[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 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.


                            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 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Subcommittee on Social Security office, room B-316 
Rayburn House Office Building, at least one hour before the hearing 
begins.
      

FORMATTING REQUIREMENTS:

      
     Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
     1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1 
format, typed in single space and may not exceed a total of 10 pages 
including attachments. Witnesses are advised that the Committee will 
rely on electronic submissions for printing the official hearing 
record.
      
     2. Copies of whole documents submitted as exhibit material will 
not be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
     3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
     4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
     The above restrictions and limitations apply only to material 
being submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press 
and the public during the course of a public hearing may be submitted 
in other forms.
      

    Note: All Committee advisories and news releases are available on 
the World Wide Web at `HTTP://WWW.HOUSE.GOV/WAYS__MEANS/'.
      


    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.''
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

           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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                               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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