Hearing Archives :Committee on Ways & Means :: U.S. House of Representatives :

Travis, Wolff & Company, L.L.P.

Dallas, Texas 75240

February 7, 2004

Congressman E. Clay Shaw, Jr.
Chairman, Subcommittee on Social Security
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515-6100

Dear Chairman Shaw:

TravisWolff respects and honors the diligence and commitment shown by you and other members of the Subcommittee on Social Security in furthering honest debate about proposed solutions to one of the most important and complex policy issues ever faced by the United States. In this regard, we are pleased to have the opportunity to offercomments on the future of our nation’s Social Security system as requested by the Subcommittee’s January 16, 2004 advisory. Our comments herein specifically address (1) definition of Social Security issues, (2) proposed changes offered by others, and (3) suggestions for further study.

“TravisWolff” refers to a group of entities (see Appendix I) performing advisory and accounting services for small to medium-sized businesses, exempt organizations, trusts and individuals. With approximately 100 personnel in Dallas, Texas, we advise clients on taxes, retirement plans, business valuation, and other financial matters, as well as prepare tax returns and audit financial statements. TravisWolff is part of the Moore Stephens network, with offices worldwide.

Most of the ideas for changing Social Security fall into three areas. Those are (1) financial soundness, (2) system design, and (3) administration. We believe that Congress has done an admirable job helping the Social Security Administration (SSA) to improve its administration. Therefore, the remainder of this letter is in reference to financial soundness and system design.

The role of ideology

In any discussion of Social Security reform, it is important to understand differences in orientation to the potential issues. This is essential before the real issues can be identified.

Most people know:

Of the upcoming surge in retirements of “baby boomers;”
that the number of workers per retiree has declined and will continue to for some time;
that Social Security is largely “pay-as-you-go;” and
that the Social Security Trust Funds are projected to be exhausted before the middle of this century.

Their reactions to this situation vary according to age, income, accumulated wealth, marital status and gender.

Younger Americans are concerned about rate of return on their contributions. Numerous financial commentators have suggested that the rate is extraordinarily low. That may be so, but measurement on an individual basis is difficult, since Social Security is not solely a worker retirement benefit. Social Security also pays worker disability benefits, spouse retirement benefits (including divorced spouses in certain cases), a very small lump sum death benefit, and income for surviving dependent children (and caretaker surviving spouses) of deceased workers.

For middle class Americans of all ages, assuredness of benefits and adequacy of benefits are very important, although there is variation by age. Representative attitudes might be:

Age 30 - “I won’t get my share before it runs out of money.”
Age 50 - “I’ve paid too much in over the last 30 years to turn my back on it, and I’ve counted on Social Security benefits
Age 60 - “Perhaps I could have saved more, but I wanted my wife and children to have a comfortable life. I’ve paid into this thing for 40 years, and soon it will be my turn.”

Wealthy Americans are not as likely to be bothered by any suggested changes to Social Security except to the extent income or payroll taxes are increased. As used herein, “wealthy Americans” would include those whose projected Social Security retirement benefit would be 10% or less of their total retirement income.

Additionally, there are some specific ideological schisms:
Purpose of Social Security benefits
The nature of Social Security taxes
Principles regarding property rights and societal benevolence

Clearly, from the time of its introduction until recently, Social Security has been a universal base for retirement planning. It was to be supplemented by employer sponsored retirement plans and private savings (the “three-legged stool”). If it had been meant as a welfare plan, its funding would have come from general revenues, as opposed to a special tax on earned income below a specific threshold.

Some people have begun to question whether the purpose should change. There have been suggestions regarding means testing of the benefits, which erodes universality. Still others believe that Social Security benefits should be property transferable by gift or inheritance.

Are Social Security taxes just like any other taxes, or are they more like a purchase of insurance with investment elements? Remember that the “I” in FICA stands for insurance.

Should Social Security taxes continue to exist and be earmarked for the Social Security system? Some say “no.” They would abolish Social Security taxes, establish a welfare plan for the poorest retirees, and suggest that everybody else save for retirement on their own terms.

All the issues above and the following questions should be discussed publicly without any political “spin.”

What ethical principles should apply?
To what extent does society owe a larger share of Social Security benefits to low-wage workers?
To what extent is it fair to expect the next generation to pay higher taxes to finance retirement benefits for its predecessor?
To what extent should parents have the right and/or obligation to pass accumulated wealth to their children?

None of these questions have single, easy answers.

The Issues Defined

When a comprehensive “plan” for “overhaul” of Social Security is proposed, many elements become mixed, and that makes the proposal difficult for an average person to understand. This letter uses the following conceptual framework to simplify the issues.

Financial soundness
System design
Adequacy of benefits
Design of benefits
Funding scheme

Financial soundness

Financial soundness is the province of actuaries, accountants and economists. The American public should not be misled in this area by politically biased “think tanks,” or “spin doctors.”

The words “solvency” and “insolvency” have been used in different ways by people writing about Social Security Reform. Some refer to the Social Security system becoming “insolvent” when current payroll taxes plus interest on the Trust Funds is no longer sufficient to pay the current year’s benefits (projected by SSA to be 2018). Others have used “insolvency” in reference to the time at which the Trust Funds become exhausted (projected by SSA to be 2042).

Because yearly projections of the system by SSA have traditionally used a 75-year horizon, many have used that in evaluating financial soundness. However, the assumptions used by SSA involve sustaining the trust funds for 75 years, and no longer. Thus, each year the target moves.

Financial soundness should be measured using an infinite time frame, in the manner promoted by the AmericanAcademy of Actuaries.

The current system has already been shown to be unsustainable, since it is projected to be bankrupt in 2042, long before the 75-year horizon. The American Academy of Actuaries has used an infinite time frame to project effects of some proposed changes to the Social Security system. The effects of proposed changes on financial soundness or "sustainable solvency" are not always intuitive for a non-actuary.

System Design

Adequacy of benefits

Here, we speak of replacement ratios. “Replacement ratio” means Social Security retirement benefits divided by pre-retirement earnings.

How much is enough? Traditionally, Social Security has provided as much as a 55% replacement ratio for low wage workers. The replacement ratio for higher wage workers is less. The proper target for replacement ratios in a changed system is the subject of debate.

Another aspect of adequacy is keeping pace with inflation. Currently, Social Security benefits are indexed to keep pace with wage inflation. Many proposals have been advanced to switch the indexing to keep pace with price inflation. In the past, wage indexing has been slightly higher than price indexing. It is thought that a switch would reduce costs by restraining growth in cash outflows. Of course, this cost savings would become an issue of adequacy for retirees and near-retirees.

Who should benefit? Currently, Social Security benefits more than just disabled and retired workers. There are also benefits for spouses (and divorced spouses) of retirement age, surviving dependent children (as well as for surviving spouses who are caretakers of children receiving benefits). These additional benefits are questioned for two reasons. First, many people do not feel that it is fair to give disparate benefits on the basis of family or marital status. This, of course also leads back to the “money’s worth” issue for single workers without children. Second, such benefits do not easily fit within a “personal account” Social Security system.

Finally, adequacy issues include means testing. Simply put, “means testing” denies or recaptures a benefit level or feature of anyone who does not need it. Currently, taxation of a portion of Social Security benefits is an indirect form of means testing. The political viability of expansion of means testing is doubtful. Many people at or near retirement age would assert that the universality of Social Security should not be disturbed. Also, the “money’s worth” argument could be made.

Presume however, that some form of expanded means testing is acceptable to voters. Fairness in means testing could become quite complex.

On the basis of:

Income? If so, what income? Earned income, taxable income or all income
Assets? What would be exempt? What about transfers to family members, trusts and private foundations?
Combination of assets and income?

Still, we believe that various forms of means testing should be explored in practical detail as part of any proposed reform of Social Security.

Design of Benefits

The current system provides defined benefits. That is, a worker (or in some cases, his/her spouse or dependent children) is entitled to prescribed benefits based upon the worker’s earnings record.

Defined benefits have become less prevalent in employer sponsored retirement plans, primarily because of portability issues. Those issues are insignificant with Social Security, since most people will work within the Social Security system their whole career.

The push for Social Security to drop defined benefits is more rooted in the “personal accounts” and “money’s worth” philosophies.

Many people are interested in personal accounts as part of a reformed Social Security system. Personal accounts allow a worker to reap some or all rewards of fortuitous investment. It would be impossible to make that happen in a continuation of the defined benefit system.

Funding scheme

Who should pay, and how much? Proposals have been made to expand coverage and taxation to groups currently outside the system. Others have suggested changes to the Social Security tax. Currently, the tax is imposed on a limited amount of earned income. What if all earned income were subject to tax (and benefits calculation)?

Of these suggestions, the one which creates the greatest gain in financial soundness is also one of the least popular…uncapping the wage base.

Whose benefits should I pay for? This question reflects concerns over both inter-generational equity and socioeconomic issues.

Should the system be converted to full pre-funding, or remain mostly “pay-as-you-go?” If there is a conversion to pre-funding, the transition deficit must be addressed. Briefly, the “transition deficit” is the system shortfall created by causing current workers to pay for their own future benefits, rather than those of the preceding generation. Various “trial balloons” have been floated over the past few years with regard to the transition deficit...lower benefits, raise taxes, better returns on investment, etc. Lately, however, it has become consensus that some form of transfers from general revenue will be necessary.

In a recent article, economist Milton Friedman seemed very open in his view that the transition deficit could easily be addressed. Just give the Trust Funds government bonds equal to the unfunded benefits obligations. Actually, in his example, the bonds were given directly to participants, but the result is essentially the same. The “compact between generations” is settled by converting it to a general obligation of the United States.

Obviously, the obligations would be paid off with general tax revenues at some point. However, the simple attraction of covering the transition deficit with general revenue transfers is that as a nation, we could stop arguing about this particularly contentious issue, and move on with the process of building a new Social Security system that most people believe in.

We urge further study of the tax and general economic effects of an instantaneous “pay-off” of the transition deficit with general obligations.

Finally, it seems undisputed that women are disproportionate recipients of benefits under the current system. This of course is due to longer life expectancy and other factors. It is a matter of some dispute how race or ethnicity factors into the “money’s worth” debate. A new system should be neutral as to gender, race and ethnicity.

Ideas we propose for further study

Means testing for retirement benefits beginning before age 70

According to the American Academy of Actuaries, raising the retirement age to 70 (gradually by 2030) could make a dramatic difference in the finances of the current system. Although this idea seems to have merit, we are afraid that some workers would be hurt by wholesale application of a rise in the retirement age. We would like to know what would happen, given the current system, under the following scenario.

Leave current benefit levels in place
Leave early retirement as of age 62 in place.
Leave current Social Security retirement ages in place.

Impose some form of means testing for benefits beginning before age 70. For simplicity, we would suggest not allowing benefit payments during years before attainment of age 70 to the extent that total positive income (taxable and tax-exempt) for the preceding year was greater than half the Social Security wage base.

Upon attainment of age 70, means testing would no longer apply.
No actuarial adjustment for delayed benefits

“Clean slate” plan

We would like to know the tax and general economic effects of a complete transition as of January 1, 2005. Here are parameters we envision.

For those in pay status, continue payments (including disability payments) from the Trust Funds.
Benefits not yet in pay status

Retirement benefits of a worker based on his own earnings record would be valued (“Retirement PVFB,” as below) and transferred to an account balance under the new system.

All other benefits based upon a worker’s earnings record (e.g., disability, spouse, divorced spouse, and dependent children, etc.) would be paid from the Trust Funds if and when they become due.

Value benefits not yet in pay status under the current system as of January 1, 2005.
1. Count only past service (i.e., earnings prior to January 1, 2005)
2. Allow for future cost-of-living adjustments (COLAs).
3. Define present value of future benefits (PVFB)
  1. Require 100 credits for full benefits. “Credits” would be defined as under the current system.
  2. Determine the credits (“C”) for the worker upon whose record benefits are based.
  3. Determine the present value of future benefits of the worker and all others (then living) with a potential future claim to benefits based upon the worker’s earnings record. Call this “tentative PVFB.” Regardless of potential beneficiaries, only one PVFB is calculated per worker.
  4. PVFB equals tentative PVFB times C divided by 100.
4. Based upon sound actuarial principles, allocate each worker’s PVFB into two portions:
1. Retirement PVFB - PVFB attributable to the worker’s retirement benefit
1. Other PVFB - PVFB minus Retirement PVFB
Establish a brand-new Social Security Retirement system with a “clean slate.”
1. Provide an individual account for each worker, tradable within a limited range of appropriate alternatives.
2. Deposit a government bond (tradable) equal to the worker’s Retirement PVFB into his/her account as of January 1, 2005.
3. Administrative matters
  1. Each worker would own his/her account.
  2. A payroll tax would be continued, and contributed to each worker’s account.
  3. The “50-50" sharing of payroll tax cost between employer and employee would continue.
  4. The spouse retirement benefit, as an add-on, would cease to exist, as would the “divorced spouse” benefit.
  5. Upon divorce, accounts of each spouse could be considered and divided in accordance with a court order.
Establish a new system (or expand SSI) to replace welfare benefits phasing out under Social Security.
1. Disability
2. Death
  1. Lump sum - increase to a meaningful amount (perhaps $5,000)
  2. Benefits for dependent children (and caretaker surviving spouses) of deceased workers

Thank you for considering TravisWolff's views on Social Security reform. Should you need any further feedback from us regarding this or any matter of tax, accounting or retirement planning, please do not hesitate to contact us.

Sincerely,

Gary W. Wyatt