[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]
THE FUTURE OF SOCIAL SECURITY FOR THIS GENERATION AND THE NEXT:
PROPOSALS REGARDING PERSONAL ACCOUNTS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SOCIAL SECURITY
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
__________
JUNE 3, 1998
__________
Serial 105-50
__________
Printed for the use of the Committee on Ways and Means
----------
U.S. GOVERNMENT PRINTING OFFICE
52-485 CC WASHINGTON : 1999
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut BARBARA B. KENNELLY, Connecticut
JIM BUNNING, Kentucky WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Social Security
JIM BUNNING, Kentucky, Chairman
SAM JOHNSON, Texas BARBARA B. KENNELLY, Connecticut
MAC COLLINS, Georgia RICHARD E. NEAL, Massachusetts
ROB PORTMAN, Ohio SANDER M. LEVIN, Michigan
JON CHRISTENSEN, Nebraska JOHN S. TANNER, Tennessee
J.D. HAYWORTH, Arizona XAVIER BECERRA, California
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
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C O N T E N T S
__________
Page
Advisory of May 27, 1998, announcing the hearing................. 2
WITNESSES
Ball, Hon. Robert M., National Academy of Social Insurance....... 31
Gramlich, Hon. Edward M., 1994-96 Quadrennial Advisory Council on
Social Security................................................ 22
Kerrey-Danforth Commission on Entitlement and Tax Reform, Hon.
Fred T. Goldberg, Jr........................................... 38
Kotlikoff, Laurence J., Boston University........................ 14
Munnell, Alicia H., Boston College Carroll School of Management.. 25
Smith, Hon. Nick, a Representative in Congress from the State of
Michigan....................................................... 4
SUBMISSIONS FOR THE RECORD
Bond Market Association, statement............................... 58
Council for Government Reform, Arlington, VA, Charles G. Hardin,
statement...................................................... 61
Employee Benefit Research Institute, Kelly A. Olsen, statement
and attachments................................................ 62
Gray Panthers Project Fund, statement............................ 65
Made in the USA Foundation, Joel D. Joseph, statement............ 66
THE FUTURE OF SOCIAL SECURITY FOR THIS GENERATION AND THE NEXT:
PROPOSALS REGARDING PERSONAL ACCOUNTS
----------
WEDNESDAY, JUNE 3, 1998
House of Representatives,
Committee on Ways and Means,
Subcommittee on Social Security,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2 p.m., in
room B-318, Rayburn House Office Building, Hon. Jim Bunning
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON SOCIAL SECURITY
CONTACT: (202) 225-9263
FOR IMMEDIATE RELEASE
May 27, 1998
No. SS-17
Bunning Announces Tenth Hearing in
the Series on ``The Future of
Social Security for this
Generation and the Next''
Congressman Jim Bunning (R-KY), Chairman, Subcommittee on Social
Security of the Committee on Ways and Means, today announced that the
Subcommittee will hold a tenth hearing on ``The Future of Social
Security for this Generation and the Next.'' At this hearing, the
Subcommittee will examine proposals regarding personal accounts. The
hearing will take place on Wednesday, June 3, 1998, in room B-318 of
the Rayburn House Office Building, beginning at 2:00 p.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be taken from invited witnesses only.
Also, any individual or organization not scheduled for an oral
appearance may submit a written statement for consideration by the
Committee or for inclusion in the printed record of the hearing.
BACKGROUND:
With the increased public debate about the future solvency of
Social Security, the idea of allowing individuals to invest retirement
funds in private markets has received considerable interest once again.
Personal accounts are seen as a way to boost workers' savings to ensure
that benefits can be paid in the future.
The 1997 report of the Advisory Council on Social Security pursued
the idea of personal accounts with two detailed plans, which included
portable and privately-owned personal accounts as part of total Social
Security reform. Since that time, Members of Congress and the President
have become engaged in a public discussion about the merits of
integrating some form of personal investments into the current social
insurance model.
Personal accounts and private investment systems in a variety of
other nations, particularly those where return on investments has been
quite positive, have further heightened the public's interest in such
an approach for the United States. As part of the ongoing analysis of
the future of the program, the Subcommittee has previously heard from
representatives of several countries who have already begun personal
accounts or are in the process of doing so.
Since the Advisory Council Report, several private individuals and
organizations have authored detailed plans that recommend some sort of
personal accounts. These range from 401(k) type plans administered by a
central government organization to individual personal accounts similar
to an IRA. The Subcommittee will be seeking detailed information from
each sponsor regarding the specific workings of their personal account
proposal.
In announcing the hearing, Chairman Bunning stated: ``Since 1935,
Social Security has changed over the years to meet the needs of this
country. We must be careful, but we must challenge ourselves to think
creatively about how this vital program can work best for all
generations in the future. Members of the Advisory Council on Social
Security, Social Security experts, and both Republican and Democrat
Members of Congress are introducing proposals for Social Security
reform, which provide for personal accounts. I look forward to hearing
from a number of the authors of these plans on the specifics of how
these personal accounts would work.''
FOCUS OF THE HEARING:
The Subcommittee will receive the views of Social Security experts
on their proposals to create personal accounts. Members of the
Subcommittee would like to hear from each witness regarding their views
on: (1) how personal accounts would be administered, (2) how personal
accounts would be financed, (3) how personal accounts would be accessed
and dispersed, (4) what investment vehicles for the personal accounts
are appropriate, (5) how personal accounts would be integrated with
other private pensions and government benefits, and (6) how these
personal accounts would work within current tax law.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Wednesday,
June, 17, 1998 , to A.L. Singleton, Chief of Staff, Committee on Ways
and Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
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purpose to the Subcommittee on Social Security office, room B-316
Rayburn House Office Building, at least one hour before the hearing
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noted above.
Chairman Bunning. The Subcommittee will come to order if
all of our guests will come in and sit down.
Today marks our 10th hearing in the series on the Future of
Social Security for this Generation and the Next. The
Subcommittee will examine proposals regarding personal accounts
today. As Americans consider the future of Social Security, the
idea of allowing individuals to invest retirement funds in
private markets is receiving more and more attention.
From the Bipartisan Commission on Entitlement and Tax
Reform chaired by Senators Kerry and Danforth, to the 1994-96
Advisory Council on Social Security, to private individuals and
organizations, we continue to see detailed plans for Social
Security reform which includes personal accounts as a way to
boost workers' retirement security income.
These range from 401(k)-type plans administered by central
government organizations to individual personal accounts
similar to an IRA.
Today we will hear from a number of bold thinkers, the
authors of personal account proposals. We look forward to
learning more about their proposals and the specifics of how
these proposals and personal accounts would work.
In the interest of time, it is our practice to dispense
with opening statements except from the Democrat Ranking
Member.
I welcome all opening statements if you will submit them
for the record, and I will yield to Mr. Levin when he arrives
for any statement that he would make.
The first witness we have is my good friend from the State
of Michigan, Hon. Nick Smith.
STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF MICHIGAN
Mr. Smith. Mr. Chairman, bravo to you for holding hearings
on Social Security for the last 2 years. I introduced my first
bill when I came to Congress in 1993 and then in the next
session introduced my next bill which----
Chairman Bunning. Nick, would you hold for 1 second?
Please come in and shut the door so we don't hear the
hallway.
Thank you. Go ahead.
Mr. Smith. This Subcommittee and subsequently President
Clinton and Senator Moynihan, Senators Roth and Gramm, and
Congressman Porter and myself and others have introduced Social
Security legislation. It is probably one of the toughest issues
facing Congress, and I am excited that we are moving ahead with
the agenda.
I see, number one, that there is no easy way to fix Social
Security. There are three solutions. You can increase revenues
by improving the rate of return on contributions, you can
reduce benefits, or you can increase revenues by raising taxes.
Actually the tendency of Congress and the White House has
been to increase taxes. We have increased taxes 36 times since
1971, more often than once a year, and I would suggest that
maybe we should rule that out as our solution as we attempt to
reform and make sure that we keep Social Security solvent in
the future.
Because of changing demographics, the pay-as-you-go
system--Mr. Chairman, did you want me to stop for Mr. Levin?
Chairman Bunning. No.
Mr. Smith. It is becoming very evident that the changing
Social Security pay-as-you-go system is not working and that we
are going to have to consider alternatives.
In my written statement, I have a chart showing the return
for individuals that have paid in their Social Security taxes.
This chart shows that earlier retirees got as much as $60,000
more than they and their employers put in. However, anyone born
after 1940 is going to lose money and not get back on average
what they contribute.
The Tax Foundation estimates that anybody that retires
after 2005 will lose on average between \1/2\ and 1\1/2\
percent.
Another way of saying that, as my next chart shows, these
are the number of years that you will have to live after
retirement to break even and get back the contributions that
you and your employer put in. Namely as you can see 2005, 2015,
you are going to have to live 23-26 years after retirement
simply to break even.
So a solution that more and more of us are looking at is a
better return on that investment. My proposal gradually makes
changes in the retirement age and makes changes to slow the
increase in benefits for higher wage earners when they retire.
To assure that no one retires in poverty, I suggest that for
every $5 dollars earned from personal retirement investment
accounts the traditional benefit be reduced by $4 dollars.
In my proposal we start out at 2.5 percent out of the 12.4
percent Social Security taxes for personal investment and
gradually increase that over the next 60 years to roughly 10
percent.
The table that compares the investment in T-bills, bonds
and stocks is interesting. With inflation adjustments, a $100
investment in 1966 would return $447 in 1996 if invested in
stocks. Including the Depression years, from 1929-59, we see
that the return is negative for T-bills--you actually lost
money--and the return in stocks was $565, again adjusted for
inflation.
The promise of personal accounts is that they can
dramatically increase returns for workers, thereby improving
the living standards for retirees. If workers are allowed to
put even a portion of their Social Security contributions into
investment accounts, the long-run return on these accounts
should earn well above what Social Security payments would have
earned under existing law. But the challenge is to fund the
existing system that is now an estimated $4 to $7 trillion in
actuarial debt. To fund that system without huge transition
costs is the challenge that we face. To do this without
personal investments and increasing the rate of return on
Social Security taxes is going to be very difficult.
[The prepared statement follows:]
Statement of Hon. Nick Smith, a Representative in Congress from the
State of Michigan
Building a Solution to Keep Social Security Solvent
We will remember 1998 as the year that both major political
parties joined together to discuss ways to save one of the most
important federal programs: Social Security. President Clinton
opened the debate with the first Social Security town meeting
on April 8, 1998, in Kansas City. We have seen new reform
proposals from Senators Moynihan, Roth and Gramm.
Representatives Porter, Sanford, and I have submitted reform
bills, and other members of Congress plan to introduce their
recommendations later this year. As a vocal advocate of Social
Security reform since 1994, I am glad to see the issue get the
national prominence it deserves.
We are Learning About the Shortcomings of Pay-as-you-go
In 1935, the Social Security Act was enacted to provide a
government guarantee against poverty. Unfortunately, many
people believe that Social Security is backed by a trust fund
filled with the surpluses from years of Social Security tax
payments. Social Security was designed as a pay-as-you-go
system where current workers pay taxes to fund current
retirees' benefits. Since it was run as a pay-as-you-go system,
the Social Security trust fund has not accumulated large
surpluses. Trustees managed the system's cash flow to keep
approximately one year's benefit payments available. The
``surplus'' cash flow that Social Security is now experiencing
should be protected to help us meet the benefit commitments we
are making to current workers.
Changing demographics--longer life expectancies, lower
birth rates--have steeply increased the tax burden on current
workers to cover retirement benefits for current retirees.
Social Security is a losing proposition for most workers born
after 1940, as shown in Chart One.
[GRAPHIC] [TIFF OMITTED] T2485.003
There is No Easy Answer
The Social Security ``fix'' can only be accomplished in
three ways--
increase revenues by improving the rate of return
on contributions
reduce benefits
increase revenues by raising taxes
We are entering a period of bipartisan debate when we will
discuss the costs and benefits of solutions using some or all
of the above ``fixes.'' I have introduced my own proposal, The
Social Security Solvency Act of 1997, which brings the system
into balance without tax increases. If we raise taxes, we are
increasing the largest tax most American families pay. Almost
80% of families pay more in Social Security taxes than they pay
in income taxes. My bill slows the increase in benefits for
higher income seniors and allows individual workers to invest
some of their tax dollars in their own personal retirement
savings accounts.
Personal retirement accounts are becoming a feature of both
Republican and Democratic plans. A plan like the one proposed
in my Social Security Solvency Act uses higher returns from
investment savings to maintain or improve the monthly
retirement benefit without increasing taxes.
TABLE ONE: SMITH BILL (H.R. 3082), INVESTING PERSONAL ACCOUNT FUNDS IN
THE STOCK MARKET, COMPARED TO CURRENT LAW
------------------------------------------------------------------------
Current Smith
Law Plan
------------------------------------------------------------------------
At retirement, a 50-year-old worker could expect
Social Security............................... $1,828 $1,507
Personal Account.............................. 0 371
Total Benefit................................. $1,825 $1,878
At retirement, a 40-year-old worker could expect
Social Security............................... $2,128 $1,618
Personal Account.............................. 0 771
Total Benefit................................. $2,128 $2,389
------------------------------------------------------------------------
Estimated retirement benefit for a worker earning the national average
wage, calculated to show the inflation-adjusted retirement benefit.
The 50-year-old worker retires eighteen months later than current law,
and the 40-year-old worker retires in 2022 instead of 2019.
The promise of personal accounts is that they can
dramatically increase returns for workers, thereby improving
the living standards of future retirees. If workers are allowed
to put even a portion of their Social Security contributions
into investment accounts, the long-run return that these
accounts should earn will keep the monthly retirement benefit
in the range of what current recipients get. This can been seen
by comparing projected benefits for a hybrid Social Security/
personal account plan like the Social Security Solvency Act of
1997 to current law Social Security benefits (Table One).
Retirement Security Depends on Having a Long-term Strategy
Retirement income has three major sources: Social Security,
private pension and profit-sharing plans, and personal savings.
While we are working to save Social Security, we must also
create incentives to encourage saving and educate all workers
on the importance of planning for retirement.
Stocks should be the investment of choice for anyone trying
to build a secure retirement. Chart Two shows that, even for
those who bought stocks just before the crash of 1929,
investors who follow a ``buy and hold'' stock strategy are
better off in the long run. An investor who put $100 in the
stock market in August 1929 and left it there would have found
that his investment had grown to $565 by August 1959, before
inflation. A similar $100 put into bonds and T-bills would have
been worth $141 and $79, respectively.
[GRAPHIC] [TIFF OMITTED] T2485.004
These investment returns are not the result of complicated
trading strategies that require advanced financial training.
Today's investor can achieve these returns by purchasing shares
of a diversified stock mutual fund.
IRAs and 401(k) Plans have Successfully Encouraged Retirement
Saving
The Social Security Trust Fund has a balance of
approximately $650 billion. By comparison, private retirement
plan and IRA balances topped $5 trillion in the beginning of
1998. Obviously, workers and companies have been saving for
retirement in many ways.
The Employee Benefit Research Institute conducts an annual
Retirement Confidence Survey. In 1997, survey results showed
that 69% of workers have started saving for retirement, many of
them using 401(k) plans and IRAs. Working Americans are gaining
first-hand experience, proving that regular savings invested in
even conservatively managed mutual funds significantly increase
in value over time. Social Security reform can build on this
foundation of personal saving and investment.
A recent study presented to the 1998 Pension Research
Council shows that 401(k) plans are being readily accepted by
workers who have the opportunity to join. In almost all income
classes, participation rates increase as workers grow older
(Chart Three).
Participation in a 401(k) plan has given some workers their
first exposure to the stock market. Many have watched their
401(k) balances grow rapidly during the bull market of the
1990s. Across all age and income categories, 401(k) investors
are learning about investment strategies. Statistical studies,
which are summarized in Chart Four, indicate that they are
developing portfolios that include both stocks and bonds.
The experience gained in private investing for 401(k) plans
and IRAs is a great start, but workers, especially those who
are not retiring for twenty to thirty years, must learn about
the benefits of long-term stock investing. This knowledge will
yield real cash dividends to them when it is their turn to
retire.
Immediate Action is Needed
We must find solutions to Social Security's $4 trillion
unfunded liability right away. Personal accounts are becoming
an accepted part of reform proposals. I have introduced H.R.
3560, legislation that would provide for a pilot program for
private accounts. This would give us an opportunity to see the
concept of private accounts in action, and to use real-world
experience to design a Social Security system for the 21st
century.
[GRAPHIC] [TIFF OMITTED] T2485.005
[GRAPHIC] [TIFF OMITTED] T2485.006
The Social Security Solvency Act of 1997
H.R. 3082
No Tax Increase
Establishes Personal Retirement Savings Accounts.
Individual savings accounts (PRSAs) will accumulate
considerable sums resulting in higher retirement benefits. The
surpluses coming into the trust fund allow private investments
(PRSAs) to start at 2.5% of payroll and increase to 10.2%
percent of payroll in the year 2070.
Social Security will have sufficient funds to
honor all retirement benefit commitments as it transitions from
pay-as-you-go to private savings accounts
Gradually reduces the increase in benefits for
high income retirees
Allows private investment account withdrawals at
age 59\1/2\
Increases retirement age two additional years over
fifteen years, then indexes the retirement age to life
expectancy
Balances the Social Security System for the next
75 years
Newly hired State and local government employees
join Social Security
Couples receive a minimum of 133% of higher
benefit, and widows/widowers receive minimum 110% of married
benefit payment
Social Security Solvency Pilot Program Act of 1998
H.R. 3560
Pilot demonstrations will
provide testing of the feasibility and popularity
of worker-owned accounts; and
reduce accrued liabilities of the Social Security
trust fund.
be implemented with no reduction in payroll tax
receipts by Social Security Administration;
require no new compliance measures for employers.
Chairman Bunning. Thank you, Nick.
I am going to allow, Sandy, if you want to make an opening
statement.
Mr. Levin. I'm sorry, I missed part of your presentation.
Mr. Smith. I won't miss yours.
Mr. Levin. But we have discussed this before, right.
Anyway, we are glad you are here.
Mr. Chairman, today the Subcommittee will take testimony on
proposals to create individual Social Security accounts as part
of Social Security reform. A variety of approaches have been
suggested for such accounts. Some offer add-ons to current
Social Security benefits while others divert a portion of
current Social Security revenues into individual investments.
These approaches have very different results for each
generation of workers and for different types of workers within
each generation. The demographic changes we face in the next
century demand that we give serious attention to proposals that
will ensure the future of Social Security.
It is important therefore that we examine carefully the
impact of each of these proposals. We must determine what a
shift from a defined benefit program to a defined contribution
program would mean for beneficiaries. Would individual accounts
provide an adequate retirement income for all people regardless
of work level or work history? Will low-wage workers and women
with intermittent work histories be worse off?
We need to ask how the risk involved in individual accounts
which rely on stock market investments would impact
beneficiaries, and we need to inquire about the costs of
implementing and administering a system of individual accounts.
Today's hearing will provide us an opportunity to hear from
authors of several of these proposals as well as from experts
who have studied the impact of privatizing Social Security.
Chairman Bunning. Thank you.
Let me start out. In describing your Social Security
Solvency Act, how do you propose to guarantee all of the
benefits of the current system by taking out certain moneys to
invest in private accounts? What kind of a transition period do
you have or propose to have?
Mr. Smith. Increasing the age limit by an additional 2
years takes place gradually over 17 years.
Chairman Bunning. Starting?
Mr. Smith. We started in the year 2000. We also have a
gradual change in reducing the increase in benefits for the
high-income wage earners when they retire.
Chairman Bunning. Means test?
Mr. Smith. You could consider it more progressive rather
than means testing. As we change the bend points, we add a
fourth bend point and so once you get over a $3,400 average
monthly earning as an average throughout several of the earlier
years, we add an additional bend point of 5 percent which makes
it more progressive or has the effect of slowing down the
increase in benefits for higher income retirees.
Chairman Bunning. Do you take the high-income retirees as
they go up and not allow them to pay as much into the system?
Mr. Smith. No, but the offset would be the private
investment accounts with the higher earnings and therefore the
2.5 percent, as that percentage goes up, is a greater dollar
amount for their high-wage earners. So the offset in increased
earnings, because of the increased personal/private investment
accounts, would more than compensate for their reduced benefits
on the fixed portion of the Social Security provisions.
Chairman Bunning. The last question. Why do you allow a
differential in age as far as retirement from the private
account or personal investment account than you do at the
Social Security account?
Mr. Smith. Well, it is our position that any time an
individual can guarantee other taxpayers that they are not
going to be a burden on those taxpayers in their old age by
having the kind of annuity that can guarantee retirement income
greater than or equal to their benefits under the traditional
Social Security system, they should be allowed to retire. As
soon as they can accommodate that kind of an annuity or
guarantee, I feel that they should be allowed to retire even if
at an earlier age.
I think it is interesting, Mr. Chairman, when the
Subcommittee has a chance to look at my statement, that we are
already seeing that 69 percent of the workers in the United
States are investing money in stocks, bonds, mutual funds----
Chairman Bunning. Or having it invested for them?
Mr. Smith. That is correct, with some options, whether
thrift savings or 401(k)s or IRAs. A larger and larger
percentage of our population is experiencing the creation of
wealth through investment.
Chairman Bunning. Thank you.
Mr. Levin. We have talked about this before, but let me
zero in on one aspect, and there are many, but raising the age
of retirement--and a panel is coming after you and we will ask
them that, which is the whole purpose of this year of dialog.
This Subcommittee under Chairman Bunning has held a lot of
hearings as part of this effort to bring the dialog to the
country and the countryside.
Talking about the country and the countryside, as you know,
there is a lot of resistance, the surveys all show it, to
raising the retirement age, and yours is a fairly steep
increase.
Do you think that resistance is irrational? Why is there
resistance?
Mr. Smith. I think there are a lot of people who would like
to retire earlier, and that is why I do provide that they can
retire as early as age 59, or maybe even as soon as they can
have the kind of annuity that is going to guarantee other
taxpayers that they are never going to be a burden on those
taxpayers.
But I think rather than calling it the retirement age, it
is more appropriate to say that we are increasing the age for
eligibility for the fixed benefits: A person can retire
whenever they want to if they have enough accumulation in
private investments. And if we are averagely fortunate, even in
a 7-percent real return on those investments, then there is
going to be substantially more money to accommodate earlier
retirement rather than a later retirement.
I add an additional 2 years where Senator Moynihan and
others have suggested we go up 3 years to age 70.
Mr. Levin. So it is 2 years.
Mr. Smith. So mine goes to 69.
Mr. Levin. And you build in an increase?
Mr. Smith. Depending on the longevity statistics, it would
increase over the years.
Mr. Levin. But my guess is if you in an objective way asked
people who are now between, say, 40 and 60 whether they would
favor that kind of a system, with the qualifications that you
mentioned, there would still be a lot of resistance to it?
Mr. Smith. I think so.
Mr. Levin. Why do you think so?
Mr. Smith. I think people would prefer not to have
politicians in Washington telling them when they can retire. I
think it is important that you allow the flexibility of
personal retirement accounts. And I would just----
Mr. Levin. What about the influence of return on
investments which may or may not happen? They may be retiring
or reaching 60, 62, or 65 after a downturn, which will come at
some point.
Mr. Smith. First the existing system is a very high risk.
It is going broke. I think for the record, Congressman Levin,
when we started this pay-as-you-go system in 1935, the average
age of death was a little over 61 years old.
Now, at birth, the average age for a female is 76, for a
male is 74. If you reach retirement age, you are going to live
another 19 years on average. Because of the tremendous medical
system and because we are taking better care of ourselves, our
lifespan has significantly expanded.
And as we look at converting a pay-as-you-go system which
can't sustain itself with the demographics that we are now
experiencing, I think it is important that you look at
alternatives.
Increasing the age is a suggestion which has been
consistent in almost all proposals.
Mr. Levin. I think we ought to look at alternatives. We do
need to look at the downsides as well as the arguments for it
and understand the resistance. As we have held forums and
talked to people, let me mention a couple of reasons for the
resistance. It is true that people are living considerably
longer than when Social Security started. It also means that
there are many more couples who survive 65, and that is having
a dramatic effect on people's attitudes. It is not even in most
cases the woman who survives but the couple, and they want to
spend time together.
Second, and this has been pointed out to me and I know it
from my own experience, children are marrying later and people
are having grandchildren later and I think that is a
demographic fact.
So as we look at suggestions to change the age, I think we
have to look at all of the human and personal dimensions.
The red light is on and so I will stop with that. Thank
you, Mr. Chairman.
Chairman Bunning. Mr. Johnson.
Mr. Johnson. Mr. Levin, I agree with you.
Mr. Levin. That is because we are both grandparents.
Mr. Johnson. That is right.
I want to pursue that same idea, Nick. You rejected the
idea of raising taxes to cover the cost of transition and yet
you picked up on raising the age limit for retirement or for
when they can take advantage of the Social Security system.
Can you explain why you came up with that solution?
Mr. Smith. Well, I guess, number one, it helps accommodate
some of the transition considerations. We tried to offset the
increase in eligibility age for fixed benefits with a reduced
age for when a person can retire and start collecting their
personal investment savings. Eventually the personal investment
savings are going to be the major part of that person's
retirement under the Social Security system.
I think probably it is one of the more objectionable areas,
but it seems to me that we have got to keep everything on the
table as we look at filling the $4 trillion hole of actuarial
debt to keep Social Security solvent.
Mr. Johnson. But are you foreclosing the retired person
from Social Security at all and forcing him into strictly
private accumulation?
Mr. Smith. No, we are keeping it as an option, but
hopefully the private accumulation is going to eventually be
much greater than even Social Security under current law. And
even if we have to find some way to continue funding that
Social Security system with fewer and fewer workers in relation
to the number of retirees, economists recommend some private
investment.
Mr. Johnson. I don't disagree that we shouldn't change the
system, but the age idea, there are some companies that force
people out at a certain age. Airline pilots can't fly if they
are 60. So if you get into some business environment where they
either fire you or politely ask you to leave because you are
too old, you are saying that you can't have Social Security
because we are going to protect the system; is that right?
Mr. Smith. Everything is a tradeoff and age discrimination
is only legal if it is safety related.
Mr. Johnson. It is a tradeoff for the elderly. You are
penalizing the elderly. There are not very much over 65 on this
Subcommittee, and I think Levin and I might be the only two.
Mr. Smith. The question is what are the alternatives to
come up with $4 trillion, the $3 or $4 trillion that is
necessary to keep this system solvent.
One area that I ruled out is increasing taxes. Now almost
80 percent of working families pay more in Social Security
taxes than they do in income taxes. So it would be offensive to
increase taxes to me.
Mr. Johnson. I agree. Thank you, Mr. Chairman.
Chairman Bunning. Mr. Christensen.
Mr. Christensen. Thank you, Mr. Chairman.
Nick, have you looked at the effects of all of this new
money into the market and what kind of a positive or negative
effect it might have on job creation, on the economy, on
inflation? And then also how does your plan address who would
be the stock pickers or how would you go about picking the
firms choosing the investments, or would it be totally open to
the market?
Mr. Smith. We looked at the thrift savings guides, and in
our bill we incorporated indexed stocks, indexed bonds, indexed
cap funds and indexed global funds and any other safe
investment determined by the Secretary of Treasury. So we tried
to limit the investment options and that was simply because of
the undue concern that maybe individuals weren't capable of
investing their own money, and so we started out with safe
investments as an option in our proposal.
And what was the first question?
Mr. Christensen. The effects on the economy.
Mr. Smith. In terms of increasing savings and investment,
this kind of proposal would increase savings and investment.
A second bill that I have introduced takes the unified
budget surplus, takes some of that money and starts these
personal retirement savings accounts, not reducing or taking
from Social Security but rather starting these accounts from
using some of the budget surplus that is expected this year.
Mr. Christensen. Do you have any ideas what kind of effect
on the market this new money would have?
Mr. Smith. Increasing savings and investment is generally
going to have a positive effect on the economy.
Mr. Christensen. Thank you, Mr. Chairman.
Chairman Bunning. Mr. Collins.
Mr. Collins. No questions.
Chairman Bunning. Mr. Hulshof.
Mr. Hulshof. No questions.
Chairman Bunning. Thank you, Mr. Smith.
If the next panel would step forward. Dr. Laurence
Kotlikoff, professor of economics from Boston University; and
Research Associate, National Bureau of Economic Research.
Hon. Edward Gramlich, member of the Board of Governors of
the Federal Reserve System and Chair of the 1994-96 Advisory
Council on Social Security.
Dr. Alicia Munnell, Peter F. Drucker Professor of
Management Sciences, Boston College Carroll School of
Management.
Hon. Robert Ball, founding Chair of the National Academy of
Social Insurance and member of the 1994-96 Advisory Council on
Social Security and former Commissioner of Social Security.
Hon. Fred Goldberg, executive director of the Bipartisan
Commission on Entitlement and Tax Reform, member of the
National Commission on Retirement Policy Center for Strategic
and International Studies, former Commissioner of the Internal
Revenue Service and former Assistant Secretary for Tax Policy
of the U.S. Department of the Treasury.
Wow, that is a mouthful.
Dr. Kotlikoff.
STATEMENT OF LAURENCE J. KOTLIKOFF, PH.D., PROFESSOR OF
ECONOMICS, BOSTON UNIVERSITY
Mr. Kotlikoff. Chairman Bunning and other distinguished
Members of the Subcommittee on Social Security, I am honored by
this opportunity to discuss with you fundamental reform of the
Social Security system. I have written testimony I would like
to submit for the record. Let me summarize it.
Chairman Bunning. Without objection we will put the whole
thing in.
Mr. Kotlikoff. Let me summarize the testimony with the
following points.
First of all, the Social Security system is in much worse
long-term financial shape than the Trustees are publicly
acknowledging. The financial shape is at least twice as bad as
is being publicly disclosed in the Trustees' Report. They are
using a truncated projection horizon. Specifically, they are
only looking at 75 years in thinking about the system's long-
term finances.
On that basis you need a 2.2 percent of payroll tax rate
increase in order to pay for benefits over the next 75 years.
If you don't truncate the projection horizon, you need a 4.7-
percent payroll tax hike. That is about a nickel on every
dollar that we earn, and this number is coming from Steve Goss
who is the Deputy Chief Actuary of the Social Security
Administration. So it is not my number.
You might say, well, looking at 75 years is long enough,
but we are now 15 years beyond the 1983 reform that occurred
back under the Greenspan Commission, and a large part of our
current problem has to do with the fact that we didn't look
long term enough in 1983. Since 1983, we have added 15 years of
those outyear deficits to our current 75-year projection
horizon.
So I want to point out that the long-run problem of Social
Security in terms of its financing is at least twice as big as
is currently being made public. And I say ``at least as''
because I think the actuaries are using overly optimistic
demographic and economic assumptions in their projections. I
think we really need something like a 6-cent-on-the-dollar tax
hike right now to pay Social Security benefits on a long-range
basis. I am not proposing that, I am saying that the problem is
much, much deeper and bigger than we are publicly discussing.
The second point I wanted to make is that, even under
current law--without any new tax hikes or benefit cuts--the
baby boom generation and their kids are getting treated very
badly by the program. On average, about 74 cents on every
dollar that they pay in contributions represents a tax. For the
oldest baby boomers it is about 55 cents on the dollar. For
today's kids, of every dollar being paid as a contribution, 81
cents represents a tax. So we already have a system which is
basically just taxing people at a very high level. If we
continue on with the same procedure that we have been following
for the last 50 years of basically--allowing taxes to go up to
deal with these benefit problems--we are going to end up with
at least a 20-percent Social Security payroll tax, plus
probably a 10-percent Medicare tax. Thus, we will probably have
a 30-percent payroll tax in 20 or 30 years which is going to be
devastating to our economy and our kids.
Let me propose an alternative to that scenario--a proposal
for Social Security reform that I have developed together with
Jeffrey Sachs who is a professor at Harvard. Our proposal has
been endorsed by 65 leading academic economists around the
country including 3 Nobel prize winners.
It is called the personal security system and it has seven
points. I think they deal with many of the legitimate concerns
that Members of Congress have raised about privatizing Social
Security.
First of all, the proposal reforms just the retirement
portion of Social Security; it leaves the disability and
survivor portions alone.
The moneys workers now contribute to Social Security's
retirement (OAI) program, would now be contributed to a private
account. There is also contribution sharing--if you are
married, half of your contribution goes into your account, and
half goes into your spouse's account. So we are protecting
spouses who may not be in the workplace. The government
provides a matching contribution on a progressive basis, so we
have progressivity in this proposal.
The account balances are invested in a single security. It
is a global index fund of stocks, bonds, and real estate. And
by investing in a single security, you ensure that nobody can
time the market, that everybody gets the same rate of return on
her contributions, and that everybody is fully diversified.
Between ages 60 and 70 each cohort's account balances are
gradually transformed into inflation protected pensions, so you
have collective annuitization of the account balances. None of
the other reform proposals that I have seen actually do this,
and this is extremely important because the insurance market
does not function very well in the United States in the case of
private annuities.
Finally, we have recognized the fact that you have to pay
the benefits of the current retirees under the old system, and
you have to pay the benefits the current workers have accrued
under the old system when they hit retirement. So we give
workers their accrued benefits when they hit retirement. We
give them what they have accumulated, and we use a business
cash flow tax to pay off those benefits over time.
However, we actually have a real mechanism for paying off
the unfunded liabilities of the existing system, and we are
very honest about the fact that we have a major fiscal problem
here. We have to get everybody on board to pay off this
liability, and that is what this business cash flow tax
achieves. Thank you.
[The prepared statement follows:]
Statement of Laurence J. Kotlikoff, Ph.D., Professor of Economics,
Boston University
Chairman Bunning and other distinguished members of the
Committee on Ways and Means, Subcommittee on Social Security,
I'm honored by this opportunity to discuss with you fundamental
reform of the U.S. Social Security reform.
Social Security's Options--Real Reform or Real Financial Distress
The U.S. Social Security System is in desperate need of
reform. The system faces a long-term fiscal crisis that is
roughly twice as bad as our government is publicly admitting.
Continuing to pay Social Security benefits on an ongoing basis
requires taxing workers another nickel out of every dollar they
earn--starting now. For those born in the postwar period,
Social Security already represents, on balance, a bad deal.
Raising taxes or cutting benefits by the amount needed to keep
the program solvent will turn a bad deal into an awful one.
Many of the same politicians and bureaucrats who under-
reformed the system is 1977 and again in 1983 and, thereby,
delivered us into our current mess now claim to have the
answer: ``Raise Social Security's retirement age, means-test
Social Security benefits, increase the income taxation of
Social Security benefits, change the benefit formula, bring
uncovered state workers into the system, raise taxes a bit now
and more later, invest the trust fund in the stock market, and
partially privatize the system by compelling workers to
contribute 1 to 2 percent of their wages to private accounts.''
This combination of piecemeal policies is, unfortunately,
the likely outcome of our national ``conversation'' about
Social Security. Their adoption will, almost surely, deliver
less than half of what is needed on the fiscal side and turn
Social Security's privatization into a costly fiasco.
The real way to reform Social Security is to privatize
fully its retirement program and require everyone who can to
contribute to paying off the liabilities of that program.
Anything short of full privatization, with full payment of the
transition costs, will leave us having another ``conversation''
15 years from now, but facing even worse options than those we
currently face.
This article presents a plan for fully privatizing the
retirement portion of Social Security. The plan was developed
by myself and Professor Jeffrey Sachs of Harvard University. It
has been endorsed by 65 leading academic economists, including
three Nobel Laureates. The plan is simple enough to describe on
a single page. It protects existing retirees, women, and the
poor, has very low administrative costs, requires full
portfolio diversification of account balances, forces
contributors to invest for the long-term, transforms
accumulated account balances into inflation-protected pensions
at retirement, and fully pays off the liabilities of the old
system in a manner that is generationally equitable.
Before describing the plan, I discuss Social Security's
long-term finances as well as its treatment of postwar
Americans. Knowledge of both these issues is critical for
judging whether or not Social Security should be privatized.
Social Security's Long-term Fiscal Crisis
According to the intermediate projection of the Social
Security Trustees, paying promised benefits over the next 75
years requires an immediate and permanent 2.2 percentage point
increase in the program's current 12.4 percentage point tax
rate. Fixing Social Security for 75 years is not, however,
fixing it for good. Each year that passes brings into the
current 75-year planning horizon a year that wasn't there
before. For example, we are currently 15 years beyond the 75-
year planning horizon that the Greenspan Commission considered
back in 1983. Recall that the Greenspan Commission was charged
with the job of solving Social Security's financial problems
once and for all. The mistakes underlying their failure should
not be repeated. These mistakes go beyond using too short a
planning horizon. They also include using economic and
demographic assumptions that were far too optimistic.
Unfortunately, when the Social Security actuaries look
beyond 75 years they see enormous deficits. These deficits are
so large that paying Social Security benefits on an ongoing,
rather than simply a 75-year, basis requires an immediate and
permanent 4.7 percentage-point tax hike! This unpublished
estimate comes from Steven Goss--the highly respected Deputy
Chief Actuary of the Social Security Administration. Goss is
also responsible for developing the 2.2 percentage point 75-
year tax hike estimate.
The 4.7 percentage-point tax hike needed for true long-term
solvency is, of course, more than twice the 2.2 percentage-
point being announced by the Trustees in their Trustees Report.
The Trustees' failure to allow Goss and his colleagues to
publish the tax hike needed for true long-term solvency
represents an incredible dereliction of duty and one that
merits Congressional attention.
Unfortunately, a 4.7 percentage-point tax hike is not the
limit of the tax hike we're likely to face. For starters, if
the 4.7 percentage-point tax hike is not imposed immediately
and if one assumes that all benefits will be fully paid, the
payroll tax rate will have to be raised by more than 4.7
percentage points when the tax hike is finally implemented.
Moreover the required 4.7 percentage-point tax hike is
calculated based on what appear to be overly optimistic
``intermediate'' assumptions concerning lifespan extension and
real wage growth. Top demographers, like Professor Ron Lee of
the University of California at Berkeley, believe lifespan will
grow by about 10 years over the next 75 years--roughly twice
the increase being projected by the Trustees in their
intermediate forecast. In the case of real wage growth, the
intermediate forecast assumes that real wages will grow in the
future at .9 percent per year--over twice the rate they've
grown since 1975.
The historic use of a truncated planning horizon and overly
optimistic ``intermediate'' demographic and economic
assumptions is responsible for about two thirds of the current
long-term imbalance in the program. The remaining third appears
to reflect technical mistakes that the actuaries uncovered in
their forecasting methodology. In this regard it's worth
pointing out that the actuaries are using what they themselves
view to be a rather crude method for projecting long-term
benefits and taxes. Their method is crude because it is based
on aggregate relationships rather than a microsimulation model
that tracks the benefits received and taxes paid of
individuals. Although the actuaries are currently actively
involved in evaluating existing microsimulation models and
developing one of their own, it will be several years until
more reliable, micro-based projections become available.
Based on the current projection methodology, the
incorporation of more realistic mortality and real wage growth
assumptions raises the tax hike needed for long-run solvency
from 4.7 percentage points to over 6 percentage points. Since
the Social Security payroll tax rate is now 12.4 percent, such
a tax rise would leave Americans workers paying close to a
fifth of their wages to the System. Medicare faces an even more
sever long-run funding problem. In combination, the two
programs could eventuate in payroll tax rates of 30 percent or
more. Payroll tax rates of this magnitude in conjunction with
the rest of the U.S. tax structure and the need to pay interest
on our large stock of official debt would have a highly
detrimental impact on the U.S. economy.
The alternatives to imposing dramatically higher Social
Security taxes is either dramatically cutting Social Security
benefits or privatizing the existing system. In contemplating
these alternatives, it's important to understand just how badly
the system, based on the current levels of taxes and benefits,
is treating Americans born since 1945.
Social Security's Treatment of Postwar Americans
In a recent study, I, together with five colleagues, used a
highly detailed micro simulation model to examine how Social
Security is treating postwar Americans.\1\ In addition to
considering the treatment of different postwar cohorts, the
study compares the treatment of different types of individuals
within each of these cohorts.
---------------------------------------------------------------------------
\1\ See Caldwell, Steven, Melissa Favreault, Alla Gantman,
Jagadeesh Gokhale, Thomas Johnson, and Laurence J. Kotlikoff, ``Social
Security's Treatment of Postwar Americans,'' forthcoming in Tax Policy
and the Economy, NBER volume, MIT Press, 1999.
---------------------------------------------------------------------------
The study using two tools: CORSIM--a dynamic micro
simulation model--and SOCSIM--a detailed Social Security
benefit calculator. CORSIM generates a representative sample of
lifetime earnings and demographic trajectories for Americans
born or to be born between 1945 and 2000. SOCSIM determines the
Old Age Insurance and Survivor (OASI) benefits and taxes
received and paid by the CORSIM sample. These benefits and
taxes are then used to a) compute the lifetime net benefits
(benefits less taxes) paid to different cohorts and subgroups
within cohorts of the baby boomers and their children,
calculate the rate of return different cohorts and groups
within cohorts are implicitly earning on their contributions to
the current systemt, and c) consider the extent to which the
OASI system pools risk across cohort members by reducing the
variance of lifetime income.
CORSIM starts with a representative sample of Americans
alive in 1960. It then ``grows'' this sample demographically
and economically. Specifically, it ages, marries, divorces,
fertilizes, educates, employs, unemploys, re-employs, retires,
and kills original sample members and their descendants over
the period 1960 through 2090.
SOCSIM uses completed lifetime demographic and economic
experiences to determine OASI retirement, spousal, widow(er),
mother, father, children, and divorcee benefits as well as OASI
taxes. It does so taking into account Social Security's
earnings test, family benefit maxima, actuarial reductions and
increases, benefit recomputation, eligibility rules, the
ceiling on taxable earnings, and legislated changes in normal
retirement ages.
The Study's Findings
This study's findings, culled from its executive summary,
are indicated below:
Social Security represents a bad deal for postwar
Americans. Moreover, the deal has gotten worse over time. Baby
boomers are projected to lose roughly 5 cents of every dollar
they earn to the OASI program in taxes net of benefits.
Generation X'ers and today's children will lose over 7 cents of
every dollar they earn in net taxes.
These losses assume no adjustment to Social Security's
taxes or benefits. But, as indicated above, major adjustments
are inevitable unless the system is privatized. If OASI taxes
are raised immediately by the amount needed to pay for OASI
benefits on an ongoing basis, baby boomers will forfeit 6 cents
of every dollar they earn in net OASI taxes. Those born after
the baby boom will forfeit 10 cents of every dollar they earn.
Measured as a proportion of their lifetime labor incomes,
the middle class are the biggest losers from Social Security,
but measured in absolute dollars, the rich lose the most. On
average, postwar middle-class workers pay 8 cents per dollar
earned to OASI in net taxes compared with 5 cents for the
lowest paid workers and 3 cents for the highest paid workers.
But in absolute terms, today's highest earners pay roughly $1
million measured as of age 65, compared to $400,000 for today's
middle-class workers, and $50,000 for today's lowest earners.
As an average, out of every dollar that postwar Americans
contribute to the OASI system, 74 cents represent a pure tax.
The pure-tax component of each dollar contributed is 55 cents
for the oldest baby boomers and 81 cents for today's newborns.
The degree of pure OASI taxation is less than 50 cents on the
dollar for very low lifetime earners and greater than 80 cents
on the dollar for very high lifetime earners.
Men pay about 1 percent more of their lifetime earnings to
OASI in net taxes than do women. The higher male net tax rates
obtain even controlling for lifetime earnings. They reflect
shorter male life expectancy and less frequent receipt of OASI
dependant and survivor benefits.
Non whites, because of their shorter life expectancies,
face slightly higher (about a third of a percentage point)
lifetime OASI net tax rates than do whites. This is
particularly true at lower levels of lifetime earnings.
College-educated workers face somewhat lower (about two
thirds of a percentage point) lifetime OASI net tax rates than
non college-educated workers, but this difference disappear
once one controls for lifetime earnings.
One rationale for the OASI program is that it pools
earnings, lifespan, and longevity risks through the
progressivity of its benefit schedule as well as through its
provision of dependant and survivor benefits. The data support
this view. Across all postwar cohorts, the OASI program reduces
the variance of lifetime income by 11 percent. Within each
cohort, OASI reduces lifetime income variance by between 6 and
10 percent.
The internal rate of return earned by postwar cohorts on
their social security contributions is very low. It's also
falling. Those born right after World War II will earn, on
average, a 2.4 percent real rate of return. Those born in the
early 1970s will average about a 1 percent real rate of return,
and those born at the end of this decade will average
essentially a zero rate of return. These internal rates of
return would be lower still if one factored in either the
massive tax increases or benefit cuts needed to restore Social
Security to long-run solvency.
Privatizing Social Security
As described above, the U.S. Social Security System is
badly broke and is treating the vast majority of its current
contributors very badly. Privatization is far from a painless
panacea, but it does represent an opportunity to resolve, once
and for all, most of the System's financial woes and to
rationalize a program that is intragenerationally as well as
intergenerationally highly inequitable, replete with
inefficiencies and economic distortions, and extraordinarily
uninformative about the benefits it is providing in exchange
for its mandatory contributions.
Once one decides that privatization is worth doing, the
next question to consider is whether one wants to fully or
partially privatize the system. As suggested, partial
privatization will leave the non privatized portion of the
system vulnerable to periodic financial half-measures that
condemn the system to ongoing financial difficulties. Equally
important, partial privatization will leave us with two basic
retirement systems with all the extra administrative costs that
entails. Finally, partial privatization will eventuate in a
large number of extremely small retirement accounts--namely
those of society's lowest earners. The fixed transactions costs
of transmitting and recording contributions to these accounts,
sending annual reports to the owners of these accounts, and
disbursing payments could wipe out much of the return these
accounts could be expected to earn. In short, if privatizing a
dollar of the retirement portion of Social Security makes
sense, privatizing all of it makes much more sense.
The Personal Security System \2\
The Personal Security System (PSS) fully privatizes the
retirement portion of Social Security. The plan has the
following seven provisions:
---------------------------------------------------------------------------
\2\ This version of the Personal Security System plan differs in
two details from the original version that was endorsed by Sachs and
the other academic economists. Rather than calling for just a
diversified portfolio, it insists that all account balances be invested
in a single security--the market-weighted global index fund of stocks,
bonds, and real estate. It also calls for financing the transition with
a business cash flow tax rather than a retail sales tax.
---------------------------------------------------------------------------
Social Security's Old Age Insurance (OAI) payroll tax is
eliminated and replaced with equivalent compulsory
contributions to PSS accounts.
Workers' PSS contributions are shared 50-50 with their
spouses.
The government matches PSS contributions on a progressive
basis.
PSS balances are invested in a single market-weighted,
global index fund of stocks, bonds, and real estate.
Current retirees and current workers receive their full
accrued Social Security retirement benefits.
Between ages 60 and 70, PSS balances are annuitized on a
cohort-specific and inflation-protected basis.
A federal business cash-flow tax finances Social Security
retirement benefits during the transition as well as the
ongoing progressive government matching of PSS contributions.
Scope of the Proposal
The PSS plan leaves unchanged the contributions paid to and
benefits received from the disability and survivor insurance
portions of Social Security.\3\ Only those contributions
currently being made to the OAI portion of Social Security
(about 70 percent of total OASDI contributions) are eliminated
and replaced with mandatory contributions of equal size to PSS
accounts.
---------------------------------------------------------------------------
\3\ These programs also need to be reformed to hold their costs to
the levels of their tax receipts. Whether privatization of these
programs is the best method to achieve this objective is, however, a
subject for another paper.
---------------------------------------------------------------------------
Earnings Sharing
To protect non-working spouses as well as spouses who are
secondary earners, total PSS contributions made by married
couples are split 50-50 between the husband and wife before
being deposited in their own PSS accounts. Although this
provision is gender neutral, it is much more important for
women than for men since women remain the major caregivers for
young children and have, as a result, less time to spend in
formal work.
Government Matching of PSS Contributions
The federal government would match PSS contributions of
low-income contributors on a progressive basis. It would also
make PSS contributions through age 65 on behalf of disabled
workers.
Tax Treatment of PSS Accounts
PSS contributions are subject to the same tax treatment as
current 401k accounts. Contributions are deductible and
withdraws are taxable.
Investment of PSS Account Balances
All PSS balances are invested in a single, market-weighted
global index fund of stocks, bonds, and real estate.
Participants would purchase this security from (set up their
accounts with) their preferred financial institution. Although
participants could choose the financial institution in which
they wanted to hold their global index fund, they couldn't sell
it off to purchase other securities. Forcing everyone to hold
this and only this asset would ensure maximum portfolio
diversification and guarantee all participants the same rate of
return on their PSS contributions. It would also prevent people
from playing the market; i.e., they would be forced to invest
for the long term.
Annuitization of PSS Account Balances
Between ages 60 and 70, participants in each birth cohort
would have their PSS balances converted into inflation-
protected pensions that continued until they died. This
conversion would be organized by the government through
competitive bidding by the insurance industry. The insurance
company winning the bid to annuitize a cohort's PSS account
balances would provide each PSS participant an inflation-
protected pension in proportion to his or her account balance,
where the factor of proportionality would be the same for all
participants; i.e., all participants would become annuitized on
identical terms so there would be no cherry picking by the
insurance industry. The insurance company winning the bid for a
particular birth cohort would sell off a portion of the
cohort's PSS global index fund holdings each day as the cohort
aged between 60 and 70. This would average out the risk of
annuitizing PSS account balances when financial markets are
temporally depressed. In being forced to bid for the right to
annuitize a cohort's PSS account balances, the insurance
industry will end up providing this service at the lowest
possible price.
Survivor Provisions of PSS Accounts
If contributors die prior to age 70, any non annuitized
portion of their PSS accounts balances is bequeathable to their
heirs.
Payment of Social Security Retirement Benefits to Current Retirees and
Current Workers
Current recipients of Social Security retirement benefits
continue to receive their full inflation-indexed benefits. When
they reach retirement, workers receive the full amount of
Social Security retirement benefits that they had accrued as of
the time of the reform. These benefits are calculated by
filling in zeros in the OAI earnings records of all Social
Security participants for years after the transition begins.
Since new workers joining the workforce will have only zeros
entered in their OAI earnings histories, new workers will
receive no OAI benefits in retirement. This ensures that over a
transition period aggregate Social Security retirement benefits
will decline to zero.
Financing the Transition
During the transition, Social Security retirement benefits
will be financed by a federal business cash-flow tax. The
business cash-flow tax would also finance the government's
ongoing PSS contribution match. Over time, the PSS business
cash-flow tax rate would decline as the amount of Social
Security retirement benefits decline. Provisional calculations
suggest that the tax would begin around 8 percent and would
decline to a permanent level of roughly 2 percent within 40
years.
Advantages of the Reform
The Personal Security System would improve benefit-tax
linkage, enhance survivor protection, equalize treatment of
one- and two-earner couples, offset the ongoing transfer of
resources from the young to the old, provide better divorce
protection to non working spouses, make the system's
progressivity apparent, resolve Social Security's long-term
funding problem, and ensure Americans an adequate level of
retirement income.
Macroeconomic Effects
Simulation studies suggest that this reform will, over
time, increase the economy's output by roughly 15 percent and
the capital stock by roughly 40 percent.
Impact on the Poor
A business cash-flow tax represents an indirect way of
taxing consumption. The current poor elderly living on Social
Security benefits will be fully insulated from the tax because
their benefits are guaranteed in real terms through the
System's indexation of benefits to the consumer price level.
Middle-class and rich elderly as well as middle-aged and
younger members of society will jointly bear the burden of the
tax. For young and middle aged workers there is an overall
decline in the tax burden since they no longer pay the OAI tax.
For the economy as a whole, the tax change is revenue neutral
with the business cash-flow tax simply replacing the OAI
payroll tax.
Simulation analyses show that poor members of current
middle aged generations, poor members of current young
generations, and poor members of future generations have the
most to gain from privatizing social security.
Intergenerational Equity
Asking the middle class and rich elderly to pay their share
of Social Security's unfunded liability is intergenerationally
equitable particularly given the massive transfers that have
been made to the elderly through Social Security, Medicare, and
other programs in the postwar period.
Conclusion
The Social Security System does lots of very useful things.
If forces us to save and to insure and protects us from running
out of money in old age. But the system was financed from the
start on a chain-letter basis and the end of the chain is in
sight. We now have two options. We can try to con our children
and grandchildren into buying our inherently worthless chain
letters by continuing to disguise the true nature of Social
Security's long-term fiscal problems. Or we can decide to act
like adults and reform once and for all a System that imperils
the financial wellbeing of our offspring.
In fully privatizing Social Security's retirement program
along the lines outlined above, we can change the bathwater
without discarding the baby. The PSS proposal achieves all the
legitimate goals of Social Security. It forces us to save, it
protects dependent spouses, it assists the poor, and it
provides annuity insurance. It also gives American workers
immediate access to the world capital market in a manner that
precludes their trying to time or otherwise play the market.
Finally, it asks all who can pay, including the middle class
and rich elderly, to recognize our collective obligation to pay
the liabilities of the current system so that we can ensure
real social security for our children.
Chairman Bunning. Thank you.
Mr. Gramlich.
STATEMENT OF HON. EDWARD M. GRAMLICH, PH.D., MEMBER, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM; AND PAST CHAIR, 1994-96
QUADRENNIAL ADVISORY COUNCIL ON SOCIAL SECURITY
Mr. Gramlich. Thank you, Mr. Chairman. I am pleased to
appear before the Subcommittee to testify on Social Security
reform, and I suppose it goes without saying that I am speaking
in my past capacity as Chair of the Advisory Council, 1994-96,
and not in my present capacity at the Federal Reserve Board.
Let me first engage in some retrospection. At the time I
and other members of our Advisory Council spoke before your
Subcommittee last year, our report was just out and there was
publicity that we couldn't agree on a single plan but had three
separate approaches. Since that time it strikes me that there
has been some coalescence around the middle-ground approach
that I advocated. After our report, both the Committee for
Economic Development and Senator Moynihan came out with plans
that were more or less similar to mine and adopted some of
those features. Two weeks ago the National Commission or
Retirement Policy came out with a similar plan, again adopting
some of the same features. In political terms, the center seems
to be holding--since our report there has been increased
interest in sensible middle-ground approaches, and I would
encourage this Subcommittee to work in that direction.
In trying to reform Social Security, the middle-ground
approach has two goals. The first is to make affordable the
important social protections of this program that have worked
so well to reduce aged poverty and the human cost of work
disabilities. The second is to add new national savings for
retirement--both to help individuals maintain their own
standard of living in retirement and build up the nation's
capital stock in advance of the baby boom retirement crunch.
My compromised plan, called the Individual Accounts Plan,
achieves both goals. It preserves the important social
protections of Social Security and still achieves long-term
financial balance in the system by what might be called kind
and gentle benefit cuts. Most of the cuts would be felt by
high-wage workers, with disabled and low-wage workers largely
protected from cuts. Unlike the other two plans proposed in the
Advisory Council Report, there would be no reliance on the
stock market to finance Social Security benefits, no worsening
of the finances of the Health Insurance Trust Fund.
Beginning in the 21st century, two measures would be mainly
responsible for reducing the growth of benefits. There would be
a slight increase in the normal retirement age for all workers,
in line with the expected growth in overall life expectancy.
There would also be a slight change in the benefit formula to
reduce the growth of Social Security benefits for high-wage
workers.
Both of these changes would be phased in very gradually to
avoid benefit cuts for present retirees and ``notches'' in the
benefit schedule. The result of the changes would be a modest
reduction in the overall real growth of Social Security
benefits. When combined with a rising number of retirees, the
share of the nation's output devoted to Social Security
spending would be approximately the same as at present,
eliminating this part of the impending explosion in future
entitlement spending.
These benefit cuts alone would mean that high-wage workers
would not experience rising real benefits as their real wages
grow, so I would supplement these changes with another measure
to raise overall retirement and national saving. Workers would
be required to contribute an extra 1.6 percent of their pay to
newly created individual accounts. These accounts would be
owned by workers but centrally managed. Workers would be able
to allocate their funds among five to ten broad mutual or index
funds covering stocks and bonds. Central management of the
funds would cut down the risk that the funds would be invested
unwisely, cut administrative costs, and would mean that Wall
Street firms would not find these individual accounts a
financial bonanza. The funds would be converted to real
annuities on retirement to protect against inflation and the
chance retirees would overspend in their early retirement
years.
Some observers have objected to mandating new retirement
contributions now when there is a welcomed prospect of Federal
budget surpluses. One option to deal with this might be to rely
on the already extensive private pension system to fill gaps in
the existing pension coverage workers. Tax qualification rules
might be changed to include a provision that requires a full or
nearly full participation of all corporate employees in order
to qualify for favorable tax treatments.
The Social Security and pension changes together would mean
that approximately the presently scheduled level of benefits
would be paid to all wage classes of workers, of all ages. The
difference between this outcome and the present law is that
under this plan these benefits would be affordable, as they are
not under present law. The changes would eliminate Social
Security's long-run financial deficit while still holding
together the important retirement safety net provided by Social
Security. They would reduce the growth of entitlement spending.
They would significantly raise the return on invested
contributions for younger workers. And, the changes would move
beyond the present pay-as-you-go financing scheme by providing
new saving to build up the nation's capital stock in advance of
the baby boom retirement crunch.
As the Congress debates Social Security reform, I hope it
will keep these goals in mind and consider these types of
changes in this very important program.
Thank you very much.
[The prepared statement follows:]
Statement of Hon. Edward M. Gramlich, Ph.D., Member, Board of
Governors, Federal Reserve System; and Past Chair, 1994-96 Quadrennial
Advisory Council on Social Security
I am pleased to appear before the Committee to testify on
Social Security reform. I speak for myself, as past chair of
the 1994-96 Quadrennial Advisory Council on Social Security,
and not in my current status as a member of the Federal Reserve
Board.
Let me first engage in some retrospection. At the time I
and other members of the Advisory Council spoke before your
Committee last year, our report was just out and there was much
publicity about the fact that we couldn't agree on a single
plan, but had three separate approaches. Since that time it
strikes me that there has been a coalescence around the middle-
ground approach I advocated. After our report, both the
Committee for Economic Development (CED) and Senator Moynihan
came out with plans which adopted some of the features of my
plan. Two weeks ago the National Commission on Retirement
Policy (NCRP) came out with a similar plan, again adopting some
features of my plan. In political terms the center seems to be
holding--since our report there has been increased interest in
sensible middle-ground approaches, and I would encourage this
Committee to work in that direction.
In trying to reform Social Security, the middle-ground
approach has two goals. The first is to make affordable the
important social protections of this program that have greatly
reduced aged poverty and the human costs of work disabilities.
The second is to add new national saving for retirement--both
to help individuals maintain their own standard of living in
retirement and to build up the nation's capital stock in
advance of the baby boom retirement crunch.
My compromise plan, called the Individual Accounts (IA)
Plan, achieves both goals. It preserves the important social
protections of Social Security and still achieves long term
financial balance in the system by what might be called kind
and gentle benefit cuts. Most of the cuts would be felt by high
wage workers, with disabled and low wage workers being largely
protected from cuts. Unlike the other two plans proposed in the
Advisory Council report, there would be no reliance at all on
the stock market to finance Social Security benefits, and no
worsening of the finances of the Health Insurance Trust Fund.
The IA plan includes some technical changes such as
including all state and local new hires in Social Security and
applying consistent income tax treatment to Social Security
benefits. These changes go some way to eliminating Social
Security's actuarial deficit.
Then, beginning in the 21st century, two other measures
would take effect. There would be a slight increase in the
normal retirement age for all workers, in line with the
expected growth in overall life expectancy (also proposed by
the CED, Senator Moynihan, and the NCRP). There would also be a
slight change in the benefit formula to reduce the growth of
Social Security benefits for high wage workers (also proposed
by the CED and NCRP). Both of these changes would be phased in
very gradually to avoid actual benefit cuts for present
retirees and ``notches'' in the benefit schedule (instances
when younger workers with the same earnings records get lower
real benefits than older workers). The result of all these
changes would be a modest reduction in the overall real growth
of Social Security benefits. When combined with the rising
number of retirees, the share of the nation's output devoted to
Social Security spending would be approximately the same as at
present, eliminating this part of the impending explosion in
future entitlement spending.
These benefit cuts alone would mean that high wage workers
would not experience rising real benefits as their real wages
grow, so I would supplement these changes with another measure
to raise overall retirement (and national) saving. Workers
would be required to contribute an extra 1.6 percent of their
pay to newly-created individual accounts. These accounts would
be owned by workers but centrally managed. Workers would be
able to allocate their funds among five to ten broad mutual or
index funds covering stocks and bonds. Central management of
the funds would cut down the risk that funds would be invested
unwisely, would cut administrative costs, and would mean that
Wall Street firms would not find these individual accounts a
financial bonanza. The funds would be converted to real
annuities on retirement, to protect against inflation and the
chance that retirees would overspend in their early retirement
years.
Some observers have objected to mandating new retirement
contributions now, when there is a welcome prospect of federal
budget surpluses. The NCRP, for example, uses both the
surpluses and the Health Insurance Fund to help finance
individual accounts. I see some problems with that approach,
though it does lessen the political difficulty of mandating
additional pension coverage. Another option might be to rely on
the already extensive private pension system to fill gaps in
the existing pension coverage of workers. Tax qualification
rules might be changed to include a provision that requires the
full participation of all corporate employees in order to
qualify for favorable tax treatment.
The Social Security and pension changes together would mean
that approximately the presently scheduled level of benefits
would be paid to all wage classes of workers, of all ages. The
difference between the outcome and present law is that under
this plan these benefits would be affordable, as they are not
under present law. The changes would eliminate Social
Security's long run financial deficit while still holding
together the important retirement safety net provided by Social
Security. They would reduce the growth of entitlement spending.
They would significantly raise the return on invested
contributions for younger workers. And, the changes would move
beyond the present pay-as-you-go financing scheme, by providing
new saving to build up the nation's capital stock in advance of
the baby boom retirement crunch.
As the Congress debates Social Security reform, I hope it
will keep these goals in mind and consider these types of
changes in this very important program. Thank you very much.
Chairman Bunning. Thank you.
Dr. Munnell.
STATEMENT OF ALICIA H. MUNNELL, PH.D., PETER F. DRUCKER
PROFESSOR OF MANAGEMENT SCIENCES, BOSTON COLLEGE CARROLL
SCHOOL OF MANAGEMENT
Ms. Munnell. Thank you. I too am delighted to be here to
discuss the future of Social Security. I am not here to offer
another plan but mainly to make some comments as an economist,
and I actually think my comments fit nicely into what Ned
Gramlich said.
I do think that the issues have sorted themselves out in
the last year. Basically it comes down at this point to whether
we are talking about cutting way back on Social Security to
introduce individual accounts and whether we are talking about
introducing individual accounts as an add-on to the current
Social Security Program.
Let me make my three points. My first point is that the
debate, at least among Members of this hearing, is not about
prefunding or broadening the investment options for Social
Security. There is considerable agreement that using the Social
Security Program to increase national saving is a good idea.
There is also considerable agreement that broadening the
investment portfolio to include equities is a good idea.
Rather, the debate is about not prefunding or investing in
equities, but given that we want to do some prefunding and
given that we want to invest in equities, should we provide
people's basic retirement income through a defined benefit plan
or through defined contribution individual accounts.
The second point is that the economics clearly suggest that
Social Security's defined benefit plan is better than
individual accounts for the basic retirement benefit. And this
is true for several reasons. First of all, because Social
Security has a defined benefit plan, it can share risks among
all people in the population and it can share risks over time.
Second, because it pulls all investments together, it can
keep transaction costs very low.
Third, because it keeps all of the money together, it
avoids the possibility that people are going to ask for their
money before they retire and end up with inadequate retirement
income.
Fourth, it is very good at turning accumulated funds into
an annuity and an inflation-indexed annuity.
And fifth, Social Security is better than the other options
on the table for protecting the dependent spouse after the
worker dies.
It is totally feasible to build up assets within the Social
Security fund, particularly if we really take Social Security
out of the budget, not the way that we have it now. And it is
totally feasible to invest some of those reserves in equities.
It would not destabilize capital markets and we have several
institutional frameworks that will ensure that the government
does not interfere in private sector activity. The Fed is one
model. The Federal Thrift Savings Plan is another model.
So everyone wants prefunding, at least at this table, and
everybody wants equity investment. The argument is not over
those issues; rather, over whether today's modest Social
Security benefits, and they are modest, should be provided
through a defined benefit program or a defined contribution
program.
The second point is that a funded Social Security Program
with equity investment is a realistic option and by far the
better way to provide the basic retirement benefit.
And my third and final point is that the argument against
individual accounts applies only to the basic benefit. Once we
have restored balance to Social Security to preserve most of
today's promises, supplemental individual accounts are a good
idea. They would encourage additional saving. They would offer
individuals some choice in their investments, and they would
keep administrative costs low.
So, in short, accumulating reserves is a good idea.
Investing in equities is a good idea. Individual accounts are a
good idea, but not if they involve major reductions to today's
Social Security promises. We should be talking about adding on
savings options, not about major cutbacks of existing Social
Security benefits.
Thank you very much.
[The prepared statement follows:]
Statement of Alicia H. Munnell, Ph.D., Peter F. Drucker Professor of
Management Sciences, Boston College Carroll School of Management
Mr. Chairman and Members of the Committee, I am delighted
to have the opportunity to appear before you today to discuss
the topic of individual accounts for Social Security. I would
like to make three points:
First, the debate at this hearing is not about
prefunding or broadening investment options for Social Security
participants. There is considerable agreement that using the
Social Security system to increase national saving is a good
idea. There is considerable agreement that broadening the
investment portfolio to include equities is a good idea. Thus,
the debate, at least among this group, is not over prefunding
or investing in equities. Rather, the debate is--given
prefunding and given the desire to invest in equities--whether
providing basic retirement income is better done through the
central Social Security trust funds or individual accounts.
Second, the economics clearly suggest that Social
Security's defined benefit plan, particularly with some
prefunding and investment in equities, is better than
individual accounts for providing the basic retirement pension.
--Because Social Security is a defined benefit plan, it can
spread risks across the population and over generations. This
means that people's basic benefits do not depend on what stocks
they pick and when they buy and sell. Pooling investments in
the Social Security trust funds also keeps reporting and
transaction costs low, ensuring higher net returns than
individual accounts. Social Security also avoids the pressure
for individuals to gain early access to their accounts, leaving
retirees with inadequate retirement income. Social Security
assures that accumulated funds are transformed into inflation-
indexed annuities so that retirees do not outlive their
retirement resources. Finally, Social Security protects
dependent spouses after the worker dies.
--Building up a fund in the Social Security program and
broadening the investment options to include equities is
perfectly feasible. Social Security equity holdings would
account for only about 5 percent of the total by 2020. Setting
up an independent investment board, investing in a broad index,
and delegating voting rights to fund managers should prevent
interference in private sector activity.
Third, the argument against individual accounts
applies only to the basic retirement income. Once we have
restored balance to Social Security to preserve most of today's
promises, supplemental individual accounts would be a good
idea. They would encourage additional saving, offer individuals
some choice in their investments, and keep administrative costs
to a minimum.
In short, accumulating reserves is a good idea, investing
in equities is a good idea, even individual accounts are a good
idea, but not if they involve major reductions in the
protections offered through today's Social Security program. We
should be talking about adding-on savings options not cutting
back on existing benefits. Let me amplify on these points.
I. The Nature of the Debate
Social Security is on the national agenda because the
system faces a projected long-term deficit. But things are
different than they were in 1983 when Congress last acted to
restore financial balance; this time the system is not facing a
short-term financing crisis. In fact, government actuaries
calculate that the system has an adequate flow of revenues
until 2032 and can cover three quarters of promised benefits
for decades thereafter. The emergence of a long-term deficit in
the absence of a short-term crisis means that policymakers can
consider comprehensive reform as well as incremental fixes to
the system.
In considering both incremental and comprehensive reform,
two relatively new considerations are playing an important
role. One is the maturation of the Social Security program.
Unlike earlier generations who received large benefits relative
to the taxes they paid, today's workers face a sharp decline in
returns that they can expect to receive on their payroll tax
contributions (the so-called money's worth issue). Since
raising taxes or reducing benefits will only worsen returns,
almost all reform plans involve equity investment in one form
or another to provide additional revenue. The second factor
influencing the Social Security reform debate is concern about
our low levels of national saving. This concern along with the
desire to avoid high pay-as-you go tax rates in the future has
spawned considerable interest in some prefunding.
The proposals presented by people at this table respond to
these concerns. Both proposals to maintain Social Security's
existing defined benefit plan and proposals to institute
individual accounts involve a substantial accumulation of
assets. Similarly, most observers agree that those covered by
Social Security should have access to the higher risks and
higher returns associated with equity investment. In other
words, the questions of prefunding and of broadening the
portfolio are not at issue.
When making proposals people often jumble together what
economists view as three very distinct issues. The first
pertains to funding: ``How much reserves should we accumulate
in retirement funds?'' The second pertains to investments: ``To
what extent should we invest those accumulated reserves in
equities?'' The third issue relates to the provision of
benefits: ``Should benefits be provided under a defined-benefit
or defined-contribution arrangement?'' These three questions
are separable from an economic perspective. That is, it is
possible to have a large trust fund with a diversified
portfolio in a defined-benefit system or a defined-contribution
system with no more than our current funding. Because it is
possible to have equivalent amounts of funding in the Social
Security program and in a system of individual accounts and
because equity investment is possible in either scenario, the
question comes down to whether defined benefit or defined
contribution arrangements are better for people's basic
retirement income.
II. Individual Accounts Put Retirement Income at Risk and Are Costly
The problem with defined contribution arrangements such as
the IRA-type proposals is that they put much of people's
retirement income at risk. Individuals' basic benefits would
depend on their investment decisions. What stocks did they buy?
When did they buy them? When did they sell? Uncertain outcomes
may be perfectly appropriate for supplementary retirement
benefits, but not for the basic guarantee. Herb Stein, Chairman
of the Council of Economic Advisers under President Nixon,
summarized the argument best.
``If there is no social interest in the income people have
at retirement, there is no justification for the Social
Security tax. If there is such an interest, there is a need for
policies that will assure that the intended amount of income is
always forthcoming. It is not sufficient to say that some
people who are very smart or very lucky in the management of
their funds will have high incomes and those who are not will
have low incomes and that everything averages out.''
Retirement income that depends on one's skills as an
investor is not consistent with the goals of a mandatory Social
Security program. Remember that Social Security is the major
source of income for two-thirds of the 65-and-over population
and virtually the only source for the poorest 30 percent. The
dollar amounts are not very large: the benefit for a low-wage
worker who retired at age 62 in 1997 was only $450 per month or
$5400 per year and for a worker with a history of average wages
was $742 per month or $8904 per year. Does it really make sense
to put these dollar amounts at risk?
In addition to making the basic retirement benefit
dependent on one's investment skills, the IRA-type accounts
would be extremely costly. The 1994-96 Social Security Advisory
Council estimates that the administrative costs for an IRA-type
individual account would amount to 100 basis points per year. A
100-basis point annual charge sounds benign, but estimates by
Peter Diamond of MIT show that it would reduce total
accumulations by roughly 20 percent over a 40-year work life.
That means benefits would be 20 percent lower than they would
have been in the absence of the transaction costs. Moreover,
while the 100-basis-point estimate includes the cost of
marketing, tracking, and maintaining the account, it does not
include brokerage fees. If the individual does not select an
index fund, then transaction costs may be twice as high.
Indeed, costs actually experienced in the United Kingdom, which
has a system of individual accounts, have been considerably
higher than the Advisory Council estimate. Finally, because
these transaction costs involve a large flat charge per
account, they will be considerably more burdensome for low-
income participants than for those with higher incomes.
Individual accounts also create a very real political risk
that account holders would pressure Congress for access to
these accounts, albeit for worthy purposes such as medical
expenses, education, or home purchase. Although most plans
prohibit such withdrawals, our experience with existing IRAs
and 401(k)s suggests that holding the line might be quite
difficult. To the extent that Congress acquiesces and allows
early access, retirees will end up with inadequate retirement
income.
Another concern pertains to the question of transforming
accumulated reserves into annuities. Without such a
transformation, individuals stand a good chance of outliving
their savings. But few people purchase private annuities and
costs are high in the private annuity market. The reason for
the high costs is adverse selection: people who think that they
will live for a long time purchase annuities, whereas those
with, say, a serious illness keep their cash, making the
provision of annuities very expensive. Moreover, the private
annuity market would have a hard time providing inflation
adjusted benefits. In contrast, by keeping participants
together and forcing them to convert their funds into
annuities, Social Security avoids the problem of adverse
selection and is in a good position to provide inflation-
adjusted benefits.
Finally, when evaluating a shift from Social Security's
defined benefit system to individual accounts, it is important
to consider not only the effect on the worker, but also on the
worker's family. A defined benefit system with auxiliary
benefits is very different from a defined contribution system
where the annuity protection for the family is paid for by the
worker and may involve choice. The evidence suggests that left
on their own, workers do not always make very good choices for
themselves, much less for their dependents. The small size of
the current U.S. annuity market suggests that retirees do not
chose to annuitize their accumulations. Evidence from the U.K.
suggests that people do not purchase inflation protection even
when they have the opportunity. Finally, pre-ERISA data
indicate that many workers select single-life annuities with no
protection for surviving spouses. Thus, without explicit
provisions to protect dependent spouses, elderly widows, who
already suffer very high rates of poverty, could be made worse
off under a system of individual accounts.
Because the IRA-type approach is so risky and costly for
the basic retirement benefit, some suggest the 401(k) or
federal Thrift Savings Plan (TSP) approach. Instead of
individuals holding their funds and investing them in anything
they like, the government would hold the money and designate a
series of investment options. In my view, this approach--when
it comes at the expense of existing Social Security benefits--
has little to recommend it and undermines protections in the
current program. First, the TSP approach introduces much of the
same unpredictability into retirement income as the IRA-type
alternative. Second, while its costs would be lower, it would
still double the costs of the current Social Security program.
Finally, for those concerned about government involvement, this
approach has the government picking the appropriate equity
funds and retaining control of the money. This is not a
particular problem in my view, but the TSP approach does raise
all the same corporate governance issues as investment by the
central trust funds.
What then is the best approach?
III. Fund Social Security and Broaden the Portfolio
Accumulating reserves in the Social Security trust funds
and investing part of those reserves in equities offers many of
the advantages of individual accounts without the risks and
costs. It has the potential to increase national saving and
offers participants the higher risk/higher returns associated
with equity investment. But, unlike individual accounts, a
partially funded Social Security program with equity
investments ensures predictable retirement incomes by
maintaining a defined benefit structure that enables the system
to spread risks across the population and over generations. In
addition, pooling investments keeps transaction and reporting
costs to a minimum, producing higher net returns on equity
investments than individual accounts.
Because a partially funded Social Security program with a
broad portfolio is the realistic alternative to individual
accounts, it is important to emphasize that equity investment
for Social Security is a feasible option. The magnitudes will
not disrupt financial markets and the investments can be
structured to prevent any government interference in private
sector activity.
The Social Security Administration actuaries present
estimates of the build-up of equity holdings under each of the
three 1994-96 Social Security Advisory Council plans. To
determine the impact on capital markets requires estimating the
growth rate of total equity holdings. If the real value of
total equities grew at the rate it grew over the period 1952-95
(5 percent), and if 40 percent of Social Security trust fund
assets were invested in equities as recommended under the
Maintenance of Benefits plan, then Social Security trust fund
holdings would equal roughly 5 percent of the total market in
2020 (Hammond and Warshawsky 1997). (The Individual Account
(IA) proposal would produce equity holding of 3 percent and the
Personal Security Account (PSA) plan holdings of 11.1 percent.)
In other words, the total equity market is likely to grow fast
enough to absorb quite easily the build up of equity reserves
in the trust funds.
Even if such an accumulation would not disrupt the markets,
could it have a substantial effect on relative rates of return,
perhaps driving up government borrowing costs? The portfolio
restructuring should have some effect. The equity premium
should decline to reflect the increased efficiency of risk
bearing in the economy. Some movement would also be expected in
interest rates. The one study that has estimated the effect on
relative returns concluded that the shift to equities in the
trust funds would lower the equity premium by 10 basis points
and, and raise the interest on Treasury securities by roughly
the same amount (Bohn 1998). With current levels of federal
debt, this increase in Treasury rates should have a relatively
small effect on the unified budget. As the economy grows and
the debt declines, the effect should be negligible.
While Social Security investment in equities is unlikely to
disrupt financial markets or cause major shifts in rates of
return, many people are concerned that Social Security
investment in equities could lead to government interference
with the allocation of capital in the economy and with
corporate activity.
Public pension funds provide a range of evidence regarding
the desirability of allowing Social Security to invest in
equities. Supporters point to the success of the federal Thrift
Savings Plan, which has established a highly efficient stock
index fund. The plan has steered clear of any issues of social
investing--that is, investing in projects with less than market
returns for a given level of risk. Divestiture of stocks for
social or political reasons has also not been an important
problem. It has also avoided government interference with
private corporations by pushing proxy decisions down to the
individual portfolio managers.
Opponents point to state and local pension funds. Indeed
one does see pressure from investment boards or states for
state and local pension funds to undertake investments that
serve other interests, often at a sacrifice in return. State
and local funds have also been pressured to divest certain
stocks in order to demonstrate that they do not support some
perceived immoral or unethical behavior.
My view is that such pressures are easy to guard against at
the federal level. Much of state-local plan activity is
conducted in relative secrecy, while Social Security
investments would be subjected to much public scrutiny.
Moreover, Social Security could build on TSP's successful
example; it could set up an independent investment board of
financial experts with fiduciary responsibility, invest in a
broad index, delegate voting rights to fund managers, and
finance its own administrative costs so it does not have to
rely on Congress to appropriate funds each year. These
protections should ensure efficient investments.
In short, a partially funded defined benefit plan with
equity investment is feasible and can do everything that
privatized accounts can do and do it at lower costs, yielding
higher net returns. A recent GAO report did not identify any
insurmountable hurdles with direct trust fund investment in
equities. Canada should provide some confirmation about the
feasibility of equity investment since is in the process of
setting up a board that will oversee the investment of its
Social Security trust funds in equities.
IV. Supplementary Individual Accounts
Prefunding Social Security and investing in equities not
only improves the distribution of risk in the economy, it also
dramatically reduces the size of the financing gap within the
Social Security program. In addition, most observers agree on
some further steps that are both inherently fair and would
further cut the long-run deficit. These include: extending
coverage to new full-time state and local government employees
(about 3.7 million workers) not now covered by Social Security,
making Social Security benefits taxable to the extent they
exceed worker contributions (comparable to other contributory
defined benefit plans), lengthening the averaging period for
the Social Security benefit calculation, and improving the
accuracy of the Cost-of-Living Adjustments as the BLS refines
the Consumer Price Index. Many would also argue for a slight
increase in the Social Security maximum earnings base to bring
the proportion of earnings subject to tax more in line with the
90 percent figure established in 1983. In short, it is not
difficult to close the 75-year financing gap in the Social
Security program; this can be done with only a modest impact on
benefits.
Once balance is restored to the existing program, it is
possible to consider changes that would improve the likelihood
that future retirees will have adequate incomes. One option is
to introduce voluntary supplemental individual accounts within
Social Security for those who would like to set aside more
money. Thus, the debate is not about whether individual
accounts are good or bad in general. Once people are assured
basic retirement protection, individual accounts may be a
perfectly reasonable addition. What opponents of individual
accounts object to in the context of Social Security reform is
cutting back on existing Social Security benefits and replacing
those benefits with a risky and costly alternative. Introducing
individual accounts as an add-on to Social Security is a good
idea; substituting individual accounts for existing Social
Security benefits needlessly undermines protection for
retirees, the disabled, and their dependents.
V. Conclusion
Most plans being discussed today involve both prefunding
and equity investment. In economic terms, the goals of
prefunding and broadening the portfolio can be achieved either
within the context of Social Security's defined benefit program
or in individual accounts. With the possibility of funding and
diversifying investments under either scenario, the question
becomes which is the best benefit structure for people's basic
retirement income. Here the economics are clear. A defined
benefit plan allows for better risk spreading, better
protection for retirees and dependents, and lower costs than
individual accounts.
References
Advisory Council on Social Security. 1997. Report of the 1994-1996
Advisory Council on Social Security (Washington: Government Printing
Office).
Bohn, Henning. 1998. ``Social Security Reform and Financial Markets
``Social Security Reform and Financial Markets,'' in Steven Sass and
Robert Triest eds. Social Security Reform: Links to Saving, Investment,
and Growth (Boston, MA: Federal Reserve Bank of Boston).
Diamond, Peter A.. 1997. ``Macroeconomic Aspects of Social Security
Reform,'' Brookings Papers on Economic Activity, 2.
Diamond, Peter A..1998 forthcoming. ``Economics of Social Security
Reform: An Overview,'' in Douglas Arnold, Michael Graetz, and Alicia
Munnell eds. Framing the Social Security Debate: Values, Politics and
Economics (Washington, D.C.: National Academy of Social Insurance and
the Brookings Institution).
Hammond, P. Brett and Mark J. Warshawsky, ``Investing in Social
Security Funds in Stocks,'' Benefits Quarterly, Third Quarter 1997, 52-
65.
Munnell, Alicia H. and Pierluigi Balduzzi. 1998. ``Investing the
Trust Funds in Equities'' (Washington, D.C.: Public Policy Institute,
American Association of Retired Persons).
Stein, Herbert. 1997. ``Social Security and the Single Investor''
Wall Street Journal (February 5,1997)
United States General Accounting Office. 1998. Social Security
Investing: Implications of Government Stock Investing for the Trust
Fund, the Federal Budget, and the Economy (Washington, D.C.: Government
Printing Office)
Chairman Bunning. Thank you very much.
Hon. Robert Ball.
STATEMENT OF HON. ROBERT M. BALL, FOUNDING CHAIR, NATIONAL
ACADEMY OF SOCIAL INSURANCE; AND MEMBER, 1994-96 ADVISORY
COUNCIL ON SOCIAL SECURITY; AND FORMER COMMISSIONER, SOCIAL
SECURITY ADMINISTRATION
Mr. Ball. Mr. Chairman, to help you keep the players
straight, I agree with everything Alicia Munnell just said and
I can take off from that.
I am really glad to be here today because I have a new
plan----
Chairman Bunning. Would you pull that mike up so that
everybody else can hear what your plan is? Thank you.
Mr. Ball. I was particularly glad to be here today because
I have a new plan, and this is the first chance that I have had
to describe it in public.
The plan has two parts. The first solves the long-term
financing problem in Social Security.
The second establishes a supplementary savings plan on top
of Social Security.
The last part is different from other supplementary savings
plans because it takes advantage of a provision in present law
that Senator Moynihan was successful in adding back a few years
ago so that everybody over 25 will be getting automatically an
annual statement estimating what their Social Security benefits
are going to be, both their own and their dependents. And they
will get that each year.
My proposal on the savings side is to have a mechanism as
part of Social Security for the worker to tell his or her
employer to deduct up to 2 percent more from earnings to be
reported through the regular Social Security reports. This
would entail no significant additional administrative problems,
and every year we would be reminding workers: Here is what you
are going to get under your individual Social Security account,
and here is how you are doing on your supplementary savings.
Thus, people who can and want to can add additional savings to
Social Security by a simple checkoff system through their
employer.
The part of the plan that deals with solving the present
Social Security long-term deficit--let me describe that:
Obviously you have to have more income to the system or pay
less out. On the ``more income'' side, what I would propose is
that we build up the fund, maintain a fund more like private
pensions do and increase the return on those funds by investing
part of it in private equities.
Those steps make a tremendous difference. Out of the 2.19-
percent deficit, over half of it would be eliminated by the
buildup in the fund and by investing part of it in equities.
Next on ``controlling the amount going out'' I would take
advantage of the changes that have been made and will be made
by the Bureau of Labor Statistics in the CPI that determines
the cost of living adjustment.
And then last, we could reach our long-term goal of
universal coverage by covering all new hires in State and local
employment. Just those three things alone get the Social
Security deficit down from 2.19 percent of payroll to 0.38
percent. That is way below what has been traditionally thought
of as ``close actuarial balance'' under Social Security.
The Trustees recognized way back that you can't keep the
Social Security system at zero balance all the time. There is
too much involved in a 75-year estimate, so they introduced
some leeway. Well, how much leeway is sensible?
They said as long as the income to the system is 95 percent
of the estimated cost of the system, that is ``close actuarial
balance,'' and no new legislation is needed. You can get there
without any tax increases, without any benefit cuts, and
without any modifications in the basic principles of the
system.
If you want to go to full balance right off instead of
being content with close actuarial balance, you probably need
at least minor tax increases. I have proposed increasing the
maximum earnings base somewhat, the $68,000 plus that governs
how much you get in the way of benefit credits and how much you
pay in, and on the benefits side I have proposed a modest 3-
percent cut in benefits. These steps would bring the system
into full actuarial balance now.
On the other hand, it is not just a step forward to bring
the system into close actuarial balance, it is a huge leap that
goes most of the way. That might be enough for the immediate
future, and we could restore the old advisory council system
and get recommendations for bringing the system into full
balance somewhat later.
Put these two things together, Mr. Chairman: A
supplementary plan built on a sound Social Security system
which maintains present benefits the defined benefit way and
allows people through the Social Security system itself to add
to savings and I believe we have a solution to our problem.
[The prepared statement and attachment follow. Additional
material is being retained in the Committee files.]
Statement of Hon. Robert M. Ball, Founding Chair, National Academy of
Social Insurance; and Member, 1994-96 Advisory Council on Social
Security; and Former Commissioner, Social Security Administration
Mr. Chairman and Members of the Committee:
My name is Robert Ball. I was Commissioner of Social
Security from 1962 to 1973. Prior to my appointment by
President Kennedy, I was the top civil servant at Social
Security for about 10 years, and have had a total of some 30
years of service at the Social Security Administration. Since
leaving the government, I have continued to write and speak
about Social Security, Medicare, health insurance more
generally, and related programs.
I was Staff Director of an Advisory Council on Social
Security to the Senate Finance Committee in 1948, a council
which recommended the major changes that became the Social
Security Amendments of 1950. I have also been a member of the
statutory Advisory Councils on Social Security in 1965, 1979,
1991, and 1994-1996. I was also a member of the small
negotiating group from the National Commission on Social
Security Reform in 1982-1983, the Greenspan Commission, which
reached an agreement with the White House on a series of
recommendations that became the basis for the important 1983
Amendments. I am the founding chair of the board of the
National Academy of Social Insurance and was a senior scholar
at the Institute of Medicine, the National Academy of Sciences
from 1973 to 1981.
I am pleased that you have asked me to present my proposal
for both bringing the present Social Security system into long-
range balance and for establishing a new kind of supplementary
saving plan operating through Social Security administrative
arrangements. Thank you very much.
Restoring Social Security to Long-Term Balance
There is a long-range deficit in Social Security that is,
estimates of income over the next 75 years under present law
fall short of estimates of the cost by an average of 2.19
percent of payroll. This deficit can be eliminated only by more
income for the system or less payout or a combination of the
two. On the income side, I propose principally to make the
scheduled tax payments more effective by building up the Trust
Funds more than would happen under present law, maintaining a
substantial fund into the future, and getting a better rate of
return on the investments. Although most retirement systems
state and local, many Federal systems and private pensions
invest their reserves partly in equities present law prohibits
Social Security from investing in anything but low-yielding
Federal obligations. This is not fair to Social Security
participants and should be changed.
On the side of reducing the Social Security payouts, I give
particular emphasis to basing future Social Security cost of
living increases on the more accurate Consumer Price Index
being developed by the Bureau of Labor Statistics (BLS).
I would also emphasize at last attaining the long sought-
after goal of universal coverage by extending the protection of
the program to all new hires in state and local employment, a
move which improves Social Security financing because with new
coverage the system collects contributions from younger workers
for many years before they become eligible for retirement
benefits.
These three changes in Social Security policy alone reduce
the presently estimated long-range deficit from 2.19 percent of
payroll to 0.38 percent of payroll 1.22 percent from the change
in investment policy, 0.45 percent from the corrections in the
CPI, and 0.21 percent from bringing under the same Social
Security arrangements as for all the rest of the country those
new hires in state and local employment who would not be
covered under present law (most state and local employees,
about 75 percent, are already under the Social Security
system).\1\
---------------------------------------------------------------------------
\1\ There are some interactions among these three proposals that
make the change in the long-range balance slightly different from the
result of adding up the individual items and subtracting them from the
estimated deficit.
---------------------------------------------------------------------------
These three changes do not involve increases in taxes or
benefit cuts, (except to the extent the CPI changes prevent
unwarranted increases in future cost of living adjustments).
The result is to bring the deficit well within what is called
``close actuarial balance,'' a concept used by the Trustees
over the years to define a proper leeway from full actuarial
balance before they have felt the need to recommend legislative
change.
Clearly a 75-year estimate should not be required to
continually show a zero balance; there are too many
uncertainties. But what is a reasonable deviation from full
balance? Many decades ago the Trustees fixed on a definition of
a reasonable leeway that is still used: keeping estimated
income up to at least 95 percent of estimated cost over the
next 75 years. Today this definition of ``close actuarial
balance'' means that a deficit anywhere below 0.78 percent of
payroll would meet the test. The three steps described above
bring us to 0.38 percent of payroll, about 50 percent below the
maximum level of ``close actuarial balance.''
The three steps would bring the system fully into actuarial
balance over the next 50-year period, extending the predicted
date of Trust Fund exhaustion from 2032 to 2054. (It is to be
recognized, of course, that Trust Fund exhaustion--a technical
concept that would most certainly not be allowed to occur--is
not the same for Social Security as running out of money.
Dedicated income from taxes on employees, employers and
beneficiaries continues after any theoretical Trust Fund
exhaustion and present law, without any change would support
the payment of at least three-fourths of benefits for decades.)
Bringing the system into the middle range of the leeway
allowed by the concept of ``close actuarial balance'' would be
not just a major first step toward full actuarial financing of
Social Security but a leap forward that would take us most of
the way to the goal. We could stop there for now, perhaps,
asking a new Advisory Council to evaluate the situation and
make recommendations on whether and how the system might be
brought the rest of the way into full balance, or we could move
ahead now with a few changes that would reach the goal of
actuarial balance for the whole 75 year period.
While close actuarial balance can be reached without
increases in the amount of contribution, or reductions in the
amount of protection promised under present law, and with the
attainment of the goal of complete coverage under the system,
to move to full actuarial balance for 75 years would require
some increase in tax income or some reduction in benefits or
both. If this is the goal we want to set for 1999, I would
propose a slight increase in taxes and a slight reduction in
promised benefits.
To increase taxes, I would propose a modest change in the
maximum contribution and benefit base--the level of annual
earnings above which earnings are neither taxed nor credited
for the purpose of computing benefits. At one time 90 percent
of all wages in covered employment fell below the maximum.
Today the base ($68,400 in 1998) is covering a smaller and
smaller proportion of earnings because wages are increasing
faster for the higher-paid than for those with wages below the
maximum covered. Even though under present law, the base is
scheduled to increase automatically each year with increases in
average wages, the percent of wages covered will continue to
fall. By 2006 the base is expected to cover only 84.5 percent
of earnings. It would take an additional 4 percent each year
between the years 2000 and 2009 in order to bring the
proportion of earnings covered back up to 90 percent. But with
the base now considerably below that target, increases of the
magnitude necessary to entirely close the gap may be ill-
advised. Higher-income earners would be required to contribute
substantially more but without being able to expect anything
like a commensurate increase in benefits. Accordingly, I would
propose closing only half of the gap that is, going from 84.5
to 87.3 percent over 10 years by increasing the maximum
earnings base 2 percent each year above the automatic increase.
The effect in any given year would ordinarily be modest as
compared to the automatic increase taking place anyway. This
change reduces the projected long-term deficit by about 0.28
percent of payroll.
On the benefit side, we could then bring the system into
full actuarial balance if we were to slow down present law
benefit increases for future beneficiaries by about 3 percent.
This could be done by a change in the benefit formula, or
consideration might be given to changing the wage averaging
period from present laws 35 years to 38 years.
The wage averaging period, which for decades now has
started for almost all workers with 1951, has been gradually
increasing as wages have been posted for more and more years.
In 1991, wages were being posted for 40 years and, as has
always been the case with averaging, retired workers were
allowed to drop the five years of lowest earnings, resulting in
1991 in basing benefits on the average of the highest 35 years.
This is the maximum number required in the basic law, so the
averaging period has remained at 35 years since 1991. Setting
the basic limit at 35 years is entirely arbitrary. The
objective is to relate the benefit to the workers career
earnings, indexed to the present and with some leeway for
periods of illness, unemployment, or special family
obligations. With crediting of additional years of earnings
since 1991, it is now feasible to relate the benefit to a
somewhat longer career average while maintaining the five-year
forgiveness period. Since most people work more than 35 years,
counting more years would cause benefits to reflect average
career earnings more accurately than they now do.
But lengthening the average period also lowers benefits for
some because earnings for currently excluded years are
necessarily lower on average than the 35 highest years now used
in computing benefits. Thus, including more years reduces
benefits somewhat for those with fewer years under the program
and those who have less than full-year earnings. Raising the
end point to 38 years would reduce benefits an average of 3
percent and reduce the Social Security deficit by 0.25 percent
of payroll.
A good case can be made for this method of trimming
benefits, but the proposal does arouse controversy. It reduces
benefits somewhat more for workers with intermittent rather
than steady wage records. Since women are more likely than men
to go in and out of the workforce, the argument is made that
this proposal is disadvantageous to more women than men. This
is true to a limited extent, but because of Social Securitys
weighted benefit formula, which favors those with intermittent
wage records, and because of the continuance of the five-year
forgiveness period, workers going in and out of the workforce
would continue to receive very favorable treatment. The issue
is whether to favor the intermittent worker slightly less than
under present law.
These two additional changes--the increase in the maximum
benefit and contribution base and the slow-down in benefit
increases brings the program into full actuarial balance over
the 75-year period and produces a slightly favorable balance--
0.04 percent of payroll. (See Table 1)
Table 1 Proposed Steps to Restore Social Security to Long-Term Balance
Expressed as a Percent of Payroll
(Long-term deficit is assumed to be 2.19% of payroll, per Trustees 1998
estimate)
------------------------------------------------------------------------
Proposed Change Reduces Deficit
------------------------------------------------------------------------
Invest part of Social Securitys accumulating funds in
stocks.............................................. -1.22
Adjust COLA to reflect BLS corrections to CPI........ -0.45
Extend coverage to all newly hired state and local
government workers.................................. -0.21
(Close actuarial balance: revenues at 95% of costs =
0.78) Deficit remaining after making the above
changes:............................................ 0.38*
Increase wage-averaging period from 35 to 38 years or
in some other way slow down benefit increases by 3
percent............................................. -0.25
Increase maximum earnings base....................... -0.28
Actuarial balance remaining after making all five
changes............................................. +0.04*
------------------------------------------------------------------------
*Adjusted for interaction of changes
Source: 1998 Trustees Report and Office of the Actuary, Social Security
Administration
Although discussed occasionally in previous years, the
direct investment of a portion of Social Security funds in
private equities is a new idea to most people. It is important
to understand that this is not a step toward privatization.
Nothing about the basic Social Security system, its policy and
principles and governance would change. The sole change would
be in investment policy, securing for Social Security the same
opportunities for a reasonable return on what people pay in as
is already available to other retirement systems and other
forms of savings.
It has not mattered very much in the past how Social
Security funds were invested because the system was a pay-as-
you-go system in practice and contemplated building only a
contingency reserve of a year to a year-and-a-half of benefit
payout. The greater rate of return from equities would not have
made much of a contribution to long-range financing in any
event. But now that the system is turning to partial reserve
financing with a significant future build-up in the Trust
Funds, how you invest the funds does make a difference.
In evaluating the three Advisory Council proposals and
other proposals, the Social Security actuaries assumed a long-
range real rate of return for Federal obligations of 2.5
percent and 7 percent for an indexed equity fund representative
of the broad market. I would propose that Social Security be
allowed to invest up to 50 percent of its funds in equities
with a one-years contingency fund kept entirely in Federal
bonds. The 50 percent figure would be reached gradually in the
years 2000 to 2014 and maintained at approximately that level
in the years thereafter.
It is very important that the fund be indexed and that the
function of portfolio managers be confined entirely to
maintaining a fund paralleling the index. It would not be a
good policy to have representatives of the government picking
and choosing individual stocks for investment or even appearing
to favor certain industries, and members of Congress would need
to be protected against pressure from constituents to favor
particular companies or industries.
The selection of indexes and portfolio managers would be
under the general direction of a Federal Reserve-type board
with members appointed for long and staggered terms. Portfolio
managers would be selected by bid from organizations qualified
by long experience in administering large indexed private
funds. Social Security or any other government agency would not
be allowed to vote stock or in any other way influence the
policies or practices of a company or industry whose stocks are
held by the indexed fund. These arrangements in their general
form have been tested by the Federal Employees Thrift Plan
which has operated under similar arrangements for many years.
They have worked well to protect that plan from deviations from
the chosen index or from any deviations from the single-minded
pursuit of the interests of the participants.
Relying on the stock market for retirement income is risky
for individuals in part because they have no control over when
they enter the market under the individual investment plans
being proposed, workers start to buy when they go to work and
they have little control either over when they convert their
investments to retirement income. Replacement rates of past
earnings by retirement income can be greatly affected by the
timing. As Gary Burtless of the Brookings Institute has shown,
for example, retirement replacement of earnings if the
retirement fund is invested entirely in equities would have
varied from 47 percent for a retirement in 1980 to 68 percent
in 1981; then back down to 42 percent in 1993; then back up to
72 percent in 1997.\2\ Variations anywhere near this magnitude
would represent a serious problem for workers, whose
expectations of retirement income could be abruptly undercut.
Investing by Social Security directly on behalf of the whole
system has no such disadvantage, and moreover, Social Security
would be able generally to ride out the ups and downs of the
market without major risk to long-term stability.
---------------------------------------------------------------------------
\2\ Robert M. Ball with Thomas N. Bethell, Straight Talk About
Social Security, A Century Foundation/Twentieth Century Fund Report,
May 1998, page 44.
---------------------------------------------------------------------------
Supplementary Individual Savings Accounts Through Social Security
With the basic Social Security system secured as a defined
benefit plan underwritten by both law and adequate financing, I
favor adding a voluntary savings plan provided through Social
Security administrative arrangements. Such a plan would provide
a safe, practical and efficient way for wage earners at all
levels to enhance their Social Security benefits without
imposing any significant administrative burdens on either
employers or the government.
Specifically, I would propose that beginning in the year
2000, wage-earners would be allowed to have an additional 2
percent deducted from earnings and forwarded by their employer
as part of regular Social Security reporting. Participants
could chose each year to invest the 2 percent as Social
Securitys portfolio is invested, or split 50-50 between stocks
and Treasury bonds, or entirely in equities or entirely in
Treasury bonds. Each year, when Social Security reports to all
workers over age 25 on the estimated amount of Social Security
benefits they may expect (as required by the Moynihan amendment
now part of present law and with full implementation beginning
next year), Social Security would also report to workers on the
amounts accumulating in their supplemental savings plans and
provide an opportunity for them to designate investments for
the following year.
Depending on the workers preference, accumulated savings
could be distributed, upon eligibility for Social Security
benefits, as an annuity, a lump sum, or in periodic
installments. At death any undistributed amount would be part
of the workers estate.
The rules governing the maximum amount to be deducted, the
tax status of the deductions, cashing-in procedures, and so on,
would all follow present IRA rules. For the first time, workers
in small companies and the lower-paid generally would have a
real opportunity to build conveniently on top of their assured
Social Security benefits and to participate in ownership of
equities should they care to do so.
These arrangements could be expected to considerably
increase voluntary savings over our present national level, and
would do so without any significant additional burden on
employers or the government and with the added advantage of
increased convenience and safety for employees.
The essential principle of the plan is that Social Security
is not in any way reduced to make room for a system of
individual savings accounts. The individual accounts are
entirely voluntary supplements logical add-ons to a refinanced
and fully dependable Social Security system.
Social Security Plus
This plan accomplishes two goals: It restores Social
Security to long-term balance; It establishes a simple,
effective way for individuals to set up savings accounts
supplemental to Social Security.
I. Restoring Social Security to long-term balance
Leverage the funds being paid into Social Security
by workers, employers, and taxpaying beneficiaries by investing
part of Social Security's accumulating funds in equities, in a
manner similar to that of most public and private pension
plans.
Under this approach, a contingency reserve sufficient to
pay benefits for approximately one year would be invested
solely in long-term Treasury bonds. Up to 50 percent of total
accumulated funds would be invested in a broadly indexed
equities fund, phased in between 2000 and 2014. A Federal
Reserve-type board with long and staggered terms would have the
limited functions of selecting the index fund, selecting the
portfolio managers by bid from among experienced managers of
private indexed funds, and reporting to the nation on the
overall operations of the plan. Social Security would not be
allowed to vote any stock or in any other way influence the
policies or practices of any company or industry whose stocks
are held by the indexed fund.
The increased revenues from investing part of Social
Security's accumulated funds in equities would cut Social
Security's estimated long-term deficit by more than half, from
2.19 percent of payroll to about 0.97 percent of payroll.
Modify the Cost-of-Living Adjustment to reflect
corrections to the Consumer Price Index announced by or
anticipated from the Bureau of Labor Statistics. This change
reduces the long-term deficit by up to 0.45 percent of payroll.
Make the program universal by covering new hires
in all state and local government jobs from the beginning of
the year 2000. (About three-fourths of state and local jobs are
now covered.) This change reduces the long-term deficit by
about 0.21 percent of payroll.
These three changes alone reduce the estimated 75-year
deficit from 2.19 percent of payroll to 0.38 percent. They
would bring the system fully into actuarial balance for a 50-
year period, extending the projected date of trust fund
exhaustion from 2032 to 2054, and over the entire 75-year
period for which Social Security estimates are traditionally
made would bring the deficit well within the definition of
``close actuarial balance'' (i.e., with revenues estimated to
be at least 95 percent of estimated costs, or in this case a
long-term deficit no greater than 0.78 of payroll).
The concept of close actuarial balance, adopted by the
Trustees decades ago, provides some leeway within which to
assess trends before calling for corrective action. Given the
inherent difficulty of forecasting anything for 75 years,
bringing the system into close actuarial balance would seem to
be a reasonable goal. However, two additional changes, both
modest in impact, would bring the system into actuarial balance
for the entire 75-year period:
Base benefit computations for future retirees on
indexed monthly earnings averaged over 38 years instead of 35
years as is done currently, or in some other way slow down
present-law benefit increases for future beneficiaries by 3
percent. This change reduces the long-term deficit by about
0.25 percent of payroll.
Increase the maximum amount of annual earnings
subject to Social Security tax and credited for benefits by 2
percent a year for 10 years beyond the increase that would
occur automatically under present law, raising the portion of
taxable wages from 84.7 percent to 87.5 percent, halfway to the
90-percent standard of the past. This change reduces the long-
term deficit by about 0.28 percent of payroll.
The following table shows the effect of the changes
described above.
Table 1 Proposed Steps to Restore Social Security to Long-Term Balance
Expressed as a Percent of Payroll
(Long-term deficit is assumed to be 2.19% of payroll, per Trustees 1998
estimate)
------------------------------------------------------------------------
Reduces
Proposed Change Deficit
------------------------------------------------------------------------
Invest part of Social Securitys accumulating funds in
stocks.................................................... -1.22
Adjust COLA to reflect BLS corrections to CPI.............. -0.45
Extend coverage to all newly hired state and local
government workers........................................ -0.21
(Close actuarial balance: revenues at 95% of costs = 0.78)
Deficit remaining after making the above changes:......... 0.38*
Increase wage-averaging period from 35 to 38 years or in
some other way slow down benefit increases by 3 percent... -0.25
Increase maximum earnings base............................. -0.28
Actuarial balance remaining after making all five changes.. +0.04*
------------------------------------------------------------------------
*Adjusted for interaction of changes Source: 1998 Trustees Report and
Office of the Actuary, Social Security Administration
II. Establishing Individual Supplemental Savings Accounts Through
Social Security
Goal: Provide an easy, safe, practical and efficient way
for wage-earners at all levels to add voluntary savings to
Social Security, with funds invested in the stock market if
they wish, and all without significant administrative costs or
burdens on either employers or government.
Beginning in the year 2000, wage-earners would be allowed
to have an additional 2 percent deducted from earnings and
forwarded by their employer as part of regular Social Security
reporting. Participants could choose each year to invest the 2
percent as Social Security's portfolio is invested, split 50-50
between stocks and bond, or entirely in equities or entirely in
Treasury bonds. Each year, when Social Security reports to all
workers over age 25 on the estimated amount of Social Security
benefits they may expect (as required by the Moynihan amendment
now part of present law), Social Security would also report to
the individual on the amounts accumulating in the individual's
supplemental savings plan.
Depending on the worker's preference, accumulated savings
could be distributed, upon eligibility for Social Security
benefits, as an annuity, a lump sum, or in periodic
installments. At death any undistributed amount would be part
of the worker's estate.
The rules governing the maximum amounts allowed to be
deducted, the tax status of the deductions, cashing-in
procedures, and so on, would all follow present IRA rules.
Each year when workers are given an estimate of their
future Social Security benefits, they would also be reminded of
the availability of this convenient and safe way to accumulate
supplemental savings to help them improve their economic
situation in retirement or when disabled, or to improve their
survivors' protection in the event of death. For the first
time, workers in small companies and the lower-paid generally
would have a real opportunity to build conveniently on top of
their assured Social Security benefits and to participate in
ownership of equities should they care to do so.
These arrangements could be expected to considerably
increase voluntary savings over our present national level, and
would do so without any significant additional burden on
employers or the government and with the added advantage of
increased convenience and safety for employees.
The essential principle of this plan is that Social
Security is not in any way reduced to make room for a system of
individual savings accounts. The individual accounts are
entirely voluntary supplements--logical add-ons to a refinanced
and fully dependable Social Security system.
Chairman Bunning. Thank you, Mr. Ball.
Mr. Goldberg.
STATEMENT OF HON. FRED T. GOLDBERG, JR., EXECUTIVE DIRECTOR,
KERREY-DANFORTH COMMISSION ON ENTITLEMENT AND TAX REFORM;
MEMBER, CENTER FOR STRATEGIC AND INTERNATIONAL STUDIES;
NATIONAL COMMISSION ON RETIREMENT POLICY; FORMER COMMISSIONER,
INTERNAL REVENUE SERVICE; AND FORMER ASSISTANT SECRETARY FOR
TAX POLICY, U.S. DEPARTMENT OF THE TREASURY
Mr. Goldberg. Thank you, Mr. Chairman.
It is a pleasure to be here today, and my understanding of
the topic of this hearing is less of a focus on the policy
issues behind Social Security reform and more of a focus on the
question of how you do private accounts.
I think an issue that was off limits and taboo several
years ago is now generating enormous bipartisan support,
support from a wide range of commentators and, if you believe
the polls, overwhelming public support.
I think private accounts is an essential ingredient of any
package of Social Security reforms. I believe those accounts
should be universal. I believe they are the only way to enhance
retirement income, create wealth for all workers, create a
universal savings infrastructure, and to remedy fundamental
inequities in the current system, especially inequities as they
affect minorities, the rural poor, single parents, and two-
income earner families.
But at the end of the day, I think both for policy and for
political reasons, the judgment that private accounts are
important and should be done is going to be overwhelming.
I think the question of whether they will happen will turn
largely on the question of can it be done, how do you implement
them, how do you administer them, and can you leave the
American public comfortable that they are going to work right,
work right for all workers, and I think these administrative
issues are going to ultimately drive the outcome in this
debate.
Before getting into that suggestion, I think it is also
important to keep in mind two ground rules. I think all of us
tend to skip them.
The two ground rules are, first, whatever you do with
private accounts, keep faith with current retirees.
And the second ground rule is that Social Security stands
for a promise, and that promise is that men and women who spend
their lives working in this country simply will not retire into
poverty. It is not perfect, but it is close, and I don't think
that we can walk away from that defined benefit commitment.
Whatever we do, indeed my personal judgment is that commitment
should be enhanced as part of this process.
Now, in thinking about designing a system of private
accounts, it is useful to break the program down into three
tasks. The first task is getting the money into the system and
crediting that money to accounts. It comes in--when does any
individual and how does any individual get those contributions
credited, how do those funds get collected?
The second problem or challenge is to figure out how do you
get those funds invested and how do you maintain individual
account records, how do you report to individual beneficiaries,
and it is the account maintenance phase.
The third phase is that the funds must be distributed only
when appropriate and must be distributed in the manner that is
appropriate. And I think breaking the tasks down into those
three pieces is helpful in thinking through the challenge.
In terms of how to design a system, I think there are three
design constraints.
First, it is essential to minimize administrative costs. If
you are talking 2 percent of payroll and you are thinking of a
kid with a summer job making $2,000, that is a tiny amount of
money to be depositing in a private account.
Second, I think it is important to minimize the burden on
employers.
Third, the system must be simple to administer. I think
this is the most important point. The surest way to destroy
private accounts is to spend your time looking for the perfect
system that accommodates all options, all choices, and
addresses all theoretical concerns.
Now, in addition to these constraints, first, the system
needs to be universal.
Second, the participant should not have access other than
to fund retirement or disability.
Third, the system should be flexible.
And fourth, the system should leave the American public
comfortable that they would not be subject to the unbridled
whims of the market.
In looking through these criteria, the approach that makes
the most sense is to build on the existing systems. The payroll
tax system functions well. It is universal, it is
understandable by the public and imposes no additional burdens
on employers.
So that is the mechanism I believe for the collection of
funds and crediting of accounts.
In terms of investing funds and investing options, I think
the Thrift Savings Plan is the most useful model in terms of
teaching limits. Limit the number of choices, the frequency of
changes, and contract out the management of the investment
funds to the private sector.
Third, in terms of distribution, I agree that the Social
Security system is an existing mechanism that functions well in
the payout and distribution of benefits, particularly in the
context of annuitized payments.
This is the easy part. The last portion of my testimony
lists 17 of what I think are myriad questions which need to be
answered in getting into the details of making a private
account system work properly.
Deciding it is a good idea, locking in on the policy,
agreeing on the basic framework I believe can be done and can
be done very quickly. I think resolving the details, making
sure the thing works well is going to be the hard part. I am
absolutely certain it can be done. Thank you very much.
[The prepared statement follows:]
Statement of Hon. Fred T. Goldberg, Jr., Executive Director, Kerry-
Danforth Commission on Entitlement and Tax Reform; Member, Center for
Strategic and International Studies; National Commission on Retirement
Policy; Former Commissioner, Internal Revenue Service; and Former
Assistant Secretary for Tax Policy, U.S. Department of the Treasury
Mr. Chairman and Members of the Committee, it is a pleasure
to appear before you today to address matters relating to the
design of individual private accounts (``IPAs'') as part of
your efforts to protect and enhance Social Security for the
21st Century. My understanding is that I have been asked to
testify on this topic based on my experience as Executive
Director of the Kerrey-Danforth Commission on Entitlement and
Tax Reform (1993-1995), and as a member of the Center for
Strategic and International Studies National Commission on
Retirement Policy (1997-1998). The Congressional Co-Chairs of
the CSIS Commission were your colleagues Congressmen Kolbe and
Stenholm, and Senators Breaux and Gregg.\1\
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\1\ These experiences have informed my views regarding IPAs, as did
April's Social Security forum in Kansas City, co-sponsored by AARP and
the Concord Coalition, where I had the honor of serving as one of the
panelists. Perhaps my most relevant experience for purposes of today's
hearing, however, is the time I spent as IRS Commissioner and as a
Member of the Kerrey-Portman National Commission on Restructuring the
IRS.
---------------------------------------------------------------------------
Senators Kerrey and Danforth, along with several of their
colleagues, endorsed IPAs in the Kerry-Danforth Commission's
final report (1995), and legislation to create IPAs was
subsequently introduced by Senators Kerrey and Simpson. The
final Report of the CSIS Commission (May 1998) also recommends
creation of IPAs. In addition, all members of the Advisory
Council on Social Security supported some form of investment in
private markets, and two-thirds of the Council supported some
form of IPAs. More than a half dozen legislative proposals
calling for the creation of IPAs have been introduced recently
by your colleagues, and opinion surveys suggest that an
overwhelming majority of Americans support IPAs.
I. Background
In my experience, those who feel strongly about IPAs--
whether pro or con--jump in to the subject far too quickly.
There are two other aspects of Social Security reform that
should be emphasized and re-emphasized, over and over again:
First, any changes must keep faith with current retirees.
Second, any changes must maintain and enhance the so-called
``safety net'' features of the system. This includes not just
the disability and survivor benefits of current law, but the
basic defined benefit features as well. The point is really
simple: Social Security stands for the proposition that men and
women who spend their lives working in this country will not
retire in poverty.
These principles reflect sound policy and political
imperatives. They also have a direct impact on the design and
implementation of IPAs. For the foreseeable future, amounts
going to an individual worker's IPA will be relatively small in
both percentage and absolute dollar terms. For example, both
Kerrey-Danforth and the CSIS Commission recommended 2% of
payroll up to the FICA cap. For a full-time worker making the
minimum wage (approximately $12,000), this translates to $240
per year, or $20 per month. For the millions of part time
workers, students with summer jobs, and the like, the dollar
amounts would be far smaller (e.g., $3,000 in wages translates
to $60 per year, or $5 per month). For a high wage worker (at
the wage cap of about $68,000), this translates to $1,260 per
year, or $105 per month. In addition, some have suggested a
fixed dollar floor amount for all IPAs, and there seems to be
widespread support for permitting voluntary add-on
contributions to IPAs.
While today's hearing is not focused on policy issues
relating to IPAs, it is worth summarizing the arguments that
are generating such widespread interest and support:
They will generate additional returns to help
maintain adequate retirement income.
IPAs will be of particular benefit to those with
short life expectancies (e.g., African Americans living in the
inner cities; the rural poor; Native Americans). They will also
benefit single individuals, single parents, and two income
earner families.
They will help create wealth for all Americans,
with benefits that transcend those related directly to Social
Security.
They will put in place a universal infrastructure
that can be used to facilitate and encourage savings by all
Americans.
Unlike legislated benefits that can be legislated
away, IPAs will ``wall off'' contributed funds, and create
property rights protected by the Constitution.
Finally, by way of full disclosure, I should acknowledge my
bias: I think that IPAs are an essential part of any effort to
preserve and protect Social Security. I also believe that--if
structured properly--IPAs will someday be viewed as one of the
most important and far-reaching domestic policy initiatives in
many decades.\2\
---------------------------------------------------------------------------
\2\ In this regard, I commend you to Senator Moynihan's truly
remarkable speech at Harvard earlier this year.
---------------------------------------------------------------------------
Hopefully, these views make me more--not less--objective
regarding the challenges you will face in legislating IPAs.
While many aren't there yet, I am convinced that the case for
IPAs is overwhelming--regardless of political party and
ideology, from the most liberal democrat to the most
conservative republican. At the end of the day, the key
question will be whether they can be implemented and
administered, and whether the American people will trust their
elected officials to get it right. I think it will be
difficult, but I am certain that it is doable.
II. Design Framework
From an administrative standpoint, a system of IPAs must
accomplish each of the following: (1) It must get funds into
the system and properly credit each individual participant's
account. (2) It must invest funds on behalf of participants,
and properly maintain each participant's IPA (e.g., provide
account statements, answer account inquiries, etc.). (3) It
must make distributions to each participant (and his or her
beneficiaries) at appropriate times as required or permitted by
statute, and preclude distributions when not otherwise allowed.
Each of these three functions should be considered in light
of three major design constraints: (1) The system should
minimize administrative costs and distribute those costs in a
manner that is perceived as fair and reasonable. This rules
out, for example, allocating fixed dollar costs to each account
(a $25 flat fee charged to a $400 account would consume an
unacceptably large share of earnings). It may also suggest that
at least some administrative costs should be funded from
general revenues. (2) The system should minimize the burden on
employers. (3) The system must be simple to administer, simple
to explain, and easily understood by normal, everyday
Americans. This last point is the most important. Our income
tax system has been destroyed by complexity--a complexity
caused in largely by well-meaning efforts to achieve
theoretical purity, eliminate every real and imagined
``abuse,'' and address non-tax policy objectives. I guarantee
you that the surest way to destroy any hope for IPAs is to
spend your time designing the ``perfect'' system.
In addition to these three constraints, the IPA system
should satisfy a number of other criteria. First, it should be
universal, rather than optional. This is the only way to
realize the intended benefits of IPAs. Second, like Social
Security itself, participants and their beneficiaries must not
be able to access IPA funds prior to disability or retirement
(or death of the participant, in situations where funds are
available for the participant's beneficiaries). Third, the
design should provide flexibility to permit the following: (a)
regulation of investment alternatives; (b) required
annuitization of IPA balances on retirement; and (c)
apportionment of any claims on IPA funds between the
participant and his/her current/former spouse(s) . Fourth, the
design should leave the American public comfortable that--while
workers will own and control their IPAs--they will not be
subject to the unbridled whims of the markets (and Wall Street)
without any safeguards or protection.
III. Some Alternatives
Three reference points are useful in thinking about design
alternatives: (1) An employer-based system (e.g., 401(k)
Plans), under which all employers would be required to set up
and maintain IPAs for all of their employees. (2) A worker-
based system (e.g., IRAs), under which each individual worker
would be responsible for setting up and maintaining his or her
own IPA. (3) A system that builds on the existing payroll tax
and Social Security systems.
There are, of course, arguments in favor of both employer-
and worker-based systems. Nonetheless, there seems to be a
widely-shared view that these approaches would violate one or
more of the three major design constraints and would be less
likely to accommodate the other criteria noted above. For
example, an employer-based system would impose substantial
additional burden on employers. In a worker-based system, it
would be difficult to minimize administrative costs and
distribute those costs in a fair and reasonable way. It would
also be difficult to assure universal participation in a
worker-based system.
The preferred way to implement IPAs is build on, and learn
from, existing systems--while recognizing that a primary
objective should be to design a system that can be modified and
enhanced, once it is up and working smoothly. In terms of the
three IPA functions noted above:
(1) Collecting Funds and Crediting Accounts.--The current
payroll tax system already covers all participants and collects
the information and funds necessary to credit and fund
individual worker accounts.\3\ While it certainly can and
should be improved, the payroll tax system generally functions
quite well. Using this structure should impose no incremental
burden on employers and minimize the administrative costs of
collecting funds and crediting accounts. Because all workers
already participate in the system, it should impose no
additional burden on participants and should be relatively easy
to understand.
---------------------------------------------------------------------------
\3\ This is clearly the case if IPAs are funded through a ``carve-
out'' from the existing payroll tax. Alternatively, the IPA system
could be funded through an ``add on'' to the current payroll tax. If
IPAs were funded from general revenues, the payroll tax reporting
system would provide the information necessary to credit individual
accounts.
---------------------------------------------------------------------------
(2) Investing Funds and Maintaining Accounts.--The
retirement plan for more than 3 million Federal employees (the
Thrift Savings Plan, or TSP) provides a useful frame of
reference for designing how to invest funds and maintain
accounts. When originally introduced, the key features of that
system were: (a) participants were given a limited number of
investment choices; (b) they had limited opportunities to
change their investment choices; and (c) the government
contracted out for the investment of funds and the maintaining
of individual participant accounts. The Federal government
would distribute information to participants regarding their
investment options, participants would select from among those
options (e.g., in connection with filing their tax returns),
and there would be a default option for participants not
specifying an investment choice.
While the orders of magnitude are many times greater (3
million versus more than one hundred million), the same
principles should apply. By limiting investment options and
frequency of changes, the IPA administrative costs can be held
to a minimum, and those costs can be allocated in a ``fair and
reasonable'' way (e.g., as a percentage of the account balance,
or funded from general revenues). Likewise (for better and for
worse), there would be no ``marketing'' costs of the type that
concern some critics of private accounts. By contracting out
for the investment of funds and maintenance of accounts (albeit
on a much larger scale), the government can minimize costs and
minimize the risk of government meddling in the capital
markets. Finally, this approach should meet the criteria of
simplicity and reasonable security from the standpoint of
individual participants. While workers are given meaningful
control and investment alternatives, those choices are limited
to prevent confusion and to define a reasonable range of risk-
taking alternatives.
(3) Distribution of Benefits.--Social Security provides an
existing--and effective--mechanism for the distribution of
benefits, and there appears to be some agreement that
distributions from IPAs should piggy back on this system. Once
again, this should impose no incremental burden on employers,
minimize administrative costs, and allow participants and
beneficiaries to deal with a system that is familiar and
perceived as reliable.
This approach addresses the three design constraints and
other criteria noted above. Moreover, it has the added virtue
of flexibility. For example, participants could be given
broader investment choices and distribution options over time
(including roll-overs to regulated private funds and the
purchase of annuities tailored to meet their particular needs
and objectives); the system could accommodate voluntary
contributions, administered through either the withholding or
income tax systems. Having said as much, however, I encourage
you to take it slowly. Don't try to do too much, too soon. Once
again, the keys are simplicity and a system that reassures the
American public.
IV. The Devils in the Details
While the foregoing is widely viewed as the most practical
and viable framework for implementing IPAs, it leaves many,
many critical details unanswered. This leads me to the one
suggestion I have for you and your colleagues. I urge you to
encourage those interested in IPAs to begin with this
framework, and set about the difficult task of identifying the
myriad practical questions and the viable options that must be
resolved before IPAs can become a reality.\4\
---------------------------------------------------------------------------
\4\ I recognize that there is some support for the other basic
approaches to IPAs: an employer- or worker-based system. My own view is
that the former is completely unrealistic for a variety of political
and practical reasons. While it is possible to design a worker-based
system, I think it would be difficult to implement and administer in
the context of universal (as distinguished from optional) IPAs.
Nonetheless, those who favor either of these approaches should go
through the same exercise: figure out the overall framework, and then
identify and resolve the myriad practical issues of implementation.
---------------------------------------------------------------------------
By way of illustrating this point, following are a few of
the many issues that should be addressed.
1. When and how to credit IPAs (should data be taken from
tax returns or W-2s; whether/how earnings should be attributed
for the period between the end of the year and the time
accounts are credited, which could take up to a year or more)
2. What are the consequences when funds are not withheld or
deposited by an employer; by a self-employed individual
3. What are the investment options
4. How are participants advised of their investment
options, and how do they make their choices
5. What is (are) the default option(s)
6. How, and how frequently, should participants be
permitted to change their investment choices
7. How to structure contracting out the investment of funds
and maintenance of accounts
8. Should some (or all) investment options guarantee a
minimum return
9. Can/should the investment options limit risk of
volatility as participants approach retirement age
10. Whether, how and when the system should accommodate
voluntary additional contributions
11. Whether, how and when the system should permit
participants to roll-over their IPAs to privately managed
investment funds
12. What rights do spouses, and former spouses, have in a
worker's IPA
13. Should participants be required to annuitize some or
all of their IPA at retirement; if less than all, how much
14. Whether, when and how participants may chose from more
than one type of annuity with respect to the portion that must
be annuitized
15. Who should bear what risks (market and mortality) with
respect to annuitized amounts
16. What, if any, early withdrawal rights are there with
respect to IPAs (e.g., disability); how should they be
structured
17. How should distributions from IPAs be taxed (if at all)
18. Effective dates
VI. Conclusion
In closing, Mr. Chairman, I would like to congratulate you
and your colleagues for your foresight in addressing issues
relating to Social Security reform and IPAs. I am convinced
that universal IPAs can and should be an important part of
Social Security in the 21st Century. That's the easy part. The
hard part will be designing a system that works. Above all, my
advice is to start slowly, build on existing systems, and keep
it simple.
I am a partner in the law firm of Skadden, Arps, Slate, Meagher
& Flom. A number of the firm's clients are interested in
matters relating to IPAs. In addition, I have been engaged by
Merrill, Lynch & Co. to study issues relating to the
implementation and administration of IPAs. I am appearing today
in my individual capacity and the views herein are solely my
own.
Chairman Bunning. I thank the panel for their
participation. I just want to ask a couple of questions.
Doctor, you said something about both spouses
contributing--in other words, if one spouse contributes and
works, that 50-50 should go into----
Mr. Kotlikoff. Right.
Chairman Bunning. Does that work both ways?
Mr. Kotlikoff. The income of the couple is combined and
divided in half.
Chairman Bunning. If the working spouse is female, she also
would share her Social Security with her working spouse who is
male?
Mr. Kotlikoff. Absolutely, yes.
Chairman Bunning. That is an interesting concept.
Somebody mentioned the CPI being changed, and that would
assist us in funding Social Security for a longer period of
time. I think it was you, Mr. Ball. When do you think that is
about to happen?
Mr. Ball. Mr. Chairman, it has been happening over the last
several years. The Bureau of Labor Statistics has given very
intensive study to updating, changing, improving the measure
and they have done a lot already. And they have announced an
additional change which has not yet been incorporated in the
Social Security estimates, another 2-percent cut actually in
the CPI itself which translates in percentage of payroll, which
are the numbers that we are using for Social Security, to about
3 percent.
And there are other things under consideration, like
updating the market basket more frequently, for example, which
would improve the Social Security situation by not having the
cost of living go up unreasonably.
I want to emphasize that the cost-of-living provision in
the Social Security Act is one of the most important parts of
Social Security. Being able to keep the benefits up to date as
the price level rises is absolutely essential to making Social
Security a good system----
Chairman Bunning. It has been 8 years since we have had an
adjustment.
Mr. Ball. No, they are making changes in the basic measure
and every year, Social Security benefits are changed to respond
to changes in the CPI every year----
Chairman Bunning. Absolutely. But I am talking about the
changes in the basket that----
Mr. Ball. The market basket? That is priced only once in 10
years. So they are wrong one way for 5 years and wrong the
other way for another 5.
Chairman Bunning. It should be updated more often.
Mr. Ball. Maybe it should be done every couple of years. It
is not that big an expense, and so many things are dependent on
it. That is not even a policy issue. If you supplied the money,
they could do it.
Chairman Bunning. You all are suggesting that there ought
to be some private accounts; all generally are in agreement. It
is how it is done, it is whether we keep the present Social
Security benefits at the level they are. It is the age when
seniors retire.
Under current law, the retirement age is gradually
increasing to age 67 for workers who reach age 62 in 2022. If
we just would continue on that same pattern, another maybe 15
or 20 years, we could get to age 70 as the retirement age.
Whether that is right or wrong, I am not going to get into that
discussion, but that is a way to help ensure the program's
long-term solvency.
The main thing is how private accounts are handled, whether
we add them on top of or whether we supplement them in
relationship to a reduction allowing certain age groups to
choose to get in or out, or allowing all age groups to get in
or out if they choose.
But you, Fred, say that they should be handled by the
government? The government should be the entity that handles
the private investment accounts?
Mr. Goldberg. I believe the government should perform
certainly the administrative functions.
Chairman Bunning. Much like the 401(k)?
Mr. Goldberg. The Federal thrift plan covers all Federal
workers. I start by believing that these accounts should be
mandatory. Cut your tax and go to your local broker, that is a
very different system. But if you think that they ought to be
mandatory, the challenge is to take this over 100 million
workers and figure out how do I get all of this money collected
and credited to accounts in a way that doesn't impose
recordkeeping burdens on the private sector and ensures that
everyone is participating. I think we have a vehicle to do
that. The payroll tax system works well. So the government does
the first step, gets the funds and figures out how much money
goes into each account.
Chairman Bunning. I don't think that we have any trouble
getting the money, for Social Security I'm talking. We get the
money, but the process after that----
Mr. Goldberg. You get the money and credit the money to the
account of the individual. I hate to be very technical, but the
IRS does not know who put in how much money until a year after
the money comes in, and that is a real technical point, but how
you deal with that is a very important point.
Chairman Bunning. None of you mentioned using the surplus.
Mr. Kotlikoff. I would be happy to.
Chairman Bunning. In my opinion, that is one area that we
could supplement what we use for individual accounts.
Mr. Kotlikoff. In my view, that is a complete inaccuracy.
Chairman Bunning. The fact that we are going to have one?
Mr. Kotlikoff. The surplus is there. We have a surplus, but
also an enormous liability. If you spend the surplus, the
assets to cover the surplus are not there anymore--the assets
to cover the liability are no longer there.
So yes, it is nice to think of ideas how to spend money,
but it is not like we got this gift from Mars.
If you look at a present-value calculation of the problems
of this system and the entire fiscal enterprise of the U.S.
Government, we have an enormous generational problem here, and
inventing money when it is not really there is not a way to
approach it.
This proposal that I am offering is the only proposal that
is really honest about the size of the problem and gets
everybody, old and young, middle aged alike, to alleviate the
problem. It is the only proposal that is really coming out
clearly and saying we need a tax that everybody pays to retire
the unfunded liabilities of the old system.
Ms. Munnell. Actually we did talk about the surplus, if not
explicitly. Any proposal that involves investing the trust fund
in equities, given the current budgetary treatment of an equity
investment, involves spending the surplus and essentially
making it disappear.
Mr. Gramlich. I would like to get an oar in on this, too.
There is what economists would call a stock and a flow
problem with this. If you are going to have individual
accounts, you want to set up the system so there are
contributions to those individual accounts indefinitely. That
way there will be individual accounts for people who are 50 or
40, who are 20 and who are not born yet and so forth. So you
have to plan on these contributions happening indefinitely.
The surplus is going to be around for 10 years or so, and
then under even the latest forecast of CBO it is gone. So if
you set up Social Security in the long run to rely on
individual accounts, you really have to come up with some other
mechanism.
Mr. Goldberg. I didn't understand a lot of those words, but
the simple point is right now we are running a surplus.
Forgetting the fact that money is fungible, the money is coming
out of the Social Security funds.
The hardest part is setting this thing up, I believe. You
could take the current surplus, you could use that current,
quote, ``surplus'' to fund private accounts. Without changing
anything else in Social Security, you could have some offset
mechanism running between those private accounts and Social
Security payments down the road to deal with the long-term
financing issues; but what you will have accomplished is put
the mechanism in place for creating the kind of wealth for
individual workers. So I think you can do something with the
surpluses; and if that is the best you can go, that is what you
ought to do.
Chairman Bunning. Thank you very much.
Sandy.
Mr. Levin. We are due on the floor.
Chairman Bunning. We have a bill on the floor, and I
apologize. We have the ticket to work bill on the floor which I
am supposed to manage and the rule is up right now. So if you
don't have any more questions--I am going to submit some
questions to you in writing because I have a lot more questions
that I want to ask, but I apologize for going to the floor
but----
Mr. Levin. Never apologize for that. I will ask just a few
questions and then join Mr. Bunning.
Without a change, the financial picture is dramatic; but
without Social Security there is hardly--there is no surplus
without it, and even with it there isn't that grand of one, so
I think we better be very cautious and get at this problem
first. I think the President is correct.
I think the discussion today has been most constructive,
and I think this kind of an interchange sets a good example of
an honest exchange of not choosing up sides reflexively, of
trying to find the common ground.
Part of the debate, though, means not to skim over issues.
So while there is considerable common ground among you, I think
there are considerable differences.
Private accounts are something very different from
privatization, and I think that we need to have the discussion
about how we get a larger return on the investment, and there
really is among you some important differences as to how we do
that. And if we are going to have a meaningful debate, we have
to have civility and also controversy. Again, I congratulate
you because I think this is the kind of discussion that we need
to have.
Everybody agrees that we need to have a larger return. I
think the restriction on the investment of Social Security in
the thirties was very natural. Social Security was set up after
the crash. I don't think that we should have expected that
anyone suggest that we invest in securities in 1935.
Mr. Kotlikoff. I would have. The price was low.
Mr. Levin. The risks seemed dramatic, right? And it would
be interesting to go back in the debates to see if anyone
suggested that. I would doubt that the person who suggested
that served more than one term or was reelected.
Now, there is a suggestion that we have individual accounts
which would be controlled by individuals, and I am not sure any
of you go very far on that. Some of you do with some government
restraints, and then others of you suggest there be an
investment of present funds, and some of you suggest that there
be some add-on that would be individually invested.
So let me just ask a couple of questions about that common
ground that has a lot of differences.
Dr. Munnell, you are the one who touched on having the
government invest in the stock market to put it in simple
terms, and Dr. Gramlich, you may want to comment from an
economist's viewpoint as well.
What kind of risk is there? If you have considerable
investment by a government entity, you seem to think that it is
minimal, a minimal risk?
Ms. Munnell. Congressman Levin, I am worried there may be
too much decorum here. I don't like Ned's plan because he cuts
back 30 percent on Social Security and I really don't like the
CSIS plan because they cut back 40 percent on Social Security,
so I just want to make sure that when we leave this hearing
that there is not all that much agreement.
Mr. Goldberg. We also ought to clarify that is a complete
mischaracterization of the CSIS plan.
Ms. Munnell. Investing the Social Security Trust Funds in
equities, is not the only proposal to invest in equities.
Everybody's proposal involves equity investments. Ned's
involves equity investments. His is similar in that the
government maintains control of the funds and designates
appropriate options. So it is not a question of equities or no
equities. It is rather a question of where the equities should
be held, and people like me who support holding them in the
central trust fund do so because they think that it would
spread the risks better over the population and also allows us
to spread risks between generations. So it is a better risk
spreading mechanism.
Mr. Gramlich. I think there are two problems with that as
long as we are going to take off the gloves here.
One is that usually plans like these, as described by both
Alicia and Bob, don't involve any real changes in Social
Security, no changes in taxes or benefits, and so that means
that the equity investment does not come out of new saving.
There is a kind of giant asset shift going on in the economy
where Social Security holds more stock than people, and average
people hold less stock, so the country is no richer.
And I think a first point is if we are going to devote new
funds to the market, we ought to do it out of new saving.
The second thing is if you don't do it through individual
accounts, if you have the regular trust fund hold all of the
stocks, it turns out to be a huge amount. It builds up to
something like a trillion dollars of stock, and then you have
got a situation where you really do come close to changing the
balance between the public and private sectors in this country.
I think just about every corporation would have Social Security
be its largest stockholder. And if you do it through individual
accounts, there would be a lot of funds, maybe 5 or 10,
individuals would be electing bonds or stocks, and I think you
would keep the firewalls, as they are called, between the
public and private sector better constructed than if you had
Social Security fund itself holding a huge amount of equity.
That is the problem that I have with that particular approach.
Mr. Levin. My time is up.
Mr. Christensen [presiding]. I think we ought to let Dr.
Kotlikoff respond.
Mr. Kotlikoff. I appreciate that.
I think the way to characterize the difference is we have
some people advocating that we basically do nothing and this
will of course get us into hotter and hotter water.
Mr. Levin. I don't think that they would agree with that.
Mr. Kotlikoff. You're right, they've deluded themselves
into believing they are advocating real reform when they are
really doing nothing of the kind.
Some people, Ned and others, are advocating doing what I
would say is far too little.
And we have one party here who is advocating doing it the
right way, and that frankly, is me. In my view, you do it the
right way or you forget it.
The real issue is that we can only harm Social Security's
funding by taking the surplus and giving it away. And we can
get rid of our liabilities by taking the trust fund and putting
it into stocks. Frankly, that is just a sham transaction and
any decent economist knows it.
As Ned was just saying, the trust fund will hold the stocks
and the public will hold the bonds and it will just be a
portfolio swap.
The real issue is whether you pay off this liability and
who is going to do it. Who is going to pay off that liability?
Are you going to get the current elderly, the current middle
aged and the current young and the future generations
collectively to pay it off or are you going to put a bigger and
bigger burden on future generations so they end up with a much
worse fiscal mess than we are already providing them?
Our proposal is not a Democratic proposal or a Republican
proposal. It is coming out of academia; first of all it
recognizes the liability--that we can't use magic or smoke and
mirrors accounting or sham transactions to pay it off. Let's
pay it off with a comprehensive business cash flow tax which is
effectively, a consumption tax, but one which insulates the
poor elderly, because they are living off Social Security and
their real incomes would be fully preserved. Let's privatize
Social Security at a large enough scale so we don't eliminate
all of the gains of privatization through transaction costs.
Let's protect dependents. Let's do it on a progressive basis,
let's make sure that there is a single security so that people
can't play the market.
Mr. Christensen. I am going to let Congressman Becerra get
in here on these questions.
Mr. Becerra. Thank you, Mr. Chairman. Actually, I don't
mind letting you finish.
Mr. Kotlikoff. I think we have to recognize that there is
nothing free here. This is not a free lunch. We have an
enormous problem. It is twice as big as the Trustees are
disclosing. The actuaries will disclose it if you call them up
on the phone. The Trustees are only looking out 75 years, which
sounds like a long time to look out, but there is an enormous
train wreck in year 76 and year 77 and those outyears. So if
you do the calculation correctly, you find that the problem is
twice as big as is being advertised.
Mr. Becerra. Regarding your business cash flow tax, you say
that it amounts to a consumption tax and the elderly will be
shielded. What about the working poor or middle class to low
middle class who will not be shielded by any governmental
program, who are not yet retired?
Mr. Kotlikoff. Under our program you are getting rid of a
payroll tax, the payroll tax for the OAI Program, and you are
replacing it with a consumption tax.
Mr. Becerra. It is a wash?
Mr. Kotlikoff. In terms of aggregate revenue, it is a wash.
Mr. Becerra. In terms of the tax on the individuals?
Mr. Kotlikoff. On the individuals we have done simulations,
and the individual poor young workers would be better off.
Because you are getting more of the fiscal burden being paid by
older people, rich and middle class older people, you are going
to have a smaller effective tax on younger workers. We also----
Mr. Becerra. But with a consumption tax, the more wealth
you have, the smaller percentage your tax will be relative to
your wealth because you consume typically the same amount
whether you are rich or poor or middle class. But if your
wealth is great, the actual amount of consumption----
Mr. Kotlikoff. I would characterize that as a
misunderstanding of the consumption tax.
Mr. Becerra. Let me follow up on that. You are rich and I
am middle class. You probably weigh about the same as I do. You
probably consume about the same amount of food. You purchase
about the same amount of clothes. You probably buy a more
expensive car than I do.
Mr. Kotlikoff. How does the tax hit me more than you?
Mr. Becerra. Yes.
Mr. Kotlikoff. First of all, if I am rich I am taking
vacations, buying yachts, and having a $2 million yacht party
in the New York harbor, as a member of the Forbes family
recently did.
Mr. Becerra. And you pay on that yacht.
Mr. Kotlikoff. That $2 million party is a consumption item.
Mr. Becerra. You tend to write it off as a business
expense.
Mr. Kotlikoff. Not under the consumption tax that I am
advocating.
One of the ways that we pay for consumption is out of our
wealth, and the other is out of our labor earnings. So when you
are taxing consumption, you are really taxing wealth plus labor
earnings.
Now, you are saying correctly Bill Gates can't spend all
his wealth, but when he leaves it to his kids----
Mr. Becerra. It is investment income.
Mr. Kotlikoff. If we have a 10 percent or 8 percent
consumption tax, the consumption that he does will be taxed,
and when he leaves his money to his kids when they spend it on
consumption, it will also be taxed.
Mr. Becerra. That doesn't mean that----
Mr. Kotlikoff. Mathematically it is equaling out to a one-
time wealth tax of 10 percent.
Mr. Becerra. He has two cars, I have one, and he is paying
more tax, but he is paying more tax because he has two cars.
Mr. Kotlikoff. How much tax is he paying under the payroll
tax on his wealth? Zero.
Under a consumption tax, which is what we are advocating,
he will--if we are talking about an 8 percent consumption tax,
be taxed to the tune of 8 percent of his wealth.
Mr. Becerra. Not all of his wealth.
Mr. Kotlikoff. If it is spent on consumption----
Mr. Becerra. Is all of his wealth going to be spent on
consumption?
Mr. Kotlikoff. When he leaves it----
Mr. Becerra. What is Bill Gates worth?
Mr. Kotlikoff. When he leaves it to his heirs, to his kids
and grandchildren, they will pay the consumption tax.
Mr. Becerra. We have to wait 50 years for his grandchildren
to spend it so we can pay for the benefits, so that retirees
who retire right now can get the full amount of their benefits?
Mr. Kotlikoff. If he is not spending his assets on
consumption, that is a positive thing for the economy. When he
does----
Mr. Becerra. When he bought a home which is worth how many
million dollars, he is consuming.
Mr. Kotlikoff. A consumption tax would tax imputed rent on
his house if set up correctly.
Mr. Becerra. If I owned that house, I would be willing to
let them tax me on that as well.
What I was saying is still accurate, that a consumption tax
hits someone who is less wealthy harder than someone who is
wealthier, simply because the wealthier person doesn't increase
his consumption at the same rate he increases his wealth.
Mr. Kotlikoff. I respectfully disagree. We are talking
about going from a payroll tax to an equal revenue consumption
tax. A consumption tax taxes wages and wealth. A payroll tax
just taxes wages. When you go from a wage tax to a consumption
tax, you are lowering the tax on workers.
Mr. Becerra. My time has expired. I would challenge you on
your definition of wealth.
Mr. Kotlikoff. This is the common definition in public
finance. Let me just point that out.
Mr. Christensen. Mr. Portman.
Mr. Portman. Go ahead.
Mr. Gramlich. Just on this issue, in these halls there have
been many long and complicated debates on consumption taxes.
The issues are tangled.
Without taking a position on that tax, the consumption tax
only comes up in Larry's plan because when you have a big scale
privatization switch, you need transition expenses.
The other plans that we have talked about here, whether
they are good or bad, don't have any transition taxes and so
the issue of whether we have a consumption tax or not, which we
don't now at the national level, would not arise.
So this is only an issue if you get into big scale
privatization plans. It is not an issue in some of these other
more gradual type plans.
Mr. Portman. I was enjoying Dr. Kotlikoff's segue into tax
reform.
Fred Goldberg talked earlier about his characterization of
the CSIS plan, and perhaps you wanted an opportunity to respond
or rebut what was said earlier?
Mr. Goldberg. First of all, I think it is correct to say if
you look at the defined benefit feature, there is a reduction.
I think that is fair to say. But if we have a reasonable
discussion about it, there is also a system of mandatory
private accounts. And if you assume that those accounts all
fall to zero, it is a 40-percent reduction. But depending on
what sorts of rates of return, it may or may not be a reduction
at all.
Second, if you look at some of the changes in the defined
benefit features as they relate to----
Mr. Portman. Let's assume a rate of return on a historical
rate of return.
Mr. Goldberg. If you assume reasonable positive rates of
return, it turns out that most cohorts will do substantially
better.
If you get into policy behind private accounts, are they
voluntary or mandatory, and are they add-ons or carve-outs, it
is sort of easy to see what those choices are. I believe you
can make reasonable, good arguments for any of those choices.
That is your box, mandatory or voluntary, carve-out or add-on.
That is all you need to decide, and then you can get about
designing the system.
Mr. Portman. Let's assume that it is a carve-out. What is
wrong with having the Social Security account that is left,
let's assume 3, 4, 5 percent would be taken out in terms of a
personal savings account of some kind, investing in a prudent
way in the capital markets as well as having this ability in
your own account, within parameters, to take advantage of some
of that wealth creation? Is there a reason that we could not do
both?
Ms. Munnell. I am concerned about Fred cutting back roughly
40 percent on the defined benefit Social Security Program and
substituting an individual account, which is defined
contribution, because I don't think the defined contribution
individual account will do as good a job as the defined benefit
that we have in place now.
There are a host of reasons, but I think the primary one is
if you tell people they have these defined contribution
accounts and it is their money, then when they get sick, they
are going to want access to that money, quite reasonably.
If they want to buy a house, they are going to try to get
access to that money. I am afraid that money is going to be
taken out before retirement and people are going to end up with
close to the 60 percent that they have left in the defined
benefit plan and they are going to have inadequate retirement
incomes.
Mr. Portman. Do you think that it is politically impossible
to draft legislation which would require that it be pulled out
for retirement only after 59\1/2\, and only then on an
actuarial basis? In other words, you get less benefit if you
retire early? Why couldn't we do that?
Ms. Munnell. I think that it will start that way and I
think that it will end up looking like the IRAs and 401(k)s
where you can get at the money. I think it is just very hard to
prevent access.
Mr. Portman. We should repeal all of those IRAs.
Mr. Goldberg. I think we are making our best judgments
about very important questions. If Alicia is right, that over
time all of these private accounts disappear, I think that is a
serious if not fatal problem.
On the other hand, I believe to suggest letting the
government collectively invest in the capital markets, which is
the suggestion, and to say I believe it is easy to prevent
political interference is dead wrong.
I think the notion that you are going to be able to avoid
questions about excluding tobacco companies from the index or
excluding companies dealing with China from the index,
inevitably that kind of pile of money is going to draw those
kinds of pressures, and I think the chances of resisting those
pressures is zero. It is a risk. We may place different weights
on it. I think that would be a fatal mistake.
Mr. Portman. Mr. Chairman, with your indulgence, Mr. Ball
had a comment.
Mr. Ball. I was going way back to a much earlier point, if
that is acceptable, Mr. Chairman.
That is, I hate to leave the record the way that it was on
the issue of whether what we propose is only a big exchange of
assets without any meaning behind it. What we are suggesting--
having the central fund invest in the market--does have
meaning.
The first point is that as far as national savings are
concerned, that doesn't come out of in our judgment, from the
way the investments are handled. The effect on national savings
comes out of whether you decide to build up the trust funds
toward partial reserve financing, which Ned and I agree you
should do.
That is his higher tax rates--he says no taxes but
additional money out of workers' earnings--and our measures to
increase the funds, these are what creates the real savings.
Allowing Social Security to invest in stocks isn't
primarily to create more national savings beyond that; it is an
issue of fairness.
If the Social Security system is kept from doing what other
retirement systems and other savings plans do, Social Security
participants are at a disadvantage and that is a fairness
issue. Under present rules, Social Security participants are at
a significant disadvantage in terms of rate of return; and then
you hear all of the criticisms about Social Security having
such a low rate of return. It can be evened up, and whatever
you can do about savings through private accounts can be done
through Social Security. And I must say the distinction between
the government investing on behalf of people who have chosen
individual funds which the government is going to invest for
them and investing directly for them in Social Security escapes
me. All the problems that Mr. Goldberg suggests are there also
if the government is the one that is going to invest the
proceeds of individual accounts. Individuals decide they are
going to put it in this fund or that fund but the government
makes the investment decisions--selects the index.
Just like the Federal employees savings plan now, the
government investing the private accounts, should be subjected
to whatever pressures are now foreseen for Social Security
direct investment. Well, I am told that, yes, the Federal
employees savings plans has been the object of pressure to
invest this way or that, but since the legislative record was
clear, those pressures were resisted and it was possible to
continue with that system without having to give into the
pressures. That is the test and it has already been met.
I think you would have to have investment in the central
fund, set up in a way through the index funds that protected
Members of Congress from being pressured by their constituents
to put my company in the index, take that guy out. I want to
get my industry favored.
I don't think that you would ever pass a bill that
subjected you to that kind of pressure about individual
components of an index because it would be very disadvantageous
to you to have your constituents pressuring you this way or
that. It would have to be clear that the plan would stick to an
index, that a government appointed board could not change
although, of course, Congress as a whole could.
Mr. Christensen. I want to go back to a question that Nick
Smith brought up earlier. He mentioned the idea of the
retirement age. I want to get your input, and I will go to Mr.
Becerra after that.
Mr. Kotlikoff. Under our proposal, we give current workers
their accrued benefits under the old system when they retire.
Specifically, their earnings record is filled in with zeros
after the time of the reform. So, under our plan, you can start
collecting at age 62 or 65; there is no increase in the
retirement age, you just get a smaller benefit because your
earnings base includes these zeros that would not otherwise be
there.
On the other hand, you have this private/personal account
to fall back on as well. So I don't think that there is any
need to raise retirement ages as part of a privatization
scheme.
Is it possible to just reply really quickly to----
Mr. Christensen. Did anyone else want to comment on that?
Mr. Ball. I think we ought to stop thinking of these
proposals primarily as a change in the retirement age. Social
Security provisions don't really control the retirement age.
They control how much money people get if they retire or have
to retire at different ages.
Raising the ``normal retirement age'' is really a big
benefit cut. The biggest benefit cut in several of these plans
is to make people wait longer before getting their full
benefits--wait, say, until age 70. And the plans that raise the
age keep going after age 70, say, and index it to longevity. I
wouldn't give up so much control of the total system so
everything is indexed and automatic. You should make decisions
as experience dictates.
Let's see how the present system works. We are just
beginning to have an extension of this so-called retirement age
beginning in the year 2000 to move up to 67. Let's see how it
works. I don't think that the American people even know about
it yet.
I think as it goes on, rising gradually as the years pass,
you can see whether employers are going to make jobs available,
whether workers will be willing to work at them until they are
older. We have no reason to rush in and change now it to 68 off
in 2022 or some such date.
Let's see how it works through the long period of time that
we have going to 67 under present law. If it turns out that it
is a good idea, jobs are there, surely, you can move it up. But
why now, before we have had any experiences?
Ms. Munnell. As you know, most people grab the Social
Security benefit as soon as they can get it, namely at age 62.
And when you look at these early retirees, they break into two
groups. One is wealthy and healthy and with a good private
pension. The other is not so healthy, low income, and has been
unemployed just before they have actually claimed their Social
Security benefit. For the wealthy, healthy people, it is
perfectly reasonable to say, look, you are going to live for a
long time, why don't you work longer, and they can adjust their
retirement pattern to accommodate this cut in benefits.
What we are worried about are those people who are not in
such good shape, who may not have a job available, and who may
not be able to change their retirement age at all. What they
are going to see is a big benefit cut, so it can be a benefit
cut on the most vulnerable people.
Mr. Christensen. Dr. Gramlich.
Mr. Gramlich. Two issues. One is on the stock market
investment, there are basically two approaches here. One is,
the thing that Goldberg and I are recommending, is what we
might call the TSP approach, where you do it through centrally
managed funds. And the kind of thing that Bob and Alicia are
talking about would be where the Social Security Trust Fund
actually holds the stock. And Bob was just saying there wasn't
much difference there. I think there are important differences.
There is, first, the firewall of having consumers choose
the stock fund to invest their money in that you wouldn't get
in their approach. The second is that TSP has been tried and is
working well; it has for 10 years. And so you are trading in
something that you know is working well for something that you
don't know, and has actually worked badly for several State
governments and in other countries.
The second thing. On the retirement age, nobody wants to
raise the retirement age. It is a benefit cut, as Bob said, and
nobody wants to raise it. It is just that if you feel as I do
that we do have to trim benefits somehow or another, because I
don't think the option is there to invest in stocks, and nobody
seems to want to raise taxes, then you have to do something,
and that is on the benefit side. It strikes me as one sensible
component of a reduction in benefits. It is not that we want to
do it, and it will cause problems and it will be a benefit cut,
but what is your alternative?
Mr. Christensen. Fred.
Mr. Goldberg. I think it is important to think about that
age. It is a hard issue, and if you are thinking about the one
group that Alicia described, you shouldn't touch it at all. If
you are thinking about the other group, maybe you ought to.
I disagree with Bob. I think we have an entire structure
inside Social Security and inside the tax system that
effectively tells people they ought to stop working in their
mid-sixties, and I think it is part of a larger and very
serious problem in terms of how employers view workers, in
terms of how individuals view themselves and their
opportunities. And I think this is part of a bigger problem.
Social Security penalizes you if you keep working past 70. I
think that it is a very difficult issue.
The piece on going back to this investment in the markets
thing, it seems to me that if you design a system that has
individual accounts over time, you have the opportunity to let
people roll directly into the private sector, you have far
greater latitude.
I also think that if you are concerned about the sick and
the poor and the low-income workers in this country, unless you
have a defined contribution piece, if you do not have that you
are telling Native Americans with a life expectancy of 55, you
are telling African-Americans with a life expectancy of 62, you
will pay 10 percent off the top into a system and you will get
nothing. And I think that if we are concerned about fairness
here, it seems to me for that group of individuals who, in
fact, work for 40 years and 35 years, who, in fact, die before
they collect any benefits, this is not a fair system at all.
Mr. Christensen. Mr. Becerra.
Mr. Becerra. If I can follow up on that, what about the
poor individual who lives until 90, and earned under $20,000 a
year, and will get to collect Social Security for those 25
years?
Mr. Goldberg. I think it is essential, absolutely essential
that any system maintain a federally run defined benefit
program that will cover that individual for all 20 years and
will give them benefits that keep them out of poverty.
Mr. Becerra. But the defined contribution program would not
address the needs of that working person who----
Mr. Goldberg. I agree with that. That is why the primary
feature of the program should remain defined benefit. The
defined contribution piece should be a small piece that is a
subsidiary to a defined benefit component, and you ought to do
more for the folks you are describing, not less.
Mr. Kotlikoff. If I can comment quickly on that, I think
that is a completely inaccurate assessment of how you can set
up a defined contribution plan. Our proposal has people
contributing about 8 percent of their salary into a defined
contribution system, on a progressive basis, into this single
global index fund. At retirement age, between 60 and 70, each
cohort's balances are collectively annuitized and transformed
into defined benefits, so there is nothing incompatible about
annuity insurance and having a privatized defined contribution
system. To say that you can't have these two things together is
just not correct.
Mr. Becerra. That assumes, of course, that the defined
contribution will have been sufficient to provide the person
with an annuity that will pay over the long term of that
person's life, while in retirement, is enough to sustain the
person.
Mr. Kotlikoff. Well, absolutely, and that is why when you
are concerned about----
Mr. Becerra. If my parent's first investment was to put
money into a housing deal where they were told they would get a
20-percent return, and they put their $3,500 in savings with
this real estate investor and lost all of it, if that was the
best judgment made----
Mr. Kotlikoff. That is precisely why our plan doesn't allow
for that to happen. Our plan is the only plan of all current
privatized proposals that mandates everyone hold the same
single security, so everybody gets the same deal; it's not that
your parents get a lousy deal and somebody else's parents get a
great deal, everybody gets the same deal. We are setting this
up for the average Joe. Everybody should get the same deal, the
same rate of return, and everyone should be invested in the
same global index funds of stocks, bonds, and real estate,
which ensures that they are fully diversified. Under our plan,
you can't play or time the market and you are forced to hold
the market for the long term. And there is also progressive
benefit contribution match by the government to protect poor
people.
Mr. Becerra. Who pays for the progressive match?
Mr. Kotlikoff. This is all financed out of the cash flow
business tax.
Mr. Becerra. Dr. Munnell, may I ask a question with regard
to women? Is there a difference between how women will be
affected by any system we come up with, whether it is a private
account system or just an expanded Social Security Trust Fund
system, vis-a-vis men?
Ms. Munnell. I am actually surprised this hasn't turned
into more of a women's issue. It is very different to have a
defined benefit plan with protections for dependent spouses
than to have individual accounts where the protection depends
on the decisions of the individual. People can decide whether
or not they want to annuitize their amounts, they can decide
whether or not they want a joint annuity or a single annuity.
With a single annuity, benefits don't continue after their
death.
People in England, where they could choose inflation index
annuities, tend not to. So people don't make very good
decisions when left on their own, not only for themselves
always, but also for their spouses.
The widows in this society, elderly widows, are one of the
groups with the highest rates of poverty, and I think that it
is a major concern of most people involved in this debate, that
they are going to be left without the protections they need,
and their situation could worsen unless special provisions were
put in for them. And that has been left out of the debate up
until this point.
Mr. Becerra. Thank you, Mr. Chairman.
Mr. Goldberg. I agree, again, with Alicia. I think if you
were going to go to private accounts, you would want to design
exactly those kinds of safeguards. But I also think if you are
going to talk about this, you ought to look at the actuarial
return on two-income-earner families where in most cases, or at
least a significant number, the woman tends to be earning a
lesser income and the actuarial value is zero.
So I agree with the need to safeguard the widow. It is a
terribly important issue. It is very difficult, but I also
think, again, a defined contribution piece, if it is small,
does something to rectify current inequities as it relates to
two-income-earner families and working women in particular.
Mr. Kotlikoff. Can I interject? You don't have to make it
small to do what's needed to protect widows. In our proposal,
you have earning sharings, so first of all, each spouse has got
the same account. In our proposal, you don't touch the survivor
insurance I part of Social Security, so the survivor insurance
part of the Social Security is still there. There is actually
more protection for widows under our proposal than under the
current system.
Mr. Christensen. I will let the last statement be by the
dean of the panel, Mr. Ball.
Mr. Ball. That is quite a responsibility, Mr. Chairman.
Just so we don't end with sweetness and light, I want to
disagree strongly with Mr. Goldberg on one thing but agree with
him on another. Alicia said earlier that one of the main
problems with these individual accounts is that sooner or later
they would be loosened up and people would spend the money
before they got to retirement age. There is another big
problem. What she said is absolutely correct, in my judgment,
but there is another problem. That is, people who support these
individual accounts to take the place of part of Social
Security rely on averages. They give you numbers that say, in
effect, yes, it is a 40-percent cut in the Social Security
part, but, look, you invest in stocks--the individual puts at
least half in stocks and half in bonds, and he turns out to be
better off. But that's the average. Some will get average
returns, some won't.
The point is, Social Security is not very much. It is only
a base, but that ought to be a certain defined benefit amount.
Supplementary savings, surely, we can take some risk with
those, but don't cut back 40 percent on Social Security and
then substitute something that depends on how good your
investment returns are.
The thing I want to agree with Mr. Goldberg on, though--
that was the disagreement. The thing I want to agree with him
on is his emphasis upon the administrative aspects of these
private accounts is terribly important, and that gets very
little attention. He and I both have career experience with
administering very large government programs, the Internal
Revenue Service, and the Social Security Administration.
Mr. Goldberg said that he thought the individual account
plans would stand or fall on administrative issues. I would
just like to leave you with that thought. The administrative
issues--the problems--with the individual account plans are
very big.
Mr. Christensen. Well, thank you. It is often impossible
for our Subcommittee to cover every issue we are interested in
during this hearing and therefore we may be submitting
additional questions to each of you in writing for you to
answer on the record.
I would like to thank our witnesses today for their
extensive and thoughtful testimony and thank you for your
participation. This hearing is adjourned.
[Whereupon, at 3:45 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of Bond Market Association
The Bond Market Association appreciates the opportunity to
comment on issues related to reforming the Social Security
system. The Bond Market Association represents securities firms
and banks that underwrite, trade and sell debt securities both
domestically and internationally.
Reforming the Social Security system has evolved into a
prominent political and policy issue. Not long ago, Social
Security was considered the ``third rail'' of politics. Today,
Congress and the administration are actively studying
alternatives to modifying the system in fundamental ways. In
our view, this is a positive development. It is inarguable that
the system cannot be left alone. In the coming years,
demographic trends will threaten the ability of Social Security
to continue to provide income to beneficiaries. Simply raising
taxes or reducing benefits does not appear to be an attractive
or viable solution.
One approach to Social Security reform that has been
studied in various forms would permit or require participants
in the program to divert a portion of their Social Security tax
to privately-owned, self-directed investment accounts. This
approach is attractive for a number of reasons. First, it would
permit retirement savings dollars accumulated through the
Social Security system to be invested more actively and
efficiently than currently. Second, this approach would,
depending on how it is structured, address the dangerous
demographic trends now facing the program. Third, and perhaps
most important, personal investment accounts have the potential
to offer program participants a greater level of retirement
security than the current program. Put simply, it is likely
that under a personal investment account approach, retirees
would have more money and would be able to live more
comfortably than under the current system.
This is not to suggest that Congress should move hastily to
reform Social Security. Social Security affects the lives of
individuals perhaps more than any other federal government
program. Over the past 60 years, people have come to depend on
the system to provide vital retirement income. Congress should
continue to study carefully all the implications of reforming
Social Security--as Chairman Bunning has done in convening this
hearing and for which we commend him and other members of the
subcommittee--before taking action. When you do, we believe
that you will find that an approach to Social Security reform
involving personal investment accounts to be a very attractive
alternative to the current system.
In this statement, we focus on two issues before the
subcommittee. First, we would like to dispel the myth that
under the current system, the Social Security trust fund is
``invested'' in bonds and that bond investments are somehow
less attractive than stock investments. Second, we would like
to discuss the value of bond investing in long-term retirement
savings and urge that in establishing a ``menu'' of investments
for personal investment accounts, bonds be offered together
with other options.
The current trust fund
Under the current Social Security system, payroll taxes
paid by employees and employers are remitted to the Treasury
Department like all tax collections. The cash collected from
payroll taxes is intermingled with other cash held by the
federal government and is used to pay general federal
obligations. It is important to note that cash collected from
the Social Security payroll tax is not earmarked to pay Social
Security benefits. Indeed, Social Security tax collections are
used in the same manner as other sources of federal revenue to
pay whatever obligations the government incurs.
To the extent that Social Security payroll taxes collected
in a given period exceed the amounts needed to meet program
obligations, an accounting entry is made to credit the excess
to the Old-Age, Survivors, and Disability (OASDI) Trust Fund.
The trust fund balance is increased by an amount equal to the
excess tax collections. At the same time, a second accounting
entry is made debiting the trust fund's cash account and
crediting its Treasury securities account. This second
accounting entry is often likened to ``investing'' the trust
fund's assets in U.S. Treasury securities. However, there is no
investment in a true, economic sense. The trust fund holds no
assets which are salable in the open market. Even more
important, the trust fund's liabilities--future payments to
Social Security beneficiaries--are backed only by the federal
government's promise to pay. There are no assets in the Trust
Fund that can be sold to meet the Fund's obligations, as is the
case with trust funds and pension funds generally. In around
2013, when, under current projections, Social Security payroll
tax collections will stop exceeding payments, the only way for
the federal government to continue to meet obligations will be
from general government revenues generated through taxation or
by borrowing from the public.
The current system for ``investing'' the Social Security
trust fund has been criticized for generating anemic returns.
However, because the Trust Fund is not truly ``invested,'' it
is inappropriate to think of the phantom interest ``paid'' to
the Fund as a return on investment. After all, when the Trust
Fund is ``paid interest,'' no money actually changes hands. The
government simply pays itself. Nevertheless, for the purpose of
discussion, it is useful to look at the trust fund as if it
really were operated like an investment account. With that in
mind, there are two points regarding the trust fund's
``investment return,'' that the subcommittee should consider.
First, the trust fund's investments are not actively
managed. Typically, investors who manage portfolios of Treasury
securities buy and sell securities on a regular basis to
maximize their returns. The U.S. Treasury securities market is
very active and liquid. Every day, managers of portfolios of
Treasury bonds buy and sell securities to take advantage of
market conditions. Active portfolio management can greatly
increase the return on a Treasury securities portfolio. The
trust fund does not benefit from active management.
Second, although the interest rates on the special series
of non-marketable Treasury securities purchased by the trust
fund bear some relation to interest rates on marketable
Treasury securities, the rates are not the same. Specifically,
the rates on trust fund securities are averages of market rates
on outstanding Treasury securities with times-to-maturity of
longer than four years. It is not possible for the trust fund
to earn the highest rate of interest paid by the government on
its long-term marketable securities.
One approach to Social Security reform suggests that any
future shortfall in trust fund assets could be addressed today
by investing a portion of the trust fund's assets in higher-
yielding, marketable securities like stocks. The same, basic
structure of Social Security as a guaranteed-benefit system
would be retained, but the trust fund's assets would be
diversified. While this approach would likely have the effect
of raising the rate of return on trust fund assets, it also
raises numerous questions. If a portion of Social Security's
annual surplus were invested in stocks rather than Treasury
securities, the federal government would be forced to borrow
more from the public than otherwise. In essence, the federal
government would be borrowing in order to finance an investment
in the stock market. Is it appropriate for the federal
government to borrow for that purpose? Who would choose which
stocks to buy, and would politics influence investment
decisions? What would be the market effect of such a large
investor as the OASDI trust fund moving into and out of
individual equities and the market as a whole? What would
happen to stock prices as the trust fund began to sell assets
to pay benefits?
Personal Investment Accounts and the Bond Market
Perhaps the most discussed approach to Social Security
reform involves diverting all or a portion of each person's
payroll tax to a personal investment account, similar to a
defined-contribution retirement savings plan like a 401(k).
Each person would make his or her own investment decisions from
a ``menu'' of permitted investments. Under various proposals,
this menu has ranged from one as limited as the current federal
employees' Thrift Savings Plan to one including any of the
nation's thousands of registered mutual funds. Under this
approach, benefits under the traditional Social Security system
would be reduced to account for retirement income to be derived
by beneficiaries from the investment account system.
Although we have not yet developed a detailed position on
how a personal investment account system should be structured,
The Bond Market Association in general believes such an
approach offers many benefits to the Social Security system, to
its beneficiaries, and to the economy as a whole. Although
significant questions still need to be answered, we believe
that conceptually, this is the correct approach for policy-
makers to take in reforming Social Security.
One of the attractions of personal investment accounts is
that it would allow funds that would otherwise be used for
current government spending to be invested according to the
individual preferences of all the participants in the Social
Security system. Presumably, the overall returns on these
investments would be significantly higher than we see currently
for the OASDI trust fund. When policy-makers and taxpayers look
at recent returns in the stock market compared to ``returns''
on the trust fund, it is difficult to resist the attractiveness
of equities. Indeed, stocks should comprise a significant
portion of most individuals' long-term retirement savings.
However, for almost everyone, bonds, too, should comprise a
significant portion of long-term investments. A Social Security
system involving personal investment accounts that limited
permissible investments to equities alone would run counter to
the interests of plan participants.
It is true that over long periods of time, diversified
portfolios of stocks have generally outperformed diversified
portfolios of bonds and other fixed-income investments.
However, ongoing portfolio management research suggests that
diversified portfolios including both stocks and bonds have
outperformed both all-stock and all-bond portfolios on a risk-
adjusted basis.\1\ (Adjusting for risk involves considering the
volatility of securities prices as well as overall investment
performance.) Although portfolio managers disagree on the
appropriate mix of stock and bonds, there is widespread
agreement that in almost all cases, long-term investors should
have a portion of their portfolios in bonds as well as stocks.
This becomes even more true when a retirement investor begins
to approach the time when he or she will sell assets to finance
current spending.
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\1\ See, for example, Clifford S. Asness, ``Why Not 100% Equities''
(Institutional Investor, Winter 1996, page 29) and Kenneth L. Fisher
and Meir Statman, ``Investment Advice from Mutual Fund Companies''
(Journal of Portfolio Management, Fall 1997, page 9).
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Bonds are important for a number of reasons. Bonds are less
volatile than stocks, i.e., they offer more consistent rates of
return. The bond portion of a portfolio tends to stabilize and
``smooth out'' the more varied returns on stocks. Bonds are
also important because they generate income. Although some
stocks pay dividends, the dividend yield on stocks overall is
significantly lower than the income yield on bonds. Income is
especially important to investors like retirees who spend,
rather than reinvest, a significant portion of their returns.
Finally, bonds are safer than stocks. They are the best way to
ensure a full return of principal.
It is also important that investors have access to a wide
variety of bond and fixed-income investments. Consider, for
example, the federal employees' Thrift Savings Plan retirement
system. Under this plan, which operates similarly to a 401(k),
federal employees self-direct their retirement savings into any
of three investment options. One invests in short-term Treasury
obligations. The second invests in a diversified portfolio of
common stocks. The third, known as the ``F'' fund, invests in a
diversified portfolio of government and corporate bonds and
mortgage-backed securities. While the availability of bond
investments is extremely valuable to federal employees, it is
interesting to note that the F fund does not invest in non-
mortgage asset-backed securities or even in ``private label''
mortgage-backed securities. It also does not invest in high-
yield corporate bonds. While these securities may not be
appropriate for all investors, they certainly have a place in
certain long-term portfolios. It is unfortunate that federal
employees do not have access to a complete menu of bond
investments.
Conclusion
We are greatly encouraged by the direction of the debate
over reform of the Social Security program. We believe that a
system where individuals are permitted to direct their own
retirement investments offers great benefits. As Congress
continues its examination of alternatives to Social Security
reform, we urge you consider issues related to the proper
diversity of investments in a retirement savings portfolio. You
will discover that bonds are a vital component of a properly
structured portfolio. A Social Security system involving self-
directed investing that did not include a wide variety of bond
investments would be against the interests of the hundreds of
millions who will depend on Social Security for their
retirement income.
We look forward to working with members of this
subcommittee as the debate over Social Security progresses. We
would be happy to provide any additional information that you
may need.
Statement of Charles G. Hardin, President, Council for Government
Reform
Mr. Chairman, on behalf of the 350,000 members of the
Council for Government Reform (CGR), thank you for this
opportunity to discuss the various proposals to redesign Social
Security for the next generation using personal retirement
savings accounts. CGR's members appreciate your interest in
this crucial issue and welcome your continued examination into
America's looming retirement income crisis.
As you are aware, Americans generally have a misconception
regarding the current state of Social Security. Many of the
seniors that I talk to are convinced that the government has
been saving for their retirement and has placed their money in
an account from which they are drawing their Social Security
benefits.
We know that this is not the case.
In fact, the Supreme Court in Nestor v. Fleming ruled that
individuals have no right to Social Security benefits based on
their lifetime contributions. Congress is the sole arbiter of
how much retirement income millions of Americans will receive.
In a nation conceived in liberty, allowing politicians
total control over how we will live after we retire is not
acceptable.
American taxpayers cannot continue to pour 12.4 percent of
their earnings into a ``public investment'' program that
already provides a negative rate of return for far too many
future retirees. Maintaining the status quo will lead to a
lower standard of living. To reverse this course, Congress must
allow Americans to invest some of their payroll tax dollars in
investment instruments where they can achieve greater rates of
return.
This can only be accomplished if Congress breaks the old
mold of tax hikes and benefit cuts and casts a new mold by
increasing the rate of return on dollars invested in Social
Security. And CGR supports a practical solution to this
critical problem.
Personal Savings Accounts (PSAs) would provide a far
superior alternative to our antiquated pay-as-you-go Social
Security system. They would increase income for retirees and
would also reduce the amount of money needed to invest to
ensure a secure retirement. Even more important, PSAs would
allow workers to own real assets for their retirement and even
create a nest egg that could be passed on to their children and
grandchildren.
How do PSAs achieve these policy goals? They simply bring
the power of the private markets to bear.
Right now, Social Security faces a huge unfunded liability
that future taxpayers and retirees must cover. Any PSA option
would reduce this actuarial imbalance and ease the tax burdens
of our children and grandchildren.
CGR is fully aware that Congress cannot just switch Social
Security from a pay-as-you-go to an advance funded system
without incurring costs. But Congress must also acknowledge the
cost of maintaining Social Security as it is. In fact, if
Social Security and Medicare were carried on our nation's
account books as a normal business would, the national debt
would rise from $5 trillion to $17 trillion! Moving Social
Security to an advance funded system would eliminate nearly all
of the program's unfunded liability.
Congress must consider other transition aspects as well.
CGR strongly believes that any PSA option must protect current
retirees' benefits. These workers have been promised a certain
level of benefits, have planned their retirement around them,
and are too late in their working careers or retirement to
change their retirement income source structure. Any PSA plan
must recognize this fact and provide financing for the current
level of benefits until a new system is in place. That way
Social Security will continue, without pause, for everyone who
is currently dependent on it.
Clearly, Congress cannot wait until 2029 to save Social
Security, as some would suggest. The Social Security Trust Fund
is projected to begin running a deficit as soon as 2012 when
many current retirees will still be collecting benefits. To
provide for adequate lead-time to make a smooth transition, the
choices must be made well before then. It is still possible to
adopt a reform plan that achieves long-term solvency for Social
Security by making the relatively modest change of increasing
the rate of return of the money invested in the program by
providing individuals with PSAs.
If Congress waits until Social Security nearly collapses,
effective reform may not be possible due to the panic created
by the imminent collapse of the Social Security behemoth. I
fear that the nation would turn to drastic measures that could
alter the fundamental principles of the program with dramatic
costs to taxpayers and loss of benefits to recipients.
Social Security is too important to the millions who rely
on it to continue to ignore its problems. American seniors
should fear continued inaction on this crisis. That's why I and
the members of CGR appreciate your interest and attention to
this matter, Mr. Chairman.
The Council for Government Reform is a 501(c)4 non-profit
citizens lobbying organization that seeks to encourage greater
responsiveness by government and to reduce its overall size and
scope at all levels. CGR seeks a lower tax burden, improved
security for our senior citizens, and a less costly system of
government for ourselves and future generations.
Statement of Kelly A. Olsen, Research Associate, Employee Benefit
Research Institute
The Employee Benefit Research Institute (EBRI) appreciates
the opportunity to submit written comments on several questions
delineated by the Subcommittee about the focus of this
hearingnamely, how personal accounts would be administered and
financed, how they would be integrated with other private
pension plans, and how they would work within current tax law.
Our contribution addresses these issues from an employer
perspective.
Traditional Social Security reforms--cutting benefits and
raising taxes--have well-known implications for employers.
Benefit cuts create pressure for enhancements to employment-
based pensions and require plan adjustments; tax increases add
to business costs and slow the growth of cash compensation.
However, public opinion surveys reveal little support among a
significant percentage of voters for these traditional fixes
relative to adding a system of individual Social Security
accounts \1\--an unprecedented reform with uncertain employer
consequences.
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\1\ In the 1996 Retirement Confidence Survey, a majority of workers
under age 54 supported investing Social Security in the markets rather
than raising taxes or cutting benefits. In 1991 and 1995, the EBRI/
Gallup Organization, Inc., poll found that one-half of respondents
believe they could make more money by investing their Social Security
in the private sector than they could from contributing to the current
Social Security system.
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Individual Social Security accounts could affect employers
in many ways. Most obviously, employers would be affected by
any change in the Social Security payroll tax if they are
required to match employee contributions, as under current law.
Second, the effects of individual accounts on retirement
decisions and employee demand for private plans could affect
pension design and offerings. In addition, individual accounts
would certainly influence plan design features and pension
offerings of employers who have retirement plans that are
integrated with Social Security (i.e., the employers of
approximately 7.7 million workers in medium and large
establishments).\2\ Finally, individual Social Security
accounts could impose additional administrative costs and
burdens on employers, depending on the extent to which
individual accounts contributions would be made within the
framework of current tax law. This testimony discusses each in
turn and is largely based on the article, ``Potential
Consequences for Employers of Social Security `Privatization':
Policy Research Implications'' (Risk Management and Insurance
Review, 1997) (Exhibit 1), as well as the forthcoming EBRI
Notes article, ``Administrative Costs for Individual Social
Security Accounts.''
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\2\ EBRI tabulation from the U.S. Department of Labor, Bureau of
Labor Statistics, Employee Benefits in Medium and Large Private
Establishments, 1993 (Washington, DC: U.S. Government Printing Office,
1995). In fact, the total number of employers who would have to
readjust is even higher, as the above figure does not include employees
of small private firms or of the government, who may also be
participating in integrated pension plans.
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A. Employers as Reporters of Payroll Contributions
Recently, the National Council on Retirement Policy (NCRP)
recommended that a system of individual Social Security
accounts be designed to work ``within the current payroll tax
structure.'' In the current tax framework, employers send the
U.S. Treasury aggregate Social Security (FICA) taxes (employee
contributions plus employer matching contributions) relatively
frequently, depending on employer size. However, employers must
reconcile only once a year which portion of the aggregate FICA
contribution has been paid on behalf of each employee (through
the W-2 form). Because they have largely not addressed the
issue, it is unknown whether other groups recommending
individual Social Security accounts would concur with NCRP's
recommendation that the current tax structure be used. Were the
current tax structure maintained for individual Social Security
accounts, a lapse of over one year would occur between the time
when contributions are made on behalf of an employee and the
time when those contributions are credited to the employee's
individual account.
While options exist for having the government
retrospectively credit contributions made on behalf of
individuals to individual investment choices in individual
accounts, such a time lapse would nonetheless stand in contrast
to current 401(k) plan operation. Therefore, staying within the
current tax structure may be unacceptable to those who view
private 401(k) plans and minimal government responsibility as
guideposts for any reform. As a result, some reformers might
insist on an increased number of deposit transactions over the
year. Depending on frequency, additional transaction
requirements would inflate administrative expenses because of
the additional work imposed on employersespecially smaller
ones. On top of these costs, additional administrative costs
for employers could arise if employers were responsible for
keeping track of employees' investment choices or voluntary
contribution rates. Further costs would be added if employers
were required to send individual account contributions on
behalf of each employee to a range of service providers
available under different investment options.
B. Employers as Pension Providers
Individual Social Security accounts could affect the design
of existing pension arrangements in two broad ways. First,
almost one-half of workers in medium and large establishments
are covered under defined benefit plans whose formula is
integrated with Social Security (U.S. Department of Labor,
1995). When determining the benefit levels that an employment-
based retirement plan must provide to workers of different
preretirement incomes in order to replace--in combination with
Social Security--a target percentage of preretirement income,
integration formulas for defined benefit pension plans adjust
for the fact that Social Security's benefits provide higher
replacement rates for low-income workers. In addition, an
unknown number of employers offering defined contribution plans
informally take Social Security benefits into account when
determining benefit provisions for workers of different income
groups.
Most proposals for adding individual Social Security
accounts call for reducing Social Security's defined benefit.
If Social Security defined benefits are reduced, benefits
levels needed from an employment-based plan using an
integration formula would increase,\3\ adding to compensation
costs and possibly slowing the growth of cash wages.
Alternatively, the employer might not pay these costs and
instead adjust the integration formula to provide smaller
replacement rates to retirees. This would create an
administrative expense for adjusting the formula and ensuring
all government regulations for the plan as a whole are still
met after the adjustment. Moreover, if employers were to try to
integrate their pension plans with a Social Security system
that has a defined contribution component, integration to
achieve desired replacement rates could not be done as precise
under Social Security's defined benefit system (because of the
uncertainty of investment performance).
---------------------------------------------------------------------------
\3\ This assumes that neither the employer's plan formula nor the
pertinent tax code (IRC Section 401(l)) and attendant regulations
change.
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A second way that employment-based pension design could be
affected depends on workers' confidence in the system of
individual accounts. If employees expected to receive larger
Social Security benefits per dollar of contribution under a
reformed system than under the status quo, confidence in the
Social Security system might increase. Presumably, the more
confidence younger workers have in Social Security, the less
pressure they will place on employers to enhance employment-
based retirement plans. Under a system of individual Social
Security accounts, depending on the reform features, confidence
in Social Security could also result in less employee demand
for employer-based defined contribution plans. For example, if
highly compensated employees are able to defer their preferred
level of salary without the need of a qualified 401(k) plan,
employers may be less inclined to offer matching contributions
to motivate nonhighly compensated employees to increase their
participation/contribution rates. If that were to happen,
meeting the required nondiscrimination requirements might
become problematic for 401(k) plans.
On the other hand, loss of part of the defined benefit
guarantee under Social Security could result in more pressure
on employers to provide guaranteed benefits. Because such
guarantees can be promised only through defined benefit plans,
employers would likely experience additional administrative
costs (Hustead, 1997) and increased exposure to market risk if
they responded to such employee demand. In addition, if
individual account reforms left many without enough retirement
income under Social Security, employers might be called upon to
make up the difference by increasing their benefits for retired
workers.
C. Employers as Payroll Taxpayers
One of privatization's primary potential advantages to
employers is its potential to maintain Social Security benefits
at current levels without raising employer payroll taxes or
reducing benefits by leveraging higher returns from the
equities markets for Social Security contributions. Assuming
that the equity premium will persist, returns on Social
Security funds invested in the equities market will generate
additional program revenue, obviating the need for future tax
increases to supplement program shortfalls. Some individual
account plans (such as the 1994-96 Advisory Council's
Individual Accounts Plan) would raise program revenues in this
way by requiring additional contributions on the part of
workers but not employers. The Individual Accounts Plan
supported by Ed Gramlich and Marc Twinney, for example,
mandates payroll contributions of 1.6 percent of taxable
payroll from workers' wages. As described above, tax increases
on employers and benefit reductions are likely to increase
compensation costs, slow the growth of cash compensation, and
increase pressure for enhancements to employment-based
retirement plans. Insofar as Social Security privatization can
avert tax hikes and benefit reductions, it will benefit
employers.
D. Employers as Employers of Older Workers
Under certain designs, a privatized system of individual
accounts could make it more difficult for employers to retire
older workers. For example, if employees near retirement age
have a large enough amount of their retirement security tied to
the equities market through an employment-based plan as well as
through Social Security, then a downturn in the market might
delay retirement. Alternatively, since individual accounts
allow workers to reap direct benefits from account
contributions under favorable investment performance, older
workers might respond to this incentive by remaining in the
labor force longer. The influence of market returns on
retirement decisions could make the retirement patterns on
which employers base their pension and salary scales
unpredictable. In addition, older workers' decision to remain
employed during a market downturn would occur just when
employers might most need to downsize their work force,
particularly their higher paid employees, in order to cut
costs. While these retirement issues already exist for
employers with defined contributions plans, individual Social
Security accounts could exacerbate these concerns by linking an
increasing portion of retirement security to market
performance.
Conclusion
In summary, employers potentially have much to gain or lose
under a system of individual Social Security accounts,
depending on reform details. Important details include how the
individual account reform would handle taxation and
administration, as well as the extent to which the reform would
increase employees' reliance on market performance for
retirement security and affect employee demand for employment-
based pension offerings. Most obviously, employers would be
affected by any change in the Social Security payroll tax if
they are required to match employee contributions. Plus, the
effects of a system of individual accounts on retirement
decisions and employee demand for private plans could affect
pension design and offerings. In addition, individual accounts
would certainly influence plan design features and pension
offerings of employers whose retirement plans are integrated
with Social Security (i.e., the employers of approximately 7.7
million workers in medium and large establishments).\4\
Finally, individual Social Security accounts could impose
additional administrative costs and burdens on employers,
depending on the extent to which individual accounts
contributions would be made within the framework current tax
law.
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\4\ EBRI tabulation from the U.S. Department of Labor, Bureau of
Labor Statistics, Employee Benefits in Medium and Large Private
Establishments, 1993 (Washington, DC: U.S. Government Printing Office,
1995). In fact, the total number of employers who would have to
readjust is even higher, as the above figure does not include employees
of small private firms or of the government who may also be
participating in integrated pension plans.
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References
Advisory Council on Social Security (1997) Report of the 1994-1996
Advisory Council on Social Security. Vols. 1 and 2. Washington, DC:
Advisory Council on Social Security.
Hustead, Edwin C. (1996) ``Trends in Retirement Income Plan
Administrative Expenses,'' Working Paper No. 96-13, Philadephia:
Pension Research Council.
Olsen, Kelly A. and Jack L. VanDerhei (1997). ``Potential
Consequences For Employers of Social Security Privatization: Policy
Research Implications,''Risk Management and Insurance Review, 1, pp.
3249.
Olsen, Kelly A. (1998). ``Administrative Costs for Individual
Social Security Accounts.'' EBRI Notes, forthcoming.
Ostuw, Pamela (1997). ``Public Attitudes on Social Security
Reform'' EBRI Notes, No. 3 (March 1997): 3-5.
U.S. Department of Labor, Bureau of Labor Statistics. Employee
Benefits in Medium and Large Private Establishments, 1993 (Washington,
DC: U.S. Government Printing Office, 1995).
Yakoboski, Paul (1997). ``The Reality of Retirement Today: Lessons
in Planning for Tomorrow.'' EBRI Issue Brief No. 181 (Washington, DC:
Employee Benefit Research Institute, 5 January 1997.
[Attachments are being retained in the Committee files.]
Statement of Gray Panthers Project Fund
There is a deep anxiety about Social Security's future. It
is important to recognize that we must attend to the possible
projected Social Security Trust Fund deficit even though many
highly credible economists dispute the forecasts. Those
pessimistic projections are based on the assumption that the
economy will grow at only HALF its historic average. In fact,
even using these conservative data, those who project a Fund
short fall have had to increase the year when the deficit is
estimated to begin from 2029 to 2032 because of today's
economy.
While we acknowledge that there should be certain changes
to the system, two important issues should be made clear:
contrary to pessimists and alarmists, Social Security is not in
crisis and unless it is undermined by profiteers or others who
would gamble with its funds, it will never be bankrupt.
Fundamental to any change in the system must be a renewal
of our commitment to the principles of Social Security: a
guarantee that workers and their families can retire with
dignity and that no one should live in poverty because of
disability or the death of a family's sole income producer.
For more than 60 years Social Security has provided vital
and important benefits for Americans. It is the foundation of
retirement income and it stands as a guaranteed base against
poverty for American workers and their families. It is also the
principle insurance against family poverty due to death or
disability. Today, approximately 44 million workers and family
members receive benefits. These benefits are the major source
of income for two out of three elderly beneficiaries and are
the only source of income for almost 20% of our elderly.
Without Social Security more than of our elderly would live
in poverty. In 1959, less than 40 years ago, more than \1/3\
of our seniors lived in poverty. Today, mostly because of
Social Security, that number has dropped to 11%.
We should also remember, Social Security is more than a
retirement program. It is a program for our most vulnerable
citizens, those, who are disabled, widowed and orphaned.
Disability and survivor benefits make up more then 30% of the
beneficiaries.
Today, there is a cry for radical change in the Social
Security system. This cry comes from Wall Street profiteers who
want to gamble with the Fund's future for their own advantage.
Although some projections show that Social Security faces
genuine, though relatively modest, long-term financing
problems, these deficits can be avoided without submitting to
the radical proposals of profiteers.
The Gray Panthers say that before we experiment with any
radical proposal to overhaul the system or compromise its
integrity we should look at the most obvious, fair, and common
sense opportunity available. The Gray Panthers say the most
direct and fair proposal to strengthen the Social Security
system is to simply lift the cap on earned income, currently
set at $68,400, that is subject to the social security tax for
both the employees and employers. This common sense proposal
would virtually eliminate any of the projected deficits and
would make the Social Security tax more fair and less
regressive. This proposal grows from the principle of economic
and social fairness and a socially responsible society.
Our richest workers currently have an elite privilege.
There is a ceiling on taxes on wages above $68,400. Simply
requiring the rich to pay their fair share of taxes would do
two things. By using projections of the Advisory Council on
Social Security, we realized that this policy would produce
sufficient funds to extend the viability of the Social Security
Trust Fund to almost the end of the next century--well beyond
2032, the doomsday date now being projected as the last year
the fund would be solvent.
The second advantage eliminating the cap would do is make
Social Security taxes less regressive. Asking the rich to pay
their fair share is progressive; asking the poor to pay an
unfair share is regressive. Regressive taxes only benefit the
rich.
Two primary arguments support this proposal of fairness.
Social Security is a national program for all its citizens and
all its citizens should contribute equally to the program. As
the Social Security tax policy is now defined, an elite set of
wage earners, those who make over $68,400, are given special
privilege and are exempted from paying into the system with any
wages over this amount. This elite group is only 16% of the
work force and were they to be taxed equally as those who make
less, this share would bring in almost all of the funds needed
to make Social Security totally solvent. Keep in mind, this
higher income group also has substantially more savings as well
as more unearned income sources, which reduces the impact of
this tax on their overall income.
The second argument supporting a progressive and fair
Social Security tax is that a precedent has already been set
with Social Security's sibling program: Medicare. The ceiling
on taxes that contribute to the Medicare program was lifted
several years ago and had significant positive impact on the
fund without major outcry or economic impact on the wealthy or
employers. There is no reason why the Social Security tax
should not also be made more progressive.
Contrary to those who try to use misinformation, fear, and
pessimism as strategies to pit generation against generation,
the Gray Panthers, who for over 27 years have dedicated our
work to inter-generational cooperation and made our motto Age
and Youth in Action say there is NO crisis in Social Security.
The Gray Panther position is simple: To correct any future
short fall in the Social Security Trust Fund, we must first do
the fair and common sense thing: eliminate privileges for the
highest income class and make the Social Security tax
progressive. We simply ask that the rich pay their share--it's
the fair thing to do.
Statement of Joel D. Joseph, Made in the USA Foundation
Give America what it Needs: a Raise While Making the Economy More
Competitive and Shoring Up the Social Security Trust Fund
The Social Security Tax is the most regressive tax that we
have, taxing the poorest among us at a higher rate than the
rich. This tax is our only flat tax, but it is not flat enough.
Most flat tax proposals do not have a cap like social security
does. Now, incomes over $68,400 are subject to no addition
social security tax. I propose that we exempt from income the
first $15,000 from the social security tax and remove the cap.
This will bring additional revenue to the Social Security Trust
Fund and make America more competitive.
I am an economist and serve as Chairman of the Made in the
USA Foundation. The Made in the USA Foundation is a non-profit,
tax-exempt organization dedicated to promoting American
products in the United States and overseas with 60,000 members.
I am proposing a tax reform plan that makes American
companies more competitive, reduces paperwork and helps those
earning less than $30,000 per year. It does all of these and
increases the budget surplus as well. At the same time it also
provides an increase in the minimum wage without increasing
unemployment. It may sound impossible, or even magical--I call
it ``trickle up economics.''
My proposal is quite simple: modify the social security tax
by creating an exemption and eliminating the ceiling. For
someone earning $15,000 per year the social security tax bite
is a whopping $2,295, half paid by the employee and half by the
employer. The first $15,000 of income would be exempt from
social security and medicare taxes, for both workers and
employers. According to the Tax Foundation (a non-profit think
tank that studies taxation issues), this exemption will cost
the U.S. treasury $40 billion, while pumping $20 billion into
the hands of those needing it most, plus another $20 billion
into their employer's pockets.
Social security and medicare taxes currently are imposed
only on the first $68,400 of wages. Those earning one million
dollars per year pay no more in social security taxes than a
taxpayer earning $75,000 annually. This tax ceiling is
illogical and unfair.
Even Steve Forbes' flat tax did not have a ceiling. By
eliminating the ceiling on wages subject to social security
taxes, the Tax Foundation estimates that we will raise $64
billion in new revenues. The $24 billion surplus in year one
can be retained by the treasury to build up the Social Security
Trust Fund. In future years the amount will increase.
This tax reform will also end the ``nanny tax'' problem for
those employing child-care workers at home: If a nanny is paid
less than $15,000 per year (and most are) she (or he) will get
more take-home pay and her employer will save money and not be
required to file quarterly tax forms.
In the real world, where American factories compete with
those in Mexico and Korea, this reform will make the United
States much more competitive. Take, for example, an assembly
worker paid $7.50 an hour to put electronic products together.
He or she now makes $15,000 in gross salary, and nets several
thousand dollars less because of taxes, including a substantial
social security tax bite of $1,122.50, nearly $100 a month. The
employee will get an immediate raise in take-home pay. At the
same time, the employer will save an equal amount for each
employee. With 100 employees, a tidy $100,000 will be added to
the employer's bottom line. The employer will thus improve its
profitability and be more likely to keep its plant in the
United States open for business.
Who else will this reform benefit? Students are often paid
under $7.50 per hour. Restaurant workers, many in the textile
industry and in general those in semi-skilled occupations will
benefit. Those earning more than $68,400 per year will pay more
social security taxes, but even the rich will benefit by saving
taxes (and paperwork) for their nannies, servants and
chauffeurs. And if they own a business, the rich will benefit
from the new exemption. This change will give America what it
needs, a raise, while benefiting the economy and the Social
Security Trust Fund at the same time.
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