<DOC>
[109th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:98642.wais]
SOCIAL SECURITY:
DEFINING THE PROBLEM
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, FEBRUARY 9, 2005
__________
Serial No. 109-2
__________
Printed for the use of the Committee on the Budget
Available on the Internet: http://www.access.gpo.gov/congress/house/
house04.html
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COMMITTEE ON THE BUDGET
JIM NUSSLE, Iowa, Chairman
ROB PORTMAN, Ohio, JOHN M. SPRATT, Jr., South
Vice Chairman Carolina,
JIM RYUN, Kansas Ranking Minority Member
ANDER CRENSHAW, Florida DENNIS MOORE, Kansas
ADAM H. PUTNAM, Florida RICHARD E. NEAL, Massachusetts
ROGER F. WICKER, Mississippi ROSA L. DeLAURO, Connecticut
KENNY C. HULSHOF, Missouri CHET EDWARDS, Texas
JO BONNER, Alabama HAROLD E. FORD, Jr., Tennessee
SCOTT GARRETT, New Jersey LOIS CAPPS, California
J. GRESHAM BARRETT, South Carolina BRIAN BAIRD, Washington
THADDEUS G. McCOTTER, Michigan JIM COOPER, Tennessee
MARIO DIAZ-BALART, Florida ARTUR DAVIS, Alabama
JEB HENSARLING, Texas WILLIAM J. JEFFERSON, Louisiana
ILEANA ROS-LEHTINEN, Florida THOMAS H. ALLEN, Maine
DANIEL E. LUNGREN, California ED CASE, Hawaii
PETE SESSIONS, Texas CYNTHIA McKINNEY, Georgia
PAUL RYAN, Wisconsin HENRY CUELLAR, Texas
MICHAEL K. SIMPSON, Idaho ALLYSON Y. SCHWARTZ, Pennsylvania
JEB BRADLEY, New Hampshire RON KIND, Wisconsin
PATRICK T. McHENRY, North Carolina
CONNIE MACK, Florida
K. MICHAEL CONAWAY, Texas
Professional Staff
James T. Bates, Chief of Staff
Thomas S. Kahn, Minority Staff Director and Chief Counsel
C O N T E N T S
Page
Hearing held in Washington, DC, February 9, 2005................. 1
Statement of:
Hon. John W. Snow, Secretary, U.S. Department of the Treasury 7
Hon. David M. Walker, Comptroller General, Government
Accountability Office...................................... 45
Douglas J. Holtz-Eakin, Director, Congressional Budget Office 60
Peter R. Orszag, Ph.D., Senior Fellow, the Brookings
Institution................................................ 89
Prepared statement of:
Secretary Snow............................................... 9
Mr. Walker................................................... 47
Mr. Holtz-Eakin.............................................. 63
Mr. Orszag................................................... 91
SOCIAL SECURITY: DEFINING THE PROBLEM
----------
WEDNESDAY, FEBRUARY 9, 2005
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 10:07 a.m., in room
210, Cannon House Office Building, Hon. Jim Nussle (chairman of
the committee) presiding.
Members present: Representatives Nussle, Portman, Crenshaw,
Putnam, Wicker, Hulshof, Bonner, McCotter, Diaz-Balart,
Hensarling, Lungren, Ros-Lehtinen, Bradley, McHenry, Mack,
Conaway, Simpson, Spratt, Moore, Neal, DeLauro, Edwards, Ford,
Capps, Baird, Cooper, Davis, Jefferson, Allen, Case, McKinney,
Cuellar, Kind, and Schwartz.
Chairman Nussle. Good morning, and welcome to this Budget
Committee hearing on Social Security long-term budget
implications. We also have the opportunity today to talk a
little bit about the economy. We have before us on the first
panel, the very distinguished and honorable Treasury Secretary
John Snow who has been before our committee before. We welcome
you back to the Budget Committee. We are pleased to have the
opportunity today to talk about a myriad of issues and subjects
that--you as one of the principal advisers to the President
with regard to a number of subjects, not the least of which of
course is the economy, is an opportunity that we take very
seriously.
On our second panel today we will have the U.S. Comptroller
General David Walker and the Director of the Congressional
Budget Office, Douglas Holtz-Eakin. They are here today to
discuss the analysis of their respective agencies with regard
to the challenges facing Social Security.
On the third panel we have Peter Orszag, who is a senior
fellow at the Brookings Institute.
We are also pleased today to welcome a new member to the
Budget Committee, Mike Simpson, we are welcoming you from the
Appropriations Committee. As we all know, because this is a
leadership committee, we accept members from a number of panels
as a subcommittee slot, and we appreciate the sacrifice you are
making in coming over here and in joining our humble crew from
the Appropriations Committee. Welcome.
We also understand, if I am not mistaken, Mr. Spratt, that
you will be welcoming another member as well. We want to yield
to you for that purpose so you can make that introduction.
Mr. Spratt. Thank you, Mr. Chairman. I don't see her here,
but Allyson Schwartz will be coming. She has just been approved
for membership on this committee by the Democratic Caucus. Oh,
that was good timing. Allyson Schwartz from Philadelphia,
Pennsylvania.
Chairman Nussle. We welcome you to the Budget Committee.
Mr. Spratt. Is this seat here open?
Chairman Nussle. That is the unfortunate thing, we show you
the last seat on the panel. But welcome to our new members of
the Budget Committee. We are pleased to have your involvement
on our committee.
To begin with, I want to make it clear that the purpose of
this hearing is probably not today to write a bill. I
understand that there is a lot of interest in coming forward
and saying, let us skip to the last chapter of the book and
write the plan, let us get on with it; but we have a lot of
consideration, I think, to make before we get to that point in
time. We are not here to try and evaluate specific reform
proposals because there aren't many to choose from just yet. We
have a lot of work just defining the problem--just kind of
getting our arms around it. We know there is a challenge out
there for Social Security. I think most reasonable people who
look at the numbers would suggest that.
In part by holding this hearing, we are trying to help
prepare the debate by examining and defining the problem itself
so we as policymakers on the Budget Committee, as well as just
Members of Congress, can begin to discuss this issue--base any
plans for reform on a solid understanding of what it is or what
it is not as a challenge, and what is possible within the
Federal budget and the parameters that we have before us.
It is clear from some of what you might call rhetoric, that
is flying around here lately, that today's hearing is probably
a pretty necessary step in helping to dispel some of the
apparent confusion and misinformation around the debate. I
think we know pretty well that, at least from my colleagues on
the other side, every chance they get to say the word
``privatization,'' I think you are going to hear that word
probably today and forever and ever. Everyone wants to use that
word. Let us go out and use that word because it seems to poll
well if you want to scare people about what we are going to do
with Social Security in the future. Well, I haven't seen
anything yet that smacks of privatization in the way most
people I think look at that term. In fact, even the
revolutionary thought of allowing people to control even a part
of their own savings I think at best you could say is
personalization rather than privatization. But I will let
people have that rhetorical debate because that seems to be the
interesting part.
Even before we talk about those specific issues and
solutions, we need to I think discuss the challenge itself--and
I thought the President did a good job of doing that in his
basic, as simple of terms as possible--why is it that Social
Security is facing such a large shortfall in the future? So I
will try in a humble way to lay it out as well as I can today.
Back when Social Security was created, far less was
demanded of it than it is today. People didn't live as long and
thus drew benefits for a shorter amount of time. The benefits
themselves were much lower. And for every one person drawing
benefits out of the system, there were some 16 workers paying
into the system. Today, 50 years later, things are a little
different. Back when Social Security was created, the average
American's life span was 62 years. Today, it is an average,
thank goodness, of 77 years. So we are living longer, we are
drawing benefits for a longer period of time, about 15 years
longer than when the program was first put into place. Plus,
the benefits themselves are scheduled to rise dramatically over
the next number of decades. So today, instead of those 16
workers paying in for every beneficiary, we now have about 3.
As I understand it, that number falls to about 2 over the next
couple of decades.
So there is the short answer to why Social Security is
heading for some problems, challenges, crises, depending on
that word that--who knows how it polls well, but we know that
there is a challenge out there, a challenge that we have to
deal with.
So now let us take a look at where that gets us. By 2018,
as we are going to hear today, I think quite often, Social
Security will be paying out more than it takes in. That is a
shortfall in a little over a decade and unless we make some
necessary changes, the shortfall will grow larger every year
after that. Let me make it clear, this doesn't just start
happening in 2018, as I understand it, the challenge begins
today and has been going on for quite some time. If we stay on
the current path, by 2033, the annual shortfall will be about
$300 billion per year. By the year 2042, the entire system in
fact by most people's definition of the word ``bankrupt'' would
be bankrupt.
So, in a nutshell, Social Security is threatened by a
looming fiscal imbalance that if left unaddressed will impose
growing burdens on the budget, on the economy, and on the
people it was meant to assist. For us to get to the point where
we can even think about finding a so-called solution, we had
better make sure that every Member of Congress on both sides
has a crystal-clear understanding of the challenge that lays
ahead. Again, it is pretty apparent that that is not
necessarily the case.
So, again, that is the reason for us to be here today to
begin that discussion. Let us all try and do our best to stay
focused on this. Now, I understand that there will be many
different solutions that will be put forward by many different
quarters. They are all responsible, they are all credible, and
they all deserve our consideration. They shouldn't be just
lambasted out of hand without consideration, and they should be
taken in total, as I see it, in the total picture of what
retirement security is for an individual.
You know, I don't know about the people that you represent
but Social Security doesn't make it for most people in and of
itself. Social Security is part of retirement security. If you
are going to retire and feel secure, you have got to have
health care, you have got to have savings, you have got to have
investments that are working. You have got to have an economy
that is growing. You have got to have long-term health care.
You have to be able to make sure your veterans' benefits are
there, and you have got to make sure your housing is secure.
You want to live in a safe environment. You want to live in a
safe community and neighborhood.
So when you talk about living in a secure retirement, if
you only focus on Social Security, I think you are missing the
point. It is an important part of it for those who depend on
it, certainly, and all of us recognize that and all of us
believe that. I believe it should be looked at in a much larger
context, so today we are going to focus on that.
As I said yesterday, the easiest job in Washington is to
say, no, that is not going to work; no, I don't like that
proposal; no, we are not going to do it that way. That is the
easiest thing to do. But we weren't elected to say no. Inaction
is not in my opinion a solution to this very vexing challenge.
So we have to begin that process today. So I would like us to
focus on that problem.
That is the purpose behind the hearing. We are very pleased
to have I believe the administration's point person with regard
to Social Security, the challenges of retirement security, and
the economy before us today to discuss those issues. I focused
on Social Security in my opening comments, but I know that we
are very interested to hear as well how the economy is doing.
We heard yesterday it is doing quite well. That is an important
factor in us getting back to a balanced budget and dealing with
the myriad of challenges that face our budget and our economy
and the people that we represent. So we are pleased to have you
before us today.
With that, I am honored to turn it over to my friend, Mr.
Spratt, for any comments he would like to make.
Mr. Spratt. Thank you very much, Mr. Chairman.
And, Mr. Secretary, welcome again. We appreciate you
coming.
It has been 4 years since President Bush first sent the
budget up to Congress. At the time we received his first
budget, the budget was in surplus left over from the previous
administration. That weekend after the budget came, the
President made a radio address describing his budget, and I
made the response to his Saturday morning address. And in my
response, I implored the President to use some of the $5.6
trillion surplus then projected to deal with our long-term
liabilities. I said, Mr. President, we may seem to be sitting
on an island of surpluses, but we are surrounded by a sea of
red ink. Not surprisingly, the President didn't take my advice.
He committed $1.7 trillion of the surplus to tax cuts, nothing
to long-term liabilities, and today we see the consequences.
Frequently in discussing Social Security, people develop in
looking at these 75-year projections a notion of futility that
the amount of money needed to make the account solvent is just
overwhelming and unattainable. This simple bar graph shows that
in choosing tax cuts over Social Security reform, there is
enough money in the tax cuts for the top 1 percent to make
Social Security solvent. Almost enough money; $3.4 trillion as
opposed to $3.7 trillion, which is the actuary's number for the
present value of the shortfall in the Social Security account.
But we didn't get anything done about that long-term
liability 4 years ago. But the Office of Management and Budget
(OMB), the Director, Mr. Daniel, did assure us that there would
be a threshold condition--his word, a threshold condition--for
every budget they submitted. He assured us that no budget they
submitted would ever invade the Social Security surplus. That
was the threshold condition.
If you recall, the Clinton administration had moved the
budget into surplus for the first time in 30 years. And when
that surplus reached $236 billion in the year 2000, both
parties in Congress, both sides of the aisle began to talk of a
lockbox in which to keep the Social Security surpluses so that
never again would those surpluses be used to buy new Government
bonds and fund Government spending. We wanted to use the
surplus to buy and retire outstanding Treasury bonds.
Congressional Budget Office (CBO) told us that if Social
Security followed this strategy diligently buying up
outstanding bonds, then some $3 trillion in Treasury debt held
by the public could be bought back, retired, over the next 10,
12 years.
Now, the lockbox had a corny name, I will grant you, but
underlining it there was a serious idea. Each dollar of
Treasury debt retired would be a dollar added to net national
savings. That would in turn lower the cost of capital, and that
in turn would spur economic growth. And, furthermore, when the
baby boomers began to retire, the Treasury would be burdened
with far less debt and be much stronger to meet the
obligations, the long-term obligations of our Government,
specifically Social Security.
Well, the $5.6 trillion surplus was soon dissipated and
replaced by ever-increasing deficits, $375 billion in the year
2003, $412 billion last year, 2004, and $427 billion OMB tells
us this year 2005. In each of these years, the Social Security
surplus was borrowed and spent in toto, all of it. So much for
the lockbox. Instead of paying off debt, this administration
has built up debt, a mountain of debt.
As this next table shows, the Treasury, the administration,
who had to come to Congress three times in the last 4 years to
ask for the legal ceiling on what the Government can borrow,
how much debt we can incur, to ask that the debt ceiling be
raised three times: $450 billion in 2002, $984 billion in 2003,
$800 billion last November, a total of $2.234 trillion. At that
rate, today we are incurring $1 trillion of additional debt of
the United States every 18 months. Surely this is not a
sustainable course.
Now you decided that Social Security will be broke soon and
needs fixing. But the solution that you are pushing, private
accounts, really does little if anything to fix the solvency of
the system. And by allowing payroll taxes to be diverted from
the Social Security Trust Fund into private trust accounts, you
add $4.9 trillion to the deficit over the first 20 years, by
our calculation, $4.9 trillion to deficits over that 20-year
period and to the national debt during that time, to be stacked
on top of other debt that could easily reach $12 trillion
within the next 10 years. Surely there is a limit somewhere.
In pushing this proposal, the administration described
Social Security in dire if not crisis condition, in need of
urgent attention. You say that in 2018 Social Security will go
cash negative. The Chairman just said it would hit a shortfall.
Well, in one sense that may be true, but it is also true that
Social Security at that point, 2018, will be sitting on a trust
fund of over $2.5 trillion in Government bonds, and that corpus
will increase to $7 trillion by the year 2028 when Social
Security will begin redeeming its bonds to add to its dedicated
revenues so that it can pay benefits in full. I don't consider
a $5 trillion nest egg or a $7 trillion nest egg insolvency
yet.
The other night the President in the State of the Union
said somehow in the year 2028 the Government of the United
States is going to have to come up with $200 billion to give to
Social Security. Well, I surely hope that the U.S. Government
can come up with $200 billion to give to Social Security when
it is sitting on a nest egg at that point in time of $7
trillion in Treasury bonds.
Now, there are detractors of Social Security who say that
these trust funds are fiction, and that the Treasury bonds they
hold are just scraps of paper, IOUs. I hope, Mr. Secretary,
that you will set this record straight today, that you will
assure us and bondholders around the world that the U.S.
Treasury will uphold the full faith and credit of the United
States and meet its obligations as they come due, and that
these bonds are just as strong as the economy and the full
faith and credit of our Government.
To wrap up, Mr. Chairman, Mr. Secretary, if we on this side
don't agree with the solution that you are advancing, it is
partly because the logic of it escapes us. First of all, this
problem is brought on because the Social Security Trust Fund
may not have sufficient assets to meet its obligations in full
through 2042 if you listen to the actuaries at Social Security,
or through 2052 if you listen to CBO. The actuaries give us the
present value of the shortfall at $3.7 trillion. Your solution
is not to add to that shortfall to try to make it sufficient,
but to subtract from it by allowing payroll taxes to be
diverted into private accounts, which makes the problem worse;
the shortfall greater, not better.
Second, private accounts may or may not be a good idea, but
they do little to make Social Security solvent over the next 75
years. You achieve solvency by reindexing the primary insurance
amount which over 50 years will slash the budget, slash Social
Security benefits in half.
Third, the critical dates that the administration keeps
referring to, 2018, 2028 and 2042, will all be advanced by many
years if the diversion of payroll taxes is allowed,
particularly at the level of 4 percentage points off FICA.
Social Security may then go negative, cash negative, as early
as 2012 instead of 2018, and the trust fund may be exhausted as
early as 2031 rather than 2042. To pay benefits in full, Social
Security under the proposal you are making will have to begin
borrowing in the 2020s and borrow in the trillions until the
midpoint of the century. As the Secretary of Treasury, we would
like you to explain to us how the U.S. Government can stack
debt on top of debt in these amounts.
Now, we all agree that Social Security is faced with a
challenge, that the sooner we resolve it the easier it will be.
But we simply can't see the merit in the solution that requires
us to borrow $5.9 trillion over the first 20 years and
trillions more thereafter, or in a solution that cuts benefits
for new retirees in half over 50 years. And we can't buy the
notion that this is the only solution we have to choose from.
In 1983, I was here, the retirement trust fund was in dire,
dire condition, in danger of running dry in July 1983. Mr.
Reagan appointed, with congressional consent, a bipartisan
commission headed by Mr. Greenspan. It recommended a number of
changes that have assured the solvency of Social Security for
60 years, from 1983 to 2042. This model was shown to work then,
and there are still today menus, whole menus of ideas to choose
from if we chose that model again.
So I say to you, Mr. Secretary, why not tune up the model
we have got, the Social Security system that has served America
so well for more than 50 years, as opposed to trading it in for
a vehicle that has never been around the track and never been
proven to work.
We look forward to your testimony and to the questions that
we will put to your afterwards. Thank you again for coming.
Chairman Nussle. Mr. Secretary, welcome to the committee.
We are pleased to receive your testimony at this time, and your
prepared remarks will be made a part of the record as well.
Welcome.
STATEMENT OF JOHN W. SNOW, SECRETARY,
U.S. DEPARTMENT OF THE TREASURY
Secretary Snow. Thank you very much, Mr. Chairman. Mr.
Spratt, thank you. I greatly appreciate the chance to appear
before you again. I always look forward to this opportunity,
always a good exchange of views and the lively discussion that
ensues.
Let me say that in the intervening years since I appeared
before you last, we have made an awful lot of progress with the
American economy. I know how pleased you must be, as we are in
the administration, with the fact the American economy is now
on a really good strong course. It is a tribute to the
Congress, the leadership the Congress provided in enacting the
President's tax cuts, because at the very center of the strong
recovery that the American economy is enjoying today are those
tax cuts.
And it is interesting to go back and look at the growth
rates in the economy and job creation in the economy before
those tax cuts took effect and what happened immediately
thereafter. It was almost like a light switch went on in the
American economy. As businesses began to take advantage of the
expensing provisions that you made available, the greatly
expanded expensing provisions, as the accelerated tax credits
took effect, as the lower marginal tax rates took effect, as
the dividends and capital gains reductions took effect, equity
markets expanded, capital spending picked up, jobs picked up,
and GDP picked up. And, Mr. Chairman, you know these numbers,
but last year we had a 4.4 percent growth rate in GDP. We have
had the best--for the last 18 months since the legislation took
effect, the best growth rates in GDP in about 20 years; 2.7
million jobs. And yet inflation stays low because productivity
is high.
The housing market is strong, the best we have ever seen.
More home ownership in America today than any time in our
history. National wealth, household wealth, the highest ever.
I cite this to you to suggest we are on the right course,
and we are going to continue on that course. And the budget
that is before you is designed to assure that we do that.
That is why the President has asked to make the tax cuts
permanent. I think the results of the jobs and growth bill
demonstrate the importance of a low-tax environment for the
success of the American economy.
I contrast our economy with Europe. Our economy has much
lower tax rates, we have much higher growth rates, we have much
higher employment rates. And we are creating lots of private
sector jobs while the Euro zone isn't.
But we also recognize that we need to focus on the deficit.
This budget tries to do that. It sustains the path that the
President called for to cut the deficit in half over the course
of the next few years, by the time he leaves office, to bring
it to a level--and this is important--to bring it to a level
which is low by historical standards. Forty-year average is
something like 2.3 percent of GDP. The President's budget
carried out over the window, the budget window period, would
bring that deficit down well below 2 percent.
There are two keys to bringing the deficit down, and you
know what they are. One is to continue the growth of the
American economy; because if the American economy stays on a
good growth path, not surprisingly, businesses become more
profitable, more small businesses are established,
entrepreneurship is rewarded, jobs are created, and we have
businesses paying more taxes and we have individuals paying
more taxes, and thus Government receipts rise. And we have seen
that. And the budget lays out a path of increasing Government
revenues as the economy gets stronger and stays on the growth
path with--and this is a very important point--with revenues as
a percent of GDP rising back up to their historic level of
about 18 percent.
That suggests to me that our problem with the deficit isn't
that we are undertaxed. Quite the contrary, it seems to me to
suggest quite plainly that the problem is that we spend too
much.
And that brings me to the second part of the equation. The
first part is growth; the second part is spending restraint.
And you can argue with the particulars of the budget that we
have sent up, but the key message from the budget is spending
restraint is awfully important to keep us on a path of fiscal
responsibility.
But the President is not simply focused on the 5-year
window, important as that is. I think we are in good shape on
that. He is also focused on the longer term, where I think
Budget Director Josh Bolten yesterday talked to you about the
long-term problems growing out of Medicare and Medicaid and
Social Security, and the need to deal with these unfunded
obligations.
That is one reason the President has put Social Security
forward as a major national issue. It is why he made it the
focal point of his State of the Union message. Social Security
is a great part of the fabric of America. It is important that
we sustain it, it is important that we secure it, it is
important that we make the benefits of Social Security
available to future generations, to the young of America.
And yet we all recognize, I think, that there are real
problems there. Mr. Spratt acknowledged there were problems. It
is hard not to acknowledge the problems. It is not what we are
saying, it is what the actuary, the nonpartisan actuary of the
Social Security Administration is saying. It is what CBO is
saying, it is what the Government Accountability Office (GAO)
is saying. And I am glad you will be hearing from them later in
the day.
All the people who really know the numbers come to the same
conclusion: The system is in real trouble, real trouble. And in
2018, the outflow exceeds the inflow. That is not a good sign.
There is a trust fund with a surplus in it, that, Mr. Spratt,
we will honor the bonds in the trust fund. Of course we will.
They carry the full faith and credit of the United States. As
with all obligations of the United States, they will be
honored. But the bonds run out in 2042. And in 2042, with no
surplus left in the fund, the fund must fall back on its own
revenues, and its own revenues are only sufficient to meet
about 72 percent of its obligations. So if we wait until 2042,
we are going to shortchange the future retirees.
We can do better than that. That is why the President has
put this issue on the table. We can do better than that. And
the personal accounts provide younger people an opportunity to
build a retirement, to build a nest egg for retirement, to take
advantage of what Albert Einstein called the most powerful
force in the universe, Congressmen, the power of compounding.
And a young person of 24 who retires now has 40 years-plus of
compounding of market returns to build a nest egg for their
retirement. With that, they will do better than they would
under the Social Security system that can't fulfill its
promises.
So I think, while you may not agree with the solutions that
have been put forward, at least I think we need to acknowledge
that the President has provided real leadership here in taking
the issue of Social Security to the American people, of
focusing on our children's retirement security. He could have
passed this one up. He could have passed it on to another
President, he could have passed it on to another Congress. He
decided that the responsible thing to do was to confront it and
to address it.
In confronting it and addressing it, though, he said to
seniors, we are not going to affect your benefits. If you are
55 or older, your benefits are absolutely secure. They won't be
affected. He said to younger people, we need to work now to put
in place savings vehicles for you so your retirement security
can be better.
And I think he has performed an extraordinarily important
national service by calling attention to the problem.
People object to the term bankruptcy, that Social Security
is going bankrupt. Bankruptcy is in fact the condition--
impending bankruptcy is in fact the condition that Social
Security faces in the very same sense that a private sector
company--and my career has been in the private sector--that a
private sector company that can't meet its obligations goes
into Chapter 11 or Chapter 7 and restructures. In that sense,
Social Security is heading for bankruptcy. We don't have to let
it happen. By acting now, we can avoid those consequences, we
can avoid a huge future burden on the young, and we can give
them a much better retirement security.
For all those reasons, Mr. Chairman, I thank you for the
chance to be here and talk about this critically important
issue. Thank you very much.
Chairman Nussle. Thank you, Mr. Secretary.
[The prepared statement of Secretary Snow follows:]
Prepared Statement of Hon. John W. Snow, Secretary, U.S. Department of
the Treasury
Good afternoon and thank you Chairman Nussle and Ranking Member
Spratt for having me here today to discuss the President's budget. I
think you'll find that it exhibits a dedication to fiscal discipline,
transparency, and economic growth.
By focusing on priorities and looking for savings in every agency,
across the board, the President's administration has come up with a
budget that we believe is fair while also holding the Government
accountable. As the President announced in his State of the Union
Address last week, this budget adheres to the principle of ``Taxpayer
dollars must be spent wisely, or not at all.''
It holds the growth of discretionary spending to just 2.1 percent,
below the expected rate of inflation. Non-discretionary spending in
this budget falls by nearly 1 percent, the tightest such restraint
proposed since the Reagan administration.
This administration appreciates that cutting taxes and exercising
fiscal discipline must go hand in hand. We appreciate that this is the
people's money with which we are dealing, and that we work for the
taxpayers.
That is why we are committed to making the President's pro-growth
tax cuts permanent and building on our strengthened economic
fundamentals as we submit to you a budget that will increase the
efficacy of our Government programs without over-spending the
taxpayers' money.
Over the weekend, the finance ministers of the G7 met--the U.S. was
represented by Treasury Undersecretary for International Affairs John
Taylor--and they discussed the importance of promoting and achieving
economic growth in our countries, as well as keeping our respective
financial houses in order. These two issues are inextricably linked.
The way that we, as the executives of the Federal Government,
manage the taxpayers' money sends a message to the people of America as
well as to our trading partners and investors around the globe. When we
control our spending, we are showing our citizens and the world that
fiscal discipline is a priority on par with our policies that promote
economic growth.
I'll talk more about fiscal discipline in a moment, but I'd like to
start with a look at what we have recently achieved through pro-growth
economic policies.
Well-timed tax cuts, combined with sound monetary policy set by the
Federal Reserve Board, have resulted in very good economic growth and,
most importantly, continual job creation. The economy has created over
2.7 million jobs since May of 2003. And while job growth can never be
fast enough for those looking for work, the steady pace of job creation
has been an unmistakable sign of an economy that has recovered from
very tough times, and is now expanding.
Whenever I speak with my counterparts in the G7, I am reminded that
the American economy is the envy of the world. Our recovery and growth,
our successful dedication to entrepreneurship--all these things are
admired, and increasingly emulated, by our G7 partners.
Is it any wonder that they want to learn the secret to our economic
resiliency? A quick look at the facts reveals much to be envied: GDP
growth for 2004 was 4.4 percent. Our economy has posted steady job
gains for twenty straight months. The unemployment rate is down to 5.2
percent--lower than the average rate of the 1970s, 1980s and 1990s.
Real after-tax income is up by over eleven percent since the end of
2000 and household wealth is at an all-time high. Inflation, interest
rates, and mortgage rates remain at low levels. Homeownership rates are
at record highs.
Tax cuts can be hard on budgets and deficits in the short term, but
if the tax cuts are geared toward improving incentives there are long-
term benefits as well as short-term ones, and this fact has been well
illustrated by these outstanding economic results.
I point to this record because it is so important that we continue
on a pro-growth path. Continued economic growth is needed, and will be
needed, to continue to improve our standard of living and until every
worker in America who is still looking for a job can find one.
For example, we've got to make the President's growth-enhancing tax
cuts permanent--and that is included in this budget. The President's
Panel on Tax Reform was also created with economic growth in mind. It
is a group of some of the best minds in our country, and they'll be
looking critically at the entire existing code and coming up with
proposals that would make it fairer, less complex, and more pro-growth.
While the Panel is working on that historic task, our efforts to
grow the American economy will continue in many other areas--I am
particularly interested in legislation that will reduce the burden of
frivolous lawsuits on our economy--and this budget is part of the
administration's overall pro-growth policy agenda.
As I already mentioned, economic growth is good for our country for
the jobs it creates and the prosperity it spreads. But it is also,
importantly, part of a winning strategy on deficit reduction--one of
the top priorities of this budget--because economic growth increases
Treasury receipts.
Treasury receipts are rising--in the second half of calendar 2004,
individual income tax revenue is up 10.5 percent versus the same period
in 2003--and will continue to rise, as long as we have economic growth.
That must be accompanied, as I emphasized earlier, by strict fiscal
discipline. That is why the President's budget proposes real savings. I
know it will have its critics as a result, but its frugality is
essential.
Let me be very clear on this: we have deficits and they are
unwelcome. But we are not under-taxed and higher taxes will not be the
solution to reducing deficits. Fiscal discipline, combined with
economic growth, is the correct path.
Using this approach, we are making headway on deficit reduction,
and we're on track to halve the deficit by 2009. The deficit is also
forecast to fall to 3.0 percent of GDP in 2006 and to 1.5 percent by
2009, well below the 40-year historical average of 2.3 percent of GDP.
The 2004 deficit came in at 3.6 percent of GDP--nearly a full
percentage point lower than had been projected. And the 2005 deficit is
projected to show another decline.
While we are pleased with this progress, we recognize that more
needs to be done.
We need to make the tough choices on spending and stand steadfast
in our commitment to continuing economic growth in order to see that
deficit whittled down.
We also need to look at our long-term deficit situation. I spoke
earlier about transparency, specifically the honesty of this budget,
which deals openly with the needs of the times in which we live, from
the war on terror to the need for continuing growth.
In the interest of honesty and transparency, I encourage all of us
to follow the politically courageous leadership of our President by
looking at, and dealing with, the $10.4 trillion deficit facing our
children and grandchildren in the form of an unsustainable Social
Security program.
The program is an important institution, a sacred trust, and it
worked well for the times in which it was designed. It is, however,
doomed by our country's demographics and in need of wise and effective
reform.
The arithmetic is simple. As people live longer and have had fewer
children, the ratio of workers paying into the system and retirees
taking benefits out has dwindled dramatically. We had 16 workers paying
into a system for every one beneficiary in 1950, and today we have just
three workers for every beneficiary. That ratio will drop to two-to-one
by the time today's young workers retire.
We all must agree that this demographic reality exists, that this
problem exists. Social Security is secure for today's retirees and for
those nearing retirement, it will not change for those people who are
55 and over... but it is offering empty promises to future generations.
When today's young workers begin to retire in 2042, the system will be
exhausted and bankrupt.
It is the future of the program that President Bush is concerned
about, and it is the future of the program that we must address, this
year, here on Capitol Hill. I echo the President's State of the Union
Address in saying that we must join together to strengthen and save
Social Security.
We can, and should, do this without increasing payroll taxes. The
level of increases that would be necessary, if we maintain the status
quo, would have a terrible impact on our economy. It would negatively
impact economic growth; jobs would be lost. We don't have to go that
way.
We can, and should, reform the system in a way that encourages
younger generations of workers to build a nest egg that they own and
control and can pass on to their loved ones.
Saving Social Security is an undertaking of historic proportions.
We have hard work ahead of us as we strive for consensus in the name of
younger generations.
We also have hard work ahead of us when it comes to strengthening
the fundamentals of our economy: deficit reduction, good fiscal policy,
energy policy, lawsuit abuse reform, and encouraging savings.
I appreciate that this administration has an ambitious agenda...
but it is a good one, worth the work it will take to move forward,
together, on it.
Let's start by passing this responsible, pro-growth budget.
Thank you for having me here today; I'm pleased to take your
questions now.
Chairman Nussle. Let me start, if I might, by going back to
what my friend Mr. Spratt opened with, and that is with regard
to the deficit, because we are here to talk about the budget as
well. I have just got to say this again. As many times as my
friend--and he is my friend and he will continue to say it, and
he is technically correct--that on September 11 and thereafter
we started running deficits. It didn't just happen, on
September 10 we were running a surplus, and on September 11 and
12 and on and on and on, yeah, we started running deficits. But
they didn't just happen. We made deliberate decisions about
strengthening the economy, about dealing with the emergency,
about strengthening our homeland security, about improving our
intelligence, about prosecuting a war on global terrorism.
Those decisions, many of which were bipartisan decisions, were
deliberate.
So, yes, we find ourselves in a deficit; yes, we are going
to run a tight budget, Mr. Secretary, the way we did last year,
and we are going to hopefully get results that we saw last
year.
As we all remember, and you came in and reported to us--and
let me just show you a chart. You reported to us last year that
we were going to run a $521 billion deficit, well, we didn't.
When we closed the books, it was $412 billion. In 1 year we
were able to reduce the deficit by $109 billion. I know my
friends will tell me, don't get too pumped up about that
because you didn't do it all by yourself, and I know that. Our
constituents did it--it is called the economy.
Our economy is a beautiful thing. When it gets unleashed
and it starts growing, it can do miraculous things like it did
last year. With tight spending restraint--we can be tighter.
But with tight spending restraint and with a growing economy we
can begin to reduce some of the challenges that we have such as
the deficit. But the challenges of the war, the challenges of
international relations that we have out there, the challenges
of intelligence, of homeland security, they are still there. We
want the economy to keep growing, so we don't want a tax
increase right now.
So we are going to keep the economy growing, and you can
report back to the President that his budget is alive and well
on Capitol Hill.
Having had the opportunity to meet with the budget director
yesterday and talking to my colleagues and our leadership and
members, we believe that we can get it done. Now, it is going
to be tough, because all of that spending, as you well know,
got there for a reason, and each and every one of us can
identify something that we voted for and some important
challenge for our State, district, or country that we believe
in. So it all got there for a reason. You have our commitment
that we are willing to work with the President in order to
reduce this deficit and continue to meet our challenges. But a
growing economy is an important part of this factor.
Now, turning to the subject that we have today. So, if our
economy is growing and growing so well, let us just grow out of
this problem. I mean, come on, Mr. Secretary, our economy is a
beautiful thing. Let us just grow out of the problem of Social
Security, I have heard people suggest that.
The interesting thing about it is, I heard the same thing
back in the 1980s and 1990s when Republicans said let us just
grow out of something, and, boy, we were lambasted for saying
we can just grow out of the problem. Now I hear it from my
friend on the other side that, just let us grow out of the
problem of Social Security.
So I would like you to address the grow-out-of-it
opportunity that we have. Can we grow out of the problem that
we face with regard to the challenge of Social Security?
Secretary Snow. Mr. Chairman, thank you. Unfortunately, no,
we can't grow our way out of the Social Security problem. With
the economy as a whole, growth helps us an awful lot in dealing
with the deficit because we pick up the top line, the revenue
line. Unfortunately, the way Social Security is structured,
growth translates into higher benefit levels and higher payout
levels. So growth in and of itself has very little effect
because of the benefit formula in Social Security, in improving
the solvency of Social Security. I wish it were otherwise, but
the fact that the benefits are indexed to wages and wages
reflect productivity and growth in the economy makes growth in
and of itself not--not--very helpful in solving the
sustainability issues of Social Security. It will help, I must
say, it will help a lot in dealing with the larger Federal
deficit, but it won't Social Security as such.
Chairman Nussle. Well, I have also heard that there are
those who suggest that the Government--the Government, you
know, at the appropriate time, I assume they mean the Federal
Government at the appropriate time, and I assume that means
2018 or 2019 or whenever we start running into this challenge,
that we should just replenish the account, we should just
replenish the trust fund, we should just start paying the
benefits. You know, just put the money in there. Why is that,
in your opinion, something that might or might not work?
Secretary Snow. Mr. Chairman, the notion of replenishing
the trust fund sounds appealing on the face of it, but how
would it be replenished? It would be replenished by tax
increases in the most likely case. The tax increases that would
be required to put Social Security on a sustainable basis would
roughly double the current taxes, 50 percent increase in the
current tax rate. And I would hate to see us go down that path
because a 50 percent increase in Social Security taxes, which
is required to put the system on a sustainable basis, would
almost surely wreck the American economy. It would almost
surely lead to very high unemployment rates, very slow growth
rates, perhaps a recession.
And I look at Europe and the Euro zone and their tax rates
on labor versus ours, and you see the consequences, you see
them visibly right before your eyes. Their growth rates are
about half of ours, their unemployment rates are twice as ours.
They aren't creating anywhere near the number of private sector
jobs we are. We don't want to go that way, in my view.
The other way is to cut other programs. That is a tough
course to follow. And the third way is to borrow. And you will
say, but you are borrowing; and I will say, yes, we are. But
there is a big difference in the sort of borrowing we are
proposing to fund the personal accounts and the sort of
borrowing that would be required simply to put money into the
trust fund.
Chairman Nussle. What is that difference?
Secretary Snow. Well, the big difference is that by doing
it the way the President has proposed with his personal
accounts, we are borrowing to save. Every dollar borrowed
becomes a dollar saved, as opposed to every dollar borrowed
becoming a dollar spent. That has far different effects on the
national accounts of the United States and on the economy of
the United States. The President's proposal will translate
borrowing into savings.
Chairman Nussle. Well, give me an example. I am borrowing
$100, all right? Let us keep it real simple so I can explain it
to my son who, according to the charts, isn't going to have
Social Security. So I want to be ale to explain this to my 14-
year-old son. All right? So I have got $100 that I want to
borrow. Now, what is the difference between borrowing that to
save and borrowing it to spend? I mean, isn't it still
borrowing $100?
Secretary Snow. It is borrowing $100 in both cases. But in
the case of your son and his personal account, the money, the
$100, becomes part of the capital stock of the United States;
it becomes part of the savings of the United States; it becomes
capital used to strengthen the growth of the American economy.
The spending--and it may well be for a very good purpose--but
the spending is spent and it is gone. The savings becomes part
of the capital base of the United States.
Chairman Nussle. Does it grow?
Secretary Snow. And with time certainly it would grow. One
of the beauties of the personal accounts is the opportunity to
use this power of compounding, which, according to virtually
all financial analysts, if you get a mutual fund-type
investment with 60 percent equities and 40 percent bonds, put
the $100 away, over a 40-year period that $100 is going to be
worth a huge multiple of the $100. So the $100 becomes many
times the $100 available then to your son when he retires. The
difference is it is savings rather than spending. Spending
disappears; savings builds and grows.
Chairman Nussle. And then I have got to understand why this
is so urgent. I mean, you know, 2018, most politicians only
worry about the next election around here. Some think a little
bit further than that, but by and large we are not used to
thinking more than about the next election. You have to pardon
us a little bit. You know, 2018 is a lot of election from now
for most people. So why is it so urgent? I mean, can't we just
wait until--how about let us try 2016? Why does the problem get
so much worse between now and 2016 that we can't just wait and
deal with it then?
Secretary Snow. Well, again, Mr. Chairman, citing the
actuary of the Social Security system, every year we put this
off, every year we postpone action, the problem becomes bigger
and bigger and bigger and bigger. As I recall the actuary's,
assessment, the problem rises at the rate of about $600 billion
a year. And whereas today, if the problem were solved simply by
reducing benefits or simply by the shortfall or solved simply
by raising taxes, you could do so with a 3.2 or 3.3 percent
reduction--or increase. If you wait, you are going to have to
have a 6.5 percent, 7 percent-type increase. So by acting now,
by acting now we have the ability to put in place solutions
that are far less costly. And we also by acting now have the
opportunity to put in place these accounts which will use the
power of compounding, take that $100 and make it many times the
$100 the future when younger people like your son move to
retire.
We also by acting now I think show good faith with markets.
Markets are watching us. Markets ultimately render judgments on
people in positions of political leadership. I think the
markets are giving us credit. They are saying, yes, you are
going to address this problem. The issue is important because
that $10.4 trillion obligation is out there and it hangs over
the markets. By showing responsible behavior in defeasing it,
in removing it, we are keeping faith with the financial markets
of the United States and the financial markets of the world.
And that sustains low interest rates. And low interest rates
are one of the principal things we have going for us in
sustaining a strong economy.
So for all those reasons, Mr. Chairman, I would suggest
that we really have no option but to act now. The problem is
urgent, and the sooner we act the better. And the longer we
wait, the bigger the problem becomes and the harsher the
solutions.
Chairman Nussle. Thank you, Mr. Secretary.
Mr. Spratt.
Mr. Spratt. Thank you very much, Mr. Chairman.
Mr. Secretary, we are trying hard to understand this
proposal in full. This is a Budget Committee, and our
understanding of it thus far is it will have an enormous impact
on the budget for years to come. In fact, if the borrowings to
finance transition are of the magnitude we expect, I don't
think we will see a balanced budget again in our lifetimes.
You know enough apparently to give us a number, $754
billion, as the cost during the first 10 years, assuming
implementation of your proposals in around 2009 to 2011. Can
you tell us what you expect the cost to be in the first 10
years after full implementation and in the second 10-year
period thereafter?
Secretary Snow. Mr. Spratt, I can't because----
Mr. Spratt. Can you give us an approximation?
Secretary Snow [continuing]. I don't yet have a detailed
understanding of what will come out of this legislative
process.
Mr. Spratt. I am asking what you are proposing, not for
what we produce.
Secretary Snow. Well, until we know the details, though, of
the proposals that will come from the negotiations with
Congress, the process that has now been launched, it is very
hard to quantify what those future costs would be. But, I mean
I certainly would grant you that the borrowing wouldn't cease
at the end of the 10-year period; it would have to go on. And,
but I have not run any or seen any runs of an--actuarial runs
of what the next 10 years and the 10 years after that would be,
because I think it depends so much on the details. But we have
to acknowledge that it is going to be a continuing budget item
going forward.
Mr. Spratt. Well, if you haven't seen the details as
Secretary of Treasury, how can you pass judgment on them?
Secretary Snow. We have seen the details and we have made
available the details of the proposal for the first 10 years.
But what happens with the cap, what happens with the
contribution levels and so on, and what happens with the other
aspects of the Social Security proposals is something that
isn't knowable at this point.
The President has put forward four or five options for
dealing, in addition to the personal accounts, for dealing with
the problem. He has invited Members of Congress to join him in
thinking about the problem and coming up with other ideas. He
doesn't think we have got all the good ideas.
Mr. Spratt. But you are his point man. The reason we are
putting the question to you is you are the chief numbers
operator in the Bush administration, and we are trying to get
some financial explanation of what the impact of this proposal
will be on our budget. And we are finding it a very elusive
pursuit. We aren't even able to find out what the cost is going
to be over the first 20 years, although we know it is going to
be significant. By our calculation, it is going to be close to
$5 trillion in additional debt of the United States. Does that
comport with your back-of-the-envelope analysis?
Secretary Snow. Well, Mr. Spratt, as I say, I don't have
the runs on that, the actuarial runs on that, so I can't
confirm that. It sounds a little high to me. But certainly
there would be continuing borrowing requirements and interest
payments requirements. But remember, net-net we are simply
making explicit an obligation which is implicit, and by doing
that we are not adding to the long-term costs of the U.S.
Government.
Mr. Spratt. Well, first of all, we are accumulating debt in
the regular budget at a rapid clip. I showed you the numbers,
$2.234 trillion increase in the debt ceiling to accommodate the
Bush budget for the first 4 years, $2.2 trillion. And we are
running at that rate now, about $1 trillion in debt
accumulation every 18 months. By 2012, 2015, we are likely to
have $12 trillion in statutory debts subject to limit. If you
go ahead and take then that debt, which is increasing as we
speak, and add on top of it another $5 trillion, the Treasury
is going to be in the private capital markets frequently
borrowing big sums of money repeatedly and crowding out private
borrowers, is it not?
Secretary Snow. No, I don't think so. I don't think so at
all in this case because, again, this borrowing is not
borrowing to spend, this is borrowing to save. And it is
borrowing to defease a very sizeable long-term obligation.
Mr. Spratt. But it is still borrowing, and the Treasury of
the United States has to go in the capital markets and say I
want $1.5 trillion dollars for these Treasury bonds.
Secretary Snow. But Mr. Chairman--I mean, Mr. Spratt.
Mr. Spratt. I will take that.
Secretary Snow. Mr. Spratt, there is a real difference
here, and it is important to maybe take a minute and talk about
this, because this isn't your traditional debt. It doesn't have
the effects of traditional debt on markets. I have spent a lot
of time now talking with the analysts in the Treasury
Department who make the U.S. Treasury market, the people who
are responsible for the largest debt market in the world, the
U.S. treasuries. I spent a lot of time talking to people up on
Wall Street about this. And Wall Street, I think, financial
market people, people who worry about the bond market and
credit ratings, they are going to applaud us, they are going to
applaud you and the Congress for taking this issue on and
defeasing that $10.4 trillion long-term liability. And they
would readily find, I am convinced, the funding manageable.
Mr. Spratt. There is still going to be debt of the United
States, and there will be interest payments either quarterly or
semiannually. Those payments will have to be made. We will have
a huge and growing amount of debt service, and that debt
service is going to displace priorities in our budget, is it
not? It is going to be a mountainous amount of debt service if
you have $5, $6, $7 trillion dollars of additional debt. It has
to be serviced. Does it not?
Secretary Snow. Well, certainly all debt has to be
serviced. But, remember, when we do the borrowing it is of an
equivalent value to the reduction that is occurring in the
liability in the Social Security system, because the borrowing,
the borrowing is exactly equal to the amount of money that is
being taken out of the system and put into the personal
accounts. So, in effect, it is a wash. The Social Security
liabilities are coming down by an amount that is equal to the
borrowing.
Mr. Spratt. But the interest is a net payment of the U.S.
Government. We will have to shell out the interest in
increasing amounts, and it will displace other priorities in
our budget.
Secretary Snow. Well, not necessarily. No, that is not the
way to look at this. If the borrowing doesn't affect----
Mr. Spratt. So we can borrow money with impunity then.
Secretary Snow. Well, no, you don't, because you don't
borrow if you spend. You can borrow to save; you can't borrow
to spend. And that is the key difference. This is borrowing to
save. And if you look at this I think in the right way, the
savings of the United States are going to rise, not fall. At
least they won't be negatively impacted. If the savings of the
United States aren't negatively impacted, then----
Mr. Spratt. You are diverting money from the public trust
fund into private accounts. At best, it is a wash. Instead of
going into the public trust fund where it would be saved, it is
going into private accounts where it is saved. So at best it is
a wash.
Secretary Snow. I would look at it a little differently. I
would look at it this way. That is going from a pay-as-you-go
system to, in a way, Mr. Spratt, the very lockbox you talked
about, because the money is now going into a private account
that could be analogized to a lockbox. It is in there, it can't
get out. The Government can't take it away from you. They can't
go spend it. It is in the lockbox. It is not called a lockbox,
it is called a personal account, but it has the same effect.
Mr. Spratt. Let me ask you to wrap up on this line of
questioning. When can we expect the numbers? When can we expect
to see a full financial display of how much debt we will have
to incur to sustain this proposal?
Secretary Snow. I wish I could give you an answer in terms
of a specific time. The time will be as the details of the
proposal get worked out with you and Members of the Congress,
is the best answer I can give you, the most honest answer.
Mr. Spratt. Let me ask you then another question about a
different line. I have looked at model 2. And, as I take it,
you are working off model 2 of the President's Social Security
Commission. And model 2 clearly acknowledges, particularly if
you read the actuary's letter that explains it, that the
private accounts don't account for the achievement of solvency
within 85 years. That has to be done through benefit reductions
or revenue enhancements, one or the other. And, in particular,
model 2 actuary's letter indicates that the primary source of
solvency is achieved by reindexing the basic primary insurance
amount. They go on to acknowledge, if you read it closely, that
the replacement ratio, if this is done, over 50 years will be
cut in half. That is a substantial reduction in benefits. And
that is a means by which you achieve solvency. It doesn't have
a thing to do with private accounts. Am I correct?
Secretary Snow. I would have to go back and review model 2.
I get model 2 and model 3 and model 1 sort of muddled
sometimes. But I think essentially you are right; model 2
doesn't rely on the personal accounts alone to fix the system.
But I think model 2, and model 3, as I recall, have the
personal accounts as an integral part of the solution.
Mr. Spratt. The actuary indicated for that study that the
cost of fixing Social Security would be equal to 1.89 percent
of payroll. In other words, that was the shortfall expressed as
a percent of payroll. The actuary's letter said that the manner
in which the primary amount of insurance would be determined
indexed to prices instead of wages would account for 2.07
percent of payroll.
So that was virtually the whole of the solution right
there, in the reindexation solution of the bend points,
redetermination of the primary insurance amount and over time,
prospectively, it becomes a significant reduction in benefits.
Secretary Snow. Yes, I think Plan 2 does, by indexing to
prices rather than wages, have the effect long-term of reducing
at least the growth rate--I think, is maybe a better way to put
it--the growth rate of benefit levels. But even then, I think
it has the retirees, the beneficiaries, having replacement
rates which are better than their parents and grandparents.
Mr. Spratt. Oh, no, not if we assume that the collateral
account earns the bond rate of return, you will see a reduction
in the--you will see a reduction in the replacement ratio of
preretirement income for the median beneficiary retiring at age
65 earning the median income of over 50 years, the replacement
ratio will decline from 43 percent to 22 percent. They will get
half what their grandparents got.
Secretary Snow. The replacement ratio declines, but the
actual----
Mr. Spratt. Well, sure wages go up, no question about it.
Secretary Snow. But the actual payout is higher than their
parents or grandparents in real terms, and I think with the
private--the personal accounts, with the personal accounts, the
payout is higher than what would be available from Social
Security alone, given the fact that Social Security can only
pay out a fraction of the promised benefits.
Mr. Spratt. Well, if you go back and read model 2, I would
recommend it to your attention.
Secretary Snow. OK, I will do that.
Mr. Spratt. You will find that they cut the replacement
ratio in half over that period of time, and that makes this
system not a fundamental source of retirement benefits but
almost an incidental. It changes the character of Social
Security.
Let me ask you--and I will then let others have a shot. If
we assume that these--and everybody is subject to this change
in the indexation of the primary insurance amount, everybody,
whether they opt into private accounts or not; everybody gets
their benefits recomputed according to this different model.
Now, that raises a particular problem for one-third, 30
percent, of the beneficiaries who are disabled beneficiaries or
survivorship beneficiaries. They will have the same benefit
reduction that others will have out through time, but in
addition to that, they will not have the opportunity, because
they will be drawing that benefit sooner than age 62 or age 65,
they will not have the benefit of allowing the collateral
accounts to build up. What happens to their benefits? It is
critically important to the disabled and the survivor.
Secretary Snow. You put your finger on a very, very good
issue, and the President in his principles to deal with Social
Security has focused on that and said that nothing should be
done to diminish the well-being, the welfare of the disabled,
as a result of any of the fixes.
Mr. Spratt. So what do we do? What is the solution? The
problem is inherent in the proposal as a problem, I understand
that.
Secretary Snow. I agree with that. It is in Model 2, it is
inherent so you would have to take that fix into account,
whether you--and there are various ways you could do that--but
including not applying the index to the disabled or making a
commitment that the disabled would receive payment----
Mr. Spratt. Then you would have disabled beneficiaries
receiving a return higher than comparable age beneficiaries
would receive at retirement who worked a whole 35, 40 years.
Secretary Snow. Now, you are putting your finger on the
very reason the President said we want to work with Congress to
find the answers.
Mr. Spratt. Well, now you are passing the buck.
Secretary Snow. Well, no, I am not.
Mr. Spratt. I am asking you for what your proposal----
Secretary Snow. I am saying this is an issue on which I
think the administration and Congress should, should spend a
lot of time focusing.
Mr. Spratt. Well, what you are giving me as a fairly
inchoate picture of what has been developed at this point in
time. We have still got a very, very great number of items of
fundamental vital importance that have to be defined before
anybody can pass judgment on the validity of the attractiveness
of this system.
Secretary Snow. As the chairman said in his well-put
opening comments, we are really trying to make sure we have an
agreement on the nature of the problem. If we can have an
agreement on the nature of the problem, I think finding the
answers will come, will come a lot more readily.
We are prepared to work with you, Mr. Spratt, on the
answers. But I think finding the answers depends on having some
agreement whether or not the Social Security actuary is right
in saying that, in 2018, the outflow exceeds the inflow.
Mr. Spratt. Well, wait now, the outflow does not exceed the
inflow if you pay interest on your bonds. If you are paying
interest on your bonds and add that to the inflow, then the
inflow exceeds the outflow in 2018.
Secretary Snow. I am saying the current system, if we could
have agreement, that the current system was unaltered, just on
its own, the way it is running, will be--produce inflows that
are less than outflows in 2018 and will produce in 2042 an
inability to pay the benefits then scheduled, that would be the
basis for finding, I think, foundation for a discussion to
produce some answers. But I am not sure we are there yet.
Mr. Spratt. Well, I do not think we are there either. I
mean, I think we have got a massive amount of detail and
information necessary to flesh out this proposal. You would
agree, I take it?
Secretary Snow. I do not. I do not agree that the problem
has not been well defined. I think the actuary, I think CBO has
been helpful.
Mr. Spratt. We cannot even agree on the method about which
insolvency is to be achieved, about whether or not the
reindexation of the primary insurance amount plays in that.
Secretary Snow. What I think we do agree--all--I think
everybody who has looked at this has agreed, everybody who has
looked at it in a serious way, from an actuarial point of view,
everyone has agreed his system is not on a firm foundation. The
system is in trouble. The President has said we have looked at
this in the past and we said, let us have a temporary fix.
All we have ever had is temporary fixes, and all we have
done is kick the problem down the road to future Congresses and
future administrations. He is saying--I think he is to be
commended for it--he has said let us get a permanent fix, let
us really fix this thing right, let us not kick it down the
road. Let us not kick it to another Congress. I think that is
commendable.
Mr. Spratt. Let me go back to words you use, this is not on
a firm foundation, I will grant you, we have a problem in 2042.
The easier, sooner we agree with it, the better it will be. But
as to the foundation, in 2018, Social Security is sitting on $5
trillion to $6 trillion in Treasury bonds; 2028, the amount of
nest egg actually increases to $7 trillion. That is a pretty
firm foundation for us to stand on while we try to work out a
good sensible, fair and operable solution; isn't it?
Secretary Snow. But the sooner we get to it, the better.
Mr. Spratt. No question about it.
Secretary Snow. The sooner we get to it is better for you
and I, I think. If we do not get to it, that surplus gets
exhausted and funded from some source----
Mr. Spratt. No question about it. You keep saying 2018, and
I keep saying, wait a minute, $5 or $6 trillion in Treasury
bonds. That is pretty liquid.
Secretary Snow. But it has to be financed. It has to be
financed, and the--and I think it is by 2040 or so, the whole
that has to be financed is on the order of $600 billion.
Mr. Spratt. One final question.
To me, it is obligations under the proposal that you are
formulating. Social Security or the general fund of the
Treasury will have to borrow substantial sums after 2020 to
make up for the deficiency in the trust fund which is
aggravated by the fact that you are going to be diverting a
third of the revenues away from it.
How far and how much from that point onward do you have to
borrow? When do you cease having to borrow money? Is it 2062?
Secretary Snow. Yes. I wish--I do not want to be evasive or
sound evasive. It depends on what the fixes are we come up
with. There are fixes that would have it in that timeframe.
There are fixes that would have it sooner. There are fixes that
would have it later. It really depends on what the ultimate
solution is.
Secretary Snow. Give us an approximation, the average and
likely proposal you are going to make. Is it around 2062 you
will be borrowing money to supplant, replace the benefits of
Social Security? Some timeframe like that, you know, depending
on--take 10, 15 years, either side of it, depending on what the
form of the ultimate--the resolution is. But I will grant you
that.
Mr. Spratt. Thank you, sir, I appreciate your answers.
Chairman Nussle. Mr. Portman.
Mr. Portman. Thank you, Mr. Chairman.
Mr. Secretary, I thank you for being with us today and
getting into some of the details of Social Security. This is
the Budget Committee, so I will start by commending you on your
budget which does restrain spending and does promote economic
growth while funding our key priorities, and we know that is
the magic. We did it back in the late 1990s, to getting back to
fiscal discipline. I think your budget presentation made by
Joshua Bolten yesterday does exactly that.
On Social Security, I wish I had more time. But I guess my
response to my friend, Mr. Spratt, he knows I respect him, you
know, you cannot have it both ways. I think we are totally
irresponsible, as Members of Congress, to be telling our
constituents that the trust fund will be in a position to fund
Social Security without sacrifice.
You know, what the trust fund is, thanks to Congress, you
know, over the last 30-plus years, is something that we have
borrowed from. And we borrowed from it today, and our deficit
numbers reflect that. In other words, there is more than there
should be. For us to sit here and say we are concerned about
the costs of personal accounts, and there is a transition
financing to personal accounts but we are not worried about
financing the $5 or $6 trillion trust fund deficit, I think is
irresponsible.
I think Members of Congress need to be very careful about
this, because it is dangerously misleading to our constituents.
I mean the honest truth is, the way the trust fund works, it is
sort of like the Government reaches into its wallet, pulls out
a little money to spend and that money gets spent on everyday
purposes of government, and then we put an IOU in the coffee
can, saying I owe myself $5; that is how it has worked. I
really think we needed to be very careful about how we talk to
our constituents and deal with this issue.
Mr. Baird. Would the gentleman yield for one moment?
Mr. Portman. No, I will not, because I do not have enough
time.
Mr. Secretary, tell me, between 2018 and 2042, what is the
amount of money that the Government would need to have by
raising taxes or by borrowing more to be able to redeem the
Government bonds in the trust fund, what is that amount of
money, just between 2018 and 2042?
Secretary Snow. I think that is about $2.7, $2.8 trillion.
Mr. Portman. $2.7, $2.8 trillion. Where are we going to
come up with it folks? I mean, this is the honest truth. I know
it is painful, and it is hard for us to realize, but we have
intergovernmental debt, and we have public debt. And they are
very different things. Here, intergovernmental debt we have
borrowed against. We are borrowing against it this year.
For us to sit here and say, it is there, and it has been
there for Social Security, and there is no pain involved in
this, it is just wrong. We are going to have to raise taxes. We
are going to have to borrow. We are going to have to cut
benefits. We are going to have to do something.
On the other hand to say, gee, we cannot do these personal
accounts because they cost too much.
Mr. Secretary, you said the $100 invested in personal
accounts for 40 years would be a lot more than $100. I am
assuming a 5 percent rate of return, which I think is
conservative. That is $704; $100 becomes $704; $10,000 becomes
$70, $100 becomes $100,000. I mean, $100 becomes $700,000. This
is what Einstein talked about, the magic, the greatest force in
the universe, the power of compounding interest. That is what
we are talking about here.
Yes, it is not cost-free in the interim period, but it
actually, it actually helped solve the Social Security problem
because of this buildup of assets, and the fact that then
Social Security will have less of a responsibility for those
people who choose voluntarily to get into the personal
accounts.
That is why it is such an exciting proposal and why I
strongly support it. Yes, we need to deal with the transition
financing, and we will. But we need to do so understanding that
the other option of relying on the $5 or $6 or $7 trillion in
trust fund is not cost-free either, and we ought not to mislead
our constituents about that.
In terms of the funds that would be used for the personal
accounts, Mr. Secretary, you indicated that it is different
because it is money that would go into savings. I would agree
with that. But also it is different--isn't it--because it
defrays our long-term liabilities. Can you talk a little about
that as well?
Secretary Snow. Yes, absolutely. Remember what is being
done here. According to Social Security actuary, there is a
$3.7 trillion hole, obligation, unfunded obligation of the
United States over the 75-year horizon, and it is $10.4 over
the permanent horizon, rising at about $600 billion a year.
What the proposal does is not only create a better
retirement than Social Security can make available for younger
people and future generations, but it defeases that obligation.
It removes that obligation.
That is why I said earlier, Mr. Portman, that Wall Street
looks favorably on this, because they know that we are
improving the balance sheet of the United States. We are
putting our long-term fiscal house in order.
Mr. Portman. So it is borrowing that goes into savings, and
it is borrowing that goes into defraying the liabilities we all
know exist in Social Security.
Let me just give you one final fact: That $100 you talked
about--assuming a 5 percent rate of return--becomes $704. That
is the 24-year-old you talked about. For that same 24-year-old,
who will get on average, we are told, who will get a 1.8
percent rate of return under the Social Security, that $100
that person would invest in Social Security would result in a
$204 return; $704 versus $204.
Thank you, Mr. Secretary.
Secretary Snow. Yes. One way of thinking about your
younger--about that person and your children--is that they
become owners in America, investors in America in exchange for
being creditors on a Government promise that cannot be
fulfilled.
Chairman Nussle. Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
Thank you, Mr. Chairman.
Thank you, Mr. Secretary, for being here today. Mr.
Chairman made the statement during his opening remarks that
members and politicians do not look beyond the next election. I
want to respectfully take issue with that, because I am very,
very concerned about my children, about my six grandchildren
and their contemporaries out there and how they are going to
dig out of this financial hole that we are putting them in
right now.
We have a $7.6 trillion national debt in this country. We
are paying almost $1 billion a day in interest on our national
debt. Deficits are running well over $400 billion a year. I
think, respectfully, we need to change the way we are doing
business in this country, and this should not--should not--be
about Democrats and Republicans. We are all in this together. I
do, really do have grave concerns about the future generations
in this country if we do not turn things around.
You said, Mr. Secretary, how can the trust funds be
replenished and how can we achieve a solvency here?
Yesterday, Mr. Secretary, I filed a bill that is called
the--well, it does not matter what it is called--but what it
will do is establish a true, a true trust fund. That would save
the American people. Money that comes in for Social Security
taxes cannot be used for even worthwhile programs such as
education, healthcare, tax cuts, Iraq, anything else, but has
to be set aside and saved for Social Security purposes in the
future. That does not totally solve this problem of solvency of
Social Security over the next few years, and I think every
member in this room--and I hope probably in the Congress--
believes there is a problem, maybe not a crisis, but a problem
that needs to be addressed sooner rather than later.
I would hope that we would start to be honest with the
American people--and I do not think most people out there
understand that the money that does come into the Social
Security trust fundright now is used for every other purpose,
and it is just not there--and we say, look up here, but do not
look at what we are doing with the money down on the other
hand.
We need to start, I think, setting aside the money and
preserving it for the intention and intended purpose. If we did
that, again, we would be several steps in the right direction
of extending the life of Social Security into probably several
decades into the future.
I want to ask a question though about this. I saw in the
paper this morning, The New York Times, about a $720 billion
estimated cost by the administration, just came out over, the
next 10 years for the Medicare drug program. I do not know if
you have seen that, Mr. Secretary, or if you are aware of that
announcement.
Secretary Snow. Not--I saw the headline in The New York
Times, but I have not yet had an opportunity to really study
the issue, Mr. Congressman.
Mr. Moore. All right. Well, apparently some administration
official offered an estimate of the cost of the Medicare drug
benefit Tuesday saying it would cost $720 in the next 20 years.
Congress has told us it would cost $24 billion. I do not want
to get into all that.
I do want to say this: It does cost a lot of money, a drug
benefit through Medicare. What I handed you right before this
meeting started was what I proposed--another bill I filed
called the Meds Act.
Back in 1992, the Secretary of Veterans Affairs was given
the authority under Federal law to negotiate with
pharmaceutical companies on behalf of about 25 million veterans
for lower pharmaceutical drug prices. We have 44 million
Medicare beneficiaries in this country. Each one right now is a
one-person buying group. If we were to get a group discount for
44 million Medicare beneficiaries, I would think they would
achieve the same kinds of savings hopefully that the veterans
would have. The veterans I had talked to are pretty pleased
with the benefit they get. I would ask you to go back to the
administration and ask them to consider something like this.
This was specifically prohibited in the Medicare bill that
Congress passed, and I think it would be a--I would ask you if
you have any comments on that, Mr. Secretary.
Secretary Snow. Congressman, I remember when we were at
that nice luncheon in Kansas City when a subject like this came
up. You were thinking about it then and yet put it into the
form of legislation--let me just say----
Mr. Moore. Thank you.
Secretary Snow. I would be delighted to look at it and give
you some thoughts on it.
Mr. Moore. Thank you.
The last issue I want to raise with you, and I am out of
time, is this: I was with our European counterparts, NATO
allies, in mid-November last year, and they raised the
prospects of our $7.6 trillion debt. They talked about the fact
that foreign nations, European countries, Japan and even China
are financing our debt, a financial portion of our debt.
They said they are concerned about the value of the dollar
and what is going to happen in the future.
Should we be concerned about that, Mr. Secretary?
Secretary Snow. Not if we do the right things, and we are
trying to do the right things, and not if other people who have
a responsible role to play here do the right things as well.
The current account deficit is--again, we have talked about
this in Kansas City. The current account deficit is really the
difference between the rate of savings in the United States,
domestic savings, and domestic investment opportunities.
Right now, with our economy doing so well and growing so
fast relative to our trading partners, we are creating a lot
more investment opportunities in the United States than we are
savings, so we need to borrow from others to finance the good
investment opportunities in the United States. It would help if
trading partners would grow faster. We are talking to our
trading partners about doing that and the things they could do
to grow faster. It would be helpful if we could save more. That
is where the deficit is so important, because if we save more,
we eliminate a source of dis-savings.
Alan Greenspan, Chairman Greenspan, gave a speech a few
days ago, saying that he thought the current deficit was in the
process of turning the corner and cresting and coming back the
other way. I think there are some reasons to think that that
truly is the case. It would be helpful on that score if China
would move to a more flexible exchange rate and go through the
process of letting their currency be set more in open
competitive markets rather than set by administrative fiat.
Mr. Moore. Thank you, sir.
Chairman Nussle. Mr. Wicker.
Mr. Wicker. Thank you, Mr. Chairman.
Thank you, Mr. Secretary, for your testimony.
Let me follow up on a point that Mr. Portman was making.
Right now, say you have got a couple out there in their late
20s, early 30s, got a couple of kids, and they are struggling
along trying to pay their bills. Right now, we are taking 6.2
percent of everything they make in FICA taxes.
As I understand it, what we are promising them right now is
something that is going to get them somewhere around a 1
percent return when they finally get to retirement age, plus or
minus, but it is a very low 1 percent return. Is that right,
Mr. Secretary?
Secretary Snow. It is. It is a very low return.
Mr. Wicker. Let me just observe: If we could do better than
that for our hardworking families out there, we ought to do
better than that. We ought to take action that gets them a
better return if we are going to take that much out of their
paycheck.
I was gratified to hear our ranking member acknowledge that
there is a problem. I mean, I think that is a start. There is a
question about whether it is a crisis or how urgent it is. But
at least we are all acknowledging that there is a problem.
Now, in the past, when Congress has decided to address the
problem, they have done what I think you referred to, Mr.
Secretary, as a temporary fix, kicking the can down the road
for a few years.
There are things that we could do again, totally different
from what I think the President is going to propose. We could
adopt a means test for benefits in the future. In other words,
we could take 6.2 percent of people's money--and they get to
certain income levels--and say, well, you are not going to get
it anyway. We could reduce benefits. Certainly, Congress has,
in the past, raised the payroll tax. We could, again, raise the
retirement age. Congress did that many years ago. It is just
now sort of coming home to roost there. We could increase the
earnings limit. Without doing anything else, we could adopt a
lower cost-of-living index. All of those things, I think, are
not going to be very popular among the American people.
But let me ask you, if we did any of that, would it help
that young couple that is 29-years-old or in their early 30s
with two kids and paying 6.2 percent of everything they make,
would it help them get a better return at the end of the day?
Secretary Snow. It would, Congressman, that is a good way
to frame the issue. It would if the personal retirement
accounts are included as part of this as well.
Mr. Wicker. OK. But I am not hearing much support from my
friends on the left about the personal retirement accounts.
Absent the personal retirement accounts, kicking the can down
the road, means testing, reducing benefits long-term, raising
taxes, raising the retirement age, raising their earnings
limit, that still gives that couple 1 percent at the end of
their working life, doesn't it?
Secretary Snow. I think that is right, and that is why the
opportunity the personal retirement account affords people
should be part of any solution, because it does give them--I
think the math on this is irrefutable. Congressman Portman took
you through some of it, but the math on this is irrefutable.
For a young person who has 40 years or 45 years to put away
money and who earns the long-term average of a blended bond in
equity, they are going to come out way, way, way ahead of that
1 percent.
Mr. Wicker. Right, but let me agree with a very important
point the ranking member made. It is going to help when we can
get specifics on the administration's proposal, because I
certainly appreciate that you cannot answer the very specific
questions that members on both sides of the aisle have, until
we do get the specifics.
But I do understand that whatever the administration
proposes, it is going to be voluntary, is that correct?
Secretary Snow. Absolutely. In other words, that couple can
decide to get into personal savings accounts, or they can stay
with their 1 percent for whatever reason.
Also, there is going to be the same guaranteed benefit at
the end of the day and whatever the administration proposal is.
We are not just going to hang them out there to float.
Secretary Snow. The whole proposal is voluntary for younger
people. Of course, not available to 55 and older who are--all
their benefits will be secured.
Mr. Wicker. Yes, I would think you may start getting a few
complaints from those 55 years of age and older that they
cannot buy into these personal accounts.
But thank you very much for your testimony.
Chairman Nussle. Mr. Edwards.
Mr. Edwards. Thank you, Mr. Chairman.
Let me just say, what I am observing is that the same
people who, I assume, in good faith 4 years ago, 3 years ago, 2
years ago, wrote partisan budgets that turned a $270 billion a
year Federal surplus in 3 years to the largest deficits in
American history, having broken the promise that they could
pass tax cuts and balance the budget, are now promising
American people that to privatize the Social Security system is
going to be better for them than a system that has been so
deeply respected by generations of Americans.
I think their promise that this Social Security
privatization plan is going to help seniors, unfortunately,
will be about as realistic as their promise that we could fight
a war on terrorism, pass massive tax cuts and balance the
budget. In regard to Mr. Portman's comment, I want to commend
you, it is irresponsible to not recognize the cost of replacing
the money borrowed from the Social Security trust fund,
although I would point out that much of that borrowing occurred
because the partisan budget passed much of the Republican
leadership in the last 4 years.
But what I would say is, I wish the gentleman had made the
statement 4 years ago, or at least listened to Democrats when
we were making that statement, saying the cost of long-term
Social Security is one of the reasons we needed to take
advantage of the surplus of the $276 billion of the Clinton
administration era and pay down our Nation's debt.
I think it was irresponsible for Republicans to not listen
to Democrats for 4 years who urged our colleagues and said we
cannot afford, given our long-term liabilities in this
Government, to pass trillion after trillion dollar tax cut that
is unpaid for.
In regard to a couple of comments made by Secretary Snow:
Mr. Secretary, you said the problem is, we spent too much. Let
me just say, for the record--and this is factual--that the Bush
administration has proposed significant increases in three of
the five largest Federal programs that, out of thousands of
programs, represent $2 out of every $3 spent by the Federal
Government.
In terms of tax cuts, lending and economic growth, I am not
sure that cause and effect has really been proven. It has been
alleged. I am not sure it has been proven. But the tradition
generally is that, coming out of recessions, you have economic
growth.
It kind of reminds me, down in Texas, we have some roosters
that think that they are the reason the sun rises in the east,
because they crow every day and the sun comes up; not long
after that, the sun comes up in the east.
I am not sure that allegation has been proven. But what I
do know is that the former Bush administration White House
economic official who now heads up the nonpartisan
Congressional Budget Office testified after doing a long report
on tax cuts and borrowing to pay for them, said that, in the
long run, paying for tax cuts by borrowing billions of dollars
from American citizens and the communist Chinese and other
foreign countries hurts economic growth, not helps economic
growth.
So I do not buy into the allegation, unproven, that somehow
massive tax cuts paid for by borrowing has somehow led to
economic growth.
Mr. Secretary, in terms of Social Security, let me just ask
you if you could give me quick yes or no answers or specific
answers without elaboration:
When does the Social Security trust fund go insolvent,
according to your numbers, what year? Just the year is all I
need.
Secretary Snow. 2042 is the bankruptcy.
Mr. Edwards. OK. When does the Medicare trust fund go
insolvent, according to your numbers?
Secretary Snow. I would have to check. I have not viewed
the Medicare actuary's report here recently, but it is headed
in the same way.
Mr. Edwards. But the Secretary full well knows that the
Medicare trust fund is going to be insolvent long before the
Social Security trust fund.
Now the chairman said his 14-year-old son, according to the
charts, will not get Social Security.
Mr. Secretary, factually, if no changes are made in Social
Security, and we simply respect the legal obligations we owe
the Social Security trust fund, is it, in fact, true that
someone in his teens or 20s or 30s will receive no Social
Security benefits?
I believe that is a false statement, and it is a myth that
is been perpetrated on the younger generation. Isn't it in fact
true that Social Security beneficiaries that are in their 20s
today--and they become beneficiaries--would actually get
somewhere--estimates are 70 to 80 percent of present-day
benefits if no changes were made? Isn't that correct?
Secretary Snow. Yes. I think the trust fund in 2042 can pay
out about 70 percent, 72 percent. That declines with----
Mr. Edwards. OK. But the statement is, it is simply false,
that teenagers and young people in their 20s and 30s would not
get any Social Security benefits if we do not change the law. I
do not think we ought to build the change on the most important
social-problem safety net in the Nation's history based on a
false myth.
Mr. Portman [presiding]. Let us see, who is next?
Mr. Bonner for 5 minutes.
Mr. Bonner. Thank you, Mr. Chairman.
Mr. Secretary, it is good to have you here today, and I am
glad you are sitting down.
Yesterday, I was reflecting when I was a freshman 2 years
ago, when I was sitting on the front row where my friend
Mr. Lungren from California is sitting, and I always had a
great view of the witnesses. And the people on this row had a
great view of my bald head. So I am glad to have this good view
of you today.
I am sad, though, that both yesterday with the OMB director
and today, it seems that the talk of bipartisanship and the
talk of Democrats and Republicans working together as Americans
is nothing more than just that, and that is frustrating. I know
it has got to be frustrating to you.
I referred to an article that was in yesterday's Hill
newspaper. For now, Democrats will offer no Social Security
reforms. It is much as the statements yesterday with OMB
director were made. On the one hand, the blasting criticism,
waxing nostalgic for the glory years of the Clinton
administration when all these surpluses were created, and yet
then turning around with the same blasting criticism that all
of these cuts are punitive--that the President's budget has
proposed--and these cuts are going to be Draconian to the
social problems, many of which were created by Great Society in
the New Deal.
I think it is frustrating for some of us people on this
side to hear people, because we know when we have a vote on the
budget, Mr. Edwards, there will be amendment after amendment
after amendment offered by members on the other side that will
raise money for all of these wonderful programs to put us in an
awkward position. Because if we vote against it, then that
becomes a campaign commercial back home because we are voting
against these programs.
Mr. Secretary, if we do nothing, if we do nothing, and the
President could have come to the Congress last week with the
State of the Union and said: Look, I inherited a recession, and
we dealt with it, and we have turned it around, and we are now
creating jobs and the economy is growing.
We inherited 9/11 because, in a large part, of failed
attempts in the past on both sides to take aggressive actions
against terrorists, but we inherited 9/11, and we are having to
pay for 9/11 now.
Ladies and gentlemen, I am going to take a break. I am not
doing to dig deep into this issue. We could have taken a pass
on it. Instead, he did not. He is asking the American people to
engage us and him in a conversation about what is the best
thing to happen about one of America's most sacred programs,
Social Security.
So my first question is, if we do nothing, can the young
couple that Congressman Wicker is talking about have anything
to look forward to other than a measly return on a very
significant portion of their paycheck taken out each month?
Secretary Snow. No. The returns, Congressman, if nothing is
done, will be very, very slight.
In fact, for future generations, I think they will be
negative, so that you get no return on your payroll taxes. You
get a negative amount back.
No, you are right about the President. He came to
Washington to solve problems. Not to pass them on to future
presidents and future generations. I think he is saying to the
Congress, on the Democratic side, on the Republican side: If
you do not like my proposals, come up with some other ones. I
want to talk to you, I want to have a dialogue on this. I want
to find the answers.
Mr. Bonner. In fact, did he not say that in the State of
the Union message when he cited several proposals Congressman
Penny, Senator Moynihan, President Clinton and others who have
made recommendations in the past on Social Security, did he not
invite all 435 Members of Congress and the 100 Senators to come
up with other proposals as well?
Secretary Snow. Yes. Yes, he did. I think he truly is
reaching out to the Congress for a bipartisan approach to this.
Mr. Bonner. Well, Mr. Secretary, again, I want to thank you
for coming up and helping, because there are a lot of questions
that we have. This is not an easy subject. But it does not help
when people go into any conversation and say that they are
close-minded to new opportunities and to new options to
consider. To me, if you go into a discussion where you already
have said, we are not willing to consider new options, it
really says that they are really not looking to solve problems.
Thank you very much, Mr. Secretary.
Secretary Snow. Thank you, Congressman.
Mr. Portman. Mrs. Capps, for 5 minutes.
Mrs. Capps. Thank you, Mr. Chairman.
May I first respond to my colleague on the other side,
directly across from me. Mr. Bonner is being critical of our
side for not having a proposal and I would only respectfully
recall the interchange between our ranking member, Mr. Spratt,
and the Secretary, trying to elicit details of the President's
proposal. Those details are woefully missing, and it is hard to
respond to something which is lacking in substance. So we await
further discussion.
But now, Mr. Secretary, thank you for appearing today.
The administration has expressed serious interest in
limiting initial benefit levels to the growth at the rate of
prices rather than the growth in rate of wages. This would mean
a basic benefit cut over the next 50 years of over 40 to 50
percent. Wouldn't this undercut Social Security's ability to
help seniors maintain their standard of living in their
retirement?
Secretary Snow. Congresswoman Capps, we have not embraced
Model 2, which I think is the Social Security Model 2, which I
think is the one that has the index, going from wages to
prices. The President did mention that as an option in the
State of the Union message along with a variety, a variety of
other options.
By going to the Model 2-type solution, you actually
overcorrect the problem, as I understand Model 2. It has a
solution which is 100 percent plus of the deficiency of the
shortfall in Social Security. I do not think we would ever
recommend that.
But even Model 2, as long as there are personal accounts
giving the retiree, the beneficiary, the chance to come out
ahead of where they would if we simply leave the system on
automatic.
Mrs. Capps. So I hear you saying that model which the
President touted in the State of the Union does have serious
flaws.
But I want to ask you now about private accounts. You said
that--you have said that the basic benefit cut would be made up
by the value of these private accounts, which is better than
doing nothing, according to your point of view.
What happens to people whose private accounts do not pan
out? Maybe they made a bad investment choice or retire at close
to a low point in the market.
This would be then tough luck?
Secretary Snow. Well, then, the investment vehicles would
be prudent and safe. They would be quite limited. People would
be required to keep their money in those vehicles. They would
not be allowed to, you know, as the President says, go off to
the roulette wheels or the racetrack with their money. They
would have to put it in these safe vehicles, and the vehicle
would not be individual bonds or individual equities. They
would be--they would be diversified funds of bonds or equities.
Mrs. Capps. Well----
Secretary Snow. Including a so-called life cycle fund that
deals with your issue, because the life cycle fund
automatically moves the ratio of equity to debt down so that
you retire with a lot more debt of fixed income instruments
than you do equity, and that mitigates any of those concerns.
Mrs. Capps. So it is a different stock market than we know
today, perhaps.
I want to ask you about one other point I would like to
bring up. Mr. Spratt raised this issue of fully a third of the
beneficiaries who are survivors or disabled, a different
population than we usually think of when we think of Social
Security beneficiaries--many of us fall into that category.
You agree that you cannot realistically cut the benefits of
these people; correct? And so if you cannot or do not want to
cut their benefits, won't you have to cut the benefits of
retirees even more than the 40 to 50 percent Plan 2 envisions
to keep the system up? In other words, the beauty of the system
that we have today is that people with disabilities and who are
survivors are part of the larger group that is protected in
substantial ways?
Secretary Snow. Right. Well, I think that the Plan 2 has a
lot of merit to it. I would not discard it entirely. But it
does not--it does not meet the President's principle of
protecting the benefits of the disabled. So that is one of the
President's core principles, and he would want to see the
disabled protected in any legislation that came out.
Mrs. Capps. Could I ask for a further explanation of how
they would be protected?
Secretary Snow. Well, there were a variety--there were a
variety of means that could be made available to do that,
technically dealing with the bend points, technically dealing
with the crediting of years, changing the ratios, number of
years work, crediting with years worked and so on. So there are
a variety of things that can be done. The President's point is,
it should be done, and he wants to work with Congress to find
out the right way, the best way to do it.
Mrs. Capps. But the bottom line would be shifting those
costs to--well, those with private accounts?
Secretary Snow. Well, there are a variety of ways to do it
within the system. I think--I do not want to speculate on
precisely how it would be done. That would be the result of the
ensuing discussion we had hoped to have with you and Members of
the Congress.
Mrs. Capps. Thank you, Mr. Chairman.
Chairman Nussle [presiding]. Mr. Secretary, just for point
of clarification--because I have been hearing about this Plan
2--is the President's plan Plan 2?
Secretary Snow. No, no.
Chairman Nussle. OK. I just wanted to make sure because I
keep hearing this Plan 2--I see charts; Plan 2 is this, and
Plan 2 is that. I mean is it Plan 2 or isn't it Plan 2?
Secretary Snow. No, sir.
Chairman Nussle. I understand you may not have a lot of
specifics about--but, I mean, if you know that at least, let us
make sure I am----
Secretary Snow. No. The President in the State of the Union
message--I think far from what someone suggested--did lay out a
lot of details. The details went to the nature of the problem.
He defined the problem. He talked about the declining ratio of
people paying into the system to those taking out of the
system, going from 40 when it was first established, to 16 in
1950, to 3 today to 2 with the baby boomers. He talked about
the nature of the problem.
He then went on to talk in quite a bit of detail about the
personal retirement accounts, laid out how they would work.
Then, in addition, he suggested that, in addition to
private, to the personal accounts, there were some other things
that need to be considered, and he talked about the indexing,
and he talked about CPIs, and he talked about things that
Members of Congress and, I think, prior presidents have talked
about, to put them on the table to say, here are the sorts of
things we need to have in the dialogue to put Social Security
on a sustainable basis. But he did not embrace commission Plan
2.
Chairman Nussle. Thank you.
Mr. Mack for 5 minutes.
Mr. Mack. Thank you, Mr. Chairman.
Thank you, Mr. Snow for being here.
Secretary Snow. Thank you.
Mr. Mack. It is a great opportunity for me and for my
constituents, I think, to talk a little bit about the
challenges that are facing us. I think that we are--this is a
historic time as it relates to our seniors and also younger
workers.
The current system is broken. I hear a lot of talk about,
you know, when is it--you know, is it broken now? Is it broken
in 18 years? Is it broken then in 2042? When is it broken?
But it is broken, and it needs to be fixed. And I commend
the President for taking this issue on. That is exactly what we
need in leadership, is someone who is willing to take the tough
issues on. It is long overdue, and I believe it needs to
include all citizens from every walk of life.
I know that this process will not be short, and I know it
will not be easy, but I think the debate is an important one to
have, and I think we should all agree to that.
You know, as a parent, I do not believe that I would
recommend to my children as they get older to buy a house that
is built on a faulty foundation. That just would not be
appropriate. It would not be the right thing to do. It would
not be a loving thing to do as a parent, to recommend to your
children to buy a home that is on a faulty foundation.
I just would like to give you an opportunity, if you would,
to talk to us a little bit about the benefits of taking this
issue on now instead of waiting for later, as someone suggested
to do--you know, let us wait 5, 10, 20, 30 years down the
road--talk about the benefits of taking this issue on now and
getting this in a sound position now, rather than later.
Secretary Snow. Congressman, thank you for that, those
comments and the question and the opportunity that gives me.
Somebody has said that you do not--as you were suggesting--
you do not wait until you are in a crisis to deal with it. You
try and anticipate a crisis and avoid it. If you know that the
girders in your house, as somebody said, are weak, you do not
wait up till they fall down to fix it. You fix it before they
fall down. The reason, the reason to deal with this now, of
course, is that we have a lot more options available to us. It
is less costly to fix it now. The longer we wait, the bigger
the problem becomes.
The longer we wait, the more prejudicial the outcome will
be. The less beneficial, the more prejudicial the outcome will
be to your children and to future generations, because by
starting it now, by getting it under way, they will be able to
use this power of compounding over a long lifetime of work and
thus build much bigger accounts and a much better, a much
better retirement.
According to the Social Security actuary, every year we
wait, the problem grows by about $600 billion.
Now, even by Washington standards, that is an awful lot of
money. To have it growing every year at that rate means that
this $10.4 trillion present value obligation becomes larger and
larger and larger, overwhelmingly large.
What we are talking about here is the fiscal future of the
United States, and the fiscal and the retirement future of
future generations. That is what this issue is about. The
sooner we get about it, the more we fulfill our obligations, I
think, as public servants to both our children, future
generations and to the financial and fiscal well-being of our
country.
Mr. Mack. Thank you, and what was that number again, $600
billion and what every year?
Secretary Snow. Billion, rising, the 10.4 is rising,
according to the Social Security actuary. These numbers we cite
are not our numbers; sometimes people say, ``those are your
numbers, they are not our numbers.'' we are using the numbers
that come from the actuary of the Social Security
Administration, a nonpartisan actuary.
Mr. Cooper. Thank you very much.
Chairman Nussle. Mr. Cooper, for 5 minutes.
Mr. Cooper. Thank you, Mr. Chairman.
Mr. Secretary, on page 149 of the December 2001
Presidential Commission on Social Security Reform, they talk
about the disability program under Social Security. Many of the
comments of my colleagues have talked about the retirement
program for Social Security.
Secretary Snow. Right.
Mr. Cooper. But it is well-known, or should be to everyone,
that Social Security really has three benefits: The retirement
plan, the survivors benefit, and the disability benefit.
Now this commission in 2001 did a lot of great work. But I
believe this is accurate to say that, regarding disability,
they were unable to come to a conclusion. They said, in fact,
that the benefit was a little bit too complicated for them to
deal with.
So I would like to ask you today, since the administration
is planning on changing one of its most popular and successful
programs in American history, I would like to ask you about
that disability element.
If a young person or middle-aged person or older person
wanted to go out on the marketplace today, could they buy a
benefit, a disability benefit, like the one in Social Security?
Could they buy such a benefit from a private company? If so,
what would the premium be?
Secretary Snow. I think disability benefits are available
in the open market. It would depend an awful lot on whether you
are a violin player, a major league baseball player or you are
climbing trees or working off 100-story buildings in New York
City.
So it is a little hard to answer the question in the
abstract without knowing the details of the individual.
Mr. Cooper. Well, let me get more specific.
Since you are part of an administration proposing this
fundamental change for all Americans, what is the valuation you
would put today on the benefit that is available under Social
Security disability? What is that worth actuarially?
Secretary Snow. We will see if we have a number. I have not
seen the actuary's valuation of the disability benefits
implicit in the Social Security system.
But what the President has said--and maybe this cuts to the
chase--what the President has said is, he wants to sustain,
protect, secure, make safe the disability benefits.
Mr. Cooper. But all the estimates that we have seen involve
out-year cuts and benefits, not sustain those benefits, so I
think it is crucial for the administration, if they want to
change the system, to know the value of what they are changing.
It is my understanding--and I do not have the power that a
Secretary of the Treasury does--it is my understanding that a
disability benefit of this type is unavailable from any
commercial source in the world today.
Now, perhaps I am mistaken in that, and perhaps you can
find a seller of disability insurance that is as good or better
than Social Security is. I would love to have that information.
So if you could supply that.
Secretary Snow. We will. I will check on that, and I will
check on the actuary's rendering of the valuation of
disabilities as well.
Mr. Cooper. But let me express some concern about your
preliminary answer though. You said, if you were to buy a
disability today, it might depend on if you were a violinist,
had some other job or worked on 100-story buildings.
But one of the great benefits of Social Security is it does
not matter what your job is as long as you pay into the system.
It protects everybody equally.
Because it is hard to predict, especially in this modern
life, what career you are going to have. It is certainly hard
to predict your health situation. You were unable to attend a
meeting last week because of your health, and that was
unexpected.
So the value of that disability benefit has to be valued
before the administration takes liberties with it.
Let me ask another question.
Secretary Snow. I agree with you. Disability is an
important, critically important part of Social Security, and we
want to sustain the benefits of Social Security.
Mr. Cooper. I see your brain trust behind you. Do any of
them have any idea what the current value of the disability is?
Brain trust?
Chairman Nussle. Well, this is--the gentleman will suspend.
The Secretary has been asked to testify. If he would like to
refer to them for an answer, otherwise he has offered to give
you that answer in the future.
So we will conduct the hearing here.
Thank you.
Mr. Cooper is recognized for the balance of his time.
Mr. Cooper. Thank you, Mr. Chairman.
Another fundamental area to ask. It is one thing to take
the existing Social Security pie and reslice that, and some
folks may advocate partial privatization of the system. Others
may not.
But basically, you are just reslicing the same pie. What is
the administration proposing to actually grow the pie to
increase the amount of money that average Americans are able to
save every year? Today, we have many wonderful ways of doing
that--IRAs; 401(k)s; SEPs; other good savings programs; but
many Americans are not fully utilizing those savings vehicles.
What can we do to grow the savings rate in this country?
Secretary Snow. Probably the single most important thing
you can do to grow the savings rate in this country and thus
help people have secureretirements is to adopt the President's
personal savings account as a part of fixing Social Security.
Mr. Cooper. Mr. Secretary.
Secretary Snow. That is real savings, that is genuine
savings.
Mr. Cooper. No.
Mr. Secretary, under the President's proposal he would take
up to 4 percent of what is being paid into the current system.
He is not suggesting a plan that would really boost savings and
additional vehicles on top of the amount that would be
allocated to Social Security. He is just talking about
reshuffling that.
Secretary Snow. In fact he is, Congressman, in fact, in the
budget, you will see a section on lifetime savings accounts,
retirement savings accounts, employer savings accounts for
employees. No, we recognize--as I responded earlier in--on the
current account question--we need to encourage more savings in
the United States. The budget reflects the need to do that.
But I would say that, in addition to all the things in the
budget, the personal retirement accounts that the President is
proposing are one other important way, because people will
then, say, accumulate, accumulate a nest egg through power of
compounding, have more at the end than they otherwise would
have; by far, earn rates of return far higher than they could
secure under the Social Security system.
Mr. Cooper. You say that as if it were a guarantee.
Chairman Nussle. The gentleman's time has expired.
Mr. Hensarling for 5 minutes.
Mr. Hensarling. Thank you, Mr. Chairman.
Mr. Secretary, I want to start out thanking you and the
President. As the father of two in diapers who knows a whole
lot more about Barney and Big Bird than Social Security, I
cannot tell you how much it warms my heart that somebody is
looking out for the next generation and not the next election.
There was an old advertising campaign many, many years ago
by a company, I believe, called AAMCO Transmissions. The tag
line was: You can pay me now or you can pay me later. I think
the idea was that, if you had maintained your transmission and
spent a couple of hundred dollars today, the thing would not
completely go bust on you so that you would have to pay $2,000
later and replace that transmission.
I am sitting here looking--I am jumping the gun a little
bit. But I have a GAO report here. I want to make sure we are
all focused on this figure. If I am reading it correctly, our
unfunded obligation to Social Security is $10.4 trillion. We
were getting into a little bit of discussion of what an
administration plan might cost. I have seen other plans that
have transition financing, perhaps $1 trillion, a very large
sum of money; but last I looked, a whole lot smaller than $10.4
trillion. So, ultimately, to save Social Security, we will be
saving not only Social Security, but we will be saving
taxpayers money.
Secretary Snow. Well, absolutely, Congressman. That is a
critical point here.
One way to look at this is $10.4 trillion obligation out
there, and on a present value basis, you might spend $2
trillion to defease it. What sensible business person would not
spend $2 to get $10? That is the reality of what we are doing
here. We are defeasing. We are removing a huge overhang
liability on the balance sheet of the United States. And in the
process we are also creating greater prosperity for future
generations.
Mr. Hensarling. Well, if I could ask you, and my second
question here is we have heard a lot of talk of massive
borrowing, how that could impact markets in order to save
Social Security. If I have done my homework right, over the
last 10 years, we as Congress have grown the size of the
Government at an average of 4.5 percent a year, which is
roughly twice the rate of inflation, and at least 50 percent
greater than the family budget is measured by median worker
income.
I want to congratulate you and the President again, and the
administration for submitting a fiscally responsible budget
that will help save the family budget from the Federal budget.
But my question is this: If we could just simply institute
some fiscal discipline in this institution, and say we grew
Government somewhere in the range of 3 to 3.5 percent a year
instead of our traditional pattern of 4.5 percent a year over
the last 10 years, and if we managed to save the remaining
Social Security surpluses, wouldn't that take us a long way
toward coming up with the transition financing to save Social
Security?
Secretary Snow. Well, certainly, if we could hold spending
to the sorts of numbers we are talking about and sustain the
sort of growth in the economy that we have got that is
producing increases in Government receipts at well above the
growth levels you are talking about on spending, you would be
quickly getting the finances of the United States into strong
and good shape. Absolutely.
Mr. Hensarling. Thank you. My next question. I don't have
the chart at my fingertips, but I have seen a chart from GAO
before that has persuaded me that my grandparents, who were
born at roughly the last turn of the century, received roughly
an 11 to 12 percent rate of return on their Social Security. My
parents, who were born in the late 1920s, early 1930s,
apparently are receiving a roughly 7 percent rate of return on
their Social Security. And it is an important part of their
retirement. I believe that I am going to receive somewhere in
the neighborhood of maybe a 2.5 percent rate of return on my
Social Security. My daughter, who is almost three, and my son
who is 16 months old, I believe could actually see a negative
rate of return.
I guess two questions. One, is that possible? And, if so,
what has happened to the security of Social Security if we do
that to future generations?
Secretary Snow. Well, your numbers are right in the
ballpark. Early generation did very well. Of course, some of
them didn't pay in very long and had long lives, retirement
lives, and collected for a long time. This is all really a
matter of basic arithmetic, and the arithmetic is compelling.
We have gone from having many, many people working and paying
for every retiree to having fewer and fewer, and we are facing
now, with the baby boomer retirees coming on stream, having
only two people paying in for every retiree.
Now, a pay-as-you-go system--and this is a pay as you go
system--works real well when you have got, you know, when you
talk about your grandparents there were 50 people paying in for
every retiree. And then, you know, back 50 years ago there were
16. Today there are 3. We are going to 2. The system just
doesn't hold together. It is a matter of basic arithmetic. And
the rates of return of future generations will clearly be
negative on the path we are on.
Chairman Nussle. Mr. Secretary, it is my understanding you
have to be walking out the door at 1:00 p.m., and we are told
that we are going to have four, maybe five procedural votes on
the floor coming up here at any moment. So what I am going to
do is to keep going around to talk to the Secretary here. But
when the votes are called, what I will do is I will dismiss the
first panel so that you can make your appointment, and we will
take the second panel. What we will do with members, unless
there is objection, I would like to continue down the row in
calling people so that they can continue.
We have a lot of members who want to participate in this,
and I don't want to start all over with the senior members and
have to work back to you. You have been very patient, our new
members in particular. So I would like to continue that, unless
I hear a strong objection. So, without objection, we will do
that.
Mr. Davis for 5 minutes.
Mr. Davis. Thank you, Mr. Chairman, and Mr. Secretary.
Let me if I can go back to a line of questions that the
ranking member on this committee pursued with you earlier. The
two of you talked about the relative difference in the size of
extending the President's tax cuts and of the actual amount of
the Social Security shortfall. And your answer was a fairly
familiar one. You were saying that if we walk away from
extending the tax cuts, that it will cause us economic damage.
So I want to test that proposition a little bit.
You agree that we had a pretty robust rate of economic
growth from the 1990s, I would assume. Wouldn't you?
Secretary Snow. Yeah, sure.
Mr. Davis. I think your are off the microphone, but I heard
you say, yeah, sure. And I agree with you on that.
Secretary Snow. We had some good growth rates.
Unfortunately, they ended in a bad way.
Mr. Davis. Well, let me ask you about this then. Right now,
the combined level of corporate and income tax as opposed to
GDP and the combined rate of corporate and income taxes added
together is as I understand it a very low share of the GDP
today--a very high share of the GDP today. The combined rate of
corporate and income is today a very low share of our GDP
relatively speaking.
Secretary Snow. It is. We have hit--for a variety of
reasons it is low, but it is now rising and returning over the
course of this budget to its historical level of roughly 18
percent.
Mr. Davis. But just to fix the level today, it is actually
the lowest combined level since 1942, or since the middle of
World War II. Is that not correct?
Secretary Snow. As a percent of GDP, I think it is about 16
percent, which is low by historical standards, yes.
Mr. Davis. Now, in the 1990s, what was the relative rate of
income and corporate taxation of GDP?
Secretary Snow. Well, by the end of the 1990s, given the
stock market and the technology bubble, while it lasted, which
produced lots of option return and capital gains returns, the
tax returns went up to about 21.6 percent of GDP.
Mr. Davis. And, again, despite the 21 percent of GDP, we
still had a high rate of growth during that time. The reason I
make that point is that--and I think if, we went back, Mr.
Secretary, you look at 1960s, we had a fairly high rate of
growth then. Did we not?
Secretary Snow. Yeah, we had a pretty good growth rate.
Mr. Davis. We also had a very high level of taxation in the
1960s. Didn't we?
Secretary Snow. Well, thanks to President Kennedy, we got
them lower.
Mr. Davis. But we still had a relatively high rate of
taxation combining corporation and income. In fact, the rate of
the 1960s was once again higher than the rate today. In fact,
considerably higher than the rate today. Isn't it?
Secretary Snow. As a percent of GDP.
Mr. Davis. Percent of GDP. So, once again, we have the two
strongest growth periods since World War II, the 1960s and the
1990s, where we had very high levels of taxation, far higher
than the levels of taxation we have today as opposed to GDP.
And it is clear that was not enough to check the economic
growth. That is an important point, because I think that
significantly undermines a good deal of the administration's
argument, frankly.
I think all of us would have the perspective, Mr.
Secretary, that if we were trading away our economic future, if
we were walking away from a recovery if we didn't extend the
tax cut, particularly just the top 1 percent, I think a lot of
us on this side of the aisle would buy into your arguments. But
the problem is, you know, some of us in the room still believe
that facts are the best evidence and not just faith. And the
facts tell us that the two biggest periods of growth, the 1990s
and the 1960s, we had very high levels of taxation, and it
apparently did nothing to slow our economy.
Let me move in the limited time I have to another round of
questions or to another topic. As I understand the Social
Security Administration, they are predicting that the slow, the
shortfall of the Social Security between now and 2042, which
troubles all of us, is apparently based on a growth rate
projection of 1.8 percent. Do you agree or disagree with that?
Secretary Snow. No, that is right.
Mr. Davis. Now, 1.8 percent growth over the next 37 years,
can you think of any period since the war where we have had
over the course of one decade a growth rate of 1.8 percent?
Secretary Snow. Yes.
Mr. Davis. What would that be?
Secretary Snow. That number which comes from the actuary,
as I remember what the actuary said, the 1.8 is basically the
productivity number for the 40 or 45 year period.
Mr. Davis. But is there any comparable period, Mr.
Secretary, where we have had--because that is a very anemic
growth.
Secretary Snow. That is it, that is the 45-year period.
Mr. Davis. But is there any period since 1945--and I am
thinking in terms of decades, where we have had growth that has
been that anemic? And the proposition that I make, if the Chair
will indulge me just 15 seconds to sum up. If we had that kind
of a growth rate over the next several years, Mr. Secretary,
over the 30-some years I should say, it strikes me that it
would mean that our economy was in dire straits. And of course,
if our economy were in dire straits, it follows for some of us
that the stock market would probably be underperforming. So it
is very curious that the administration that is always
optimistic about growth is basing its Social Security program
on a growth rate line of 1.8 percent, far worse than we have
had in our recent experiences, and incredibly willing to gamble
our seniors on Social Security being invested in the stock
market. Can you respond to that?
Secretary Snow. Oh, sure. I would be delighted to, because
I think there is a huge misconception implicit in what you just
said.
The stock market correlates with productivity. There is a
recent study by a professor, I think at the University of
California who looks at over a 40, 50-year period the stock
market and what it correlates with. And the stock market best
correlates over any long period of time with productivity per
capita.
What is happening for the--and the actuary uses in that
1.8, I think 1.6 of that 1.8 which is GDP, 1.6 of the 1.8 is
the productivity. The point two is population. Now of course
the population growth of the United States is slowing, but the
productivity growth according to the actuary, which is based on
the prior 45 years, is the same.
Mr. Davis. But 1.8 is still a very slow growth rate.
Secretary Snow. No, it not. 1.8 is the historic 45-year
average productivity growth rate in the United States economy
which has produced the returns to the stock market we have seen
over that period. So the correlation is one to one.
Chairman Nussle. Mr. Simpson for 5 minutes.
Mr. Simpson. Thank you, Mr. Chairman.
And I appreciate you being here today, Mr. Secretary, and
taking the time to discuss this issue with us. First of all, in
relation to what Mr. Davis said, it was interesting as I
listened to that. I was over in Ireland earlier this year,
talked to some of the officials over there, several of them.
And they told me that about 15 years ago Ireland had the lowest
per capita income in the European Union. They currently have
the second highest per capita income in the EU next to
Luxembourg. And I said, what did you do to change that outcome?
And they said, we sat down and made some really tough
decisions, and that is that we were taxing our people too much,
that we were--that it would cost too much to produce in this
country, and we made some tough choices. And we went through
some very difficult times, but it has changed our economy
around, and essentially every major corporation in the country
now has a--in the world, has a company located in Ireland.
So, and I think you are on the right track. And I
appreciate--you know, this is something we have known ever
since Adam Smith, but we haven't always followed it. But I
appreciate the track that you are on and what you are doing for
the economy.
Secretary Snow. I visited there, myself, sometime back, and
got a first-hand conversation with the people who created the
so-called Celtic miracle, and they talked about where they were
two decades back and the transformation that has occurred,
largely because they embraced Adam Smith and market practices
and low tax rates.
Mr. Simpson. Right. I appreciate that. One of the things
that concerns me is the rhetoric that is surrounding all this
proposal, and in fact the American people out there are very
confused about whether there actually is a problem with Social
Security or not. Because when we start talking about the actual
problem, we start talking about our favored plan to solve that
problem and it gets mixed up with it, or the cause of the
problem, or whatever. What is the administration doing? I
appreciate the fact that the President has been out on the
stump the last while, and ultimately we respond to voters.
What are we doing to try to educate the American public to
the nature of the problem? Because, to me, we have got to have
a discussion with the American people about their retirement
system, and also not only that it is their system but that it
is a--as was mentioned by the chairman earlier, it is not their
total retirement system, it is supposed to be supplemental
retirement, and they need to also be saving for retirement in
other areas.
Too many people have depended on Social Security for their
total retirement fund and figured, well, the Government will
take care of that. I don't have to worry about retirement
anymore. And somehow we have got to change that attitude. But
we have to do, I think, a good job somehow of engaging the
American people in this discussion. And unfortunately what
happens right now is you have got the American senior citizens
who are very engaged in this subject who the President says
this won't affect; and I find it interesting that it is 55 and
older that are not going to have their benefits affected and
then we talk about the younger people.
I am 54, I am worried. But we have to, the American senior
citizen is engaged because they obviously depend on Social
Security. The younger generation is not real engaged in this
discussion because, just like I am sure you and the rest of us,
we didn't care about Social Security when we were first
entering the workforce, but they had better start caring about
it relatively soon.
How are we going to engage them?
Secretary Snow. Well, Congressman, you put your finger on a
critical issue here. I think the President knows he has got an
obligation to lead this, to get out and use the bully pulpit
and talk to the American people and really engage them on the
problem and be straight with them, be honest with them, tell
them the facts and get the facts out. You know, America is a
Nation of problem solvers, we are a Nation of fixers, but we
first have to understand what the problem is. That is why this
hearing today, the other hearings are so important to get the
facts out. And I am glad to hear people from both sides of the
aisle agreeing that there is a problem, because that is where
the solution starts, with identifying the problem.
This is only going to be addressed when the American people
say there is a problem and we want answers. And the President
knows he has to take that message to the American people. He
has asked us in the cabinet to do it, but he knows he has to
lead that effort.
Mr. Simpson. Do you think there is broad consensus about
what the problem exactly is?
Secretary Snow. I think there is a growing understanding of
what the problem is, the demographics which are--this is all
about arithmetic, it is not about ideology. It is simple,
straightforward arithmetic. Nobody can repeal the laws of
arithmetic. And the laws of arithmetic are dooming Social
Security on its present course. And the sooner we act to fix
it, the better the chances. I think that more and more people--
I wouldn't say it is fully understood by any means, but more
and more people are beginning to get a sense of the dimensions
of the problem and the need to act on it, and I think they are
going to be asking their elected representatives around the
country, what are you doing?
Mr. Simpson. Well, I hope so. I have spent the last 2 years
actually talking about the problem we have with entitlement
spending and how that is driving really the budget deficit and
a few other things, and Social Security particularly. And I
have found that any number of people have come up afterwards
and said I appreciate the fact that you are talking about that
because I really didn't understand it before. So I appreciate
the fact that you are engaged in this and the President is
engaged in this. It is something that would be so easy for us
to put off for another 10 years.
Chairman Nussle. I am going to call on Mr. Allen for 5
minutes, a quick 5 minutes, and then Mr. Bradley for 5 minutes,
and then we will wrap up. We have as I understand a couple
votes on the floor. Mr. Allen for 5 minutes.
Mr. Allen. Thank you, Mr. Chairman.
And thank you, Mr. Secretary, for being here. If I were
trying to summarize your testimony so far, I would say that you
are saying that mathematics is not important. There is basic
math involved here. You don't know the details of the
President's proposal, but you certainly know it includes
private accounts. You don't know how much money will have to be
borrowed after the first 10 years, but you do know it will save
taxpayers money and it will be better, that younger people will
be better off.
What I take from this is the conclusion has been arrived at
before the mathematics has been done. We are not talking about
model two, but we are talking about something close to model
two. We don't know all the details, we don't know how many
trillions of dollars will be borrowed. But just to look at one
analysis based on Social Security Administration economic
assumptions--I would like to have chart 4 put up on the screen,
and I will come back to that in a moment. I mean, just to take
one--we will wait for that to come up.
Now, you have said that you know that the plan will take
care of the long-term Social Security liability, but you don't
know how much borrowing the plan requires after the first 10
years. It is those kinds of conflicts which makes some of us
really skeptical.
The second point I would say is that what I hear you saying
is that deficits really--I think you are saying that deficits
really matter between now and 2009. And we have to knock down
the deficit from that estimated inflated, I would argue, level
of $521 billion. But after 2009, it is OK to borrow trillions
and trillions of dollars. As you may remember, your
predecessor, Paul O'Neill had a little disagreement with the
President over the 2003 tax cuts. And Vice President Cheney
said to Mr. O'Neill that Ronald Reagan proved that deficits
don't matter. But Mr. O'Neill's advice to the President was, if
you pass the 2003 tax cuts, if you do that, you will not be
able to do anything else that you want to do including,
specifically he was concerned about privatizing Social Security
because he is a believer in privatization.
Yesterday, Josh Bolten was here and said that it is all OK,
we don't have exact numbers but it is OK. This new idea of
borrowing to save instead of borrowing to spend, he checked it
out with some Wall Street analysts; you are telling us today
you have checked it out with some Wall Street analysts, and
also with Treasury analysts, it is OK, it is fine. Of course,
someone on Wall Street is going to make billions of dollars in
all probability from this plan. But thinking about my friends
from the other side of the aisle, when it comes to estimates
from this administration--today's Washington Post says:
Medicare drug benefit may cost $1.2 trillion.
Now, we have been through here before with estimates from
the administration, and, frankly, particularly Republicans were
sandbagged when the administration refused to give them--or us
for that matter--the true estimated cost of the administration
when it came to the cost of the Medicare benefit, which is
exploding in cost. The American people are going to need more
than someone standing up and saying Wall Street analysts say
this is OK. Aren't they?
Secretary Snow. Well, I hope you don't think that is all we
are saying, Congressman.
Mr. Allen. It is all I have heard. It is all I have heard
about the source of the confidence as to the fact that
borrowing $5 or $6 trillion in the first 20 years is not going
to suck money out of the private capital markets. It seems to
me it is inevitably going to suck money out of the private
capital markets, drive up interest rates, and slow down the
economy.
Secretary Snow. Remember what is happening here. Remember
what is happening. The structure of what is happening is
essential to keep in mind. People will be taking money that
otherwise would go into Social Security. Right? And they will
be putting it into these private accounts. As they remove money
from Social Security, they also give up a future claim on
Social Security.
Mr. Allen. Their benefits will be cut.
Secretary Snow. They give up, the liability of the United
States goes down by the amount of the money that is diverted.
So from the Social Security point of view, this is not a cost
to the Social Security system. But from the point of view of
the balance sheet of the United States and the American
economy, the money that is diverted is put into savings. It
helps the savings. Net savings is not adversely affected. In
fact, I think it would be positively affected.
Chairman Nussle. Mr. Bradley for 5 minutes.
Mr. Bradley. Thank you very much, Mr. Chairman.
Mr. Snow, just two quick questions, please, if I might. My
home State which is New Hampshire ranks second highest in the
percentage of the population between the ages of 34 and 54.
Could you just outline for me what the administration's
thinking is as to how the personal accounts proposed are going
to be structured to ensure that these middle-aged workers--and
I guess with my gray hair I am getting almost beyond that--who
don't have the same amount of time as younger workers, for
instance Mr. Hensarling's children, will be able to build up
their portfolios? That is question number one.
And number two. There was a recent article last week in The
Wall Street Journal about other country's experiences with
personal accounts. Could you just touch on some of the issues
that have arisen with regard to other countries and how you are
incorporating that into your thinking?
Secretary Snow. Right. Well, on the 34 to 54 age cohorts,
any reduction in benefits we have said would have to be gradual
so that they wouldn't face a sharp dropoff in their benefits
and they would be able to help offset those benefits reductions
with the personal accounts. One reason to start this soon is
that that group of people will then have more time. Every year
we put it off, they have one less year to get the virtue of
compounding.
I will be glad to share with you some research the Treasury
has done on the variety of countries who have put in place
approaches that are called personal accounts. They vary a lot
and therefore it is hard to come up with one overall
conclusion. The article that was in the paper that got some
prominent feature on Chile, I think sort of badly distorted the
reality of what has happened in Chile and did not reflect the
real facts. But I will be happy to send you our analysis of--
and many, many, many countries. The United States is in a way
not in the forefront but one of the later countries to come to
the use of personal accounts, the market investments to help
augment retirement. But I will be glad to do that.
Mr. Bradley. Thank you. And I will yield my time.
Ms. McKinney. Mr. Chairman, inasmuch as I haven't had an
opportunity to address the Secretary, I would like to ask
unanimous consent that I have a statement submitted for the
record.
Chairman Nussle. The gentlelady is--and would the
gentlelady like to ask? I have got time for one question. You
will get the last word. If you have one question you would like
to ask? But certainly without objection, your statement will be
part of the record, as is true for all members, without
objection.
Ms. McKinney. Well, thank you very much, Mr. Chairman, for
the indulgence.
I have a series of newspaper articles about the Senator
Frist political fund losing, as they say, big time in the stock
market. The Tennessean newspaper, the Washington Post reported
that after big losses in the stock market, U.S. Senate Majority
Leader Bill Frist campaign committee was short of money and
couldn't make its loan.
Now, Mr. Secretary, you are suggesting that the guaranteed
retirement benefit in Social Security be replaced with a system
that could yield for the average participant a result like
Senator Frist. My question is, what happens then to the person
whose investment goes bust?
Secretary Snow. Congresswoman, thank you for that question.
I think the President in the State of the Union message made it
clear that these would be safe investment vehicles. This
wouldn't be investments in individual stocks, it wouldn't be
investments in options or hedge funds or trade or derivatives,
anything like that. It is very important that these funds be
deployed in a way that is safe and secure, and the investment
vehicle that would be designed to accomplish that is very much
like the investment vehicle available to you as a Government
public official, the so-called Thrift Savings Plan. This would
have some other features to it though.
Ms. McKinney. But what I have is in addition, the Thrift
Savings Plan is in addition to the Social Security. So what you
are proposing is instead of.
Secretary Snow. But you are asking me the nature of the
investment opportunities, and the nature of the investment
opportunities would be the same sort of safe and secure
investment opportunities that you have through your savings
plan.
Ms. McKinney. But the benefit is--the guaranteed benefit is
definitely not guaranteed under your plan.
Secretary Snow. No. This is an opportunity for people to
invest in bonds and stocks; and there is no guarantee on bonds
and stocks except that over time they tend to do very, very,
very well relative to the return you would get in the----
Ms. McKinney. So the average taxpayer's personal accounts
could end up like Senator Frist's; it could go bust.
Secretary Snow. That is extraordinarily unlikely.
Ms. McKinney. Thank you, Mr. Chairman.
Chairman Nussle. I thank the gentlelady.
Mr. Secretary, thank you for indulging us your time today.
I will dismiss this panel. And when we resume after the series
of votes we will resume with panel two. The committee stands in
recess. [Recess.]
We will resume the Budget Committee hearing. We are pleased
to welcome our second panel to the witness table. We have
before us today the two very distinguished public servants, who
in their own right, deserve their own panel, to be quite
honest. Typically we ask the two of them to give us their
information singularly. We are asking them to do it today
together because, quite frankly, have both of you have given us
some ideas and sounded the alarms and suggested that we need to
tackle these problems in many different ways.
So I think, if there is any time to put the two of you
together and, as they say, put your heads together, we have got
two of the best thinkers that provide information to our
Congress on our panel. We are pleased to have both of you here
today.
STATEMENTS OF HON. DAVID M. WALKER, COMPTROLLER GENERAL,
GOVERNMENT ACCOUNTABILITY OFFICE; AND DOUGLAS J. HOLTZ-EAKIN,
Ph.D., DIRECTOR, CONGRESSIONAL BUDGET OFFICE
Chairman Nussle. By a coin flip and going in alphabetical
order, we will call on Douglas Holtz-Eakin. Or you would like
to go first? We will do it that way. We will go in reverse
alphabetical order and call on David Walker, the Comptroller
General of the Government Accountability Office. Welcome,
General, and we are pleased to receive your testimony. Your
entire testimony will be made a part of the record.
STATEMENT OF HON. DAVID M. WALKER
Mr. Walker. Thank you, Mr. Chairman. It is good to be back
before the House Budget Committee, this time to speak about our
Nation's Social Security program. I appreciate you putting my
entire statement in the record. I will summarize some key
points.
I think it is important for the members to know at the
outset that, in addition to working on this issue at GAO in my
capacity as Comptroller General of the United States, I was
also a trustee of Social Security and Medicare from 1990 to
1995, so I am very deep on these issues and care about them
very much.
As I have testified on many times before Congress, Mr.
Chairman, the Social Security system faces both a solvency and
a sustainability challenge over the longer term. And while the
Social Security program does not face an immediate crisis, it
does have a $3.7 trillion gap in current dollar terms between
promised and funded benefits. This gap is growing daily; and
given this and other major fiscal challenges that face the
country, it would be prudent to act sooner than later to reform
the Social Security program. Failure to take steps to address
our large and structural long-range fiscal imbalance which is
driven largely by projected increases in Medicare, Medicaid,
and Social Security spending, will ultimately have significant
adverse effects on our country, children, and grandchildren. If
I can, let me make a few key points.
In looking at Social Security, several key points are
important. First, solving Social Security's long-term financing
problem is more important and complex than merely making the
numbers add up. It is important to keep in mind that Social
Security is not only a program for retirement income, but also
a program for disabled workers and for survivors of deceased
workers. It is important to keep all those dimensions in mind.
Secondly, and the first chart (chart 1). Social Security
reform is part of a broader fiscal economic challenge. We need
to keep this in context with regard to the larger challenges
that we face. This chart shows one scenario in GAO's long-range
budget simulations. This one is based on CBO's baseline
projection; you can see that we face large and growing
structural deficits in the out years due largely to known
demographic trends and rising health care costs.
If you look at the simulation, you have to keep in mind
three things. First, it is bound by the constraints imposed on
CBO's 10-year baseline. Those relevant to this simulation are,
number one, that no new laws will be passed. Number two, that
discretionary spending will grow by inflation. And, number
three, that all tax cuts will sunset as scheduled.
So even under those assumptions you can see that we have a
problem which increases with time, the white line being revenue
as a percentage of GDP, the bar being spending as a percentage
of GDP.
The next one (chart 2), however, is much more sobering and
dramatic. The only two differences between this one and the
next one are number one, discretionary spending grows by the
rate of the economy throughout the period. And, number two, all
tax cuts are made permanent.
Under the second scenario, the only thing that the Federal
Government can do in the year 2040 or slightly beyond is pay
interest on massive debt. That is obviously not an acceptable
outcome. Next, please (chart 3).
It is important to keep in mind that you can't just look at
trust fund solvency alone. After all, the trust funds are
nothing more than an accounting device. They are not true
fiduciary trust funds. If you look on the financial statements
of the U.S. Government, you will not find a liability of the
U.S. Government owing to the trust funds. Further, the trust
fund does not tell us whether or not the program is
sustainable; it doesn't tell us how much of a burden the
program represents on future budgets or on the economy. So it
is important to keep in mind cash flows because cash is of
critical importance. We have already turned a negative cash
flow in Medicare Part A. That happened last year in 2004. We
are projected to turn a negative cash flow in Social Security/
OASDI combined in 2018, and it will get progressively worse
every year thereafter.
I think it is also important to note that acting sooner
rather than later will help to ease the difficulty in achieving
reforms. Not only will you not have to make dramatic changes,
but people have more time to adjust to whatever changes that
you make.
Just as importantly, by acting sooner, we can send a
positive signal to the markets that will enhance our
credibility that the Government is willing to act to deal with
known long-range challenges before they reach crisis
proportions. Furthermore, it would hopefully give elected
officials the confidence necessary to take on truly more
difficult challenges. Because Medicare is eight times worse
than Social Security. Candidly, Medicare is going to be a lot
tougher to solve. It is going to take many years, and you are
going to have to do it in installments.
Last, is it is very important to keep in mind that any
Social Security reform proposals need to be evaluated as
packages. There are going to be pros and cons of every Social
Security reform proposal. It is also important to keep in mind
that not all promised benefits are funded. And, therefore, it
is not fair to compare reform proposals solely to promised
benefits. They must be compared to both funded benefits and
promised benefits to understand the relative trade-offs. And,
in doing that, I would respectfully suggest to the committee
that you consider the work that GAO has done for the Congress
in this regard. We basically recommend analyzing Social
Security reform proposals as a package against those two
benchmarks and based on three criteria: Whether and to what
extent the proposal will achieve sustainable solvency, not just
over 75 years but for the long term; whether or not it meets
the standard of adequacy and equity; and, whether or not it can
be implemented and administered in a feasible and a cost
effective manner.
In summary, Mr. Chairman, Social Security may not be in a
crisis, but it has a large and growing financing problem. It
would be prudent to act sooner rather than later because,
candidly, Social Security should be easy lifting as compared to
the other work that has to be done. The Congress has an
opportunity to exceed the expectations of every generation of
Americans with or without individual accounts. I realize that
is an issue that is going to be debated. In any event,
individual accounts would have to be part of a comprehensive
reform package in order to achieve the objectives that I
outlined earlier. But with or without individual accounts you
can exceed the expectations of every generation. I hope that
the Congress will act. Thank you, Mr. Chairman.
[The prepared statement of David M. Walker follows:]
Prepared Statement of Hon. David M. Walker, Comptroller General, U.S.
Government Accountability Office
Mr. Chairman and Members of the Committee, I appreciate the
opportunity to talk with you about our nation's Social Security
program\1\ and how to address the challenges presented in ensuring the
long-term viability of this important social insurance system. Social
Security provides a foundation of retirement income for millions of
Americans and has prevented many former workers and their families from
living their retirement years in poverty. Fixing Social Security is
about more than finances. It is also about maintaining an adequate
safety net for American workers against loss of income from retirement,
disability, or death.
As I have said in congressional testimonies over the past several
years, the Social Security system faces both solvency and
sustainability challenges in the longer term.\2\ While the Social
Security program does not face an immediate crisis, it does have a $3.7
trillion gap between promised and funded benefits in current dollar
terms. This gap is growing daily and, given this and other major fiscal
challenges including expected growth in Federal health spending, it
would be prudent to act sooner rather than later to reform the Social
Security program. Failure to take steps to address our large and
structural long-range fiscal imbalance, which is driven in large part
by projected increases in Medicare, Medicaid, and Social Security
spending, will ultimately have significant adverse consequences for our
country, children, and grandchildren.
Let me begin by highlighting a number of important points
concerning the Social Security challenge and our broader fiscal and
economic challenge.
<bullet> Solving Social Security's long-term financing problem is
more important and complex than simply making the numbers add up.
Social Security is an important and successful social insurance program
that affects virtually every American family. It currently pays
benefits to more than 47 million people, including retired workers,
disabled workers, the spouses and children of retired and disabled
workers, and the survivors of deceased workers. The number of
individuals receiving benefits is expected to grow to almost 69 million
by 2020. The program has been highly effective at reducing the
incidence of poverty among the elderly, and the disability and survivor
benefits have been critical to the financial well-being of millions of
others.
<bullet> Social Security reform is part of a broader fiscal and
economic challenge. If you look ahead in the Federal budget, Social
Security together with the rapidly growing health programs (Medicare
and Medicaid) will dominate the Federal Government's future fiscal
outlook. While this hearing is not about the complexities of Medicare,
it is important to note that Medicare presents a much greater, more
complex, and more urgent fiscal challenge than Social Security.
Medicare growth rates reflect not only a burgeoning beneficiary
population, but also the escalation of health care costs at rates well
exceeding general rates of inflation. Taken together, Social Security,
Medicare, and Medicaid represent an unsustainable burden on future
generations. Furthermore, any changes to Social Security should be
considered in the context of the problems currently facing our nation's
private pension system. These include the chronically low level of
coverage of the private workforce, the continued decline in defined
benefit plans coupled with the termination of large underfunded plans
by bankrupt firms, and the shift by employers to defined contribution
plans, where workers face the potential for greater return but also
assume greater financial risk.
<bullet> Focusing on trust fund solvency alone is not sufficient.
We need to put the program on a path toward sustainable solvency. Trust
fund solvency is an important concept, but focusing on trust fund
solvency alone can lead to a false sense of security about the overall
condition of the Social Security program. After all, the Social
Security Trust Fund is a subaccount of the Federal Government rather
than a private trust fund. Its assets are not readily marketable nor
are they convertible into cash other than through raising revenues,
cutting other Government expenses, or increasing debt held by the
public. Furthermore, the size of the trust fund does not tell us
whether the program is sustainable--that is, whether the Government
will have the capacity to pay future claims or what else will have to
be squeezed to pay those claims. Aiming for sustainable solvency would
increase the chance that future policymakers would not have to face
these difficult questions on a recurring basis. Estimates of what it
would take to achieve 75-year trust fund solvency understate the extent
of the problem because the program's financial imbalance gets worse in
the 76th and subsequent years.
<bullet> Acting sooner rather than later helps to ease the
difficulty of change. The challenge of facing the imminent and daunting
budget pressure from Medicare, Medicaid, and Social Security increases
over time. Social Security will begin to constrain the budget long
before the trust fund is exhausted in 2042. The Social Security cash
surpluses that are now helping to finance the rest of the Government's
budgetary needs will begin to decline in 2008, and by 2018, the cash
surpluses will turn to deficits. Social Security's cash shortfall will
place increasing pressure on the rest of the budget to raise the
resources necessary to meet the program's costs. Waiting until Social
Security faces an immediate trust fund solvency crisis will limit the
scope of feasible solutions and could reduce the options to only those
choices that are the most difficult. It could also contribute to a
further delay of the really tough decisions on Federal health programs.
Acting sooner rather than later would allow changes to be more modest
while also being phased in so that future retirees will have time to
adjust their retirement planning. Furthermore, acting sooner rather
than later would serve to increase our credibility with the markets and
improve the public's confidence in the Federal Government's ability to
deal with our significant long-range fiscal challenges before they
reach crisis proportions.
<bullet> Reform proposals should be evaluated as packages. The
elements of any reform proposal interact; every package will have
pluses and minuses, and no plan will satisfy everyone on all
dimensions. If we focus on the pros and cons of each element of reform
by itself, we may find it impossible to build the bridges necessary to
achieve consensus. Analyses of reform proposals should reflect the fact
that the program faces a long-term actuarial deficit and that benefit
reduction and/or revenue increases will be necessary to restore
solvency. This requires looking at proposed reforms from at least two
perspectives or benchmarks--one that raises revenue to fund currently
scheduled benefits (promised benefits) and one that adjusts benefits to
a level supported by current tax financing (funded benefits).
Today, the Social Security program does not face an immediate
crisis, but rather a long-range financing problem driven by demographic
trends. While the crisis is not immediate, the challenge is more urgent
than it may appear since the program will experience increasing
negative cash flow starting in 2018. Acting soon to address these
problems reduces the likelihood that Congress will have to choose
between imposing severe benefit cuts and unfairly burdening future
generations with the program's rising costs. Acting soon would also
allow changes to be phased in so the individuals who are most likely to
be affected, namely younger and future workers, will have time to
adjust their retirement planning while helping to avoid related
``expectation gaps.'' On the other hand, failure to take remedial
action will, in combination with other entitlement spending, lead to a
situation unsustainable both for the Federal Government and,
ultimately, the economy.
Today we have an opportunity to address the relatively easier part
of the overall entitlement challenge before the baby boom generation
begins to retire and the challenge begins to compound. Medicare
represents a much larger driver of the long-term fiscal outlook, but
this does not mean that Social Security reform should be postponed
until after it is addressed. On the contrary, it argues for moving
ahead on Social Security soon. Unlike the case in health care,
potential approaches to Social Security reform have already been
articulated in various proposals in recent years. These approaches can
serve as a starting point for deliberations. Since health care will be
much harder to address, there is a significant danger that if we do not
move ahead on Social Security now, we could end up reforming neither.
Successful Social Security reform could also help build both trust and
confidence and thereby facilitate consideration of the needed
structural changes in the health care system.
The Social Security system has required changes in the past to
ensure its future solvency. Congress took action to address an
immediate solvency crisis in 1983. While such an immediate crisis will
not occur for many years, waiting until it is imminent will not be
prudent. Furthermore, I believe it is possible to craft a solution that
will protect Social Security benefits for the nation's current and
near-term retirees, while ensuring that the system will be there for
future generations. I believe that it is possible to reform Social
Security in a way that will assure the program's solvency and
sustainability while exceeding the expectations of all generations of
Americans.
SOCIAL SECURITY REFORM IS PART OF A BROADER FISCAL AND ECONOMIC
CHALLENGE
In my role as lead partner on the audit of the U.S. Government's
consolidated financial statements and the de facto Chief Accountability
Officer of the U.S. Government, I have become increasingly concerned
about the state of our nation's finances. In speeches and presentations
over the past several years, I have called attention to our large and
growing long-term fiscal challenge and the risks it poses to our
nation's future.\3\ Simply put, our nation's fiscal policy is on an
unsustainable course, and our long-term fiscal imbalance worsened
significantly in 2004. GAO's simulations--as well as those of the
Congressional Budget Office (CBO) and others--show that over the long
term we face a large and growing structural deficit due primarily to
known demographic trends and rising health care costs. Continuing on
this unsustainable fiscal path will gradually erode, if not suddenly
damage, our economy, our standard of living, and ultimately our
national security. Our current path also will increasingly constrain
our ability to address emerging and unexpected budgetary needs.
Regardless of the assumptions used, all simulations indicate that
the problem is too big to be solved by economic growth alone or by
making modest changes to existing spending and tax policies. Nothing
less than a fundamental reexamination of all major spending and tax
policies and priorities is needed. This reexamination should also
involve a national discussion about what Americans want from their
Government and how much they are willing to pay for those things. This
discussion will not be easy, but it must take place.
In fiscal year 2004 alone, the nation's fiscal imbalance grew
dramatically, primarily due to enactment of the new Medicare
prescription drug benefit, which added $8.1 trillion to the outstanding
commitments and obligations of the U.S. Government. The near-term
deficits also reflected higher defense, homeland security, and overall
discretionary spending which exceeded growth in the economy, as well as
revenues which have fallen below historical averages due to policy
decisions and other economic and technical factors.
While the nation's long-term fiscal imbalance grew significantly,
the retirement of the baby boom generation has come closer to becoming
a reality. In fact, the cost implications of the baby boom generation's
retirement have already become a factor in CBO's baseline projections
and will only intensify as the boomers age. According to CBO, total
Federal spending for Social Security, Medicare, and Medicaid is
projected to grow by about 25 percent over the next 10 years--from 8.4
percent of gross domestic product (GDP) in 2004 to 10.4 percent in
2015. Given these and other factors, it is clear that the nation's
current fiscal path is unsustainable and that tough choices will be
necessary in order to address the growing imbalance.
There are different ways to describe the magnitude of Social
Security's long-term financing challenge, but they all show a need for
program reform sooner rather than later. A case can be made for a range
of different measures, as well as different time horizons. For
instance, the shortfall can be measured in present value, as a
percentage of GDP, or as a percentage of taxable payroll. The Social
Security Administration (SSA) has made projections of the Social
Security shortfall using different time horizons. (See table 1.)
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While estimates vary due to different horizons, both identify the
same long-term challenge: The Social Security system is unsustainable
in the long run. Taking action soon on Social Security would not only
make the necessary action less dramatic than if we wait but would also
promote increased budgetary flexibility in the future and stronger
economic growth.
Although the Trustees' 2004 intermediate estimates project that the
combined Social Security Trust Funds will be solvent until 2042,\4\
within the next few years, Social Security spending will begin to put
pressure on the rest of the Federal budget. (See table 2.) Under the
Trustees' 2004 intermediate estimates, Social Security's cash surplus--
the difference between program tax income and the costs of paying
scheduled benefits--will begin a permanent decline in 2008. (See fig.
1.) To finance the same level of Federal spending as in the previous
year, additional revenues and/or increased borrowing will be needed in
each subsequent year.
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By 2018,\5\ Social Security's cash income (tax revenue) is
projected to fall below program expenses. At that time, Social Security
will join Medicare's Hospital Insurance Trust Fund, whose outlays
exceeded cash revenues in 2004, as a net claimant on the rest of the
Federal budget. The combined OASDI Trust Funds will begin drawing on
the Treasury to cover the cash shortfall. At this point, Treasury will
need to obtain cash for those redeemed securities either through
increased taxes, and/or spending cuts, and/or more borrowing from the
public than would have been the case had Social Security's cash flow
remained positive.
Today Social Security spending exceeds Federal spending for
Medicare and Medicaid, but that will change. While Social Security is
expected to grow about 5.6 percent per year on average over the next 10
years, Medicare and Medicaid combined are expected to grow at 8.5
percent per year. As a result, CBO's baseline projects Medicare and
Medicaid spending will be about 30 percent higher than Social Security
in 2015. According to the Social Security and Medicare trustees, Social
Security will grow from 4.3 percent of GDP today to 6.6 percent in
2075, and Medicare's burden on the economy will quintuple--from 2.7
percent to 13.3 percent of the economy.
GAO's long-term simulations illustrate the magnitude of the fiscal
challenges associated with an aging society and the significance of the
related challenges the Government will be called upon to address.
Figures 2 and 3 present these simulations under two different sets of
assumptions. In figure 2, we begin with CBO's January baseline,
constructed according to the statutory requirements for that
baseline.\6\ Consistent with these requirements, discretionary spending
is assumed to grow with inflation for the first 10 years and tax cuts
scheduled to expire are assumed to expire. After 2015, discretionary
spending is assumed to grow with the economy, and revenue is held
constant as a share of GDP at the 2015 level. In figure 3 two
assumptions are changed: discretionary spending is assumed to grow with
the economy after 2005 rather than merely with inflation and the tax
cuts are extended. For both simulations Social Security and Medicare
spending is based on the 2004 Trustees' intermediate projections, and
we assume that benefits continue to be paid in full after the trust
funds are exhausted. Medicaid spending is based on CBO's December 2003
long-term projections under mid-range assumptions.
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Both these simulations illustrate that, absent policy changes, the
growth in spending on Federal retirement and health entitlements will
encumber an escalating share of the Government's resources. Indeed,
when we assume that recent tax reductions are made permanent and
discretionary spending keeps pace with the economy, our long-term
simulations suggest that by 2040 Federal revenues may be adequate to
pay little more than interest on the Federal debt. Neither slowing the
growth in discretionary spending nor allowing the tax provisions to
expire--nor both together--would eliminate the imbalance. Although
revenues will be part of the debate about our fiscal future, the
failure to reform Social Security, Medicare, Medicaid, and other
drivers of the long-term fiscal gap would require at least a doubling
of taxes--and that seems implausible. Accordingly, substantive reform
of Social Security and our major health programs remains critical to
recapturing our future fiscal flexibility.
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Although considerable uncertainty surrounds long-term budget
projections, we know two things for certain: the population is aging
and the baby boom generation is approaching retirement age. The aging
population and rising health care spending will have significant
implications not only for the budget but also for the economy as a
whole. Figure 4 shows the total future draw on the economy represented
by Social Security, Medicare, and Medicaid. Under the 2004 Trustees'
intermediate estimates and CBO's long-term Medicaid estimates, spending
for these entitlement programs combined will grow to 15.6 percent of
GDP in 2030 from today's 8.5 percent. It is clear that, taken together,
Social Security, Medicare, and Medicaid represent an unsustainable
burden on future generations.
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The Government can help ease future fiscal burdens through spending
reductions or revenue actions that reduce debt held by the public,
thereby saving for the future and enhancing the pool of economic
resources available for private investment and long-term growth.
Economic growth can help, but given the size of our projected fiscal
gap we will not be able to simply grow our way out of the problem.
Closing the current long-term fiscal gap would require sustained
economic growth far beyond that experienced in U.S. economic history
since World War II. Tough choices are inevitable, and the sooner we act
the better.
Some of the benefits of early action--and the costs of delay--can
be illustrated using the 2004 Social Security Trustees' intermediate
projections. Figure 5 compares what it would take to keep Social
Security solvent through 2078 by either raising payroll taxes or
reducing benefits. If we did nothing until 2042--the year SSA estimates
the Trust Funds will be exhausted--achieving actuarial balance would
require changes in benefits of 30 percent or changes in taxes of 43
percent. As figure 5 shows, earlier action shrinks the size of the
necessary adjustment.
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Both sustainability concerns and solvency considerations drive us
to act sooner rather than later. Trust Fund exhaustion may be nearly 40
years away, but the squeeze on the Federal budget will begin as the
baby boom generation begins to retire. Actions taken today can ease
both these pressures and the pain of future actions. Acting sooner
rather than later also provides a more reasonable planning horizon for
future retirees.
DEMOGRAPHIC TRENDS DRIVE BOTH THE LONG-TERM FISCAL OUTLOOK AND SOCIAL
SECURITY'S FINANCING CHALLENGE
The Social Security program's situation is but one symptom of
larger demographic trends that will have broad and profound effects on
our Nation's future in other ways as well. As you are aware, Social
Security has always been a largely pay-as-you-go system. This means
that the system's financial condition is directly affected by the
relative size of the populations of covered workers and beneficiaries.
Historically, this relationship has been favorable to the system's
financial condition. Now, however, people are living longer and
spending more time in retirement.
As shown in figure 6, the U.S. elderly dependency ratio is expected
to continue to increase.\7\ The proportion of the elderly population
relative to the working-age population in the U.S. rose from 13 percent
in 1950 to 19 percent in 2000. By 2050, there is projected to be almost
1 elderly dependent for every 3 people of working age--a ratio of 32
percent. Additionally, the average life expectancy of males at birth
has increased from 66.6 in 1960 to 74.3 in 2000, with females at birth
experiencing a rise from 73.1 to 79.7 over the same period. As general
life expectancy has increased in the United States, there has also been
an increase in the number of years spent in retirement. Improvements in
life expectancy have extended the average amount of time spent by
workers in retirement from 11.5 years in 1950 to 18 years for the
average male worker as of 2003.
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A falling fertility rate is the other principal factor underlying
the growth in the elderly's share of the population. In the 1960s, the
fertility rate, which is the average number of children that would be
born to women during their childbearing years, was an average of 3
children per woman. Today it is a little over 2, and by 2030 it is
expected to fall to 1.95--a rate that is below what it takes to
maintain a stable population. Taken together, these trends threaten the
financial solvency and sustainability of Social Security.
The combination of these factors means that annual labor force
growth will begin to slow after 2010 and by 2025 is expected to be less
than a fifth of what it is today. (See fig. 7.) Relatively fewer
workers will be available to produce the goods and services that all
will consume. Without a major increase in productivity or increases in
immigration, low labor force growth will lead to slower growth in the
economy and to slower growth of Federal revenues. This in turn will
only accentuate the overall pressure on the Federal budget.
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The aging of the labor force and the reduced growth in the number
of workers will have important implications for the size and
composition of the labor force, as well as the characteristics of many
jobs, throughout the 21st century. The U.S. workforce of the 21st
century will be facing a very different set of opportunities and
challenges than that of previous generations.
Increased investment could increase the productivity of workers and
spur economic growth. However, increasing investment depends on
national saving, which remains at historically low levels.
Historically, the most direct way for the Federal Government to
increase saving has been to reduce the deficit (or run a surplus).
Although the Government may try to increase personal saving, results of
these efforts have been mixed. For example, even with the preferential
tax treatment granted since the 1970s to encourage retirement saving,
the personal saving rate has steadily declined. Even if economic growth
increases, the structure of retirement programs and historical
experience in health care cost growth suggest that higher economic
growth results in a generally commensurate growth in spending for these
programs in the long term.\8\
In recent years, personal saving by households has reached record
lows while at the same time the Federal budget deficit has climbed.
(See fig. 8.) Accordingly, national saving has diminished but the
economy has continued to grow in part because more and better
investments were made. That is, each dollar saved bought more
investment goods and a greater share of saving was invested in highly
productive information technology. The economy has also continued to
grow because the United States was able to invest more than it saved by
borrowing abroad, that is, by running a current account deficit.
However, a portion of the income generated by foreign-owned assets in
the United States must be paid to foreign lenders. National saving is
the only way a country can have its capital and own it too.
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In general, saving involves trading off consumption today for
greater consumption tomorrow. Our budget decisions today will have
important consequences for the living standards of future generations.
The financial burdens facing the smaller cohort of future workers in an
aging society would most certainly be lessened if the economic pie were
enlarged. This is no easy challenge, but in a very real sense, our
fiscal decisions affect the longer-term economy through their effects
on national saving.
The persistent U.S. current account deficits of recent years have
translated into a rising level of indebtedness to other countries.
However, many other nations currently financing investment in the
United States also will face aging populations and declining national
saving, so relying on foreign savings to finance a large share of U.S.
domestic investment or Federal borrowing is not a viable strategy in
the long run.
HEALTH CARE IS A LARGER AND MORE DIFFICULT CHALLENGE THAN SOCIAL
SECURITY
As figure 4 showed, over the long term Medicare and Medicaid will
dominate the Federal Government's future fiscal outlook. Medicare
growth rates reflect not only a burgeoning beneficiary population but
also the escalation of health care costs at rates well exceeding
general rates of inflation. Health care generally presents not only a
much greater but a more complex challenge than Social Security. The
structural changes needed to address health care cost growth will take
time to develop, and the process of reforming health care is likely to
be an incremental one.
While the long-term fiscal challenge cannot be successfully
addressed without addressing Medicare and Medicaid, Federal health
spending trends should not be viewed in isolation from the health care
system as a whole. For example, Medicare and Medicaid cannot grow over
the long term at a slower rate than cost in the rest of the health care
system without resulting in a two-tier health care system. This, for
example, could squeeze providers who then in turn might seek to recoup
costs from other payers elsewhere in the health care system. Rather, in
order to address the long-term fiscal challenge, it will be necessary
to find approaches that deal with health care cost growth in the
overall health care system.
Although health care spending is the largest driver of the long-
term fiscal outlook, this does not mean that Social Security reform
should be postponed until after health is addressed. On the contrary,
it argues for moving ahead on Social Security now. The outlines of
Social Security reform have already been articulated in many Social
Security reform proposals. These approaches and the specific elements
of reform are well known and have been the subject of many analyses,
including GAO reports and testimonies. Reform approaches already put
forward can serve as a starting point for deliberations.
CONSIDERATIONS IN ASSESSING REFORM OPTIONS
As important as financial stability may be for Social Security, it
cannot be the only consideration. As a former public trustee of Social
Security and Medicare, I am well aware of the central role these
programs play in the lives of millions of Americans. Social Security
remains the foundation of the Nation's retirement system. It is also
much more than just a retirement program; it pays benefits to disabled
workers and their dependents, spouses and children of retired workers,
and survivors of deceased workers. In 2004, Social Security paid almost
$493 billion in benefits to more than 47 million people. Since its
inception, the program has successfully reduced poverty among the
elderly. In 1959, 35 percent of the elderly were poor. In 2000, about 8
percent of beneficiaries aged 65 or older were poor, and 48 percent
would have been poor without Social Security. It is precisely because
the program is so deeply woven into the fabric of our nation that any
proposed reform must consider the program in its entirety, rather than
one aspect alone. To assist policymakers, GAO has developed a broad
framework for evaluating reform proposals that considers not only
solvency but other aspects of the program as well. Our criteria aim to
balance financial and economic considerations with benefit adequacy and
equity issues and the administrative challenges associated with various
proposals.
GAO FRAMEWORK FOR EVALUATING REFORM PROPOSALS
The analytic framework GAO has developed to assess proposals
comprises three basic criteria:
<bullet> Financing Sustainable Solvency--the extent to which a
proposal achieves sustainable solvency and how it would affect the
economy and the Federal budget. Our sustainable solvency standard
encompasses several different ways of looking at the Social Security
program's financing needs. While a 75-year actuarial balance has
generally been used in evaluating the long-term financial outlook of
the Social Security program and reform proposals, it is not sufficient
in gauging the program's solvency after the 75th year. For example,
under the trustees' intermediate assumptions, each year the 75-year
actuarial period changes, and a year with a surplus is replaced by a
new 75th year that has a significant deficit. As a result, changes made
to restore trust fund solvency only for the 75-year period can result
in future actuarial imbalances almost immediately. Reform plans that
lead to sustainable solvency would be those that consider the broader
issues of fiscal sustainability and affordability over the long term.
Specifically, a standard of sustainable solvency also involves looking
at (1) the balance between program income and costs beyond the 75th
year and (2) the share of the budget and economy consumed by Social
Security spending.
<bullet> Balancing Adequacy and Equity--the relative balance struck
between the goals of individual equity and income adequacy. The current
Social Security system's benefit structure attempts to strike a balance
between these two goals. From the beginning, Social Security benefits
were set in a way that focused especially on replacing some portion of
workers' preretirement earnings. Over time other changes were made that
were intended to enhance the program's role in helping ensure adequate
incomes. Retirement income adequacy, therefore, is addressed in part
through the program's progressive benefit structure, providing
proportionately larger benefits to lower earners and certain household
types, such as those with dependents. Individual equity refers to the
relationship between contributions made and benefits received. This can
be thought of as the rate of return on individual contributions.
Balancing these seemingly conflicting objectives through the political
process has resulted in the design of the current Social Security
program and should still be taken into account in any proposed reforms.
<bullet> Implementing and Administering Proposed Reforms--how
readily a proposal could be implemented, administered, and explained to
the public. Program complexity makes implementation and administration
both more difficult and harder to explain. Some degree of
implementation and administrative complexity arises in virtually all
proposed changes to Social Security, even those that make incremental
changes in the already existing structure. Although these issues may
appear technical or routine on the surface, they are important issues
because they have the potential to delay--if not derail--reform if they
are not considered early enough for planning purposes. Moreover, issues
such as feasibility and cost can, and should, influence policy choices.
Continued public acceptance of and confidence in the Social Security
program require that any reforms and their implications for benefits be
well understood. This means that the American people must understand
why change is necessary, what the reforms are, why they are needed, how
they are to be implemented and administered, and how they will affect
their own retirement income. All reform proposals will require some
additional outreach to the public so that future beneficiaries can
adjust their retirement planning accordingly. The more transparent the
implementation and administration of reform, and the more carefully
such reform is phased in, the more likely it will be understood and
accepted by the American people.
The weight that different policymakers place on different criteria
will vary, depending on how they value different attributes. For
example, if offering individual choice and control is less important
than maintaining replacement rates for low-income workers, then a
reform proposal emphasizing adequacy considerations might be preferred.
As they fashion a comprehensive proposal, however, policymakers will
ultimately have to balance the relative importance they place on each
of these criteria. As we have noted in the past before this committee
and elsewhere, a comprehensive evaluation is needed that considers a
range of effects together. Focusing on comprehensive packages of
reforms will enable us to foster credibility and acceptance. This will
help us avoid getting mired in the details and losing sight of
important interactive effects. It will help build the bridges necessary
to achieve consensus.
REFORM'S POTENTIAL EFFECTS ON THE SOCIAL SECURITY PROGRAM
A variety of proposals have been offered to address Social
Security's financial problems. Many proposals contain reforms that
would alter benefits or revenues within the structure of the current
defined benefits system. Some would reduce benefits by modifying the
benefit formula (such as increasing the number of years used to
calculate benefits or using price indexing instead of wage indexing),
reduce cost-of-living adjustments (COLA), raise the normal and/or early
retirement ages, or revise dependent benefits. Some of the proposals
also include measures or benefit changes that seek to strengthen
progressivity (e.g., replacement rates) in an effort to mitigate the
effect on low-income workers. Others have proposed revenue increases,
including raising the payroll tax or expanding the Social Security
taxable wage base that finances the system; increasing the taxation of
benefits; or covering those few remaining workers not currently
required to participate in Social Security, such as older state and
local government employees.
A number of proposals also seek to restructure the program through
the creation of individual accounts. Under a system of individual
accounts, workers would manage a portion of their own Social Security
contributions to varying degrees. This would expose workers to a
greater degree of risk in return for both greater individual choice in
retirement investments and the possibility of a higher rate of return
on contributions than available under current law. There are many
different ways that an individual account system could be set up. For
example, contributions to individual accounts could be mandatory or
they could be voluntary. Proposals also differ in the manner in which
accounts would be financed, the extent of choice and flexibility
concerning investment options, the way in which benefits are paid out,
and the way the accounts would interact with the existing Social
Security program--individual accounts could serve either as an addition
to or as a replacement for part of the current benefit structure.
In addition, the timing and impact of individual accounts on the
solvency, sustainability, adequacy, equity, net savings, and rate of
return associated with the Social Security system varies depending on
the structure of the total reform package. Individual accounts by
themselves will not lead the system to sustainable solvency. Achieving
sustainable solvency requires more revenue, lower benefits, or both.
Furthermore, incorporating a system of individual accounts may involve
significant transition costs. These costs come about because the Social
Security system would have to continue paying out benefits to current
and near-term retirees concurrently with establishing new individual
accounts.
Individual accounts can contribute to sustainability as they could
provide a mechanism to prefund retirement benefits that would be immune
to demographic booms and busts. However, if such accounts are funded
through borrowing, no such prefunding is achieved. An additional
important consideration in adopting a reform package that contains
individual accounts would be the level of benefit adequacy achieved by
the reform. To the extent that benefits are not adequate, it may result
in the Government eventually providing additional revenues to make up
the difference.
Also, some degree of implementation and administrative complexity
arises in virtually all proposed changes to Social Security. The
greatest potential implementation and administrative challenges are
associated with proposals that would create individual accounts. These
include, for example, issues concerning the management of the
information and money flow needed to maintain such a system, the degree
of choice and flexibility individuals would have over investment
options and access to their accounts, investment education and
transitional efforts, and the mechanisms that would be used to pay out
benefits upon retirement. The Federal Thrift Savings Plan (TSP) could
serve as a model for providing a limited amount of options that reduce
risk and administrative costs while still providing some degree of
choice. However, a system of accounts that spans the entire national
workforce and millions of employers would be significantly larger and
more complex than TSP or any other system we have in place today.
Another important consideration for Social Security reform is
assessing a proposal's effect on national saving. Individual account
proposals that fund accounts through redirection of payroll taxes or
general revenue do not increase national saving on a first order basis.
The redirection of payroll taxes or general revenue reduces Government
saving by the same amount that the individual accounts increase private
saving. Beyond these first order effects, the actual net effect of a
proposal on national saving is difficult to estimate due to
uncertainties in predicting changes in future spending and revenue
policies of the Government as well as changes in the saving behavior of
private households and individuals. For example, the lower surpluses
and higher deficits that result from redirecting payroll taxes to
individual accounts could lead to changes in Federal fiscal policy that
would increase national saving. On the other hand, households may
respond by reducing their other saving in response to the creation of
individual accounts. No expert consensus exists on how Social Security
reform proposals would affect the saving behavior of private households
and businesses.
Finally, the effort to reform Social Security is occurring as our
Nation's private pension system is also facing serious challenges. Only
about half of the private sector workforce is covered by a pension
plan. A number of large underfunded traditional defined benefit plans-
<bullet> plans where the employer bears the risk of investment--
have been terminated by bankrupt firms, including household names like
Bethlehem Steel, US Airways, and Polaroid. These terminations have
resulted in thousands of workers losing promised benefits and have
saddled the Pension Benefit Guaranty Corporation, the Government
corporation that partially insures certain defined benefit pension
benefits, with billions of dollars in liabilities that threaten its
long-term solvency. Meanwhile, the number of traditional defined
benefit pension plans continues to decline as employers increasingly
offer workers defined contribution plans like 401(k) plans where, like
individual accounts, workers face the potential of both greater return
and greater risk. These challenges serve to reinforce the imperative to
place Social Security on a sound financial footing which provides a
foundation of certain and secure retirement income.
Regardless of what type of Social Security reform package is
adopted, continued confidence in the Social Security program is
essential. This means that the American people must understand why
change is necessary, what the reforms are, why they are needed, how
they are to be implemented and administered, and how they will affect
their own retirement income. All reform proposals will require some
additional outreach to the public so that future beneficiaries can
adjust their retirement planning accordingly. The more transparent the
implementation and administration of reform, and the more carefully
such reform is phased in, the more likely it will be understood and
accepted by the American people.
CONCLUSIONS
Social Security does not face an immediate crisis but it does face
a large and growing financial problem. In addition, our Social Security
challenge is only part of a much broader fiscal challenge that
includes, among other things, the need to reform Medicare, Medicaid,
and our overall health care system.
Today we have an opportunity to address Social Security as a first
step toward improving the Nation's long-term fiscal outlook. Steps to
reform our Federal health care system are likely to be much more
difficult. They are also likely to require a series of incremental
actions over an extended period of time. As I have said before, the
future sustainability of programs is the key issue policy makers should
address--i.e., the capacity of the economy and budget to afford the
commitment over time. Absent substantive reform, these important
Federal programs will not be sustainable. Furthermore, absent reform,
younger workers will face dramatic benefit reductions or tax increases
that will grow over time.
Many retirees and near retirees fear cuts that would affect them in
the immediate future while young people believe they will get little or
no Social Security benefits in the longer term. I believe that it is
possible to reform Social Security in a way that will ensure the
program's solvency, sustainability, and security while exceeding the
expectations of all generations of Americans.
ENDNOTES
1. In this statement, Social Security refers to the Old-Age and
Survivors Insurance and Disability Insurance (OASDI) program.
2. GAO, Budget Issues: Long-Term Fiscal Challenges, GAO-02-467T
(Washington, D.C.: Feb. 27, 2002); Social Security: Long-Term Financing
Shortfall Drives Need for Reform, GAO-02-845T (Washington, D.C.: June
19, 2002); and Social Security: Long-Term Challenges Warrant Early
Action, GAO-05-303T (Washington, D.C.: Feb. 3, 2005).
3. Saving Our Nation's Future: An Intergovernmental Challenge,
Outlook 2005 Conference, The National Press Club (Washington D.C.: Feb.
2, 2005). This product can be found on GAO's web site, www.gao.gov.
4. Separately, the Disability Insurance (DI) fund is projected to
be exhausted in 2029 and the Old-Age and Survivors' Insurance (OASI)
fund in 2044. Using slightly different economic assumptions and model
specifications, CBO estimated the combined Social Security trust fund
will be solvent until 2052. See Congressional Budget Office, The
Outlook for Social Security (Washington, D.C.: June 2004) and Updated
Long-Term Projections for Social Security (Washington, D.C.: January
2005).
5. CBO estimates that this will occur in 2020. See CBO's Updated
Long-
Term Projections for Social Security (January 2005).
6. The Congressional Budget Office, The Budget and Economic
Outlook: Fiscal Years 2006 to 2015, (Washington, D.C.: January 2005).
7. The elderly dependency ratio is the ratio of the population aged
65 years or over to the population aged 15 to 64.
8. Initial Social Security benefits are indexed to nominal wage
growth resulting in higher benefits over time.
Chairman Nussle. To your credit, if I may amplify your
testimony, this is not the first time you have given us this
advice. We appreciate that.
Mr. Walker. Thank you.
Chairman Nussle. Doug Holtz-Eakin, the Director of the
Congressional Budget Office. We welcome you back to the
committee, and we are pleased to receive your testimony. All of
your statement will be made part of the record.
STATEMENT OF DOUGLAS J. HOLTZ-EAKIN
Mr. Holtz-Eakin. Thank you, Mr. Chairman, and members of
the committee. The CBO is happy to be back to talk about this
important issue and to continue to work with the committee on
this and other areas. I wanted to simply submit the testimony
as we have it written and talk about this program, which is
very important from many perspectives, and bring to the
discussion not merely a discussion of the system's finances,
but the larger perspective of the economy, where the Social
Security program is very important to beneficiaries in deciding
their labor supply, how much they work and when they retire,
where it is central to decisions on saving for retirement and
the kind of portfolios people hold at the moment, where it has
a big contribution to retirement income along with private
saving and private pension plans, and where it has important
implications for the distribution of well-being between parents
and their children.
It is one of the central pieces of economic policymaking in
the United States. It is also a very important budgetary issue.
It is our single largest Federal program at the moment and
should be analyzed from budgetary perspectives as well.
I thought I would devote my time to talking about three
figures which outline the future of the Social Security program
and shed light on the nature of the problem facing this
committee from a budgetary and economic perspective. If we
could look at the first of those.
This summarizes the current CBO projections for the outlook
for Social Security under the current law. It may differ in
numerical detail from those you would hear from my colleague to
the right or from those in the Social Security Administration.
However, qualitatively, we all have the same message about the
outlook for the program. And that is, that at the moment
revenues dedicated to Social Security exceed the outlays for
benefits to current retirees. And that will continue and grow,
in fact, until shortly after the retirement of the leading edge
of the baby boom generation.
Beginning in about 2010, that excess will begin to
diminish. It diminishes steadily in our projections until 2020,
at which point the cash flow surplus switches to a cash flow
deficit. At that point, Social Security is entitled to continue
to pay full benefits, the red line, which will exceed dedicated
revenues, the blue line, for decades. And those benefits will
be paid in full from resources drawn elsewhere in the Federal
budget. They will come from either lower spending elsewhere in
the Federal budget, higher taxes, or greater borrowing from the
public.
In our projections, the trust fund, the accounting
mechanism that gives the legal authority to pay full benefits
will exhaust in 2052, at which point there will be an across-
the-board 22 percent diminishment in the ability to pay
benefits, and the program can then continue paying out benefits
equal to payroll taxes thereafter.
That suggests a couple of things. Number one, in terms of
timing, some form of the current Social Security program can in
fact be sustained indefinitely, and that is the edge at the
right where benefits are brought down to payroll taxes.
In terms of other issues of urgency, whether things need to
be done sooner or later, it is in the eye of the beholder. At
some point, 2052 would be the across-the-board benefit cut.
Others would point to 2020 in our projections when cash flow
surplus turns to cash flow deficit. Others would note that
surplus peaks in 2010, and that between 2010 and 2025, we will
swing from providing $100 billion from Social Security to the
remainder of the budget to $100 billion in today's dollars from
the remainder of the budget for Social Security, and that
budgetary pressure should be the driving consideration in
reform. Any of those I think are plausible dates, and in the
context of the larger Federal budget all will be noticeable
events for this committee.
If we go to slide two. This simple display also I think
displays the size of the problem. There are many different
measures of what is deemed to be how large a problem we have.
To my eye, the size of the problem is illustrated by the fact
that scheduled benefits under current law, the outlay line on
top in red exceeds dedicated revenues under current law, the
blue line at the bottom, as far as the eyes can see. And all
measures that you will hear about the size of the problem have
to do with adding up over different horizons and for different
people the size of that gap between the outlays and the
revenues. From a larger budgetary point of view, one could make
the arithmetic case that we simply do not have a Social
Security problem. That we can honor the benefit promises at the
top. But I would note that, as a matter of arithmetic, if one
makes that case, they must simultaneously make the case that
they can find those resources elsewhere in the Federal budget
and solve the larger looming problem that we face and that
David illustrated so nicely.
The third thing this shows us, if we go to slide three, is
the difference between two notions of fixing the problem. One
notion of fixing the problem that one hears quite frequently is
fixing it in a 75-year actuarial balance sense. CBO's estimates
are that over 75 years the actuarial imbalance is a bit above 1
percent of taxable payroll. That would suggest that the problem
is fixed if one simply raises, for example, the payroll tax by
1 percentage point and has that as the solution to Social
security. That is the rise in blue line from the bottom one to
the dotted one above it. You will notice that, from a budgetary
point of view, this diminishes but does not eliminate the cash
flow shortfall between promised benefits and dedicated
revenues.
A different way to say is that any actuarial fix comes with
it a budget financing plan, a dedication of future cash flows
that must come out of the remainder of the Federal budget
through either less borrowing or some other source that makes
good on that 75 year actuarial fix. It is also the case that
once you get to the end of 75 years, you have a problem
remaining, this is not a sustainable fix in every sense.
All of this will come to pass in an environment in which
there will be even greater budgetary demands from other
programs. So to the extent that you adopt a fix for Social
Security, it must be developed in the context of rising demands
for Medicare and Medicaid that will dwarf the rising outlays
for Social Security. Social Security's outlays are likely to go
up by about 50 percent, it is a fraction of GDP; Medicare and
Medicaid, if things go well, may triple in size and could in
fact be quite large.
These are the budgetary problems that face this committee
and the Congress as a whole as it faces Social Security. I
would remind everyone in closing that these budgetary futures
will be a reflection of economic policy issues, and that the
threshold questions are whether this Social Security system is
the one that the Congress wants for the 21st century, whether
it is designed appropriately for a world in which there are
very different demographics, where fertility is much different
than it was at the time the program was put into place, where
longevity is rising, and where the dependency ratio, as a
result, is much greater.
And in looking at the program, the new element that has
been raised is the possibility of individual accounts. And
there, I would suggest, that in addition to the financing
considerations that we have heard so much about already today,
one remember the economic policy considerations; that to the
extent that one favors individual accounts and prefunding in
that form, it is an argument in favor of increased reliance on
individuals, in enhancing labor supply incentives in this
program, in enhancing savings incentives in the program, and
offering participants a potential for a higher rate of return.
In contrast, those who favor a modification of a pay-as-
you-go Social Security system for the new demographics are
highlighting the importance of universality in the program, the
ability to redistribute through Social Security, and to offer
genuine social insurance in which the retirement benefit is
decoupled from the particulars of someone's labor market
experience. These are important economic policy issues. They
will reflect themselves in the budget and in Social Security
more narrowly, and we look forward to working with the Congress
in helping you as you make these decisions. Thank you, Mr.
Chairman.
[The prepared statement of Douglas J. Holtz-Eakin follows:]
Prepared Statement of Douglas Holtz-Eakin, Director,
Congressional Budget Office
Chairman Nussle, Congressman Spratt, and Members of the Committee,
I appreciate the opportunity to appear before you today to discuss the
Social Security system. Discussions about reforming the system have
focused on the program and its trust funds. But important insights can
also be gained by looking at Social Security from the perspectives of
the economy and the Federal budget as a whole.
First, from the perspective of the economy, beneficiaries make
decisions about when to retire and how much to work before retirement
partly on the basis of the amount of taxes they pay and the amount of
benefits they expect to receive. Social Security also influences
people's decisions about how much to save, and that saving plays a role
in determining the size not only of people's retirement income but also
of the Nation's capital stock as a whole. Consequently, Social Security
has important implications for aggregate economic performance for the
flow of income that the economy will be able to generate and for the
total stock of wealth and overall economic resources that will be
available in the future. As a result, Social Security can significantly
affect the Nation's standard of living as well as the distribution of
income within and among generations.
Second, from a budgetary standpoint, Social Security is the single
largest program of the Federal Government. This fiscal year, outlays
for Social Security are expected to top $500 billion and account for 23
percent of total Federal spending (excluding interest). Looking further
ahead, the Congressional Budget Office (CBO) projects that Social
Security outlays will grow from 4.2 percent of gross domestic product
(GDP) in 2005 to 6.5 percent in 2050. Although that growth is
significant, it pales in comparison with the projected growth of the
Government's two big health programs, Medicare and Medicaid.
Finally, Social Security can be analyzed from the perspective of
the program itself. The most recent programmatic focus has been on the
``sustainability'' of the system's finances. However, several other
aspects of the program are also important. Throughout its long history,
Social Security has had multiple goals--some related to redistributing
income, others to offsetting lost earnings. In 2004, only about two-
thirds of Social Security's beneficiaries were retired workers; the
rest were disabled workers, survivors of deceased workers, and workers'
spouses and minor children. Policymakers will need to decide whether
the program's goals are still appropriate, and if so, how changes to
Social Security would aid or hinder the achievement of those goals and
affect various types of beneficiaries and taxpayers. Those decisions
will also need to take into account the dramatic increase in the
elderly population that is expected in coming decades.
My statement examines the prospects for Social Security from each
of those three perspectives, in reverse order, beginning at the
programmatic level.
THE OUTLOOK FOR THE SOCIAL SECURITY PROGRAM
Although there is significant uncertainty involved in making
numerical projections of the future of Social Security, the basic
trajectory is widely accepted. The outlook for the Social Security
program is generally the same regardless of whether one turns to the
long-term projections of Social Security's trustees or to those of the
Congressional Budget Office.
In 2008, the leading edge of the baby-boom generation will become
eligible for early retirement benefits. Shortly thereafter, the annual
Social Security surplus--the amount by which the program's dedicated
revenues exceed benefits paid--will begin to diminish (see Figure 1).
That trend will continue until about 2020, when Social Security's
finances will reach a balance, with the revenues coming into the system
from payroll taxes and taxes on benefits matching the benefit payments
going out. Thereafter, outlays for benefits are projected to exceed the
system's revenues. To pay full benefits, the Social Security system
will eventually have to rely on interest on Government bonds held in
its trust funds and ultimately on the redemption of those bonds. But
where will the Treasury find the money to pay for the bonds? Will
policymakers cut back other spending in the budget? Will they raise
taxes? Or will they borrow more?
FIGURE 1.--SOCIAL SECURITY REVENUES AND OUTLAYS AS A SHARE OF GDP UNDER
CURRENT LAW
(Percentage of GDP)
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Congressional Budget Office.
Note: Based on a simulation from CBO's long-term model using the
Social Security trustees' 2004 intermediate demographic assumptions and
CBO's January 2005 economic assumptions. Revenues include payroll taxes
and income taxes on benefits but not interest credited to the Social
Security trust funds; outlays include trust-fund-financed Social
Security benefits and administrative costs. Under current law, outlays
will begin to exceed revenues in 2020; starting in 2053, the program
will no longer be able to pay the full amount of scheduled benefits.
In the absence of other changes, the redemption of bonds can
continue until the trust funds are exhausted. In the Social Security
trustees' projections, that happens in 2042; in CBO's projections, it
occurs about a decade later, largely because CBO projects higher real
(inflation-adjusted) interest rates and slightly lower benefits for men
than the trustees do. Once the trust funds are exhausted, the program
will no longer have the legal authority to pay full benefits. As a
result, it will have to reduce payments to beneficiaries to match the
amount of revenue coming into the system each year. Although there is
some uncertainty about the size of that reduction, benefits would
probably have to be cut by 20 percent to 30 percent to match the
system's available revenue.
The key message from those numbers is that some form of the program
is, in fact, sustainable for the indefinite future. With benefits
reduced annually to match available revenue (as they will be under
current law when the trust funds run out), the program can be continued
or sustained forever. Of course, many people may not consider a sudden
cut in benefits of 20 percent to 30 percent to be desirable policy. In
addition, the budgetary demands of bridging the gap between outlays and
revenues in the years before that cut may prove onerous. But the
program is sustainable from a financing perspective.
What is not sustainable is continuing to provide the present level
of scheduled benefits--those based on the benefit formulas that exist
today--given the present financing. Under current formulas, outlays for
scheduled benefits are projected to exceed available revenues forever
after about 2020 (see Figure 2). That gap cannot be sustained without
continual--and substantial--injections of funds from the rest of the
budget.
THE IMPACT OF SOCIAL SECURITY ON THE FEDERAL BUDGET
I would like to make three points about Social Security in the
larger context of the total budget. First, Social Security will soon
begin to create problems for the rest of the budget. Right now, Social
Security surpluses are still growing and contributing increasing
amounts to the rest of the budget. But as explained above, those
surpluses will begin to shrink shortly after 2008, when the baby
boomers start to become eligible for early retirement benefits. As the
rest of the budget receives declining amounts of funding from Social
Security, the Government will face a period of increasing budgetary
stringency. By about 2020, Social Security will no longer be
contributing any surpluses to the total budget, and after that, it will
be drawing funds from the rest of the budget to make up the difference
between the benefits promised and payable under current law and the
system's revenues. Policymakers will have only three ways to make up
for the declining Social Security surpluses and emerging Social
Security deficits: reduce spending, raise taxes, or borrow more.
FIGURE 2.--SOCIAL SECURITY REVENUES AND OUTLAYS AS A SHARE OF GDP WITH
SCHEDULED BENEFITS EXTENDED
(Percentage of GDP)
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Congressional Budget Office.
Note: Based on a simulation from CBO's long-term model using the
Social Security trustees' 2004 intermediate demographic assumptions and
CBO's January 2005 economic assumptions. Revenues include payroll taxes
and income taxes on benefits but not interest credited to the Social
Security trust funds; outlays include Social Security benefits and
administrative costs. In this simulation, currently scheduled benefits
are assumed to be paid in full after 2053 using funds from outside the
Social Security system.
CBO's projections offer some guidance about the potential impact of
those developments on the budget. By CBO's calculations, the Social
Security surplus (excluding interest) will reach about $100 billion in
2007; but by 2025, that surplus is projected to become a deficit of
roughly $100 billion (in 2005 dollars). That $200 billion swing will
create significant challenges for the budget as a whole.
Second, the demand on the budget from Social Security will take
place simultaneously with--but be eclipsed by--the demand generated by
Medicare and Medicaid. Currently, outlays for Social Security benefits
equal about 4 percent of GDP, as does Federal spending on Medicare and
Medicaid. But whereas Social Security outlays are projected to grow to
almost 6.5 percent of GDP by 2050, spending on the two health programs
is expected to grow substantially more. Over the past few decades,
excess growth in health care costs--the extent to which per-beneficiary
costs increase faster than per capita GDP--has been about 2.5 percent
annually. If one assumes a fairly dramatic shift to a slower increase
in health care costs--that excess cost growth will decline to less than
half of its historical rate Federal spending on Medicare and Medicaid
will still roughly triple by 2050, to 12 percent of GDP. The clear
message is that although Social Security will place demands on the
Federal budget, those demands will coincide with much greater demands
from Medicare and Medicaid.
Third, a key distinction exists between the programmatic
perspective and the budgetary perspective in analyzing policy changes.
From a programmatic standpoint, the 75-year actuarial imbalance in the
Social Security system (the present value of expected outlays over 75
years minus the present value of expected revenues over that period)
equals 1.04 percent of the present value of Social Security's taxable
payroll over those years, CBO estimates. That number suggests that,
leaving aside economic feedbacks on the budget, immediately and
permanently raising the payroll tax rate by about 1 percentage point or
reducing initial benefits for newly entitled beneficiaries by 9 percent
would address the 75-year imbalance in the system.
From a budgetary perspective, however, annual benefits would
continue to exceed revenues by a large margin after 2025 under either
policy change (see Figure 3). Thus, neither policy would provide a
permanent solution for the system's financing. Either policy could fix
that financing for the next 75 years, but only if the projected cash-
flow deficits shown in Figure 3 were offset elsewhere in the Federal
budget. In principle, lower net interest payments on Federal debt held
by the public could provide that offset. But such a policy change would
fix Social Security over the next 75 years only if the rest of the
budget was not altered.
SOCIAL SECURITY AND THE ECONOMY
Although looking at the overall budgetary context is important,
Social Security and its possible reform also carry significant
implications for the economy and economic policy.
One of the major achievements of reform could be to resolve
uncertainty about the future of the program. Uncertainty is an economic
cost in its most fundamental form, and in the current context, there is
uncertainty about the future of Social Security, its configuration, and
who will be affected. The sooner that uncertainty is resolved or
reduced, the better served will be current and future beneficiaries,
who must make various decisions about their retirement (from how much
they should save to when they will be able to stop working).
FIGURE 3.--SOCIAL SECURITY REVENUES AND OUTLAYS AS A SHARE OF GDP UNDER
VARIOUS POLICY OPTIONS
(Percentage of GDP)
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Source: Congressional Budget Office.
Notes: Based on a simulation from CBO's long-term model using the
Social Security trustees' 2004 intermediate demographic assumptions and
CBO's January 2005 economic assumptions. Revenues include payroll taxes
and income taxes on benefits but not interest credited to the Social
Security trust funds; outlays include Social Security benefits and
administrative costs. The projections do not incorporate macroeconomic
feedbacks.
Under current law, annual outlays will begin to exceed revenues in
2020; starting in 2053, the program will no longer be able to pay the
full amount of scheduled benefits. Under either a 1 percentage point
increase in the payroll tax rate or a 9 percent cut in initial
benefits, outlays will exceed revenues by 2025, and scheduled benefits
will not be able to be paid starting in 2083.
A key uncertainty stems from a central policy question: to what
extent should the Social Security program in the 21st century resemble
the program in the 20th century? There are two separate aspects to
consider: insurance and financing.
In terms of insurance, the major issue is finding the appropriate
balance between social responsibility and individual responsibility. On
one side, some people argue that the nation needs a program of
universal social insurance that allows for the redistribution of
resources among individuals and provides a hedge against such adverse
outcomes as poor health, unemployment, low wages, or simply bad luck.
On the other side, some people argue that it would be better to have a
retirement system that relied more on individuals (which proponents
view as desirable in itself) and included provisions that strengthened
incentives for individuals to work and save.
In terms of financing, the major issue is striking the appropriate
balance between prefunding retirement (with each generation saving for
its own retirement) and employing a traditional pay-as-you-go method of
financing (in which assets are not accumulated, but instead current
revenues are used to finance benefit payments to retirees). Prefunding
retirement benefits has the potential to increase the nation's capital
stock, boost productivity, and raise GDP in the long run. However,
prefunding requires some people to consume less or work more than they
would otherwise during a transitional period.
Although prefunding could be carried out either by having
individuals save more or by having the Government save more (through
smaller budget deficits or larger budget surpluses), analysts disagree
about the extent to which the Government could actually prefund
retirement benefits, for several reasons. The experience of recent
years, for instance, raises questions about the likelihood that the
Government would be able to maintain budget surpluses for long periods
of time.
Regardless of one's views about those issues, any approach to
Social Security will have to confront the new demographic situation--
low fertility rates; declining mortality rates; and changing patterns
of marriage, divorce, participation in the labor force, and
immigration--as well as a host of other factors that are very different
now than they were in the past. Reconfiguring Social Security to
reflect those new realities, and better insulating the system from
unexpected demographic or economic changes, will be major challenges
for policymakers.
Chairman Nussle. Thank you, Mr. Director. As I announced
previously, I am going to go to members who have not had an
opportunity to question the first panel to begin with. So Mr.
Baird is recognized for 5 minutes.
Mr. Baird. I thank the Chairman. I thank the gentleman.
I would say at the outset that our experience, my
experience on this committee, these two individuals have given
us the most forthright, balanced, and objective information
that we are privileged to receive. And I am grateful for their
presentations, not only today, but previously.
I want to just address a few quick items that were sort of
left over from the last speaker. First of all, one of my good
colleagues Mr. Portman, suggested that it is the Congress that
has been spending the Social Security trust funds. I would
point to page 363 of the President's budget offered to us by
OMB, and would note that in 2005, the President proposes to
spend $162 billion of the Social Security trust fund; in 2006,
173 billion; in 2007, 197 billion, on up to a total of 256
billion in 2010 alone. In 5 years, it amounts to over a
trillion dollars. In 10 years, I suspect it would be $2
trillion of expenditures not proposed by the Congress but
proposed by the administration. Just to clear that.
Secondly, the Treasury Secretary said that he thought it
was appropriate to characterize Social Security as approaching
bankruptcy. My assumption there is he seeming to be suggesting
that if current demands exceed current revenues into a system,
we are thereby bankrupt. If that were to apply to the Federal
budget overall, do current--and I will ask the two gentlemen as
experts in this area. Do current revenues for the U.S.
Government exceed or fall short of current expenditures?
Mr. Walker. They fall short. And if I can address the issue
of insolvency versus bankruptcy. One of the things I find in
Washington is that sometimes you have to go back to Webster's
to look for the definition. The definition of bankruptcy is
utter failure or impoverishment. The definition of insolvency
is unable to pay debts as they fall due.
I would respectfully suggest, for 2042, the program would
be insolvent under that definition but not bankrupt.
Mr. Baird. That is a very helpful clarification, and I
appreciate it and share the opinion. I would be remiss if I
didn't just make a marker here today about one of our concerns
in the northwest about the President's proposed budget. I will
not ask these gentlemen necessarily to comment on it, but it
needs to be for the record. The proposed budget seems to depend
for an increased source of revenues on gradually shifting what
are currently cost based power rates in four power marketing
areas of the country to market-based power rates, effectively
leveling an increased taxation in the form of increased power
rates on those four regions of the country. I personally am
profoundly opposed to that. It goes against a proud tradition
of this Government of supporting market-based rates in the
public power supply systems, and would just like to put that
down. And I believe it would have a profoundly negative impact
if you increase power rates by up to 20 to 50 percent in those
regions. I think it would be tantamount to a gross taxation on
those consumers, and would be opposed to that.
Let me ask a question that maybe you can help me address.
Would you think it is good advice for a hypothetical family
alluded to by Mr. Wicker and others to advise your children to
go out and borrow money in order that they can invest it?
Mr. Holtz-Eakin. At the individual level, the issue is the
degree to which you have a comfort for risk. You can borrow and
invest. That is known as leverage. It offers you the potential
for higher rates of return and it carries with it greater risk.
And in the United States' financial markets, individuals have
the ability to tailor their investment strategy to the kind of
risk that they are comfortable taking.
Mr. Baird. Would it be a good----
Mr. Holtz-Eakin. Truthfully, that is not the kind of advice
you will ever get me to give personally or otherwise. I am much
too much of a coward. But I would give them exactly those
options and send them on their way.
Mr. Baird. So in general, though, it would seem to me that
to some extent banks must set their interest rates
proportionate to what one might receive were they to invest the
money in another way, and they must somewhere make a
calculation that we think overall, again bearing in mind risk,
that the amount of risk you would obtain from investing your
borrowed money doesn't seem to me that the percentages would
play out. In other words, would you say son or daughter go out
and borrow a bunch of money from the bank and then put it in
the stock market because that will get you more money for sure
than the interest rates you will pay on the loan?
Mr. Walker. Well, first, as you know, interest rates vary
based upon the type of borrowing. Credit card interest rates
are very, very high; interest rates for mortgages or home
equity loans are a lot less. And so, therefore, one would have
to determine with what degree of confidence that they have that
they are going to end up gaining a net positive return from
that leverage, understanding that there is nothing guaranteed.
Mr. Baird. That is a good summary.
The final question, and I don't think you have time
necessarily to answer it. But I haven't heard anyone really
talk about this and I have some questions. What would be the
impact on the value of extent shares in the stock market of
gradual or sudden influx of new purchasers of stocks under this
type of scenario? In other words, we tend to talk about what
happens to the Federal budget deficit vis-a-vis this, but
wouldn't there be some substantial impact on the value of
stocks in the market?
Mr. Holtz-Eakin. The benchmark valuation will be driven by
the underlying fundamentals in each company. And shares are
worth no more than the future profits to which they give you
claim. It could be the case that, given shifts in portfolios of
this type you would see some transitory revaluation, but it is
hard to imagine you would get a persistent revaluation of the
same profits.
Mr. Baird. Thank you. I thank the gentleman and I thank the
Chair.
Chairman Nussle. Mr. Walker, I have before me the Webster's
No. 2 New College Dictionary. I would just like to read you a
definition of the word ``crisis:'' A crucial or decisive point
or situation.
I think we are probably, at least according to Mr. Webster,
at a crisis point if in fact we have got to make a decision now
as you have counseled us. Problem is defined as, a question or
situation that presents doubt or perplexity. I would suggest to
you that politicians have problems with Social Security, and I
would suggest that Social Security itself is in a crisis,
according to these definitions. I am just having fun with you.
Mr. Jefferson for 5 minutes.
Mr. Jefferson. Thank you, Mr. Chairman. This is the first
time I will have a chance to inquire about anything as a member
of the Budget Committee, so I am pleased to have a chance to
participate in these most important hearings. I am sorry that
Mr. Portman isn't here, because my line of inquiry has to do
with his assertions about the value of private accounts. He
said, if I can remember correctly, that one might expect a 5
percent return on private accounts as against a 1.8 percent or
so percent return on that is now yielded by Social Security
investments. But I note, however, that under the President's
proposal, as I am given to understand it, CBO projects a 3.3
percent return on private accounts; the Social Security
Administration projects a 4.6 percent return; but in each case
they also anticipate a crawlback of 3 percent.
And I just want to see if you agree with me that if the CBO
bears out to be correct at 3.3, with a clawback of 3 percent,
then there is virtually nothing from the investment that would
be yielded from private accounts. And if SSA is right and the
return is 4.6 percent with a clawback of 3 percent, then there
is actually a 1.6 percent return. Am I correct in my analysis
of that?
Mr. Holtz-Eakin. If I could, let me say a few words about
the different rates of return that are floating around, because
I think there is a fair amount of confusion, particularly about
the work that we have done. One rate of return is the rate of
return that is possible in a sustainable pay-as-you-go Social
Security system. That rate of return with current beneficiaries
being paid by current taxes, the rate of return is only the
rise in the payroll tax base. That is the only way you can get
a rate of return in that kind of a system. In our projections,
that would be a number that would look like one and a half, 2
percent real increase. We don't have a sustainable Social
Security system, so rates of return are quite likely to be
lower than that in the future as taxes are raised or benefits
are cut.
The second rate of return would be the rate of return
possible in a prefunded system. One could imagine paying for
one's own retirement. Instead of paying for current retirees,
you pay for your own retirement by putting funds away. There,
you could get, given historical rates of return, 3.3 percent
after inflation simply by putting it in U.S. Treasuries.
You could also then get a higher rate of return if you
chose to take more risk. In our estimates, we assume the return
on corporate equities is 6.8 percent, inflation adjusted, and
corporate bonds would be in between. You could pick a portfolio
and get a higher rate of return. Our rates of return are no
different than anyone else's. Although they differ numerically,
we acknowledge the higher rate of return----
Mr. Jefferson. You have chosen the 3.3 percent figure even
though you could check the figures and have chosen some other
ones.
Mr. Holtz-Eakin. Let me finish. Those are all the rates of
return that we use, and so those are consistent with history,
they are consistent with the economics that we have.
The final question is, what would be the valuation now of a
transaction that gave me the access to, say, corporate equity?
It has a higher return historically, and we don't dispute that
it comes with a higher risk. As Mr. Baird's question suggested,
different people value that risk return trade-off differently.
What we have done is examined the average as reflected in U.S.
financial markets and note that in the U.S. financial markets
individuals simultaneously hold Treasuries for the 3.3 return
and equities that get 6.8 in the presence of risk. They
therefore right now view their futures as valued equivalently.
And that is the nature of our analysis. It is not quite the
same thing as saying the individual account will get 3.3
percent.
Mr. Orszag. We should be building accounts where they
belong and shoring up the traditional program as a core tier of
financial security. Thank you very much.
Mr. Jefferson. I understand.
Mr. Holtz-Eakin. It was a long answer, I apologize.
Mr. Jefferson. Right.
Mr. Holtz-Eakin. There are many, many different returns
there.
Mr. Jefferson. At the end of the day, though, I am using
the figure 3.3 percent, because that is--after all that
summarizing, we ended up with a number that we used as a--I
mean, the report that I have is that CBO's suggested rate of
return, inflation adjusted, such and such.
But my point is, there is a clawback in this provision,
isn't there, of 3 percent? So whatever we do, whatever number
we arrive at, we have taken away 3 percent which goes back to
the Government. The individual person gets what the excess is,
correct?
Mr. Holtz-Eakin. Correct.
Mr. Jefferson. So it would be incorrect to say that there
is a 5 percent return, any percent return is pure investment
that doesn't involve the clawback, that would be correct
wouldn't it?
Mr. Holtz-Eakin. One could evaluate the investment or, as
David suggested, the whole package. If the package has
investment plus diminished regular benefit, it is the net
effect that would matter.
Mr. Jefferson. Last question, if I could squeeze it in
here. What would be the value of one's nest egg now that would
yield $850, or something like the average return, the average
Social Security check today that one gets every month? What
would be the size of a nest egg that one would need to generate
that sort of monthly income?
Mr. Holtz-Eakin. I am sure that is a question for Dave. I
will be happy to provide----
Mr. Walker. We can find out. Mr. Jefferson, I think there
is one thing that you and all members need to keep in mind, not
all promised Social Security benefits have been funded.
If you did nothing, then if you are 30 years of age or
younger, your benefits are going to get cut by 27 percent plus,
all at once, for your entire life. If you are over 30, your
benefit is going to get cut by 27 plus percent, all at once,
for the remaining portion of your life.
We believe it is important, when you analyze proposals, you
have benchmarks based on both promised benefits and funded
benefits, because it is not fair to assume that all the current
promised benefits are funded.
There are going to have to be changes, with or without
individual accounts, to make this program solvent, sustainable,
and secure for future generations.
Mr. Jefferson. On the nest egg, can someone answer that--
what size would the nest egg have to be to generate----
Mr. Walker. I would be happy to try to provide something
for the record. We could do some math on it and be happy to try
to give you something.
Mr. Walker's Response to Congressman Jefferson's Query About Nest Egg
Size
One estimate of the nest egg required today to yield a monthly
benefit is the present value of one's lifetime Social Security
benefits. Based on CBO's Updated Long-Term Projections for Social
Security (March 2005), the initial median monthly Social Security
benefit for a peson aged 65 today\1\ is about $1,140. CBO estimates the
lifetime scheduled benefits for that person to total about $127,000 (in
present value 2004 dollars discounted at the Treasury rate.\2\
---------------------------------------------------------------------------
\1\ This estimate reflects the benefit for a retired worker; it
does not reflect disability or survivor benefits.
\2\ All values are net of income taxes paid on benefits.
---------------------------------------------------------------------------
However, as time goes on and both wages and Social Security
benefits increase, the nest egg required to provide median scheduled
Social Security benefits would increase. For example, the initial
median monthly Social Security benefit for a perwson born in 2000 is
about $2,083. CBO estimates the lifetime scheduled benefits for that
person to total about $265,700 (in present value 2004 dollars
discounted at the Treasury rate).
As I noted at my testimony, scheduled Social Security benefits are
not funded. If you did nothing, according to CBO's estimates a person
born in 2000 would only receive 71 percent of scheduled benefits over
his lifetime.
Chairman Nussle. Mr. Lungren for 5 minutes.
Mr. Lungren. Thank you, Mr. Chairman, and thank you for
appearing. I am sorry I missed your live comments. I was over
on the floor on the immigration bill.
From the exchange I just heard, it reminds me of Larry
Gatlin and the Gatlin Brothers, and the lyrics of the song they
sang a number of years ago: ``all the gold in California is in
a bank in Beverly Hills in someone else's name.'' There are a
lot of people who assume that there is an account sitting there
at the Department of Treasury with their name on it that is
fully funded.
I guess one of the things we have to do is to try to
explain to people what the reality is. I think as you pointed
out, we have promised benefits, but we haven't funded those
benefits. The question is, how do we fund it, and do we do
something to essentially change in part the nature of Social
Security, so it is not only funded, but that we don't run into
these problems in the future?
I guess I would address this question to both of you to see
your perspectives on that.
Secretary Snow has said that each year that we don't do
something it gets worse. They have put a number on it, $600
billion a year.
Can you give me your observations on the accuracy of that
comment and how we come to that conclusion?
Mr. Holtz-Eakin. My observation would be--I am not the
source of the number, I don't know how it was calculated, but
it has the feel of one of these actuarial numbers that looks
out over the future horizon.
As I noted in the remarks that you missed, ultimately those
actuarial calculations carry with them some budgetary
implications to make them whole. So to the extent that you want
to go that way is a matter of preference. I think it is more
useful to look at the cash-flow demands in the context of the
other demands that this Congress will face, and that those
happen very quickly, the surpluses begin to diminish. They are
consequential aspects of the Federal budget, and I think that
is a metric of how soon things happen that will be useful and
reveal the trade-offs.
Mr. Lungren. Let me ask it very simply, and that is, is it
true that every year that we postpone doing something to change
the system as it is now makes the system worse?
Mr. Walker. That is true. The reason it is true is because
of demographics, because every year you drop a positive year--
last year we had $151 billion surplus, and you add an
increasingly bad year because of demographic trends. So it is
true that it gets worse with the passage of time.
Mr. Holtz-Eakin. Yes.
Mr. Lungren. A question that I have for you, and this has
been a subject that often has been talked about, I guess; it is
option 2, or the Penny option, or whatever we call it, the Tim
Penny option--which is to change the indexing from, as it is
now, wage increases to price increases.
There is some graph that the other side keeps putting up
that shows you are going to diminish the benefits, and they do
it as a percentage of replacement income, I believe.
My question is a little different. Maybe I am wrong on
this. I would like both of your observations.
If we go to a price indexing, is it not in the nature of
price indexing that you are preserving the purchasing power for
the individual? In other words, there is purchasing power
equity as opposed to what appears that they are suggesting. If
you have wage indexing, you actually have more purchasing power
10 years down the line as opposed to price indexed?
Mr. Holtz-Eakin. Can we pull up slide 14?
Slide 14 is an illustrative example of exactly the question
that you asked, and it shows what would happen to the median
person in the population.
Go back one, please. Thank you.
Under current law, black lines, price indexing, blue lines,
current law--and these are for people, going from left to
right, older to younger. The right-hand are those born in 2000.
So, under current law, you will see that as we move to the
right, ultimately benefits get cut due to trust fund
exhaustion, and then begin to rise after that.
The pricing indexing just sets the purchasing power roughly
equal. You see the blue lines are the same for all cohorts
going forward. That is the nature of that kind of a proposal.
Mr. Lungren. So price indexing would allow you to have the
same purchasing power year after year after year.
Mr. Holtz-Eakin. Right. That is the blue lines I am looking
at.
Mr. Lungren. Right. But I am just trying to get that
clarified, because when you go to this question of salary
replacement percentage, or whatever it was they were using
there, it shows--it gives a tremendous diminishing line. If
what we are trying to do is preserve a system that allows you
to purchase what you can now on into the future with price
indexing, that means something different to me than I had
thought.
Mr. Walker. I think I can help you. I would say that the
difference if you do price indexing, you are preserving
purchasing power based on today's standard of living.
Mr. Lungren. Correct.
Mr. Walker. OK. If you do wage indexing, you are preserving
a relative standard of living for tomorrow's standard of
living, so that is the difference.
Chairman Nussle. Mr. Case for 5 minutes.
Mr. Case. Thank you, Mr. Chairman.
Gentlemen, Social Security is the big picture, and so are a
number of the other issues. I am going to go a step above that
and talk about something that I raised with
Mr. Bolten yesterday: debt over the long term.
What I want to engage you in is getting straight in my mind
where we stand with the debt of this country. Under the budget
as submitted by the President, as I understand it, the total
debt of our country today is roughly $7.6 trillion; is that
about right, a little bit above the $7.3 trillion it was a few
months ago?
Mr. Holtz-Eakin. That presumably includes debt held in
trust funds?
Mr. Case. Yes, all debt; debt subject to the debt ceiling
that we have voted on a number of times, total debt. The
President's budget projection, which only goes out 5 years,
projects the debt is going to go to $11.1 trillion in 5 years.
Now, I just want to be sure that I have got straight what I am
being told by everybody.
That is that when we talk about that debt, when we talk
about the President saying he wants to halve the budget deficit
within 5 years, we are still talking about the accumulation of
greater debt every single year; is that right? I mean we are
not halving the budget, but halving the deficit. We have still
got a deficit of somewhere between $200 and $300 billion a
year. That is adding up, right?
Mr. Holtz-Eakin. Yes.
Mr. Case. Fueling a higher debt. That does not include, as
I understand, any additional spending, because that is what it
is. Spending for either outright expenditures having to do with
the Iraq-Afghanistan war or whatever costs there are, short
term, long term, permanent or temporary, of converting Social
Security or to repair the alternative minimum tax or increased
debt service for that matter. Is that your understanding?
Mr. Holtz-Eakin. We will do a complete analysis. As you
know, my understanding is there is recognition in there--the
potential $80 billion supplemental for 2005 but nothing past
that in Iraq.
Mr. Case. Now, if we added up all of those assumptions, do
you have any quarrel with the estimate by my ranking member
that the total amount would be somewhere in the range of $2
trillion additional to that debt?
Mr. Holtz-Eakin. I am always loath to certify numbers on
the fly, but we have done calculations similar to that in our
January budget outlook, and I would be happy to work with you
on that if you want me.
Mr. Case. Is that in the range?
Mr. Holtz-Eakin. Sounds about right, but I don't know the
pieces.
Mr. Case. Now, let me cover the next 5 years. I have been
told, and I believe, that it gets a lot worse a lot faster
after that first 5 years, unless we do something now or next
year or sometime in the near future. Does that generically ring
true to you?
Mr. Holtz-Eakin. Oh, yes; generically these are the good
times. The outyears with Medicare, Medicaid, Social Security,
rising costs in the budget, are all far more daunting than what
we are seeing right now.
Mr. Case. For example, that debt number of $11.1 trillion
does not include the potential extension of tax cuts that under
current law sunset prior to the end of that budget cycle, is
that right?
Mr. Holtz-Eakin. That is true. I would add that in our 2003
long-term budget outlook, we showed paths going out to 2050 for
the budget, with and without the tax cuts, and alternative
scenarios.
The troubling fact is it is very unlikely that current law,
fiscal policy is sustainable with or without the tax cuts over
the long term, and that to attempt to maintain the levels of
spending committed at the moment would be quite damaging.
Mr. Case. I guess what I am trying to get at is, OK, we
have got the President somehow saying that somehow it is cool
and good, and it is OK, manageable, sustainable, that we see
our total Federal debt run up 60 percent in the next 5 years,
an increase to 60 percent, but it is actually a lot worse than
that. We can add on $2 trillion more debt unless we have a wild
increase in income somehow or a $2 trillion reduction in
offsetting expenses somewhere else.
We also have the potential at least of a much greater
deficit arising, and debt, if we extend the reduction in
revenue arising from the tax cut extension, right?
Mr. Walker. That is right.
The bottom line is that we face large and growing
structural deficits due primarily to known demographic trends
and rising health care costs; and it is not just on the revenue
side, it is also on the spending side.
There are a number of spending items--for example, the new
Medicare prescription drug bill is going to cost a tremendous
amount of money. The related costs will escalate beyond the 5-
year horizon.
To help let us take last year. Last year the unified budget
had a deficit of $412 billion, so the Government had to borrow
that. But the Government also borrowed the $151 billion Social
Security surplus and the $4 billion in surpluses elsewhere.
So the ``on-budget,'' largely non-Social Security budget
deficit was much bigger, and that is one reason why you have a
difference between debt held by the public, trust fund debt,
and total debt. When we have trust fund surpluses the
Government spends it all on operating expenses and replaces the
excess cash with IOUs. That affects the total number for the
debt ceiling, but it is not shown as a liability on the
financial statements of the U.S. Government.
Mr. Case. I am afraid my time has expired. I was just
getting going. Thank you.
Chairman Nussle. Let me take a quick round, and then I
understand that Gen. Walker has to get to another hearing.
My very good friend, Mr. Baird, earlier was talking about
this notion that was brought up before about the difference
between borrowing to spend and borrowing to save. I was trying
to think, because when I first heard this by the
administration, I have to say, similar to my friend, I thought,
well, wait a minute, borrowing is borrowing, you know. There
really--is there really a difference?
Then I got to thinking, now, wait a minute. I do it all the
time--or, not all the time--I did it once when I bought my
house. I mean, I borrowed to invest in something I couldn't
afford right off the bat in cash. So we do borrow.
My guess is my friend from Washington has probably a
similar situation. He can't afford his house either. None of us
can. But we borrow to save and invest in that home.
We do the same thing for our kids, interestingly enough. I
can't pay for my son to go to the college I went to. So I
borrow, and I am going to make him, you know, work as well to
pay for his fair share.
The point is, is that I am willing to borrow to invest in
something that is going to come back with a--maybe not a
financial rate of return for me, but something I know is a
pretty strong investment, or at least I hope it is. If it
isn't, I am going to--like I said yesterday--build a woodshed.
The same is true for business, and small business. I was
reading here in an article in ``Entrepreneur Magazine''
recently, that in order to start your own Subway--not subway
system but the new franchise, which is evidently one of the
hottest-growing franchises in the country--you need, I think,
$175,000. But it is a pretty good investment right now, with
the low carb and diets and all that kind of stuff, to go out
and sink and borrow and invest in a business that you want to
get a rate of return. So borrowing for operating, as you
indicated, is different than borrowing for savings or borrowing
for an investment vehicle.
So I understand that there are--you know, to borrow to go
to Vegas, that is not interesting to me--and it certainly
wouldn't be--according to what Mr. Holtz-Eakin just said,
borrowing possibly to sink it into a security might also be a
little bit riskier than I want to go. But businesses do provide
that kind of function all the time.
We do have a personal connection with this notion of
borrowing in order to invest. So I see a difference between
borrowing for spending in the operating budget versus borrowing
for savings or investment. I just want to put that out there.
The expected thing was this whole notion of rate of return.
This is going to be a big challenge, because depending what
number we pick and how we come up with that, it is going to be
a huge debate, because some are going to say, wait a minute.
Some are first of all going to say, this isn't the way to do
it.
Let us assume for a moment that they are not part of this
discussion. Let us assume that it is a matter of do you take
the high or the medium or the low. What advice would you have
with regard to rate of return and how we go through the
discussion of making this determination? You are going to give
us advice, the actuaries are going to give us advice, the
markets are going to give us advice, our constituents are
certainly going to give us advice. What process would you
suggest we go through in determining the rate of return for
this vehicle that we want to set up, which is, as I said, it is
similar to investing in our kids' education or investing in our
home; which is borrowing some money, knowing full well that you
are taking some risk, but it is a pretty good investment.
People do it all the time. It is the No. 1 way people save for
their retirement is in their home.
So how would you help us through this process of going
through this issue of rate of return?
Mr. Holtz-Eakin. I would offer a couple of observations.
The first is that you do not place great emphasis on
differences between the CBO and SSA. We believe the long-term
real return to Treasury is 3.3. They say it is 3 percent--that
is, given the standards of economic science over these
durations, the same estimate.
We have corporate equities at 6.8 percent. Their estimate
is very similar. So I think qualitatively these are the same
kinds of perceived returns to different investment vehicles
that have different levels of risk, be they Treasuries, the
least risky; corporate bonds, a bit more risky. Corporate
equity is the most risky out of the broad sets of choices. So
that is number one.
Number two, I don't think that there is any great
disagreement about the historic returns, as I said, or, as a
result, the possible outcomes that one could get if you held a
portfolio over 50 years, again and again and again. On average,
we think the corporate equities will turn out to be 6.8
percent. That is what people historically have gotten and would
likely continue to receive in the absence of large changes in
the economy.
The real tough question is to make sure that people
understand the difference between looking backward and, right
now, looking forward in doing the valuation exercise that
financial markets do every day. Every day, financial markets
and the participants look at return opportunities and their
risk, and they value those opportunities. They evaluate them by
putting their money in or selling them off because they decide
that that the risk/return trade-off is unacceptable.
This Congress and participants in this debate are making
that same valuation decision. They are looking at potential
risk and return--and we hope that we have displayed that to
people in our analyses--and they can make a judgment as to
whether it constitutes good public policy in the area of Social
Security.
The CBO, in my final observation, simply follows what we
think of as bread-and-butter budgetary practice in doing this.
When we value things on the budget, we look to the market. We
ask what would it cost to buy these supplies for the military?
We ask what would it cost to provide this aid to schools and
education?
In this instance, we ask what is the market's valuation of
a dollar put out there for investments in the financial market,
and markets equate $1 for Treasury and $1 for equity in a very
particular way, which reflects the average tolerance for risk
out there in American financial markets, and that is what we
are going to use to do that valuation exercise.
It is an extraordinarily difficult area. I anticipate that
it will continue to be an area of great confusion. I once made
a vow I would not talk about modern finance in public, and I
have violated that vow several times now.
I would be happy to work with the committee as we work
through the understanding of the different risks and returns
that are present in the current system and in any reforms.
Chairman Nussle. Mr. Walker.
Mr. Walker. Mr. Chairman, I would say two things. One, I
think you need to consider input from a number of sources in
analyzing what is an appropriate assumption to make with regard
to rates of return. But I think you ought to give heavier
weight to professional, objective, and credible organizations
that do not have a vested interest in the outcome, like CBO,
GAO and the Social Security actuaries.
Secondly, I think you have to also understand to what
extent is the rate of return relevant. We have to keep in mind
this is a social insurance system.
Rate of return is something that is interesting for an
individual to understand how well they are doing, and it may be
relevant in determining what type of offset there might be in
order to be able to pay for the individual accounts. If there
is a standard offset, for example, the example that Mr.
Jefferson gave, then the rate of return is only relevant for
purposes of determining what kind of deal the individual is
going to get.
On the other hand, if there is not a standard offset, it
could be relevant for determining what the--you know, what
other costs to the Government might be.
Thank you.
Chairman Nussle. Thank you.
I understand, Mr. Walker, you need to leave for your----
Mr. Walker. I need to leave in about 10 minutes,
Mr. Chairman, if I that is OK. I wanted to make sure----
Chairman Nussle. OK.
Then Mr. Spratt is recognized for 5 minutes.
Mr. Spratt. Has everybody had a chance?
Chairman Nussle. On this panel, as I understand it, yes.
What we are doing, we went around one time, now we are going to
go around again.
So, Mr. Spratt, quickly.
Mr. Spratt. First of all, with respect to the time frame
for talking about solvency, 75 years is the common standard--
the actuaries have established that--but Treasury and others
sometimes use an infinite timeframe. The dollar difference is
significant, it is $3.7 trillion for the 75-year-period. It is
over $10 trillion for the infinite time period.
Which is a better index?
Mr. Walker. I personally use 75 years, but I think the
important point is this: irrespective of what period of time
you use, you want to try to make sure that whatever solution
you come up with deals with the problem, hopefully
indefinitely. In 1983, they solved the problem, but they knew
on day one that they had only solved it for at most 75 years
because of demographics. So whichever period you use, try to
make sure you are achieving a solution that doesn't
automatically require you to come back and deal with it again.
Mr. Holtz-Eakin. I don't like either. I prefer to look at
these in the cash-flow context that we displayed in the charts
at the outset. If one is realistic about the fact that this
will take place in the context of a larger set of budgetary
demands, I think it is important to note not just the number,
which is divorced of timing, but how fast things get big, and
which things hit first. The demographics drive Social Security,
it is true.
The demographics also drive Medicare and Medicaid, but the
health care costs also drive them so they get bigger and they
get bigger quicker. Using these present-value horizons divorces
the analysis of timing and makes it hard to examine budgetary
trade-offs.
For that reason, I would encourage you to think about the
cash-flow futures, the qualitative information you get from the
notion that the promised benefits lie above the dedicated
revenues for as far as I can see. So you can pick a horizon and
pick a number, but qualitatively the policy number is that
cash-flow.
Mr. Spratt. Well, given the problems we are projecting way
into the future--longevity, fertility, productivity, and the
factors that underlie that--isn't an infinite time frame
terribly tenuous?
Mr. Holtz-Eakin. The uncertainty increases as time goes
out, which is a reason why we don't prefer it. Even if it
arises at the CBO, we try to display the uncertainties because
we think they are important. But mechanically, we calculate
year by year numbers, so infinity is a problematic concept for
us.
I think you should look at this not in terms of a right-or-
wrong issue, but a risk-management issue, and know that making
decisions about longer horizons involves greater uncertainty.
Mr. Spratt. We had an exchange with the Secretary about the
likely cost additions to the deficit and to the debt to move
to, say, partial privatization.
Our back-of-the-envelope analysis indicates that in the
first 10 years of implementation, the costs would be $1.4
trillion. In the second 10 years, the cost would be $3.5
trillion. Therefore with 20 years, the first 20 years of
implementation, the cost would be $4.9 trillion. And of course
it wouldn't stop there, it would continue at least past the
midpoint of the 21st century.
Do those numbers sound as if they are roughly in the ball
park to you, number one?
Number two, if the Government has to borrow that kind of
money, are there consequences for the Federal Government, for
the economy?
Mr. Holtz-Eakin. Let us just stipulate the numbers are
right. We haven't had a chance to scrub them. I would say there
are a couple of things that are important.
The first is that this is borrowing that will be put right
into savings. So from a national saving perspective, this is a
wash. That is the difference between a budgetary view of the
world and a broader economic view of the world.
Number two, in any reform analysis, the borrowing for
individual accounts is step two of a two-part process. Step one
is what happens to the underlying program. Without knowing the
answer of what happens to the underlying program, it is not
possible to calculate the net borrowing with any real
precision. Neither can you calculate the economically important
impact, which is what will happen to net national saving, and,
as a result, the ultimate growth in the economy. So to be
honest----
Mr. Spratt. You have to make behavioral assumptions amongst
other things, don't you?
Mr. Holtz-Eakin. You have to know the plan. Without knowing
that, it is not possible to say with any great precision.
Mr. Walker. Mr. Spratt, having individual accounts funded
from the existing payroll tax revenue, even with other reforms,
will accelerate the negative cash flow, because obviously the
other reforms are likely to save money in the outyears, whereas
the individual accounts are going to cost money in the near-
term years.
But to a certain extent it is a timing difference. Because
if you do nothing and if you want to deliver on the promised
benefits, it is only a matter of how much and when you will
have to borrow.
The other thing is if we end up having to go to the markets
to borrow more debt from the public rather than borrowing from
ourselves--i.e., from the trust funds--then that could have an
effect on interest rates, because obviously there is going to
be more competition for capital. Now, whether or not it would,
I don't know. I am not a Ph.D economist, but----
Mr. Spratt. But this is going to occur in 2020, for
example, as we begin to liquidate those trust fund bonds in a
matter of ordinary course, the ones that have already
accumulated, and the Social Security administrator has to go to
the Treasury window, present their bonds for redemption. That
is going to require that internally held debt be converted to
externally held debt. So you have that burden in the market,
several trillion dollars for that kind of conversion.
Then you load on top of it $3, $4, $5 trillion more, plus
the debt we are accumulating in the operating budget of the
United States. It seems to me that sooner or later we hit the
wall. I mean, there is a limit beyond which we can go and
borrow without convincing the world's markets that there is a
high risk that we will try to inflate our way out of it, that
this somehow disavows some of the debt.
Mr. Holtz-Eakin. Let us do all three in order.
First, the operating or budget deficit. I won't repeat all
the things I have said about what I view as the sustainability
of our fiscal condition.
Step two, redemption of bonds in the trust fund.
Absolutely, those bonds will be redeemed. They are backed by
the full faith and credit of the Federal Government. The
question is how they will be redeemed; if indeed they are
redeemed by simply borrowing from the public, that will
represent essentially de facto increases in the operating
borrowing, and we will have the same consequences.
Step three, additional borrowing, which is immediately
funneled into individual accounts. That, I think, is
qualitatively different. I believe financial markets will be
well equipped to see the difference. They will see additional
Treasury borrowing; they will see a simultaneous increase in
the demand for that same borrowing if individuals put
Treasuries into their portfolios. If they don't, there will be
a broadly defined increase in the demand for financial market
investments.
Mr. Spratt. Well, it may be perceived differently to some
extent by the financial markets. But with respect to the
Federal budget and how the debt affects its operation, it still
has to be serviced, it still has to be paid. To the extent
those things are honored, it displaces something else. It takes
precedence. If anything, it is obligatory in a Federal budget
that we have got to pay the interest, and we have got to pay
the debt.
Mr. Holtz-Eakin. I will be the last person to disagree with
focusing on the budgetary consequences of Social Security
reform. I mean, I think looking at the broad budget context is
exactly right.
My point is simply that financial markets will be in a
position to see both the additional borrowing and any
additional investments. They won't have to speculate about it.
It will happen at the same time with observable cash flows, and
that will make it easier for them to discern the net demands
that the Nation makes on their capital markets.
Mr. Spratt. One final question to Dr. Holtz-Eakin. Can we
expect your analysis of the President's budget early in March,
the first week in March?
Mr. Holtz-Eakin. You will have the numerical analysis in
time to mark up the budget resolution. You will get the full-
blown analysis with the words shortly thereafter.
Mr. Spratt. One other question. Do you have enough data now
to do a financial markup of the President's proposal?
Mr. Holtz-Eakin. No.
Mr. Spratt. Thank you.
Mr. Portman [presiding]. Thank you, Mr. Spratt.
I missed my questions earlier, so I will take my questions
now, and then we will go on to Mr. Cooper.
First of all, I appreciate your testimony today, as always.
Both of you give us additional insights that are helpful. And
we had an interesting discussion earlier, the Secretary of the
Treasury, about so many of these issues.
The one I focused on, of course, was the fact that we have
this trust fund that is sometimes described as being available
for retirement benefits without paying, in other words, without
having to either borrow more, tax more, or cut spending. And
that is simply not the case, because we have spent it.
You talked about the personal accounts as being
qualitatively different, Mr. Holtz-Eakin, and you focused on
the fact that net national savings should be a wash, because
you are taking funds in for investments.
Some of those investments, as you rightly state, will
actually go directly into Treasury; others will go into
equities; others will go into corporate bonds. And in a very
regulated way, the President has laid out a program, you know,
that is not outside of Social Security. It is very much
regulated by the Government and within Social Security.
Can you talk a little about that aspect of it? In other
words, when we are borrowing for whatever the number is--and
Mr. Spratt has a number--it may be correct for personal
accounts--aren't we both adding to our savings--and this is
capital that will be available out there in the municipal--
therefore also helping the economy. In other words, your
economic growth numbers that you need to come up with, your
projections I assume would be affected by that.
Then finally this notion of whether we have a long-term
liability or not with regard to the trust fund. Couldn't you
say in a sense that some of that liability is being prepaid--
and this is what Mr. Walker indicated earlier--that in effect,
what we are doing with part of this is we are prefunding a part
of the Social Security obligation, and in a sense, therefore,
we are deferring some future liabilities.
I guess my specific question would be to you, you know, how
would you analyze all of this? What would your economic growth
projections be? How would they be affected by this? How would
you analyze it in terms of your impact on the budget deficit as
compared to other kinds of borrowings; and, you know, how you
believe this--what you termed as qualitatively different kind
of borrowing--would affect the economy?
Mr. Holtz-Eakin. With the caveat that the details will
matter, the rough template by which one would go through the
analysis, I think, is fairly straightforward. The first would
be to look at the difference from current law in the nature of
the traditional benefits under Social Security, and what that
looks like to individuals on a forward-looking basis: Are they
getting a better or worse deal from the traditional program
compared to what they could have expected under current law?
That will inform their saving and labor supply decisions from
that perspective alone.
The second would be to add in any individual accounts, and
they would then make their decision about whether on the whole
they have been made better or worse off in a financial sense by
the reform. To the extent that every individual, say, on
average, felt that they were better off, they would actually
save less. By that, I mean, if they had more in their future
and they were wealthier, they could consume more. If they felt
that this increased their desire to save, we would see
increases in personal saving. Then we would balance that
against any change in the overall Government borrowing to look
at what happens to national saving.
That, in the end, is the key determinant in the ability to
finance capital accumulation, that grows the size of the
economy. So we would have to trace through for individuals and
for the Government the net impacts on their financial futures
and look at the economic feedbacks, and we would do that.
Starting with a projection of the future, you would layer on it
the new program, you would analyze at the individual level the
benefits they get out and taxes they would pay.
As you can imagine, all of this hinges critically on the
nature of the reform, number one, but it also hinges critically
on the baseline--in particular, for financial markets--the
baseline perception of the outlook for Social Security.
To give you the outer bounds, one could think that the
baseline perception of financial markets is the gap between
benefits promised and benefits--revenues dedicated. That gap is
wide and forever. That would be a daunting thing for financial
markets.
Or they could take current law at face value and assume
that after 2052 that closes. There is a very different baseline
view of the outlook for Social Security depending on where you
come down on that. We are actively engaged in talking with the
financial markets and talking with experts in this area to see
what their expectations are about the current program before
you can analyze how they would react to any change.
Mr. Portman. That is an interesting point and the
behavioral model is interesting, too. But let me ask two
questions.
One, with regard to the Social Security proposal as it has
been laid out, whether it is the President's proposal or others
that have been talked about in the past--Senator Moynihan's
commission laid out a few different options--is it your sense
that financial markets would react favorably or unfavorably to
those kinds of options? And this is relevant not because
financial markets determine what our entire economy is going to
look like, but they do have a big impact on interest rates. You
say you are going to run some of these ideas past some people
who might reflect for you the financial markets. Don't you
already have a sense of that one way or another, and what is
it?
Mr. Walker. Mr. Portman, if I can excuse myself.
I had mentioned to Chairman Nussle that I have got an
oversight hearing before an oversight committee.
I would be happy to answer any questions that anybody might
want to----
Mr. Portman. Thank you for your testimony, Mr. Walker.
Mr. Walker. Thank you.
Mr. Portman. If you want to take a crack at this question
before you leave, you certainly may.
Mr. Walker. No, that is OK. I think I will let Doug answer
it.
Mr. Holtz-Eakin. We have some sense of it, but I would
hesitate to give it a convenient summary. Here is the hard
part--and this is shared by the financial markets and the CBO
and anyone who with will look at this area ultimately--with a
voluntary election reform--the real money depends on how many
people participate.
The details then at the individual level about how this
looks in terms of what they are going to get with their
individual account, first, the unspecified-at-the-moment
traditional program is a key part of how many people will take
it; as a result, how much borrowing will be necessary to
finance it and what the ultimate financial implications will
be.
I would say the financial markets in the CBO are roughly in
the same place at the moment, which is--we would really like to
see the details before we make that call.
Mr. Portman. If you assume that two-thirds of those people
who would be available would take advantage of the personal
accounts, you indicated that you would have to make certain
assumptions about their saving behavior, so on. Wouldn't they
feel safe--or less safe, and therefore save more or less--but
wouldn't it have an independent impact on economic growth
simply that by having the savings out there--it would be, as we
know probably, in bonds, corporate bonds or in Treasuries or in
some kind of an index Treasury account--doesn't have that have
an impact on the economy independently?
Mr. Holtz-Eakin. To a first-order effect, no, because it
will be balanced by the borrowing at the Federal level and then
borrowings in the financial market would be unchanged.
Mr. Portman. Thank you, Mr. Holtz-Eakin.
We now have at least one more questioner, Mr. Cooper.
Mr. Cooper. Thank you, Mr. Chairman.
I apologize, I had a simultaneous hearing with Armed
Services.
First, I think Republicans and Democrats would both agree
that four of President Bush's primary initiatives, probably
four initiatives that he will be judged by history on, would be
the Iraq war, tax-cut permanency, Social Security reform, and
the Medicare drug bill.
My chief of staff, Greg Hinote, thought this up. What do
those completely different major initiatives have in common?
The answer is, sadly, maybe tragically, none of those is
accurately reflected in the President's budget.
We learned today that the Medicare drug bill was seriously
underestimated. Social Security reform is completely ignored in
the budget. The Iraq war is not funded beyond September 30th of
this year. And for tax-cut permanency, apparently they are
thinking about changing the budget rules, so the cost of that
scored a zero.
Mr. Holtz-Eakin. If I could, I would like to point out that
Mr. Spratt and Chairman Nussle were given a copy of the
testimony we wrote to Chairman Thomas of the Ways and Means
Committee today about this question of whether the Medicare
drug bill is, in fact, more expensive than originally
estimated.
The answer to the question basically is no. I think that if
one did an apples-to-apples comparison over the same budget
windows, with the same components, we would estimate that it is
about $6 billion more expensive than we anticipated. I don't
think that the CMS estimates are radically different from that.
So I think for the record it is important to recognize that
there has not been a lot of clarity about these cost estimates
from the beginning, but it doesn't look like the bill is any
more expensive at the beginning than it was at the outset.
Mr. Cooper. Even if we concede that point, three out of the
four President's major initiatives are met, representing the
budget, which almost makes a travesty of the operations of this
committee. You know, we can talk about whether we are seeing
150 programs the President promises to cut and things like
that; that is the small potatoes.
The big stuff, none of it is accurately represented in the
budget, with the possible exception of the Medicare amendment.
On Medicare, did you anticipate that Medicare was going to
cover Viagra and other things like that in their medical
benefits package? That was just in the news a week or two ago.
Mr. Holtz-Eakin. Well, in our review of Medicare, to date
we haven't changed our estimate very much. The most important,
even in the young life of the MMA, is the issue of the final
regulations. We are reading through the thousands of pages to
see if the implementation matches what we envisioned when we
did the cost estimate. The answer to that question will arrive
with our estimate of the President's budget in March.
Mr. Cooper. Different line of questioning. I asked
Secretary Snow if he had a valuation for the disability
component of Social Security benefits. He did not give me an
answer; said he would try to supply one. Do you have a
valuation for the disability component of Social Security
benefits or the survivorship death benefit component of Social
Security benefits? What would that be?
Mr. Holtz-Eakin. Our analysis includes all three components
of the program. It includes the dollar values. I don't know
them off the top of my head. We can certainly get them to you.
They are buried in our reports.
I will point out that our numbers are the answer to the
question: What do you get after the fact, given that you are
disabled? The real valuation question is the insurance value if
you don't know how it is going to turn out. We are still
working, trying to put the best number on that.
Mr. Cooper. So you at CBO still do not have a valuation, an
insurance valuation of those benefits?
Mr. Holtz-Eakin. Not a broad social insurance value that--
of the type that would be appropriate.
Mr. Cooper. As far as you know, are those benefits
commercially available from any company in the United States?
Mr. Holtz-Eakin. Not the type of benefit offered in the
broad pool at Social Security.
Mr. Cooper. So, right now, would it be available for
purchase nowhere else other than through the Social Security
system?
Mr. Walker. That benefit, no.
Mr. Cooper. Final question. What if in a Social Security
compromise reform package some part of the corpus of the Social
Security Trust Fund was invested in some sort of safe market
investment as opposed to just Treasury securities? That would
achieve some of the goals of the folks who advocate privatized
accounts, wouldn't it, by enabling a better rate of return
possibly to be achieved, rather than just the ultraconservative
investment and Treasury instruments?
Mr. Holtz-Eakin. It would have the same implications as the
analysis of individual accounts. You have higher return at
higher risk, risk is present.
Mr. Cooper. Only the risk would be spread across the
society, as opposed to perhaps subjecting an individual who may
have chosen unwisely--the risk would be spread, as opposed to
individualized, right?
Mr. Holtz-Eakin. The same total risk would be present. It
could be distributed in many ways.
Mr. Cooper. Has the CBO done a study of that sort of Social
Security reform?
Mr. Holtz-Eakin. In the late 1990s, there were a series of
studies looking at Social Security reforms, including looking
at investments in private accounts. I don't know the names off
the top of my head, but we would be happy to get what we have
to you.
CBO Papers on Private Accounts and Related Issues
Social Security Privatization and the Annuities Markets (February 1998)
Letter to the Honorable Bill Archer regarding Professor Martin
Feldstein's proposal to set up personal retirement accounts
financed by tax credits (August 1998)
Social Security Privatization: Experiences Abroad (January 1999)
The Budgetary Treatment of Personal Retirement Accounts (March 2000)
Social Security: A Primer (September 2001)
Evaluating and Accounting for Federal Investments in Corporate Stocks
and Other Private Securities (January 2003)
Social Security Reform: The Use of Private Securities and the Need for
Economic Growth (January 2003)
Acquiring Financial Assets to Fund Future Entitlements (June 2003)
Administrative Costs of Private Accounts in Social Security (March
2004)
Long-Term Analysis of Plan 2 of the President's Commission to
Strengthen Social Security (July 2004)
Long-Term Analysis of H.R. 3821, the Bipartisan Retirement Security Act
of 2004 (July 2004)
Mr. Cooper. I thank the Chairman.
I see my time has expired.
Chairman Nussle [presiding]. Thank you, Mr. Cooper.
Mr. Davis for 5 minutes.
Mr. Davis. Thank you, Mr. Chairman. I don't mean to prolong
Mr. Holtz-Eakin by coming in late, but I had multiple hearings
going on also.
Let me go back to the line of questions I had with the
Secretary, and I think it is an important policy to debate with
this committee.
Obviously, I think there is very broad agreement if we
wanted to fix, quote-unquote, the Social Security shortfall, we
would have the fiscal capacity to do it by dipping into the tax
cuts, if you will, by suspending a portion of the tax cuts. The
argument against doing that is based on the theory that if we
walk away from the tax cuts that it will retard the great rate
of growth.
What I was exploring with the Secretary is that that has
not empirically been the case in our economic history. In the
1990s--well, today as I understand it, the rate of corporate
individual taxation as to GDP is around 15 to 16 percent; is
that about right?
Mr. Holtz-Eakin. I am sorry, say it again.
Mr. Davis. The rate of corporate individual taxation as to
GDP is 15 to 16 percent of GDP today.
Mr. Holtz-Eakin. We are at about 15 to 16 percent Federal
receipts, a fraction of GDP.
Mr. Davis. OK. So about 15 to 16 percent, very low levels
historically, lowest since World War II.
Now, we have also had--what has our growth been for the
first half of this decade; growth of GDP for the first half of
this decade?
Mr. Holtz-Eakin. I don't know the number off the top of my
head. It runs through a recession, then a recovery.
Mr. Davis. But you would certainly say less than the 1990s
when we had a robust recovery.
Mr. Holtz-Eakin. Yes.
Mr. Davis. And in the 1990s, we had a taxation rate--
combined corporate rate plus income--of around 21 percent, 22
percent; you would agree with that?
Mr. Holtz-Eakin. Only at the end. Tax receipts as a
fraction of GDP edged above 20 percent toward the end of the
1990s, largely driven by the equity-based income taxation.
Mr. Davis. Was there any point where it dropped as low as
16 percent during the 1990s?
Mr. Holtz-Eakin. No.
Mr. Davis. At the time of greatest growth in the 1990s;
what would those years have been, 1996 to 2000 roughly, or 1996
to 1999?
Mr. Holtz-Eakin. Yes.
Mr. Davis. What was the rate of taxation from 1996 to 1999
as to GDP?
Mr. Holtz-Eakin. Well, it rose during that period.
Mr. Davis. OK.
Mr. Holtz-Eakin. Receipts as a fraction----
Mr. Davis. OK. So obviously higher than the 16 percent we
have today, conservatively higher. You would agree with that.
Mr. Holtz-Eakin. Yes.
Mr. Davis. So we can conclude from the 1990s that a higher
tax rate did appear to retard growth. Go back to the 1960s,
when you and I were born, we had a very high--what some people
thought was a confiscatory rate of taxation--corporate-based
income was 28 or 29 percent in the 1960s, wasn't it?
Mr. Holtz-Eakin. Rates were much higher in the 1960s.
Mr. Davis. So as to GDP it would have been 28 to 29
percent.
Mr. Holtz-Eakin. No, as a fraction of GDP it wasn't that
high.
Mr. Davis. OK. Was it higher than 16 percent?
Mr. Holtz-Eakin. The GDP number will be the average taxes
raised. Economic behavior is going to be driven by marginal tax
rates. We have seen big shifts across this period in average
rates between individuals and corporations and the structure of
the individual rates across that.
So I am sympathetic to your point that not just taxes drive
economic performance. I think that is absolutely right. I guess
what I would also point out at the outset is in thinking about
this in the context of Social Security, it is important to
discuss what constitutes a fix.
The reason I raise this is that in our projections
scheduled benefits are about 2 percentage points above
scheduled receipts as a fraction of GDP. On the long term, the
tax cuts are about 1.4 percentages points of GDP.
So if one wants to fix Social Security in a cash-flow
sense, so that it never intervenes with the rest of the Federal
budget, it requires a larger fix than the one you are
discussing.
If one wants to fix it in an actuarial sense, those numbers
are typically smaller, but they require a simultaneous effort
on the part of this committee, and in particular on the
Congress in general, not to touch funds that are dedicated from
the remainder of the budget to Social Security.
Mr. Davis. So let me cut you off, because my time is
expiring.
Mr. Holtz-Eakin. So I know what the fix means here.
Mr. Davis. Yes, I think that is an important distinction.
But since my time is low, let me ask another point. Let us
assume hypothetically we were to take the short-term approach
as you describe it, and that we were to draw down the tax cuts,
if you will, to deal with the temporary shortfall projected in
Social Security.
Wouldn't there be a commensurate rise in consumer and
investor confidence that might make up for any lost confidence
because some of the tax cuts were being repealed?
Mr. Holtz-Eakin. First of all, we will have to figure out
what ``temporary'' means. But let us leave that aside. I think
the problem is as far as the eye can see.
Mr. Davis. I guess I am asking a fairly narrow proposition,
then.
Mr. Holtz-Eakin. But if you ask what will happen to
financial market confidence, you know, long-term interest rates
reveal no lack of confidence at the moment in U.S. Treasury
securities.
Mr. Davis. Let me slip in another quick question in the
last 15 seconds.
Another thing that I asked the Secretary about was the
basis for the projections around the shortfall by 2042. I
thought the Secretary initially agreed with me and with the
Social Security Administration that the projected growth of the
GDP over that period of 30-some years was around 1.8 percent.
Then he seemed to say that it wasn't the GDP, it was the level
of productivity.
Can you weigh into that and tell us what is accurate? Is
the President's estimate of the shortfall based on 1.8 percent
productivity or 1.8 percent GDP between now and 2042?
Mr. Holtz-Eakin. Long-term GDP projections are usually put
together by counting the number of bodies that will be
available, growth in the labor force, and then how much more
productive each body will be. Those are the two basic building
blocks.
Mr. Davis. OK.
Mr. Holtz-Eakin. Over the long term, the key movement is
not in productivity which remains, in those projections and in
ours, pretty solid over the long term and similar to history.
The key aspect is the slower growth in the labor force. That is
present even in our 10-year budget projections where GDP growth
averages 3.4 percent up to about 2010 and then drops to 2.7
percent. That is the retirement of the baby boom, that is fewer
people coming into the labor force. It reflects the fact that
over the long term the native population is below replacement
fertility.
So it is true that the fundamentals are in the same good
historical shape they were, but the bodies to which they were
being applied are diminishing as we go forward.
Mr. Davis. Let me--and I don't want to push my luck on the
time--but just to push this to its logical conclusion, taking
all of that aside--and that is not exactly what Secretary Snow
said. I have probably been on your accuracy over his, given
your impartiality as opposed to his.
But let us assume that 1.8 percent number over 30-some
years--would that not be a lower number than the growth that we
have enjoyed, for example, than we have enjoyed over the last
30 years?
Mr. Holtz-Eakin. Yes, it would be.
Mr. Davis. OK. And would that not likely indicate that the
stock market possibly would not perform as robustly as we would
want it to? I mean, he argued that there was--he rejected that
correlation. Can you comment on that?
Mr. Holtz-Eakin. Yes, I think there is no reason to
automatically assume there is a bad stock market going forward.
The fundamentals----
Mr. Davis. There is no reason to assume either way, is
there?
Mr. Holtz-Eakin. No, I think that there is no reason to
dramatically change your view of the future of returns to
equities based on that number in any way. I mean, if the
productivity numbers are about the same, if the productivity
numbers are about the same, productivity drives profitability
and the pricing in the market. While we can fiddle at the edges
with the number, I think qualitatively those projections and
the ones we do are all in line.
Mr. Davis. OK. Thank you Mr. Chairman.
Chairman Nussle. Thank you, Mr. Davis.
There has been a discussion--while you are still here to be
able to respond--we did discuss yesterday this issue of the
percentage of Federal receipts as to GDP and determined that,
in fact, if the permanence goes forward--in other words, there
is no change in our current tax policy--which is assumed in the
budget, by the way, per Mr. Cooper--that the percentage would
rise. I believe it was to 17.2 percent. I can't remember the
number. So you will have an increase in your percentage of GDP,
even with tax permanence.
Thank you, Dr. Holtz-Eakin for your testimony today. We
appreciate your coming before us again. We look forward to
working with you on Social Security and the budget.
No further questions for you.
We are going to move on to the next panel.
Mr. Holtz-Eakin. Thank you.
Chairman Nussle. We are pleased to be joined now by Dr.
Peter Orszag.
Dr. Orszag is a senior fellow at the Brookings Institution.
He is also a retirement policy expert, one with whom I have
agreed and disagreed, but always respect his work.
Dr. Orszag, thank you for being with us. We have had a long
day. As you can see, we have lost a few members to other
hearings.
But if you would please proceed after we have an
opportunity for my colleague, the ranking member, to make any
introductory remarks.
Mr. Spratt, I already welcomed him.
Mr. Spratt. Dr. Orszag, Mr. Orszag, thank you very much for
coming, and, more than anything, thank you for your
forbearance. We are sorry you had to wait so long. We will let
you be the clean-up hitter and we expect you to hit it out of
the park.
Thanks for your interest and thanks for coming and your
excellent contributions.
Chairman Nussle. Dr. Orszag.
STATEMENT OF PETER R. ORSZAG, PH.D., SENIOR FELLOW, THE
BROOKINGS INSTITUTION
Mr. Orszag. Thank you. I want to make four or five points,
and I would emphasize that there are a lot of details that have
not been filled in yet, but those that we do have are
insightful--and even more insightful when I turn on my
microphone.
First, under the administration's proposal, workers who opt
for individual accounts would pay back that diverted revenue
plus 3 percent interest at retirement through reduced Social
Security benefits.
In many ways this is quite similar to a loan. The worker
receives cash up front, gets to invest that money, but then has
to pay back the principal plus interest later. In many ways,
again, this is quite similar to a loan. The form of repayment
is not critical to the underlying nature of the transaction.
Let me give you a specific example. Someone in high school
today, who would turn 21 in 2011, could put $500 in 2011 into
his or her account, $1,000 in 2015, et cetera--these are all
inflation-adjusted dollars--but would also owe a debt back to
Social Security at retirement at age 65 in 2054 of roughly
$150,000.
So that worker, just like with borrowing money, that worker
winds up better off only if his or her account exceeds that
$150,000. It is worth noting that under the administration's
assumptions, if the worker did invest in bonds, in Government
bonds, that account would only grow to $142,000, less than the
$150,000 debt owed back to Social Security. The reason is that
the administrative costs on the accounts open up a wedge
between the Government bond rate and the net return to the
individual.
Of course, this is not a--this analogy should not be taken
literally. There is not a contract involved in this
transaction. But nonetheless, it is a very useful analogy.
Basically the outcomes are equivalent to someone borrowing
money at a 3 percent real interest rate, with the repayment
undertaken through reductions in traditional Social Security
benefits.
Second point. The administration itself has said that there
is a net neutral effect from this proposal on the solvency of
Social Security. And viewing it from the prism of a loan, one
can see why the Treasury rate is assumed to be 3 percent. If
you loan money at 3 percent, and you are borrowing at 3
percent, it is a wash as long as the loan is fully repaid. But
I want to emphasize that that is actually the best possible
outcome, because there are many situations in which these
implicit loans will not be fully repaid. Let me give you a few
examples.
First, the administration has highlighted that if you would
die before retirement, your account will pass to an heir. A key
question is what happens to the liability associated with that
account? Does that also pass to your heir, in which case the
bequest is a mixed blessing; the young will inherit both an
account and a debt.
Under the President's Commission models, all that happened
was the account was passed along, not the debt. That means
Social Security and the Federal Government is out that money.
Similarly, there are many workers who work for less than 40
quarters or 10 years. They don't have any traditional Social
Security benefits because they are not eligible for retirement
benefits under the current program. They have no traditional
benefit under which to offset the cost of the diverted revenue
plus interest. And you can keep going down the line.
There are a variety of situations in which--at least based
on the specification we have seen to date--the situation, the
accounts would actually make solvency worse, not better, even
over the infinite horizon that the administration prefers. That
conclusion is only strengthened over the 75-year horizon that
is traditionally used.
Third point. It has already been emphasized that there is a
significant increase in public debt associated with these
accounts.
I want to point out that that increase is a permanent
increase in the very long term if just the accounts by
themselves raise public debt as a share of GDP by about 25 to
30 percent of the economy. The reason is that even if each
individual loan is eventually repaid through reductions in
Social Security benefits, at any point in time there are always
some loans outstanding. That means that public debt is always
higher than in the absence of the accounts.
Now, there was a discussion earlier about whether this
matters, about whether that is just trading one form of debt,
public debt, for another form which is future benefit promises.
I would argue that it does matter. I don't know any country
that has gotten in trouble or had trouble, a financial crisis,
because of a high implicit debt; that is, large future benefit
promises. I know of many that have gotten in trouble with a
large explicit debt.
Trading implicit debt for explicit debt is not a neutral
transaction. Explicit debt has to be financed in the financial
markets. It has to be rolled over. Arguing that a dollar of
debt today doesn't really matter, because we will have a dollar
less public debt in present value in 50 or 60 years, I think is
a problematic argument in the real world. It works in economic
theory; it doesn't work in real-word financial markets.
My final point is that because the accounts do not do
anything to improve long-term solvency, and likely harm it,
there are other changes that will be necessary to restore
solvency to Social Security. If there is no additional revenue
dedicated to the program, there are very severe benefit
reductions that have to occur in order to eliminate the
deficit.
So if you combine the benefit reductions that are tied to
the accounts, and then add on top of that the benefit
reductions that are necessary under the administration's type
of approach to eliminate the long-term deficit in Social
Security, the traditional program truly withers on the vine
over time.
Take that young worker I already talked about. The
traditional benefit would go from replacing 36 percent of
previous wages to 7 percent of previous wages, a dramatic
decline, roughly a fifth of the current-law benefit. Now, that
worker would have an account which could make up part of the
difference. But if you use the Congressional Budget Office
analysis, it does not make up the full difference, so there are
very substantial benefit reductions that are entailed in these
accounts, plus trying to eliminate the long-term deficit in
Social Security.
My final point would be--my view is that we do need
individual accounts. We already have them, they are called
401(k)s and IRAs. Mr. Portman has been one of the leaders of
building savings in the areas of those vehicles. I think that
is where our attention should be in terms of building wealth
and ownership. There is a growing body of evidence about what
works there. It is not necessary to mortgage future Social
Security benefits to increase account ownership.
Prepared Statement of Peter R. Orszag, Joseph A. Pechman Senior Fellow,
the Brookings Institution\1\
Mr. Chairman, thank you for inviting me to testify before you this
morning. On February 2, the Bush Administration released some details
about its proposal to replace part of Social Security with individual
accounts. Even with these admittedly incomplete details, several points
now appear clear: \2\
<bullet> Under the Administration's plan, payroll taxes deposited
into an individual account are essentially a loan from the government
to the worker. The Administration's proposal is the equivalent of a
loan that mortgages future Social Security benefits: Workers opting to
divert payroll taxes into an account today would pay back those funds,
plus interest, through reductions in Social Security benefits at
retirement.\3\ In other words, just as with a loan, the worker receives
cash up front and then owes money back, with interest, later. Someone
who borrows money to make an investment benefits if the assets
purchased with the borrowed funds grow faster than the debt; the person
is worse off if the debt grows faster than the investment. Similarly,
under the Administration's plan, workers wind up with higher retirement
income if the income from their accounts exceeds the benefit reductions
that pay off the loan, and vice versa.
<bullet> The accounts not only fail to reduce the Social Security
deficit, but will likely increase it. Even an Administration official
has acknowledged that the accounts proposed by the President would have
a ``net neutral effect'' on Social Security's financial condition over
the long term. The reality is likely to be even worse, however: The
accounts will likely harm Social Security's long-term deficit. The
reason is that not all the ``loans'' from diverted revenue will be
repaid in full; in several situations, which I will describe below,
subsequent benefit reductions will be insufficient to offset the cost
of the diverted revenue plus interest. As a result, even over the
``infinite horizon'' that the Administration favors, the accounts not
only fail to reduce the deficit in Social Security; they make it worse.
Over the traditional 75-year horizon used to evaluate Social Security
solvency, this conclusion is only strengthened.
<bullet> The accounts by themselves entail a significant and
sustained increase in public debt. By themselves, the individual
accounts would increase public debt by more than $1 trillion during the
first decade they were in effect and by more than $3.5 trillion during
their second decade. The increase in public debt, moreover, would be
permanent: Even if each individual ``loan'' were eventually repaid in
full, public debt would remain higher than in the absence of the
accounts over the long term. The reason is that even if each loan were
eventually repaid, some loans will always be outstanding. As a result,
the government will never, at any point in time, yet have been paid
back for all the revenue diverted into accounts--and therefore public
debt will always be higher than without the accounts. The bottom line
is that the Administration's account proposal would raise public debt
by more than 30 percent of GDP over the very long term. And even if the
account proposal were combined with other measures that (unlike the
accounts) would reduce the deficit in Social Security, public debt
would remain higher than in the absence of the plan for several
decades. Such higher levels of public debt are problematic because they
increase the exposure of the government to a collapse in financial
market confidence.
<bullet> The Administration's ultimate plan will have to rely on
severe benefit reductions to eliminate the Social Security deficit.
Since by the Administration's own admission the accounts do not reduce
Social Security's deficit, and since the Administration is opposed to
dedicating additional payroll taxes to the program, the
Administration's plan to eliminate the long-term deficit in Social
Security must involve severe reductions in benefits (or introduce some
new revenue source for the program). In particular, any plan that
closes the deficit, includes the accounts the Administration has
already proposed, and fails to dedicate additional revenue to Social
Security must involve substantial cuts in traditional benefits beyond
those required to pay back the loans to workers opting for individual
accounts.\4\ The combined effect would be a stunning decline in the
defined benefit component of Social Security over time. For example, if
one prominent type of benefit reduction (often referred to as ``price
indexation '') were combined with the loan repayments necessary under
the Administration's accounts, traditional benefits for a young average
earner today could decline drastically--instead of replacing more than
a third of the worker's previous wages, Social Security's defined
benefits would replace well under a tenth.
Building ownership and wealth should not come at the expense of
mortgaging future Social Security benefits. Nor should Social Security
reform be associated with a significant increase in public debt: such
an increase is not necessary to reform Social Security or even to
create individual accounts. Furthermore, the accounts in the
Administration's plan by themselves would not increase national
savings, and could end up reducing it (if individuals decide to
contribute less to their 401(k)s and IRAs because they see other money
accumulating in their individual account).\5\
A better approach would shore up the existing Social Security
system while raising saving in addition to Social Security. Several
common-sense steps could substantially boost saving outside of Social
Security.
THE LOAN ANALOGY
Under the Administration's proposal, the individual account system
would involve two components: the individual account assets, which
would contain a worker's deposits and the accumulated earnings on them,
and a ``liability account.'' If a worker chose to participate in the
individual account system, 4 percent of payroll taxes (initially up to
a limit of $1,000, with the limit gradually eased over time) would be
diverted into the account, accumulate during the worker's career, and
be available to the worker upon retirement.\6\ Since the revenue
diverted to this account would reduce the financing available to the
traditional Social Security system, a ``liability account'' would also
be created. This liability account would track the amounts diverted,
and accumulate them at a 3 percent real interest rate. The liability
account would determine the debt owed back to Social Security at
retirement because of the diverted funds.
Upon retirement, the worker's debt to the Social Security system
would be repaid by reducing his or her traditional Social Security
benefits--that is, the monthly check paid to a retiree. Specifically,
the monthly benefit reduction would be computed so that the present
value of the reduction would equal the accumulated balance in the
liability account. In other words, the reduction in monthly benefits
would be just enough, in expected present value, to pay off the
accumulated debt to the Social Security system.
This system is quite similar to a loan: As under a loan, the worker
receives cash up-front and can invest the money. The worker pays back
the borrowed funds, with interest, later. The specific form of the
repayment, through a reduction in traditional Social Security benefits,
does not alter the underlying nature of the transaction.\7\
To take a specific example, consider a medium-earning worker aged
21 at the beginning of 2011 who elects to participate in the accounts.
In inflation-adjusted dollars, the worker would divert about $500 in
payroll taxes into his or her account in 2011, about $1,000 in 2015,
about $1,500 in 2020, and so on. Those funds would build, along with
the investment returns on them, and be available to the worker upon
retirement. This worker would also, however, incur a debt to Social
Security that would accumulate to more than $150,000 by the end of
2054, when the worker would be 65.\8\ Repayment of the $150,000 debt to
Social Security would consume roughly half of the worker's retirement
benefit under the current benefit formula.\9\
If the assets in the worker's account upon retirement exceed
$150,000, the worker would experience a net increase in retirement
income, and vice versa, compared to not participating in the
account.\10\ Thus the worker's retirement income, on net, increases if
the account yields 3 percentage points per year above administrative
costs and inflation. The worker's retirement income declines if the
account yields less than that.
Note that because of administrative costs, it is impossible for the
worker to break even while holding government bonds and for the
government to be held harmless on the transaction. The reason is that
one party or the other must bear the administrative costs of the
investment. Under the Administration's assumptions, for example, the
real interest rate on government bonds is 3 percent per year. Under
that assumption, the system would hold the government harmless as long
as the worker reached retirement and paid back the loan (the government
would be held harmless since the loan carries the same real interest
rate as the projected government borrowing rate). The worker, however,
would be worse off if she opted for an account and held government
bonds in it. Such an account would have a net real yield of 2.7 percent
per year (the 3 percent real return on government bonds minus the
assumed 0.3 percent per year in administrative costs), leaving the
worker with a net reduction in retirement income. The worker's account
in this case would grow to only about $142,000, or almost $10,000 less
than the worker's debt of more than $150,000 back to Social Security.
Although the loan analogy is insightful in understanding the basic
effects of the proposal, there are some important distinctions between
a conventional loan and the proposed system. For example, under the
Administration's proposal, workers must make a one-time decision to
participate in the accounts; after that initial decision, they are
required to continue diverting revenue over the rest of their
careers.\11\ (The ability to invest the additional borrowing in
Treasury bonds does not necessarily insulate the worker from the
effects of the borrowing, given administrative costs and the
possibility that the realized interest rate on government bonds may in
the future diverge from the interest rate on the ``loan. '')
Conventional loans do not typically require the borrower to continue
borrowing over time. In addition, the proposed accounts carry
restrictions that are not typical of conventional loans: The Social
Security loan can only be used for purchasing assets such as stocks
held until retirement, and can only be repaid in a specific form
(through a reduction in future Social Security benefits).\12\ Finally,
unlike a conventional loan, this transaction would presumably not
involve a contract.\13\ Despite these important distinctions, the loan
analogy is useful in evaluating the impact of the proposal.
ACCOUNTS DO NOT IMPROVE SOLVENCY AND LIKELY HARM IT
The loans to workers opting for the accounts carry a 3 percent real
interest rate. This rate is equal to the expected real interest rate on
government bonds projected by the Social Security trustees in their
intermediate cost assumptions. Since the interest rate on the loans is
equal to the interest rate that the Social Security system is assumed
to earn on its own funds, the system is held harmless on each
individual loan, under the trustees' assumptions, as long as the loans
are repaid in full. This is why a senior Administration official was
quoted on February 2 as saying, ``So in a long-term sense, the personal
accounts would have a net neutral effect on the fiscal situation of the
Social Security and on the Federal Government.'' A reporter than asked:
``And am I right in assuming that in the way you describe this, because
it's a wash in terms of the net effect on Social Security from the
accounts by themselves, that it would be fair to describe this as
having--the personal accounts by themselves as having no effect
whatsoever on the solvency issue?'' The senior Administration official
replied: ``That's a fair inference.'' \14\
Two crucial points are worth noting about this statement. First,
even the Administration now acknowledges that the accounts do nothing
to reduce the long-term deficit in Social Security. In other words,
according to the Administration itself, individual accounts are simply
a non-answer to the question of how the deficit in Social Security will
be addressed.
Second, the statement by the Administration official is likely to
be incorrect: The accounts are likely to harm Social Security's
solvency. The reason is simply that there are several likely situations
in which the loan repayment back to Social Security (through reduced
Social Security benefits) would be insufficient to offset the cost of
the diverted revenue. Only if repayment is always made in full will the
Administration official's statement prove to be correct. If repayment
is incomplete in some circumstances, the accounts not only fail to
reduce the Social Security deficit, they actually widen it.\15\
Several likely scenarios suggest that at least some of the loans
will not be repaid in full, and therefore the accounts will harm the
system's long-term finances:
<bullet> Pre-retirement deaths. If a worker dies before retirement
without a living spouse, the amount in the individual asset account may
be distributed to heirs, but the amount in the individual liability
account could be extinguished. This is how the system worked under the
proposals put forward by the President's Commission to Strengthen
Social Security in 2001; the Administration has apparently not
clarified whether the same approach would be adopted now. Under this
approach, some loans are not paid off--and the system is thus made
financially worse off. The effect may be significant, since roughly
one-seventh of workers die before retirement. (The alternative is to
have the debt inherited along with the account. In that case, the
Administration should clarify that the pre-retirement bequests
facilitated by the accounts may be a decidedly mixed blessing: the
heirs will inherit both an account and a debt.)
<bullet> Backsliding on loan repayments. The benefit reductions
necessary to pay off the ``loans'' from Social Security--especially if
combined with additional benefit reductions to improve solvency--may be
so large that they could prove politically untenable over time. For
example, retirees may pressure the government to reduce the loan
repayments during periods of weak stock market performance. If such
pressures were accommodated and full loan repayments not enforced, the
actuarial effect of the accounts could be negative over an infinite
horizon.
<bullet> Traditional benefits insufficient to finance loan
repayment. Even without political pressure to reduce loan repayments,
some repayments may be curtailed simply because the traditional defined
benefit component of Social Security is too small to pay back the loan
in full. In other words, for some workers, the required benefit
reductions may exceed the size of the traditional defined benefit part
of Social Security that is supposed to provide the repayment
financing.\16\ In such a situation, the loan would apparently not be
repaid in full; in other words, workers would apparently not be forced
to repay debts back to Social Security that exceed their traditional
benefits. An extreme version of this could arise for workers with less
than 10 years of covered earnings, who do not even qualify for Social
Security retirement benefits. Such workers would have no traditional
benefit against which to apply the loan repayment. If someone working
for, say, 5 years were allowed to keep his or her account, the loan may
never be repaid, since the worker would not have any traditional
benefits with which to repay it. Again, the net result from these types
of situations would be that the accounts harm Social Security solvency
over the long term.
<bullet> Interest rate on Trust Fund more than 3 percentage points
above inflation. The interest rate on the loan to workers is apparently
specified as 3 percentage points above inflation. That holds the Social
Security system harmless on each individual loan, assuming each is
repaid in full, as long as the interest rate actually turns out to be 3
percentage points above inflation. But if real interest rates turn out
to be higher than 3 percent, the system would not be compensated
sufficiently for the diverted funds, and the accounts would widen the
Social Security deficit. It is therefore noteworthy that the
Congressional Budget Office assumes a long-term real interest rate on
government bonds of 3.3 percent.\17\ In other words, under CBO
assumptions, the Administration's proposal (with a 3 percent real rate
charged on the loans to workers) would harm solvency even over an
infinite horizon. If real interest rates on government bonds turn out
to be lower than the 3 percent rate applied to the loans, the opposite
would be true.
These effects mean that even over the problematic infinite horizon
preferred by the Administration, the accounts may harm solvency. That
conclusion is only strengthened over the 75-year horizon traditionally
used to evaluate Social Security solvency. Over that 75-year horizon,
the accounts unambiguously widen the deficit even if all loans are
ultimately repaid in full. (The reason is that some loans issued over
the next 75 years will not have been repaid by the end of the 75th
year.)
ACCOUNTS ENTAIL A SIGNIFICANT INCREASE IN PUBLIC DEBT
According to a memorandum from the Office of the Chief Actuary, the
Administration's accounts would raise debt held by the public by $743
billion as of the end of Fiscal Year 2015.\18\ The increase in debt,
moreover, would not subside thereafter: If the accounts were continued
past 2015, they would raise debt by more than $3.5 trillion by
2025.\19\ Over the first 10 years that they were in existence (2009-
2018), the accounts would raise debt by more than $1 trillion; during
their second decade (2019-2028), they would raise debt by more than
$3.5 trillion.\20\ (There has been some confusion over $743 billion
figure and the more than $1 trillion figure. The $743 billion figure
applies to the next 10 years. The more than $1 trillion figure applies
to the first 10 years the accounts would be in existence, from 2009
through 2018.)
The loan analogy helps to explain this increase in debt, and it
also provides insight into a surprising result: The debt increase would
be permanent. To finance a loan to a worker (provided in the form of
revenue deposited into an individual account) under the
Administration's proposal, the government borrows funds. If the worker
repays the loan, the additional government debt on that transaction is
extinguished, so public debt returns to the same level as if that
worker had not opted for an account. But note that at any point in
time, even if all loans were eventually repaid, some loans would always
be outstanding. As a result, public debt at any point in time would
forever remain higher with the accounts than without them.
Figure 1 illustrates the impact of the Administration's accounts on
debt held by the public. Three aspects of the figure are noteworthy.
First, debt increases sharply as a share of Gross Domestic Product
(GDP) for roughly five to six decades. Second, the higher level of debt
is perpetuated, rather than eliminated, in the long term. Finally, the
additional, ongoing higher level of debt in the long term is
substantial--the increase in debt outstanding of more than 30 percent
of GDP is only somewhat smaller than today's level of publicly held
debt relative to GDP (38 percent).
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Even if the accounts were combined with proposals to eliminate the
underlying deficit in Social Security, the increase in debt is likely
to be extended and substantial. For example, the leading proposal from
the President's Commission to Strengthen Social Security in 2001 would
have changed the determination of individual benefits to incorporate
what is commonly--but somewhat misleadingly--referred to as ``price
indexing.'' \21\ The change may sound innocuous, but as explained
below, it would dramatically reduce benefits over time. For the
immediate purpose, note that price indexation is sufficient by itself
to more than eliminate the long-term deficit in Social Security. Yet
even if the accounts proposed by the Administration were combined with
this price indexing proposal, debt held by the public would remain
higher than in the absence of the combined proposal for roughly five
decades.
Some advocates of the Administration's plan argue that the debt
shown in Figure 1 merely creates ``explicit debt'' in exchange for
``implicit debt'' that the government has already incurred (in the form
of future Social Security benefits). From this perspective, advocates
argue that the loan transactions merely trade more explicit debt for a
reduction in implicit debt (since the loan repayments will reduce
future Social Security benefits). The argument is then put forward that
these two types of debt--``implicit debt'' and ``explicit debt''--are
essentially the same, so that converting one into the other does not
represent an increase in Federal liabilities and should not raise
concerns.
This argument is, however, flawed. The two types of debt are not
equivalent. The explicit debt that the government would incur as a
result of the Administration's proposal for individual accounts would
have to be purchased by creditors in financial markets. When the
additional debt matured, it would have to be paid off or rolled over.
By contrast, the implicit debt associated with future Social Security
benefit promises does not have to be financed in financial markets now.
A government with a large explicit debt thus has less room for maneuver
and is more vulnerable to a lessening of confidence on the part of the
financial markets than a government with a large implicit debt.
Converting implicit debt into explicit debt is thus problematic.
substantial benefit reductions necessary to eliminate long-term deficit
Since the accounts do not reduce Social Security's deficit (and may
expand it), and since the Administration appears to be opposed to
dedicating additional payroll tax revenue to the program, the
Administration's approach to eliminating the long-term deficit in
Social Security must involve some new source of revenue dedicated to
the program or rely on severe reductions in benefits beyond the loan
repayments linked to the accounts. In other words, any plan from the
Administration that closes the deficit, includes the accounts it has
already proposed, and fails to dedicate additional revenue to Social
Security must entail two types of benefit reductions. The first type of
benefit reductions would repay the loans to workers opting for the
accounts. The second type would be intended to eliminate the long-term
deficit in Social Security. The combined effect of these two types of
benefit reductions would be a stunning decline in the defined benefit
component of Social Security over time.
To examine the impact of relying solely on benefit reductions to
eliminate the underlying deficit in Social Security, consider the
proposal from Model 2 of the President's Commission in 2001. This
proposal would have changed the determination of individual benefits to
incorporate ``price indexing,'' instead of the wage indexing that is
currently used to determine initial benefits. Had this ``price
indexing'' rule been fully in effect by 1983, at the time of the last
major reform to Social Security, benefits for newly eligible retirees
and disabled workers now would be almost 20 percent lower and
continuing to decline relative to current law. These benefit reductions
would apply regardless of whether a worker elected to participate in
the individual accounts.
Under current law, benefits for new retirees roughly keep pace with
wage growth.\22\ Successive generations of retirees thus receive higher
benefits because they had higher earnings--and paid higher payroll
taxes--during their careers. This feature of the Social Security system
makes sense, since a goal of Social Security is to ensure that a
worker's income does not drop too precipitously when the worker retires
and ceases to have earnings. A focus on how much of previous earnings
are replaced by benefits (which is called the ``replacement rate '')
recognizes the real-world phenomenon by which families, having become
accustomed to a given level of consumption, experience difficult
adjustment problems with substantial declines in income during
retirement.
Under what is called price indexing, by contrast, initial benefit
levels upon retirement would increasingly lag behind wage growth. In
particular, real benefit levels would be constant over time, rather
than increasing in line with real wages. Since real wage growth is
positive on average, the change would reduce initial benefit levels and
the size of the reduction would increase over time.\23\
Under this proposal, if average real wages were 10 percent higher
after 10 years, the roughly 10 percent benefit growth to keep pace with
this wage growth would simply be removed. The provision thus is more
accurately described as ``real wage growth negating'' than as ``price
indexing,'' since it simply cancels the benefit increases from real
wage growth.\24\
Several commentators have underscored the troubling consequences
that would result from ``price indexing.'' Edward Gramlich, a leading
economist who chaired the Advisory Commission on Social Security in the
mid-1990's and who is now a governor of the Federal Reserve System, has
been quoted as saying that if this methodology had been adopted when
Social Security was created, [retirees] ``would be living today at 1940
living standards.'' \25\ An earlier analysis of the proposal
underscored that: ``This is like saying retirees who could afford
indoor plumbing when they were working should, in retirement, not be
able to afford indoor plumbing because their parents' generation could
not afford it.'' \26\ Even some leading proponents of the
Administration's broad approach have acknowledged this point. For
example, John Goodman, president of the National Center for Policy
Analysis, recently commented about the price-indexing proposal: ``What
people are forgetting is why the system is there in the first place.
The reason is that people don't want to reach retirement age and have
their standard of living cut in half.'' \27\
Two implications of reducing benefits to cancel out real wage
growth are immediately obvious. First, the longer the ``price
indexing'' provision stays in effect, the larger the benefit cuts,
assuming ongoing real wage gains. Second, the more rapid real wage
growth, the larger the benefit cuts.\28\
The bottom line is that under ``price indexing,'' the role of the
Social Security system in allowing the elderly to maintain their
standard of living after retirement would decline sharply over time.
Consider the effect of the price indexing proposal combined with
the loan repayment for workers opting for the accounts put forward by
the Administration. Specifically, as above, consider a medium earner
who is 21 in 2011, and assume the worker claims benefits at age 65 in
2054. Given the economic assumptions used by the Congressional Budget
Office, price indexing would first reduce this worker's retirement
benefit by more than 35 percent.\29\ Then the loan repayment for the
revenue diverted into the worker's account would consume about half of
the benefit provided by the current benefit formula. As a result, the
worker would have a traditional benefit equal to less than one-fifth of
the benefit provided by the current benefit formula.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
To be sure, the worker would also have an individual account. But
the Congressional Budget Office has correctly emphasized that the
projected income from such accounts must be adjusted for its riskiness.
With the type of risk adjustment adopted by the Congressional Budget
Office, the income from the individual account would make up about half
of the initial benefit under the current formula.\30\ The net result
would leave the worker with total combined benefits that were roughly
35 percent lower than under the current benefit formula.
Perhaps more surprisingly, the reduction in benefits even including
the account income is roughly twice as large as would be required if
benefits in 2054 were simply reduced to match incoming payroll revenue
in that year. This level of ``payable benefits'' is about 20 percent
higher than the income from the account plus the remaining traditional
benefit after price indexing and the loan repayment, under the type of
assumptions used by the Congressional Budget Office.
Figure 2 illustrates these effects in terms of the replacement rate
at retirement in 2054. Financial planners suggest that a comfortable
retirement requires income during retirement equal to about 70 percent
of pre-retirement earnings. The current benefit formula would provide
about half the necessary amount, requiring the worker to save enough in
addition to Social Security to replace roughly 35 percent of pre-
retirement earnings. If benefits were reduced to match incoming payroll
revenue in 2054, traditional benefits would replace a little under 30
percent of pre-retirement wages, requiring the worker to save a little
more than 40 percent of previous earnings.\31\ If the Administration's
accounts were combined with price indexing, however, the traditional
benefit after both price indexation and the loan repayment were applied
would replace less than 10 percent of previous wages. The income from
the individual account would replace a little under 20 percent of
previous wages. The net result would be that the worker would have to
save substantially more in addition to Social Security; such savings
would have to be enough to replace almost half of pre-retirement
earnings.
Figure 2 shows that combining price indexing with the loan
repayments on individual accounts would cause the traditional benefit
to wither on the vine over time.
CONCLUSION
Individual accounts that mortgage future Social Security benefits
raise a number of troubling questions, as this testimony has
highlighted. A better approach involves raising saving above and beyond
Social Security. As illustrated in Figure 2, individual accounts--in
the form of the 401(k)s and IRAs--have a critical role to play in
filling the hole between the foundation provided by Social Security and
a comfortable retirement. Many Americans, however, have not accumulated
enough financial assets on top of Social Security. Half of households
on the verge of retirement have only $10,000 or less in a 401(k) or
IRA. Yet we now know what works to get people to save in 401(k)s and
IRAs, and we're not doing it.
Individual accounts can and should be strengthened outside Social
Security, where they belong. Social Security itself can then be shored
up through a combination of benefit and revenue changes that would
retain the program's critical role in delivering a solid foundation of
financial security.\32\
ENDNOTES
1. The views expressed here are those of the author alone. This
testimony draws upon joint work with Peter Diamond, Jason Furman,
William Gale, and Robert Greenstein. For a detailed discussion of the
issues involved in payouts from individual accounts, see National
Academy of Social Insurance, Uncharted Waters: Paying Benefits from
Individual Accounts in Federal Retirement Policy, 2005.
2. The Administration still has not specified many important
aspects of the accounts. I have tried to reflect the proposal as I
understand it, based on official White House documents and on the
memorandum from the Office of the Chief Actuary. In some cases,
however, these documents contradict each other. As more details about
the proposal become available, some of the specific figures cited in
this testimony may be slightly affected, but the fundamental points
will not be. For other analyses of the Administration's proposal, see
Jason Furman, ``New White House Details Show the Proposed Private
Accounts Would Worsen Social Security's Finances,'' Center on Budget
and Policy Priorities, February 4, 2004; Jason Furman and Robert
Greenstein, ``An Overview of Issues Raised by the Administration's
Social Security Plan,'' Center on Budget and Policy Priorities,
February 3, 2004; and Jason Furman, ``How the Individual Accounts in
the President's New Plan Would Work: Plan Would Allow Individuals to
Mortgage Half of Their Social Security Benefit,'' Center on Budget and
Policy Priorities, February 4, 2004.
3. Although the system operates like a loan, it is not literally a
loan because the transaction does not involve a contract. For some
purposes, such as budget scoring, the fact that the transaction does
not involve a contract and therefore is not legally a loan may be
determinative. For further discussion of the budget scoring issues
involved in proposals of this type, see Jason Furman, William G. Gale,
and Peter R. Orszag, ``Should the Budget Exclude the Cost of Individual
Accounts?'' Tax Notes, January 24, 2005.
4. Such a plan would entail two types of benefit reductions: those
that would apply only to workers opting for the accounts, which would
be intended to repay the loan to the worker, and benefit reductions
that would likely apply to all future workers, regardless of whether
they opted for an account, which would be intended to eliminate the
long-term deficit in Social Security.
5. Specifically, if individuals understand that the individual
accounts are equivalent to a loan, they may not reduce their other
savings. But if they do not understand the nature of the offsetting
benefit reduction, then they may mistakenly consider the individual
account an asset and reduce other asset accumulation accordingly.
6. The limit would increase by $100 above wage inflation, at least
through 2015. The Office of the Chief Actuary, in its memorandum on the
proposal, indicated that the parameters of the system past 2015 had not
been specified. It is noteworthy, however, that the White House Fact
Sheet indicates that: ``Under the President's plan, personal retirement
accounts would start gradually. Yearly contribution limits would be
raised over time, eventually permitting all workers to set aside 4
percentage points of their payroll taxes in their accounts.'' Given
this statement, the analysis in this testimony assumes that the
threshold would continue to increase more rapidly than wages until all
workers could contribute 4 percent of taxable earnings. None of the
qualitative conclusions are affected by this specific assumption.
7. In effect, the individual accounts proposed by the
Administration represent a ``Social Security line of credit.'' Workers
drawing upon that line of credit receive payroll revenue in their
individual account today, but must pay back the funds at retirement.
8. Since the worker was 21 at the beginning of 2011, he or she
would turn 22 during 2011. The worker would therefore turn 65 during
2054.
9. Note that the worker would be diverting less than one-third of
the Social Security payroll tax into the account, but the benefit
reduction would total roughly one-half of the benefit under the current
benefit formula. The reason is that the loan is correctly charging the
marginal return on funds within the Social Security system, not the
average return.
10. The outcome is identical to the worker borrowing from future
Social Security benefits at a 3 percent real interest rate. The worker
benefits only if the return to the assets purchased with the borrowed
funds exceeds 3 percentage points above inflation. As emphasized in the
text, because of administrative costs, the worker would have to earn
more than 3 percentage points above inflation on the underlying
investments in order to break even; the net return above inflation and
after administrative costs must be 3 percent per year to break even.
11. As the White House Fact Sheet put it, ``At any time, a worker
could ``opt in'' by making a one-time election to put a portion of his
or her payroll taxes into a personal retirement account. Workers would
have the flexibility to choose from several different low-cost, broad-
based investment funds and would have the opportunity to adjust
investment allocations periodically, but would not be allowed to move
back and forth between personal retirement accounts and the traditional
system.'' (See below:)
http://www.whitehouse.gov/infocus/social-security/200501/
socialsecurity3.pdf.
12. It is unclear whether these restrictions would be sustainable.
Most workers currently enjoy some form of access to the balances in
their 401(k) accounts prior to retirement. A critical question
regarding the Administration's proposal is whether Congress would
sustain the prohibition on pre-retirement access even if it were
initially adopted. Workers will likely argue that they should indeed
have earlier access. At the beginning, such an argument may be made
only in hardship cases--such as a terminal disease. Over time, this
might evolve into withdrawals for education or first-time home
purchases, or into an ability to borrow against an account. Such pre-
retirement liberalization would then severely undercut the role of
Social Security as financing retirement.
13. As noted in a footnote above, this distinction may be
determinative for the purposes of budget scoring.
14. Transcript of briefing as posted on Washington Post website:
http://www.washingtonpost.com/ac2/wp-dyn/A59045-
2005Feb2?language=printer.
15. In theory, one could construct the system so that those
actually repaying the loans overpaid, in order to compensate for the
losses from those who underpaid. But this would impose even greater
costs, beyond the administrative cost issue noted in the text, on
workers who elected the accounts and then held bonds in them until
retirement.
16. The example provided in the text above suggested that a medium-
earner's loan repayments back to Social Security could represent about
half of the benefit under the current benefit formula. For higher
earners, the pay-back on the loan would be an even higher share of
benefits under the current benefit formula. Compared to the reduced
benefits that would exist under the Administration's approach to
restoring solvency in Social Security, furthermore, the loan repayments
would be even larger.
17. Congressional Budget Office, ``Updated Long-Term Projections
for Social Security,'' January 2005, Table W-5, http://www.cbo.gov/
Spreadsheet/6064--Data.xls.
18. ``Preliminary Estimated Financial Effects of a Proposal to
Phase in Personal Accounts--INFORMATION,'' Memorandum from Stephen C.
Goss to Charles P. Blahous, February 3, 2005.
19. These figures, like the ones in the memo from the Office of the
Chief Actuary, assume two-thirds participation in the accounts.
20. Such increases in debt would occur even if the maximum account
size were capped at its (wage-adjusted) 2015 level, rather than
continuing to be increased more rapidly than wages after 2015 to ensure
the White House goal that all workers could eventually contribute 4
percent of payroll to the accounts.
21. This approach has also been employed in legislation introduced
by Senator Lindsey Graham. As noted below, it is more accurately called
``real wage growth negating'' than ``price indexing,'' since it removes
the impact of real wage growth on benefit levels, rather than
incorporating a price index directly into the benefit formula.
22. Initial retirement benefits are based on a worker's average
indexed monthly earnings. Average indexed monthly earnings, in turn,
are determined by taking earnings in previous years and scaling them up
by subsequent national average wage growth. The wage indexing occurs
through the year in which a worker turns 60, with later wages used on a
nominal basis (unindexed). The initial benefit level is thus indexed to
wage growth through age 60. After initial benefit determination,
benefit increases are indexed to price growth. Price indexing of
benefits begins after the year in which a worker turns 62. Thus there
is a gap with no indexing to either wages or prices, which should be
corrected--and could be addressed on a revenue-neutral basis if
desired. The formula relating full benefits (the so-called Primary
Insurance Amount) to earnings is also indexed to average earnings. In
2005, the Primary Insurance Amount is equal to 90 percent of the first
$627 of AIME; 32 percent of AIME over $627 and through $3,779; and 15
percent of AIME over $3,779. The ``bend points'' at which the 90, 32,
and 15 percent factors apply are indexed to wage growth.
23. The 2004 Trustees Report projects long-run growth of prices of
3.0 percent per year and long-run growth of taxable wages of 4.1
percent per year, resulting in a growth of real wages of 1.1 percent
per year. But real wage growth may turn out to be larger or smaller
than this amount.
24. More precisely, the proposal would multiply the 90 percent, 32
percent and 15 percent factors used to compute the Primary Insurance
Amount by the ratio of cumulative price growth to cumulative wage
growth between the start date and the year in which a worker becomes
entitled to claim benefits. It is thus important to note that wage
indexing would still be part of the determination of benefits.
25. Greg Ip, ``Social Security: Five Burning Questions,'' Wall
Street Journal Online, December 19, 2004.
26. ``Price-Indexing the Social Security Benefit Formula Is a
Substantial Benefit Cut,'' prepared by the minority staff of the Social
Security Subcommittee, House Committee on Ways and Means, November 30,
2001.
27. Cited in Edmund L. Andrews, ``Most G.O.P. Plans to Remake
Social Security Involve Deep Cuts to Tomorrow's Retirees,'' New York
Times, December 13, 2004.
28. This second implication may not be widely understood: The
proposal reduces benefits more if real wage growth is more rapid than
expected. Yet if real wage growth is more rapid, the actuarial deficit
over 75 years in the absence of this provision would be smaller, not
larger. The use of real wage negating is thus even more troubling than
simply reducing benefits based on expected real wage growth today. The
larger actual real wage growth turns out to be, the smaller the need
for benefit reductions--but the larger those reductions actually are
under the real wage negating approach. In other words, the approach
introduces variation in benefit reductions relative to scheduled
benefits that are larger the less the financial need of Social Security
for such reductions.
29. The figure assumes that price indexing applies to workers who
are 54 years old and younger in 2005.
30. The risk adjustment implemented by the Congressional Budget
Office is consistent with the approach adopted by the Administration in
evaluating stock investments by the National Railroard Retirement
Investment Trust. As the Analytical Perspectives of the
Administration's Fiscal Year 2006 budget notes (page 421), ``Economic
theory suggests...that the difference between the expected return of a
risky liquid asset and the Treasury rate is equal to the cost of the
asset's additional risk as priced by the market.''
31. The CBO assumptions show a cost rate in 2054 of 6.39 percent of
GDP and an income rate of 4.95 percent of GDP. A benefit reduction of
23 percent (1-4.95/6.39) would thus reduce cost to income. A reduction
of 23 percent compared to the current benefit formula would leave this
worker with a replacement rate from Social Security of roughly 28
percent (.77*.36).
32. For one plan that achieves sustainable solvency without the
severe benefit reductions implied by price indexing, see Peter A.
Diamond, and Peter R. Orszag, Saving Social Security: A Balanced
Approach (Washington: Brookings Institution Press, 2004).
Mr. Portman [presiding]. Thank you, Dr. Orszag, for your
testimony. I appreciate the fact that you have spent so much
time on not just the Social Security side but retirement
security generally. And I, as you know, happen to agree with
you that we need to do both additive. I also find I disagree
with you with regard to the possibility of doing something
within Social Security as well.
Just a couple of quick questions about your testimony,
first with regard to administrative costs. You indicate that
that is the major reason you would see the 3 percent, which you
note is the bond rate that has been used in some of the
analysis, not being--not leading to someone with a personal
account to have a much higher rate of return than someone, say,
entering the workforce today, which I think the estimate is
about 1.8 percent return. What do you assume by the
administrative cost? Do you believe the administration's
numbers that they had out last week of a 30 to 40 basis point
administrative cost.
Mr. Orszag. In that calculation, I did assume the 30 basis
point number that the administration has used. So that is the
assumption that I used. I do want to comment on that for a
second, though, because that administrative cost assumption
assumes a very centralized type of account in which investment
choices are restricted. There are a variety of restrictions. It
is not clear to me that that ultimately will be sustainable
given the way these accounts are being sold, And if you have a
more decentralized system where you can hold the accounts at
any financial services firm, the administrative cost could be
much higher.
Mr. Portman. But you basically take the Thrift Savings Plan
model and think that, assuming that they were that regulated
and that centralized, that that administrative cost could be
that low.
With regard to your second point, I agree with you, there
are some unanswered questions here. You didn't mention the
annuitization of the funds but you talked about the liability
that is reflected in the choice to take a personal account and
if someone were to predecease their retirement age that that
account would then be, as some have said, available for kids
and grandkids, family. It is also relatively easy under the
Social Security system to determine what that liability would
be, isn't it? In other words, couldn't you come up with a
calculation as to what the liability is with regard to that
account going forward at any particular age and be able to
provide that personal account as a lump sum in addition to
whatever the liability was?
Mr. Orszag. Yes. My only point there was--and again we are
talking about roughly 14 percent of the workforce dying before
retirement. To talk about only the bequests either raises the
question of these accounts actually harming the solvency of
Social Security even over an infinite horizon or the hidden
subtext that there will be a debt passed on along with the
account. That was my only point.
Mr. Portman. But it is not impossible to make that
calculation?
Mr. Orszag. That is correct.
Mr. Portman. The 40 quarters issue is an interesting one,
because some people don't make 40 quarters, therefore they
don't get the traditional benefit. Do you think it would be
appropriate for those people to have a personal account at all?
Mr. Orszag. Again, an unanswered question. I mean,
presumably what would happen is that the accounts would not be
delayed until after you had worked 40 quarters. So I guess the
question is, are you confiscating the accounts, or are the
deposits not going in?
Mr. Portman. That is a good point.
Mr. Orszag. I was going to say, there is another situation
that I think is worth paying attention to in which the
traditional benefit would not be sufficient to pay back the
diverted revenue plus interest. That is, if you combined this
proposal with price indexing, which is the leading way of
actually--leading proposal apparently to restore solvency
within the traditional program for the top end of the income
distribution (and it is not a trivial share, we are still
working on the numbers but it is not 1 or 2 percent of the
workforce, much higher than that), the traditional benefit
would not be sufficient to offset the cost of the diverted
revenue plus interest. That means the system would actually
lose money for any high earners who went into the accounts
because the traditional benefits just wouldn't be there--be
sufficient to pay back the diverted revenue plus interest. And
there are a wide variety of these kinds of situations that
could arise.
Mr. Portman. Your third point was that with no new revenue
you need to look at the benefits side. Do you have a favorite
proposal?
Mr. Orszag. I think there are a variety of proposals on
both the benefit and revenue side. I have co-authored a plan
with Peter Diamond of MIT. That is one way of doing it. We
tried to balance or combine benefit and revenue changes. One
can move beyond just talking about the payroll tax, and I know
there is some discussion of that. One could talk about
dedicating a state tax revenue or dedicating various different
kinds of revenue to the system.
The key point is without any additional revenue dedicated
to the program you are looking at very substantial reductions
in replacement rates or reductions relative to the current
benefit formula to restore solvency to the program beyond, in
my opinion, what is justified for that core tier of retirement
security.
Mr. Portman. One of the interesting things as you look at
our tax system and how it relates to Social Security is the
fact that, as you know, many workers, low-wage workers, even
some low to middle wage workers do not have a personal
individual income tax liability; some in fact get a tax check
back from the Government through the EITC, earned income tax
credit. Therefore, to look at retirement as you and I have from
the outside as it affects Social Security, it is difficult
without offsetting payroll taxes in the way the President is
talking about to affect those people who you most want to
encourage to save, and that would be lower income workers,
middle income workers who do have a payroll tax liability. And
so my challenge to you would be, as much as I agree with you on
the individual accounts, as you know, and even on the savers
credits and so on, how do you get at the solvency of Social
Security with these outside accounts? And, number two, how do
you really help the low wage worker who for the most part does
not have an income tax liability, therefore a tax deduction, a
tax credit is not useful?
This is one thing that I think needs to be looked at. And
as you know, I believe in the individual accounts, I also
believe we ought to do much more on the 401(k) and the IRA side
and even some new vehicles. But using that payroll tax does
provide certain advantages that you don't have given the fact
that increasingly under George Bush's leadership fewer people
are paying Federal income tax and the burden is shifting more
to the upper end. So it is harder to use the income tax,
Federal income tax to effect savings among lower and middle
income workers. Can you give us a response to that?
Mr. Orszag. Sure. Let me answer that second question first
and then come back to solvency. I actually think the whole way
that we have been trying to encourage savings in the United
States, private savings, is wrong, that trying to do it through
financial incentives is not the most auspicious mechanism for
raising savings. The fact of the matter is most families are
busy, they don't focus on the decision. The decisions to save
are complicated, and so there is a lot of inertia and just
delaying the decision. If you put in plans where, for example,
you are automatically in a 401(k) plan unless you opt out,
which alters that inertia decision, participation rate even at
the very bottom, below $20,000 in income, jumped from about 7,
it shows, from 15 percent to 80 percent. Similarly, outside of
401(k) plans I think we just need to make it more automatic.
Get those tax refunds automatically into an IRA, set up payroll
deduction IRAs in a more universal way. I will even say, I
mean, even at Brookings--give you an example, a little personal
example. Because of changes in the 2001 tax law, the amount
that--the maximum amount that can be put in a 401(k) or a
403(b) is increasing each year and increased this year. We got
a form at Brookings saying if you wanted to put in the maximum
amount this year you need to fill out this form. If you don't
fill it out, you are going to stay at the lower level from last
year. I would bet that half of my colleagues have not filled
out that form. They just lose it. We need to make the whole
process more automatic so that the default is that you are
always saving. I would sign up for saving the maximum amount
for the rest of my life until I tell someone otherwise, and I
think many of my colleagues would also. The same thing. I think
we just need to make it more automatic. We are looking in the
wrong way when we--families that are too busy to focus on the
decisions will still be too busy to focus on the decisions when
we throw more financial incentives at it.
So that is my answer. I don't think that we should attack
the problem primarily through financial incentives. They can
help, but the big thing is to get the structure right.
And in terms of the solvency of Social Security, the way I
think about it is the following. Financial planners say that we
need 70 percent of preretirement income to live comfortably in
retirement. Social Security for the average earner is providing
about a half of that, 35 percent; the other half happens to
come from the sorts of things we were just talking about. I
think that bottom tier, that foundation should be provided in a
form that lasts as long as you are alive; that is, protected
against inflation and that doesn't fluctuate with the stock
market. And that is exactly what the current program does. So
in my view, while there might be some benefit adjustments that
are necessary, taking that 35 percent replacement rate and
going all the way down to 20 for young workers and then even
further below that, which is what would be happening under
price indexing, is not a very sound approach. So I have a
proposal that avoids that kind of outcome. There are lots of
ways of avoiding that kind of outcome. But I don't see
individual accounts within that core tier as providing the kind
of benefit that they can provide above that core tier.
Mr. Portman. I appreciate your answer. I know that at least
one proposal that you support it, and I admire your courage,
raises payroll taxes which, as you know, is something the
President has ruled out and I don't think would be very popular
here on the Hill. And also it has some negative economic
impacts. Others have talked about using general revenues, which
is in essence not allowing the taxes to become permanent that
are currently in place, the tax relief. So I do appreciate your
stepping forward with a proposal. But I would just say I think
the challenge we have got is how do you link this notion of
higher private savings and the private vehicles with our
solvency? And with that I will turn to my colleague and ranking
member, Mr. Spratt.
Mr. Spratt. Mr. Portman, I don't know if you have seen the
book, but Peter Orszag has worked his way through all of these
problems in a very commendable fashion to come up with a
proposal that I think has been reduced to legislation. Hasn't
it, Peter?
Mr. Orszag. Not to my knowledge. It has been scored by the
Social Security actuaries and also by the Congressional Budget
Office though.
Mr. Spratt. In it you develop the idea of a legacy debt,
that Social Security owes for the overpayment of benefits in
past years, particularly when the early employees retired after
not having put a full 40, 35 years into the system but
nevertheless drew, relatively speaking, pretty substantial
benefits. Would you elaborate upon that?
Mr. Orszag. Sure. And, in fact, this comes back to Mr.
Portman has asked about the rate of return for current
generations of 1 or 2 percent on Social Security, why is that
any lower than the Government bond rate of 3 percent. And it
has to do--precisely to do with the legacy debt that you
mentioned. Early retirees under Social Security were given
rates of return that were well above market rates of return.
Think about it, someone had paid in for 5 or 10 years and then
received benefits for perhaps 20 or 30 or 40 years. By the way,
that decision was probably a good one. These people had lived
through the Great Depression, fought in World War I and World
War II, that that decision probably from society's perspective
made sense. But because we gave away excess returns early, we
all now collectively face the prospect of having to pay off
again what we call that legacy debt.
The legacy debt comes because we gave away excess returns
under the program early, and there is nothing that we can do to
erase that debt. I mean, a lot of these comparisons of rates of
return pretend that we can just erase that debt. Right now what
that would mean in practice is cutting off current
beneficiaries. That is the only real way that we can erase the
debt. And then of course their rates of return would be harmed.
We gave away that money or we made a decision as a society to
provide super normal rates of return. That is now water under
the bridge and we all must face it.
That is the difference, and I think economists on both
sides of the aisle agree on this. That is the reason that
Social Security provides a 1 to 2 percent rate of return and
the Government bond rate is 3 percent, and there is nothing we
can do at this point to take back the money that we had given
away early on.
Mr. Spratt. You propose, however, a rectification in your
book.
Mr. Orszag. Well, I think the key thing is that is water
under the bridge. We all now collectively have to face the fact
that we are all going to have to finance that in some way, and
the key question is how do we share that burden. There are
extremes. You could put off reform for a long period of time
and have far distant generations bear an undue burden. You
could move immediately to a fully funded system which would
require current workers to bear the full burden. We think those
two extremes don't make any sense and that something in between
does.
So I guess there are really two points here. One is, this
is a key underlying issue in Social Security reform. And it is
not issue--it is not sort of--it doesn't bubble to the surface
enough how different generations are sharing that burden.
The second thing is any plan will distribute that burden in
some way, and it is very important to look at how the burden is
being distributed.
And just a final point, and I guess this come back to the
individual accounts. Individual accounts are often pitched as
helping young workers today. That is sort of where the natural
pitch is made to. But the fact of the matter is if the
individual accounts were honestly financed; that is, through
additional revenue or offsetting changes today, the young
workers today are the ones who bear that legacy debt. They are
the ones who bear that transition cost. Or another way of
putting it is they are the ones who have to pay twice. They
will have to pay for current beneficiaries and then for their
own retirement. So focusing on the legacy debt illuminates
questions like that; much of the rhetoric surrounding the
debate obscures it.
Mr. Spratt. Let me ask you about the 75-year time frame as
opposed to the infinity time frame. You deal with that in your
book, and you come down on the side of sticking with the 75-
year time frame primarily because projecting so far over the
horizon and into the future is terribly tenuous.
Mr. Orszag. I think it is illuminating that out of the
$10.4 trillion infinite horizon imbalance, more than 60 percent
of it occurs after 2078; that is, between 2078 and eternity.
And while I think it is important that we are aware of how
sensitive the projections are out in 2100 or 2200, I don't
think that it is the best basis for policy making. It is just
too sensitive. If we change the discount rate from 3 percent to
2.9 percent or the interest rate from 3 percent to 2.9 percent,
and that number swings all over the place. So if that is the
goal that you are trying to hit, I worry that reasonable
changes in the parameters cause you to be chasing your tail.
Mr. Spratt. Extended out over a long period of time?
Mr. Orszag. Extended out beyond the traditional 75-year
window.
Mr. Spratt. Discuss with us for a minute what happens to
disability payment if we have the significant disability and
survivorship benefits. You may have heard the exchange earlier
with Secretary Snow.
Mr. Orszag. I did.
Mr. Spratt. If indeed you recompute the primary insurance
amount, indexing the income streams to prices rather than wages
as they are indexed today, and over time reduce the replacement
ratio by 50 percent, what does this do to the 30 percent of
those who are on Social Security and are drawing either
survivorship or disability benefits?
Mr. Orszag. Well, let me answer the question in two
different ways. Under the President's commission model 2 and
model 3, the reductions that you are describing were assumed to
apply, or at least in their numbers they assume that they
applied to disabled workers, to young surviving children, to a
whole variety of other very vulnerable beneficiaries. The
implication of that is very severe reductions in benefits for
the most vulnerable set of beneficiaries under Social Security.
Now, the administration currently says that there will be
no changes in the disability component or the survivor's
component of Social Security. I would just warn you that to say
that there are no changes in the disability component is not
necessarily to say that there are no changes in disability
benefits, and the President's commission danced around that
question. I think it is a very important topic and something
that policymakers like all of you need to pay a lot of
attention to, to look in the fine print about exactly what is
happening to those beneficiaries.
Mr. Spratt. Now, let me ask you about the proposal in model
2, which I presume will be an integral part of the President's
proposal once it is fully formulated, to recompute the primary
insurance amount using prices instead of wages to index the
income streams. We showed a chart earlier that shows how the
replacement ratio for the median beneficiary declines by about
50 percent, from 43 percent of preretirement income to 22
percent of preretirement income over a period of 40 or 50
years. That also includes the return that would--the net return
that that beneficiary would receive in his collateral savings
account, whatever it is called. With a return at a rate equal
to the bond rate, which is 3 percent real rate of return, how
much would the rate of return have to be in the collateral
account for the PIA or the replacement ratio to remain
constant?
Mr. Orszag. First, just to give you the numbers, the
Congressional Budget Office analysis of model 2, which is the
one that you are referring to, makes it very clear that even
including the individual account and even comparing to payable
benefits, not scheduled benefits, model 2 pays less than what
the system could afford even after the trust fund is exhausted
and benefits were reduced to match incoming payroll revenues.
So, in particular, table 2 of their analysis shows that in the
middle household earnings quintile, or for basically the
typical household in the middle of the distribution, that lower
level of payable benefits would be $19,900 a year. Model 2
would give $14,600 a year, including the individual account as
analyzed by CBO. So that is roughly a $5,000 a year
differential, a very substantial amount for a typical family.
To make up that difference would require an implausibly large
rate of return on stocks as long as you are assuming some mix
between stocks and bonds.
Mr. Spratt. Of what magnitude? Can you give us a ball park
figure?
Mr. Orszag. Above 10 percent real on a sustained basis,
assuming a 60/40 split.
Mr. Spratt. So to be held harmless, so to speak, the
account would have to make above 10 percent, and that is after
the clawback of 3 percent real?
Mr. Orszag. Just to be clear, that is on the stock
component, and then of course there is the bond component, too.
Stocks would have to be yielding well in excess of their
historical average.
Mr. Spratt. But is that after the deduction of 3 percent--
--
Mr. Orszag. Yes, I am sorry. That is net of the benefit
offset.
Mr. Portman. OK. So you have to make well above 10 percent
on the whole account?
Mr. Orszag. Again, just to repeat, you need to make more
than 10 percent on the stock component. The bond component
would then be accruing at the interest rate that CBO assumes.
After all of that, subtracting the benefit offset, you would
just make back up to the 19,900 only if stocks were yielding
well above 10 percent real, which again is substantially higher
than their historical average.
In other words, under CBO's assumptions it is unlikely that
you would get back the payable benefits. And in fact you can
see that in the CBO analysis. If you look at figure 3B, they
show you the range of uncertainty over benefits compared to the
payable benefits baseline. And out in the outyears, even with
80-percent probability, one would--plus or minus 40 percent on
either side, you are not getting back to payable benefits. So
it is a very small probability that you will get back even to
payable benefits let alone to the current benefit formula under
CBO's assumptions.
Mr. Spratt. Now, let me ask you. Have you had an
opportunity to run the numbers on what amount of debt
accumulation would be necessary, at least in the first 20
years, to float model 2 or to float a proposal based upon that,
particularly if the diversion is four points off FICA as
opposed to two points off FICA?
Mr. Orszag. Yes, and I think this chart actually shows you.
This shows you as a percent of GDP. But just to give you the
numbers in dollars, starting from when the accounts actually
begin in 2009, the first decade they are fully--or, in effect;
they are not even fully in effect. The first decade they are in
effect the additional debt would be more than $1 trillion. And
then in the second decade it would be more than $3.5 trillion.
The details will matter--will depend a little bit on whether we
should take a briefing from a senior White House official at
face value in suggesting that the accounts will ultimately grow
to 4 percent of earnings and exactly how that happens. But that
is the order of magnitude that we are talking about.
Mr. Spratt. About $4.5, $4.6 trillion over the first 20
years of implementation?
Mr. Orszag. Correct.
Mr. Spratt. OK. Do you have any opinion as to what that
would do to--you have heard the discussion today. Is that debt,
or is that something else, since we supposedly have a wash
here, that we are only prepaying future obligations and that
financial markets will treat this differently? What is your
view of what that sort of debt accumulation will do to the
budget and to the economy?
Mr. Orszag. I think we are running an increasing risk over
time of running into problems, rolling over our debt, and
maintaining the confidence of investors. Implicit debt and
explicit debt are different things. Implicit debt does not have
to be rolled over in financial markets. By issuing the
trillions of dollars in additional explicit debt, we are
increasing the risk that we run into problems with financial
market confidence, in my view.
And just to rephrase that, the consequences of a collapse
in financial market confidence are more extreme, and the
probability of that diminution in financial market confidence
seems to me higher when we trade future implicit debt for
current explicit debt.
Mr. Spratt. Thank you very much.
Mr. Portman. Well, I believe Mr. Cuellar has now left us,
so Dr. Orszag, thank you very much for your testimony. It was
an interesting exchange. I will say that you talked about some
CBO numbers that we don't have yet, and we are eager to get
them. When we look at the potential range of benefits as a
share of GDP, we are getting some different numbers based on
some projections that we have, but we do not have all the
numbers you have. So we are looking forward to those.
Mr. Orszag. This is with regard to model 2.
Mr. Portman. I am not sure that we would entirely agree
with the 80 percent range of uncertainty number that you listed
based on model 2. But in any case we will have more of those
figures as this debate goes forward.
Mr. Spratt. Mr. Chairman.
Mr. Portman. Mr. Spratt.
Mr. Spratt. Can I take a second to tout his book, Saving
Social Security, published by Brookings, Diamond and Orszag. I
guess you can find it on their web page.
Mr. Orszag. You can indeed.
Mr. Spratt. An excellent discussion of all of this.
Mr. Portman. Mr. Spratt, you really should be holding up a
1-800 number. That would be more----
Mr. Spratt. If I had it, I would.
Mr. Portman. Or something dot.com.
Anyway, Peter, thank you very for your testimony today, and
with that our hearing is adjourned.
[Whereupon, at 2:41 p.m., the committee was adjourned.]
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