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.
- Count only past service (i.e.,
earnings prior to January 1, 2005)
- Allow for future cost-of-living
adjustments (COLAs).
- Define present value of future benefits (PVFB)
- Require 100 credits for full
benefits. “Credits” would be defined as under the current system.
- Determine the credits (“C”) for
the worker upon whose record benefits are based.
- 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.
- PVFB equals tentative PVFB times
C divided by 100.
- Based upon sound actuarial
principles, allocate each worker’s PVFB into two portions:
- Retirement PVFB - PVFB
attributable to the worker’s retirement benefit
- Other PVFB - PVFB minus
Retirement PVFB
- Establish a brand-new Social
Security Retirement system with a “clean slate.”
- Provide an individual account
for each worker, tradable within a limited range of appropriate alternatives.
- Deposit a government bond
(tradable) equal to the worker’s Retirement PVFB into his/her account as of January 1, 2005.
- Administrative matters
- Each worker would own his/her
account.
- A payroll tax would be
continued, and contributed to each worker’s account.
- The “50-50" sharing of
payroll tax cost between employer and employee would continue.
- The spouse retirement benefit, as
an add-on, would cease to exist, as would the “divorced spouse” benefit.
- 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.
- Disability
- Death
- Lump sum - increase to a
meaningful amount (perhaps $5,000)
- 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
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