative and the same trust for us as we have
for him. Thank you.
Chairman Smith. Congressman Toomey.
Mr. Toomey. Thank you, Mr. Chairman. I would just like to
reflect for a moment on what I think you have accomplished with
this plan, which is a very interesting approach. It seems that
this is a strategy designed to save Social Security in
essentially its current form by eliminating the funding
liability problem, but without making profound changes in the
nature of the program. And I say that because it seems to me
that there is really quite little flexibility in investment
options for these personal accounts. There is little or no
upside, as I can see it, in terms of the return on that
investment for--certainly for most workers that are currently
in the work force. And you don't have a complete ownership in
the accounts because you force an annuitization whereby the
moment after retirement, the value of one's entire savings is
turned over to the government.
Did you consider an alternative approach which would give
greater flexibility to workers, the freedom to make various
investment decisions, and ask people to live with the
consequences of those decisions, either greater returns or
lesser as the case may be?
Mr. Archer. Well, you have, Congressman Toomey, and you
have asked, I think, a very good question. You have to weigh
risk against gain. Clearly, if you happen to be lucky and you
take a bigger risk, you are going to have a bigger gain, but
you also have a greater risk of loss, and that has always got
to be considered. I don't believe we can leave the workers with
an account that is funded by the taxpayers, which all of these
programs provide in one way or other, with the free opportunity
to invest in Uncle Joe's automobile repair shop or whatever
else. And if you are referring to that, no, I don't think we
can ever reach that point in any one of these plans.
Now, I don't know what the limitations are in the
Chairman's plan, and I will say this, the Chairman comes
forward and says, look, we are going to abolish Social Security
ultimately, and we are going to rely totally on personal
retirement accounts, and his plan stands apart from the rest of
the plans in that regard. I personally do not think that is
politically doable.
As far as whether you have personal ownership, if you do
not require conversion to an annuity at the time of retirement,
you will have those people who live beyond actual life
expectancy having exhausted their retirement account, and they
will become a ward of government potentially. So it seems to me
that any plan is going to have to have a requirement that there
be an annuitization at the time of retirement to eliminate the
winners and the losers.
I don't know how else you can validly look at the future.
Once you annuitize, you have nothing left to leave to your
heirs in anybody's plans. If you annuitize an IRA today, you
have nothing left. You have turned over your property ownership
to a third party that has agreed to pay you a certain amount of
money for the rest of your life per month, and that is all this
we do in our plan.
Mr. Toomey. One of the alternatives, for instance, that is
implemented in Chile is that the amount that is required to be
annuitized is such that you provide a relatively minimal
benefit and give flexibility with any savings above and beyond
that. That would be an alternative.
Mr. Archer. But we are, number one, not Chile. And even
Jose Pinera, whom I have gotten to know very well, does not say
that what he has designed for Chile is appropriate for the
United States.
I think we have reached the area importantly that will
accomplish the end result. Let workers, if they die prior to
retirement, leave that money to their heirs if they want to
keep it through retirement. They don't have to retire. They can
then leave it to their heirs at the time of their death if they
do not elect to annuitize and to retire and on to get the
coverage of the safety net of the Social Security System.
So I believe that we have given property rights to people.
That money continues to be theirs. It continues to stay in
their account. The title is theirs, not the Federal
Government's. But they are required, if they are going to
retire, to annuitize, and that is not very different than many
other systems.
Of course, I don't know what Chairman Smith does relative
to the long range once Social Security is no longer there, but,
of course, Chile guarantees a minimum benefit, which is the
equivalent of guaranteeing a Social Security benefit for all
time to workers so that if their account falls below an amount
that is enough to be able to pay that minimum benefit, the
government still has to reach in. It has that continuous
obligation for all time. It is not funded, but it is there. And
there are variations to all of these systems.
Chairman Smith. The gentleman's time has expired. I would
just like to say----
Mr. Shaw. Mr. Chairman, could I comment briefly on that
answer?
Chairman Smith. Yes. Let me just say very briefly that my
proposal never goes above 8.4 percent that would ever go into
the private savings accounts to make sure that there is
adequate money there for the disability, and we do have a
safety net.
Mr. Shaw.
Mr. Shaw. With regard to the very nature of Social Security
and the very nature of it, it can be described as the greatest
antipoverty program ever put in place here in this country.
Lower-wage people may not have the sophistication to do
investments, and those are the ones we have to be most
concerned about. We have to be sure that the investments are
made in a sensible way--that they are widespread, and that they
are done by capable people.
There are elements of ownership included in our plan. As
the Chairman said, you have property rights in your individual
retirement account. If you die before retirement, you can will
it away if it is not necessary to take care of survivor
benefits. So there are some very strong ownership rights. By
case law right now, none of us have a vested interest that we
can enforce in Social Security if Congress decides to change
the system. This would be an absolute property right, and we
have drawn the bill up in such a way so that future Congresses,
although they can change the law, but they cannot take away
what is in your individual retirement account.
Also it is important to understand that you pick your time
of retirement. If you decide you do not want to retire, and you
want to leave the individual retirement account to your heirs,
you can do it, and it passes along estate-tax-free--no estate
tax. Also we do away with the earnings limit, which has not
been mentioned here, which is a position that is immensely
popular among our seniors. Right now it makes absolutely no
sense for us to penalize the guy who has to bag groceries down
at the grocery store in order to supplement his income and not
penalize the guy who has $100,000 a year coming in in interest
and dividends.
Chairman Smith. Mr. Ryan.
Mr. Ryan. Thank you very much for coming. I wanted to ask
you a few budgetary questions from the Budget Committee's
perspective.
When you first gave us your original briefing 2 months ago,
it was my understanding that you were relying mostly on the
off-budget surplus to fund the beginning part of the plan, then
the on-budget surplus in the outyears. Right now our
projections show us that we have an off-budget Social Security
surplus of $1.8 trillion, and on-budget is $778 billion. Those
numbers are going to be changed to our benefit in the next few
days, and we eagerly await those numbers.
But now looking at the summary, it looks like that you are
relying solely on on-budget surpluses to fund the annual tax
credit. Is that correct? Is that a change in the plan from its
inception?
Mr. Archer. The answer to that is no, Mr. Ryan. There is
not a change.
Mr. Ryan. So you are relying on----
Mr. Archer. We are living within--when we budget, as you
know, we budget only out 10 years in the Congress.
Mr. Ryan. Right.
Mr. Archer. And in that 10-year period we are living
totally within the walled-off lockbox Social Security surpluses
which are put there for the purpose of saving Social Security.
Mr. Ryan. So you are relying exclusively on the $1.8
trillion off-budget surplus; not going into the on-budget
surpluses of $778 billion?
Mr. Archer. That is correct. And let me also add, one of
the tremendous advantages of our plan is that it establishes
with certification from SSA the ability to save Social Security
for all time, improving in the outyears rather than hitting a
cliff, and that is something that we should always be concerned
about on the basis of $1.3 trillion over the next 10 years.
Now, that includes----
Mr. Ryan. Freeing up 500?
Mr. Archer. That includes the interest. Actual outlays are
$900 billion to save Social Security, but because you are no
longer putting all of that money to pay down the debt, you have
to recapture the interest charges, and that gets you up to $1.3
trillion, that is included in that surplus of $1.8 trillion. So
we have a half trillion dollars available for other purposes
after having saved Social Security.
Now, with the new projections, and we don't know what CBO
is going to do, but under OMB's projections we will have
roughly an additional $150 billion over that 10-year period.
Mr. Ryan. Now, as you know, the mix of surpluses between
on-budget and off-budget surpluses, the proportions change
fairly drastically over the next 10 years. Right now it is
entirely--before we find out in the next few days we are going
to have an on-budget surplus, but right now the surplus is
almost entirely off-budget. Social Security. And that begins to
go down very rapidly over the next 10 years, and the on-budget
surplus starts from basically nothing now and then gets very
large and basically is the entire surplus at the end of our 10-
year window.
Does your plan at any time on its year-to-year basis go
into the on-budget surplus for its $1.3 trillion calculation?
The reason I am asking this is because if we are reserving our
on-budget surpluses, income tax overpayments, for the tax bill
that you will be marking up in committee, will your plan dip
into your ability to provide that on-budget surplus tax cut?
Are we running into each other on this thing?
The tax bill that the Ways and Means Committee has to
produce will be solely from the on-budget surplus and hopefully
all of the on-budget surplus. But this plan relies on a $1.3
trillion stream which is in the outyears of our 10-year window.
I assume that the annual revenue that you require for your plan
is fairly substantial. Does that begin to eat into the on-
budget surplus?
Mr. Archer. Well, first--that is an excellent question.
Under the projections prior to the update which we expect this
week, we do go slightly for a few years into the on-budget
surplus. But you have got to also remember that we are not
dealing in a vacuum. We are not using all of what has been
locked up in the off-budget surpluses, and that extra money is
going to be available on an amortized basis to go out into
those years that begin 15 or 20 years out.
And the interest on that money is also available, coupled
with the fact that, as I mentioned over the 75-year basis, and
I believe that our program does a better job on this than
anybody else's, we generate a unified budget surplus of $122
trillion. And I know the gentleman from Wisconsin looks at
things long term, because I have talked to you too many times.
And there is no doubt that even if we went into the on-budget
surplus temporarily, in a relatively small amount in a
transition number of years, that even if we had to borrow the
monoamortizeable bonds, we would come out way ahead by virtue
of the $122 trillion unified budget surplus that comes under
our plan. And to me, that is what we have got to do more of, is
look at the long term and not simply the short term.
Mr. Ryan. So you don't see our goals as mutually exclusive
of fashioning a tax bill out of the Ways and Means Committee
that relies on the on-budget surplus and passing your plan?
Mr. Archer. I do not. But again I think we have to look at
the new projections and see what they show for those
intervening years at the same time. And then we have got to
throw in the interest that will be on the amount of the off-
budget surplus that we have not used that literally can be
attributed to that period of time which otherwise would not be
there.
Mr. Ryan. I think Gene Sperling said today that it was
going to be $107 billion over 10 years interest savings we will
have accomplished.
Mr. Shaw. It is important to realize that we don't go into
on-budget financing until after 2015. Our plan is completely
funded from the Social Security surplus until that time.
Chairman Archer spoke about going into it for a relatively
short time. This generates $43 trillion of Social Security
surpluses after 2044, which allow the payroll taxes to actually
be reduced from 12.4 percent to 8.9. That is huge.
It is important to realize here that we are legislating for
the next generation. We are going to have a completely funded
pension system for American workers. But you have got to get
over the transition.
Mr. Ryan. That is your chart on page 4, right?
Chairman Smith. The gentleman's time has expired.
Mr. Archer. Mr. Chairman, would you indulge me just to jump
in a little bit and tie together what Congressman Ryan and what
Congressman Toomey were saying. In Chile, there had to be added
debt. They had to take on added debt in order to make their
program work. And it was amortized over a period of years for
them to be able to come out with their final result.
I hope we will not have to do that, but if we did it in a
program that was the right kind of program where we are putting
money to work and creating wealth and more personal savings for
a temporary period of time in order to be able to get to the
long-term tremendous benefits, that is not bad fiscal policy.
Mr. Ryan. Thank you very much, gentlemen.
Chairman Smith. Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman. I want to thank both
of the gentlemen, our two Chairmen, Chairman Archer and
Chairman Shaw, for the courage you have taken. I was present in
several of our Ways and Means meetings when we were discussing
whether or not you would move forward, whether or not it was
wise to move forward or not, and I know at that time there was
a lot of discussion about the possible repercussions, that
maybe this was not the time to come out with a plan. And I want
to thank you for having the courage to move forward as you have
with a plan that I think is very beneficial, and so I thank the
two Chairmen, and I know we have Chairman Kasich coming up. I
will end with that. But thank you very much for what you have
offered.
Chairman Smith. A final comment?
Mr. Archer. Yes, Mr. Chairman, very briefly, and we could
probably go on for several hours with the comparison of plans.
To legislate a CPI fix, which is part of many of these plans,
shows a benefit to the Social Security outflow, a reduction in
the Social Security benefit outflow, but it also is a hidden
tax on middle-income Americans when applied to the income tax.
It is a sword that has two edges. It helps on Social Security;
it hurts middle-income people by raising the amount of their
income taxes which are now indexed for inflation. And I don't
think we can be oblivious to that.
Finally, I would say, Mr. Chairman, we have an analysis
here of the various plans that we know about today, of which
there are eight, as to their total cost in order to create a
saving of the Social Security system. And I would like to
insert that in the record, if I might.
And let me just refer to the year 2074, which is the end of
the 75-year period, the total cost of the Archer-Shaw 12.11
percent of payroll. The total cost of the Sanford plan is 18.38
percent of payroll. And the total cost of the Chairman's plan,
which is one of the least costly, is 13.23 percent of payroll.
So in that final year, and those projections will work out
in the following years, our plan costs 1 percent of payroll
less than the next least costly plan. And actually, that is
John Kasich's plan, which is 13.08 percent of payroll. So, if I
may, I would like to insert this data into the record.
Chairman Smith. Mr. Shaw.
Mr. Shaw. Mr. Ryan was making the comment regarding his
concern about whether the tax dollars or general revenue on-
budget comes in to have to pay these benefits. It is important
that all of us not lose sight of the fact that in the year
2014, tax dollars are going to have to start cashing in these
Treasury bills. That is when the Social Security surplus dries
up. We don't have until 2032 or 2055. Building up more Treasury
bills within the Social Security Trust Fund is not going to in
any way delay the Congress' having to appropriate revenue in
order to have to take care of the benefits. 2014 is our drop-
dead date. That is the date we have to be very concerned about.
Chairman Smith. Absolutely. Gentlemen, thank you very much
again.
Mr. Kasich, who was written up today in the Wall Street
Journal as being a brave soul in coming ahead with legislation
to save Social Security.
[The information referred to follows:]
[From the Wall Street Journal, June 28, 1999]
How to Save Social Security
by john r. kasich
Most Americans know that Social Security is headed toward
bankruptcy. Nothing makes the point better than the poll taken a couple
of years ago in which young people said they had a better chance of
spotting a UFO than receiving Social Security benefits.
But many may not know why the system is threatened. In order to
develop a solution-one that meets my goal of saving Social Security for
today's retirees and those near retirement, the baby boomers and their
children-we need to understand the serious difficulties facing Social
Security.
Believe it or not, in 1945 there were about 42 workers for each
person receiving Social Security benefits. By 1960, that ratio had
shrunk to about 5 to 1. Today, it's 3.4 to one and by 2030, there will
be just 2.1 workers for each beneficiary.
At the same time, Americans are living longer. That's good news.
But it means retirees will receive benefits for a longer period.
Americans are also having fewer children, which means relatively fewer
workers paying Social Security payroll taxes. It is those taxes that
finance current benefits.
Aside from these demographic trends, first-time Social Security
benefits are growing far faster than inflation. These benefits now rise
with overall wage growth, and wages are rising faster than prices. The
result: over the next 75 years, benefits will increase more than 20
times, while prices will go up at half that rate. A retiree in 2060,
for example, has been promised annual benefits starting at over
$140,000.
The result is a system that would require people in the future to
work longer hours and pay more in taxes to support retirees. By 2034,
payroll taxes would need to be increased by 50% to pay promised
benefits or benefits would need to be slashed. Between now and 2070,
benefits will exceed payroll taxes by a cumulative $120 trillion.
Is it any wonder young people don't expect to receive their Social
Security?
We must do better, and we can. Every generation of Americans has
left a legacy of prosperity for its children. We cannot let our legacy
be a Social Security system drowning in a sea of red ink.
My plan does not affect current retirees and those nearing
retirement-benefits for those now 55 or older would be untouched.
Neither would it increase the retirement age above current law,
increase payroll taxes or reduce annual cost-of-living adjustments
(COLAs), now or in the future.
We save Social Security by making two fundamental changes to the
system for those now under 55. First, this plan changes the way first-
time benefits will be calculated. These benefits now rise with overall
wage growth. Under my plan, growth in initial benefits would be linked
to the consumer price index. Initial benefits would still rise over
time, only at a slower rate. Instead of rising 20 times over the next
75 years, they will increase by a factor of 10.
Switching from wage indexing to price indexing will eliminate the
unfunded liability of the Social Security system and allow us to avoid
increasing the payroll tax for young workers. At the same time, future
workers could count on receiving their benefits.
Second, workers currently contribute 6.2% of their wages to Social
Security. My proposal allows workers under 55 the option of
establishing their own personal savings accounts. Contributions into
these accounts would range from 3.5% of wages for low income workers to
1% for those at high income levels. Workers who choose to contribute to
these accounts would have a variety of investment options and could
withdraw proceeds upon retirement. But as they will be paying less into
Social Security, their Social Security benefit will be slightly
reduced. The basic Social Security benefit will be reduced by 25 cents
on the dollar for each dollar they receive from their personal savings
account.
Nonetheless, the private investment account option should offer
most recipients the opportunity for greater returns than Social
Security alone could generate.
Yes, we are asking some in the baby boom generation to insure the
solvency of Social Security by making a sacrifice in terms of accepting
a slightly lower initial benefit. An average 45-year-old male, for
example, would receive about 1.7% less under my plan, but look what
happens in return. First, he is assured of receiving benefits because
the solvency of Social Security is assured. More important, his
children will receive far more in benefits. Under my plan a 25-year-old
male who takes advantage of the personal savings account option should
receive 19% more in benefits than promised under the existing system,
based on historical averages for conservative investments.
Today's retirees and those nearing retirement will receive their
benefits just as they expected. Younger workers can not only count on
receiving benefits, they will not have to worry about the prospect of
working longer hours and paying increased payroll taxes that would
otherwise be needed to keep the current system afloat. If they take
advantage of the personal savings account option, they'll have more
control over their own retirement resources and the opportunity for
greater overall benefits than under our current Social Security system-
even if it could pay all their promised benefits.
Finally, and most important, my plan is honest and realistic. The
problems facing Social Security have built up for so long and become so
mammoth that everyone must realize they cannot just be wished away.
This plan makes clear the costs and benefits, and it avoids false
promises.
If we are truly concerned about saving Social Security, there is no
better plan than this one and no better time to start than today. If we
face the challenge now, we can provide for our retirement security
without sacrificing our children's and grandchildren's standard of
living.
STATEMENT OF THE HON. JOHN KASICH, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF OHIO
Mr. Kasich. I want to thank Mr. Stenholm for letting me
slide in here. I want to just basically lay out precisely what
we are doing. As I know you have had a number of hearings and
the full committee is going to start having hearings very soon,
there are really fundamentally, as you know, three things I
hope you know, three things that are driving Social Security to
bankruptcy. One, of course, is demographics which we all know
about; the second issue is that people obviously are living
much longer, which is great news, which also contributes to the
fiscal situation with Social Security; but the third reason is
the way in which we create initial benefits for Social
Security, which is based on a wages and prices program that was
designed to replace wages of people when most Americans were
fundamentally below poverty. In fact, many years ago, the
Social Security program represented a percentage of poverty and
now we are providing money well above the poverty rate.
That is all good. In fact, what has happened is senior
citizens have been able to systematically move out of poverty.
But here is what I get down to in this program:
First of all, this is not sustainable. And it is not
sustainable because of this large factor of growth in these
initial benefits, this initial starting point. If what we were
to do was to--I don't finish, you know, the complicated factor
whereby benefits are initially established, but in the year you
turn 60, they take the average wage of every American and they
divide it by the average wage of your other 34 years in the
workplace, because they come up with this initial benefit based
on 35 years' worth of work.
They take the average wage when you are 60, divide it by
the average wage of your other 34 years, multiply times your
income, which gives you a yearly number. Then they break it
down into 12 months and then they replace the first amount of
income with 90 percent of your income at the low levels. It is
a very complicated formula. And it is a factor of wages and
prices that establish your initial benefit.
I think that first of all, it is essential that we make
Social Security balance, flat out; that we need to make sure
that the program is not just based on economic factors that are
removed from Social Security. I think we need to make Social
Security balance in and of itself and then create the
individual retirement accounts that allow us to have more
growth than what the benefits provide.
Now, Mr. Herger, if we were to establish the initial
benefit in this complicated formula on the basis of prices,
which is exactly how our seniors today have their benefits
determined, and we exclude wages, what we will do is we will
balance the Social Security program. Period. Flat out. It will
balance. In a number of years, but it will balance.
And then what we do in this program is to then permit you
to have a part of your payroll tax for investing in the private
economy. Now if you are a 45-year-old man under my program,
over your lifetime you will receive 1.7 percent less than what
you were promised by the government, but your 25-year-old son
would be able to earn 20 percent more than what the current
system promises.
You would have an individual retirement account established
under your name. It would be an individual retirement account
that you could have as part of your estate. The government
would not recapture it. The government doesn't own it, you own
it. And it is amazing when you stop and think that for a 45-
year-old man to give up a total of 1.7 percent in benefits over
a lifetime in exchange for having his son or his daughter in a
position of where they can earn at least 20 more than what
Social Security promises, and we know that Social Security
promises are empty promises, you will have balanced the system
forever. It will not be based on just the theory of how fast
the economy grows; it will be based on the fact that we brought
Social Security into balance and add on top of it an individual
retirement account that we control.
It does nothing beyond that. It does not affect the cost of
living increases, it doesn't affect anymore the CPI. It
essentially says we balance Social Security by slowing that
starting point and in exchange giving Americans the freedom and
the security to be able to have individual retirement accounts
out of their current payroll taxes that would provide for a
very secure system.
I maintain that in this whole debate on Social Security,
the issue of wages and prices have never emerged before, I have
never heard it discussed before. The beauty of this is it
doesn't mean we have to go in and change anybody's COLAs. It
doesn't mean we have to monkey around with the CPI.
But I want to commend my friends, Mr. Kolbe and Mr.
Stenholm, because I think frankly they have been the leaders on
this. No question. And every time I look at how you can get
there, you try to build a better mousetrap. I believe that if
we can slow the starting point, politically it is the best way
to go.
Secondly, economically, it is the best way to go, and
thirdly, not only will it balance the system, but it will
guarantee retirement security for every American based on the
notion that the long-term rate of return is at 5.3 percent with
60/40 investment in stocks and bonds. I mean, think about this.
The other thing I want to make is that nobody knows what
their starting point is with Social Security anyway. Nobody
sits around and calculates the 35 years and the replacement
wage. Nobody knows that. So if we just tell the baby boomers
that you have got to take a little bit less--and the other
final point is, if you are under the age of 45, you don't lose
anything because the power of compound interest makes up for
those benefits that you have foregone in terms of your starting
point.
So virtually everybody in America wins and we have balanced
the system. Do you understand what I am suggesting? If we do
not slow the growth in the starting point of benefits, you
cannot fix this problem. You cannot guarantee a fix of this
problem. That is why it is necessary to do both things: To slow
the growth and starting point of the benefits while at the same
time giving people the economic freedom to invest in our
economy.
Mr. Chairman, thank you for giving me the opportunity to be
here and I hope you will take a very good look at this approach
to this problem that needs to be resolved.
[The information referred to follows:]
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Initial benefits are growing faster than inflation.
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In the new millennium, Social Security will face a tidal wave of red
ink! Benefits will exceed payroll taxes by $120 trillion!
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Chairman Smith. Chairman Kasich, I think this is our 12th
Task Force meeting and I would just like to point out the bill
that I wrote in 1995 did exactly what your bill does, but we
only changed it from wage inflation to CPI inflation for the
second and third bend points. You also change it for the first
bend point. Let me ask you, why did you consider or rule out
any change in the CPI in developing your solution to Social
Security?
Mr. Kasich. Well, because the CPI has already been
significantly adjusted. And if you take a look at what the--I
can't remember the guy's name, who was the guy that did--the
Boskin Report, we have already made significant adjustments in
the CPI. Now I am sure you can make the argument that we can
squeeze some more out of it, but I just think it is unlikely we
are going to pass that. I think--and I don't even know if it is
going to be accurate.
In terms of change in CPI, it is very, very difficult. And
as you know, Mr. Smith, this committee struggled mightily with
the issue of CPI with the Bureau of Labor Statistics, and we
were able to move them to a large degree to upgrade the CPI
calculation. I just am not convinced that there is a whole lot
left to wring out. And frankly, that starts affecting your
benefits on almost a yearly basis.
I mean, if you can remove this significant cost driver from
the initial stages of the formula, you don't--you never have to
go back and look at CPIs or COLAs or anything else. The benefit
flows straight out.
Chairman Smith. Is your plan voluntary?
Mr. Kasich. Yes.
Chairman Smith. Does your plan have any special provisions
for women?
Mr. Kasich. No. But what we do is we maintain the
progressivity of the system so if you are at the top end you
will get 1 percent of payroll tax into an account, but if you
are at the lowest end you will get up to 3.5 percent. So we
wanted to make sure that Social Security replacement concept
progressivity was maintained in this plan. And the reason why,
if you take a look at the benefit life of women in some
categories, it appears as though women don't make out as well
as men. It has to do with the total period in which the loss of
benefits are calculated because women live longer. But we have
no special provisions affecting anybody else other than this
progressivity factor retained.
Chairman Smith. Explain how the personal retirement savings
accounts are offset for any reduction in fixed benefits.
Mr. Kasich. You would lose 25 cents on every dollar that
you earned from your private account. So not only would you
begin your Social Security at a lower starting point, but for
every dollar you earn in your private account, you lose a
quarter, you make out 75 cents. The amazing thing about this
approach is that virtually the entire public benefits.
Mr. Archer's plan, you don't get your private account. You
don't have the potential to earn more than what Social Security
promised. Under my program, you can earn an immense amount more
than what Social Security promised at the same time that Social
Security comes into balance.
And remember, when you say that a 25-year-old son or
daughter can make 20 percent more, that is based on a 60/40
ratio. If you were at 80/20 ratio, stocks to bonds, then your
potential to earn far more than even the 20 percent is there.
Chairman Smith. Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman. And thanks for joining
us today, Mr. Chairman. A couple of questions. Does your plan
contemplate forced annuitization at the point of retirement?
That the savings be required to be converted into annuity?
Mr. Kasich. No, they do not.
Mr. Toomey. So the person continues to have true ownership?
Mr. Kasich. Absolutely. This actually becomes part of your
estate. This is your account.
Mr. Toomey. Before and after retirement?
Mr. Kasich. Absolutely.
Mr. Toomey. How about investment options? Do you
contemplate giving individuals a considerable degree of
latitude, or would do you as Archer does and say equity funds--
--
Mr. Kasich. No, I would do it the same way we do our
Federal program. I mean, what we anticipate, that we would have
companies that would seek contracts to be able to provide the
menu list of choice, because I know there would be a lot of
people that would want to do better than 60/40. So we want to
give people a lot of flexibility. Maximum flexibility.
Frankly, I would like to be able to give them their money,
but my concern is then that people would put all of their money
in an IPO. And Social Security is a contract that we have made
in this country that is going to be a bedrock of the way our
government works. So I think that to give them the maximum
flexibility, like we have in thrift savings, is the way to go.
And I understand thrift savings will be offering us even more
investment opportunities.
Mr. Toomey. So there are certain restrictions. You
presumably cannot leverage the funds and get involved in very
risky investments, but otherwise you would advocate a great
deal of latitude.
Mr. Kasich. Without question; yes, absolutely.
Mr. Toomey. Did you consider a different approach in the
considerations of the personal accounts? It suggests that it
ranges 1 percent to 3.5 percent and that is a function of a
person's income. Depending on the trade-off, the reduction in
fixed benefits, could we not accomplish as much, maybe even
more, by allowing more people to have a greater contribution to
their personal account?
Mr. Kasich. Well, as you know, Mr. Toomey, this is a matter
of filling various holes. I mean, I would love to give 8
percent, but how are you going to handle the transition period?
How do you handle the people who are retired today? But what I
try under my program is after--you see, what happens is you
start running a surplus in Social Security as a result of
establishing initial benefits based on prices, and not prices
and wages. And you run a huge surplus that can be used to do
two things. One is to cut payroll taxes or, two, to allow
larger private accounts that will be a decision for our
children to make, because I believe that Social Security for
our children is going to look dramatically different than it
looks today, but we have got to get started in this process,
and those surpluses would allow people to have more in a
private account.
But you know, what I suspect is that our children would
rather have their payroll taxes cut and take their money and
put it in Ebay. That is what I suspect because I think the
younger generation is distrustful of government and they have
concluded that there is not a wizard behind the curtain; there
is just a tired old man.
Mr. Toomey. And given the average return that the market
has consistently returned over the entire history of this
Nation and comparing that to that which Social Security
promises and cannot deliver, I think there is a lot of truth to
that wisdom.
I will yield the balance of my time, but I would like to
say that I congratulate the Chairman. I think this is a
tremendous contribution to this debate and a huge step forward
in terms of freedom, in terms of solving the fiscal problems
and making Social Security very different and better for the
next generation.
Mr. Kasich. I think that it is the most reasonable
approach, would not force us to come to this floor and start
adjusting COLAs or whatever, which is what we always do around
here. It gets it solved. It balances the system. It creates
private accounts that are yours, that go to your estate, that
give you the ability to earn far more than the current system.
To me, it is a lay-down, it is a ``gimme pot.'' The next
President ought to put it in.
Chairman Smith. Mr. Collins.
Mr. Collins. Was that last statement a campaign statement?
Mr. Kasich. It wasn't, Mr. Collins.
Mr. Collins. And why not? Let me ask you this, Mr.
Chairman; 3.5 percent is the opt-out figure for low-income wage
earners; right?
Mr. Kasich. That is the amount that you would be permitted
to put in your account; right. Everybody is going to want to be
in this. I can't imagine anybody not wanting to be in this.
Mr. Collins. What is the range of wages that apply to 3.5?
Mr. Kasich. I don't have those figures in front of me, but
they are obviously the lowest-income workers.
Mr. Collins. The highest would be 1 percent?
Mr. Kasich. One percent, correct.
Mr. Collins. Why is there a variation?
Mr. Kasich. Because the system was created to be
progressive. It was created to provide the greatest amount of
replacement wages for people at their first dollar of earnings
because we wanted to try to rescue people from poverty. And the
people at the very top, their 1 percent gives them more money
and they also have a lot of other investment opportunities. And
the people at the very bottom are putting just a little smaller
amount into their fund.
So I think you could take issue with the progressive nature
of it, but I just think it is the fairest way to go on a
program like Social Security.
Mr. Collins. Is there a ceiling on the wages earned for the
1 percent?
Mr. Kasich. Well, it is that $72,000 or wherever those
numbers go to ultimately.
Mr. Collins. Would there not be a greater incentive to opt-
out for the higher income through $72,000 if the percentage was
more?
Mr. Kasich. No. When you do the numbers you find out that
anybody under the age of 45 wins. You either--you do better
than what you would do under the promised program of Social
Security at all income levels. I think there are a couple--I
think that is accurate in and of itself. Yes, everybody would
win, so everybody would want to opt into this program.
What I worry about is that--you see, the surplus on Social
Security is so important because what it allows you to do is to
start these private retirement accounts, and what I get
concerned about is that we enact some kind of a program on
Social Security that really does not force Social Security to
balance in and of itself and is based on theory. That is my
greatest concern.
But in terms of the 1 percent, the 3 percent, I mean, I
can't imagine any American that would not want to opt into this
program since the numbers turn out so well for everybody.
Mr. Collins. What you are getting around to, then, is
anybody 45 or under is a winner. They would receive total
retirement or benefit from their personal account, none from
Social Security?
Mr. Kasich. No, they would get both. You put the two
together. They would get their Social Security benefits but
they would be established on the basis of prices and not prices
and wages. And you take that amount and you combine it with
your private retirement account measured at what we are all
assuming, the 5.3 percent is what you would get from the 60/40,
ratio and that is how we calculate how you would do under the
program. And people who are 45 years old could actually not
lose their money if they invested 80/20.
Mr. Collins. Well, your program doesn't give you the option
to entirely opt out of Social Security.
Mr. Kasich. Oh, no; no, it does not.
Mr. Collins. Have you looked at that approach?
Mr. Kasich. Well, I don't think that that is a manageable
program if you buy into the fundamental basis as to why we
established Social Security, Mr. Collins. I think that that is
a very interesting discussion and debate that can occur
probably a couple generations down the road. But I don't think
that is where we ought to be today and it is not where I am
today. I see Social Security as something--see, my problem with
it is if you give everybody a total opt-out and you make sure
that we are going to have some kind of a survivor benefit for
people who invest their money in Uncle Joe's pork bellies and
lose everything, then we have to create a welfare program for
our seniors that lost all of their money, which is why I
believe you have to have a program like this.
One other point I would like to make is that there is a
notion that if the economy grows fast, that we can grow our way
out of the Social Security problem. And it is simply not true.
You don't make any headway based on strong economic growth. But
I think your question is a legitimate one and our children are
going to have that debate, and probably it is going to be
pretty fierce if we can take the first few steps.
Mr. Collins. Thank you.
Chairman Smith. Except, John, with your proposal and my
proposal, an expanding economy is going to be much more
significant as we change it to a CPI inflation rather than wage
inflation.
Mr. Kasich. I am saying if the economy is growing strong,
this thing is gangbusters. What I am saying, Mr. Smith, is that
there are a lot of people who think that the current Social
Security problem can be solved if we just have rapid economic
growth. But the system is set up that the more rapidly wages
grow, the more benefits you pay, so you can't get out of it.
And the other problem is, of course, the longer we delay on
this, look, everybody in this room who is here obviously, and
particularly the young people, have an interest in this
program. Providing it for young people is essential to, I
think, restoring a little confidence. Every year you delay
compound interest is every year that you lose a chance to get
ahead. That is why you have got to do this soon.
Chairman Smith. Mr. Ryan.
Mr. Ryan. Thank you. Thank you very much, John, for coming.
And I had the opportunity of visiting with your staff, Steve
Robinson, to go over this plan last week. And what I think your
plan does is highlight a really important issue that we have
been talking about a little bit, which is the wage peg and the
price peg. One of the newspapers recently just brought that out
as well.
Can you shed some more light on the wage peg versus the
price peg, when and how that change is scheduled to occur, and
how changing from the wage peg to the price peg is not a cut in
benefits--it is actually still increasing benefits? How does it
also help us solve the huge liability in the outyears?
Mr. Kasich. Well, the first thing we have to realize is
that it is the price peg that our seniors now are geared to
when it comes to their cost-of-living increase. So what we
would be doing is essentially saying that our benefits would
have growth, but the growth would not exceed----
Mr. Ryan. Prices.
Mr. Kasich. It would not exceed prices and it would not
exceed that indexing which occurs with our senior citizens
today. So you would have a slowing of the starting point, yet
you wouldn't be going backwards. I hate to get into this
slowing the growth, but I suppose that is how you would argue
this. You slow the growth in the establishing of benefits.
But once it is established, of course, then you get the
juice on the other side, which is the ability to invest in the
economy at a far faster rate than what the rate of return is on
a government investment. And I mean, it has got to be
astounding to everybody to find out if you are under the age of
45, you win. The only people who have to pay are people like
me. I stood on my parents's shoulders to get where I am. I
don't want to stand on my kids' shoulders to get out of this. I
can give up a little of this. Frankly, most Americans don't
think they are going to get any of it anyway. It is a
reasonable approach to being able to solve this.
And, Paul, it has got to be wages and prices because in the
early years, essentially, we were trying to get people really
out of poverty. And the wages and the prices were a way to try
to make this system equitable. If we don't change wages and
prices, we will grind down. All the plans at some point have to
borrow from the general fund. Mine, fortunately, becomes
totally self-financing.
The other programs--I don't want to comment on Mr. Kolbe's
because his and Mr. Stenholm's both do as well, which is why I
take my hat off to them. But the inability to deal with the
benefits side means we will not fix this and we will keep
robbing from the general fund or driving up huge, huge--not
minor, huge borrowing costs.
So what you get with this program, I mean, think about it,
a little lower starting point where virtually all Americans
benefit. We have more retirement security, we have private
accounts that we control, that we can pass on to our families.
That allows us to earn more than what the current system
provides. And I understand Mr. Archer's plan does not even
permit that. You don't have an opportunity to earn more than
what the government program provides.
Mr. Ryan. I am glad you brought the Archer plan up. He was
just here. I asked him as a Budget Committee member about the
score, the cost for our purposes of budgeting. And he is
supposed to prepare a tax bill using all on-budget surpluses
for that tax bill. I was unsure as to whether his bill eats
into that tax bill, that on-budget surplus. As the Chairman of
the Budget Committee, I know you are acutely aware of off-
budget surpluses going to debt reduction and on-budget going
back to the taxpayer who produced it.
What is the score of your bill? What does it do with
respect to the off-budget surplus? How much would it take of
that? Is it totally self-funding?
Mr. Kasich. The off-budget, all of it goes into creating
the accounts; and at some point when this program starts nose-
diving into the ground, you have to incur some debt from the
on-budget side. But the beauty of this is that it becomes self-
enforcing because at some point the payroll taxes collected
will be much greater than the benefits that are passed out, and
at that point you can reduce payroll taxes or you can create
larger private accounts.
Under the other plans that I am aware of, look, I don't
know about all of these plans, I haven't studied them all, but
I know that programs that do not in some way, shape, or form
impact benefits are programs--I mean we all know intuitively
that if you do not slow some of this benefit growth, you are
not going to make it, and that your borrowing costs are going
to be enormous.
And I think if we were trying to ratchet somebody down and
clobber somebody, it would be unacceptable. But if I am going
to tell you that a 45-year-old guy loses less than 2 percent in
exchange for an amazing benefit for everybody else in our
society that will probably also drive up the savings rate in
America, it is a very, very small price to pay for making this
program solvent.
What I fear, Paul, is that we are going to go ahead and
pass something and we are not going to get to the nub of the
problem.
Mr. Ryan. And just delay the problem. I just wanted to
clarify with you, your plan doesn't eat into our on-budget
surplus and therefore take away from the tax reduction that we
are hoping to achieve in this budget in this Congress?
Mr. Kasich. It would not.
Mr. Ryan. That is an important point. Some plans do. As a
gentleman under 45----
Mr. Kasich. You need to know that at some point when the
off-budget surplus doesn't provide enough money to finance the
private retirement accounts, there will be a borrowing cost on
the general revenue side. But at some point it ends because
mine is self-enforcing.
Now, remember, we also found out presumably that we have
got about a trillion dollars more in surplus. Now, I must tell
you that that then means that our borrowing costs for financing
the Social Security plan would be reduced, but it also gives us
perhaps a great opportunity to fix Medicare. I want to bring to
your attention that Medicare is a far more acute problem than
Social Security. That is why it is so important we don't
fritter away this surplus on more government spending, but use
that surplus to be able to address these huge entitlement
challenges that we have for the next generation.
Chairman Smith. The gentleman's time has expired.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. Let me say at the
outset, some specificity from a candidate for the Republican
nomination for the presidency is increasingly uncommon and I
commend you for that. And I know the Chairman has thought long
and hard about all of these issues. And I apologize for not
being here for your opening testimony. I was caught up in
another meeting.
Let me also reference the comment made by my young
colleague on the other side with respect to the previous
speakers, that that is a critical element, that you can only
spend the on-budget surplus once--you can spend it twice, but
we are only supposed to spend once or we get into the problem
that we have been in before.
With respect to the wage--first of all, have you had your
program scored by----
Mr. Kasich. That is all worked out.
Mr. Bentsen. By the trustees and all? With respect to the
wage peg, if I understand this correctly, for future or new
retirees, you would just eliminate the wage peg so that the
initial average benefit would be whatever it is, $740 a month
today or something like that, and it would just stay there,
flat----
Mr. Kasich. No, the initial establishment would be on that
complicated formula that takes your average wage at 60 and
divides it by your average wage in the other 34 years, times
your income, to give you a yearly total and breakdown into 12-
month totals, and then there is a factor applied that includes
both wages and prices--that initial factor would be based on
prices and not wages. But then beyond that, you would grow,
because we don't affect CPI or anything else.
Mr. Bentsen. Right, you would grow based on the annual
COLA.
Mr. Kasich. Correct.
Mr. Bentsen. But initially----
Mr. Kasich. And you would receive a lesser amount.
Mr. Bentsen. No adjustment going forward for adjusting the
wage base in effect.
Mr. Kasich. Correct.
Mr. Bentsen. How did the Social Security actuaries score
that over the 75-year period in terms of--did they make any
projections as to what the net reduction would be?
Mr. Kasich. Yes, they did. I don't have those numbers in
front of me, but in about 30 or 40 years, the system balances
itself and then starts to run a huge surplus. And then that
surplus, of course, can be used either to reduce payroll taxes
or to increase the amount in the personal account. Mr. Bentsen,
I would argue that your children probably would rather have a
lower payroll tax so they could have the freedom to invest as
opposed to staying in the----
Mr. Bentsen. Mine would like to have the freedom to spend,
has been my experience so far. But nonetheless, if you could
provide my staff with----
Mr. Kasich. Yes, we will get you all the details of this
program.
Mr. Bentsen. That is what I would be interested in.
Mr. Kasich. The inability to be candid on these major
issues is not limited to certain classes of people. I have
talked to my own Republican colleagues who, when they find out
that you may not be giving everybody a chicken in every pot,
probably all the way down to the school board level people are
like, oh, that is the ``third rail.''
I have to tell you I think the public is ready for changes
in this, and I think they are ready for some straight talk; and
frankly, this is not any different than what we did with trying
to balance the budget. As you know, we had to make choices and
a lot of times those choices meant that some people would get
less. But look at what the result has been, not that that is
the reason that the economy has done so well, but if you take a
look at the stock market, and if we keep going like this we
will be at 20,000. I am not so sure that that is not an
accurate projection.
I think the beauty of this plan is that for people under
the age of 45, they are a winner in every single way. And it
just takes such a small give on the part of a limited number of
people in order to make this whole thing work. I don't think it
takes any great courage at all to do this. I think it is like
falling off of a log. I think it is pretty simple. And I think
you are the kind of person that says, I didn't come here to
waste my time either, I might as well just get some things
done. I think it is the nature of the individual in this. But I
think that our Congress needs to realize that I think on this
issue, it is time for it to be done.
Mr. Bentsen. Well, I would just tell the gentleman,
generally I would concur with you. And I think that being up
front--and I know our next panel has done this as well, and the
first panel we had today in getting into specifics. And where
the adjustments are made, where the cuts are made, is important
because I think what the American people want more than
anything else is honesty. They are willing, I think ultimately,
to take the tough medicine if they think you are being honest
with them. We may have disagreements on how we get there, but
we need to deal in specifics, not broad generalities, which as
the Chairman will tell you in some cases has been the case with
some groups that have come up here and said, we will take care
of that later. And we all know what that means: It never gets
taken care of.
Mr. Kasich. Thank you. I thank you, Mr. Chairman. I
apologize to Mr. Kolbe and Mr. Stenholm for getting their time,
and I appreciate it very much.
Chairman Smith. Mr. Herger has a question.
Mr. Kasich. Oh.
Mr. Herger. Mr. Chairman, I want to thank you for your
involvement, for taking the effort to put forward a plan to
help save Social Security. I guess my question is in this area
of 45, what is it, 45 to 54, would be receiving something less
than what they would be receiving now. And I know you are one
of those who would be very willing to sacrifice that.
Mr. Kasich. Yes; just barely made the cutoff.
Mr. Herger. I think of my town hall meetings and we all
have these notch babies that come up, whether or not it is
correct.
Mr. Kasich. Well, we know it is not correct.
Mr. Herger. In their eyes. I still have them come forward,
and I hope you have been more successful than I have.
Mr. Kasich. What I tell them is if you are a notch baby and
you are complaining, we can treat you like everybody after the
notch, and you will get less because you got phased in with a
higher amount than is reflected in your wages. I just don't
dabble around it. They are mad and I say, well, you know, you
have got to get un-mad.
Mr. Herger. Bless you for taking that head-on. I hope you
have been more successful with those notch babies than I have
been. My concern is that this group that we are setting up, do
you feel that other than yourself and myself and some others,
that this would be a political liability?
Mr. Kasich. Let me say something about the notch-year
people. The reason why the notch-year people are so upset is
that they think they literally got shafted, and there were
people that wrote articles and drove this and drove this, and
then folks out here making money by writing to these notch-year
people and telling them what a terrible rip-off it is.
And people are fundamentally not selfish. You talk to the
people who were the notch-year people, they are very concerned
about their grandchildren, there is no question about it. And
so you have to tell them the fact is that the system was going
bankrupt. We did a phase-in period for you. And when they
understand that and--see, the problem is I am a politician, so
whatever I tell them, they don't believe me to begin with. If
you tell them enough times, they start thinking about it and I
think they can accept it. But the problem is they read it in
the paper and then they listen to a politician, and there is a
big gap there. That is the first thing.
The second thing is, do I think that people between 45 and
54 would be willing to do something? Let me tell you, Wally,
Mr. Herger, I would be astounded if we were not. I would be
absolutely astounded if we said, no, we would very much like to
stand on the shoulders of our kids. I don't believe it. And I
can tell you that when I travel and people know about this
plan, they are very positive about it. They are glad somebody
is laying out the facts and somebody is trying to do something.
And remember, even for people who are 45, look how many
more retirement tools we have right now. And so we are not
asking anybody to take a bludgeoning here. This is a tiny
little give for significantly fixing the system and improving
the quality of our children's lives. So would somebody write
that somebody is a notch-year in 2025? Yeah, probably, if they
are still having town hall meetings, and we might still have to
go and explain this. And I will be old enough to be able to
hobble into that room and say, let me tell you what I really
meant to be doing here.
And I think it is something that this generation would be
willing to do. I hope. If not, you tell me what the alternative
is. The alternative is to whack everything or melt this program
down or continue to put off what we know needs to be done? That
is not acceptable.
Mr. Herger. And that is certainly what the great debate is,
and thank you very much. I yield to Mr. Collins.
Mr. Collins. This is a volunteer program; right?
Mr. Kasich. Correct. You can stay under the current system.
Mr. Collins. If you are not willing to give it up, you
don't have to opt into this program?
Mr. Kasich. That is correct. Thank you, Mr. Chairman.
Chairman Smith. Thank you, Mr. Chairman.
Mr. Kolbe and Mr. Stenholm, let me just say that in
addition to the thank-yous for being here and developing a
proposal, these two gentleman have headed up the Public Pension
Reform Caucus for the last 5 years and probably have been the
catalyst and burr under the saddle to move the discussion
forward. So congratulations and please proceed.
STATEMENT OF THE HON. JIM KOLBE, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF ARIZONA
Mr. Kolbe. Thank you, Mr. Chairman. I also want to commend
Mr. Kasich, who has already left, for the contribution he has
made. I think his plan and ours share a lot in common. They are
both fiscally responsible and I think the Chairman of the
Budget Committee has done a great deal to advance this debate.
Mr. Chairman, I appreciate your kind remarks about our
efforts with the Public Pension Reform program because I hope
it has helped to educate Members of both the House, Republican
and Democratic Caucuses, and our staffs about it.
Congressman Stenholm and I have been working on this a long
time, as have you Mr. Chairman, on your own proposal. And I am
delighted that this Task Force is looking at this issue and
recognizing the need for comprehensive Social Security reform.
We remain steadfast in our belief that comprehensive reform
is possible in this Congress and this year. Now, the window of
opportunity for doing it is closing very fast. And we
respectfully submit to the committee that our legislation,
though not perfect, we think can form a foundation for
legislation which might be considered by Congress. You have a
written copy of our statement. You also I believe have received
a briefing book about our plan.
There are four specific issues that I think that I would
like you to focus on with regard to our plan. One, how the
Kolbe-Stenholm plan reduces Social Security's program costs to
sustainable levels; second, why the Kolbe-Stenholm plan is a
better deal for women than the current Social Security law;
third, the property rights and opportunities for wealth
creation under the Kolbe-Stenholm plan; fourth, why a carveout
is absolutely necessary.
Because of the time constraints, I am only going to be able
to address the first two of these issues. First, on the issue
of sustainable costs. While restoring actuarial balance to the
Social Security Trust Fund is an important step, it is only one
measure of the financial stability of the Social Security
reform plan. A truly responsible Social Security plan has to
control the costs of the Social Security program over the long
run, and it has to address the cash shortfalls that begin in
2014.
And I cannot emphasize that last point enough, Mr.
Chairman. Not one plan, not yours, not ours, not Mr. Archer's
not Mr. Kasich's, none of them deal entirely with the cash
shortfall that exists in the year 2014 because the cash
shortfall is so large. I think it is very important to keep
that in mind.
And if you think the budget caps are tough now, imagine the
budget pain that we will experience when the growth in Social
Security and Medicare programs forces Congress to cut programs
like NIH, cancer research grants, Pell grants, Meals on Wheels,
any of those worthy programs that we all know about, by 15
percent or more, and that is what we are looking at. The day
that that would happen is not that far in the future and that
is why we have to act now. If we don't act now, the future is
the present.
There are three ways to measure the financial stability of
a Social Security reform plan: The impact on program costs; the
plan's impact on annual cash flow deficits; the plan's impact
on the national debt.
First, on the program costs, briefly. You have a chart and
it is also in the packet of information up there. What are the
average costs? We haven't been able to put the Kasich plan up
there yet. Current law versus the Kolbe-Stenholm and the Archer
somewhat, and you can see that ours is, over the 75 years, is
better than any certainly current law. And Archer-Shaw and the
peak costs--and this is important in terms of the incredible
pain that you would suffer--under current law it is going to go
to 19.6 over the next 7 years and then it just keeps on going,
it keeps on rising; whereas ours levels off and we have a
lower, much lower peak cost.
Cash flow deficits: No plan, as I mentioned, can eliminate
that cash flow directly, but ours does more about doing that.
Current law, cash deficit would be over $814 billion by the
year 2030. Ours would be at $272 billion.
And finally on the national debt, during the years that
Social Security is running cash flow deficits, the government
is going to have to borrow money to pay benefits. The current
law, there is no figure because it is bankrupt, so there is no
limit on it. And ours is much, much less than that which has
been proposed by some of the other plans.
Let me very briefly in my remaining time focus on the
impact on women, because there are several provisions that are
especially beneficial to women, and I don't think other plans
have addressed that. The most notable is the minimum benefit
provision which would provide a more robust benefit than is
currently provided by current law. If you work for 40 years,
you get a benefit that is 100 percent of poverty level. Under
that provision alone, 50 percent of women will do better under
our plan than current law. It allows for voluntary
contributions, as I think you know. You can contribute, like an
IRS, up to $2,000 additional in the account. So women who take
time out to raise children can make voluntary contributions
before and after the hiatus to catch up.
And women who are at the lower end of the economic scale,
and more single women are in that category, there is a savings
subsidy. For each dollar of a voluntary contribution you put
in, you get a $150 match by the Federal Government, and each
additional dollar is matched 50 percent, up to a cap of $600.
And we provide a mechanism for doing that through the earned
income tax credit.
One last thing about why women are going to do better under
ours is the changing nature of divorce. Current law stipulates
that a woman gets a benefit if her marriage lasts 10 years. She
is entitled to 50 percent of her spouse's Social Security
benefit. But divorce and marriage is changing. Whereas it used
to be that marriages lasted longer and divorce occurred after
15 to 20 years of marriage, today it is most likely to occur in
the fourth to seventh year of marriage, so a woman is not going
to get any benefit today.
I think our plan does more in terms of helping women than
the other plans have done. There is much more to be said about
our plan, and I will turn to Mr. Stenholm to talk about some of
those.
[The information referred to follows:]
Prepared Statement of Hon. Jim Kolbe, a Representative in Congress From
the State of Arizona, and Hon. Charles W. Stenholm, a Representative in
Congress From the State of Texas
Chairman Smith, Congresswoman Rivers and Members of the House
Budget Committee Social Security Task Force, we appreciate the
opportunity to appear here today to discuss Social Security reform and
present our legislation for your consideration. We've spent several
years working together on this issue and we are delighted that the
Budget Committee recognizes the need to address the financial and
demographics problems that threaten our nation's most successful anti-
poverty program.
A few weeks ago, we testified before the Ways and Means Committee.
Chairman Archer invited all sponsors of plans with 75-year solvency to
address the Committee. We think 75-year solvency is a critical element
of this debate. Groups on and off the Hill have suggested that this
goal may be too ambitious, and that incremental reform may be a better
solution. We disagree. It is for good reason current law mandates that
the Social Security Trustees evaluate the health of the Trust Fund over
a 75-year horizon. This period encompasses the entire future life span
of all current workers and beneficiaries, including newborn babies--the
beneficiaries of tomorrow. Also, the projection period is sufficient to
evaluate the full effect of changes to the Social Security program.
In fact, we would like to see the Budget Committee set the bar even
higher. We believe the Members also should consider the impact of
reform proposals on the annual operating cash flow of the Federal
Government, and on the Trust Fund balance at the end of the 75-year
forecast horizon. Solvency alone is an incomplete standard for
determining whether legislation truly strengthens Social Security.
Solvency is not sufficient if we leave the Social Security system in a
deteriorating condition at the end of the period, or if the Federal
budget incurs massive cash deficits in the interim years.
The difference between a plan that leaves in place a strong and
growing Trust Fund at the end of seventy-five years, and a plan that
extends solvency for a finite period of time but leaves the system with
a depleted Trust Fund, is fundamental and significant. The issue should
not be 50 years versus 75 years, it should be whether a reform plan
offers a complete solution that puts the Social Security system on a
permanent, sustainable fiscal course.
A ``partial'' solution will only exacerbate the cynicism among
young people that Social Security won't be there for them. A
``partial'' solution will require continuous ``tinkering'' and
adjustment, impeding the ability of Americans to plan for retirement
with a degree of certainty. Any credible reform plan must put the Trust
Fund on a permanent path of financial stability that will ensure the
system remains fiscally sound throughout the valuation period and
beyond. Genuine solvency is achieved only if the cash flow is balanced,
and the Trust Fund is stable and getting stronger at the end of the
forecast period.
We Were Country When Country Wasn't Cool
To paraphrase the country and western song, we were Social Security
reformers before Social Security reform was cool. Three years ago, we
came together to form the Public Pension Reform Caucus and begin a
discussion in Congress. Today, the PPRC has a bipartisan membership of
75 members. Our goal was to educate ourselves and our colleagues about
the issues and challenges facing Social Security. Perhaps just as
importantly, we sought to demonstrate the type of centrist, bipartisan
approach to the substance and politics of Social Security reform
necessary to resolve the impending crisis.
Two years ago, we joined Senators Judd Gregg (R-NH) and John Breaux
(D-LA) to serve as Congressional cochairmen of the CSIS National
Commission on Retirement Policy (NCRP). The NCRP was a 24-member
commission comprised of leaders from the business community and experts
on retirement policy. Our goal was to develop a plan to strengthen
America's retirement programs, including employer-provided pensions,
personal savings and, finally, Social Security. Fifteen months after
the panel's creation, we disproved the notion that all commissions must
end in disagreement or irrelevance. In a unanimous vote, our commission
agreed on the 21st Century Retirement Security Act.
We introduced legislation last Congress (H.R. 4824, 105th Congress)
based on the NCRP report. That legislation generated considerable
interest and praise for representing a fiscally responsible approach to
strengthen the Social Security program. Since then, we have talked with
many of our colleagues on both sides of the aisle, met with
Administration's staff to discuss our proposal and listened to
constructive criticisms of our plan. The legislation we bring before
you today is a revised version of the NCRP plan--a ``new and improved''
plan that we believe addresses many of the concerns that have been
brought to our attention over the last year.
H.R. 1793: The 21st Century Retirement Security Act
We still adhere to the same guiding principles as our previous
legislation: a balanced, actuarially sound plan that reduces the $7.4
trillion unfunded liability, improves rates of return and strengthens
the safety net. We accomplish this by using personal accounts to
advance-fund future obligations and by implementing much needed
structural reforms. We've softened some of the tough choices in last
year's bill and included some new provisions aimed at improving the
retirement income of the working poor. What we don't do, however, is
rely on double counting, cost-shifting, uncertain budget surpluses and
accounting gimmickry to hide the true costs of reform--unlike some
``free lunch'' plans that have been offered by the right and left.
Our legislation, The 21st Century Retirement Security Act, provides
a payroll tax cut for all working individuals under the age of 55 by
diverting 2 percent of FICA taxes into personal Individual Security
Accounts. Workers also would be allowed to make additional voluntary
contributions of up to $2,000 a year to their individual account. The
legislation also provides a savings match for voluntary contributions
to help low-income workers build their individual accounts.
The individual accounts in our plan would be modeled on the Federal
Government's Thrift Savings Plan. In the TSP, individuals personally
choose investment options, including a stock index fund, a bond index
fund and a Treasury securities index fund. Unlike other proposals, our
plan would provide individuals with ownership and control over their
retirement assets, including the freedom to invest in safe, risk-free
Treasury securities. We don't force anyone to invest their Social
Security monies in the stock market--it's your money, your choice.
Our bill also strengthens traditional Social Security's safety net
by creating a more substantial guaranteed minimum benefit that ensures
stronger poverty protections than currently provided for low-income
workers. Moreover, this benefit is given regardless of any other
factors. Consequently, any income from the individual accounts would
supplement the enhanced guaranteed Social Security benefit for low-
income workers.
Our plan makes changes in the defined benefit program, but in a
progressive manner that insulates vulnerable populations. Changes to
the defined benefit largely affect mid-to-high income individuals who
will benefit disproportionately from the individual accounts. We
implement additional reforms that reduce the cost of the Social
Security program. For example, our plan makes changes to reflect the
increases in life expectancy and longer working lives, provides for a
more accurate inflation adjustment, and rewards work. While these
provisions involve some pain, it is necessary to make tough choices to
ensure that future governments will have resources to deal with other
problems in addition to Social Security.
We have never claimed that our plan is perfect. Every one of you
could go through our plan and select individual items in the plan to
criticize--either we went too far or not far enough. We remain open to
constructive suggestions about how our plan can be improved. However,
we encourage you to look at the plan ``holistically''--to examine what
the proposal accomplishes in it's entirety, rather than focus on one or
two provisions. If everyone determines the acceptability or
unacceptability of various proposals based on a single element, we'll
never achieve the bipartisan consensus necessary to pass a bill and
save Social Security.
Kolbe-Stenholm is a Foundation Plan
We respectfully suggest to this committee that the bipartisan work
embodied by this legislation offers a foundation for you to commence
negotiations and create meaningful, comprehensive reform that can be
enacted in to law this year. There are several elements in our proposal
that we believe are essential to reaching a bipartisan consensus on
Social Security reform:
1. Bipartisan. Our proposal is a truly bipartisan solution that
balances the objectives of different political perspectives.
2. Solvent. The legislation we introduced has been scored by the
actuaries of the Social Security Administration as restoring solvency
to the Social Security program for the next 75 years and beyond.
3. Fiscally responsible. Our legislation tackles the tough choices
that are necessary to control cost and reduce the pressures on future
general revenues. It does not use cost shifts or other accounting
gimmickry and does not rely on projected surpluses to create new
general fund liabilities.
4. Empowers all Americans. The legislation establishes individual
accounts that provide all Americans the opportunity to create wealth,
and provides individuals with ownership of and control over their
retirement assets.
5. Enhances the safety net. Our legislation contains several
provisions in both the defined benefit program and individual accounts
that provide stronger poverty protections and greater assistance to
low-income workers than are contained in current law.
6. Rewards work. The legislation makes several reforms to enhance
the work incentives in the current system.
7. Improves Social Security for all Americans. Our proposal
provides all future retirees with a better rate of return than the
current system can afford, and protects all taxpayers from the
increased tax burden created by the existing general fund obligations
to the Social Security system.
The Kolbe-Stenholm Plan is Bipartisan
An agreement on legislation to strengthen Social Security will
require bipartisan cooperation. We must put party affiliations aside
and think about the future generations who will be affected by the
decisions we make today.
The Kolbe-Stenholm plan is a model for building this bridge. The
Social Security reform debate has been characterized as an either-or
choice between two ideological poles--``status quo'' or ``full
privatization.'' Defenders of the status quo argue that any reform that
includes a market-based component will undermine the current safety net
features and expose workers to dangerous risks. Advocates of full
privatization suggest that the creation of privately managed personal
accounts will painlessly solve every challenge while, in fact, they
ignore existing long-term liabilities and the needs of special
populations. Both extremes make for good, albeit myopic, rhetoric and
fail to acknowledge the virtue of hybridization. The complete solution
to the Social Security problem can and must combine the best of the
traditional program with new market-based options.
Our plan attempts to balance three competing objectives we think
are necessary to achieve a responsible consensus that can win the
support of the left, right and middle of the Social Security debate. It
establishes individual accounts to improve rates of return for all
retirees--the key objective of most Republicans. At the same time, it
maintains and strengthens the important protections that the Social
Security system provides for low-income retirees, survivors and the
disabled--the key objective of most Democrats. Last, but definitely not
least, it honestly deals with the financial challenges of Social
Security, the key concern of those of us in the radical center.
The Kolbe-Stenholm Plan is Fiscally Responsible--or ``Show Me the
Money!''
Our plan sets the standard for a credible, responsible solution to
Social Security.
The 21st Century Retirement Act ensures the Social Security program
will operate on a solid, sustainable fiscal path well into the next
millennium. It does this by honestly and responsibly addressing the
unfunded liabilities of the program.
Three distinguishing characteristics separate this plan from other
prominent proposals. First, unlike the President's proposal, our plan
restores the Social Security Trust Fund to 75-year actuarial balance.
Second, unlike several ``free lunch'' proposals, our plan addresses the
cash deficits that begin in 2014 (when benefit costs exceed payroll tax
revenues), by reducing the pressure on general revenues and preserving
the flexibility of future governments to meet other critical budget
needs. Third, the 21st Century Retirement Security Act does not depend
on projected budget surpluses, cost shifts or accounting gimmicks to
balance the Social Security program.
The 21st Century Retirement Security Act restores solvency of the
Social Security Trust Fund by eliminating the entire projected cash
shortfall in the Trust Fund over the next 75 years. Moreover, it does
so using conservative economic assumptions. Just as importantly, the
21st Century Retirement Security Act makes structural reforms to the
Social Security system that help restore the traditional program to a
path of long-term solvency that does not deteriorate over time. The
Kolbe-Stenholm plan puts Social Security revenues and outlays on a
sustainable course over the entire 75-year period. The Trust Fund
ratio--the amount of cash reserves in the Trust Fund relative to
projected benefits--is rising at the end of the 75-year period. Thus,
there is no ``cliff effect.''
While restoring actuarial balance to the Social Security Trust Fund
is an important step, it is only one measure of the financial stability
of a Social Security reform plan. A truly responsible Social Security
plan must control the costs of the Social Security program over the
long term and address the cash shortfalls that will create tremendous
liabilities on general revenues beginning in 2014. Controlling the
costs of the Social Security system is essential to the fiscal health
of our government. If we do not address the pressures on the rest of
the budget caused by the growth in the costs of Social Security, future
Congresses will be forced to cut other important government programs or
raise additional taxes to meet the obligations to our senior citizens.
Not only will there be no room for any domestic initiatives; we will
have to cut back on existing programs to make room for growth in
spending on Social Security
According to the Congressional Budget Office long-term budget
projections, which assume that we will use 100 percent of projected
surpluses to reduce our national debt, Social Security will consume an
ever growing portion of the Federal budget, creating tremendous
budgetary pressures. Between now and 2030, the percentage of our
national income consumed by Social Security will increase by 50
percent. Spending on Social Security consumes slightly less than 20
percent of total Federal revenues today. CBO projects that Social
Security will grow to 23.5 percent of total revenues by 2015 and nearly
30 percent of total revenues by 2030.
The tough choices we struggle with in the current appropriations
cycle are mild compared to the problems we will leave for future
Congresses if we do not take action now to control the costs of the
Social Security program. By 2025, spending on programs other than
Social Security and Medicare will have to be reduced by nearly 9
percent below current levels if we do not take action. By 2030,
spending on programs other than Social Security and Medicare will have
to be reduced by 16 percent below current levels.
Under current law, the U.S. Treasury must find $7.4 trillion in
cash from general revenues between 2014 and 2034 to convert the IOUs in
the Social Security Trust Fund into cash benefits for Social Security
recipients. These general fund liabilities will be more than $200
billion a year by 2020 and more than $800 billion in 2030 alone. After
adjusting for inflation, the amount of general revenues that will need
to be provided to the Social Security system in 2030 to provide
promised benefits will be greater than total non-defense discretionary
spending last year.
The 21st Century Retirement Security Act restores the costs of the
Social Security system to sustainable levels. According the Social
Security Administration actuaries, the costs of the Social Security
system will average 14.0 percent of payroll over the 75-year period
under our plan, compared to 16.4 percent under current law. The costs
of the Social Security system will never exceed 15.7 percent of payroll
under our plan. Under current law, the costs of the Social Security
system will reach 19.6 percent of payroll by 2075 and will continue
growing. Our proposal and the Senate bipartisan proposal will do more
to control the costs of the Social Security system than any other
proposal. In fact, several prominent proposals that have been put
forward would actually result in higher costs for the Social Security
system than the projected costs under current law (see Table 1).
TABLE 1.--COMPARISON OF COST RATES OF CURRENT LAW AND ALTERNATIVE PLANS
[As a percent of Taxable Payroll]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year Current law Archer-Shaw Senate bipartisan Kolbe-Stenholm Gramm Stark
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2000................................................. 10.8 12.8 12.7 12.9 15.0 10.8
2005................................................. 11.2 13.3 13.2 13.0 15.2 11.2
2010................................................. 11.9 13.9 13.4 13.4 15.6 11.9
2015................................................. 13.3 15.0 14.0 14.0 16.4 13.3
2020................................................. 15.0 16.4 14.7 14.8 17.3 15.0
2025................................................. 16.6 17.4 15.4 15.6 17.6 16.6
2030................................................. 17.7 17.8 15.7 15.7 17.1 17.7
2035................................................. 18.2 17.3 15.5 15.2 16.4 18.2
2040................................................. 18.2 16.2 14.8 14.5 15.2 18.2
2045................................................. 18.2 14.9 14.3 13.8 14.1 18.2
2050................................................. 18.3 13.8 13.9 13.3 13.4 18.3
2055................................................. 18.6 13.1 13.7 13.2 13.0 18.6
2060................................................. 19.1 12.6 13.7 13.2 12.8 19.1
2065................................................. 19.4 12.3 13.6 13.4 12.5 19.4
2070................................................. 19.6 12.1 13.5 13.7 12.4 19.6
Minimum.............................................. 10.8 12.1 12.7 12.9 12.4 10.8
Maximum.............................................. 19.6 17.8 15.7 15.7 17.6 19.6
Average.............................................. 16.4 14.6 14.1 14.0 14.9 16.4
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Office of the Actuary, Social Security Administration. Archer-Shaw plan memo dated April 29, 1999; Senate Bipartisan plan memo dated June 3,
1999; Kolbe-Stenholm plan memo dated May 25, 1999; and Gramm plan memo dated April 16, 1999. Nadler plan memo unavailable on date of publication.
Because our plan advance-funds future liabilities and addresses
tough choices, it will dramatically reduce the general fund liabilities
that exist under current law. By contrast, the leading plans proposed
from the left and the right leave this liability in place and actually
increase these general fund liabilities for the next fifty years.
According to estimates prepared by the Social Security administration
actuaries, the 21st Century Retirement Security Act would reduce the
$7.4 trillion liability facing general revenues between 2014 and 2034
by approximately $3.8 trillion, a reduction of more than 50 percent. It
would reduce the amount that the Federal Government will have to come
up with from general revenues in 2025 from $420 billion to $217
billion. In 2030, our plan would reduce the burden on general revenues
by more than half a trillion dollars, reducing a $814 billion liability
to just $272 billion.
These reductions represent resources that will be available for
other priorities, including programs for education, training, health
care, debt reduction or tax cuts. The tough choices that are contained
in our plan to control program costs must be viewed in context of the
resources that would be freed for other priorities. Likewise, any
evaluation of ``free lunch'' plans that claim to save Social Security
without tackling tough choices must consider the problems these plans
shunt onto the rest of the budget--problems that will be left for
future Congresses. We can responsibly tackle some tough choices today
or we can leave a fiscal time bomb for future generations. A plan that
restores the Social Security Trust Fund to 75-year actuarial balance,
but does not address the budgetary pressures created by these growing
costs and general fund liabilities, does no favors for future
generations.
Unlike other Social Security reform plans that are dependent upon
funding from projected surpluses, the 21st Century Retirement Security
Act is entirely self-financed and will achieve its goals whether or not
current surplus projections are accurate. Although our plan relies on
general revenue transfers, all of the general revenue transfers in our
plan are paid for by savings in the non-Social Security budget from the
CPI recapture provision. Plans which rely on general revenue transfers
financed by projected surpluses either place the solvency of the Social
Security Trust Fund in jeopardy, or create problems in the non-Social
Security budget if the surpluses are not as large as currently
projected. Under our plan, if the surpluses do materialize, they would
remain available for debt reduction, strengthening Medicare, tax cuts,
or spending on other priorities.
The 21st Century Retirement Security Act does not rely on double-
counting, optimistic assumptions or other gimmicks to make the plan
appear balanced on paper. The plan does not mask the costs of the
program by shifting costs to other areas of the budget or the private
economy. All payroll taxes are used only once, either to fund current
benefits, fund individual accounts, or credit the Trust Fund. Unlike
other plans, the Kolbe-Stenholm plan does not use Social Security
surpluses already credited to the Social Security Trust Fund to justify
a second round of credits to the Trust Fund. Nor does the plan pay for
individual accounts with funds that already have been credited to the
Trust Fund, like some ``free lunch'' plans do.
We learned a long time ago that if something sounds too good to be
true, it probably is. There is no free lunch. We cannot afford to meet
all of the promises in current law without finding additional resources
elsewhere. Proponents of plans that claim to preserve benefits at
levels promised under current law, or even suggest that benefits will
be increased above current law, must answer the call ``Show me the
money!'' Where does the money come from to fund these promises? These
so-called ``free lunch'' plans which suggest it is possible to save
Social Security without any pain actually have tremendous hidden costs
that will require very real pain. They will drain the Federal budget
and U.S. economy of resources that are needed for other government
programs. They will result in higher tax burdens and lower national
savings. Congress and the President must honestly address the fiscal
challenges posed by the Social Security system, instead of ignoring
hidden costs and pretending that we can meet these challenges without
tough choices.
H.R. 1793 Empowers All Americans With Freedom and Control Over Their
Retirement Assets
H.R. 1793 creates individual accounts based on the Federal
employees' Thrift Savings Plan. This model combines the benefits of
individual ownership with the protections offered by a quasi-private
board governing fund managers. The TSP model offers a straight-forward,
low-cost retirement savings mechanism safeguarded against fraud and
abuse. The Thrift Savings Plan has been an extremely successful program
for all Federal employees, including Members of Congress. The burden of
record-keeping for each individual account would be assumed by the
Board. Employer burdens and administrative costs would be kept to a
minimum. The administrative costs would be spread across accounts
proportionally based on account balances to limit the impact of
administrative charges on small accounts.
Under our legislation, every worker would be able to choose from
among a number of investment options selected by a quasi-private Board
based on a competitive bidding process. Workers would have the
opportunity to choose between options with higher risk and the
potential of a commensurate higher return and those that are safer,
with lower rates of return. The options would include a stock index
fund, a bond index fund, and a government securities fund. No worker
would be forced to put his or her retirement funds in the stock market.
Workers would have the opportunity to select their own risk profile,
including the freedom to invest in safe, risk free Treasury securities.
Conversely, workers who want to take advantage of stock market returns
could place all or most of their account in stock funds. The individual
accounts under our plan are based on a simple philosophy: it's your
money, your choice.
Opponents of individual accounts highlight examples of poorly
implemented individual account systems in other countries that resulted
in high administrative costs. There are legitimate administrative cost
concerns about purely privatized individual account plans involving
dozens of private account managers. However, these concerns can be
addressed without eliminating individual control and turning investment
decisions over to the government. Our legislation demonstrates that it
is possible to give individuals control over their retirement income
while also providing government safeguards that address legitimate risk
concerns.
Federal Reserve Board Chairman Alan Greenspan and others have made
a persuasive case about the risks of social investing, government
interference in the market and conflicts of interest inherent in having
the Trust Fund invested by the government in the stock market. Most
significantly, though, the collective investment approach doesn't
address the central impetus behind calls for individual accounts:
taxpayers want their own stake in the economy and more control over
their retirement benefits.
Critics argue that individual accounts are too risky for lower-
income individuals. We believe that it is more risky, and certainly
unfair, not to give lower-income individuals the opportunity to realize
the benefits of accumulating assets. It is precisely this lack of
investment opportunity that has left too many Americans on the fringe
of the economy. Our legislation gives low-income workers the same
opportunities to have savings for their retirement and reap the
benefits of investment earnings that are already available to higher
earning workers who benefit from 401(k) plans and other private savings
vehicles. For low-income people, the individual security accounts are a
pure bonus above and beyond the strengthened safety net provided by the
guaranteed minimum benefit provision included in our legislation.
Why a Carve-Out is Necessary
H.R. 1793 creates individual accounts within the existing payroll
tax structure instead of creating individual accounts above the current
12.4 percent payroll taxes. Some plans ``add on'' personal accounts
through explicit or implicit tax increases or by diverting revenues
from other programs. Diverting a portion of payroll taxes to create
individual accounts--sometimes referred to as a ``carve-out''--has been
criticized as weakening the financial status of the Social Security
system and requiring deeper benefit cuts than otherwise would be
necessary. This argument completely ignores the benefits of using
individual accounts funded with current payroll taxes to replace a
portion of future unfunded liabilities instead of building up Trust
Fund assets.
By placing a portion of current payroll taxes into individual
accounts that will be available to provide retirement income for future
retirees, our legislation would significantly reduce future unfunded
benefit promises without reducing retirement income for these retirees.
Under our plan, a portion of retirement income for future retirees will
come from payroll taxes collected today and placed in individual
accounts, instead of leaving the entire burden of funding retirement
income to future taxpayers. The large reductions in future liabilities
on general revenues that we outlined earlier in our statement are
possible because of the advance funding from creating individual
accounts with existing payroll taxes.
While there has been a lot of discussion about the transition costs
of creating individual accounts, the transition costs resulting from
advance funding future benefits must be viewed in context of the
reductions in future liabilities that are achieved by this advance
funding. Proposals which rely on increasing the balances of the Social
Security Trust Fund to meet future benefit promises--instead of
creating individual accounts--effectively leave the financial burden of
providing retirement income for future retirees to future taxpayers.
The transition costs of creating individual accounts out of existing
payroll taxes are much smaller than the liabilities that future
taxpayers will face in redeeming trust fund balances under current law.
Those who criticize plans to advance fund future benefits with
individual accounts because of the transition costs resulting from
diverting a portion of current payroll taxes should be asked to explain
how they plan to meet the general fund liabilities that would be
reduced under our plan. Our legislation takes responsibility for itself
and preserves the flexibility of future Americans to address other
national needs.
There have been some suggestions that creating individual accounts
outside of the existing payroll taxes--sometimes referred to as an
``add-on''--would represent a compromise on the issue of individual
accounts. We strongly disagree with that suggestion. In fact, creating
individual accounts above the existing payroll tax would actually
exacerbate the concerns that we have outlined about the budgetary
pressures that will be created by retirement programs under current
law. That would represent a major step backwards from current law, not
a compromise.
Since there is very little willingness to explicitly require
additional contributions above the current 12.4 percent payroll tax
rate to fund individual accounts, most proposals that create individual
accounts outside of the current payroll tax are funded with general
revenues from projected surpluses. This approach presents some very
serious problems in terms of fiscal responsibility, future tax burdens
and resources available for other needs. Even if projected surpluses
materialize as currently estimated--an uncertain prospect at best--they
will not last indefinitely. However, the obligation to fund individual
accounts from general revenues would be permanent.
A Congressional Budget Office analysis of one such plan to create
individual accounts with general revenues warned that this approach
would result in higher implicit tax burdens, increased budgetary
pressures and a higher national debt. The Social Security Actuaries
have found that creating individual accounts of 2 percent funded with
general revenues could increase the national debt by more than $10
trillion above current projections over the next thirty years. Creating
individual accounts outside of the existing 12.4 percent payroll tax
means higher tax burdens on future generations, less resources
available for all other government priorities, and higher debt. We
cannot afford to ignore the very serious fiscal consequences that this
approach would have in the future in order to meet political needs of
today.
The real question isn't whether or not a plan has individual
accounts, it is whether the plan uses the individual accounts to
address future liabilities to taxpayers. Unlike plans which use current
payroll taxes to prefund future benefits instead of building IOUs in
the Trust Fund, individual accounts funded outside of the current
payroll tax would allow the Trust Fund to continue to accumulate IOUs.
These IOUs are merely claims against future general revenues. Using
current payroll taxes to create individual accounts and advance fund
future benefits will substantially reduce the liabilities on future
general revenues. By contrast, individual accounts added on top of the
current system take funds from general revenues today and leave in
place the future liabilities on general revenues. This is a fundamental
difference from a fiscal perspective that must not be brushed aside to
reach a political compromise.
The Kolbe-Stenholm Plan Strengthens the Government Safety Net
The 21st Century Retirement Security Act restores the solvency of
the Social Security Trust Fund in a way that not only protects low-
income workers from any reduction in benefits, it actually strengthens
the safety net provided by the Social Security program. It contains a
new minimum benefit provision that offers stronger poverty protection
than provided under current law. The plan also provides a subsidy to
supplement the individual accounts of low-income workers. Finally, by
addressing the unfunded liabilities of the Social Security without
shifting new obligations onto general revenues, our plan reduces the
pressure to cut funding for other government programs that benefit low-
income populations.
One of the innovative features of our bill is a minimum benefit
provision that provides a much stronger safety net for low and
moderate-income workers when they retire than is contained in current
law. An individual who has worked for 40 years and qualified for 40
years of coverage will be guaranteed a Social Security benefit equal to
100 percent of the poverty level. Workers would be eligible for a
minimum benefit equal to 60 percent of poverty after 20 years of work,
and the minimum benefit would increase by 2 percent of the poverty
level for each additional year of work. This minimum benefit level is
calculated without regard to any other change in the benefit formula
under our legislation. Any income from the individual accounts would
supplement this guaranteed benefit. Widows would be covered by the
minimum benefit guarantee based on his or her spouse's work history.
The new minimum benefit provision will enable Social Security to
lift more of the elderly out of poverty than current law. Currently,
nearly 8 million seniors receive benefits that are less than the
poverty level. According to the Social Security Administration
actuaries, 50 percent of women and 10 percent of men would receive
higher guaranteed Social Security benefits as a result of the minimum
benefit provision in H.R. 1793. For a low-wage worker, defined by the
Social Security Administration as a worker with lifetime earnings equal
to 45 percent of the national median, the minimum benefit provision
increases retirement income by more than 10 percent (see Table 2)--not
including any balances that would accrue in the worker's personal
account. We say to all Americans--if you work all your life and play by
the rules, you won't retire into poverty.
The Kolbe-Stenholm plan also incorporates the concept from the
President's USA proposal of helping low-income workers save for their
retirement by providing subsidies for workers. The individual accounts
in the 21st Century Retirement Security Act will give low and moderate
income workers the opportunity to benefit from investment opportunities
that higher income workers already have with 401(k) plans, IRAs and
mutual funds. To help low-income workers take advantage of this new
savings vehicle the Kolbe-Stenholm plan provides a savings subsidy, or
``match'' for low-income workers who make voluntary contributions to
their individual account. A maximum of $600 per individual is allowed
per year. To qualify for the subsidy in any given year, an individual
must earn less than $30,000 per year and make at least $1 in voluntary
contributions to their personal account. The subsidy for low income
workers will help increase retirement savings for lower income workers
who do not have access to private pensions and have little or no other
savings for retirement.
TABLE 2.--IMPACT OF THE MINIMUM BENEFIT PROVISION ON A LOW-WAGE WORKER
Low-wage worker earning 45% of the National Average Wage $12,600
(per year).............................................
CURRENT LAW SOCIAL SECURITY BENEFIT
Social Security Benefit at Normal Retirement Age:....... $568
Plus: Spousal Benefit (if applicable):.................. $284
---------------
Equals: Total Monthly Social Security Benefit:.... $852
===============
SOCIAL SECURITY BENEFIT UNDER KOLBE-STENHOLM
Poverty Level for a single-person household over age 65 $7,525
(per year).............................................
Translated into a monthly benefit (divide by 12)........ $627
Plus: Spousal Benefit (if applicable)................... $314
---------------
Equals: Total Monthly Social Security Benefit \1\. $941
===============
Kolbe-Stenholm increase over current law benefits (per 10.4% / $89
month).................................................
\1\ This amount does not include any balances that accrue in the workers
personal account. Consequently, total benefits will be higher.
We've discussed in detail the reduction in the unfunded liabilities
of the Social Security system under our proposal. This effect is
substantial for low-income individuals as well, because the budgetary
pressures that will occur under current law threaten deep cuts in other
safety net programs that benefit low-income populations. By honestly
addressing the budgetary pressures created by the unfunded liabilities
of the Social Security system, our plan ensures that future governments
will have resources available to preserve funding for discretionary
spending and other programs that benefit low-income families in
addition to providing Social Security benefits.
Instead of focusing on rhetoric about what Social Security reform
could do to vulnerable populations, we encourage you to look closely at
what our plan actually does. The 21st Century Retirement Security Act
demonstrates that a fiscally responsible plan to strengthen the Social
Security system and create individual accounts with existing payroll
taxes can actually preserve and strengthen the safety net provided by
Social Security.
The Kolbe-Stenholm Plan Increases National Savings
It is a basic rule of economics that increasing national savings is
vital to maintaining a strong and growing economy. Comprehensive Social
Security reform, done properly, could be the most significant action
the government could take to increase national savings. Estelle James,
a World Bank Economist who has studied retirement systems and across
the world and served on the NCRP, wrote in a study of public pension
reforms around the world that:
``* * * a change from the old traditional pay-as-you-go, defined-
benefit type of Social Security system to a system that includes more
funding, more individual accounts, and a closer link between benefits
and contributions is good for the overall economy * * * It helps all
countries develop their long-term saving, which seems to be linked to
economic growth.''
The 21st Century Retirement Security Act contains several features
that will help increase national savings. By advance funding a portion
of future benefits and tackling the tough choices necessary to control
the cots of the Social Security system, our plan dramatically reduces
the unfunded liabilities that will place a tremendous drain on national
savings in the future. The individual accounts in our plan create a new
vehicle for increased retirement savings by allowing workers to make
voluntary contributions of up to $2000 a year to their individual
accounts. The savings match for low-income workers will provide low-
income workers with an incentive and assistance to save for their own
retirement. The reductions in the defined benefits for the middle and
upper income workers who have the means to save for their own
retirement will encourage these workers to increase their private
retirement savings. The Congressional Budget Office and several
economic studies have found that the existence of high guaranteed
benefit levels for higher income workers has the effect of reducing
private savings among these workers.
The Kolbe-Stenholm Plan is a Better Deal for All Americans
When all of the provisions of the 21st Century Retirement Security
Act are taken into consideration, it offers a much better deal for all
Americans than current law. Our plan will put into place a Social
Security system that will remain financially strong for the next 75
years and beyond, and reduces the tax burdens that will be necessary to
support the system. At the same time, the legislation we have
introduced will provide a better rate of return than can be provided
under current law and strengthens the safety net for low-income
workers. The individual accounts in our plan will allow all workers to
create wealth and benefit from market forces. Perhaps most importantly,
our plan will help restore public confidence in the future of the
Social Security system.
Our legislation increases the rate of return for all workers
compared to what current law can fund. Comparing the benefits under our
plan to the benefits promised under current law is extremely
misleading, because we cannot afford the benefits promised under
current law. Today, the Social Security system faces a funding gap that
must be closed if beneficiaries are to be protected. Eliminating the
funding shortfall under current law through a traditional package of
benefit reductions or tax increases would exacerbate the bad deal that
Americans receive from Social Security.
Under current law, benefits will have to be cut by more than 25
percent after 2034 unless we raise payroll taxes. If the burden of
closing this funding gap were spread evenly among all generations,
benefit levels would be cut by nearly 16 percent beginning immediately.
To accurately compare our plan to the benefits promised under current
law, it is necessary to consider the substantially higher tax burdens
that will be necessary to fund the benefits promised under current law.
To the extent that current law promises higher benefit levels than our
plan can deliver for some middle and upper income retirees, it can only
meet those promises by imposing much higher taxes on those workers.
When the benefits promised under current law are viewed in context of
the taxes that must be raised to fund those benefit promises, the deal
offered by current law is not nearly as attractive for today's workers.
When all of the benefits under 21st Century Retirement Security Act are
compared to what current law can actually deliver, future retirees will
get a much better deal under our legislation than they would under
current law.
Our legislation establishes the opportunity for all Americans to
create wealth and benefit from the market forces to increase their
retirement income. Individual accounts will extend to low and moderate
income workers the investment opportunities that higher income workers
with 401(k) plans and mutual funds already enjoy. Unlike the current
system and some other individual account plans, H.R. 1793 will provide
individuals with ownership of and control over their retirement assets.
Finally, the 21st Century Retirement Security Act will improve
public confidence in the future of the Social Security system. The
Social Security system has a well-deserved reputation as one of the
most successful government programs in history, and has enjoyed strong
public support. However, the financial problems facing the system and
the low-rate of return that current workers can expect to receive on
their payroll taxes threatens to undermine this support. The plan we
have introduced offers a message of reassurance to seniors and a
message of hope to younger generations.
Our plan reassures seniors that the long-term challenges facing
Social Security can be addressed without threatening the benefits they
have been promised. Our bill restores the solvency of the Social
Security system while preserving existing benefit promises for current
and near-retirees. Current retirees would continue to receive their
existing benefits, with full increases for inflation, accurately
measured. By putting the Social Security system on a sustainable fiscal
path, our plan protects current retirees from the threat of benefit
changes that may be necessary if the Social Security system continues
to face financial problems.
While it is important that Social Security reform protect the
interests of current retirees, it is just as important that we address
the concerns of younger generations that doubt that the Social Security
system will be there for them. The Social Security system has always
been based on an implicit generational contract that workers will pay
taxes to fund benefits for current retirees in the expectation that
they will receive similar benefits when they retire. This generational
contract is threatened by the growing skepticism among younger workers
about the future of the Social Security system. Requiring workers to
pay taxes to support a system that they do not expect to benefit from
will create discord that can only jeopardize the political legitimacy
of the Social Security program.
The 21st Century Retirement Security Act will give younger
generations much greater confidence in the Social Security system. Our
plan reassures younger generations that the Social Security program
will be there for them when they retire by putting the system on a
long-term, sustainable fiscal path. In addition, our legislation will
give younger workers ownership of and control over a portion of their
retirement income, providing them with concrete assurance that the
Social Security system will provide them with retirement income. Our
legislation will modernize the Social Security system to ensure that it
can earn the support of younger generations that will be necessary to
preserve the program.
Congress Must Not Shirk Its Responsibilities in Exchange for Political
Expediency
We realize that reaching agreement on an honest solution to the
long-term challenges facing Social Security will be difficult, but the
difficulty of the task must not prevent us from confronting it. Social
Security reform will require us to tackle tough choices. We were
elected to make tough choices, and our constituents deserve no less
from us.
We hope that the suggestions contained in the legislation we have
presented to you will help create a foundation to build a bipartisan
agreement on Social Security reform. While our legislation may not be
perfect, it does offer all of the elements that will be necessary for a
responsible bipartisan deal to strengthen the Social Security system.
We do not agree with those who say that the issue of Social
Security reform is dead. These hearings are evidence that the issue
remains very much alive. More importantly, those of us who have the
honor of serving in public office have an obligation to keep this issue
alive for the sake of future generations that are counting on this
system. As we tackle the tough choices that will be necessary to enact
credible Social Security reforms, we must look beyond current polls and
think about how our children and grandchildren will look back at the
decisions we make today. We look forward to working with this Committee
to create a future for the Social Security system that will make future
generations grateful for the decisions we make today.
STATEMENT OF THE HON. CHARLES W. STENHOLM, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF TEXAS
Mr. Stenholm. I too, Mr. Chairman, thank you for your
efforts and leadership on this subject on which you hold the
hearings today. And I also commend Chairman Kasich for the
approach which he has taken, which Jim has mentioned bears some
similarities to the program and the proposal that he has
briefly described part of, and I want to concentrate on the
fiscal responsibility side of the question today, being fitting
that this is the Budget Committee.
The hallmark of our plan is honestly addressing the
financial problems facing Social Security and tackling the
tough choices that are necessary. And we don't do all of what
needs to be done, but we do a heck of a lot more than most of
the other plans.
Restoring solvency of the trust fund is important, but
simply restoring solvency over 75 years is not enough. There
are some basic questions that all of us need to ask who care
about fiscal responsibility that should be asked of any Social
Security plan being put forward.
One, does the plan put the Social Security System on a
permanent sustainable course that will continue to remain
strong at the end of the estimating period? Or does it leave
the trust fund in a deteriorating condition at the end of the
period? Does the plan deal with the tremendous liabilities on
general revenue that will squeeze the rest of the budget
beginning by 2014? And here I would emphasize very strongly,
unless we as a Congress are prepared to deal with the 2014
problem, we had better be extremely conservative in the amount
of taxes that we cut, and spending that we increase that just
happen to begin at the end of a 15-year estimating window.
We have been through this. I served on this committee with
Mr. Kolbe for many years, and we were always a little skeptical
and very critical of administrations that were always
estimating in the sixth year of a 5-year plan, or were
estimating 5 years but not moving forward and looking at what
would happen in the sixth and seventh.
I would encourage this committee to spend a considerable
amount of time looking at the 2014 problem. And using that,
first off, as you look at our chart--I assume we have got the
one up that shows the red area here--we would have that amount
of money available for cutting taxes if you do that which we
suggest.
If you cannot do that which we suggest, then you had better
come up with another way of dealing with that red area, because
between now and 2032, the percentage of our national income
consumed by Social Security will increase by 50 percent.
According to CBO's long-term budget projections, spending
on Social Security consumes slightly less than 20 percent of
total budget revenue today. It will grow to 30 percent by 2030.
There will be no room for any domestic initiatives and we will
have to cut back on existing programs or borrow the money
beginning in 2014 if we do not make some additional choices
that both Mr. Kasich and we talk about today.
There is no free lunch. The promised benefit under Social
Security will cost $20 trillion more than we can afford over
the next 75 years. That money will have to come from somewhere.
Comparing the benefits of any reform plan to the benefits
promised under current law is unfair because current law makes
promises we cannot keep. Plans which suggest we can save Social
Security without any tough choices depend on taking funds away
from other government priorities in order to provide promised
Social Security benefits.
Our plan does more than any other plan to reduce the long-
term budgetary problems facing Social Security. Our plan makes
some tough choices today that will require some sacrifices. We
either make the tough choices today to honestly deal with the
financial challenge facing Social Security or we leave a fiscal
time bomb for future generations to deal with.
Our plan reduces the liability that Social Security will
place on general revenues between 2014 and 2034 by more than 50
percent, reducing a $7.4 trillion liability by more than $3.8
trillion. Reducing those liabilities will provide future
generations with the flexibility to deal with other problems in
addition to preserving the Social Security system.
I point out again, the area in the red on the chart is
money that will be available for other programs, whether it is
money for education or agriculture or health care or defense or
tax cuts or any other priorities that we may have in the
future, but only if we make the decisions that we are talking
about today.
And the final thing I would want to emphasize is what we
believe is one of the strong points of our plan, is the changes
we make to strengthen the safety net for those in the lower
income levels. Our plan restores the solvency of the Social
Security Trust Fund in a way that not only protects low-income
workers from a reduction in benefits, but actually strengthens
the safety net provided by the Social Security program.
The benefit changes in our plan primarily affect middle-
and upper-income workers who will benefit from individual
accounts. The new minimum benefit provision of our plan will
enable Social Security to lift more of the elderly out of
poverty than current law.
As you heard, 50 percent of women and 10 percent of men
would receive higher guaranteed Social Security benefits as a
result of the minimum benefit provision in our bill. A low-wage
earner, defined by the Social Security Administration as a
worker with earnings equal to 45 percent of the national
average, would have a 10 percent increase in guaranteed
benefits from our minimum benefit.
Under our proposal, no individual who works a full career
will have to retire in poverty. Currently, nearly 8 million
seniors receive benefits that are less than the poverty level.
We say to all Americans, if you work all of your life and play
by the rules, you won't retire into poverty.
Thank you, Mr. Chairman.
Chairman Smith. Gentlemen, thank you very much. I guess one
concern that I have is the unpredictable nature of
demographics. We have had witnesses before this Task Force that
suggested that within 40 years you would almost have the option
of whether you wanted to live to 100 or 120, so I criticized
the scoring for only 75 years. And the more that your plan is
based on promising fixed benefits rather than fixed
contributions, the more danger there is in future insolvency,
depending on demographics and depending on a lot of the other
issues that might face our economy.
So my question is: Have you considered the possibility, and
why have you ruled out never going above a 2 percent private
savings account?
Mr. Kolbe. Well, my answer would be I would never say never
to that. But let's get this system in place and see how
something in the future might change to be able to phase that
in. As far as the demographics are concerned, I recognize that
medical technology and other things are changing. But I don't
know how else you can go about scoring a plan if you don't use
a common base of data and information; and ours, of course,
does use both the Social Security actuarial information and the
Congressional Budget Office scoring mechanisms.
Chairman Smith. But the problem with the 75-year scoring is
that you take advantage of the existing 800 billion in the
Social Security Trust Fund now and assume that that is going to
come in and make the program more safe for retirement.
Mr. Kolbe. I will let Charlie respond, but ours really does
not do that. Although we don't attempt to go beyond 75 years,
our projections are that ours continues on a level, stable
basis after 75 years. And certainly, there is far more
volatility to go with the parts of scoring a Social Security
plan in terms of wages and incomes and economic growth than--
that is far more unstable than anything dealing with the
demographics would be.
Mr. Stenholm. I would just say that under the scoring that
we have, and I believe our charts show that the Social Security
Trust Fund is actually improving in its solvency at the end of
our 75-year projection, and you will find that many others,
that is not the case. But your point is very relevant.
I am uncomfortable with projecting 2 years, much less 75
years, with any kind of accuracy. And that is why we will
continue to emphasize, both in this forum and others, being
conservative with the utilization of 15-year estimates for
purposes of making short-term, politically very popular
decisions, whether it be in Social Security or otherwise.
And the reason we came up with 2 percent, it was the number
that we could fit within what we believed to be a fiscally
responsible approach, but it doesn't say it can't go up. If it
works as well as we hope it does, there can be future
adjustments and changes made. But we think you need to crawl
before you walk before you run. And this one fits and others
have a difficult time fitting within the fiscal responsibility
criteria that we put upon our plan.
Chairman Smith. I just want to make sure that you know I am
a cosponsor of this. It moves us ahead. It has got tremendous
value.
Mr. Kolbe. And we appreciate that.
Chairman Smith. I am somewhat concerned and don't
understand the full impact of the additional income tax that
would be paid over the next 75 years, considering that the
change in the CPI becomes compounded in terms of its total
effect on the bracket creep and on deductions. Comments?
Mr. Stenholm. Well, yeah, CPI change is not a tax increase
or a benefit cut. It is a decrease in the rate of growth in
Federal expenditures by making adjustments for inflation
accuracy. The purpose of indexing benefits under Social
Security and other programs in the provision of the Tax Code is
to hold folks harmless from inflation. Our bill simply provides
that we do so with accurate measures of inflation. And for
those who argue this is a tax increase, show me where we change
the tax rate and show me where we expand the base or increase
the rate, because I can't find them in my bill, Mr. Chairman.
Chairman Smith. The actuaries credit some of that money
from tax savings going back into Social Security for your plan.
So there is some tax benefit that is credited back to your plan
as I read the actuaries's report.
Mr. Stenholm. But it is based on an accurate estimation of
what cost of living is. And how can you argue against trying to
make it accurate, whether it is on spending increases or tax
cuts?
Mr. Kolbe. Because I would note that it would also affect,
for example, your Medicare premiums which would not rise as
rapidly, so there is that factor too.
Chairman Smith. Mr. Collins.
Mr. Collins. Mr. Chairman, I don't really have any
questions but I do want to thank the two gentlemen for coming
forward with a plan. Once again we have demonstrated that
Members of Congress are willing to step up to the plate and
offer an idea and proposal and put it forth for the American
people to see. That is more than I can say about some folks in
this town. Thank you.
Mr. Kolbe. Thank you very much.
Chairman Smith. Jim, Charlie, do you have any specific
suggestions on any other efforts that we might take, or your
evaluation of moving this debate forward to increase the
possibility or probability, that we can accomplish a bill?
Mr. Kolbe. Well, Mr. Chairman, I still believe, despite the
rosy news yesterday about budget surpluses being better than
anybody had anticipated over the next several years, I still
believe we are clearly up against a budget caps problem this
fall. And as Members of Congress become aware of that, and they
then link that to the lockbox legislation that we passed here
in the House not too long ago, I think they are going to come
to the realization that the only way to solve our dilemma, both
politically and economically, is to unlock that lockbox by
doing something with Social Security. Once we solve Social
Security, we free up the surplus that is in there for whatever
spending we need this year, the tax cuts we need this year. We
can do that. We cannot do it until we resolve Social Security.
Our goal as members of our Task Force and your Task Force,
and our bill and all the other bills, should be to convince our
colleagues that they need to deal with this now, because it is
the key to solving the other political dilemmas that they face
this fall. Otherwise we are headed for one heck of a massive
train wreck this fall.
Mr. Stenholm. Mr. Chairman, if I might add to that, I think
we don't pretend that this plan is the perfect plan, and we
stand ready to work with any individuals on both sides of the
aisle and the administration to continue to develop a plan that
can get the required number of votes and support. Our plan has
one thing that only one other plan--and you heard from it
earlier today--and that is the Senate plan that Senator Gregg
and Senator Breaux brought forward, but ours is the only one
that has bipartisan support, and nothing will happen except
with bipartisan support.
So anything, Mr. Chairman, that you can do to continue to
promote the bipartisanship and moving forward will be very
helpful.
One of the things that we didn't mention, but we have asked
CBO to score our plan on a 10-year basis, which is the longest
that CBO scores things of this nature. And we don't have those
numbers as yet, but I would hope, I would add, that in any
actions that we take--because I happen to agree with Mr.
Kolbe's statement regarding the caps problem this year, and the
fact that the considerably more rosy scenario that we heard
yesterday, it is all very good. But one of the best things we
can do with these surpluses until we deal with Social Security
and Medicare in a very rational way is apply it to the debt.
Avoid the temptation to spend this money we have for tax cuts
that explode in 2014 and create tremendous problems for Social
Security, and by the same token avoid the temptation to spend
more on the spending side. That is what we can do and what this
committee can continue to provide the leadership to do.
Chairman Smith. Gentlemen, thank you very much. Mr. Collins
will preside, and I will go to that table to make a
presentation of my Social Security bill.
Mr. Collins [presiding]. Mr. Smith--that is Mr. Chairman,
the committee will now ``endure'' your testimony. So if you
will begin and pay real close attention to the lights, sir.
STATEMENT OF THE HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF MICHIGAN
Chairman Smith. Yes, sir. This is the third scored Social
Security bill that I have introduced. I started writing it in
1994, and it takes into account several, what I think are
dynamic ideas about our future economy and to the survival of
the Social Security system.
First, let me say that we cannot just deal with Social
Security alone, without considering Medicare and what we do on
Medicare, because both of these problems are important; and to
take one without the other means that the eventual retirement
security is going to be less secure.
This legislation, number one, allows workers to own and
invest a portion of their Social Security taxes by creating
these personal retirement savings accounts. I start at 2.6
percent--Mr. Chairman, gosh, that seemed so quick.
Mr. Collins. Glad you are paying attention to the lights.
Chairman Smith. I start at 2.6 percent of payroll and that
2.6 percent of taxable payroll increases over the next 60 years
to 8.4 percent. In other words, I move Social Security--except
for the 4.2 percent that is reserved for the safety net and the
disabled and their dependents, into a private system.
The 2.6 percent eventually can go as high as 8.4 percent.
It only takes 5.4 percent over a period of 30 years to have a
return on those investments greater than what current Social
Security promises.
So under all of these plans, an individual that is able to
invest in their own accounts for over 25 years has a
significant advantage over current promises of Social Security.
I come up with funding in several ways. One is I take on-
budget surpluses for 8 years, not to exceed Social Security
surplus revenues, to help support investment in those early
years. Secondly, I index the retirement age to life expectancy
after the person reaches the retirement age of 67 under current
law.
The PRSAs, the personal retirement savings accounts, in my
first bill were given the same restrictions as IRAs. A lot of
individuals need to know more about investing, because we have
failed in educating our young people and we need to start doing
that. My legislation simplifies the investment choices by
limiting participants to about the same options you have under
the thrift savings program, index stocks, index bonds, index
small cap funds and index global funds. It uses the surpluses
coming into the Social Security Trust Fund to finance these.
There is no increase in taxes or government borrowing. The PRSA
accounts can be taken out for individuals that want to retire
early, so anybody that has enough PRSA savings or other savings
and can buy an annuity to guarantee taxpayers that they are not
going to come back on taxpayers later on for welfare benefits
or other Social Security benefits, can retire at any time.
So we are suggesting that the age of retirement with PRSAs
is much more flexible. Workers are encouraged to invest by
allowing an individual to invest with the same tax benefits as
Social Security; in other words, only taxing half of it. They
can put up to an additional $2,000 a year in their PRSA
account. The tax incentives, I think, will help spur additional
savings.
This proposal gradually slows down the benefits for high-
income workers by changing the bend points. John Kasich
suggested the problem of indexing the bend points and indexing
what retirees are going to get. Under the current law it is
indexed to wage inflation that is higher than CPI. So for our
first bill in 1994, when we were writing it, we brought this
back to CPI inflation rather than wage inflation, which slows
down the increase in benefits for the higher income, precisely
because we only change the second and third bend points. We
don't change the wage inflation index for the first bend point.
Therefore, it slows down benefits for higher-income recipients.
We have several advantages to women in our bill. One, we
divide the personal savings account equally between husband and
wife. In other words, we add both spouses individual
contributions together, then divide by two, so both the wife
and the husband can invest in their own personal retirement
savings account the exact same amount of dollars. Also, we
increase the minimum benefit for surviving spouses to 110
percent over the 100 percent that is now in current law. This
has been scored by the Social Security Administration to keep
Social Security solvent, but because we gradually over the
years increase the amount allowed to go into that personal
retirement savings account, it is going to stay solvent
forever, not just the 75 years calculated by the SSA actuaries.
It maintains a trust fund reserve continually, so we always
have at least one-half year's Social Security benefits in that
trust fund.
I think it is the kind of proposal that faces up to the
challenges ahead of us. I would be glad to respond to any
questions.
[The prepared statement of Mr. Smith follows:]
Prepared Statement of Hon. Nick Smith, a Representative in Congress
From the State of Michigan
As a member of the 104th Congress, I introduced the first reform
plan in the House this decade that provided private retirements savings
accounts and was scored to keep Social Security solvent. That bill,
``The Social Security Solvency Act of 1996,'' was updated and re-
introduced as ``The Social Security Solvency Act of 1997.'' Shortly, I
will introduce ``The Social Security Solvency Act of 1999.''
Today, I would like to use the lessons we have learned during our
months of fact-finding on the Task Force to argue in favor of my
``Social Security Solvency Act of 1999,'' which I will introduce
shortly. Although there are some important refinements, this Act is
patterned on the ``Social Security Solvency Act of 1997'' that I
introduced previously. Like the 1997 bill, it has been scored by the
actuaries as restoring the solvency of America's most popular public
program. The development of my plan follows from what I consider to be
the Ten Commandments of Social Security reform.
The Ten Commandments for Social Security Reformers
The first commandment is that time is our enemy and we must move
without delay. Alan Greenspan informed us in March that OASDI has an
unfunded open liability of $9 trillion 1999 dollars. This means that an
outside party would require an up-front payment of $9 trillion now,
plus the legal right to 12.4 percent of 85 percent of the nation's
payroll forever just to honor the promises we have made to present and
future retirees, survivors, and disabled individuals. This obligation
is very real, and it exceeds by almost three times the size of the
national debt held by the public. Every year we delay, this unfunded
liability goes up by hundreds of billions of dollars as we grow closer
to the day when Social Security's temporary positive cash flow first
halts, then stops forever.
Put another way, to keep Social Security solvent for just the next
75 years, it would take an across-the-board cut in Social Security
benefits of 14 percent for current or all future beneficiaries to make
up the shortfall if we act now. Alternatively, a 16 percent increase in
Social Security taxes would also eliminate the shortfall. These
representative figures will get larger the longer we delay.
In 1983, the Congress felt an urgent need to act when Social
Security had an unfunded liability of -1.82 percent of taxable payroll.
The system now has an unfunded liability of -2.07 percent, a problem
that is 15 percent larger than the one in 1983! With the danger so
high, we must act with at least the same sense of urgency. Anyone who
says we have the luxury of time to tackle this difficult subject is
committing the nation to wrenching changes later rather than less
dramatic corrections now.
The second commandment is that we must reform the system to take
into account the growing probability of a significant rise in life
expectancy. Dramatic increases in life spans is wonderful news. Dr.
Kenneth Manton, one of America's most respected demographers, told the
Task Force to expect to see many of our next generation celebrating
their 100th birthday. Dr. William Haseltine, a recognized expert on
aging and regenerative biology and President of a company that expects
to complete mapping the human genome in the next few years, thinks that
science will make even greater advances. He believes that many of our
children will live to 120. As life expectancy increases, we must create
opportunities for our elderly population to remain productive and
active long into that period of life we now call ``retirement.''
Third, we should move prudently but boldly. Our actions must equal
the scope of the problem before us. Fortunately, it is now possible to
solve our problems by making gradual and continual Solvency. It took 60
years to create the current crisis. We can resolve it in steady
measured steps over 40 years.
The fourth commandment is that the burden of adjustment must fall
equitably. Any change should hold current retirees harmless. They
should receive full cost-of-living increases. Those near their
retirement years and low income workers should also be protected.
Meanwhile, better paid workers should contribute more than those with
moderate incomes.
The fifth commandment states that no tax increases should be
adopted to eliminate Social Security's unfunded liability. Medicare has
very difficult problems, and added revenue will be needed to resolve
them. Its unfunded liability is twice that of Social Security. Social
Security reformers who use new tax revenue to solve their problems
complicate efforts to resolve Medicare's difficulties--where lives, not
dollars, are at stake.
The sixth commandment holds that every worker should enjoy the
benefits of saving and investing. A primary reason why the rich are
outpacing the lower and middle classes is their ability to invest in
thriving corporations that yield returns that significantly exceed
those received by putting funds in banks. Professor Roger Ibbotson, the
nation's foremost historian on stock and fixed income markets,
predicted in 1974 that the Dow would rise from 1,000 to 10,000 by the
year 2000. He now projects that the Dow will reach 100,000 before 2025.
A way must be found so that everyone can get a share of this $140
trillion in new wealth that will be created.
The seventh commandment dictates that investments made for
retirement must be prudent. Prudent risk-taking does not require that
every investment turn out brilliantly. It does require that no matter
what happens every retiree have adequate funds from Social Security to
remain above the poverty level.
The eighth commandment declares that professional money managers
should not earn excessive fees from carrying out an essential national
mission. The Task Force heard from William Shipman, a Principal of
State Street Global Research, who presented the firm's detailed
administrative cost model. Workers can have access to broadly
diversified stock and bonds portfolios for only pennies a day. The GAO
is confirming these findings, and will publish its report before the
end of the month.
The ninth commandment compels us to redesign social security so
that it commands full public confidence. Currently, many workers have
so little faith in the System that they view their payroll taxes, not a
contributions for their own retirement but, as sacrifices. While they
support helping seniors, they don't personally expect to receive checks
when they become seniors themselves. Social Security will never be free
from political peril until all workers view participation as a valuable
fringe benefit from going to work.
The tenth commandment requires us to maintain our lead in a
competitive global economy. Other nations are modernizing their
national retirement systems. If we fail to improve ours, it will hurt
our national economic performance and our standing in the world.
Countries that have prepared themselves for the coming demographic
changes will have strong economies that vault them ahead of their
global competitors. I want the U.S. to be among that group of world
economy leaders.
If you agree with these principles, you will like my plan. It is
derived from them.
The Most Essential Step: Creating Personal Retirement Savings Accounts
(PRSAs)
The central element of my plan is to provide all workers with
Personal Retirement Savings Accounts (PRSAs) that they own and are
professionally invested solely for their benefit. For the next 36 years
all workers will contribute 2.6 percent of their pay, up to the maximum
Social Security wage base, into their accounts. Individuals will choose
where to invest these funds but will be offered attractive low cost,
high reward, equity and fixed income index funds as well as more
specialized programs if they so choose. After 2036, the actuaries say
the contribution rate can rapidly climb, reaching 11 percent by 2074.
Here are some examples of PRSAs in action. A 20-year old worker
earning $20,000 will deposit $520 the first year. Assuming a 2.5
percent inflation rate and she earns a pay raise 3.5 percent annually,
the annual contributions will grow over time reaching $3,944 forty-five
years from now. Over 45 years, she will place a total of $62,800 in her
account. Assuming her funds were placed in an equity index fund that
earned a 6.5 percent real rate of return, this $62,800 will grow to
$422,000--4.6 times her final salary. By converting this sum into an
annuity, she can expect to receive $34,500 a year for 19 years after
her retirement. I choose that time period because it is how long the
actuaries assume in their Social Security projections.
The amount that better-off workers will have in their accounts is
proportionate. A teacher starting at $30,000 will see her account grow
to $633,000, and her annual benefits for 19 years will be $51,750. A
young attorney graduating from a fine law school who lands a job at
$60,000 will retire a millionaire, having $1,266,000 in her account,
and see annual benefits of $103,500 for 19 years.
Here are representative figures for 40 year old workers. A worker
earning $20,000 today will have $59,200 in her PRSA account at 65. A
$30,000 per year bus driver will have $88,800. The 40 year middle
management executive will hold $177,600. These workers will see their
annual retirement incomes supplemented by $5,000, $7,500, and $15,000
when the PSRAs are converted into annuities good until the anticipated
time of death.
Finally, here are figures for 55 year old workers. The grocery
clerk earning $20,000 now will acquire a $9,000 PRSA in 10 years. The
bank teller earing $30,000 now will have $15,600 while the successful
architect earning $60,000 now will have $27,000 in 2010.
The point of these examples is that PRSAs grow very rapidly under
the magic of compound interest. The biggest beneficiaries of PSRAs are
the young and future generations. It makes sense, therefore, to take
this into account when allocating costs across generations for
restoring the System.
Investment Risk Can Be Managed
Fears about sudden stock market tumbles are overblown. It will be
20 years or more before the amounts at risk represent significant sums
as a percentage of the resources needed to ensure a secure retirement.
Put another way, even with a 2.6 percent ``carve out'' of Social
Security payroll taxes, it will be far into the future before the
monthly private retirement check exceeds the check received from Social
Security. We will have time to evaluate investment returns and account
for unexpected events that jeopardize workers retirement security long
before they could happen. These fears should not prevent us from
instituting needed reforms today.
I am exploring ways to reassure workers who may not have had
experience with 401(k) plans or mutual funds. Although the number of
happy investors has reached an all time high along with the DOW, the
process may seem frightening to those who haven't personally benefited
from the Reagan-Bush-Clinton bull market. One idea that I would
encourage the Committee to explore is a formal guarantee that anyone 45
or under will be guaranteed a retirement income equal to current law
benefits provided they invest their PSRAs in equity investments. We
know from 200 years of stock market history that equity returns over
long periods outperform all other prudent investments. Consequently,
the government can offer guarantees to long term investors with
confidence that there is at least a 200 to 1 chance it will never be
called upon to honor them. I haven't had this provision scored by the
actuaries. Therefore, I cannot present it to you in a formal way.
There are other ways cautious investors can avoid risk. First, they
can transfer the risk of market downturns to others who accept it
voluntarily. There are many life insurance and annuity products that do
just that. Insurance companies are professional risk takers, and are
quite successful at it. Many annuity investors give up the chance for
large gains, but they avoid losses in exchange. Here's another example.
Right now, a large investment house offers the public for a fee a
bundle of equities with the right to sell it back to them at the price
you paid for it 5 years from now. As Will Rogers once said, ``Sometime
the important thing isn't the return on capital. It's the return of
capital.''
When introduced, my bill will include an elimination of the
earnings test for retirees. I believe the benefits of encouraging
Americans to stay in the work force will strengthen Social Security in
the long run.
Paying for It
An important issue that any reformer must confront is how to
finance the transition to a modern system. We start deep in the hole
with a $9 trillion unfunded liability. The problem becomes harder when
2.6 percent or more of taxable payroll is channeled into PRSAs, the
earnings test is repealed, and widows benefits expanded by 10 percent
as I propose.
Fortunately, the problem can be resolved under a policy of ``easy
does it'' and ``steady as she goes.'' My answer is to slow down the
growth of benefits by a small amount each year for a long time. Under
currently law, OASDI benefits will increase by 90 percent, after
inflation, over the next 75 years. If we agree that real benefits
should grow at a slower rate, then we can solve this problem.
My bill does this by amending the benefit formula. Before
presenting my amendments, I wish to first review how initial Social
Security benefit checks are determined. Under current law, a worker at
normal retirement age earns a monthly benefit check known as the
``primary insurance amount'' or PIA. The PIA is calculated in steps.
First, a worker's entire earnings record, from teenage years to
retirement, is updated for inflation. Then, only the highest earning 35
years are isolated. Next, these best earning years are averaged to get
an average annual earnings level. Finally, this total is divided by 12
to get ``Average Indexed Monthly Earnings'' or AIME.
Social Security is often described as a progressive program. The
reason for this belief is that the PIA is derived from AIME in a
progressive way. In 1999, anyone with an AIME of $505 or less, the
equivalent of only $6,060 in year, will receive 90 percent of this
amount annually. Anyone with an AIME of $3,043 will receive 90 percent
of the first $505 of AIME, then 32 percent of the remaining amount.
Anyone with an AIME in excess of $3,043 will receive 90 percent of the
first $505 of AIME, 32 percent of the next $2,538, and only 15 percent
of any remaining amounts. As you can see, Social Security provides 90
percent of the earnings of a very low paid worker's historic pay while
only 42 percent of workers who averaged earnings of $36,000. The wage
replacement percentage dips lower for the best off participants. The
1999 dollar thresholds of $505 and $3,043 where the benefit rates shift
are known as ``bend points.'' Under current law, they are annually
increased by changes in average nominal wages.
I propose to make the Social Security system more progressive by
slowing down the growth rate of benefits for those in the 32 percent
and 15 percent benefit brackets. I do this first by phasing in a 5
percent bracket over 5 years that only the highest paid workers would
face. It would start at AIME above $3,720 if fully in effect today.
Next, I propose that the 5 percent and 15 percent brackets gradually
decline at a 2.5 percent rate. In the first adjustment year for
example, they would be 4.875 (5 x 0.975) and 31.2 percent (32 x 0.975).
Five years out they would be 4.41 (5 x 0.985 x 0.985 x 0.985 x 0.985 x
0.985) and 28.2 percent ( 32 x 0.985 x 0.985 x 0.985 x 0.985 x 0.985).
I propose that the 32 percent rate also decline but by only 2 percent a
year, not 2.5 percent. I want the lowest paid workers to be unaffected
or unambiguously better off from my changes. Consequently, the 90
percent rate is not subject to reduction.
As a further way to slow down the growth rate in real benefits, I
proposed that the 15 percent and 5 percent bend points, and their
future derivative rates, be indexed to changes in the CPI, not nominal
wages. The bend point that defines the 90 percent AIME credit level
will continue to rise with nominal wages.
I believe the mechanism under my bill, which generates a very
gradual change annual change over a long period of time is a fair way
to allocate the costs across generations and income levels. It's true
that high school kids and young workers today would make the largest
contributions to solvency. However, as we saw earlier, they have the
time to benefit from the magic of compound interest. The two payment
streams, one from Social Security, the other from PRSAs, together will
exceed the amount of benefits projected under current law just from
Social Security.
It's worth remarking that our youngest workers have the least faith
that they will ever receive a Social Security benefit. In one famous
poll, a larger number said they believed in UFOs than they would
collect Social Security. Young workers will especially like having a
binding property right in their own privately managed PRSA while giving
up only some of a Social Security benefit many never expect to see in
the first place.
Gradually Raising the Retirement Age as Life Expectancy at
Age 65 Rapidly Improves
There are two other reforms required to restore Social Security to
long-term health. The first requires thinking through a pleasant
subject, increasing life expectancy during our retirement years. The
actuaries predict that newborn children today who reach 65 years of age
will live 3 years longer than those who reach that age now. The
difference in life expectancy works out to about 1/2 additional month
of life for every passing year. This means an infant born today who
reaches his 65th birthday can expect to live until 85.5, compared to
82.5 today.
I propose that we all share our good fortune of living longer with
the taxpayers. After all, we'll have more time to prepare for it! I
propose eliminating the 11 year hiatus in current law between 2005-16
where the retirement age remains at 66 before increasing in 2 month
increments in 2017 to 2021. Instead, I recommend raising it to 67 by
2010, then indexing it to life expectancy. The indexing provision may
be the most important idea in the bill if the Task Force experts prove
prescient and our children and grandchildren are destined to led much
longer lives than we. Reflecting on the age of this Committee's
venerable Chairman and my upcoming 65th birthday, I think the vast
majority of future workers, who can be expected to be in better shape
than we are today, are up to the task. For those who are not, we should
update the disability program. For those who want to retire early, we
should let them do so, as is now done, with actuarially fair reduced
benefits.
Sharing the PRSA Bounty With the Taxpayers
As the size of PRSAs grows, the need for taxpayer assistance
declines. We can ask for an especially large contribution from that
young attorney who will have a PRSA worth over $1,000,000 for example.
I propose that PRSA accounts be offset by the future value of
contributions made into PRSA assuming a 3.7 percent real rate of
return. In effect, a worker who gets a 6.5 percent real rate of return
from equity investments will keep 2.8 percent. The remaining 3.7
percent is returned to the Trust Funds so they balance. A 2.8 percent
real rate of return is much higher than the 1 percent or less experts
now predict on future OASDI payroll tax payments if, and it's a big if,
Congress finds a way to honor all benefit promises under current law. I
wish it could be higher. But as Billy Joel sang, ``We didn't start the
fire. It's been burning since the world been turning.'' We have to
eliminate the $9 trillion shortfall we've been handed or leave a more
difficult challenge to future leaders who will lead if we refuse the
challenge.
Actuarial Scoring of the Social Security Solvency Act
Here is the summary table the Social Security actuaries.
ESTIMATED LONG-RANGE OASDI FINANCIAL EFFECT OF PROPOSAL OF
REPRESENTATIVE NICK SMITH
------------------------------------------------------------------------
Estimated
change in long-
Section range OASDI
actuarial
balance\1\
------------------------------------------------------------------------
201 Raise the NRA by 2 months per year for those 0.50
age 62 in 2000 to 2011, then index to maintain
a constant ratio of expected retirement years
to potential work years.......................
202 Provide a third PIA bend point in 2000 with a 5 2.89
percent percent factor; index the second and
third bend points by the CPI and gradually
phase down the 32, 15 and 5 percent factors
after 2000....................................
203 Annual statement for workers and beneficiaries. (\2\)
205 Cover under OASDI all State and local 0.21
government employees hired after 2000.........
206 Increase benefit payable to all surviving -0.30
spouses by 10 percent beginning 2001..........
207 SSA study the feasibility of optional (\2\)
participation.................................
Subtotal for sections 201, 202, 203, 205, 3.21
206, 207......................................
101 Set up PRSA accounts starting 2001.............
102 Redirect 2.6 percentage points of OASDI payroll
tax to PRSAs for 2001-2036. After 2036,
redirect to PRSAs any OASDI income in excess
of the amount needed to cover annual program
costs and maintain a minimal contingency
reserve trust fund. Transfer specified amounts
from the Treasury to OASDI for years 2001-9
(based on current CBO surplus est)............
103 Reduce OASI benefit levels by the amount of -1.15
lifetime PRSA contributions, accumulated at
the yield on trust fund assets plus 0.7
percent.......................................
---------------
Total for proposal......................... 2.06
------------------------------------------------------------------------
\1\ Estimates for individual provisions exclude interaction.
\2\ Negligible, i.e., less than 0.005 percent of payroll.
Notes: Based on the intermediate assumptions of the 1999 Annual Trustees
Report, Office of the Chief Actuary, Social Security Administration,
June 5, 1999.
The Impact of the Plan on the Unified Budget
The Social Security Solvency Act has a very salutary effect on the
long run unified budget. Under current law, the nation will experience
a dramatic swing in the unified budget over the next sixty years. Until
most of the baby boomers retire around 2020, the nation can expect to
run unified budget surpluses. For the fifty years or longer that follow
2020, the unified budget will plunge into the red with accelerating
speed. My bill helps to stabilize the unified budget over the long run
by reducing the size of surpluses now and reducing the size of the
deficits that appear after 2020. The bill principally reduces unified
surpluses now by channeling a portion of payroll receipts into PSRAs.
By amending the benefits formula, it reduces unified budget deficits
significantly later on. Overall, my bill makes the government smaller.
Both taxes and spending as a share of GDP fall significantly in the
middle of the next century.
My bill's primary impact in the early years is to reduce revenues
by 2.6 percent of taxable payroll, starting in 2001. Table II F7 of the
Social Security 1999 Trustees Report specifies how much revenue, by
year, 12.4 percent of taxable payroll tax raises for the several years.
By calculating what fraction 2.6 is of 12.4, then multiplying by
projected taxable payroll receipts its possible to calculate how much
the bill reduces revenues. We estimate these revenue reductions will be
offset by $12 billion annually by 2008 by bringing newly hired state
and local government workers under Social Security.
My bill provides for a 10 percent increase in widows/widower
benefits, which will increase Social Security outlays. Short term
outlays also will increase because less Federal debt will be retired
due to the revenue reductions and outlays increases, resulting in
higher interest expenses.
Gradual reduction in benefits, due to indexing the bend points to
the CPI rather than nominal wages, and gradual phasing down the 32
percent, 15 percent, and 5 percent benefit factors, will reduce outlays
by growing amounts. Benefits are further reduced through the 3.7
percent offset formula described above.
The combined impact of all these changes is shown in the following
table:
IMPACT OF THE MAJOR PROVISIONS OF THE SOCIAL SECURITY SOLVENCY ACT ON THE UNIFIED BUDGET
[Dollars in billions]
----------------------------------------------------------------------------------------------------------------
Impact on unified
Year Debt Widow/Widower Benefits Total outlays Revenues budget
----------------------------------------------------------------------------------------------------------------
2001 +$5 +$9 -$1 +$13 -$95 -$108
2002 +9 +9 -3 +15 -97 -112
2003 +14 +9 -4 +19 -100 -119
2004 +19 +9 -6 +22 -104 -126
2005 +24 +10 -9 +25 -109 -134
2006 +29 +10 -14 +25 -113 -138
2007 +34 +10 -19 +25 -117 -142
2008 +39 +10 -25 +24 -122 -146
----------------------------------------------------------
To ............ ............... ............ +205 -857 -1,025
t
a
l
----------------------------------------------------------------------------------------------------------------
To comply with reconciliation instructions, the Committee could
elect to defer some contributions into PRSA accounts from 2001-4 until
2005-8. Additional revenue would have to be found since estimated
revenue losses total $857 billion from 2000 to 2008 while the
instruction limits reductions to $778 billion from 2000 to 2009.
Spending offsets will be needed to pay for the widow's benefit.
The Act Prevents Dangerous Future Unified Budget Deficits
PERCENT OF TAXABLE PAYROLL
----------------------------------------------------------------------------------------------------------------
Current law Current law cost Smith bill Smith bill Cost
Year income rate rate Annual balance income rate rate Annual balance
----------------------------------------------------------------------------------------------------------------
2010 12.75 11.91 .84 10.13 11.30 -1.18
2020 12.91 15.03 -2.12 10.22 11.86 -1.63
2030 13.09 17.71 -4.62 10.33 11.98 -1.65
2040 13.17 18.18 -5.00 9.62 9.85 -0.23
2050 13.22 18.28 -5.06 7.10 7.26 -0.17
2060 13.29 19.05 -5.77 5.02 5.14 -0.12
2070 13.34 19.63 -6.29 3.09 3.18 -0.09
----------------------------------------------------------------------------------------------------------------
After 2015, my bill substantially reduces future unified budget
deficits. The precise amounts are difficult to calculate 15, 25, or 50
years out. However, their magnitude can be suggested from the
actuaries' scoring. Under current law, the 1999 Trustees Report found
that OASDI would run deficits starting in 2015 by growing amounts. By
2040, OASDI will run deficits equal to 5.00 percent of taxable payroll
and growing. Under my plan, OASDI will run only a minor deficit of 0.23
percent of taxable payroll, and it will be falling. Here is a
comparison of the two actuarial projections. It proves that my bill
avoids the creation of massive unified deficits for most of the 21st
century. It therefore stabilizes long-run fiscal policy.
Impact on the Social Security Trust Funds
Instead of exhausting the Trust Funds in 2035, my plan keeps them
in the black.
[Percentages]
----------------------------------------------------------------------------------------------------------------
Year Trust fund ratio Year Trust fund ratio Year Trust fund ratio
----------------------------------------------------------------------------------------------------------------
2005 241 2035 54 2065 49
2015 267 2045 45 2074 68
2025 159 2055 45
----------------------------------------------------------------------------------------------------------------
Note: The Trust Fund Ratio equals the amount of assets on hand divided by that year's disbursements.
Use of General Revenues
I believe solving Social Security's problems is so important we
should apply the proceeds from of on-budget surpluses from 2000 until
2008 to achieve it. Importantly, the plan still provides room for tax
relief, improving Medicare's unstable financing, or a reduction in the
national debt.
SMITH PLAN REDUCES, BUT DOES NOT ELIMINATE, SHORT-TERM UNIFIED BUDGET SURPLUSES
[Dollars in billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 2001 2002 2003 2004 2005 2006 2007 2008
--------------------------------------------------------------------------------------------------------------------------------------------------------
Off-Budget...................................................... $145 $153 $161 $171 $183 $193 $204 $212
On Budget....................................................... 6 55 48 63 72 113 130 143
Smith Plan...................................................... -107 -111 -118 -125 -132 -137 -141 -146
Remaining Surplus............................................... +44 +98 +91 +109 +123 +169 +193 +209
--------------------------------------------------------------------------------------------------------------------------------------------------------
Every day of delay leaves us with fewer resources to bring solvency
to Social Security. Right now, the system is enjoying robust surpluses.
In fifteen years, these surpluses will be gone, replaced by deficits
that grow larger each year. We must act now for the baby boomers'
retirement.
Congressman Nick Smith's Social Security Solvency Act: A Tax Cut for
Workers
<bullet> Allows workers to own and invest a portion of their Social
Security taxes by creating Personal Retirement Savings Accounts
(PRSAs).
<bullet> PRSA investment starts at 2.5 percent of wages (20 percent
of Social Security taxes) and gradually increases.
<bullet> PRSA limited to a variety of safe investments.
<bullet> Uses surpluses coming into the Social Security Trust Fund
to finance PRSAs.
<bullet> No increases in taxes or government borrowing.
<bullet> PRSA account withdrawals may begin at 59\1/2\, while the
eligibility age for fixed benefits is gradually increased by 2 years
over current law.
<bullet> Tax incentive for workers to invest an additional $2,000
each year.
<bullet> Gradually slows down benefit increases for high income
retirees.
<bullet> Divides PRSA contributions between couples to protect non-
working spouses.
<bullet> Widows or widowers benefit increased to 110 percent of
standard benefit payment.
<bullet> Scored by the Social Security Administration to keep
Social Security solvent.
<bullet> Maintains a Trust Fund reserve.
Mr. Collins. Is this an option, or does this 2.6 percent
apply to all?
Chairman Smith. It is optional when you go into the
program. But here again if you are expecting to receive a
return on your private investments of 4 percent or more, then
in the long run it is going to be an advantage to go into the
program. So the way it is scored by Social Security is assuming
that everybody is going into the program, but in our
legislation it is optional.
Mr. Collins. How about age? Is there any age limitation to
opt into it?
Chairman Smith. No age limitation. In fact, what we do,
Mac, is we also require the Social Security trustees to start
looking at ways individuals can totally opt out of Social
Security if they want to. That is going to be somewhat
expensive, but at least it seemed reasonable for younger people
to have some way of opting out of Social Security if they
wanted to, except we wouldn't allow them to opt out of the
disability insurance portion of the program.
Mr. Collins. Do I understand that someone age 61 could opt
into this?
Chairman Smith. Yes, any age can opt into it. Of course,
the people who are really going to benefit are those who can
keep that private investment in there for 20 years or 25 years.
Then the magic of compound interest is going to give you a much
higher benefit in relation to what you can now get under Social
Security.
Mr. Collins. What age maximum is the least benefit to opt
into it; 55, 60?
Chairman Smith. If you can get a 5 or 6 percent real
return, then you should opt into it at any age because, No. 1,
it becomes your account. If you happen to die before
retirement, you are getting all of that personal retirement
savings, unlike the current Social Security system that leaves
you with nothing. In terms of what future Congresses might do,
because the Supreme Court has ruled twice now that there is no
entitlement for benefits regardless of what you pay in Social
Security taxes, then I think once people understand the
consequences, most everybody is going to opt into the program
unless they are ready to retire in the next year or two.
So maybe, if I were answering your question specifically, I
would say anybody that was under 60 might find an advantage in
coming into this program.
Mr. Collins. You have two spouses working, both the husband
and wife. The wife makes $30,000 a year. The husband makes
$60,000. You mentioned something about you treat them equal?
Chairman Smith. Yes. I take 2.6 percent to start out. In
the early years it is 2.6 percent. Ultimately it gets to 8.4
percent. In the early years 2.6 percent times 30,000 plus 2.6
percent times 60,000 are added together, so each spouse, each
husband and wife, would have the exact same amount to invest in
their personal retirement account. It might reduce some of the
business for attorneys in case there is ever a divorce because
it has been equally divided while they are married. Then the
division and equal investment would, of course, stop, but it is
all accounted for in terms of if there is a divorce or
something else happens plus the fairness of having it equally
in both names.
Mr. Collins. Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman.
Mr. Smith, a couple of questions. First I want to start by
saying I think this is a tremendous plan, extremely thoughtful
in detail, and it accomplishes a number of things. Is it fair
to say that the goal of your plan is to gradually transition to
a fully funded, fully prefunded system of personal savings
accounts, and with respect to the retirement portion of Social
Security, that is your goal to profoundly transform the nature
of this system?
Chairman Smith. That is the goal. And if you can get a real
return of more than 3.7 percent, then you are going to be ahead
of fixed benefits. What we did do is we saved out almost 4
percent in the current plan. I am not sure what is going to
happen to the disability insurance portion of the program.
Since that has grown so tremendously, we wanted to save enough
aside there to make sure it is covered.
Mr. Toomey. By using 4 percent you are using more than
twice of what it would currently cost to finance that part of
it?
Chairman Smith. The financing now is 1.7 percent.
Mr. Toomey. As far as ownership of the plans go, does your
plan contemplate complete ownership, by which I mean--first of
all, do you force annuitization?
Chairman Smith. Yes, we force annuitization so that the
fixed portion of benefits plus the annuity would equal ultimate
Social Security benefits.
Mr. Toomey. So the forced annuitization would only apply to
that amount of the savings account which is necessary to
generate that minimum savings; is that correct? Anything above
and beyond that a person would be free to do with as they
please?
Chairman Smith. Correct.
Mr. Toomey. As far as investment options, do I understand
you correctly to say that you would limit them to index funds?
Chairman Smith. Yes. We limit them to four choices. Now, we
add sort of a fifth option directing the Secretary of Treasury
to add any other investment account allowances that he thinks
is appropriate that are less risky investments.
Ultimately it seems to me that we have got to start
training our young kids about investment if they are going to
be able to enjoy the wealth creation that investment can
accomplish. I would like to incorporate in my bill, but I can't
very well do it, that we start training these kids in high
school to excite them about the magic of compound interest and
investments, but eventually I think it is important that we
expand that to a broader range of investments.
Mr. Toomey. Right. I agree with that sense.
As far as the reduction in fixed benefits, if I understand
correctly, you apply a calculation equivalent of a theoretical
annuitization based on 3.7 percent assumed return to the
savings account, and that is the amount by which you would
reduce the fixed benefit portion?
Chairman Smith. Technically in the bill we add what
Treasury's 30-year treasuries are getting plus 0.7 percent.
That amounts to 3.7 percent. Your offset of your fixed benefits
would equal 3.7 percent of your personal retirement savings
account.
Mr. Toomey. That is a fixed amount. You don't contemplate
that fluctuating with respect to some market index or anything?
Chairman Smith. No, I don't.
Mr. Toomey. The administration of accounts like this we
have heard a lot of discussion over the course of our hearing.
Some believe that it is absolutely impossible. Some have made
reasonably compelling arguments that they have got a system for
this. Do you advocate using an approach similar to what State
Street recommended using?
Chairman Smith. Yes, we include the State Street type of
approach in our bill.
Mr. Toomey. Last question. The--using CPI versus wages to
determine initial benefits, you mention you do that with an
application of two out of the three bend points, not the first,
as Chairman Kasich approaches it, with all three of the bend
points. Is that primarily to keep the system more progressive,
or does that have the net effect of keeping the system more
progressive or less, or does it not----
Chairman Smith. It has the effect of keeping the system
more progressive so the low- and moderate-wage individuals
would continue to have their benefits grow faster than the
higher-income recipients.
Mr. Toomey. If you applied it to all three bend points, as
Chairman Kasich does, there would still be an element of
progressivity in the program, correct?
Chairman Smith. There would be some progressivity. Mr.
Kasich, as I understand his proposal, offsets the disadvantage
of changing the bend point for--the first bend point by
allowing a higher percentage of investment for those low
income.
Mr. Toomey. Thank you very much.
Mr. Collins. One other question, Chairman Smith. If I
understand your proposal here, you don't have any transfer
payments built into this as was presented by the memos from the
other end of the hall; is that correct?
Chairman Smith. I do have transfer payments. I call on
general fund surpluses not to exceed Social Security surpluses
to help in the transition. Also, what we will be doing in the
bill is we are using the Social Security surplus to pay down
the debt and to reduce any negative effects for any recipients
regardless of their age. We are going to look for the general
fund to contribute the amount of interest savings to try to
make sure that nobody is disadvantaged, even that vulnerable
age group from 45 to 60.
Mr. Collins. But by transfer payment, you are not setting
up, you are not requiring above the current tax rate any
additional funds? I know it is going to take general funds to
bail out any----
Chairman Smith. No.
Mr. Collins. You are not setting up a kitty account; you
are not setting up a personal account that takes money beyond
the current tax system?
Chairman Smith. No, except we do call on money coming in
from the general fund to a certain extent.
Mr. Collins. You have a safety net?
Chairman Smith. And then we have a safety net, yes.
Mr. Collins. Thank you.
Chairman Smith. Thank you.
Mr. Collins. Any further questions for this gentleman?
Mr. Toomey. Not at the present time.
Mr. Collins. Stand in reserve in case some question comes
up, please.
Chairman Smith. You may mail me questions.
Mr. Collins. We expect a full answer, too.
Chairman Smith. Mr. DeFazio, I think, is next.
Mr. Collins. Mr. DeFazio.
Chairman Smith [presiding]. Mr. Roscoe Bartlett.
Mr. Bartlett. Mr. Markey should be here to testify with me.
We are checking to see if he is on his way.
Chairman Smith. We will stand in ease for the next 4
minutes while the members of the Task Force eat lunch.
[Recess.]
Chairman Smith. Congressman Bartlett, thank you for your
willingness to go ahead of time, and we will have
Representative Markey join you when he gets here.
STATEMENT OF HON. ROSCOE G. BARTLETT, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MARYLAND
Mr. Bartlett. Thank you very much. Mr. Chairman and members
of the Social Security Task Force of the House Budget
Committee, I want to thank you for the opportunity to testify
before you this afternoon. I appreciate the opportunity to
discuss H.R. 990, the Social Security Investment Fund Act of
1999, with the Task Force.
H.R. 990 was written to achieve a simple goal: putting the
excess Social Security taxes to their highest and best use. We
believe that the surplus taxes collected for Social Security
should get a rate of return comparable to what a fund manager
would get for a private retirement program. With that in mind,
the Social Security Investment Fund Act was written to allow
surplus payroll taxes to take advantage of the historically
higher rates of return realized in the United States equities
market. To accomplish this, our bill would authorize the
managing trustee of the Social Security Trust Fund to transfer
specific portions of the trust fund surplus to an independent
agency which will broadly invest in the United States equity
market.
The Federal Government has extensive experience with
investing of this sort under the Thrift Savings Plan, the TSP.
Because of the positive experience of the TSP, we chose to
closely model the Social Security Investment Board after the
Thrift Savings Board. I would like to point out that we are all
members of the Thrift Savings Plan, and I cannot recall in my 7
years as a Member anyone taking to the well of the House to
question the management of the Thrift Savings Plan. Not only
can government manage broad-based stock investments, but it has
been doing so for a number of years.
After the Social Security Investment Board receives the
surplus Social Security revenue, the taxes will be invested in
broad-based index funds. Index funds are passively managed
funds which replicate the performance of the market as a whole,
not individual stocks. The funds envisioned by H.R. 990 would
be similar to the C-Fund in the Thrift Savings Plan. In all
likelihood, the indices selected would be similar to the
popular Standard and Poor 500 or the Willshire 5000. I believe
it is important to point out that private sector professionals,
such as those at the widely respected Standard and Poor's, will
determine what companies are included in the Social Security
Investment Fund by the criteria they establish to govern
inclusion of stocks in their indices. Under our bill, there
cannot be a room full of government bureaucrats picking and
choosing what companies get included in an index.
I understand that there are some Members who have concerns
about our bill. Many Members may be concerned that our bill
will unduly involve the Federal Government in the affairs of
national businesses. I had the same concern when I first
started working on this bill. Mr. Markey and I went to great
pains to include a number of provisions in this bill that would
address these concerns.
As I mentioned earlier, the surpluses would be invested in
broad-based private sector investment funds. This effectively
prevents the fund managers from picking and choosing winners
and losers. The companies that are included in the Social
Security Investment Fund will be included because they are
already a constituent company in a widely used private sector
index.
Secondly, we prevent the manager of the fund from
influencing corporate decision-making by requiring them to
mirror vote their shares. This means that the managers are
explicitly instructed to vote last and cast their votes in the
same proportion as the votes were cast in the company as a
whole. This will effectively eliminate any possibility of
government managers having an effect on the selection of
members of the corporate boards or on the formulation of
corporate policy.
We have also included extensive reporting requirements so
that the Congress will be able to closely monitor the
management of the funds. Since the surplus would be invested in
funds that track widely available private sector indices, it
will be fairly simple to monitor whether or not the funds are
tracking the indices or not. Since the members of the board
will be regularly reporting to Congress, there will be ample
opportunity to publicly address an inconsistency should it
arise.
We also have included language in the bill which prohibits
companies from being included or excluded from an index for
social, political, or religious reasons. Although I may
personally object to the policies of various companies in a
fund, the only criteria that can be used for the inclusion or
exclusion is whether or not they would otherwise be included in
the index.
Finally, there have been some concerns that while our bill
may be well crafted and left untouched would prevent the
government from acting irresponsibly or imprudently, its
provisions could be changed. I will be the first to concede
that our bill can in no way prevent a future Congress from
altering its provisions in breaking down the firewalls that we
have constructed, but I have rarely heard Members retreat from
passing good legislation because a future Congress could undo
their good work. Should we abandon tax cuts because a future
Congress may increase tax rates? Should we forsake Medicare
reform because a presently unelected Congress would scuttle our
changes? Of course not. What we have to do is pass prudent
reform and remain vigilant in the future so the safeguards will
not be undone.
Our bill represents a common-sense proposal that Members
from both sides of the aisle can support. The bill will add at
least 6 years to the life of the Social Security program
without raising taxes or cutting benefits. It will get the
Social Security surplus out of Washington and put it to work
for Social Security beneficiaries. Most importantly, the bill
will give the Congress the opportunity to craft a proposal that
addresses the underlying demographic and unfunded liability
problems that exist within the Social Security program.
Task force members, our bill is a modest proposal, but we
believe the right proposal for the 106th Congress. I believe
that comprehensive reform is not possible in this Congress.
Early next year Presidential politics will take center stage.
Considering the House has only passed three appropriations
bills, we have a $788 billion tax bill pending, and it is
nearly the 4th of July. I am unsure when we will have time for
the national debate necessary to reach the consensus required
for fundamental Social Security reform. With that in mind, I
believe Congress should act while times are good and embrace
the Bartlett-Markey bill and bide some time for Social Security
while Congress works out a more comprehensive solution.
I thank the Task Force for its time and welcome any
questions.
[The prepared statement of Mr. Bartlett follows:]
Prepared Statement of Hon. Roscoe G. Bartlett, a Representative in
Congress From the State of Maryland
Mr. Chairman and members of the Social Security Task Force of the
House Budget Committee, I want to thank you for the opportunity to
testify before you this afternoon. I appreciate the opportunity to
discuss H.R. 990, the Social Security Investment Fund Act of 1999, with
your Task Force.
H.R. 990 was written to achieve a simple goal; putting the excess
Social Security taxes to their highest and best use. We believe that
the surplus taxes collected for Social Security, should get a rate of
return comparable to what a private sector fund manager would get for a
private retirement program. With that in mind, the Social Security
Investment Fund Act was written to allow ``surplus'' payroll taxes to
take advantage of the historically higher rates of return realized in
the United States equity market. Estimates are that investing a portion
of the surplus in the equities market alone will add at least 6 years
to the life of Social Security.
To realize this goal we establish an independent Federal agency
which will be responsible for investing portions of the projected
Social Security surplus in broad based private-sector index funds.
Advantages of Investment in an ``Index Fund''
At regular intervals, a portion of the surplus Social Security
taxes that are not necessary to pay current beneficiaries will be
transferred to the Social Security Investment Board to be invested for
their benefit in broad-based stock index funds. ``Index funds'' are
passively managed funds which replicate the performance of the market
as a whole, not individual companies.
By investing in widely used indices the Social Security Investment
Fund will be able to take advantage of the traditionally higher rates
of return available in the equities market, effectively giving the
taxpayer, ``more bang for their buck.''
The General Accounting Office (GAO) estimates that indexed
investment in the stock market will have a long-term real rate of
return of 7 percent, as opposed to the 2.5 percent real rate of return
the Social Security Trust Fund currently receives on government
securities. In addition to having a higher rate of return than the
government securities, stocks are real assets that can be liquidated to
pay beneficiaries, without having to resort to another government
revenue stream. Indices are also a prudent choice, because they perform
well when compared to actively managed private sector funds. The
Standard and Poor's 500 (S&P 500), an index of the ``large-cap''
companies, out-performs over 75 percent of the actively managed mutual
funds.
The funds envisioned by H.R. 990 would be similar to the C-Fund
currently available in the TSP and administered by Wells Fargo. It is
anticipated that the indices selected would be similar to the popular
S&P 500 or the Willshire 5000. By selecting indices which only use
value-neutral criteria, market-weighting in the case of the S&P 500, we
will be vesting the market professionals, such as Standard and Poor's,
with the responsibility for selecting what companies are included in
the funds in the Social Security Investment Fund.
Finally by investing a portion of the Social Security Trust Fund in
the American market, there will be tangible assets available for Social
Security benefits when Social Security outlays surpass revenues in
2014.
Administration of the Fund and the Social Security Investment Board and
Executive Director
The Social Security Investment Board will be composed of five
members who will serve staggered 10 year terms. One of the members will
be elected chairman. All of the members of the board will be required
to have extensive private sector experience in the management of large
investment portfolios. The members will be appointed by the President
and require Senate ratification. The Speaker of the House and the
Senate Majority Leader shall each recommend one member.
The Board develops policies to be carried out by the Executive
Director. The Board is prohibited, however, from directing any
investment in any specific stock. The Executive Director will be
responsible for overseeing the investment of surplus Social Security
revenue by qualified private-sector managers. The private sector
managers will be chosen on a competitive basis consistent with Federal
procurement policies. The managers will have to be presently engaged in
the management of large portfolios in the private-sector. Because the
surplus will be invested in existing indices, the managers will be
competing only to provide the Board with administration of the funds
for the lowest possible cost, not to sell the Board the ``best''
performing fund. It is anticipated that because there will be a small
number of accounts to manage that the administrative costs of the Fund
will be extremely low.
Safeguards to Prevent Political Manipulation
There have been a number of legitimate concerns raised about
government directed investment. One of the most prominent concerns is
that our bill will unduly involve the Federal Government in the affairs
of national businesses. I had the same concern when I first started
working on this bill. Mr. Markey and I went to great lengths to include
a number of provisions in this bill that would address this concern.
As outlined earlier, the surpluses would be invested in broad-based
private sector investment funds. This effectively prevents the fund
managers from ``picking and choosing'' ``winners and losers.'' The
companies that are included in the Social Security Investment Fund will
be included because they are already a constituent company in a widely
used private sector index.
Secondly the bill prevents the members of the board, the Executive
Director or the managers of the funds from influencing corporate
decision making by requiring them to mirror-vote their shares. This
means that the managers are explicitly instructed to vote last and cast
their votes in the same proportion as the votes were cast in the
company as a whole. This will effectively eliminate any possibility of
the government managers having an effect on the selection of members of
the corporate boards or on the formulation of corporate policy.
We have also included extensive reporting requirements so that
Congress will be able to closely monitor the management of the funds.
The Board and the Executive Director will be required to appear before
the House Ways and Means Committee and the Senate Finance Committee
semi-annually. The Board will also be required to file quarterly
reports with Congress detailing the management of the fund.
Additionally the Board will be subjected to an annual audit. These
provision provide for a significant degree of transparency which is not
required of many of the agencies Congress currently oversees.
In addition to the reporting requirements, the nature of the
indices lends them to easy monitoring. Because the composition of the
S&P 500 and the Willshire 5000 is widely known, and closely monitored
in the markets, it would be difficult for the Board to inappropriately
drop a company without eliciting the attention of Congress. Moreover,
one would expect that if a company felt that it had been
inappropriately excluded from an index, they would bring it to the
attention of their Congressman. Because of the rigorous reporting and
testimony requirements, there will be ample opportunity to publicly
address an inconsistency should it arise.
Additionally, we have included language in the bill which
explicitly prohibits companies from being included or excluded from an
index for social, political or religious reasons. Although a Member or
an interest group may object to the policies of various companies in an
index and desire their exclusion, the only criteria that can be used
for their inclusion or exclusion is whether or not they would otherwise
be included in the index.
Lastly there have been some concerns, that these safeguards are
insufficient because they can be changed by a future Congress. I will
be the first to concede that our bill can in no way prevent a future
Congress from altering its provisions and breaking down the firewalls
that we have constructed. But I have rarely heard members retreat from
passing good legislation because a future Congress could undue their
good work. Should we abandon tax cuts because a future Congress may
increase tax rates? Should we forsake Medicare reform, because a
presently unelected Congress would scuttle our changes? Of course not.
What we have to do, is pass prudent reform and remain vigilant in the
future so the safeguards will not be undone.
Political Reality Makes Bartlett/Markey the Common-Sense Solution
Our bill represents a common-sense proposal that members from both
sides of the isle can support. The bill will add at least 6 years to
the life of the Social Security program without raising taxes or
cutting benefits. It will get the Social Security Surplus out of
Washington and put it to work for Social Security beneficiaries. Most
importantly, the bill will give the Congress the opportunity to craft a
proposal that addresses the underling demographic and unfunded
liability problems that exist within the Social Security Program.
Task Force Members, our bill is a modest proposal, but we believe
the right proposal for the 106th Congress. I believe that comprehensive
reform is not possible this Congress. Early next year, Presidential
politics will take center-stage. Considering the House has only passed
three appropriations bills, we have a $788 Billion tax bill pending and
it is nearly the forth of July, I am unsure when we will have time for
the national debate necessary to reach the consensus required for
fundamental Social Security Reform. With that in mind, I believe
Congress should act while times are good and embrace the Bartlett/
Markey bill and bide some time for Social Security while Congress works
on a more comprehensive solution.
I thank the Task Force for its time and attention.
Chairman Smith. Roscoe, it might be the plan that we move
ahead with. I agree with you, it is important that we proceed
with doing something to get some of the money out of town
because the danger is you use it for something else, tax cuts
or expanded spending. But your bill only extends the solvency
for 6 years. Have you looked at or thought about what
ultimately might be a way to keep it solvent forever or for at
least 75 years?
Mr. Bartlett. What this does it gives us 6 more years to
have that debate and reach that conclusion. But the earlier we
have the debate and reach the conclusion, the easier it will be
to solve the problem.
Obviously there are only two things you can do. One is to
increase revenues, and the other is to decrease expenses. I
think that increasing revenues is unacceptable already. The
FICA payroll tax is the largest tax on many working people's
pay stub, so I don't think we can raise that percentage tax.
I don't think also that it is acceptable to reduce the
benefits that current beneficiaries get. There are many of our
senior citizens that live on the edge, and reducing these
benefits would, I think, be unconscionable for them.
We might means test, and that is something we need to talk
about. If, in fact, this is a trust fund, then we shouldn't
means test. If it is an insurance fund, and you have invested
your money in it, you ought to get back what you have put in,
but after you have gotten back what you put in, I don't see any
problems in mean testing beyond that.
I know that the President's Commission on Social Security
Solvency has recommended that we simply increase the retirement
age. It is now 67 for all born after 1960, I think. If we were
to increase that to 70, most people believe that that would
solve our Social Security solvency problem. And the truth is
today at 70, we are healthier and will live longer than we
would have at 65 when Social Security went into effect. As a
matter of fact, when Social Security first went into effect,
the average male did not live to be 65. The average female
lived a bit longer. But today the average male will live longer
after 70 than he would have lived after 65 when Social Security
was put into effect. There are many seniors that do not want to
be forced out of the job market at 65 or 67 in the future. They
are very vital. They feel they have something to contribute,
and so I do not find seniors adverse to increasing the
retirement age to 70. It is my understanding that for the long
haul this would solve the problem, but for the short term, we
think that our bill, which I think addresses all of the
concerns that Alan Greenspan had.
The government managers cannot pick and choose stocks. They
can't even vote the stocks. They are mirror voting the stocks,
and all we are doing is using the same prescription we have in
the Thrift Savings Plan, which has been in operation for a
number of years. We all are a part of this, and nobody
complains about it. The amount of money that our plan would
invest in the market is less than the amount of money that
State and local retirement plans invest in the market, so it is
not a really large share of the market.
Chairman Smith. How long does your proposal extend the cash
flow, positive cash flow, of Social Security? In other words,
does it go beyond 2013 in terms of cash flow?
Mr. Bartlett. CBO said it extended it 6 years.
Chairman Smith. Six years would be the total solvency,
assuming that all of the trust fund is paid back, so it takes
it to 2039, as I understand it, but in terms of cash flow,
right now there is going to be less taxes coming in than would
accommodate payments by the year 2013, I think is the current
date. Does your bill extend that?
Mr. Bartlett. Six years on the front end means 6 years on
the back end. It is my understanding it extended it from 2013
to 2019. Of course, all of this depends on your assumptions as
to what the economy is going to do, but extended the date when
the income and the expenses were going to be equal for 6 years,
which gives us 6 more years to solve the problem.
Chairman Smith. Has anybody calculated the administrative
cost?
Mr. Bartlett. The administrative cost should be very small.
They are the same as administrative costs in the Thrift Savings
Plan, and this, of course, was a part of the computations that
CBO did. The Thrift Savings Plan had to be subtracted from the
total increased revenues to reach the 6 years. I do not know
what the percentage of the administrative costs are, but they
are very, very much less than if you had an individual account
and you were paying an individual fund manager to manage it for
you.
Another good thing about our bill is that this would
provide a mechanism so that when we move it--and I hope we do
move to individual savings account--that when we move to
individual savings account, that there will already be there a
mechanism with very low administrative cost that you could
choose to buy into, like now when you have the Thrift Savings
Plan, you don't do that on your own. You are a participant with
a large number of other people, so the administrative costs are
very low. If you do an equivalent thing on your own, the
administrative cost would be relatively very high.
Chairman Smith. Currently thrift savings is working under
two basis points, I believe.
Mr. Bentsen.
Mr. Bentsen. No questions.
Chairman Smith. Mr. Herger.
Mr. Herger. I have no questions.
Chairman Smith. Roscoe, I don't believe we have any more
questions. Any final comments? And we can still allow Mr.
Markey when he comes to give his testimony.
Mr. Bartlett. Just a word about how we got here. We had
prepared a bill, and when Mr. Markey's staff saw the bill, they
called and asked us if we would like to participate with them.
Mr. Markey is pretty much on the left of the political
spectrum, I am pretty much on the right of the political
spectrum, and I thought it was interesting that two people from
the two ends of the political spectrum had similar notions as
to how we might craft a bill that would meet some of the
challenges that we have in Social Security.
We worked very hard. Mr. Pomeroy was a part of that, who
previously was a State manager of this kind of fund, and he
worked with us in crafting a bill that we thought met all of
the objections that people might have and the objective of
extending Social Security solvency.
We start out, by the way, with investing only about 15
percent of the funds. As time goes on, more and more of the
funds are invested until near the end. Essentially 100 percent
of the surpluses are invested here. This was intentional so
that we would have experience; if it wasn't going well at any
time, the Congress could change that, and we have ample
opportunities to monitor this through the reporting
requirements of the bill. But initially it is only about 15
percent of the surplus that would be invested. You could
increase that 6 years to more years, and I don't know how many
more years if you started investing all of the funds
immediately. We thought that that was a step that Congress
would not be willing to take; that this little demonstration,
if you will, of 15 percent was something that would be
acceptable, and then it grows as we gain experience with it to
ultimately be essentially all of the funds that would be
invested.
As you know, this market yields about three times more than
has traditionally been yielded by the non-negotiable U.S.
Securities, which by law now is the only place that these funds
can be invested. The average investor, if he were retiring
today, had invested his funds in the market, would have the
equivalent of over $800,000 of investment. Social Security
gives him about $180,000 of investment, the income from an
investment, about a fourth of what it would be had he invested
in the market. This is not accrued to the individual investor.
It accrues to the fund, unlike a personal savings account where
the increased income would accrue to the individual investor.
This accrues to the Social Security Trust Fund, which extends
it for the 6 years.
Thank you very much.
Chairman Smith. Roscoe, thank you very much. Our
compliments for your willingness to move ahead in this--down
these tough roads.
Congressman DeFazio.
STATEMENT OF HON. PETER A. DeFAZIO, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF OREGON
Mr. DeFazio. Thank you, Mr. Chairman. Mr. Chairman, I have
a prepared statement. I would enter it in the record and make
some brief comments.
Chairman Smith. It is entered into the record.
Mr. DeFazio. Thank you, Mr. Chairman.
Mr. Chairman, a bit in common with the previous gentleman,
so I don't need to explain it, is I would take part of the
surplus, 40 percent, and invest it, but invest it in an
aggregate manner, but with the same protections as mentioned by
the previous speaker.
In addition, what I adopted was an objective of 75-year
solvency, no decrease in benefit, no increase in retirement
age, and no impact on the general fund. And I did that through
both the investment and through a lifting the cap on the ages
upon which one pays payroll tax, and then since that provides
more revenue than is needed for 75-year solvency, I provide a
$4,000 exemption on FICA taxes. And as the previous gentleman
said, more than 40 percent of workers in America pay more than
FICA than they do in income tax. So my proposal would reduce
taxes for 95 percent of wage-earners in America; that is,
everyone who earns less than $76,600 per year. So 95 percent of
the workers would come out ahead with a tax reduction. They
would have no increase in--no decrease in benefits, no increase
in age relative to full eligibility or partial eligibility with
reductions.
I would also increase benefits for people over age 85,
because the current system shows that people over age 85 are
more likely to be in poverty when they are relying upon Social
Security, and would provide for five child care dropout years;
that is, parents should not be penalized if they stay home to
raise their children.
So I meet the objectives of the trustees, 75-year solvency,
and provide tax relief to 95 percent of working Americans.
Chairman Smith. Thank you very much.
[The prepared statement of Mr. DeFazio follows:]
Prepared Statement of Hon. Peter A. DeFazio, a Representative in
Congress From the State of Oregon
Thank you, Mr. Chairman, Ms. Rivers and members of the Task Force
for giving me the opportunity to testify today on my proposal to insure
the future health of the Social Security program.
Social Security is one of the most popular and successful New Deal
programs. It was created in 1935 and today provides essential
retirement, survivors and disability benefits to 44 million Americans.
Before Social Security was approved by Congress, more than one-half of
America's elderly citizens lived in poverty.
Thanks to Social Security, fewer than 11 percent of today's seniors
fall below the poverty line. Social Security provides more than half of
the retirement income for two out of every three people over 65 years
of age. Social Security benefits make up 90 percent or more of the
income for about one out of three seniors.
It is important to understand that the Social Security Trust Fund
is not bankrupt, nor will it be. According to the 1999 Social Security
Trustees Report, Social Security is financially sound until at least
2034-35 years from now. Even if Congress does nothing to reform the
program, Social Security will continue to provide 75 percent of current
benefits for an additional 40 years--until the year 2073. With the
relatively modest reforms that I am proposing, the Social Security
system should be able to provide promised retirement benefits for many
generations to come.
In fact, my proposal cuts taxes for 94 percent of working
Americans, increases Social Security benefits for the most needy, and
saves Social Security. My proposal amends the Social Security Act to
restore 75 year solvency by:
<bullet> Providing a FICA payroll tax exemption for first $4000 of
income, cutting taxes for 94 percent of all workers. This exemption
would cut Social Security taxes by more than 11 percent for an
individual earning $35,000 a year. Approximately 40 percent of American
taxpayers pay more in FICA taxes than they pay in Federal income tax!
<bullet> Investing 40 percent of the future Social Security surplus
in broadly indexed equity funds. Many state retirement plans already
invest a portion of their surplus in the stock market.
<bullet> Making all earnings subject to payroll tax for both
employer and employee beginning in 2000. Retain the cap for benefit
calculations. This affects only those who earn more than $72,600 a
year--less than 6 percent of wage earners.
<bullet> Increasing benefits at age 85 by 5 percent. Women over the
age of 85 are more than twice as likely to live in poverty than men of
the same age. There are more than twice as many women as men over the
age of 85.
<bullet> Allowing up to 5 child-care drop-out years. Parents should
not have reduced Social Security benefits because they chose to stay
home to raise their children.
The Social Security program is the most successful government
program ever undertaken. With these changes it can remain so. Thank
you, Mr. Chairman. I would welcome questions from you or other members
of the Committee.
Memorandum
Date: June 8, 1999
To: Harry C. Ballantyne, Chief Actuary
From: Stephen C. Goss, Deputy Chief Actuary; Alice H. Wade, Actuary
Subject: Estimates of Long-Range OASDI Financial Effect of Proposal for
Representative Peter DeFazio
Information
This memorandum provides long-range estimates of the effect on the
financial status of the OASDI program of a proposed plan to change
several provisions of the program. This analysis has been produced at
the request of Aaron Deas of Representative DeFazio's staff. All
estimates are based on the intermediate assumptions of the 1999
Trustees Report.
The comprehensive proposal is described in Table A, attached. Table
A provides estimates of the change in the long-range OASDI actuarial
balance that would result from the enactment of the total proposed
package, as well as from each individual provision of the proposed
package.
If all modifications are implemented, the resulting long-range
actuarial balance for the 75-year period (1999-2073) is estimated to be
+0.07 percent of taxable payroll. This is a change of +2.14 from the
long-range actuarial balance under present law of -2.07 percent of
taxable payroll. The combined OASDI Trust Fund would rise to a peak of
579 percent of annual cost for 2021, declining thereafter, and reaching
a level of 217 percent of annual cost at the end of the long-range
period.
Stephen C Goss
Alice H. Wade
TABLE A.--ESTIMATED LONG-RANGE OASDI FINANCIAL EFFECT OF REFORM PROPOSAL
(REPRESENTATIVE DEFAZIO)
------------------------------------------------------------------------
Estimated change in
long-range OASDI
Provision actuarial balance
(percent of taxable
payroll)
------------------------------------------------------------------------
1 Invest a portion of the OASDI Trust 1.01
Funds in stocks beginning in 2000,
reaching 40 percent of assets in
stocks for 2014 and later..........
2 For earnings in years after 1999, 2.02
change the OASDI contribution and
benefit base to be a benefit base
only. Subject all covered earnings
to OASDI payroll taxes, but use the
base to establish the maximum
annual amount of earnings that is
credited for the purpose of benefit
computation........................
3 Beginning in 2000, establish an -1.03
exempt amount for a worker's annual
taxable earnings. The exempt amount
would be set at $4,000 in 2000, and
would serve to exempt the first
$4,000 of each worker's annual
taxable earnings from the 6.2
percent employee's tax. For self-
employed individuals, the provision
would exempt the first $4,000 of
self-employment income from one
half of the 12.4 percent self-
employed tax rate. The $4,000 would
be included in determining benefit
amounts. For years after 2000, the
exempt amount would be indexed by
growth in the SSA average wage
index..............................
4 In 2020, increase the level of -0.05
benefits for all beneficiaries who
are age 85 or older by 5 percent.
This increase is phased in
beginning in 2001. Benefit payments
for beneficiaries meeting this age
requirement would increase by 0.25
percent for 2001, 0.5 percent for
2002, etc., reaching 0.5 percent
for 2020 and later.................
5a Increase the benefit computation 0.35
period by up to 5 additional years
for new eligibles (by one
additional year for new eligibles
in each year 2005, 2007, 2009,
2011, 2013)........................
5b Provide up to 5 child-care drop-out -0.15
years. These years will be granted
to a parent who has $0 earnings
during the year and is providing
care to his/her child under the age
of 12 or to his/her disabled child.
Drop-out years are phased in by one
additional year for new eligibles
in each year 2005, 2007, 2009,
2011, 2013. (This provision
reflects interaction with provision
5a.)...............................
----------------------
Total for Provisions 1 through 5 2.14
(including interaction among
provisions)........................
------------------------------------------------------------------------
Note: Based on the intermediate assumptions of the 1999 Trustees Report
under present law, the long-range actuarial balance for the 75-year
period (1999-2073) is -2.07 percent of taxable payroll.
Source: Social Security Administration, Office of the Chief Actuary,
June 8, 1999.
Chairman Smith. Alan Greenspan and Secretary Summers
suggested to our Task Force that it is important to encourage
additional savings. Do you see your plan as having an effect of
encouraging additional savings and investment?
Mr. DeFazio. Well, since you would be providing much-needed
tax relief to 95 percent of Americans if you made available an
optional, you know, either--401(k)-type plan, as has been
proposed by some, could be administered through Social
Security, or you could enhance their capability of
participating in IRAs or Roth IRAs on the other hand, that
would certainly be money that would be available to them which
is not now available.
Chairman Smith. Peter, as I understand your proposal, it
takes the cap off of the maximum amount that can be taxed under
Social Security and has no increase in benefits over the
current cap in terms of the calculation of benefits. Is that
right? In other words, it adds another bend point of zero over
$74,000.
Mr. DeFazio. That is correct. As indexed in the future,
anticipating the indexation in the future of the capped amount
of wages, the benefits would only rise with what is currently
projected under--with the formulas in place today. So those
monies, you know, would in effect go to relieve the burden of
the entire fund.
The analogy goes to Medicare, of course, although there the
benefits are uniform for all income levels. But we have lifted
the cap on Medicare, so people are paying Medicare on their
entire income, so it is a precedent.
Chairman Smith. As you move Social Security--you can say it
either way--in the direction of a welfare program or at least
more progressive, do you think there is additional
justification to have some of the funding come out of the
general fund rather than the tax on wages that tends to be
somewhat less progressive on lower income?
Mr. DeFazio. Well, I mean, that is a very interesting
question. I mean, you could look at a progressive tax for
Social Security. I did not go that far. What I thought, since
people are accustomed to the existing flat tax, and 95 percent
of Americans pay it on all their wages, you know, that the plan
I proposed would mean for 95 percent of the people, you know,
they would get the $4,000 exemption, some tax reduction, and
for everybody over $76,600, they would be paying on all their
income which they are now paying on the first $72,600. So it
was less radical of a change in terms of people's thinking
about Social Security. Certainly you could look at something
closer to our income tax system where you have brackets at
different income levels. That would be another way to go. I
haven't seen anyone propose that yet.
Chairman Smith. Any suggestions when we hit payback time of
what is now estimated to be 2013 or 2014 when there is less
Social Security taxes coming in that can accommodate benefits?
In fact, your proposal probably would bring that back a year or
so. I don't know----
Mr. DeFazio. I think a little more than that. We have the
numbers at the office. I could certainly provide them to the
committee, but what I would like to see is--which goes beyond
the scope of this hearing--but for my mind, if the surplus does
indeed arrive, as many pundits and economists and others are
suggesting, rather than use it for general tax reductions or
additional spending, I would use it to pay down the debt, which
would enhance our capability to cash in those IOUs or bonds
starting in 2015 or so. In fact, the President said yesterday,
although I don't quite see the math, that current projections
could show us at zero debt by 2017 or so; 2015, I believe he
said.
Chairman Smith. This would be zero public debt.
Mr. DeFazio. Right.
Chairman Smith. The debt for what we would owe Social
Security Trust Fund and other trust funds would continue.
Mr. DeFazio. Is that what he said? I was wondering about
the math there, how it--with a trillion dollars additional
surplus. But at any point if indeed--you know, we have to honor
the IOUs, but if indeed, you know, we did get into some
unexpected problems in the future, paying down our public debt
would give us more flexibility to borrow if need be to meet
hard and fast obligations to the Federal Treasury.
Chairman Smith. That is an area that it is easy not to pay
a great deal of attention. It is assumed in most of these
proposals that what is owed to the trust fund is somehow
automatically going to be paid back. Have you thought once we
hit about 2022, 2025 that it is going to be substantial, and
somehow we have got to increase borrowing or taxes or reduce
other government expenditures to pay back what we owe the trust
fund.
Mr. DeFazio. That has bothered me a long time. When I came
to Congress and met Dorcas Hardy, then the Social Security
Administrator, I said, what is going to happen when Social
Security owns the entire debt of the United States, which at
that point it was projected to be around 2005, and, of course,
things have changed. She said, what do you mean? I said,
wouldn't a future Congress be tempted to say, gee, why are we
paying ourselves all this interest on this debt which we owe
for this program? Let's cancel the debt and find some other way
to finance it.
I have worried about that for a long time, which is why a
long time ago I became interested in diverting some of the
incoming Social Security Trust Fund money into other
investments other than IOUs, which is why I have gone with the
40 percent proposal here as opposed to 15 of the President and
I think 20 with Nadler and others, is to at least move 40
percent of that money that is coming in on an annual basis, and
this year I believe it is--Social Security surplus is projected
this year at 120, I believe.
Chairman Smith. 127 maybe.
Mr. DeFazio. If 40 percent of that were diverted, we would
have real assets and real income stream out there, and if we
did that every year between now and 2015 or so, we would have a
substantial income stream and assets even. If the stock market
or the broadly diversified investments didn't do really well,
would you still have something other than paper IOUs to pay the
money?
Chairman Smith. And Mr. Bentsen and I have talked about it.
Now that we have proven that Congress is capable of wiping out
some of that indebtedness to trust funds like we did in the
Highway Trust Fund, we know what can happen.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Mr. DeFazio, I will say this, though. Certainly you can
have terms of an agreement where the debtor--the creditor and
the debtor can cancel debt, and that doesn't necessarily
undermine the value of the debt. But you raise an interesting
point, if the only public--the only debt outstanding is
nonpublic intergovernmental debt, and whether or not you try
and get out from under it, I still think in a large-scale--a
large-scale attempt to do that would have detrimental impact on
future ability to raise debt in the capital markets. And I
think you are right, Mr. DeFazio, that the President--I don't
know that you are endorsing the President's proposal, but the
idea of using some of the surplus to pay down the publicly held
debt does put the Nation in a better fiscal position in the
future to the extent you need to raise debt or raise capital in
the debt markets. Your proposal, if I understand it, would
invest 40 percent of the future cash flow stream from the
Social Security payroll tax in the private markets----
Mr. DeFazio. Forty percent of that, which exceeds need for
current benefits, yes.
Mr. Bentsen. Of the surplus.
Mr. DeFazio. Right.
Mr. Bentsen. In private markets in the same capacity as we
do now with the Federal employees' thrift plan?
Mr. DeFazio. Actually very similar. It would be a broadly
based index fund without voting rights. It would be very
similar.
Mr. Bentsen. And avoid any political tampering that might
occur?
Mr. DeFazio. That is correct.
Mr. Bentsen. But much more narrow than, say, States or
localities invest their pension funds or the pension funds of
teachers or State employees, where in some cases they invest in
actual stocks, particular stocks, or capital projects or things
like that.
Mr. DeFazio. Yeah, I did not go down that path. There is
certainly an argument to be made. In fact, the PERS fund in my
State, Public Employees Retirement System, had a rate of return
to more than two times that of what Social Security gets on its
fixed equities in a broadly diversified investment base which
includes both individual equities, index equities and bonds and
real property. So, I mean, there is certainly some case to be
made for that. I just didn't--this was the least controversial
route.
Mr. Bentsen. Your construct is one that is the least
political as well that the government is all of a sudden in the
business of managing capitalism through stock ownership or
something like that.
Mr. DeFazio. Right. Although in my State, again, they
have--Fred Meyer, for instance, was one of their major equities
because it was a Northwest-based corporation, and when it was
bought out by a New York firm, even though they had substantial
voting rights, you know, they did not exercise those to try and
keep the headquarters in the Pacific Northwest. You know, the
State has been--since they are required as fiduciaries to
basically do things in the best interests of returns for the
fund, we haven't found that kind of political manipulation
because very infrequently does a political objective optimize
returns. So in voting, they do have voting rights. They have
voted as pretty much, you know, as people who--well, all the
time as someone to optimize their income, not to optimize their
political objectives.
Mr. Bentsen. This wasn't where I was going, but you raise
an interesting point that throughout the country, State and
local governments invest in private markets like Fred Meyer,
and they operate with the fiduciary responsibility as opposed
to a political responsibility, and I think it is fair to say
that we haven't seen a retreat to socialism as a result of this
occurring.
Let me ask you this: Based upon your analysis or the
analysis that has been done then, you invest 40 percent of the
future Social Security surplus in private market index funds or
whatever, and then you lift the cap on the payroll tax, and
those two measures alone are sufficient to meet the needs of
Social Security over the next 75 years?
Mr. DeFazio. No, they exceed the need.
Mr. Bentsen. And furthermore, you are able to credit back
$4,000--$4,000 tax credit for our payroll.
Mr. DeFazio. $4,000 of income would be exempt. So in fact,
the total would be 2.0--would be 3.03 would be from those two
assumptions. The lifting the cap is 2.02, and investing, the
assumption used by the actuaries for 40 percent is 1.01, and
the total need is 2.07. So we are considerably over and then--
--
Mr. Bentsen. I am sorry, what were those again?
Mr. DeFazio. I can provide the table for the committee.
They do it as a----
Mr. Bentsen. So a little less than----
Mr. DeFazio.--percent of taxable payroll.
Mr. Bentsen. A little bit less than half out of the return
on investment and the other from the payroll.
Mr. DeFazio. Right. In fact, lifting the cap almost meets
the total need. If you just lifted the cap, you would come very
close to, within the margin of error, obviously, 75 years out,
meeting the 75-year need if you made no other changes in the
program.
Mr. Bentsen. Finally, do you make any recommendation or
proposal for what you do if investment of the 40 percent
doesn't pan out; does that have any--can that affect your
future cash flow needs in any given year, and to the extent
that it does, does the government just underwrite any shortfall
at that point in time?
Mr. DeFazio. Well, pretty conservative assumptions were
used for rate of return and economic growth by the actuaries in
projecting returns in a broadly based equity fund less than
historic over the last 25 years. So certainly if we entered
into another Great Depression, we are going to be in trouble
with that portion of the fund's investments, but we would be in
trouble with a whole bunch of other things. I haven't
accommodated that, nor did I put in any special device.
You know, generally you just find that these things over
time average out. That is the problem in the criticism of
individual funds; if you happen to retire in a down year, or it
may be in the middle of 5 down years, and the market was an
individual fund, you are kind of out of luck in terms of
annuitizing or whatever you have to do when you withdraw your
money. But if you are part of a broad group which has a tail
behind you and ahead of you, that all tends--you can maintain
the benefit.
Mr. Bentsen. If I might, back on the tax exemption or
deduction, does that apply across the board?
Mr. DeFazio. That would be to the first $4,000 of income
for all workers who work for wages and pay FICA taxes. That is
correct. So essentially that would mean that with the current
cap at $72,600, that means everybody who earns less than
$76,600 would get a tax break, obviously skewed toward people
at the bottom in terms of percentage.
Mr. Bentsen. Thank you.
Thank you, Mr. Chairman.
Chairman Smith. During the apartheid controversy in the
State of Michigan, we had a law that our pension program
decisions could not be influenced by political decisions, with
independent investors making the decision on how and where to
invest the money. But on the apartheid controversy, we simply
passed another law that was signed by the Governor saying
regardless of all other provisions, it couldn't be invested in
any company that was doing business with South Africa at the
time. So I am still a little nervous of ways that we might
insulate, protect those investments enough. Let me ask you----
Mr. DeFazio. Mr. Chairman, that is a very valid concern. As
I recall, my State, the State legislature passed that, but then
they were sued because the fiduciary responsibility was
embedded in the Constitution for the trustees, and to tell the
truth, I don't remember the resolution, but the other point I
would make is that those sorts of restrictions on investment
are now GATT-illegal, and since a majority of people here in
Congress are great fans of GATT and the WTO, which I am not, we
could not have those sorts of restrictions in the future under
GATT and the WTO.
Chairman Smith. One final question. Have you considered the
danger--along this same line of discussion, have you considered
the possibility that Congress and the President are going to
look on investment revenues--the money coming in from capital
investments, once we hit a crucial year of problems with cash
flow, that governments might start looking at the returns on
that capital investment to use for financing other government
programs which would significantly reduce the benefits of long-
term investment in terms of compound interest?
Mr. DeFazio. Well, the language that I have adopted would
basically leave the--for instance, if any of the investments
were to be terminated, those decisions are up to the board of
trustees, and they are to manage only in the best interest of
the fund. So, you know, you would have to somehow convince the
board of trustees that it would be a better return for the fund
to cash in some investments and divert that money to the
Treasury that would replace it with IOUs at a lower rate of
return, and so then the trustees would be immediately in
violation of their responsibility.
Mr. Smith. Thank you very much for your being here today
and your willingness to move ahead for a solution to a tough
problem.
The next witness to testify, I think, is Mr. Nadler, who is
scheduled to be here in 3 minutes, and so we will stand at ease
for 3 minutes and see if Mr. Nadler shows up.
[Recess.]
Mr. Smith. Mr. Nadler has indicated that he is unable to be
here, so the Budget Task Force on Social Security is adjourned.
[The prepared statement of Mr. Nadler follows:]
Prepared Statement of Hon. Jerrold Nadler, a Representative in Congress
From the State of New York
Thank you, Mr. Chairman, for your invitation to testify before this
committee.
Earlier this year, I introduced H.R. 1043, legislation which would
make Social Security solvent for at least 75 years without raising the
retirement age, without cutting benefits, without shifting the risk
onto individuals through private accounts funded by FICA taxes, and
without raising tax rates.
This plan also would not adjust the CPI, would not force all new
state and local government employees into Social Security, would not
increase the benefit computation period above 35 years, and would not
cut benefits by adjusting the bend points. This plan does not rely on
general fund transfers beyond an initial 15-year period.
It has been scored by the Social Security Actuaries as completely
eliminating the long-range OASDI actuarial deficit. In fact, it would
improve the long-range OASDI actuarial balance by an estimated 2.55
percent of taxable payroll, replacing the actuarial deficit of 2.07
percent under present law with an positive actuarial balance of 0.48
percent of taxable payroll.
In addition, at the end of the 75-year period, Social Security
would remain strong. In fact, the trust fund ratio would then be 793
percent. The current trust fund ratio is approximately 194 percent.
This plan would maintain Social Security as a guaranteed, life-
long, cost-of-living-adjusted, defined benefit plan. That is the heart
and soul of Social Security, and that is why I have fought so hard to
preserve this vital program.
So, how does this legislation work?
Essentially, the bill would transfer 62 percent of the projected
budget surplus to the Social Security Trust Fund for a period of 15
years, would provide for the investment of a portion of the funds in
broad stock index funds, and would raise the wage cap above the current
$72,600.
Surplus Transfer
The bill would implement the President's proposal to authorize the
transfer of 62 percent of the projected budget surplus to the Social
Security Trust Fund for a period of 15 years. It expresses this figure
as a percent of taxable payroll, and is not dependent on actual budget
surpluses to materialize. If the economy does better than predicted
over the 15-year period, more funds would be allocated to Social
Security. If the economy does worse, less funds would be transferred,
and there would be correspondingly less pressure on other government
spending.
The Independent Social Security Investment Oversight Board
The bill would create the Independent Social Security Investment
Oversight Board--members of which would have long, staggered terms--
which would then hire several competing private managers to invest
small portions of the Trust Fund in broad index funds which track the
market based on a fixed formula. Some people incorrectly describe this
as ``government investment in the market''. This is terribly
misleading. There would be no picking and choosing of stocks by the
President, Congress, or anyone else in government. The investments
would follow a fixed formula and not the whims of some investment
genius. No geniuses need apply under this plan.
The investment is completely private and fully insulated from
political influence by several layers of protection. Federal employees
currently invest in the market through the Thrift Savings Plan. I am
not aware of anyone who has accused Congress of tampering with the
market due to this type of collective investment. In fact, several of
the plans that include individual accounts have similar restrictions on
investments which would essentially require the same type of
protections to be included in their plans. Individuals would be
severely restricted in their investment decisions and in some cases
only allowed to invest in broad index funds approved by the government.
Many state and local governments invest up to 60 percent of their
assets in the stock market. This bill would authorize half of that
amount and would prohibit investing more than 30 percent of total Trust
Fund assets in the market. In order to extend the projected solvency of
the Social Security system for 75 years, the bill invests a larger, but
still prudent, amount of the Trust Funds in index funds than the
President's proposal which extends the projected solvency for 56 years.
Keep in mind, under this legislation most of Social Security's
funding will still come from payroll taxes and interest from government
bonds. The Actuaries inform us that under current law in 2034, payroll
taxes will still be sufficient to cover about 75 percent of benefit
payments. The other 25 percent is from the Trust Fund. Only 30 percent
of this Trust Fund is invested in the market. That means that only 7 1/
2 percent is at any market risk at all. It has been estimated that if
the market collapsed, and only held 50 percent of its current value,
the ability of Social Security to pay benefits would only be reduced by
about 2 percent. So the risk to the system, under this bill, is quite
small.
The real difference between this approach and private accounts is
that this approach is a lower cost, more efficient, and more prudent
way of increasing the rate of return on Social Security assets. There
are staggering administrative costs for setting up 150 million
individual accounts and tracking them year by year for 40 years with
allowances made for annual adjustments to each account. This is an
incredible burden that is completely unnecessary and wasteful.
Increase, and Then Index, the Cap on Taxable Wages
This legislation, starting in fiscal year 2000, also incrementally
increases the cap on taxable wages above the current $72,600.
Currently, approximately 86 percent of all wages are subject to FICA
contributions. This has slipped in recent years from the historic 90
percent due to the dramatic rise in disparity of wages. The Social
Security Actuaries inform us that 93 percent percent of wage earners
earn less than the current cap, and, therefore, pay FICA taxes on all
of their earnings. About 7 percent of wage earners do not pay FICA
taxes on all of their income. My bill would require the wealthiest 7
percent to pay the same FICA tax rate on a slightly greater portion of
their earnings. It would not eliminate the cap completely. To ensure
fairness, these individuals' Social Security benefit levels would
increase as well.
Keep in mind this plan makes the system solvent even under the
Actuaries extremely pessimistic intermediate assumptions. Many of their
predictions are questionable especially the fact that they predict
economic growth to average 2.0 for the years 2000-2007, despite
economic growth of 3.4 percent in 1996, 3.9 percent in 1997, and 3.9
percent in 1998. They then predict economic growth to take a
significant downturn to average 1.4 from 2020-2040 and 1.3 percent in
2050-2070. They further predict that the economy will do even worse
after that. To put these numbers in some perspective the economic
growth rate was 4.6 percent from 1960-64, 5.4 percent in 1976, 7.0
percent in 1984. So H.R. 1043 restores solvency even in light of these
extremely pessimistic predictions. If the Actuaries are wrong, and the
economy does better than predicted, Social Security will be in even
better shape.
The legislation that I have proposed, H.R. 1043, is also supported
by Americans for Democratic Action, OWL (the Older Women's League), and
the 2030 Center. A large national organization, a women's organization,
and an organization primarily concerned with protecting the interests
of young people.
[The prepared statement of Senators Moynihan and Kerrey
follows:]
Social Security Solvency Act of 1999 (S.21), Introduced on January 19,
1999, By Senators Moynihan and Kerrey
brief description of provisions
I. Reduce Payroll Taxes and Return to Pay-As-You-Go System with
Voluntary Personal Savings Accounts
A. Reduce Payroll Taxes and Return to Pay-As-You-Go
The bill would return Social Security to a pay-as-you-go system.
That is, payroll tax rates would be adjusted so that annual revenues
from taxes closely match annual outlays. This makes possible an
immediate payroll tax cut of approximately $800 billion over the next
10 years, with reduced rates remaining in place for the next 30 years.
Payroll tax rates would be cut from 12.4 to 10.4 percent for the period
2002 to 2029, and the rate would not increase above 12.4 percent until
2035. Even in the out-years, the pay-as-you go rates under the plan
will increase only slightly above the current rate of 12.4 percent.
Based on estimates prepared last year the proposed rate schedule is:
2002-2029 . . . . . . . . . 10.4%
2030-2034 . . . . . . . . . 12.4%
2035-2049 . . . . . . . . . 12.9%
2050-2059 . . . . . . . . . 13.3%
2060 and thereafter . . . . 13.7%
To ensure continued solvency, the Board of Trustees of the Social
Security Trust Funds would make recommendations for a new pay-as-you-go
tax rate schedule if the Trust Funds fall out of close actuarial
balance. The new tax rate schedule would be considered by Congress
under fast track procedures.
B. Personal Savings Accounts
Beginning in 2002, the bill would permit voluntary personal savings
accounts which workers could finance with the proceeds of the 2
percentage point cut in the payroll tax. Alternatively, a worker could
simply take the employee share of the tax cut (one percent of wages) as
an increase in take-home pay. In addition, KidSave accounts, of up to
$3,500, would be opened for all children born in 1995 or later.
C. Increase in Amount of Wages Subject to Tax
Under current law, the Social Security payroll tax applies only to
the first $72,600 of wages in 1999. At that level, about 85 percent of
wages in covered employment are taxed. That percentage has been falling
because wages of persons above the taxable maximum have been growing
faster than wages of persons below it.
Historically, about 90 percent of wages have been subject to tax.
Under the bill, the taxable maximum would be increased to $99,900
(thereby imposing the tax on about 87 percent of wages) by 2004.
Thereafter, automatic changes in the base, tied to increases in average
wages, would be resumed. (Under current law, the taxable maximum is
projected to increase to $84,900 in 2004, with automatic changes also
continuing thereafter.)
II. Indexation Provisions
A. Correct Cost of Living Adjustments by One Percentage
Point
The bill includes a 1-percentage point correction in cost of living
adjustments. The correction would apply to all indexed programs
(outlays and revenues) except Supplemental Security Income. The Bureau
of Labor Statistics has made some improvements in the Consumer Price
Index, but most of these were already taken into account when the
Boskin Commission appointed by the Senate Finance Committee reported in
1996 that the overstatement of the cost of living by the CPI was 1.1
percentage points.\1\ Members of the Commission believe that the
overstatement will average about 1 percentage point for the next
several years. The proposed legislation would also establish a Cost of
Living Board to determine on an annual basis if further refinements are
necessary.
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\1\ A number of improvements announced by the BLS after this
legislation was first introduced in 1998 would lower the reported
change in prices. The authors are considering what modifications, if
any, should be made to the bill as a result of the BLS announcements.
They are also discussing, with the Social Security actuaries, the
effects of this change on the long-run projections made by the
actuaries.
---------------------------------------------------------------------------
B. Adjustments in Monthly Benefits Related to Changes in
Life Expectancy
Under current law, the so-called normal retirement age (NRA) is
scheduled to gradually increase from age 65 to 67. In practice, the NRA
is important as a benchmark for determining the monthly benefit amount,
but it does not reflect the actual age at which workers receive
retirement benefits. More than 70 percent of workers begin collecting
Social Security retirement benefits before they reach age 65, and more
than 50 percent do so at age 62. Under the bill, workers can continue
to receive benefits at age 62 and the provision in the 1983 Social
Security amendments that increased the NRA to 67 is repealed. Instead,
under this legislation, if life expectancy increases the level of
monthly benefits payable at age 65 (or at the age at which the worker
actually retires) decreases.
These changes in monthly benefits are a form of indexation that
mirrors the projected gradual increase in life expectancy over a period
of more than 100 years. For example, persons who retired in 1960 at age
65 had a life expectancy, at age 65, of 15 years and spent about 25
percent of their adult life in retirement. Persons retiring in 2060, at
age 70, are projected to have a life expectancy at age 70 of more than
16 years, and thus would also spend about 25 percent of their adult
life in retirement.
III. Program Simplification--Repeal of Earnings Test
The so-called earnings test would be eliminated for all
beneficiaries age 62 and over, beginning in 2003. (Under current law,
the test increases to $30,000 in 2002.) Under the earnings test
benefits are withheld (reduced) for one million beneficiaries because
wages are in excess of the earnings limit. This is an unnecessary
administrative burden because beneficiaries eventually receive all of
the benefits that are withheld. Indeed, Social Security Administration
actuaries estimate that the long-run cost of repealing the earnings
test is zero.
IV. Other Changes
All three factions of the 1994-96 Social Security Advisory Council
supported some variation of the following common sense changes in the
program.
A. Normal Taxation of Benefits
Social Security benefits would be taxed to the same extent private
pensions are taxed. That is, Social Security benefits would be taxed to
the extent that the worker's benefits exceed his or her contributions
to the system (currently about 95 percent of benefits would be taxed).
This provision would be phased-in over the 5 year period 2000-2004.
B. Coverage of Newly Hired State and Local Employees
Effective in 2002, Social Security coverage would be extended to
newly hired employees in currently excluded State and local positions.
Inclusion of State and local workers is sound public policy because
most of the five million State and local employees (about a quarter of
all State and local employees) not covered by Social Security in their
government employment do receive Social Security benefits as a result
of working at other jobs--part-time or otherwise--that are covered by
Social Security. Relative to their contributions these workers receive
generous benefits.
C. Increase in Length of Computation Period
The legislation would increase the length of the computation period
from 35 to 38 years. Consistent with the increase in life expectancy
and the increase in the retirement age we would expect workers to have
more years with earnings. Computation of their benefits should be based
on these additional years of earnings.
summary of budget effects
The legislation provides for long-run solvency of Social Security,
with little or no effect on the budget surplus. In its latest (March,
1999) baseline, the Congressional Budget Office (CBO) projected that
for the 5-year period FY 2000-2004, the cumulative surplus would be
$953 billion, and $2.604 trillion for the 10-year period FY 2000-2009.
Preliminary estimates, based on these budget projections, indicate that
this legislation, while preserving Social Security, reduces payroll
taxes by almost $800 billion, and only reduces the 10-year cumulative
surplus by about $150 billion. In no year is there a budget deficit
and, starting in 2007, the legislation increases the annual unified
budget surplus.
[The prepared statement of Senator Gramm follows:]
Prepared Statement of Hon. Phil Gramm, a United States Senator From the
State of Texas
The attached summary provides a section-by-section analysis of the
Social Security Preservation Act, an Investment-based Social Security
reform plan authored by Senator Phil Gramm. According to estimates
prepared by the Social Security Administration, ``the plan would
eliminate the long-range OASDI actuarial deficit, estimated at 2.07
percent of taxable payroll under present law. The OASDI trust fund
would be substantial and rising at the end of the long-range 75-year
period.'' In addition to providing permanent solvency, the plan
guarantees each worker 100 percent of the benefits promised by the
current system, plus a onus equal to percent of the benefits funded by
their investments.
The Social Security Preservation Act allows each worker to set
aside 3 percent of their 12.4 percent Social Security payroll tax,
which will be owned by the worker and invested in stocks and bonds by a
professional money manager in a ``Social Security Savings Account for
Employees'' or ``SAFE Account. The worker can choose from any
privately-managed SAFE Account fund certified for safety and soundness
by a Federal board.
Upon retirement, any worker can opt out of the investment-based
system and receive I 00 percent of the Social Security benefits
guaranteed to them under current law. However, it is expected that most
workers will choose to remain in investment-based Social Security and
will use the funds in their SAFE Account to purchase a ``Savings
Annuity For Eligible Retirees'' or ``SAFER Annuity.'' The SAFER Annuity
will be guaranteed for life and supplemented by the Social Security
system if it does not produce a retirement benefit at least equal to
100 percent of the benefits promised under the current system, plus a
bonus equal to 20 percent of the payments funded by the SAFER Annuity.
Private companies offering SAFE Accounts and SAFER Annuities will
charge all participants a single uniform investment fee, not to exceed
0.3 percent of assets. SAFER Annuities will provide workers of the same
age the same monthly benefit relative to the size of their SAFE
Account, regardless of sex, race, health status, etc.
Over the next 10 years, the Congressional Budget Office projects a
Social Security surplus of about $1.78 trillion, while SAFE Accounts
funded at 3 percent of OASDI wages would cost about $1.35 trillion,
leaving $430 billion in Social Security surpluses. The Social Security
Preservation Act uses these remaining surpluses to target additional
investment for those aged 35-55 in the year 2000, allowing these
workers to invest an extra 2 percent of their wages. These extra
investments will begin to fund Social Security benefits at the height
of the baby boom retirement, providing additional resources in the
critical years of the transition. The extra 2 percent will not be
counted in calculating the worker's 20 percent bonus, but will be used
entirely to fund the benefits they receive from the existing Social
Security system.
sec. 1--short title and table of contents
sec. 2--findings
sec. 3--establishment of investment-based option for social security
benefits
Amends the Social Security Act to preserve all existing Social
Security provisions (OASDI) in a new Part A and creates a new Part B
providing an Investment-Based Social Security option for those workers
who voluntarily choose to participate in the investment-based
alternative.
sec. 250 guarantee of promised benefits
Those opting into the Investment-Based system are guaranteed never
to have a benefit less than that promised under the current system,
plus a bonus of 20 percent of the benefits paid by their Part B
investments.
sec. 251 definitions
sec. 252 social security savings accounts for employees (safe accounts)
Each current worker may choose to establish a Social Security
Savings Account for Employees or SAFE Account. All individuals who will
join the work force in 2000 or later will enter the investment-based
system. The worker shall choose the investment fund to professionally
manage his SAFE Account from among those investment funds qualified by
high standards of safety and soundness, and may change funds once every
year. The Account will be the property of the investing worker.
sec. 253 safe investment funds
SAFE Accounts will be managed by qualified SAFE Investment Funds,
which will be certified and regulated for safety and soundness by the
new Social Security Investment Board. Under the parameters set by the
Board, the Funds will invest the assets of the SAFE Accounts in stocks,
bonds, bank deposits, insurance instruments, annuities and other
earnings assets. The Funds will provide an annual report to each
participant showing the dollar value of investments over the last
quarter, the last year and the life of the SAFE Account. The report
shall also project how much each worker will have at retirement if
contributions and earnings continue at the same rate during the
remainder of his or her working life. Each Fund shall accept all
eligible workers requesting to join such Fund. The Fund shall charge
all participants a single uniform investment fee as a percent of the
investment, not to exceed 0.3 percent of assets.
sec. 254 social security investment board
Establishes a Social Security Investment Board which will set the
general safety and soundness parameters of investments held as part of
SAFE Accounts but will be prohibited from requiring or denying the
purchase of any specific stock, or in any way dictating which
individual investments are made. The Board will protect the safety and
soundness of SAFE Investment Funds with the power to order compliance
and, where appropriate, decertify and shut down any Fund found to be in
violation of Board standards. The Board shall annually provide
information on all qualified Funds to workers. The annual report shall
include data on the rate of return achieved by each SAFE Investment
Fund.
The Board will be comprised of the Secretary of the Treasury, the
Chairman of the Federal Reserve Board, the Chairman of the Securities
and Exchange Commission and two outside experts with substantial
experience in financial matters, who will be appointed by the President
and confirmed by the Senate. One of the outside Members will be
nominated and confirmed as Chairman.
sec. 255 safe account contributions
Workers participating in the investment-based system will initially
invest 3 percent of their wages into their individual SAFE Account. The
remaining 9.4 percent of the current 12.4 percent paid in Social
Security taxes would continue to be used to pay benefits under the
current Social Security system. The 3 percent investment rate will
automatically increase in the future as Investment-based Social
Security becomes self-financing. In addition, workers age 35-55 in the
year 2000 will invest an extra 2 percent of their wages to provide
additional resources in the critical years of the transition. The extra
2 percent will not be counted in calculating the worker's 20 percent
bonus, but will be used entirely to fund the benefits they receive from
the existing Social Security system.
An entry on participating workers' paycheck stubs will show exactly
how much money was invested in their SAFE Accounts for that pay period.
The payment into the workers' designated account will be made directly
from the Social Security Administration at least once a quarter. The
Board is empowered to require that investments are made on a more
timely basis if more frequent investment is deemed to be feasible.
sec. 256 social security savings annuities for eligible retirees (safer
annuities)
Upon retirement, a worker participating in investment-based Social
Security will use the funds in his SAFE Account to purchase a Savings
Annuity For Eligible Retirees or SAFER Annuity. Under the investment-
based system, the SAFER Annuity will be guaranteed for life and
supplemented by the Social Security system if it does not produce a
retirement benefit at least equal to a) 100 percent of the benefits
promised under the current system plus b) a bonus equal to 20 percent
of the payments from the SAFER Annuity. This benefit will be fully
protected against inflation. Each SAFER Annuity Fund must accept all
eligible retirees requesting to join such Fund. SAFER Annuity Funds
shall charge all participants a single uniform investment fee, not to
exceed 0.3 percent, and shall provide each worker of a particular age
the same monthly benefit relative to the size of their SAFE Account,
regardless of sex, race, health status, etc.
Early Retirement Option
Workers can retire at any age and draw their Investment-Based
Social Security benefits once they have built up a SAFE Account large
enough to fund a SAFER Annuity equal to at least 120 percent of the
Social Security benefit promised at the early retirement age and fund
any survivor, spousal or other benefits that might be triggered by
their retirement.
Unrestricted Right to Use Remaining SAFE Account Assets
Workers who have built up enough funds in their SAFE Account to
finance more than 120 percent of the benefits promised under Social
Security and fund any other benefits their family might receive under
the current Social Security system may use any remaining SAFE Account
funds as they see fit.
Bequests
If a worker dies prior to retirement, the worker's SAFE Account,
minus the present value of benefits promised to the surviving family
members under the current Social Security system, will become part of
the worker's estate.
sec. 257 money back guarantee
Upon retirement, any worker may choose to opt out of the
Investment-Based system and instead receive 100 percent of the benefits
he would have received had he stayed in the current Social Security
system. Those opting for this money back guarantee will receive monthly
benefit checks directly from Social Security. Workers who opt upon
retirement to return to the existing Social Security system will
forfeit all their SAFE Account assets directly to the Social Security
Administration to be deposited into the Social Security Trust Fund.
sec. 258 guarantee of promised benefits
A worker whose SAFE Account is not sufficient to purchase a SAFER
Annuity which will pay a monthly benefit equal to that promised under
the current system plus a bonus of 20 percent of any payments from
their SAFER Annuity will receive a supplemental payment from the Social
Security Administration. Because this guarantee is based on the
inflation-adjusted benefit a worker is promised under the current
system, the guarantee fully covers the effects of inflation.
sec. 259 investment rate increases
Social Security Surplus Investment
In any year the Social Security Investment Board certifies that the
annual Social Security surplus is greater than the amount needed to
finance the 3 percent investment rate (and the temporary 2 percent
additional investment to help cover the transition), the Board shall
automatically increase the investment rate in increments of 1/10 of 1
percent, up to a maximum of 8 percent. If, in any year, the annual
Social Security surplus is less than the amount needed to fund the 3
percent investment rate, the Social Security Commissioner shall redeem
assets of the Trust Fund to ensure that benefits are fully paid and
that the investment rate shall never drop below 3 percent.
Social Security Reserve
The Social Security Investment Board shall ensure that a suitable
reserve is maintained in the OASDI Trust Funds.
sec. 260 tax treatment of investment based social security
SAFE Accounts and SAFER Annuities will build up tax-free until
withdrawal. At retirement, payments from a SAFER Annuity up to 120
percent of benefits promised by the current system will be taxed in the
same manner as Social Security benefits. Any additional payment, or any
lump sum withdrawal, would be taxed as any annuity payment would be
taxed under the Internal Revenue Code. The amount of SAFE Account
contributions must be shown on a worker's W-2 as well as the worker's
payroll receipt.
sec. 4--payroll tax reduction resulting from investment-based social
security
After the investment rate has risen to 8 percent and the necessary
portion of the remaining payroll tax is dedicated to fully fund
disability insurance, the payroll tax rate shall drop from 12.4 percent
to 8 percent plus the rate required to fund disability insurance.
sec. 5 financing of investment-based social security
Recapture of Federal Corporate Income Taxes Arising from SAFE Account
and SAFER Annuity Investments
The Secretary of Treasury, in consultation with the Social Security
Investment Board, will annually estimate the amount of corporate income
tax revenues that can be attributed to the contributions and
accumulated capital buildup in the SAFE Accounts and SAFER Annuities.
Within 3 months after the end of each fiscal year, the Secretary of
Treasury shall transfer to the OASDI Trust Funds the amount of Federal
corporate income taxes attributable to the assets held in SAFE Accounts
or SAFER Annuities.
In calculating the recapture rate during 2000 and 2001, the
Secretary of Treasury shall assume that 80 percent of the total SAFE
Account and SAFER Annuity assets are net additions to national
investment, that 10 percent of that amount will be invested abroad and
not subject to Federal taxes, and that 5 percent will be invested
domestically but outside the corporate sector. Thus 68.4 percent of the
profits from SAFE Account and SAFER Annuity assets shall be assumed to
be net additions to taxable corporate income, resulting in an effective
tax rate of 23.9 percent which will be credited to Social Security.
Dedication of Part B Savings to Social Security Trust Fund
Any other savings resulting from Investment-Based Social Security
that flow to the Federal Government, including increased revenues
resulting from Federal taxation of SAFER Annuity bonuses and excess
SAFE Account distributions, shall be credited to the OASDI Trust Funds.
Dedication of Budget Surplus to Saving Social Security
Each quarter beginning in the year 2000, the Secretary of Treasury
shall reimburse the OASDI Trust Funds from the unified budget surplus
an amount equal to the actual investments made in SAFE Accounts in that
quarter. This reimbursement will be permanently reduced in any year
that a reduction can be made without creating a future cash shortfall
in OASDI, until the reimbursement is eventually eliminated. To ensure
that these budget surpluses materialize, the discretionary spending
caps in place under current law are extended through 2009.
[Whereupon, at 1:48 p.m., the Task Force was adjourned.]
The Cost of Transitioning to Solvency
----------
TUESDAY, JULY 13, 1999
House of Representatives,
Committee on the Budget,
Task Force on Social 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.
Chairman Smith. The Social Security Task Force of the
Budget Committee will come to order today for the purpose of
hearing witnesses testifying on the cost of transitioning to
solvency.
Today will be the last official meeting of this Task Force
unless it is renewed. We have held 14 different meetings. I
hope that we can come to some common bipartisan agreement on
some findings in terms of outlining our goals on how we might
proceed with solving Social Security, such as the finding that
time is not on our side, and the longer we put the solutions
off, the more drastic those solutions are going to have to be.
So without objection, we will reconvene this meeting at the
call of the Chair probably this Thursday, and also, without
objection, each individual Member may submit a statement by the
30th of this month that will be included in the final report
and also, minority and majority views in that report. Hearing
no objection, it is so ordered, and we will set the target date
as of now for the 30th of this month to have those individual
or minority/majority reports in.
Today's hearing focuses on transition costs. This topic is
an essential element of the Task Force's mission to review the
long-term budget ramifications of the various Social Security
reform proposals and work toward a bipartisan solution of the
impending insolvency of our Nation's retirement system.
We all know that there are only three ways to eliminate
Social Security's $9 trillion debt in a closed system and
estimated $4 trillion unfunded liability in an open system. Our
choices are to raise taxes, to cut benefits or increase the
rate of return that is earned on the taxes that are now coming
in. The comprehensive reform plans that have been proposed use
some or all of these three ways. Our witnesses have reviewed
the various reform proposals under consideration and will tell
us how each brings financial stability to Social Security.
We have an extraordinary opportunity, I think, to soften
the impact of transition costs by using the Federal surplus to
strengthen Social Security. Let us hope that we can work
together and make this happen. Let us hope that there are some
areas where we as a Task Force can have bipartisan agreement.
After witnesses have testified, we will open it for any
individual Member that wants to make a comment today, and like
we have already agreed to, those individual written comments
and then majority/minority reports will be due by the 30th of
this month.
And I would call on our ranking member, Lynn Rivers, for a
statement.
Ms. Rivers. No statement.
Chairman Smith. Let me introduce our witnesses today. Dr.
Rudolph Penner holds the Arjay and Frances Miller Chair in
Public Policy at the Urban Institute. He directed the
Congressional Budget Office from 1983 until 1987, highly
respected by both Republicans and Democrats. He served as a
senior government official at the Council of Economic Advisers
and the Department of Housing and Urban Development. Dr. Penner
has directed fiscal research programs at the Urban Institute
and the American Enterprise Institute.
David John is a Senior Policy Analyst for Social Security
at the Heritage Foundation, a 20-year veteran of Washington
policy debates, and David has worked on Capitol Hill and in the
private sector as well. We look forward to the testimony from
Heritage.
And William Beach, of course, is Director of the Center for
Data Analysis for the Heritage Foundation and has developed
various econometric and computer models used by policy
analysts. And we are very happy that within the last couple
years the Heritage Foundation has taken on Social Security as a
priority venture for them in terms to arrive at a solution.
And, Dr. Penner, we will start with you. All written
testimony will be included in total in the record, and if you
would keep your remarks to 5 or 8 minutes, we would appreciate
it.
Prepared Statement of Hon. Nick Smith, a Representative in Congress
From the State of Michigan
Today's hearing focuses on transition costs. This topic is an
essential element of the Task Force's mission to review the long-term
budget ramifications of the various Social Security reform proposals
and work toward bipartisan solution to the impending insolvency of our
nation's retirement system.
We all know that there are only three ways to eliminate Social
Security's $9 trillion unfunded liability and return the system to
solvency: raise taxes, cut benefits, or increase the rate of return
earned on the taxes workers pay. The comprehensive reform plans that
have been proposed use some or all of these three ways. Our witnesses
have reviewed the various reform proposals under consideration, and
will tell us how each brings financial stability to Social Security.
We have an extraordinary opportunity to soften the impact of
transition costs by using the Federal surplus to strengthen Social
Security. Let's hope that we can work together to make this happen.
After witnesses have testified, Members will be invited to make
closing statements. Finally, I want to propose Task Force findings
review what we have learned during the past 4 months that we have been
meeting.
STATEMENT OF RUDOLPH PENNER, ARJAY AND FRANCES MILLER CHAIR IN
PUBLIC POLICY, THE URBAN INSTITUTE
Mr. Penner. Well, Mr. Chairman, members of the Task Force,
thank you for the opportunity to testify. As we all know, the
current pay-as-you-go Social Security system is in trouble.
Adverse demographics will force tax increases and benefit cuts
in the future and the rate of return on tax payments will be
far lower for future retirees than they have been in the past.
As a result, many believe that we should reduce our
reliance on the current pay-as-you-go system and move toward a
funded system in which real investments would provide income to
fund pensions in the future. The rate of return on payments to
pension accounts is then ultimately determined by the real
return on investments rather than by demographic developments,
and as a result, the expected rate of return will be much
higher.
As I explain in my complete testimony, funding can be
accomplished publicly or privately. Here I shall concentrate on
private approaches, since I deem them to be highly preferable.
Funding involves a sacrifice. The money going into personal
accounts could have been used for immediate consumption of
goods and services. At the same time, people already retired or
who are approaching retirement will not receive much benefit
from funded pension accounts. They will have to be supported by
the working population, and that will be an additional
sacrifice.
The problems involved in moving toward funding are
complicated by the fact that we start with a system in which
the earmarked payroll tax is insufficient to fund future
benefits and either benefit growth will have to be slowed or
taxes raised to solve this problem. Solving this problem,
therefore, also involves sacrifice.
The sacrifices involved in the financial problems of the
current system will have to be faced whether or not we move
toward a funded system. In policy discussions, the sacrifices
involved in moving toward funding are often merged and muddled
with the sacrifices involved in solving the system's financial
problem. It is useful conceptually to keep the two problems
distinct.
Both types of sacrifices can be distributed across
generations and within generations in a multitude of ways. Both
the transition problem and the actuarial problem can be
mitigated by slowing the future growth of benefits. Here we
face a difficult trade-off. The more quickly benefits are
reduced, the smaller the necessary reduction. But quick benefit
reductions are only possible if they affect those already
retired or those near retirement. It is generally believed that
this is undesirable because such people do not have much time
to adjust their private saving or work efforts to change this
in the rules, but if benefit cuts are phased in over a long
period, they have to be much larger in the end.
My own feeling is that the sacrifice should be spread
broadly and that the currently retired should not be spared
some small cut. Tiny cuts now mean significantly less cutting
in the future.
The sacrifice can be spread within generations in a variety
of ways. Plans like the Smith plan and the Kolbe-Stenholm plan
cut higher earners more than lower earners. Kolbe-Stenholm
provides a new benefit equal to the poverty line for those who
have worked 40 years.
The President's USA plan and Kolbe-Stenholm private
accounts subsidize contributions to individual accounts by
lower income earners to reduce the sacrifice that they have to
bear. Such provisions show that reforms can be accomplished in
a highly progressive manner if that is deemed desirable.
With all the talk of sacrifice, it should be emphasized
that most plans do not impose much of a transition cost because
they do not contain much transition. If we were talking about
replacing the entire pay-as-you-go system with a Chilean-type
reform, the transition costs would be quite enormous, but that
is not politically plausible in the United States, and most
plans from the political middle replace a relatively small
portion of the current pay-as-you-go system.
Were it not for the actuarial problem, the total sacrifice
of lost consumption would be less than 2 or 3 percent of total
income immediately, and much less than that in the very long
run.
Even the actuarial problem can be solved without huge
sacrifice. It must be remembered that a considerable part of
the actuarial problem comes from the fact that current promises
involve providing average benefits that constantly rise faster
than the inflation rate. Keeping the retired population at the
current absolute living standard can help solve a considerable
portion of the problem.
The current surplus can also be used to ease the immediate
sacrifice because it means that we can fund contributions to
individual accounts without reducing consumption below recent
levels. True, we give up the potential of a tax cut or spending
increases, but I think, as you said, Mr. Chairman, the
existence of the surplus makes this all very, very much easier
than it would be otherwise.
So it should not be as hard to solve the Social Security
problem as it seems to be. I think people are reluctant to
contemplate even small changes in the system because Social
Security has been so popular and has worked so well in the
past, but adverse demographics will keep it from working as
well in the future, and therefore, it has to be changed.
Thank you very much, Mr. Chairman.
Chairman Smith. Dr. Penner, thank you.
[The prepared statement of Mr. Penner follows:]
Prepared Statement of Rudolph Penner, Arjay and Frances Miller Chair in
Public Policy, the Urban Institute
The views expressed in this testimony are those of the author and
do not necessarily reflect the views of the trustees and employees of
The Urban Institute.
Mr. Chairman and members of the Task Force, thank you for the
opportunity to testify. The current pay-as-you-go (PAYGO) Social
Security system is in trouble. Revenue growth will slow because the
rate of growth of the labor force is declining. Meanwhile, the number
of beneficiaries will grow rapidly because of increases in expected
life and the retirement of the baby boomers. The cost of benefits will
outrun the revenues provided by the payroll tax, and either benefit
growth will have to be reduced, payroll taxes raised, or general
revenues used to finance the system. Regardless of the option chosen,
the rate of return to taxes paid will be much lower for future retirees
than for current and past retirees.
This has led many to support reduced reliance on the traditional
PAYGO system and more reliance on a funded system in which
contributions would be invested in a mixture of public and private
securities, the return on which would be used to finance future
pensions. The low rate of return created for the traditional system by
adverse demographics would be replaced by a higher rate of return
associated with investments in real capital. Both rates of return are
associated with considerable risk, but given the current demographic
outlook, the expected return on a funded system far exceeds that on a
PAYGO system.
In theory, a funded system can be managed using either public or
private accounts. Conceptually, the fundamental economic effects of the
two approaches can be made to be identical. The dispute over which
approach is preferable is therefore not a matter of economic theory.
Instead, it involves different political forecasts as to how the two
approaches would function in practice. Those of us who favor a private
approach doubt that the government could resist dipping into the
reserves of a public account in the long run in order to fund deficits
emerging in the rest of government. We also worry that the government
would use its investment policy to achieve political ends rather than
investing in an optimum portfolio for future retirees.
But forgetting these problems for the moment, one can imagine
diverting an amount of current tax revenue, say equal to 2 percent of
payroll to a funding account that could be invested in stocks and bonds
by either the government or private individuals. This approach is often
called a ``carve out'' approach and essentially uses the current
surplus to finance the move toward funding. The diversion of revenues
can be from payroll taxes or any other taxes. The choice of an approach
will have distributional and other consequences that are important, but
the choice does not change the fundamental nature of the transition
problem to be discussed at this hearing.
The important point is that the policy imposes a sacrifice. If the
revenues were not diverted into a funded account, they could be used to
finance a tax cut or some spending increase that would allow taxpayers
to increase their consumption of goods and services immediately.
A different approach would either increase taxes to fund a public
account or mandate that individuals invest a certain portion of their
earnings in a personal retirement account. Assuming that individuals
did not evade the mandate, consumption would have to be reduced
immediately compared to levels enjoyed in the recent past.
The two approaches are meaningless unless they reduce consumption
below what it would be otherwise. This is the same as saying that the
reform must increase national saving, thus providing additional
national wealth which can be used to finance the pensions of the
future.
These approaches to increasing saving should be differentiated from
recent ``lock box'' proposals that strive to increase national saving
by running a unified budget surplus at least equal to the surplus in
the Social Security trust fund. The lock box approach only increases
national saving while the trust fund surpluses last, whereas true
funding would go on indefinitely. Moreover, the amount of increased
saving resulting from the lock box proposal is not directly related to
future pension needs.
The language surrounding lock box proposals is more than a little
confusing, but that does not mean that the goal of a lock box is a bad
idea. If adhered to, it will increase national saving as long as trust
fund surpluses continue. This is appropriate, since most economists
agree that current American saving levels are woefully inadequate.
When people speak of a transition problem related to funding, they
are referring to the fact that consumption must be forgone immediately
to finance the funded account, but the funded accounts will be of no
help to the currently retired and of little help to those soon to
retire. These potential beneficiaries of the traditional system will
have to be supported somehow by the working population and that will
involve an additional sacrifice. The amount of the sacrifice can be
reduced by reducing promised benefits, but it is politically
unrealistic to assume that promises can be cut back radically.
The problem is intensified by the fact that the current earmarked
payroll tax is inadequate to finance future promised benefits.
Therefore, some benefit reductions or tax increases will be necessary,
even if we do not move toward a funded system. Put another way, any
sacrifice involved in moving toward a funded system will be on top of
that involved in fixing what remains of the current PAYGO system.
In current policy discussions, the problems of fixing the current
system are often merged and muddled with the problems involved in
moving toward funding. The two problems are distinct and should be
separated conceptually. But it is desirable to solve both
simultaneously, and it is necessary to consider this twofold burden
when analyzing reforms.
The sacrifices involved in solving both can be spread in different
ways across different age cohorts in the population and within each
cohort. Plans often strive to provide about the same retirement income
as is promised by the current system. This can be done in two ways.
Reductions in traditional benefits can be phased in slowly and designed
to match the growth in income from individual accounts. The designer
must make explicit assumptions about the rates of return to individual
investments and this is a risky business. Of course, if such a reform
were implemented, individuals could make their own assumptions about
rates of return and if they preferred to assume lower returns on a
safer portfolio, they could compensate by saving more than the mandated
amount in order to replace traditional benefits. That is to say, they
could choose to lower their risk by reducing immediate consumption by a
larger amount. The second approach is to directly link the reduction in
traditional benefits to the amount earned on individual accounts as in
the Feldstein and Archer-Shaw plans. Then government bears a
considerable portion, or all, of the risks of the investment and it is
certainly not appropriate to refer to this as privatization.
(Privatization is not a good word for any mandated highly regulated
plan involving individual accounts.) Such guarantees make the approach
more similar to public funding of benefits in that the general taxpayer
bears some or all of the risk of the investment in private securities.
In Congressman Smith's plan, the reduction in future benefits is linked
to the amount contributed and not to the amount earned on the
individual account. This approach leaves the general taxpayer with a
lower contingent liability and is preferable in my view.
Benefit Reductions
To the extent that benefit reductions are used to ease the
transition burden on future workers and to bring the existing system
into actuarial balance, reformers face a difficult tradeoff. It is
generally agreed that any benefit reductions should be phased in
slowly, so that people have time to adjust to changes in the rules by
altering their work effort and private saving. But if changes are
phased in slowly, the ultimate reduction in benefits must be greater
than if the changes are implemented immediately. This suggests that
those currently retired should not be totally exempted from making
sacrifices to help insure that future cohorts will have adequate
retirement income. A very small current sacrifice can mean less
significant cuts in traditional benefits for future retirees.
Many reforms cut taxes immediately to finance contributions to
individual accounts while traditional benefit reductions are phased in
slowly. An example of such a plan has been put forward by
Representatives Kolbe and Stenholm. The effects of this class of plan
on the unified budget balance are negative at first as the revenue loss
exceeds the outlay savings from the benefit reductions. The negative
impact grows for a time and in the Kolbe-Stenholm plan reaches a peak
about 2012. But the outlay savings eventually catch up with the revenue
loss and eventually exceed it, so that such plans ultimately improve
the budget balance. Put another way, such plans first reduce the amount
of debt that can be redeemed, all else equal, and depending on fiscal
policy choices and economic developments between now and the time that
their net cost reaches a peak, may require some net borrowing from the
public.
Such plans probably would not be contemplated were it not for the
current surplus. But the fact that such plans may temporarily result in
a small deficit should not be considered a major problem. (The maximum
negative effect of the Kolbe-Stenholm plan on the unified budget
balance never exceeds 0.8 percent of the GDP.) To the extent that
future Congresses decide to run deficits, it is equivalent to passing
some of the costs of reforms to future generations. Those future
generations will benefit from the reform in that they face a reduced
burden associated with paying for traditional benefits. In other words,
the explicit liability associated with government debt will replace
some of the implicit liability associated with promised benefits.
Unlike some, I do not believe that the two liabilities should be
regarded as being equivalent on a dollar for dollar basis, but there is
room for some tradeoff between the two types of liability.
Alternatively, it may be decided 20 or 30 years from now that economic
conditions do not warrant running a deficit and that taxes should be
raised or spending cut. The issue again involves which age cohorts
should bear the costs of reform and that need not be decided
immediately for all future time.
There is a multitude of options for spreading the burden of benefit
cuts within cohorts. Traditional benefits can be cut progressively by
altering the benefit formula appropriately or by using means testing,
although the latter runs the risk of destroying incentives for
privately saving for retirement. The sacrifice imposed by mandated
accounts can also be made progressive by subsidizing the contributions
of low-income individuals as in the President's USA accounts and in the
accounts established by the Kolbe-Stenholm plan.
Tax Increases
Tax increases can also be used to fund a public account or to
reduce the actuarial imbalance in the current system. Whether one uses
tax increases or benefit cuts to reform the system depends on what
portion of the nation's resources one wants to convey to the retired
population. Today, slightly more than half the noninterest civilian
budget goes to the elderly. Those of us who emphasize benefit cuts as a
solution rather than tax increases are concerned that elderly programs
are already crowding out programs for children, defense, infrastructure
and other things out of the budget, and unless benefits are reformed,
the problem will intensify rapidly in the future.
If traditions are maintained and payroll taxes continue to be the
main sources of income for the traditional system, revenue-increasing
options are limited to rate or tax base increases. Roughly speaking, it
takes a doubling of the tax base to produce revenues equivalent to a 1-
percentage point increase in the tax rate. Base increases concentrate
the pain of reform on the upper middle class and affluent two earner
families while rate increases afflict all who have earnings. If the
burden of a rate increase is examined relative to total income, the
highest percentage burden tends to be on lower income families who do
not have much income other than from earnings. However, the effects of
a rate increase extend far up the income scale--far beyond the wage
base, because affluent families often attain high incomes because they
contain more than one worker. At the very bottom, the effects of a rate
increase are mitigated somewhat on average, because the very poor are
often at the bottom because they have no earnings.
The Severity of the Transition Problem
With all the above discussion of sacrifices and burdens, there is a
danger of greatly exaggerating the pain involved in meaningful Social
Security reform. Transition problems are very severe if a PAYGO system
is entirely replaced with a funded system as in Chile, but such a
radical reform does not seem politically plausible in the United
States. Because the traditional American PAYGO system has been so
popular, it is likely to continue to be a very large component of our
public retirement system. A move toward funding is only feasible in my
judgment if it is relatively small. Most plans for individual accounts
from the political center convey the equivalent of only two or 3
percentage points of the current payroll tax into individual accounts.
Were it not for the perceived need to simultaneously cure the actuarial
imbalance in the traditional system, the pain of reform would be quite
small. The immediate forgone consumption in many plans would initially
be less than 2 percent of income and would be less than that in the
very long run.
The existence of the current budget surplus provides a golden
opportunity to further reduce the pain of partially funding the system.
It allows a portion of revenues to be saved either publicly or
privately without having to reduce consumption below current levels. It
is true this approach sacrifices the opportunity for tax cuts or
spending increases, but that is much easier than having to accept the
reduction in consumption that would be necessary if a tax increase was
necessary to fund a public account, or a mandated contribution to an
individual account was imposed on top of the current tax burden.
Although the problems of the actuarial imbalance and of any move
toward funding will have to be solved simultaneously, they should not
be confused conceptually. Because the current system is not sustainable
under current law, some sacrifice will be necessary even if we do not
move toward funding. It is therefore illusory to compare reform plans
to the current system as though current benefit and tax laws can be
sustained forever. The Congressional Research Service (CRS) has done a
good job analyzing different reforms under two scenarios--one in which
benefits are lowered to payroll tax receipts and another in which taxes
are raised to finance promised benefits. If adverse assumptions are
made--retirement at age 65, bond rate of return on individual accounts,
no retirement saving that is not mandated--monthly retirement income
tends to be lower than that under current law in plans like Moynihan-
Kerrey or H.R. 4256 for most of those retiring before the trust fund
empties, but much higher after, if it is assumed that benefits are
lowered to tax receipts. If taxes are raised to finance promised
benefits, the burden on future taxpayers will be higher than under the
reform plans.
The sacrifice will be even less if the move toward funding is
successful in increasing saving and enhancing economic growth. The CRS
study is inconsistent in this regard in that the projections of future
retirement income implicitly assume that people truly increase their
saving by the amount of any mandate, but it does not take account of
any increase in incomes that might result from enhanced economic
growth.
This is a tricky issue whether funding is done publicly or
privately. It was noted previously that public funding will not work if
surpluses in any retirement fund allow deficits to be larger in the
rest of government. Mandates to save privately can also be evaded if
people respond by reducing other retirement saving or by borrowing
more. However, any plan cutting the growth of benefits provides a
powerful inducement for people to save more privately in order to
replace those benefits. Consequently, it is my judgment that a mandate
combined with a benefit reduction would be very effective in increasing
saving. Saving should also rise, even though individual accounts are
voluntary and also in the case where no special provision has been made
for private saving to offset benefit cuts. However, mandates may be
useful in encouraging people to exercise the self-discipline that they
should be exercising in any case when confronted by lower Social
Security benefits than they originally expected.
To the degree that saving is increased as the result of Social
Security reform, growth should be enhanced. This does little to reduce
the proportionate economic burden imposed by the Social Security
system, because faster growth means higher wages and higher wages mean
higher benefits. However, more growth makes reform less painful,
because it reduces any loss of consumption compared to past history.
Indeed, it should be noted that today's system promises each successive
cohort of retirees a higher real benefit. Simply, keeping traditional
benefits constant in real terms would solve a significant portion of
the financing problem without at all reducing the absolute living
standard of average retirees.
Conclusions
It is necessary to contemplate two types of Social Security reform,
both of which are highly desirable. First, we have to adjust to the
fact that under current law payroll taxes are not sufficient to finance
promised benefits in the long run. Second, it would be useful to fund
part of the system, so that the rate of return to tax payments is
dependent on the real return to capital rather than on demographic
variables. Both types of reform will impose sacrifices in the sense
that someone's consumption will have to be lowered below what it could
be otherwise, either now or in the future. However, the total sacrifice
is not large in size, because most politically feasible reforms fund
only a small portion of the public retirement system and if we act
quickly, the financing problem under current law is small relative to
total income. Moreover, the sacrifice can be spread in an infinite
number of ways among and within the generations. The neediest in
society can be easily protected against any drop in absolute living
standards.
Consequently, Social Security reform should not be as hard as it
is. Part of the problem is due to a lack of understanding of the
current system and of the implications of specific reform proposals.
More important, Social Security is hard to reform because it has been
so popular and has worked so well in the past. But it cannot work as
well in the future because of adverse demographics. Leaving it the same
is not a viable option in the long run.
Chairman Smith. Mr. John and Mr. Beach, do you have a
preference on who goes first? Mr. John.
STATEMENT OF DAVID C. JOHN, SENIOR POLICY ANALYST FOR SOCIAL
SECURITY, HERITAGE FOUNDATION
Mr. John. We appreciate the opportunity to appear before
you today to discuss the cost of transitioning to a solvent
Social Security system.
High transition costs will be a fact of life for Social
Security regardless of whether the program is radically
reformed or just left as it is. As a result, the transition
costs of the various reform proposals should be measured
against the costs associated with doing nothing at all.
We define the transition costs for Social Security
retirement programs as the total amount of money that must come
from sources other than Social Security payroll taxes at the
current level.
The easiest way to measure this cost is to look at the
annual cash flow deficit of the OASDI trust funds under both
the existing program and the various proposals that have been
made. We have used the cost estimates made by the SSA's Office
of the Chief Actuary with only one change. While SSA measures
these amounts in percentages of taxable payroll, we have
translated them into constant 1999 dollars in order to make
them more understandable.
Increased payroll taxes, whether by raising the wage cap or
increasing the tax rate or other revenues that are used to fill
the operating deficit, count as part of the transition costs
under this definition. This is true regardless of whether or
not the general fund revenues come from a budget surplus. In
either case, they represent additional resources that are used
to pay Social Security benefits.
Three quick examples for the year 2020 show how this
definition applies to the existing system and the various
reform plans. Looking at SSA's intermediate prediction for the
existing program in 2020, the OASDI trust fund is estimated to
take in $634 billion in taxes and pay out $737 billion in
benefits. Even if this $104 billion operating deficit is
covered by liquidating some of the assets in the OASDI trust
fund, that money comes from sources other than the payroll tax
and should be considered part of the transition cost.
This is not to imply that the special issue Treasury bonds
held in the trust fund are worthless or will not be repaid on
schedule. However, the Analytical Perspectives volume of
President Clinton's fiscal year 2000 budget accurately
characterized the assets in the trust fund when it said:
``These balances,'' I quote, ``are available to finance
future benefit payments only in a bookkeeping sense. They do
not consist of real economic assets that can be drawn down in
the future to fund benefits. Instead, they are claims on the
Treasury that, when redeemed, will have to be financed by
raising taxes, borrowing from the public, or reducing benefits,
or other expenditures,'' end quote.
Looking at the Kolbe-Stenholm plan, in 2020, by comparison,
after adjusting the traditional benefit, SSA found that $57
billion will be transferred from general revenues to cover the
operating deficit. A further $27 billion will be brought in
from the effect on the income tax collections of reestimating
the CPI, Consumer Price Index, for a total transition cost of
$84 billion in 2020.
The Archer-Shaw plan makes no change in the existing
payroll tax rate or to the existing benefit structure. However,
it funds individual accounts with an amount of general revenues
equal to 2 percent of income and requires general revenue funds
to pay a portion of Social Security benefits during its
transition period. Thus, in 2020 the transition cost for
Archer-Shaw includes both $98 billion for the amount that goes
into the personal accounts and $72 billion that is used to pay
some benefits for a total transition cost of $170 billion.
The source of the money for general revenue transfers to
pay Social Security benefits is extremely important. In short,
no matter where the money comes from, Congress will always face
opportunity costs.
The phrase, ``There is no free lunch,'' has never been
truer than in this situation. To the extent that the money is
borrowed, future generations will bear a significant interest
cost that will be in addition to the base transition cost.
The other alternatives are to cut spending or raise payroll
taxes. Future Congresses may face the choice between paying
Social Security benefits or paying for education or defense
programs.
It is easy to assume that this money can be repaid out of
surpluses, but there is a catch to the recent good news on that
front. Over the last 6 months, the White House's estimate of
the cumulative 15-year budget surplus has gone up by $1.1
trillion. However, the beginning of an economic downturn, which
is inevitable at some point, could cause a downward revision of
an equal amount. It is a fallacy to assume that these surpluses
are inevitable.
There is no easy solution to Social Security. No matter
what, future taxpayers will bear a significant additional
burden to pay the benefits of that time's retirees. The only
question is when the annual deficits begin, how big they are
and how long they last.
The benefits of individual accounts would take some time to
develop. Even if a taxpayer is allowed to begin them tomorrow,
the accounts will not grow large enough to offset any
significant amount of the traditional benefits for a good 20 to
30 years.
If Congress does nothing, the annual cash flow deficits for
Social Security begin in 2014. They reach $516 billion in 1999
dollars by 2070. It appears that the annual deficits continue
and grow in size as long as they can be measured. On the other
hand, most reform plans start to run overall deficits sooner,
but they tend to be smaller over time, and in a few cases they
actually end.
Plans that finance individual accounts with part of the
existing Social Security taxes must begin to run deficits
almost immediately, for obvious reasons. There is less money
going to Social Security. While these plans adjust the
traditional benefit that is financed solely from payroll taxes,
these reductions only begin to reduce costs after the
individual accounts have had a chance to grow for a number of
years. This necessary delay in cost reduction causes these
plans to run significant deficits that grow for about 30 years
and then begin to steadily decline.
Of course, there is more to be considered in Social
Security reform than just aggregate costs. The simple fact is
that for millions of low- and moderate-income families Social
Security is the only retirement plan that they have.
Unfortunately, for most of them, today's Social Security is not
a good investment. At a time when the S&P 500 has gone up 20.5
percent in the last 12 months, Social Security earns the
equivalent of only about 1.3 percent.
The objective of Social Security reform must be more than
just restoring the financial health of the system. It is time
to allow every American family, no matter what their income
level, to have the opportunity to fully participate in our
economy. Social Security reform must also improve the
retirement income of low- and moderate-income individuals.
The real question is how responsible this Congress and the
one following wants to be to future generations. It can do
nothing and place a significant burden on our children or
grandchildren, or it can act responsibly and reduce that
burden.
Chairman Smith. Thank you.
[The prepared statement of Mr. John and Mr. Beach follows:]
Prepared Statement of David C. John, Senior Policy Analyst for Social
Security, and William W. Beach, Director, Center for Data Analysis, the
Heritage Foundation
We appreciate the opportunity to appear before you today to discuss
the costs of transitioning to a solvent Social Security system. At the
outset, let me state that the views that are expressed in this
testimony are our own, and should not be construed as representing any
official position of the Heritage Foundation.
High transition costs will be a fact of life for Social Security
regardless of whether the program is radically reformed or just left as
it is. While some consider transition costs to apply only to proposals
that would reform Social Security, this is not the case. Since the
existing program will begin to run cash flow deficits in 2014, the
transition costs of various reform proposals should be measured against
the costs associated with doing nothing at all. In fact, it would
probably be more accurate to talk about ``preservation costs'' instead
of transition costs.
``Transition Costs'' Defined
We define the transition costs for Social Security retirement
program as the total amount of money that must come from sources other
than Social Security payroll taxes at the current level and the small
portion of the income tax on benefits paid to certain higher income
retirees. Thus, increasing the payroll taxes would count as part of the
transition costs as would any general revenue that is transferred to
the program.
The easiest way to measure this cost is to look at the annual cash
flow deficits of the Old-Age, Survivors and Disability Insurance
(OASDI) trust funds under both the existing program and the various
proposals that have been made. For this analysis, we have used
estimates made by the Social Security Administration (SSA) Office of
the Chief Actuary with only one change. While SSA measures these
amounts in percentages of taxable payroll, we have translated them into
constant 1999 dollars in order to make them more understandable.
When considering the various reform plans, we compared the
operating deficits (if any) that would result after subtracting trust
fund income (mainly payroll tax revenues) from trust fund costs (the
aggregate benefits that would be paid under the reformed system).
However, let me emphasize once again that our definition only considers
payroll taxes at the current level. Increased payroll taxes, whether by
raising the wage cap or increasing the tax rate or other revenues that
are used to fill the operating deficit count as part of the transition
cost. This is true regardless of whether or not the general fund
revenues come from a budget surplus. In either case, they represent
additional resources that are used to pay Social Security benefits.
This analysis is limited to measuring the effect of various policy
options on Social Security revenue and outlays, and by extension on the
government's budget. It does not measure changes in the retirement
benefits received by individuals. For instance, both the existing
system and the Archer-Shaw plan assume that benefits will be paid at
levels called for under current law, while the Gramm plan assumes that
the combination of traditional benefits and individual accounts will
equal at least 120 percent of that amount. On the other hand, the
Kasich plan assumes that retirement benefits will remain at the current
level instead of growing in real terms as is called for under existing
law. Kolbe-Stenholm, meanwhile, assumes that Social Security retirement
benefits from traditional sources will gradually decline as the amount
available from individual accounts grows. These effects on the
individual can only be measured indirectly in a discussion of
transition costs.
Applying This Definition to the Existing System and Various Reform
Plans
Three quick examples show how this definition applies to the
existing system and various reform plans. Looking at SSA's intermediate
prediction for the existing program in 2020, the OASI trust fund is
estimated to take in $634 billion in taxes and pay out $737 billion in
benefits. Even if the $104 billion operating deficit is covered by
liquidating some of the assets in the OASI trust fund, that money comes
from sources other than the payroll tax, and should be considered part
of the transition cost.
This is not to imply that the special issue Treasury bonds held in
the trust fund are worthless or will not be repaid on schedule.
However, the Analytical Perspectives volume of President Clinton's
FY2000 budget accurately characterized the assets in this trust fund
when it said:
``These balances are available to finance future benefit payments *
* * only in a bookkeeping sense. They do not consist of real economic
assets that can be drawn down in the future to fund benefits. Instead,
they are claims on the Treasury that, when redeemed, will have to be
financed by raising taxes, borrowing from the public, or reducing
benefits, or other expenditures.'' (P.337--Italics added for emphasis)
On the other hand, the Kolbe-Stenholm plan diverts an amount of the
Social Security tax equal to 2 percent of income to individual accounts
and adjusts the traditional benefits to reflect the gradual ability of
individual accounts to pay some portion of Social Security benefits. In
2020, after making these adjustments, Kolbe-Stenholm assumes that $57
billion will be transferred from general revenues to cover the
operating deficit. A further $27 billion will be brought in from the
effect on income tax collections of re-estimating the Consumer Price
Index (CPI), for a total of $84 billion.
The Archer-Shaw plan makes no changes to the existing payroll tax
rate or to the existing benefit structure. However, it funds individual
accounts with an amount of general revenues equal to 2 percent of
income and requires general revenue funds to pay Social Security
benefits. Thus, in 2020 the transition cost for Archer-Shaw includes
both $98 billion for the personal accounts and $72 billion to pay
benefits for a total of $170 billion.
Where Does the Money Come From?
The source of the money for general revenue transfers to pay Social
Security benefits is extremely important. In short, no matter where the
money comes from, Congress must always face opportunity costs. They
range from foregoing expansion of a non-Social Security program in
order to pay the interest on borrowed money to being forced to raise
taxes to support Social Security outlays rather than spending those
funds on urgent needs in education or defense. Depending on a variety
of factors, there also could be an effect on the growth rate of the
entire domestic economy.
The phrase ``There is no free lunch'' has never been truer than in
this situation. To the extent that the money is borrowed, future
generations will bear a significant interest cost that will be in
addition to the base transition cost. If the Federal Government borrows
a significant amount for Social Security, under some circumstances this
could cause an increase in interest rates for the overall economy. This
in turn could lower economic growth, thus reducing payroll tax
collections below anticipated levels.
Congress also needs to consider the effects on the rest of the
budget that stems from increased general revenue spending to meet
Social Security's challenges. . It is easy to assume that this can be
paid out of surpluses, but there is a catch to the recent good news on
that front. Over the last 6 months, the White House's estimate of the
cumulative 15-year budget surplus has gone up by $1.1 trillion.
However, the beginning of an economic downturn, which is inevitable at
some point, could cause a downward revision of an equal amount. It is a
fallacy to assume that these surpluses are inevitable.
In that case, future Congresses may face the choice between tax
increases and significant reductions in other programs. If there is no
surplus, where will the $104 billion come from that will be required to
redeem assets of the trust fund in 2020? Will the 115th Congress
sitting in 2020 be forced to reduce spending for education, highways,
defense, or other programs to pay Social Security benefits? When
considering transition costs, it will be important to consider
aggregate deficits, how long they will last, and how large the
individual annual deficits are. To a very real degree, the actions of
this Congress and the next one will limit the ability of future
Congresses to meet national needs.
You Can Pay Me Now or You Can Pay Me Later
As it will become clear from looking at both the forecast for the
current system and various reform options, there is no easy solution to
Social Security. No matter what, future taxpayers will bear a
significant additional burden to pay the benefits of that time's
retirees. The only question is when the annual deficits begin, how big
they are, and how long they last.
The benefits of individual accounts would take some time to
develop. Even if a taxpayer is allowed to begin them tomorrow, the
accounts will not grow large enough to offset any significant amount of
the traditional benefits for a good 20 to 30 years.
If a portion of the existing Social Security tax is diverted to
individual accounts, there is a direct relationship between the amount
that can go into an individual account, the size of the initial
deficits, and how soon the deficits can end. Diverting part of the tax
reduces Social Security's income and causes almost immediate deficits.
On the other hand, the more that goes into the individual accounts, the
faster they grow to a significant size and can replace much of the
traditional benefit. However, since the early deficits can be so large,
most reform plans initially limit individual accounts to an amount
equal to 2 percent of income.
If Congress does nothing, annual cash flow deficits begin in 2014.
They amount to about $21 billion in 2015, $252 billion in 2030, and
reach $516 billion in 2070. It appears that the annual deficits
continue and grow in size as long as they can be measured. On the other
hand, most reform plans start to run overall deficits sooner, but they
tend to be smaller over time, and in a few cases they eventually end.
As expected, plans such as Kolbe-Stenholm, Kasich and the Senate
bipartisan plan that finance individual accounts with part of the
existing Social Security taxes begin to run deficits almost
immediately. While these plans adjust the traditional benefit that is
financed solely from payroll taxes, these reductions only begin to
reduce costs after the individual accounts have had a chance to grow
for 20 to 30 years. This necessary delay in cost reduction causes these
plans to run significant deficits that grow for about 30 years and then
begin to steadily decline.
For instance, Kolbe-Stenholm reaches a maximum annual deficit of
$133 billion in 2030, but by 2070, the deficit has declined to only $38
billion. In several years in between, there is actually a surplus. The
Kasich plan also reaches a maximum deficit of $187 billion in 2030, but
deficits essentially end after 2065. This pattern is also true for the
Senate bipartisan plan, where deficits reach $130 billion in 2030, but
end in 2065.
Because our definition includes all outside revenues other than the
existing level of payroll taxes, this pattern is also true for the
Archer-Shaw plan. Even though under Archer-Shaw, the Social Security
trust fund does not begin annual cash flow deficits until 2014, the
level of general revenues that are necessary to fund the add-on
individual accounts causes an almost immediate aggregate deficit. Thus,
while Social Security runs a surplus in 2000 of $69 billion, the $74
billion for general revenues that goes into the Archer-Shaw accounts
causes a $5 billion aggregate deficit. This deficit climbs to $255
billion in 2030, before declining to $185 billion in 2070.
Thus, what this Congress does will have a major impact on the
future. In 2000, this country could face a Social Security surplus if
Congress does nothing. Passing Kolbe-Stenholm, Archer-Shaw, the Senate
bipartisan plan, or Kasich will result in a deficit of about $5
billion.
By the time a child born in 2000 reaches the age of 30 in 2030, the
annual deficit will climb to $252 billion under the existing system.
Under Kolbe-Stenholm, it would be $133 billion, while the Archer-Shaw
deficit would be $255 billion. That same year, the Senate bipartisan
plan would run a deficit of $130 billion, and the Kasich plan deficit
would be $187 billion.
In 2070, the existing system will run a $516 billion deficit. For
Kolbe-Stenholm, it will be $38 billion, for Archer-Shaw $185 billion.
However, for both the Senate bipartisan plan and the Kasich plan, there
will be no Social Security deficit.
Of course, there is more to be considered than just aggregate
costs. The simple fact is that for millions of low and moderate-income
families, Social Security is the only retirement plan that they have.
Unfortunately, for most of them today's Social Security is not a good
investment. At a time when the S&P 500 has gone up 20.5 percent in the
last 12 months, Social Security ``earns'' the equivalent of only 1.3
percent.
The objective of Social Security reform must be more than just
restoring the financial health of the system. It is time to allow every
American family--no matter what their income level--to have the
opportunity to fully participate in our economy. Social Security reform
must also improve the retirement income for low and moderate-income
workers.
The real question is how responsible this Congress and the one
following want to be to future generations. It can do nothing and place
a significant burden on our children and grandchildren, or it can act
responsibly and reduce that burden. Your decision will have an even
greater impact on our children's grandchildren. What kind of a legacy
do we as a people want to leave to the future?
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Chairman Smith. Did you have a comment, Mr. Beach?
Mr. Beach. Just a very quick comment, first, to explain why
I am here. I am Robin to this man, Batman, today, so I don't
have formal remarks.
Secondly, I would like to point out to the committee that
this country has faced significant transition costs before, and
there is in these hallowed halls, actually across the street,
good history coming out of our own Revolution. As you may know
from your history, this country faced a significant amount of
debt which was going to significantly constrain the ability of
the country to grow economically. Many of our creditors in
Europe simply had given up on the United States when Alexander
Hamilton funded the debt. That funding of the debt was done
over a long period of time with long-term bonds--they didn't
have income taxes at the time because it was not part of the
Constitution--and it was successful.
Sometimes when we think about the challenges of funding our
transition to a Social Security system that works from a trust
fund standpoint and it works from a retirement standpoint, they
seem like large obstacles, but we can keep in mind what many
times we have done in this past.
Mr. Chairman, David and I have before you graphic material
that shows various plans, just a selection of plans. I have
brought with me a number of documents from Social Security to
answer questions. All of these data are data from Steve Goss
and his fine deputy actuaries over at the SSA.
Chairman Smith. Dr. Penner, let me start with you. In an
article published by Investors Business Daily last April, you
stated: ``By focusing the Nation's attention on solvency while
ignoring the severe fiscal imbalances underlying both Social
Security and Medicare the President does the nation a great
disservice.'' That is somewhat aggressive. Do you still feel
that way? And please elaborate.
Mr. Penner. Yes, Mr. Chairman, I certainly still feel that
way. I do feel that the President's proposal probably has a
negative effect on the prospects for Social Security reform. By
a bookkeeping entry, he makes it seem as though the problem is
solved, but he did nothing to real benefits. He did nothing to
the payroll tax, and I think it shows the problem of focusing
on the solvency of the trust fund. That can be cured by the
stroke of a pen, as he did it, but that in no way reduces the
real economic burden of having to pay people benefits; and that
burden, in my judgment, is much better measured by the ratio of
those benefits to our total income or our gross domestic
product. And that burden is going to start rising and rises
quite rapidly after we get past the first decade of the next
century. The total increase in that burden is roughly 2 percent
of the GDP by 2030 or so. That is not a lot and wouldn't be
much of a problem except that it is also combined with a much
bigger rise in the Medicare burden caused by the same sort of
demographics, plus the increase in the relative price of
medical care.
So unless we focus on these real burdens, it seems to me
that we miss the total problem. So while the President has made
some proposals on Medicare, and I believe that those should be
taken very seriously, his proposals on Social Security are an
empty box as far as I am concerned.
Chairman Smith. There seem to be several empty boxes from
another perspective. Almost all of the Social Security
proposals, there may be nine that have now been evaluated by
the actuaries, assume that the Social Security trust fund
indebtedness is going to somehow be paid back. That is
technically a legal obligation, but the trust fund is not a
financial asset until we find some way to pay it back. How
should we be looking at plans to pay that back? And I will go
across, with each of you making a comment on that.
Mr. Penner. Well, I think that is exactly right, Mr.
Chairman. The President has essentially just put a lot more
debt into the trust fund. Some people refer to that as general
revenue financing of Social Security, but I think that is a
misnomer. It would be general revenue financing if he had said
that in the future, maybe in 2020, he would like to see an
increase of 10 percent in income taxes and 20 percent in the
corporate tax in order to pay off that debt, but he has not
given any indication of how that debt should be paid off in the
future. So I would refer to it as general debt financing as
opposed to general revenue financing.
Chairman Smith. Mr. Beach.
Mr. Beach. Yes, I agree with that. The source of all
government revenues comes from the productivity of households,
individual workers, and that productivity is taken from them in
a sense through the tax system. Income taxes is a source for
rolling over debts and other source. If we operate in a fashion
to raise taxes on those households that are most covered by the
Social Security system, we are doing a double disservice.
Unless we reform Social Security to increase the savings in
those households, we are doing a disservice. If we say we are
going to balance on the basis of increased payroll taxes,
increased aid to retirement and so forth, we are doing another
disservice to those households, so we have to be very careful.
But that repaying of existing debt must come, in some fashion
or another, ultimately out of the tax sources.
Chairman Smith. Mr. John.
Mr. John. Well, as Bill said, the bottom line here is that
we have our choice. We can raise taxes, we can reduce other
government spending. There is not a whole lot else on the menu
here. The biggest cost that is going to come up here is if we
do nothing.
Chairman Smith. Ms. Rivers.
Ms. Rivers. Thank you, Mr. Chairman. I have several
questions, but the first one I want to start with is, I know
you have got your materials from the Heritage Foundation that
you gave to us today. Would you be amenable to having the
actuaries from Social Security take a look at them and put
their comments in the record with yours?
Mr. Beach. By all means, Congresswoman. The materials that
we have today, in fact, are all taken from, except our
comments, of course, from Social Security. So we would be more
than happy to supply your staff with an exact duplicate of the
materials I have in front of me.
Ms. Rivers. Wonderful. A lot of the proposals that I have
heard rely on either the on-budget surplus or the Social
Security surplus as a source of funds for transition; and I
have a couple questions about that. The first is, if you use
any portion of the Social Security surplus, don't you
exacerbate the problem that we were just discussing, which is
the 2012, or I guess it is 2013 problem now, where we have to
draw down on the trust fund; and then in 2034, you have got a
gap between income and outgoing. So doesn't any proposal to use
trust funds today, to plan transition to another program,
intensify the existing liability of the existing program or
make it worse?
Mr. Penner. I think that if you want to retain the
traditional characteristics of the Social Security system, that
is to say, have the benefits largely funded by the earmarked
payroll tax, then you are right that reducing the payroll tax
to fund private accounts, as in the Kolbe-Stenholm plan, for
example, means you have to make a sacrifice in the sense that
you could have used those payroll taxes for something else in
the first place. But also, you have a double burden. You have
got to reduce future benefit growth sufficiently to fund the 2
percent diversion first of all, and then you also have to fund
the 2 percent actuarial deficit in the system. So you must have
substantial benefit cuts in the program.
If you are willing to go outside the system and use some
general revenue financing, then obviously you will have to
reduce benefits as much, but that leaves you with a bigger
burden in the future, because benefits will be higher relative
to our total income.
Ms. Rivers. Do either of you want to speak to the issue of
using the Social Security surplus?
Mr. Beach. Yes, I would be happy to. Before you today are
the drafts that I have already referred to, based on what the
Office of the Chief Actuary has told us about the plans which
are represented on the graphs. If I could answer your question
by pointing to the baseline first, the baseline assumes that
those Social Security surpluses remain available for current
law use, and as we know from a couple of months ago when the
trustees made their report on the Old-Age, Survivors and
Disability Insurance trust fund, they predicted that by 2035,
in that year, with the absence of assets now in the trust fund,
that they would only be able to pay 71 percent of current law
benefits; and that absent any other change by 2075, only 66
percent of current law benefits.
Now, as you notice from looking at the graph, the Office of
the Chief Actuary has followed the plans in their detail and
said, using the surplus in the way that each plan uses it and
making the appropriate changes to current law, then points to
COLAs and so forth, that in point of fact each of those plans
results in a better actuarial balance by the end of that period
of time.
So I guess my answer is, if we use the surpluses occurring
to those plans, the actuary----
Ms. Rivers. But these plans don't all rely exclusively on
Social Security revenues. Archer-Shaw looks for general revenue
funds.
Mr. Beach. Exactly right, and you will see in each of these
plans in some cases a very large use of general revenue funds,
in some cases a more prudent use of general revenue funds. They
all require some kind of funding outside of the system.
Ms. Rivers. The other question I have regarding surpluses
is about the general funding surplus, which people are only
beginning to understand is predicated on the idea that we are
going to see real cuts in domestic discretionary spending,
about a 20 percent cut in real spending. What happens to these
plans if these surpluses don't materialize, if we agree to make
changes today, like Wimpy, I will pay you for a hamburger on
Tuesday if I can have it today, what happens; and what we have
seen in the 5 years since the Republican revolution is that
even a Republican majority is not willing to make these kinds
of cuts in the budget.
Mr. Penner. As I explained in my complete testimony, the
typical plan of this type lowers the growth of benefits very
slowly, and on the other side you have an abrupt fall in tax
revenues because they are conveyed to individual accounts. So
all such plans substantially reduce the surplus in the short
run. That reduction in the surplus tends to grow with most of
these plans over time. I think with Kolbe-Stenholm it reaches a
peak about 2012 and then eventually the cut in benefits catches
up, and ultimately the plan is beneficial to the unified budget
surplus in the very long run.
Now, if, in fact, our projections are far too optimistic,
these plans can cause actual deficits in the future. At that
time the Congress should ask itself, is this deficit
permissible or should we do something to prevent it? You don't
have to decide that now. Some deficit may be considered
permissible because that is just a way of conveying some of the
transition cost to future generations. We are, after all,
relieving future generations of the burden of paying as high
benefits in the future as under current law.
So you might say it is a fair trade, but again, I don't
think the Congress has to decide that at this moment. They can
decide that depending on how the surplus and economic
conditions evolve in the long run.
Mr. John. If I understand your question correctly, what you
are asking is, if these overall budget surpluses fail to
appear, how does that affect these charts. The answer is that
it doesn't really affect them at all because these charts show
essentially a hole that has to be filled from some form of
resources in order to pay Social Security benefits under these
different scenarios. Now, if there is a budget surplus at that
point, then some of that budget surplus can be used to fill the
hole. If there is no budget surplus at that point, then
essentially either taxes go up or we have got to make other
spending cuts.
Ms. Rivers. Have you heard many people put that as part of
their proposal? I mean, has anybody said, we will use the
budget surplus, but of course, if there is a problem with the
budget surplus, we are going to raise your taxes or cut your
benefits?
Mr. John. I haven't heard it said explicitly, but the
simple fact is that this is true regardless of whether Congress
does nothing or whether it passes Kolbe-Stenholm or Mr. Smith's
plan or any of the others.
Ms. Rivers. Thank you, Mr. Chairman.
Chairman Smith. Thank you.
Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman.
A couple of questions, gentlemen. First, in evaluating the
cost of a transition, assuming we were to engage in one from
the current system to one that is more prefunded through a
system of savings accounts, would you evaluate--aside from the
politics of it, but looking at the economics of it, would you
suggest that there is an advantage to minimizing the present
value of the transition costs, and that rather than looking at
given years, year after year, of what that deficit may be--or
as you put it, the hole that needs to be filled with other
resources--that it is most useful to discount everything back
to a present value and to compare apples to apples by having
that tool available.
If so, then I guess my real question is, does it help to
divert more money sooner from, say, the payroll tax into
personal accounts to start the benefit from the greater returns
of investing in real economic assets; and while that may create
a greater shortfall in the earlier years, does that lead to a
lower total transition cost?
Mr. Beach. Yes. In my view, it does, and I think that that
is standard operating procedure in the private sector when you
are looking at large investments and payoffs down the line, to
size the problem up, begin quickly and move forward; and I
think that that would be a prudent move in this particular case
for yet another reason. This is not the major transition cost
this Congress is going to have to face and that--of course,
that major transition cost will be Medicare. It is there. The
insurance pool is adverse to big changes.
So Social Security, I think you need to look at all--give
me a discount factor, and we will come back to this table with
those calculations based on Social Security's own estimates,
and you can size it up at that point. Begin that process now. I
think the sooner you get it started, the better. The economy
will certainly benefit.
The earlier question about the economy is highly relevant
to your particular question. If the economy doesn't perform
based on the intermediate assumptions of SSA, but in fact below
that--and it would have to be a pretty poor economy to be below
the intermediate assumption--then the problem worsens, and it
worsens rapidly sooner rather than later.
If there is an economic benefit from reform that does rely
upon personal saving accounts, it will be able to realize that
as soon as we begin to see the benefit offsets for the first
retirees, and that should be in about 20-years, and that would
be a good thing to get started soon, yes.
Mr. Penner. I would agree that it is very useful to look at
the present value numbers on these things, but I would suggest
that under usual circumstances the choices you have to make are
more choices of political values as opposed to economics in
that regard.
Assuming the deficit or the surplus that evolves is not
really large relative to GDP, then you have a lot of choices,
and the more you borrow to fund the hole that David talked
about, the more you are passing this burden on to future
generations. So it is really a question of intergenerational
equity: How much do we do for those who aren't born yet and not
voting yet, and how much of a burden do we leave them?
Mr. Toomey. Thank you. One other question on a different
line. I am looking at the graphic presentation that you
provided us with. A question comes to mind, in particular if I
look at the way you have depicted the Archer-Shaw plan.
Am I correct in concluding from that graph that what you
are suggesting is that the Archer-Shaw plan essentially locks
in a permanent hole that has to be filled from sources outside
of Social Security? What I see is a graph that goes up and then
it iterates a bit but seems to sort of level off somewhere over
$200 billion. So is that a permanent deficit in the Social
Security system that that reform plan would create.
Mr. Beach. That is what Social Security has in fact
concluded. That line rises to about $200 billion a year and
that is what you were pointing to. In about 2050, under the
plan, you have a reduction in the payroll tax rate; so that
difference is not being replaced except through general funding
or through the debt instrument funding.
Mr. Penner. There is a bit of a problem with the analysis
here, and frankly, as an analyst, I am not sure how to solve
it. But many of the analyses of these various plans for the
purpose of computing people's future income assume that people
really increase their saving by whatever is mandated, or
sometimes by the amounts in voluntary accounts.
On the other hand, that increased saving is not allowed to
affect the future growth of the economy and the future growth
of income.
Now, there is a lot of uncertainty as to how you would do
that, but there is this basic logical inconsistency in the way
much of the analysis proceeds.
Mr. Toomey. Thank you very much.
Chairman Smith. Representative Clayton.
Mrs. Clayton. I am just wondering, as we look at the
transitional costs, should I assume that we could have some
efficiencies as they relate to savings, but in the public
policies some of the transitional costs could be amassed but
yet would come up later on? Let me give you an example.
If indeed, as I understood the gentleman from the Urban
Institute to say, in terms of our beneficiaries, if we change
the structure of our benefits, to see--one way of changing that
is to structure it in a way that we wouldn't cover the
disability, we would have that from another source, but at the
same time, it is conceivable not to structure a finance
resource for that would translate into a cost for Medicare and/
or Medicaid that would not be accounted for here.
In other words, there are some public purposes in society,
whether you fund it out of the payroll tax roll or fund it out
of another source, it is going to be funded one way or another.
And another one would be--I don't know if you said it, but
I have heard others say it--one way to look at the benefit
coverage is not to be so generous to widows and to dependent
children, so we would restructure this in such a way that it
wouldn't be as generous; but again, the transitional costs
could conceivably not anticipate the full costs until a
dependent became 18 years of age, or do very much like similar
retirement funds.
Could you speak to that? Could either of you or all of you
speak to all the public purposes which Social Security now is
providing in the transitional costs, because regardless of
which model we went to support, assuming we are going to either
do something with the source of income or the structure, am I
to assume that you have anticipated all of those public goods
that we are doing in your transitional costs?
Mr. Penner. Well, I was negligent, I guess, in writing my
testimony. I implicitly assumed that the disability system
would go on as it is defined in current law, but I must admit I
did not explicitly say that in my testimony.
Mrs. Clayton. I misunderstood you then.
Mr. Penner. But with regard to particular social problems
afflicting retirees, certainly old widows are among the poorest
members of society, and I think if we can solve the big-picture
problem, there would be a good reason to look at the
possibility of increasing the benefits of that subset of the
population.
In the Kolbe-Stenholm plan that I was involved in
developing, there is a special new benefit, a minimum benefit
equal to the poverty line for people who have worked 40 years.
The basic message I wanted to get at in my testimony is that
you have a lot of choices in how you design the rate of
reduction of benefits or how the payments to individual
accounts are designed. The President's and Kolbe-Stenholm plans
actually subsidize contributions to individual accounts. So if
you perceive social problems out there, I think intellectually
at least it is very easy to address them in a reform proposal.
Politically it might be more difficult, but I think there is a
potential solution to almost every problem.
Mrs. Clayton. I was just wondering whether your assumption
was in the transitional costs or in the restructuring?
Mr. Penner. In those remarks, I am combining the two
problems we face, transition and the actuarial deficit.
Mr. Beach. Right. The data displayed before you,
Congresswoman, is for the combined trust funds, Old-Age and
Survivors Insurance and Disability Insurance. So we are working
with 12.4 percent of the payroll tax and these numbers
represent the spending gap, the outgo gap between revenues and
expenditures associated with both programs. So this would be a
combined situation.
As you know from studying this problem, the Disability
Insurance trust fund is forecasted to have negative cash flows
sooner than the Old-Age and Survivors Insurance trust fund; and
also contained in these numbers are estimates by the actuaries
of what transfers will have to occur from Old-Age and Survivors
Insurance to Disability Insurance in order for that particular
fund to be paying out benefits when its assets are essentially
zero. So that is all contained in here, as well as the
preretirement survivors insurance program which is funded
through the Old-Age and Survivors Insurance program.
I point out to you that many of these plans do have
significant changes in benefits. One of the major common
elements, not in all plans but in many, is to adopt the rebased
CPI, which has you know through the Boskin Commission is
saying, has argued CPI has been too high for too long, let us
bring it down a point. That is part of Moynihan-Kerrey, the old
bill. That is part of the Senate bipartisan plan, Kolbe-
Stenholm.
In the Kasich plan, he in fact moves the balance-point
calculations which are important for figuring what that income
will be during retirement away from the average wage index,
which is growing at about a 4.4 percent rate to the CPI All
Workers Series, which is growing at a much lower rate, so he
has an implicit growth rate reduction in benefits, and that is
one of the ways he gets to his actuarial balance points.
In point of fact, personal retirement accounts, while they
are important to these plans, are only one of many of the
important details and they are making a transition to get away
from a negative actuarial balance of minus 2.07 percent to
something closer to the zero line that you see going across. So
I believe that Social Security has captured all of the related
Social Security programs in their analysis.
You have raise a fascinating point: What are the spillover
effects from Social Security reform to the non-Social Security
entitlement programs, which are part of the package of work
that Congress and the Federal Government does with older
Americans; and of course, a big one is Medicare. A less large
one is Medicaid for those who have reached retirement survivor
situations. Clearly, that has to be addressed in looking at the
full ramifications of reform.
Chairman Smith. I think we will have time for a second
round.
Mr. Herger.
Mr. Herger. Thank you.
Mr. Beach and perhaps anyone else who would like to
comment, regrettably it would seem that Congress many times
only makes changes when it has to, when we are confronted with
it immediately in front of us, as opposed to 15 years out, if
you will.
Mr. Beach, if you would make a comment, what is the
impact--you have already spoken on this somewhat, but maybe if
you would care to comment a little bit more--what is the impact
of choosing now versus over time, and should we put reforms in
place now that prepare Social Security for projected cash flow
deficits 15 years in the future or should we make incremental
changes to the system over time as they are needed?
Mr. Beach. Well, thank you very much for that question.
One thing I have learned over the last several years in
working on the Social Security reform agenda in the debates is
that this is very much a generational program. People who are
working today may not be saving for their retirement because of
their income status because Congress has said there will be a
viable Social Security retirement program for you in 30 years.
So their time horizon is their entire working life. If you are
a--well, take my family that grew up around Newton, Kansas. We
are all Lithuanian immigrants despite my name. He was a
foreigner who came into the family.
We were not in a position, Congressman, to save for our
retirement. We did, but we did it as a family, as a community.
We had a long time horizon.
What I am suggesting to you is this, that because of the
long time horizons that the covered workers have with respect
to their retirement, you should do this now to single people,
that, yes, you do need to supplement your retirement income;
or, yes, you do need to put, when you are 25, aside 2 percent
and let it grow and be prudent in your investment. That is a
key.
Can you make incremental changes along the way? Of course
you can and you will. There are certain things, though, that
you need to signal now so that workers who are 25 years of age
know that that is coming in 30 years or 40 years when they
retire.
Again, back to my original comment, the sooner you do that,
the better off your chances are of success. If we had made
changes in 1983 of the type that are envisioned in these plans
that we have before you, we would no doubt be holding a
different kind of hearing today, and I think we have the
evidence of other countries and the success with which they
have been able to fund much of their retirement overhang as a
guide here.
So I wish we had done that. I hope that you will be doing
this very soon for that reason.
Mr. Herger. I think that is a very good point. I believe
that even when Social Security was originally set up it was
never set up to be a complete, as I understand it, retirement.
Mr. Beach. You are right.
Mr. Herger. You have people who tend to look at it that
way, and perhaps Congress has oversold this.
Mr. Beach. In fact, Congressman, the original first
administrator of the Social Security system said that it is
only one of a three-legged stool, that you have private savings
or personal savings, that is one leg. You have something from
your place of work; I wish we all had that now, but that was
the second leg. And the third leg was Social Security. And he
also said, once Social Security crowds out either of the other
two legs, it is important to look at Social Security because it
is supplemental.
Now, we have grown Social Security since that time, and it
is a very large tax on low- and moderate-income households, and
it has got to work for them as a retirement program. That is
part of the mission here, not just to save the trust fund but
to save a retirement program for people that are totally
dependent on it.
Mr. Penner. I think Bill made a really important point, and
that is, it is so much better if you can give people advance
notice of a change in the rules. When the later normal
retirement age was phased in in the 1983 reforms, no one was
affected that was older than 45 at the time. It is too late now
to give that kind of notice. If I am correct, Mr. Chairman,
your plan doesn't affect anyone over 58, but that is older. We
had the luxury before of being able to give more notice, but
now you have to move more quickly. So next year is not too
early to do something about the problem.
Mr. Herger. Thank you.
Chairman Smith. Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Mr. Penner, your testimony, there are a new questions about
it. I appreciate your comments on page 6 regarding the
Feldstein and Archer-Shaw plans, which I read to say that
privatization, those plans aren't just privatization because
you call it that. It is just trying to privatize the system for
the sake of calling it privatization, but otherwise it doesn't
really do much.
Mr. Penner. I didn't mean to imply it didn't do much. It is
not done privately.
Mr. Bentsen. It doesn't seem to accomplish what the stated
goal is.
I do take issue, if I understood you correctly, that the
President is just debt financing because the question of how
future obligations would be paid will be determined at that
point in time, whether it is paid through existing revenues or
through further taxes; and what you are saying in your
testimony--you talk about the various carve-out plans, and in
one case you use the current surplus to finance the move toward
funding which, in effect, would be debt financing, as well, I
presume, because any use of an on-budget surplus has some
effect of possibly debt financing in the long run.
But more importantly, you make a comment that says the
choice of an approach will have distributional and other
consequences that are important, but the choice does not change
the fundamental nature of the transition problems to be
discussed at this hearing.
I know we are talking about transitional, and I think you
get into great detail or at least conceptual detail about how
you would deal with that, but what I am interested in is the
first part of that sentence. In going to a carve-out, can you,
for the benefit of the members of the panel, tell us what is
the trade-off, what are the distributional and other
consequences that exist, forgetting about, you know, holding
harmless those who are not affected by the transition, but the
retiree of the future that is under a carve-out? Because I
think that is an area where we have heard what the potential
upside is; we haven't heard what the potential downside is. And
there is skepticism among, I think, more Members than just
Democrats, but I think there is some skepticism that were this
to really happen and were this to really work, whose ox gets
gored or does everybody come out ahead?
And I am skeptical because I don't think there are plans
where everybody comes out ahead. That is sort of, you know, the
``free lunch'' theory. And so I would like, given your
expertise and experience on this, I would like to hear what you
have to say.
Mr. Penner. Well, first of all, differentiating the
President's plan from the plans that are mentioned explicitly
in my testimony, all of the plans I mentioned do real things to
benefits one way or the other. The President's plan does not.
With regard to the distributional implications of having a
carve-out versus an add-on, much of one's analyses of these
different plans depends on political as opposed to economic
forecasts. But if you think that you are not affecting future
tax and spending decisions by what you do, you will obviously
retire less debt immediately with the carve-out than if you had
some sort of add-on plan. So, from a distributional point of
view, you could say if that was the end of the analysis, the
carve-out puts more of the burden and sacrifice on future
generations, than would an add-on tax, say, to finance a funded
account.
Mr. Bentsen. Or not even an add-on, the chairman's
indulgence, but just current law, trying to maintain a current
benefit structure. Because you also say in your testimony, you
talk about the reform and actuarial balance are not necessarily
the same thing. So assuming you figure out a way to address
actuarial balance, absent reform, and it may not be possible,
but absent a change in the overall structure, what is the
distributional effect of that?
Mr. Penner. Well, just to finish my other point on carve
outs first, I think what seems so appealing about them right
now is political. I think it is a lot easier to have a reform
that lets consumption go on at recently experienced levels as
opposed to having a tax increase which actually makes people
lower their living standard.
So that is why the surplus presents a golden opportunity
but, of course, the lower the surplus, the more burden you are
passing onto the future.
Can you move to more funding and reform the system without
changing the benefit structure at all? It is theoretically
possible, but then you get to a question of values. Already
more than half of the non-interest, non-defense budget of the
United States goes to people over 65. So the question really is
how much of the Nation's resources do you want to continue to
convey to those people as opposed to conveying them to children
and defense and highways and all sorts of other things.
If you don't reform the structure, the proportion of the
Federal budget going to the elderly is just going to grow and
grow and grow. But deciding the proper portion is a value
judgment. Do you really want to spend that much resources
supporting people in longer and longer retirements, many of
those people being very affluent people? So that is the value
judgment you have to make. Sure you can do it without reforming
benefits, but it means a big burden on the taxpayer in the
future.
Chairman Smith. The gentleman's time has expired. Mr.
Collins.
Mr. Collins. Mr. Greenspan testified before the Ways and
Means Committee several months ago that in order to address the
Social Security situation, the current pay as you go system
should be ending. In your review of plans that have been
proposed, does any plan or, if so, which plan or plans will
actually terminate the pay as you go system as we know it
today?
Mr. Beach. Congressman, none of the plans we have before
you eliminate the pay as you go system in its entirety. I would
suggest that perhaps Senator Gramm's plan comes closest because
of the higher personal account percentage that you can put
aside. But then again, all of these plans take a portion of the
payroll tax and use that for retirement. The remaining portion
is still pay as you go. It still supports the system as it
currently is structured.
What they are trying to do--just close on this--what they
are trying to do is fill a hole. It is not the hole that David
referred to. It is a demographic hole. As you know, Social
Security is based on pay as you go so it is based on workers.
Those workers are going to be fewer in number relative to
retirees in the future than they are today. That is a
certainty, unless, of course, we have some miraculous thing
hatch.
Mr. Penner. There are plans like the Cato Institute's plan
that I believe has been put into legislation by Congressman
Porter that really do scrap the current system entirely. But
even those very radical plans typically keep a minimum benefit
of some sort that is financed on a pay as you go basis.
Mr. Collins. What you are saying is that there will be a
social insurance program of some type that will exist for those
who some way fall through the traps.
Mr. Penner. I think, in my judgment and most peoples', it
is not politically plausible to think that something as radical
as the Cato Institute has proposed can pass.
Mr. Beach. We have made a commitment that is not likely to
be repudiated in the absence of complete economic chaos toward
a social insurance system on many fronts. So at the Heritage
Foundation while we don't have a plan yet that we are promoting
as the Heritage plan, we nevertheless have five principles. One
of those principles, I think principle number three, is that we
have a two-tiered system, one tier made up of personal accounts
and the second tier made up of this safety net. And a
substantial safety net it will be in order to replace the
demographic hole that is out there and maintain some kind of a
minimum floor that everybody will have access to, no matter
what their condition.
Mr. Collins. Thank you. That is all I have,
Mr. Chairman.
Chairman Smith. We will briefly entertain a second round of
questions which gives me the opportunity for a couple more. In
coming up with a solution now that would keep Social Security
solvent forever, there is some question on whether we should
try to address the problems of reaching 75 years and the
problems we face after 75 years. Maybe each one of you can give
me your comments and evaluations of solving part of the problem
and moving toward a solution in incremental steps as we proceed
into a future where there is less money coming in than is
needed to pay Social Security benefits estimated around 2014.
Coming up with a total plan now versus incremental changes. Any
comments?
Start with you, Mr. Penner.
Mr. Penner. I think that it would be highly preferable to
come up with a comprehensive plan now for the reason we have
already discussed. Then people will know what the rules are in
the future. After all, retirement planning is a matter of 20 or
30 years for most people. And it would be good to have the
rules stable so you aren't always tweaking them incrementally
and forcing everybody to adjust to new rules all the time.
Chairman Smith. Bill.
Mr. Beach. I will defer to David.
Chairman Smith. David.
Mr. John. Actually also to address one of the points Mr.
Collins raised, the one problem that you face with a wholesale
restructuring of Social Security--a complete replacement of the
pay-as-you-go system--is that you have a huge Social Security
deficit that hits almost immediately. And while it does end
sooner rather than later because the individual accounts build
up fairly quickly, there will be a 20- or 30-year period with
monster deficits.
As far as what is to be done, realistically, Congress could
pass probably a 2, 3, or 4 percent account individual account.
Preferably from our point of view, a carve-out from the
existing tax would be the way to go. We also agree that the
sooner that that is done, the easier the transition is going to
be. Although under no circumstances is it going to be an easy
situation.
There is also going to be a fair amount of education that
is going to have to be undertaken before people can take
responsibility for investing a certain amount of their Social
Security money. And that is something that is also going to
take time. Realistically, if we could start to put something in
the schools at a fairly early date to teach people how to
invest, that would be a very fine move to start out with.
Also, it is going to take a fair amount of time to develop
the infrastructure whether we have an individual account that
is run on a TSP model or an individual account where you
basically go out and choose your provider. But no matter what,
there is going to be a fairly healthy infrastructure that will
have to be built. And it is something that doesn't really exist
now, although it is certainly not impossible to develop. The
sooner that Congress starts to lay down the marker and indicate
which direction it is going to go, the sooner we will be able
to work out details on that kind of plan.
Chairman Smith. Representative Rivers, did you have
additional questions?
Ms. Rivers. Thank you. On page 8 of your testimony from the
Heritage Foundation, the last paragraph gives numbers regarding
annual deficits under the various systems for the year 2030. Is
there an assumption within these numbers that none of the
bonds, none of the treasury bonds will be redeemed?
Mr. John. No, as a matter of fact what we are pointing out
here and the reason that we chose 2030 was that that is within
the time that the trust fund is being redeemed to pay benefits.
The question comes how much money is going to have to be used
to retire those bonds. Now, those bonds, as was mentioned in
the paragraph from the OMB, President Clinton's----
Ms. Rivers. So what you are presenting is you are
presenting the debt owed in the form of the Treasury bonds as a
deficit on the system.
Mr. John. Yes. Because the thing is money is going to have
to come in from outside the system, from outside the payroll
tax in order to repay the bonds in the trust fund.
Ms. Rivers. Okay. Which leads me to my second question, I
will add, I asked questions earlier about the on-budget surplus
and my concerns about the fact that it is predicated on real
cuts in the budget, 20 percent in discretionary spending
including defense. Given that, given that we have a Federal
debt approaching 6 trillion and we have Medicare problems, that
we have Social Security problems here, how much harder are
these tasks going to be to address if we give a substantial tax
cut at the current time?
Mr. Beach. We made the point Congresswoman, that these
numbers we presented today are based on various assumptions,
demographic assumptions, economic growth assumptions and so
forth, so that is one of the realities that we have to face.
Tax cuts are important for reasons beyond Social Security, some
would argue, and I would argue, that they are good for the
economy, that there is a level of tax cuts which is important
for economic purposes, equity purposes. We have----
Ms. Rivers. I understand the reasons for it. My question is
did it make the job easier or harder to deal with Social
Security and our existing obligations if we give a tax cut
right now?
Mr. Beach. No, I think that you can separate the two one
from another now. Now, you can't do that 10 years from now.
Because 10 years from now this problem is a much worse problem
than it is now.
Ms. Rivers. But 10 years from now, tax cuts--if they are
predicated on cuts that never exist, that never happen, don't
we have an even worse problem not just with Social Security but
with everything else that we are dealing with?
Mr. Beach. No, I don't think so. I think if you have the
kinds of tax cuts that a number of people across the spectrum
are recommending, the capital gains, and on second earner bias,
that you have a bigger economy, you have more jobs and have you
a bigger tax base. And that is part of the policy judgment you
have to bring to this issue.
Ms. Rivers. I didn't bring this today for this reason, I
brought it because I am looking for something else. But I have
read this about four or five times. It is David Stockman's
book. He tells us that what happened in 1981 is that a tax cut
was predicated on the idea that the budget was going to be cut.
The budget cuts never materialized. There was a hope that a tax
decrease would, in fact, increase economic activity just like
what you are talking about. And, in fact, none of those things
happened, and we moved into the largest period of deficit
spending that we have experienced as a Nation.
And my question, and I really want to address this in terms
of problem solving, is we have some huge tasks in front of us,
some real heavy lifting economically. We have to deal with
redeeming the bonds and, as you say, the money has to come from
somewhere. We have to deal with restructuring Social Security,
we have to deal with Medicare. We are basing a surplus
projection on cuts that this body has not been willing to make
in the past.
How reasonable, how responsible--you are from the midwest,
you are from Kansas, I am from Michigan, my training says to
me, my upbringing says you don't spend money you don't have.
You don't spend the same dollar twice. How reasonable is it to
talk about doing all of these things with the same budget
surplus?
Mr. Beach. And my training also tells me that there is not
a government program on the face of the earth that can't be
made more efficient and better for the people that it is
supposed to serve. Now, Social Security is a--as a retirement
program has got to be fixed. It just has to be fixed. And by
fixing it now, and then doing things to grow your tax base at
the same time, you may be able to avoid major financial
problems 2020 to 2050 period that are stemming from other
things besides the issues that we are talking about today. We
have $22 trillion worth of anticipated revenues over the next
10 years, counting Social Security revenues. We are talking
about tax cuts between 300 billion and 800 billion over that
time period that should be directed to help this problem and
not hinder it.
Ms. Rivers. With the Chair's indulgence I would like Mr.
Penner to speak to it then I will finish.
Mr. Penner. I tend to agree with you, Congresswoman. I
don't think this is the time for tax cuts. I wouldn't say that
were it not for the huge demographic problem that we face
starting around 2010. But I would like to get the debt, the GDP
ratio down a lot lower than it is today before I started
talking about tax cuts. Especially tax cuts that would be
promised for the year 2003 or so. There is just no reason to
have to do that.
If the Congress follows its goal of trying to keep the
unified budget surplus at least as large as the Social Security
surplus with some kind of lockbox proposal, there is no room
for tax cuts in the next few years even if you abide by the
spending caps, which almost certainly you won't. I don't
disagree with Bill that we could probably all go into a room
together and find enormous amount of government waste that we
could cut out.
Ms. Rivers. But we all go into a room together, and we
can't come up with things that can be cut, Congress.
Chairman Smith. And that is our experience. Our experience
is that government tends to grow. Right now taxes as a
percentage of GDP are at the highest point they have ever been
at in peacetime. And we have already got many proposals out
there suggesting that we spend some of the surplus for other
government programs that are so much needed. And so the
argument is: should we get this money out of town to the extent
that a surplus is another way of defining overtaxation. Is it
reasonable at this time, to give some of that money back to the
individuals that earn it? Can we do it in such a way that is
going to be conducive to an expanded economy and a growing
economy? That ultimately is going to be the solution.
If we simply take a larger piece of a smaller economic pie
that might exist 30 years from now, and say these are our
Social Security benefits, the system will shortchange younger
workers. It is better for our retirees if we take the kind of
actions that are necessary to expand the economy and enlarge
the economic pie when they retire.
And did you have a statement, Mac, that you want to close
on? Then I will ask each one of these individuals to summarize
for a couple minutes if they would like to.
Mr. Collins. Well, Mr. Chairman, we talk about spending and
talk about tax relief here for working folks around this
country. You know, the budget resolution that the Congress
passed was a resolution, it was the work of the Congress. It
was a blueprint laid out by the Congress, no other branch of
government was involved, just the Congress.
Now, if Members of Congress will follow the philosophy that
our dear colleague on my left has just stated, then we will be
able to follow through with that blueprint, that resolution,
that will control spending, much different than is reported by
Mr. Stockman's writing in his book of 1981. And in doing so,
then we have fallen through with managing the people's
business. And we will be able then to also pass and give tax
relief to working people to leave more of their income to them,
and they will spend it. And when people spend money, that has a
tendency to increase and enhance the economy.
There are also some provisions in this tax proposal that
Mr. Archer released just this morning that encourage divesting
of assets and then reinvesting. And why is that important? It
is important because--and I like to refer to a story of when I
was campaigning in 1992, I walked in a little, small TV rental
shop in Barnesville, GA, and the shop itself was about a third
the size of this room. One lady was working in there. And I
told her who I was and what I was doing. She says I want to
talk to you about taxes. I said--I was a candidate; I would
talk to her about anything.
She says I got this little piece of property out here at
the edge of town that I could have sold three times. But I
haven't sold it, and I am not going to sell it because I don't
want to give a large part of the money to the government. I
said, lady you are talking about capital gains. She says I
don't know what you call it, she just said I know if I sell my
property I have to give a lot of it to the government, and I am
not going to do that.
Well, the gist of the story is this, she didn't sell that
property. When she didn't sell that property, there were no
profits made, no tax liability at all generated. So the Federal
Government got no tax from it. The local system, the local
government there got no money because there was no transfer tax
on it, neither did the State recoup any kind of income tax
because there was no sale, no tax liability.
So there are provisions of tax relief that can enhance the
economy and grow the economy and help the situation that we
face by creating more jobs and creating more revenue. And as we
sit around, it is as 430 people on this end of the hall, 100 on
the other end trying to make these decisions about how we are
going to manage the people's money, the people's business, how
we are going to by law force them to pay a portion of their
income, they are sitting around a hundred million plus kitchen
tables in this country trying to figure out their budget based
on their income and the deductions from their income and the
needs for the balance of that income that is left and how they
are going to provide for their family.
So I think we can follow suit, and we can do exactly what
we laid out in the resolution. And then once we do that, we
send it down to the other end of the street. Then we bring into
play the executive branch. And this executive branch then has
the opportunity to either agree or disagree with what the
legislative branch has done, and that is the work of the
people's business.
Thank you, Mr. Chairman.
Chairman Smith. Mr. Herger.
Mr. Herger. Well, I want to thank the Chairman for having
this hearing. I want to thank each of you for being here. I
want to say that I sit on the same committee that my colleague
Mr. Mac Collins serves on, the Ways and Means, tax writing
committee. I don't know how anyone could say it more eloquently
than he just said.
The fact is we are being taxed at the highest rate in
peacetime history. When we allow working people to be able to
keep more of their money, and we have done that several times
under the Kennedy administration, under the Reagan
administration, again a few years ago, I believe we have found
out conclusively that very, very, very few people take that
extra money and go bury it in the back yard. They go, and they
pay off debts. They purchase things that they weren't able to
before. And the multiplier effect, we end up having more than
we did before, be able to take care of Social Security,
particularly at the high rate we are being taxed now.
So I really can't add anything to that. I think it says it
very well, the example he gave. I believe we could give a
hundred other examples in other areas as well. So, again, this
Social Security is an issue that we can't wait 15 years to take
care of. It is something that we have to begin taking care of
right now. And whether it be the thinking that those who are
receiving it have or whether it be those of us as elected
officials, we have to make the tough decision now, and it is a
decision we have to make on a bipartisan basis. It is a
decision we have to make, Senate, House, the President.
I am more encouraged now than I was before, it sounds like
perhaps the President is moving more and more this way and
others. And I believe probably only through the pressure of the
American public are we going to do something. But I believe it
is something we have to do right away. And again, Mr. Chairman,
I understand this is the last of the hearings. I want to thank
you for what I feel are very, very productive hearings. And I
want to thank each of our participants for contributing. Thank
you.
Chairman Smith. And in summary, Mr. Herger, the Task Force
decided earlier that we are going to recess today at the call
of the Chair. A business meeting is tentatively scheduled for 1
p.m. this coming Thursday or at another time that will be
appropriately announced. Any statements that individuals would
like to have included in the Task Force report should be in by
the 30th of this month. And the minority and majority
statements likewise. And I would like to ask each of the
witnesses today if they would have a concluding statement.
Mr. Penner. Well, Mr. Chairman, I think all the important
points have been made. But maybe the one that needs repeating
is that this, combined with the Medicare problem, is the most
important fiscal problem facing the Nation. It would be so much
easier if we acted earlier rather than waiting until later. So
I urge you on.
Mr. Beach. About a year ago I was in south-central LA
addressing a congregation of African and Methodist Episcopal
ministers and church leaders on Social Security. Social
Security reform for them is a problem of capital in their
community. We toured the area several times Crenshaw, south-
central LA, the place where Reginald Denny was pulled from the
truck. The problem that these people have really isn't the
glass sealing of civil rights. Congress, the President, the
courts have provided the tools necessary to fight the civil
rights problems, plenty of racism left in this country. The
problem is the sticky floor of economic opportunity.
We need to find ways of using Social Security, the main way
people say save for their retirement in those communities, to
build capital in those communities through personal savings
accounts. That is doing something inside Social Security. If
you could do that, the economic benefits would be rather
immediate, tangible in exactly the places where they need to
be. So I urge this Congress to keep one thing in mind as you go
forward, as Dr. Penner has said repeatedly, solving the trust
fund problem is a couple of handles moved here and there and
little bit of paint and basically you have got something done.
Generational effects are going to be important.
The real objective here should be solving the retirement
program for low and moderate income Americans, restructuring,
changing that program to make it work for them.
Chairman Smith. David.
Mr. John. I have a 13-year-old daughter who is going to be
retiring, with luck, about 2050 or so. If this Congress, or if
the next Congress acts, she basically could be retiring at a
time when the Social Security or deficit, is somewhere between
$25 billion and maybe $8 billion. If you do nothing, the
deficit is going to be $342 billion. Now what is that going to
mean to her quality of life and the quality of life my
grandchildren and, with luck, my great grandchildren?
Basically if you act now and if you act responsibly, and if
you bite the bullet, there can be some sort of a reform that
will make a tremendous amount of difference not just in terms
of an operating deficit but in terms of the quality of life
that she will face. As Bill was saying, allowing all Americans
to participate in the economy through some sort of an
individual retirement account gives people an opportunity that
they never had. This is possibly the most important decision
that is going to be facing this Congress or the next one.
Chairman Smith. Well, again I thank each one of you for all
the work that you have contributed to this effort. The Chairman
handed out 14 potential findings that should be considered for
Social Security changes. And without objection, those suggested
findings will be included in the record. And with that, this
Task Force is recessed for next Thursday at 1 or at the call of
the Chair.
[The information referred to follows:]
Budget Committee Social Security Task Force 14 Findings We Might Be
Able to Agree On
1. The current demographic projections may very well underestimate
future life expectancy.
2. Investment in the capital markets is an important part of
restoring Social Security 's solvency.
3. The investments should be limited strictly for retirement.
4. Guaranteed return securities and annuities can be used with
personal accounts to ensure an investment safety net.
5. Social Security reform should encourage savings and overall
economic growth.
6. Congress should consider paying for a portion of disability
benefits for workers who have been in the system a short time out of
the general fund.
7. Private or other capital investments can be managed to minimize
administrative costs to avoid substantial reductions rates of return on
investment.
8. We can learn from the experiences of other countries to more
effectively develop Social Security reforms.
9. Any reform must consider the effects on all generations of
workers and retirees.
10. The Social Security Trust Fund is a legal entity, but only
becomes a financial asset when General Fund provides actual funding.
11. Time is the enemy of Social Security reform and we should move
without delay.
12. Change should be gradual to allow workers to adjust their
retirement plans and any change for current or near-term retirees
should be minimal.
13. No payroll tax increase.
14. Social Security surpluses should only be spent for Social
Security.
Prepared Statement of Hon. Kenneth F. Bentsen, Jr., a Representative in
Congress From the State of Texas
Mr. Chairman, I want to start by thanking you for your leadership
on this panel and for holding these hearings. They have been, if
anything, informative and insightful. I personally have learned more
about Social Security, its successes, its problems, and potential
solutions to achieve solvency.
I would like to spend the next few minutes laying out what I think
are some key principles that all of us can take away from this Task
Force.
First, I sensed that there is widespread agreement on the need to
keep the Disability Insurance and Survivors' Insurance programs intact.
If government should do anything at all, it should help those who
cannot help themselves and protect widows and their children from
poverty. No private insurance program would assume the disabled or
those unable to work--children--as beneficiaries. They represent a
perfect example of the problem of adverse selection. The Disability
Insurance and Survivors' Insurance program is a sound safety net that
should be maintained in its present form.
Second, it is also clear that Social Security is the most
successful social program of the 20th Century. It, along with Medicare,
has brought the poverty rate among our senior citizens down to 13
percent from almost 50 percent before its inception. That in and of
itself is a tremendous accomplishment.
In spite of the program's achievements, it is also clear what is
broken. The current program is fiscally unsustainable. Social Security
is a pay-as-you go system where payroll taxes on current workers and
their employers fund current beneficiaries. The basic problem is this:
Social Security in its current form requires that the number of workers
and the economy's payroll tax base expand faster than the number of
beneficiaries and the size of their benefits. But demographic and
economic trends have made this virtually impossible.
In about 10 years, 76 million baby boomers will begin to retire,
and they are expected to live longer than their parents. The number of
Social Security beneficiaries will double over the next four decades.
Let me repeat that. The number of beneficiaries will double over the
next four decades. At the same time, the number of workers will grow by
only 17 percent. In 1950, there were forty workers for every retiree.
In 1997, there were only 3.3 workers for each retiree. And that ratio
is expected to fall to two to one in 2020. Under these conditions we
cannot maintain current benefit levels with this kind of retirement
boom.
So a proportionately smaller pool of workers--primarily younger
workers and employers who pay the 12.5 percent payroll tax--will have
to support a larger pool of retirees. Payroll contributions will only
be able to cover 75 cents on the dollar of current benefits after 2055.
The big question is how do we make up those 25 cents on the dollar or 2
percent of payroll?
Yet, this Task Force and the Congress should work to pierce the
myth that the Trust Fund is an accounting fiction. Indeed, it is not.
The Treasury Bonds invested in the Trust Fund are backed by the full
faith and credit of the United States Government. The United States has
never defaulted on its debt. In fact, Alexander Hamilton made debt
repayment a significant part of his agenda as our nation's first
Treasury Secretary. Since then, this nation has not backed down from
debt repayment. To do so is unthinkable and irresponsible.
The problem with the Trust Fund is that while the dollars deposited
in the fund are to be spent on general operations, they are credited to
the Trust Fund and spent on general operations. Then, this increases in
annual obligations ultimately increases debt and results in
macroeconomic consequences in the future as total per capita debt grows
and must be repaid. This puts additional pressure on fiscal policy. But
while this practice has consequences for the general economic well-
being of the U.S., it should be strongly noted that no obligation to
the Social Security Trust Fund has been diminished.
Third, there are some credible plans that exist. Mr. Stenholm and
Mr. Kolbe's plan, while I do not agree with all of its features, it is
honest in that it meets fiscal considerations, such as transition costs
and balanced budgeting. It also says there is no free lunch. Mr.
Kasich's plan too is rather straightforward, although I may not agree
with everything that is in there. Other plans, such as Mr. Archer's and
Mr. Shaw's, show how difficult it is for a plan to be driven by
ideology. Their plan does not differ much from the President's in the
near term because all they do is commit future general revenues to the
Social Security Trust Fund. Even worse, some have appeared before this
Task Force with plans that promise ever lasting economic growth and
higher than average returns on equity investments. While investments in
equities have generated higher returns on average when compared with T-
bills, there have been some periods of time when there have been
negative returns. Seven times in the 1970's and 1980's the real value
of the S&P 500 was at least 40 percent below what it had been in the
previous 10 years. What is really a tragedy is when private interest
groups put forth plans without saying how they are going to pay for
them and do not take into account transition costs. Those plans are
just not credible.
Finally, I want to emphasize again what Mr. Greenspan said
privately to the Task Force. He favors a more privatized system or, at
least, if I can read into what he said, individual accounts, because he
is a conservative. He believes the value of placing a greater burden on
an individual to save for his or her retirement makes for a better
society; it does not necessarily make for a better retirement program.
In fact, a private system does not have to be pre-funded and can have
the same liabilities as our current system. Just because a system is
privatized does not mean that it will not have the same liabilities as
a pay-as-you-go system. Solvency is not the same as reform and just
because a system is reformed does not mean that it is solvent. His
preference for a private system is based, in large part, on
macroeconomic theory and he clearly stated that a system of private
accounts is no more solvent or sustainable if the current the current
public system.
For example, a privatized but unfunded pension system has recently
been established in Latvia, where payroll taxes are collected by the
government, which then credits workers' so-called ``notional'' accounts
with paper returns on contributions. Singapore, on the other hand, has
a public retirement benefit that is pre-funded where the central
government collects taxes sufficient to generate substantial assets,
which it then invests on the systems behalf.\1\
---------------------------------------------------------------------------
\1\ This paragraph is extrapolated from a paper by John
Geanakoplos, Olivia S. Mitchell, and Stephen P. Zeldes. ``Would A
Privatized Social Security System Really Pay a Higher Rate of Return?''
(Latest draft, August 3, 1998).
---------------------------------------------------------------------------
The bottom line is that a plan to extend the solvency of the system
is needed and such a plan should be enacted sooner rather than later.
Solvency may include, but does not have to include, radical overhaul of
the current system. Any system should maintain the basic
characteristics of the existing system with respect to the principles
of universality and progressivity. And, any reform plan, must indicate
upfront how it is paid for and on whom the burden falls. Mr. Chairman,
our work is cut out for us. There are hard decisions that have to be
made and I hope we can do this in a bipartisan, constructive manner.
Thank you.
Prepared Statement of Hon. Eva M. Clayton, a Representative in Congress
From the State of North Carolina
Mr. Chairman, preserving Social Security is one of the most
important issues that we face today. We finally have a balanced budget
which gives us an opportunity to save and strengthen Social Security.
It is the obligation of this Congress to protect the financial security
and promised benefits that so many of this nation's retirees are
depending on when they retire within the next 10 to 15 years.
Additionally, it is through Social Security that we must ensure the
economic future for our children and grandchildren.
Social Security has been one of the country's most successful
social programs. It is largely responsible for the dramatic reduction
in poverty among elderly people. Half of the population aged 65 and
older would be living in poverty if it were not for Social Security and
other government programs. Social Security alone lifted over 11 million
seniors out of poverty in 1997, reducing the elderly poverty rate from
about 48 percent to about 12 percent. Social Security has become more
effective in reducing poverty over time.
Strategies for saving Social Security for future generations is
probably the most significant debate facing us. We want to make sure
that the future of Social Security is secure for our children and
grandchildren, but we also want to protect the financial security and
promised benefits of retirees. It is important for Congress to remember
that while Social Security was not designed as a retirement program,
many Americans have paid into the system in good faith and feel
justified in relying on these benefits to survive in their retirement
years.
The Social Security system is projected to have long-range funding
problems. Therefore, we must find a way to reform this system. The
House Budget Committee Social Security Task Force was formed with the
intent to look at the various reform proposals, problems that different
generations and genders have, and possible solutions to these problems.
We have held hearings, and as a result, have defined eighteen
bipartisan statement findings.
Mr. Chairman, one particular area that I would like to focus on is
consideration of the effects reform will have on all generations,
genders, and minorities. Social Security is particularly important to
people of color. Elderly African Americans and Hispanic Americans rely
on Social Security benefits more than white elders rely on the program.
Social Security benefits make up 43 percent of the income received by
elderly African American people and their spouses and 41 percent of
income received by elderly Hispanic Americans, compared to 36 percent
of the income of elderly whites.
Social Security is also an important source of income for women.
The program made up 61 percent of the total income received by elderly
women in 1997 and it was the only source of income for one out of five
elderly women. Women have fewer resources to draw upon in their older
years than do men. Only 30 percent of women 65 and older had pension
coverage in 1994 while 48 percent of men were covered.
While Social Security is intended to be only one source for
retirement income, the lack of pension coverage and limited resources
for savings places greater weight on Social Security as a reliable,
guaranteed source of income for minorities.
Mr. Chairman, thank you for holding these hearings since ensuring
that Social Security remains intact is so important to the livelihood
of many people. The questions and problems surrounding Social Security,
as well as the impact on every U.S. citizen, certainly justifies a
close examination by Members of Congress.
Prepared Statement of Hon. Rush D. Holt, a Representative in Congress
From the State of New Jersey
Mr. Chairman, it has been a pleasure to serve with you and other
members of the Social Security Task Force throughout the past several
months. Preparing for the retirement of the baby boom generation looms
as one of our nation's most difficult challenges, and I commend the
efforts being made here to develop a long-term solution.
Social Security--the nation's largest and most successful domestic
program--has reached a critical juncture in its development. When
Social Security was passed, to be old was usually to be destitute--
Social Security changed that. People in the U.S. believe it is a
fundamental value to help workers save for retirement.
As its creators anticipated, nearly every wage earner now pays
taxes into the system. In principle, all citizens may be eligible for
entitlements at some point in their lives. Yet senior citizens worry
that their benefits will be cut; younger Americans are skeptical about
their own benefits upon retirement.
If the government were to do absolutely nothing to Social Security,
the Social Security Trust Fund would still be solvent for about 35 more
years. There is no immediate Social Security crisis. But because the
issue concerns every American, it is critical that the debate on Social
Security reform be based on a deep understanding of the economic and
social underpinnings of the system. This Task Force has augmented my
personal learning process and for that I am appreciative.
Although the Social Security system is now running surpluses, its
board of trustees projects that its trust funds will be depleted in
2034 and only 71 percent of its benefits will then be payable with
incoming receipts. The trustees project that, on average, over the next
75 years, the system's cost will be 15 percent higher than its income;
by 2075 it would be 49 percent higher. The primary reason is
demographic: the post-World War II baby boomers will begin retiring in
a decade and life expectancy is rising. By 2025, the number of people
age 65 and older is predicted to grow by 75 percent. In contrast, the
number of workers supporting the system is expected to grow by only 13
percent. As a result, the ratio of workers to recipients is expected to
fall from 3.4 to 1 today to 2.0 to 1 in 2035.
Trustees project that the surplus Social Security taxes now being
collected will cause the Social Security Trust Funds--comprised
exclusively of Federal bonds--to grow to a peak of $4.5 trillion in
2021. The system's outgo would thereafter exceed its income and the
trust funds would fall until their depletion. However, the trustees
also project that the system's taxes (ignoring interest income) would
fall below its outgo in 2014. Interest paid to the funds is simply an
exchange of credits among government accounts. It is not a resource for
the government--only the system's taxes are. Hence, it is in 2014 that
other Federal receipts would be needed to help pay for benefits. If
there are no other receipts, we would have three primary options: raise
taxes, cut spending, or borrow the needed money.
Public opinion polls show that fewer than 50 percent of Americans
are confident that Social Security can meet its long-range commitments.
We have also heard testimony that Social Security may not be as good a
value in the future as it is for today's retirees. These concerns and a
belief that the remedy lies partly in increasing national savings have
led to proposals to completely revamp the system.
Some witnesses suggest that the system's problems are not as
serious as sometimes portrayed. They argued that the system is now
running surpluses, that the public still values the program, and that
there is risk in some of the new reform ideas. They contend that only
modest changes are necessary.
In our Social Security Task Force, we have considered ideas ranging
from restoring solvency with minimal alterations to totally replacing
the system with something modeled after IRAs or 401(k)s.
I agree with the Committee for Economic Development that there are
three primary goals for reform that address the central problems of
Social Security--fiscal imbalance, declining returns, and the resulting
loss of confidence among young workers. When crafting solutions to
achieve basic reforms, we must keep in mind the key principles of
restoring the system's solvency, preserving Social Security as a safety
net, reducing inequities in the system, and raising the national saving
rate.
We Americans have made Social Security one of our most useful and
basic commitments to younger and future generations. We cannot let the
Social Security system slide toward insolvency and allowing confidence
in the system to erode, especially among young workers. To do so would
undermine one of the most successful and important programs of the 20th
Century.
The nation can--and should--keep its commitment to future workers
as well as to today's retirees. Social Security provides reliable
income that is critical to millions of retirees in this country; it is
the primary means of cash support for nearly all retired low-income
workers. To abandon Social Security would be to cast millions of future
retirees adrift to fend for themselves. Sensible reforms, building on
existing structures and drawing on the productive power of this
country's private economy, can ensure a healthy Social Security system
for America.
But the nation must act promptly. Delay is unwise and dangerous. It
will raise the cost of reform and is unfair to future generations. The
most compelling reason to act soon, however, is to reverse the alarming
erosion in popular support for Social Security, especially among
younger workers.
It is well within the resources of our country to provide support
for our retirees and other who receive payments under disability. It is
no secret that at this time, our nation is enjoying a budget surplus. I
believe that every penny of the entire budget surplus, not just the
Social Security surplus, should be saved until legislation is enacted
to strengthen and protect Social Security first.
Spending any projected budget surpluses before protecting and
strengthening Social Security would be wrong. Projected budget
surpluses over the next decade offer a once-in-a-lifetime opportunity
for addressing the challenges that Social Security faces. This hard-won
achievement resulted from responsible steps that were taken in the
past. We should not deviate from the path of responsibility now, with
problems looming over the horizon for Social Security.
Mr. Chairman, Social Security is the most important and successful
program of the 20th Century. We must not forget that it provides
vitally important protections for American seniors. A majority of
workers have no pension coverage other than Social Security, and more
than three fifths of seniors receive most of their income from Social
Security.
Let's put the need of America's current and future retirees first.
Thank you.
Prepared Statement of Hon. Paul Ryan, a Representative in Congress From
the State of Wisconsin
I want to take this opportunity to provide my conclusions on the
work of this Task Force in the past few months and congratulate the
Chairman of the House Budget Committee Social Security Task Force, Mr.
Nick Smith, for his leadership on Social Security and this special Task
Force. The hearings we held have provided a good opportunity to
facilitate the dialogue on both sides of the aisle. The bottom line for
Social Security, however, is that Social Security cannot and will not
survive in its current form. It faces the grave reality of insolvency
within the next few years if we do nothing.
On the other hand Congress and this Administration now have the
opportunity to address this pending insolvency. One of my highest
priorities in Congress is Social Security. There are many important
steps that need to be met in order to, first, protect the Social
Security Trust Fund, and second, improve Social Security for current
retirees and future generations. In addition, before any changes are
made to Social Security, I believe it is important to guarantee current
benefits to current and future beneficiaries.
First, to guarantee these benefits, earlier this year, I introduced
the Social Security Guarantee Initiative, H.J.Res. 32, which would
guarantee benefits to current and future retirees as we work to improve
Social Security. It passed overwhelmingly in the House. This needs to
be a fundamental ingredient to any initiative to save Social Security.
Second, I introduced and cosponsored Social Security ``Lock box''
legislation which would change the rules of the House of
Representatives to help us stop Congress from passing legislation that
dips into Social Security. For years, the Federal Government has been
taking money from the Social Security Trust Fund to pay for no-related
government programs.
In addition, I, along with the Chairman of the House Budget
Committee, Congressman John Kasich, have introduced the Social Security
Surplus Preservation and Debt Reduction Act, H.R. 1803, which would
establish a new enforceable limit on the amount of debt held by the
public. The debt ceiling would be reduced as the debt is paid off. A
point of order would lie against any legislation, in the House or the
Senate, which would increase the public debt limit or provide borrowing
authority that exceeds the debt held by the public.
Finally, I am still in the process of evaluating each Social
Security reform proposal. I have heard from many of my constituents in
the District and will be looking very carefully to see whether each
proposal would:
<bullet> Increase the rate of return for payroll taxes paid into
the Social Security Trust Fund.
<bullet> Not increase the Federal Government's role in Social
Security.
<bullet> Continue to provide a safety net for retirement income.
<bullet> Not decrease benefits.
<bullet> Not increase taxes.
Again, reforming Social Security is a priority for me this
Congress. I look forward to working with my constituents and my
colleagues to improve Social Security for the current and future
generations.
[Additional resource on Social Security privatization
submitted by the Budget Committee minority staff follows:]
Internet Link to National Bureau of Economic Research Working Paper,
``Would a Privatized Social Security System Really Pay a Higher Rate of
Return?''
http://www.nber.org/papers/w6713
[Additional resources on Social Security reform submitted
by Mr. Smith follow:]
Prepared Statement of William G. Shipman, Principal, State Street
Global Advisors
Chairman Smith, Congresswoman Rivers and Members of the Task Force,
I thank you for giving me the opportunity to submit testimony to the
House Budget Committee Task Force on Social Security concerning
administrative costs in a reformed Social Security system. I come
before you as an interested citizen who has spent his career in the
financial services industry. I am a Principal of State Street Global
Advisors, an investment management firm that is part of the State
Street Corporation.
Founded in 1792, the State Street Corporation is committed by our
corporate plan to ``Participate in the governmental process, and
contribute our efforts and resources to serving the common good.'' In
that spirit, we have participated in the national debate over ways to
strengthen and revitalize America's Social Security System. In response
to numerous requests, we have examined the technical and administrative
costs and challenges that would arise in creating a national system of
individual investment accounts. Our analysis, based upon our extensive
experience in administering pension funds and 401(k) plans, does not
advocate any specific proposal or its financing.
Moving to an individual account system is a significant and
unprecedented undertaking. To put it into perspective, at year-end
1994, the latest government data available, there were about 200
thousand 401(k) plans, and about 21 million individual participants.
Given the growth since then it is presently estimated that 25.4 million
individuals now have 401(k) accounts.\1\ The individual account system
we are discussing here would be more than five times the size.
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\1\ Spectrum Group, San Francisco, CA.
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Many, if not most, analyses of administrative costs have approached
the issue by looking at what other countries have done, estimating
their costs, and then projecting that those costs reasonably would be
borne by the United States, as well, if we were to move to a market-
based structure. We took a different tack. We looked at individual
account systems in our country and wondered if they could be applied to
this challenge. We concluded that they could.
This testimony is in four parts. The first is a description of the
objective of a market-based system. The second is the summary of a
model currently in use that meets the objective. The third is the
significant challenge in applying that model to Social Security reform
given present accounting and record-keeping systems. And the fourth is
a solution that overcomes the challenge.
The feasibility analysis conducted by State Street is just that--a
feasibility study--and does not advocate one course of action over
another.
The Objective: An Individual Account, Market-Based Social Security
Option
The objective is to develop an investment and administrative plan
that:
<bullet> Creates individual accounts with assets owned by the
account holder;
<bullet> Ensures reasonable costs for all participants, low- as
well as high-income workers;
<bullet> Minimizes employers' administrative burden;
<bullet> Provides the opportunity for workers of all incomes to
invest in capital markets;
<bullet> Ensures that inexperienced investors will not suffer poor
returns relative to experienced investors;
<bullet> Provides investment choice;
<bullet> Offers a solution for workers who make no investment
choice;
<bullet> Automatically adapts to changing technology and services
offered by the financial services industry.
These objectives are considered important because they have been
central in the debate on Social Security reform. They are also integral
to the most popular defined contribution system in the United States,
the 401(k) plan.\1\ Indeed, the 401(k) plan structure is often
referenced as a potential model for an individual retirement account
plan for Social Security. It should be noted that even though the
401(k) plan may be a useful model, it is unlikely that it would be
applied precisely.
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\2\ Profit Sharing/401(k) Council of America. ``Helping Americans
to Help Themselves: The Role of Profit-Sharing/401(k) Plans in the
Retirement-Income Security Framework.'' http://www.psca.org/role.html.
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The Model: The 401(k) Plan
Since the late 1970s, defined contribution systems have increased
in popularity among American companies and workers. And just since 1985
those that have sponsored as well as those that have participated in
401(k) plans have increased several fold.
Under 401(k) programs, a plan sponsor, usually a company or union,
oversees administration of a savings and investment program for its
employees. Under such plans:
<bullet> Employees opting to participate in the program designate
the amount they wish deducted from their pay;
<bullet> Employees select investment options prescribed by the plan
sponsor;
<bullet> The plan sponsor deducts the specified funds from the
employee's pay and in many cases invests the funds as of that day in
the designated investment vehicles;
<bullet> Deductions are made on a pre-tax basis;
<bullet> Investment earnings grow on a tax-deferred basis;
<bullet> Benefits are subject to tax when taken out;
<bullet> In many plans, the employer provides some level of
matching contribution to the employee's account;
<bullet> Account holders normally can call an 800 number voice
response unit or individual account representative and change their
portfolio holdings and receive that day's closing price for each asset
traded.
In the early years of 401(k) plans investment options were often
limited to a stable value fund, a diversified fund and company stock.
In recent years, however, there has been a significant increase in
investment choice. Many plans now include a large number of investment
options as well as self-directed brokerage accounts. These accounts
provide access to a large universe of institutional and mutual funds as
well as individual securities. With all of the choice available,
individuals can now create portfolios that are appropriate for their
age, their risk tolerance, and their wealth objectives.
The Challenge: The Government's Record-Keeping and Accounting System
The major challenge in creating a 401(k) model of individual
accounts linked to Social Security is the timely posting of
individuals' savings contributions. This is not possible given the
present Social Security record-keeping system.\3\ Although the Treasury
Department has built a comprehensive system for the collection of FICA
taxes from employers, there is no detailed record of individual taxes
paid at the time they are collected and sent to Treasury. This
information is not communicated to the government until the following
year.
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\3\ See, for example, Kelly A. Olsen and Dallas L. Salisbury,
``Individual Social Security Accounts: Issues in Assessing
Administrative Feasibility and Costs.'' EBRI Special Report and Issue
Brief #203.
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Companies remit FICA taxes in lump sums throughout the calendar
year, but do not forward to the government at the same time the names
of the individual employees who paid those taxes or the amount each
paid. That information isn't provided to the government until the next
calendar year when the employer sends W-2 forms to both the government
and the employee. Treasury knows throughout 1998, for instance, that a
company has paid a sum of FICA taxes for its employees, but the Social
Security Administration will not update its records until late June of
1999, and possibly a few months later, with the names of the individual
workers who paid those taxes and how much each worker paid. The
government never knows when during the year the individual paid the
taxes. This recordkeeping process, although workable in Social
Security's defined benefit structure, is unworkable in a daily
environment defined contribution structure. But it is all that
currently exists for identifying individual payroll taxes.
The Solution: A Three-Level Approach
A solution is to structure investment options, not all of which
require timely and detailed contribution data. This approach involves
three investment levels.
At the first level, workers' savings are deducted from payroll and
invested in a collective money market fund. Workers own the assets of
the fund although the accounting at the individual level is not
completed until the following year. This reconciliation is accomplished
with the filing of the W-2 form. When the individual's assets are
accounted for, units in the money market fund, which include earned
interest, are then posted to each worker's account. The fund is dollar
priced which means each unit is valued at one dollar.
The units are then invested in one of four funds--three balanced
funds and a money market account--selected by the worker. Individuals
who do not or choose not to make a selection have their assets invested
in a default option.
The account holder has the option--after a startup of about three
years, a period required to successfully build up assets to achieve
economies of scale--to transfer some or all of his balance to an
appropriate retail retirement account.
Level One Investment: A Pooled Money Market Account
This pooled account would be a conservative fund similar to a large
institutional money market fund. The funds would be held in this pool
earning interest for all participants. Given that the timing of an
individual's contribution is not known, all participants are assumed to
invest on June 30th. The effect of this accommodation is that interest
earned is one half of what it would be if one started investing in
January. The loss, or gain for those that start working in the latter
part of the year, is not significant in most cases. For example, an
average wage worker making about $28,000 and contributing 4 percent of
wages throughout the year and earning 5 percent interest incurs a loss
of about $13. For average wage workers who work intermittently during
the year the loss is most likely less. High-income workers, however,
effectively subsidize low-income workers because high-income workers
contribute a disproportionate amount of their income during the early
part of the year.
Each worker would know during the year how much is invested because
it is the same as the year-to-date reduction in the FICA tax that goes
to savings, often referred to as the carve-out. The carve-out may be
itemized as a separate line item on the pay stub. Interest would always
accrue, so the account balance would be in excess of the contribution.
All workers, regardless of income, would receive an identical rate of
return. Funds would remain in the money market account until the
reconciliation of how much each worker contributed, about August of the
following year.
Level Two Investment: Balanced Funds
When the individual account balance is determined it is converted
to units in one of three balanced funds that the worker chooses.
Balanced funds are diversified portfolios that are generally invested
in stocks, bonds and cash. The combined assets underlying very
successful private employer-sponsored defined benefit plans are
essentially balanced funds. One of the Level Two balanced funds may
have an allocation that closely approximates these plans. This allows
all workers, if they wish, to maintain an asset allocation similar to
that provided to the employees of many sophisticated corporations in
the world. There would be another fund on each side of this fund: one
for younger workers that would be weighted more toward equities, while
the other would be weighted more toward bonds for those closer to
retirement.
Although workers could choose their balanced fund, some may not. In
this case, they would default to the middle fund. In other words, a
worker--perhaps low income and financially unsophisticated--would be
invested in a well diversified balanced portfolio suited for retirement
savings. The portfolios would be managed by professional asset managers
chosen through an open and competitive bidding process. Index fund
investment management fees most likely would be less than two basis
points (bps): two one-hundredths of one percentage point. The balanced
funds would be valued daily and prices would be published in the
popular press. Workers only need multiply their units by the daily
price to monitor their account balance.
Level Three Investment: Rollover Option
After a period of perhaps three years, a period required to
successfully build up the assets in the Level Two account system to
realize economies of scale, investors seeking more investment choice
would have the option of rolling their investment funds out of the
Level Two asset allocation funds and into any qualified retirement
investment account.
Those choosing Level Three would transfer assets to a qualified
account with a financial services company meeting reasonable and
specified standards.\4\ While investors would have a wider range of
choice within Level Three, there still would be reasonable investment
guidelines. In Level Three investment managers would act as the
fiduciary for their product offerings and be subject to Department of
Labor oversight. This is consistent with many employer-sponsored plans,
both defined contribution and defined benefit.\5\
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\4\ This process should be fully automated and driven by a third
party, such as the National Securities Clearing Corp. At the individual
account holder's instructions the Level Three provider should be able
to initiate the transfer and cause the money to be moved from Level Two
to Level Three without having to provide any paperwork.
\5\ Department of Labor Pension and Welfare Benefits
Administration. ``Study of 401(k) Plan Fees and Expenses.'' April 13,
1998.
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Level Three might well suit those workers who have a high degree of
confidence in a particular money manager, a particular firm or a
particular style of investing. It will also serve investors seeking a
type of investment unavailable in the Level Two asset allocation funds.
An investor, for example, may wish a greater concentration of equity
investments than is available in the asset allocation funds. Should a
worker find a particular Level Three provider or product
unsatisfactory, the worker could transfer to another provider or move
back to Level Two. This assures competition across Level Three as well
as competition between Levels Two and Three. Competition will ensure
the lowest cost and best service for the entire system.
Record-Keeping and Administration
The administration of an individual account system will require the
development of a large-scale, customized record-keeping system with the
capability to produce a highly efficient service solution. The
efficiency of the service application will be dependent upon the design
and execution of the system. There is no existing application that
meets all the requirements.
The requirements to support a national individual account system
will be complex, large-scale and capital intensive. As noted above,
this is a challenge of unprecedented scope.
Nonetheless, the application itself is relatively straightforward.
Development time can be minimized to allow focus on sizing and scaling
the network and building the necessary interfaces to the Social
Security Administration (SSA). Unlike mutual fund or 401(k) record-
keeping systems, there will not be many unique product features or
functions, thus significantly reducing complexity and cost. It is
reasonable to assume a system could be developed in 12-18 months to
support these requirements.
The greatest challenge in building a record-keeping system to
support the requirements of an individual account system is not the
complexity of the application, but the need to support the high volume
of participant inquiries, transactions, transfers and report
generation. To keep costs low, it is critical that most participants
utilize voice and Internet technology to obtain information and
transact business. The greater the percentage of calls that requires a
customer service agent the higher the administrative cost.
The volume of calls will be driven by the frequency of transactions
and statements, as well as average account size and market volatility.
Assuming 140 million accounts and the plan described, participant call
volumes are projected to range from 175 million to 350 million
annually. In addition, the system will issue 140 million statements,
process fund transfers and distributions. This approach assumes the
funds are priced daily and accounts updated nightly.
Whether the record keeping is done by a government entity such as
the Social Security Administration or out-sourced to the private
sector, this task will require the formation of a large service
organization to support these requirements. The service firm would need
call centers in multiple locations around the country and would need to
hire between three and seven thousand employees. For the purpose of
this analysis, it is assumed that the Social Security individual
account system will incur volumes between 0.5 and 1.0 calls per
participant per annum.
Another important factor in projecting costs is determining what
percentage of the participant's call volume will be processed by voice
response and Internet technology versus requiring the services of a
call center representative. The cost to handle calls using the
technology is a fraction of the cost to process through a
representative. Therefore, to achieve an efficient solution it is
critical that high levels of automation are achieved. The analysis
assumes 85 percent of the call volume will be handled through voice and
Internet technology, comparable to the levels currently achieved in
many large defined contribution plans. Estimated first year
expenditures will range from $473 to $922 million.
Cost Model
Based on the plan design defined above, a cost model has been
developed to project the administration costs under a range of
assumptions. The unit cost factors are based on experience in the
401(k) business and have been adjusted in some cases to account for the
scale of the individual account option. The requirements of a national
system of individual accounts are unique and, therefore, extrapolations
from 401(k) experience pose some risks. Unlike the 401(k) structure we
assume that in a timely fashion the Social Security Administration will
provide the individual account recordkeeper an accurate, automated
transmission of earnings' histories that will be used to calculate
annual contribution data. These and any other expenses associated with
reconciling W2 records are to be borne by Social Security and are not
included in this cost model. It is also assumed that Social Security,
at its cost, will maintain accurate and up to date employee address
files, as will be necessary anyway with the annual mailing of Social
Security statements starting in 2000. We envision that one's investment
account statement would be included in this mailing.
Another cost not included in this model is the expense associated
with communicating this program to employees. The assumption is that
the government would bear these expenses. Therefore, they expressly are
not included in the asset based fees reported below. There is precedent
for this in that the government pays directly some of the communication
expense of the Federal Thrift Plan.
Cost Summary
Based on the design criteria outlined and our unit cost
assumptions, it is projected that the first year's administrative
expenses to support an individual account system will range from $473
to $922 million. Assuming 140 million accounts this translates to a
cost per account range of $3.38 to $6.58 in the first year. Although
costs would be expected to increase annually driven primarily by
employee compensation and benefits, assets would increase more rapidly.
Costs as a percent of assets, therefore, would fall. We project that
steady-state asset based costs would range from 19 to 35 basis points.
These costs are competitive with other investment products. For
example, the Federal Thrift Plan, which is often used as an example of
an efficient retirement plan, had an expense ratio of 65 bps in its
second year. Another benchmark is a portfolio of individual mutual
funds representing different asset classes and weighted to approximate
a Level Two balanced fund. Such a portfolio is presently available for
a total cost of about 40 basis points.
Final Comments
Although many approaches to the administrative challenges inherent
in an individual account system linked to Social Security may be
expensive, not all need to be. Under reasonable assumptions, a well
thought out plan that meets our nation's retirement needs is
affordable.
Presentation on Individual Accounts by EBRI
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[Whereupon, at 1:36 p.m., the Task Force was adjourned,
subject to the call of the Chair.]
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