[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
SOCIAL SECURITY REFORM LESSONS LEARNED IN OTHER COUNTRIES
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
FEBRUARY 11, 1999
__________
Serial 106-1
__________
Printed for the use of the Committee on Ways and Means
----------
U.S. GOVERNMENT PRINTING OFFICE
56-189 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 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
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
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
Advisories announcing the hearing................................ 2
WITNESSES
Congressional Budget Office, Dan L. Crippen, Director............ 77
Social Security Administration, James Roosevelt, Jr., Associate
Commissioner, Retirement Policy................................ 93
______
Cato Institute, Jose Pinera...................................... 8
Harris, David O., Watson Wyatt Worldwide......................... 61
International Center for Pension Reform, Jose Pinera............. 8
Kay, Stephen J., Federal Reserve Bank of Atlanta................. 129
Kingson, Eric, School of Social Work, Syracuse University........ 113
Lilley, Rt. Hon. Peter, Member of Parliament, United Kingdom, and
Deputy Leader, Conservative Party.............................. 47
Sebago Associates, Inc., Peter R. Orszag......................... 106
SUBMISSIONS FOR THE RECORD
Green, Joseph G., Toronto, Ontario, Canada, statement............ 144
Heritage Foundation, statements and attachments.................. 145
SOCIAL SECURITY REFORM LESSONS LEARNED IN OTHER COUNTRIES
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THURSDAY, FEBRUARY 11, 1999
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 9:30 a.m. in room
1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisories announcing the hearing follow:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
February 3, 1999
No. FC-5
Archer Announces Hearing on
Social Security Reform Lessons
Learned in Other Countries
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
Social Security reforms in other countries. The hearing will take place
on Thursday, February 11, 1999, in the main Committee hearing room,
1100 Longworth House Office Building, beginning at 9:00 a.m.
Oral testimony at this hearing will be from invited witnesses only.
Witnesses will include scholars of foreign public retirement programs
as well as representatives of selected nations that have made program
changes in recent years. However, any individual or organization not
scheduled for an oral appearance may submit a written statement for
consideration by the Committee and for inclusion in the printed record
of the hearing.
BACKGROUND:
Despite its success in the past, the Social Security program faces
a solvency crisis in the coming years. The United States however, is
not alone. Increased life expectancies, accompanied by a surge in
births following the Great Depression and World War II, portend
enormous strains on public retirement programs around the world. The
World Bank estimates that the number of people age 60 and over will
triple between 1990 and 2030, placing particular stress on already-
developed nations in Europe, Asia, and the Americas. Many
industrialized countries, in particular, are finding that promised
public retirement benefits are not sustainable given current
demographic and economic trends. Several countries, including Germany,
Japan, and the United Kingdom, have raised retirement ages
prospectively. Others, including France, Italy, and Sweden, have begun
to implement benefit reductions. Still others, including Chile, Mexico,
and Australia, have attempted more comprehensive reforms by shifting
towards a forward-funded approach based more on personal savings for
retirement than strictly on pay-as-you-go public benefits.
In announcing the hearing, Chairman Archer stated: ``Our country is
not alone in facing a public retirement crisis. In fact, many countries
have already implemented the types of changes we are just starting to
debate in earnest. Whenever possible, we should seek to benefit from
this international experience as we proceed down our own path to
reform. This hearing will help us do just that.''
FOCUS OF THE HEARING:
The hearing will focus on Social Security reform experiences in
other countries, with a particular focus on lessons learned that can be
applied as the United States considers Social Security reform options.
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, Thursday,
February 25, 1999, 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 Committee office, room 1102 Longworth House Office
Building, by close of business the day before the hearing.
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.
*** NOTICE -- CHANGE IN TIME ***
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
February 4, 1999
No. FC-5-Revised
Time Change for Full Committee Hearing on
Thursday, February 11, 1999,
on Social Security Reform Lessons
Learned in Other Countries
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the full Committee hearing on Social
Security reforms in other countries, previously scheduled for Thursday,
February 11, 1999, at 9:00 a.m., in the main Committee hearing room,
1100 Longworth House Office Building, will begin instead at 9:30 a.m.
All other details for the hearing remain the same. (See full
Committee press release No. FC-5, dated February 3, 1999.)
Chairman Archer [presiding]. The Committee will come to
order. The Chair would invite Members, staff, and guests to
take seats. The Chair would invite our first witness, Mr.
Pinera, to sit at the witness chair.
Today's hearing focuses on Social Security reform lessons
that we can learn from other countries. It is clear that the
United States does not stand alone when it comes to the baby
boomer retirement problem. Many industrialized countries are
struggling with how to make ends meet as their citizens grow
older and their work force, relative to the retired population,
shrinks.
Several countries, including Germany, Japan, and the United
Kingdom, have raised the retirement ages. France, Italy, and
Sweden have begun to implement benefit reductions. Other
nations, such as Chile, Mexico, and Australia, have reformed
their systems through the creation of personal retirement
accounts. What should the United States do? That is the
question that we will be grappling with in this Congress.
President Clinton has put forward a framework of a plan
around which, I believe, we can make progress. To ward off
Social Security's bankruptcy, the White House proposes
crediting the Social Security Trust Fund with an additional
$445 billion over the next 5 years. Where does this money come
from? It comes from payroll tax money that is already destined
for the trust fund and invested in Treasury securities. This is
why many have written that it is double counting. In order to
extend the solvency of the trust fund, the administration's
budget puts $445 billion in the trust fund twice. Can the
President do that? Sure he can do that with a simple change in
the law. Many Americans wonder how Washington's budget process
works. But just because he can, doesn't mean that he should. As
we reform Social Security, some things have got to change.
This morning, I am pleased to release an analysis of how
the President's proposal impacts the national debt and the
Social Security Trust Fund. To me, nothing is more important
than saving Social Security so that our children and our
grandchildren can enjoy the same comfort that today's seniors
enjoy.
This analysis shows the administration's proposal increases
the total Federal debt by $1.2 trillion between 1999 and 2004
and it increases the debt held by the government by over $1.5
trillion over the same period. These increases do not hurt the
economy, nor do they crowd out private savings. They do,
however, represent a large burden on our children and
grandchildren who will have to repay this debt when it comes
due in just 13 years.
In addition, under the administration's plan, Congress will
now be required to vote to increase the debt ceiling 2 years
from now, and that is the true barometer of whether we have
increased the debt of our country. Under CBO's analysis, under
current law, we will not hit the debt ceiling for as far as the
eye can see.
Finally, this analysis shows that the debt held by the
public, and that is the debt that hurts the economy by crowding
out public savings, is higher under the President's plan than
it would be under current law. One reason is because the
President, like the Congress, doesn't use every penny of the
surplus to pay down the debt. But it is also because the
President's budget takes money out of the Social Security Trust
Fund to pay for other government spending programs.
So, what does all of this mean? It means that in order to
extend the trust fund solvency, the administration's proposal
risks saddling our children with more debt. I believe that some
time soon the President and the congressional leadership will
begin the hard work to save Social Security. As we proceed, let
us remember that extending the life of the trust fund is the
purpose of our endeavor, but not if it is at the expense of our
children. I think that it is better to begin the hard work of
reforming the system so that we can indeed save Social Security
for this generation and the next.
[The opening statement follows:]
Opening Statement of Hon. Bill Archer, a Representative in Congress
from the State of Texas
Good morning.
Today's hearing will focus on Social Security reform
lessons we can learn from other countries.
It's clear that the United States does not stand alone when
it comes to the baby boomer retirement. Many industrialized
counties are struggling with how to make ends meet as their
citizens age.
Several countries, including Germany, Japan, and the United
Kingdom have raised retirement ages. France, Italy and Sweden
have begun to implement benefit reductions. Other nations, such
as Chile, Mexico, and Australia, have reformed their systems
through the creation of personal retirement accounts.
What should the United States do?
President Clinton has put forward a framework of a plan
around which I believe we can make progress. To ward off Social
Security's bankruptcy, the White House proposes crediting the
Social Security trust fund with an additional $445 billion over
the next five years. Where does this money come from? It comes
from payroll tax money already destined for the trust fund.
This my friends, is the famous double-count.
In order to extend the solvency of the trust fund, the
Administration's budget puts $445 billion in the trust fund
twice. Can the President do that? Sure he can. Welcome to way
Washington works. But just because he can, doesn't mean he
should. As we reform Social Security, some things have got to
change.
This morning, I'm pleased to release an analysis of how the
President's proposal impacts the national debt and the Social
Security Trust Fund.
To me, nothing is more important than saving Social
Security so our children and our children's children can enjoy
the same comfort that today's seniors enjoy.
This analysis shows the Administration's proposal increases
the total federal debt by $1.2 trillion between 1999 and 2004
and it increases the debt held by the government by $1.5
trillion over the same period. These increases do not hurt the
economy nor do they crowd out private savings. The do, however,
represent a large burden on our children and grandchildren who
will have to repay this debt when it comes due in just thirteen
years.
In addition, under the Administration's plan, Congress will
be required to vote to increase the debt limit two years from
now. Under current law, we won't hit the limit for at least ten
years.
Finally, this analysis shows that the debt held by the
public--that's the debt that hurts the economy by crowding out
private savings--is higher under the President's plan than it
would be under current law. One reason is because the
President, like the Congress, doesn't use every penny of the
surplus to pay down the debt. But it's also because the
President's budget takes money out of the Social Security trust
fund to pay for other government spending programs.
What's all this mean?
It means that in order to extend the trust fund's solvency,
the Administration's proposal risks saddling our children with
more debt.
I believe that sometime soon the President and the
Congressional leadership will meet to begin the hard work of
saving Social Security. As we proceed, let's remember that
extending the life of the trust fund is the purpose of our
endeavor, but not if it's done at the expense of our children.
I think it's better to begin the hard work of reforming the
system so we can indeed save Social Security for this
generation and the next.''
Chairman Archer. Now, we start our hearing this morning
with a gentleman who has been ahead of the world, as it were,
in recognizing the problems of a government Social Security
Program, and initiating, almost singlehandedly, a new reform
process which was ultimately adopted by the country of Chile
and is still working today.
Before I recognize you, Mr. Pinera, for your comments and
welcome you more warmly, I yield to my colleague, the gentleman
from New York, Mr. Rangel, for any comments that he might like
to make.
Mr. Rangel. Thank you, Mr. Chairman, and I would like to
welcome our foreign guest and expert in privatization of
retirement funds. You put me at a complete disadvantage because
I am not familiar with the protocol, and I am not much of a
diplomat. So whatever is good for Chile I would assume is good
for Chile. I am very anxious to see what impact this would have
on our great democracy, but I assume that your plan went into
effect before Chile had an opportunity to enjoy a democracy. I
assume, further, that it was, and is still, mandatory. I assume
that the economic conditions in the great Government of Chile
are dramatically different than the economic conditions in the
great Government of the United States of America.
It would be difficult for me to find out whether all of the
people and economists in Chile support the position which you
have taken today. And, you may ask, how do I know what position
you have taken. Knowing my Chairman as well as I do, he would
not have invited you unless you were supporting his position.
But, with all due respect to your government, I think that
I will just withhold any comment except welcome to America, the
land of democracy where debate is open and sometimes criticism
is not very diplomatic. But you probably know all of that or
you wouldn't have accepted our invitation. So, thank you so
much for appearing.
[The opening statement of Hon. Jim Ramstad follows:]
Opening statement of Hon. Jim Ramstad, a Representative in Congress
from the State of Minnesota
Mr. Chairman, thank you for calling this important hearing
to discuss some of the reforms to public retirement programs
that have been implemented in other nations.
As we all know, the demographic scenarios that are plaguing
the financial future of the current Social Security system are
not unique to the United States. Many other nations have
already taken bold steps to tackle the complex problems facing
their public retirement systems, and we should welcome this
opportunity to learn from the pioneers in this area. We can
learn a lot from our friends about what they have done that
works well, and not so well, as we search for appropriate
measures to preserve and protect this critical program for
current and future beneficiaries.
I am hopeful that we can discuss, in a bipartisan,
pragmatic way, how to truly restructure the system so it is
financially solvent for the future. While I greatly appreciate
the President's attention to this issue, I am concerned about
the fact the President's proposal does nothing to ensure long-
term solvency of the system. Rather, as U.S. Comptroller
General David Walker testified before the Senate Finance
Committee earlier this week, it ``represents a different means
to finance the current program.''
That is how we handled Medicare in the last Congress. We
made some short-term changes to keep the program operational
for another 10 years. While that was necessary at the time, it
forces us to revisit the issue and make even tougher decisions
the second time through.
If we act soon, we have time to do this right. No senior
wants a reduction in benefits. No worker wants to pay more in
taxes. We have time to craft a plan that will increase benefits
by increasing the rate of return on dollars set aside for
retirement. We will also be able to take steps to encourage
additional personal savings.
Thank you again, Mr. Chairman, for calling this important
hearing. I look forward to hearing from today's witnesses about
the pros and cons of the various efforts that have been tested
across the world.
Chairman Archer. Mr. Pinera, I am not sure that you
represent everything that I think, but I think that you
represent a great deal of knowledge on this subject, and I
believe that we can learn from all those people who have walked
the path and not just walked the path whether they be in Chile,
or whether they be in Great Britain, or whether they be in
Australia, which are the two other countries from whom we will
hear witnesses later today.
But your background is outstanding. As Minister of Labor, I
believe, at the time that this program was initiated by you in
Chile, you worked very, very hard and very thoughtfully in
trying to design a program. We can learn from you, as we can
learn from people from all over the world.
As great as America is, we can still learn from others, and
we are happy to have you here this morning. I would encourage
you, if you would, to make as concise, as possible, your verbal
remarks to the Committee, and we will, without objection,
include your entire written statement, if you have one, in the
record. I am sure that Members, during the inquiry period, will
get at an awful lot of aspects of your knowledge of Social
Security, and I hope that we will have time for every Member to
inquire.
So, with that format, welcome. We are happy to have you
here, and we will be pleased to hear your testimony.
STATEMENT OF JOSE PINERA, PRESIDENT, INTERNATIONAL CENTER FOR
PENSION REFORM, AND COCHAIRMAN, PROJECT ON SOCIAL SECURITY
PRIVATIZATION, CATO INSTITUTE
Mr. Pinera. Thank you very much, Mr. Chairman. I am really,
really honored to be here. I am very grateful to every one of
the Members for being so openminded as to discuss an idea like
this.
Thank you, Mr. Rangel, for your views. I remember that I
met you in Chile when you visited us, of course. And I remember
that I told you that even though every idea has to be applied
in different ways in different countries, we have benefited in
Chile, enormously, from the ideas of your Founding Fathers. I
believe that the ideas of democracy, of freedom, of liberty,
are universal ideas. And what I come today to explain to you is
that we have applied precisely those principles to Social
Security. So, I would never say that the system within Chile is
a Chilean system. It is basically a system that respects human
dignity, human freedom, and, in that sense, it is very
American.
As you know, I studied in the United States. I got a lot of
my ideas in this country. It was precisely during my graduate
studies here that I was worried about the problems of poverty
in old age. And I was astonished by the fact that workers were
contributing a very high proportion of their wages, one-eighth
of their wages in the United States, to a Social Security
system. But at the same time, they were anguished about their
retirement benefits in old age. And it was here, in America,
when I began to think about how to save a national retirement
system by transforming it into a fully funded system that will
not depend on demographics in order to provide the benefit to
the people in old age.
And when we did it in my country 20 years ago, it was
exactly that. We saved a national retirement system by
transforming it into a system of private, individual accounts.
In Chile, every worker puts the equivalent of your FICA taxes
in a passbook account. Every worker has a passbook like this,
and every month, instead of sending the FICA tax to a
government body where they do not know really if that money is
there, is invested, they do not understand the concept of a
trust fund, but they understand very clearly the idea of
investing their money in a passbook account of their own. They
have a property right over this money. This money accumulates
during their whole working life, and when they reach retirement
age, they do not look at whether the macroeconomic numbers
allow the government to pay them a benefit, but they have huge
capital of their own in the account, and, with that, they get
an annuity for life indexed to inflation. So, every worker in
Chile does not have the anguish in old age of depending on, for
example, a congressional election on whether they will keep or
reduce, because of living increases, but they do have an
indexed annuity for life.
Now, the essence of the system, sir, is that we are
allowing every worker, even the poorest worker of the country,
to benefit from the extraordinary force of compounded interest.
Every investor knows that if you keep money in an account for
40 years, the money gets interest over interest and, therefore,
grows exponentially. And people who have high incomes have
always had savings accounts and have, therefore, been able to
benefit from that force. But, regrettably, the common worker,
the simple worker, the person who, at the end of the month,
after paying food, shelter, taxes, does not have additional
income to save in an account. They have not been able to
benefit from compounded interest. So, the essence of the
Chilean system is to allow every worker, and especially the
very poor, to benefit from the extraordinary force of
compounded returns over their whole life.
When I explained the system to the Chilean workers 20 years
ago, I used a very conservative rate of return of only 4
percent above inflation, and I told them, ``If you are able to
get 4 percent, you will accumulate a huge amount of money in
your account.'' Well, the system has performed beyond all of
our dreams because the average rate of return of the system
during the last 18 years, as you can see by the table has been
11 percent above inflation on average every year. Therefore,
this has been an enormous benefit to Chilean workers, and this
has transformed every worker into a shareholder. In America,
something like 40 percent of American citizens own an IRA
account or a 401(k) account, therefore they benefit when the
stock market goes up. In Chile, every single worker is a
shareholder, and, therefore, whenever the economy grows faster,
whenever companies do better, they are able, also, to benefit
from the well-being of the economy.
The system has been in place for 20 years. We placed three
very important rules for the transition from the old system to
the new one. The first one was that we guaranteed the benefits
of the elderly people. So, every person who was already
receiving a benefit in the Chilean system has nothing to fear
from the reform. We gave a government guarantee that we would
not take away our grandmother's check because those are
promises made and those are promises that must be kept.
The second important rule is that every young person who
enters the work force goes into the system on the passbook
account because we couldn't keep open the door of a system that
we knew that because of demographic forces would not be able to
pay benefits in the future.
And the third rule, and I would say that it is a very
important rule, was that we gave every worker who was already
in the labor force, the option to stay in the government-run
Social Security system, if they like it, or to move to the new
system. So, it was a completely voluntary choice of every
worker. So, by definition, nobody can be worse with a reform
like this because, if someone doesn't like investing in the
market, if someone doesn't like a passbook, if someone doesn't
like compounded interest, they simply stay where they are. And
those who move to the new system will recognize their past
contributions through what we call a recognition bond, that is,
a government bond that the government pays when the person
reaches retirement age. So, someone who is 50 years old, if he
moves from one system to the other, we have, when they reach
the retirement age, both the accumulated savings in the new
account plus the recognition bond.
Now, the extraordinary result has been that 93 percent of
Chilean workers have chosen the new system even though there
has been the usual discussion about market risk and so on, but
people understand that, if you have a very conservative
portfolio, you can reduce market risk to almost zero. So,
people in Chile put all their money in government bonds. You
could do it in the United States. Your government bonds are
giving you, for 30 years, a rate of return of 5.5 percent while
Social Security is giving 2 percent to the current workers and
will give 0 percent to a young man who is entering the work
force today. So, if someone is very worried, very risk adverse,
he can invest only in government bonds and still get, in
America, 5.5 percent of compound return over 30 years. If you
put 50 percent in bonds and 50 percent in shares, maybe you get
the 11 percent that we got in Chile. So, you can have a very
conservative, safe portfolio. And I do agree that that is a
very important concern for a worker, and the system should
provide the alternative of very conservative investment.
The system has worked, sir, extremely well. Under three
different governments the system has been kept exactly like it
is. Those of you who have visited Chile, and I see a lot of
faces here, have seen that the workers are happy with the new
system. They are shareholders of the country. They are owners
of the country's capital.
And in that sense, the system, I do not believe that it can
be qualified as being of the right or of the left. This is
basically a system for the 21st century rather than the pay-as-
you-go system that, as we all know, was created in the 19th
century by a German Chancellor, by Prince Otto Von Bismarck.
So, Mr. von Bismarck exported the idea to Chile in 1925, then
to the United States in 1935.
But I do believe that a system that is a tax-and-spend
system, unfunded, is really not consistent with the basic
American values. And that is why I believe an idea like this
could work in the United States even better than it has worked
in Chile.
Thank you, sir.
[The prepared statement follows:]
Statement of Jose Pinera, President, International Center for Pension
Reform, and Cochairman, Project on Social Security Privatization, Cato
Institute
Mr. Chairman, distinguished members of the committee:
My name is Jose Pinera and I am a Chilean citizen. I
learned to love your country during the four years that I spent
at Harvard University, earning a Master in Arts and a Ph.D. in
economics. Today, I am president of the International Center
for Pension Reform and co-chairman of the Cato Institute's
Project on Social Security Privatization. As Minister of Labor
and Social Security from 1978 to 1980, I was responsible for
the creation of Chile's private Social Security system.
I want to thank Chairman Archer for his invitation to me to
testify in the U.S. House of Representatives. In keeping with
the truth in testimony requirements, let me first note that
neither the Cato Institute nor the International Center for
Pension Reform receives any government money of any kind.
I believe there is no economic issue facing the world today
that is more important than converting unfunded pay-as-you-go
Social Security systems into fully funded systems of individual
retirement accounts. For that reason, there has been great
international interest in the pioneering Chilean Social
Security model. This is a global crisis, affecting all
countries, large and small, wealthy and poor, including the
United States.
I am here to share with you an idea, a powerful idea that
can improve the lives of all Americans. That idea was
implemented in Chile 19 years ago when we approved the Social
Security reform.
The Chilean USA System \1\
On Nov. 4, 1980, Chile approved a law to fully replace a
government-run retirement system with a fully funded privately
administered system of Universal Savings Accounts (USAs).
---------------------------------------------------------------------------
\1\ This section follows Jose Pinera, ``Empowering Workers: The
Privatization of Social Security in Chile.'' Cato's Letter No. 10, Cato
Institute (1996).
---------------------------------------------------------------------------
The new system began to operate on May 1, 1981 (Labor Day in
Chile). After 18 years of operation, the results speak for themselves.
The main goals of the reform have been achieved: much better retirement
benefits for all workers and control over their retirement savings. But
there have been other important consequences. By improving the
functioning of both the capital and the labor markets, the USA system
has been one of the key initiatives that, in conjunction with other
free-market reforms, have pushed the growth rate of the economy upwards
from the historical 3 percent a year to 7.0 percent on average during
the last 13 years.
In a recent work, UCLA Professor Sebastian Edwards has stated that,
``The Chilean pension reform has had important effects on the overall
functioning of the economy. Perhaps one of the most important of these
is that it has contributed to the phenomenal increase in the country's
saving rate, from less than 10 percent in 1986 to almost 29 percent in
1996.'' \2\ He goes on to say that, ``The pension reform has also had
an important effect on the functioning of the labor market. First, by
reducing the total rate of payroll taxes, it has reduced the cost of
labor and, thus, has encouraged job creation. Second, by relying on a
capitalization system, it has greatly reduced--if not eliminated--the
labor tax component of the retirement system.''
---------------------------------------------------------------------------
\2\ Sebastian Edwards, ``The Chilean Pension Reform: A Pioneering
Program.'' In M. Feldstein, ed., Privatizing Social Security, Chicago,
Ill.: University of Chicago Press (1998).
---------------------------------------------------------------------------
Under Chile's USA system, what determines a worker's retirement
benefits is the amount of money he accumulates during his working
years. Neither the worker nor the employer pays a social security tax
to the state. Nor does the worker collect government-funded retirement
benefits. Instead, during his working life, he automatically has 10
percent of his wages deposited by his employer each month in his own,
individual USA. A worker may contribute an additional 10 percent of his
wages each month, which is also deductible from taxable income, as a
form of voluntary savings.
A worker chooses one of the private Pension Fund Administration
companies (Administradoras de Fondos de Pensiones, or AFPs) to manage
his USA. These companies can engage in no other activities and are
subject to government regulation intended to guarantee a diversified
and low-risk portfolio and to prevent theft or fraud. A separate
government entity, a highly technical ``AFP Superintendency''
(Superintendencia de AFPs, or SAFP), provides oversight. Of course,
there is free entry to the AFP industry.
Each AFP operates the equivalent of a mutual fund that invests in
stocks and bonds. Investment decisions are made by the AFP. Government
regulation sets only maximum percentage limits both for specific types
of instruments and for the overall mix of the portfolio; and the spirit
of the reform is that those regulations should be reduced constantly
with the passage of time and as the AFP companies gain experience.
There is no obligation whatsoever to invest in government or any other
type of bonds. Legally, the AFP company and the mutual fund that it
administers are two separate entities. Thus, should an AFP go under,
the assets of the mutual fund--that is, the workers' investments--are
not affected.
Workers are free to change from one AFP company to another. For
this reason there is competition among the companies to provide a
higher return on investment, better customer service, or a lower
commission. Each worker is given a USA passbook and every four months
receives a regular statement informing him how much money has been
accumulated in his retirement account and how well his investment fund
has performed. The account bears the worker's name, is his property,
and will be used to pay his old age retirement benefits (with a
provision for survivors' benefits).
As should be expected, individual preferences about old age differ
as much as any other preferences. The old, pay-as-you-go system does
not permit the satisfaction of such preferences, except through
collective pressure to have, for example, an early retirement age for
powerful political constituencies. It is a one-size-fits-all scheme
that exacts a price in human happiness.
The USA system, on the other hand, allows for individual
preferences to be translated into individual decisions that will
produce the desired outcome. In the branch offices of many AFPs there
are user-friendly computer terminals that permit the worker to
calculate the expected value of his future retirement benefits, based
on the money in his account, and the year in which he wishes to retire.
Alternatively, the worker can specify the retirement benefits he hopes
to receive and ask the computer how much he must deposit each month if
he wants to retire at a given age. Once he gets the answer, he simply
asks his employer to withdraw that new percentage from his salary. Of
course, he can adjust that figure as time goes on, depending on the
actual yield of his retirement fund or the changes in the life
expectancy of his age group. The bottom line is that a worker can
determine his desired benefits and retirement age in the same way one
can order a tailor-made suit.
As noted above, worker contributions are deductible for income tax
purposes. The return on the USA is also tax-free. Upon retirement, when
funds are withdrawn, taxes are paid according to the income tax bracket
at that moment.
The Chilean USA system includes both private and public sector
employees. The only ones excluded are members of the police and armed
forces, whose social security systems, as in other countries, are built
into their pay and working conditions system. (In my opinion--but not
theirs yet--they would also be better off with an USA). Self-employed
workers may enter the system, if they wish, thus creating an incentive
for informal workers to join the formal economy.
A worker who has contributed for at least 20 years but whose
retirement fund, upon reaching retirement age, is below the legally
defined minimum receives benefits from the state once his USA has been
depleted. What should be stressed here is that no one is defined as
``poor'' a priori. Only a posteriori, after his working life has ended
and his USA has been depleted, does a poor retiree receive a government
subsidy. (Those without 20 years of contributions can apply for
welfare-type benefits at a lower level).
The USA system also includes insurance against premature death and
disability. Each AFP provides this service to its clients by taking out
group life and disability coverage from private life insurance
companies. This coverage is paid for by an additional worker
contribution of around 2.6 percent of salary, which includes the
commission to the AFP.
The mandatory minimum savings level of 10 percent was calculated on
the assumption of a 4 percent average net yield during the whole
working life, so that the typical worker would have sufficient money in
his USA to fund benefits equal to 70 percent of his final salary.
Upon retiring, a worker may choose from two general payout options.
In one case, a retiree may use the capital in his USA to purchase an
annuity from any private life insurance company. The annuity guarantees
a constant monthly income for life, indexed to inflation (there are
indexed bonds available in the Chilean capital market so that companies
can invest accordingly), plus survivors' benefits for the worker's
dependents. Alternatively, a retiree may leave his funds in the USA and
make programmed withdrawals, subject to limits based on the life
expectancy of the retiree and his dependents. In the latter case, if he
dies, the remaining funds in his account form a part of his estate. In
both cases, he can withdraw as a lump sum the capital in excess of that
needed to obtain an annuity or programmed withdrawal equal to 70
percent of his last wages.
The USA system solves the typical problem of pay-as-you-go systems
with respect to labor demographics: in an aging population the number
of workers per retiree decreases. Under the USA system, the working
population does not pay for the retired population. Thus, in contrast
with the pay-as-you-go system, the potential for inter-generational
conflict and eventual bankruptcy is avoided. The problem that many
countries face--unfunded social security liabilities--does not exist
under the USA system.
In contrast to company-based private retirement systems that
generally impose costs on workers who leave before a given number of
years and that sometimes result in bankruptcy of the workers'
retirement funds--thus depriving workers of both their jobs and their
retirement rights--the USA system is completely independent of the
company employing the worker. Since the USA is tied to the worker, not
the company, the account is fully portable. The problem of ``job lock''
is entirely avoided. By not impinging on labor mobility, both inside a
country and internationally, the USA system helps create labor market
flexibility and neither subsidizes nor penalizes immigrants.
An USA system is also consistent with a truly flexible labor
market. In fact, people are increasingly deciding to work only a few
hours a day or to interrupt their working lives--especially women and
young people. In pay-as-you-go systems, those flexible working styles
generally create the problem of filling the gaps in contributions. Not
so in an USA scheme where stop-and-go contributions are no problem
whatsoever.
The Transition
Countries that already have a pay-as-you-go system have to
manage the transition to an USA system. Of course, the
transition has to take into account the particular
characteristics of each country, especially constraints posed
by the budget situation.
In Chile we set three basic rules for the transition:
1. The government guaranteed those already receiving
retirement benefits that they would be unaffected by the
reform. It would be unfair to the elderly to change their
benefits or expectations at this point in their lives.
2. Every worker already contributing to the pay-as-you-go
system was given the choice of staying in that system or moving
to the new USA system. Those who left the old system were given
a ``recognition bond'' that was deposited in their new USAs.
(It was a zero coupon bond, indexed and with 4 percent real
interest rate). The government pays the bond only when the
worker reaches the legal retirement age. The bonds are traded
in secondary markets, so as to allow them to be used for early
retirement. This bond reflected the rights the worker had
already acquired in the pay-as-you-go system. Thus, a worker
who had made social security contributions for years did not
have to start at zero when he entered the new system.
3. All new entrants to the labor force were required to
enter the USA system. The door was closed to the pay-as-you-go
system because it was unsustainable. This requirement assured
the complete end of the old system once the last worker who
remained in it reaches retirement age (from then on, and during
a limited period of time, the government has only to pay
retirement benefits to retirees of the old system).
After several months of national debate on the proposed
reforms, and a communication and education effort to explain
the reform to the people, the social security reform law was
approved on November 4, 1980.
Together with the creation of the new system, all gross
wages were redefined to include most of the employer's
contribution to the old system. (The rest of the employer's
contribution was turned into a transitory tax on the use of
labor to help the financing of the transition; once that tax
was completely phased out, as established in the social
security reform law, the cost to the employer of hiring workers
decreased). The worker's contribution was deducted from the
increased gross wage. Because the total contribution was lower
in the new system than in the old, net salaries for those who
moved to the new system increased by around 5 percent.
In that way, we ended the illusion that both the employer
and the worker contribute to social security, a device that
allows political manipulation of those rates. From an economic
standpoint, all the contributions are ultimately paid from the
worker's marginal productivity, because employers take into
account all labor costs--whether termed salary or social
security contributions--in making their hiring and pay
decisions. By renaming the employer's contribution, the system
makes it evident that workers make all contributions. In this
scenario, of course, the final wage level is determined by the
interplay of market forces.
The financing of the transition is a complex technical
issue and each country must address this problem according to
its own circumstances. The implicit pay-as-you-go debt of the
Chilean system in 1980 has been estimated by the World Bank at
around 80 percent of GDP.\3\ (The value of that debt had been
reduced by a reform of the old system in 1978, especially by
the rationalization of indexing, the elimination of special
regimes, and the raising of the retirement age.) A World Bank
study stated that ``Chile shows that a country with a
reasonably competitive banking system, a well-functioning debt
market, and a fair degree of macroeconomic stability can
finance large transition deficits without large interest rate
repercussions.''
---------------------------------------------------------------------------
\3\ World Bank, Averting the Old Age Crisis (1994).
---------------------------------------------------------------------------
Chile used five methods to finance the transition to an USA
system:
1. Since the contribution needed in a capitalization system
to finance adequate social security levels is generally lower
than the current payroll taxes, a fraction of the difference
between them was used as a temporary transition payroll tax
without reducing net wages or increasing the cost of labor to
the employer (the gradual elimination of that tax was
considered in the original law and, in fact, that happened, so
that today it does not exist).
2. Using debt, the transition cost was shared by future
generations. In Chile roughly 40 percent of the cost has been
financed issuing government bonds at market rates of interest.
These bonds have been bought mainly by the AFPs as part of
their investment portfolios and that ``bridge debt'' should be
completely redeemed when the retirees of the old system are no
longer with us.
3. The need to finance the transition was a powerful
incentive to reduce wasteful government spending. For years,
the budget director has been able to use this argument to kill
unjustified new spending or to reduce wasteful government
programs, thereby making a crucial contribution to the increase
in the national savings rate.
4. The increased economic growth that the USA system
promoted substantially increased tax revenues. Only 15 years
after the social security reform, Chile started running fiscal
budget surpluses of around 2 percent of GNP.
5. Privatization of state-owned companies in Chile were
another way to contribute, although marginally, to finance the
transition. Of course, this had several additional benefits
such as increasing efficiency, spreading ownership, and
depoliticizing the economy.
The Results
The USAs have already accumulated an investment fund of $31
billion, an unusually large pool of internally generated
capital for a developing country of 15 million people and a GDP
of $70 billion.
This long-term investment capital has not only helped fund
economic growth but has spurred the development of efficient
financial markets and institutions. The decision to create the
USA system first, and then privatize the large state-owned
companies second, resulted in a ``virtuous sequence.'' It gave
workers the possibility of benefiting handsomely from the
enormous increase in productivity of the privatized companies
by allowing workers, through higher stock prices that increased
the yield of their USAs, to capture a large share of the wealth
created by the privatization process.
One of the key results of the new system has been to
increase the productivity of capital and thus the rate of
economic growth in the Chilean economy. The USA system has made
the capital market more efficient and influenced its growth
over the last 18 years. The vast resources administered by the
AFPs have encouraged the creation of new kinds of financial
instruments while enhancing others already in existence, but
not fully developed. Another of Chile's social security reform
contributions to the sound operation and transparency of the
capital market has been the creation of a domestic risk-rating
industry and the improvement of corporate governance. (The AFPs
appoint outside directors in the companies in which they own
shares, thus shattering complacency at board meetings.)
Since the system began to operate on May 1, 1981, the
average real return on investment has been 11 percent per year,
almost three times higher than the estimated yield of 4
percent. Of course, the annual yield has shown the oscillations
that are intrinsic to the free market--ranging from minus 2.5
percent to almost 30 percent in real terms--but the important
yield is the average one over the long term (see Table 1).
Retirement benefits under the new system have been
significantly higher than under the old, state-administered
system, which required a total payroll tax of around 25
percent. According to a recent study, the average AFP retiree
is receiving benefits equal to 78 percent of his mean annual
income over the previous 10 years of his working life. As
mentioned, upon retirement workers may withdraw in a lump sum
their ``excess savings'' (above the 70 percent of salary
threshold). If that money were included in calculating the
value of the benefits, the total value would come close to 84
percent of working income. Recipients of disability benefits
also receive, on average, 70 percent of their working income.
The new social security system, therefore, has made a
significant contribution to the reduction of poverty by
increasing the size and certainty of old age, survivors, and
disability benefits, and by the indirect but very powerful
effect of promoting economic growth and employment.
When the USA was inaugurated in Chile in 1981, workers were
given the choice of entering the new system or remaining in the
old one. One fourth of the eligible workforce chose the new
system by joining in the first month of operation alone. Today,
more than 95 percent of Chilean workers are in the new system.
Social security is no longer a source of political
conflict. A person's retirement income will depend on his own
work and on the success of the economy, not on the government
or on the pressures brought by special interest groups.
Real annual rate of return of Chile's private social security system
(Note: rate of return above inflation)
------------------------------------------------------------------------
Year Rate
------------------------------------------------------------------------
1981....................................................... 12.6
1982....................................................... 28.8
1983....................................................... 21.3
1984....................................................... 3.5
1985....................................................... 13.4
1986....................................................... 12.3
1987....................................................... 5.4
1988....................................................... 6.4
1989....................................................... 6.9
1990....................................................... 15.5
1991....................................................... 29.7
1992....................................................... 3.1
1993....................................................... 16.2
1994....................................................... 18.2
1995....................................................... -2.5
1996....................................................... 3.5
1997....................................................... 4.7
1998....................................................... -1.1
------------
Annual Average:........................................ 11.0
------------------------------------------------------------------------
Source: Official Government Statistics (SAFP).
For Chileans, USAs now represent real and visible property
rights--they are the primary sources of security for
retirement. After 18 years of operation of the new system, the
typical Chilean worker's main asset is not his used car or even
his small house (probably still mortgaged), but the capital in
his USA.
Finally, the private social security system has had a very
important political and cultural consequence. Indeed, the new
social security system gives Chileans a personal stake in the
economy. A typical Chilean worker is not indifferent to the
behavior of the stock market or interest rates. Intuitively he
knows that his old age security depends on the wellbeing of the
companies that represent the backbone of the economy.
The Global Social Security Crisis
The real specter haunting the world these days is the
specter of bankrupt state-run social security systems. The pay-
as-you-go social security system created by Chancellor Otto Von
Bismarck has a fundamental flaw, one rooted in a false
conception of how human beings behave: it destroys, at the
individual level, the essential link between effort and
reward--in other words, between personal responsibilities and
personal rights. Whenever that happens on a massive scale and
for a long period of time, the result is disaster.
Two exogenous factors aggravate the results of that flaw:
(1) the global demographic trend toward decreasing fertility
rates; and, (2) medical advances that are lengthening life. As
a result, fewer workers are supporting more and more retirees.
Since the raising of both the retirement age and payroll taxes
has an upper limit, sooner or later the system has to reduce
the promised benefits, a telltale sign of a bankrupt system.
Whether this reduction of benefits is done through
inflation, as in most developing countries, or through
legislation, the final result for the retired worker is the
same: anguish in old age created, paradoxically, by the
inherent insecurity of the ``social security'' system.
The success of the USA system in Chile has led seven other
Latin American countries to follow suit. In recent years, Peru
(1993), Argentina (1994), Colombia (1994), Uruguay (1995),
Mexico (1997), Bolivia (1997), and El Salvador (1998) undertook
similar reforms. It is possible that before entering the new
millennium, several other countries in the Americas will have
implemented USA systems instead of unfunded government-run
social security ones. This would mean a massive redistribution
of power from the state to individuals, thus enhancing personal
freedom, promoting faster economic growth, and alleviating
poverty, especially in old age.
Mr. Chairman, let me conclude with a warning about the
damaging moral effects of unfunded social security and other
entitlement programs issued at the dawn of the New Deal:
The lessons of history, confirmed by evidence immediately
before me, show conclusively that continued dependence on
relief induces a spiritual and moral disintegration
fundamentally destructive to the national fiber. To dole out
relief in this way is to administer a narcotic, a subtle
destroyer of the human spirit. It is inimical to the dictates
of sound policy. It is a violation of the traditions of
America.\4\
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\4\ Franklin D. Roosevelt, The Public Papers and Addresses of
Franklin D. Roosevelt, Vol. 4, The Court Disapproves: 1935, Random
House (1938).
That warning was issued by President Franklin Delano
Roosevelt in his 1935 State of the Union address.
I believe that the road is clear in the United States to
replace a Bismarckian program with a system that is so
inherently consistent with American values.
Thank you very much.
Chairman Archer. Thank you, Mr. Pinera.
Mr. Crane will inquire.
Mr. Crane. Thank you, Mr. Chairman.
It is a real honor to have this opportunity to visit with
Dr. Pinera. The only unfortunate thing in his resume is that he
got his Ph.D. in economics at Harvard rather than at the
University of Chicago, but I will say that Chicago School of
Economics all the way.
We had the privilege of meeting with Jose when our Trade
Subcommittee was down in Chile in 1995, and the trade trip had
a few moments set aside for Jose to explain to us what he had
done there, miraculously, in saving their universal savings
account. I think that we borrowed from Bismarck, we call ours
SS, and yours is USA. Is that not correct?
Mr. Pinera. Yes.
Mr. Crane. At any rate, I thought I would pass that on to
you, Charlie, just in case there was any confusion.
But at any rate, I enjoyed that visit enormously. But the
thing that was so striking to me was your explanation to us. At
the time you started down that path it was a big gamble, like
throwing dice at the craps table, and you were not sure how
many, even though it was voluntary, how many workers would jump
onboard and how attractive a potential program it might be. And
that you were overwhelmed with the percentage that did, at the
very beginning. And, at that time, I think, you told us it was
just a little over 90 percent, now it is up to 93 or 94 percent
that have gotten into the program. I mean, it was the most
exciting part of the trip that we had down there, was the visit
with you. And I say that because it opens up the door of the
possibility of us, who are faced with this awesome problem of
dealing with our own Social Security system, which is in big
trouble, down the line, dealing with it along the positive
lines you gave us.
I would like to ask you one question, though, and that is,
when you originally created the program down there, how did you
get the message out to individual Chileans that they had this
opportunity, and convey to them, a potential for a return that
exceeded the existing program?
Mr. Pinera. Well, that is a very interesting question, sir.
I believe that when you are doing a reform like this you have
the duty to educate, to inform, to debate the system. So, we
had a great effort of communication and education.
The most important part of the effort was 3-minute
television comment by me every week. I went on television as a
Secretary, and I said that I would like to have 3 minutes,
because I generally believe that people do not like a
government official for more than 3 minutes on television. And
they have now the zapping machine so they can immediately make
it go away. Of course, Fidel Castro has never heard this thesis
from me.
So, I worked exactly 3 minutes. And I believe, sir, that
people understand these issues when they are explained in
simple terms. I believe that it is a grave mistake of some
economists from Harvard or Chicago, to use jargon to explain
simple things. When you tell people that you can put the money
in an account like this--I even remember that I used a Spanish
term. In Chile we say ``la plata donde tos offos la vaya,''
``the money where your eyes can see.'' And everywhere that I
went, I said, ``Would you like the money where your eyes cannot
see it?'' Because in the Social Security Administration you
don't know where the money is. Or whether you would like it in
a passbook. You know, Chileans can go to an ATM machine every
month, put the passbook, and immediately know the amount of the
contribution, the compounded interest, and the total amount. My
Secretary goes every month and goes to my office in the morning
and tells me how rich she is, and therefore how much respect,
not that only me, but everyone should show to someone who has,
I don't remember $60,000 or $70,000, in her account already.
So, I believe, sir, that it was not a gamble. I believe
that you can trust it when you explain the ideas to them in
simple, but truthful, terms. And that is how it worked in
Chile.
Mr. Crane. Well, I commend you, Jose. Our time is limited
here, and your time, too, I know. But I appreciate the fact
that you make these periodic visits up here. Maybe more than
periodic. And your association with a think tank to help
disseminate good, sound policy. And yours is the shining
example, that I am aware of, worldwide in this area. And you
are to be heartily congratulated. You have had a major
influence already, but you will continue to expand that
influence. And hopefully, people like Clay here, can take
advantage of that. He is having the hearings right now with a
view to our reforms here in the United States. But your example
and your experience down there is so commendable that I think
that you are the shining light as far as this investigation
goes.
And I yield back the balance of my time, Mr. Chairman.
Chairman Archer. Mr. Rangel.
Mr. Rangel. Thank you, Mr. Chairman.
It is going to take me a little time, Dr. Pinera, to leave
the system that was created by Franklin Roosevelt in order to
get to the one that you have been able to create. Listening to
my friend, Congressman Crane, I am inclined to suggest to my
President that he take our surplus and invest it in Chilean
stock here. Then we will make certain that everything is
secure.
I think that Mr. Crane asked you how did you sell this to
the Chilean people. But at the time that this system went into
effect, it was mandatory, wasn't it? I mean, the Chileans never
had a vote on this, and there was no Parliament and no
congressional question. Wasn't it under General Pinochet? I
mean, when this system went in, it just went in. It was
mandatory, wasn't it?
Mr. Pinera. The pay-as-you-go system, sir, was mandatory
before this. What we did was to give workers a choice between a
mandatory pay-as-you-go system----
Mr. Rangel. Yes.
Mr. Pinera [continuing]. To a mandatory system of
individual accounts. Of course, in both cases, the system is
mandatory. But we gave workers the choice to choose one way,
basically a pay-as-you-go, or another way, the passbooks. And
workers were free to choose one.
Mr. Rangel. Once you make the decision, can you change your
mind? If you go into the passbook system, can you take your
money out of that system any time you want, or do you have to
wait until the retirement age is at hand?
Mr. Pinera. No, you have to wait, sir, until your
retirement age because, like the definition, you cannot use the
same money for two different purposes. Regrettably. So, if you
have a retirement system, the money should be there for
retirement.
But we do have an option that maybe you are interested in,
sir, and it is the following. We know that some people want to
work forever until 90 years old, but some people want to retire
at 55 because they have grandchildren or they want to write a
novel.
Mr. Rangel. I am familiar with that. They can take it out
and put it in an annuity, or do something else with it. But let
me ask some other questions.
One of the concerns that we have about privatization in the
United States is whether or not there is any guaranteed income,
notwithstanding a negative market. Is there a guarantee? A
minimum? A ground floor? A safety net in case the Chilean stock
market is negative?
Mr. Pinera. Absolutely, sir. Everyone, as I said, has a
passbook. But, if someone reaches retirement age and has
accumulated in his passbook a given amount of money--let's
imagine in this glass, this amount of water--and not all this,
but should be the minimal, the government from Federal revenues
made like this, sees the glass so that everyone has at least
the minimum retirement income. So the system assures everyone a
safety net, but above the safety net you get extra net from
your passbook account.
Mr. Rangel. And the market has not been as positive in
recent years as it was when this system started. Has there been
any need for the Chilean Government to pour in that additional
money for current retirees?
Mr. Pinera. Not yet, sir, precisely because of the
diversification rules. Last year, when the stock market in
Chile went down by 25 percent because of the Asian, the
Russian, the Brazilian crisis, the funds' return went down only
1 percent. That seems magic. Twenty-five percent down the stock
market, but the funds, 1 percent. Why? Because the funds are
invested also in bonds, in mortgages, in international shares.
And even with that minus 1 percent of 1998, the average return
over 18 years is still 11 percent above inflation on average
every year.
Mr. Rangel. Did your government urge workers, because of
the condition of the market, to delay retirement?
Mr. Pinera. No. The government cannot tell the people when
they should retire. I do know that Vice President Gore
misinterpreted, maybe, the translation of some official in
Chile and included that in one of his addresses, but that has
been corrected by the Chilean official by saying that the
government has nothing to do with telling people when they
should retire. That is completely against the whole philosophy
of the system.
Mr. Rangel. We're talking about Deputy Secretary for Social
Security, Patricio Tambolini? That is the same controversy that
you say that the Vice President misunderstood?
Mr. Pinera. Yes, I just think that he quoted a
Superintendent. But anyway, it is definite that neither the
President nor the Secretary nor anyone has a right in Chile to
tell people when to retire. It would be like telling people
when to buy a car or when to buy a house. It may be a personal
opinion, but it is not in the philosophy of the system, sir.
Mr. Rangel. No, I agree. We are also concerned with the
cost of administration.
Let me, again, welcome you to the United States. I didn't
know that you were Harvard trained, or at least I forgot it.
This is like your second home, so, welcome home.
Mr. Pinera. Thank you, sir, and we welcomed you also to
Chile when you went, and I hope that you can go again and keep
being informed about this system.
Mr. Rangel. I look forward to it.
Chairman Archer. Mrs. Johnson.
Mrs. Johnson of Connecticut. Thank you.
Dr. Pinera, thank you very much for being with us. Could
you discuss with us how the government goes about certifying
the companies that manage the investing funds? And have you had
any occasion to decertify any of your fund managers. And, you
know, just that whole mechanism. How do you keep politics out
of the decisions about fund managers and the fund investments
and those kinds of things. If you could talk a little bit about
the politics and the mechanism of that fund management, I would
appreciate it.
Mr. Pinera. Well, that is a very important element, Miss,
because the whole idea of the reform has been the
depoliticization of Social Security. That is, Social Security
is not any longer a main political issue in Chile.
Representatives of the people, of course, debate health,
education, crime, but not Social Security because this is a
system that works on its own.
Now, how can politicians certify? We put in the law certain
basic requirements to be a certified manager. The requirements
are that--our objective requirements, that is--have a given
amount of capital, have never had a problem with the Securities
and Exchange Commission of Chile--this is a very objective
test. If a company can meet that test, a Chilean or a foreign
company--because we allow a 100-percent ownership of a foreign
company of the Chilean mutual fund. And we do have Citibank
there, we have American International Group, we have AETNA Life
Insurance--so, a lot of your companies have understood that
this is a worldwide megatrend, and they want to be in Chile.
They are in Chile.
So, the companies are certified through a very objective,
completely depoliticized system, and there has been, in 19
years, never a problem. And if a company were to feel treated
in a nonobjective way, they can go to the Supreme Court because
the rules are very, very clear.
Mrs. Johnson of Connecticut. And could you also talk a
little bit about the early retirement options? Under our
system, you really have no early retirement option until 62,
and then, of course, you get a reduced benefit. What are the
rules under the Chilean system?
Mr. Pinera. Well, that is exactly what I was explaining to
the question of Mr. Rangel. In Chile, everyone can begin to
retire money from his account from the moment that he or she
has accumulated enough capital to buy an annuity equal to at
least 50 percent of his last wages. So, even though the
mandatory contribution to the passbook is 10 percent of wages,
you can put another 10 percent in tax free. And, therefore,
some people, for example, that want to retire at 55, they go to
a mutual fund company, they sit in front of a friendly
computer, and they ask the computer, ``How much money should I
save if I want to retire at 55?'' The computer makes a
calculation with historic rate of return, and they tell him
that, for example, 14.3. And what about if I want to retire at
57? In that case, 12.8.
So, basically, we have given back to the people the right
to retire whenever they want as long as they save enough for
retirement. They cannot retire early with someone else's money,
because that would be, of course, an abuse.
Mrs. Johnson of Connecticut. And also, Dr. Pinera, is it
possible to save more some years than others? For instance, if
you have a high paying 2 years, can you up your savings? And
then, if you move to another job where you earn less, can you
lower your savings as long as it is 10 percent? In other words,
can you float between the 10- and 20-percent contribution
levels?
Mr. Pinera. You can always move between the 10- and 20-
percent contribution levels. But when you choose the early
retirement option, that is, when you have been able to buy that
annuity for 50 percent of your wages----
Mrs. Johnson of Connecticut. Yes, once it is bought. But up
to that point, you may do that, cancellation and then oh, I
don't want to retire early after all. But during your working
years, can you elect to contribute say, 14 or 15 percent, and
then later on, a few years later, elect to go back down to the
10 percent?
Mr. Pinera. You could do it a few months later.
Mrs. Johnson of Connecticut. Yes, OK.
Mr. Pinera. You could do it at any moment. It is your
money. It is your future. It is your decision.
Mrs. Johnson of Connecticut. You can actually determine at
what pace you want to save throughout your working life as long
as it doesn't go below 10 percent? And when you want to retire?
Mr. Pinera. Exactly.
Mrs. Johnson of Connecticut. Thank you very much.
Mr. Pinera. And you can go on----
Mrs. Johnson of Connecticut. A construction worker who had
a very good season could up their investment and retire
earlier.
Thank you.
Mr. Pinera. Could I just add one point? You can go on
working after 65 years, and in that case, you do not have to
pay the 10 percent. You can retire from your account, and all
the wages that you get are your wages. To me this is very
important because I simply cannot understand the fact that on a
given moment, on your 65th birthday, the day before you have
been working many years, and the day after you don't know what
to do in the morning. In Chile you can say that I imagine now
that I will work now half a day. I will work 3 hours a day. We
have stopped this contradiction that on a given day you are a
worker and on the next day someone who has nothing to do.
Mrs. Johnson of Connecticut. Interesting. Thank you very
much, that is important.
Chairman Archer. Mr. Houghton.
Mr. Houghton is not here.
Mr. Camp.
Mr. Camp. Thank you.
Dr. Pinera, could you state for the Committee what the
savings rate is in Chile?
Mr. Pinera. Around 25 percent of GNP. Up from 10 percent
before this reform was done. But I cannot say, sir, being very
honest, whether the whole difference has been because of this
reform because we were doing several reforms at the same time.
There have been some experts who have said that this reform has
been the most important one, but not the only one. So, I
wouldn't want to give to this reform more than it is due.
Mr. Camp. I understand that a majority of the personal
account assets are invested in government bonds. Are these
Chilean bonds or the bonds of other countries?
Mr. Pinera. Both. Most, of course, are invested in Chilean
bonds, but now we are in the process of allowing the pension
funds to invest abroad, and they are investing in U.S. Treasury
bonds, German Treasury bonds, and so on. That is the decision
of the fund managers according to some levels of certification
criteria.
Mr. Camp. Is this a requirement of participating in the
personal accounts?
Mr. Pinera. No there is no requirement whatsoever to invest
a penny in a government bond. There can be a fund that could
say that we do not invest in government bonds, and they can
invest zero.
The only requirements are ceilings. That is, you have to
invest no more than 6 percent in government bonds, no more than
a certain percent in shares. But you should never put a floor
because the moment you put a floor, it is a possibility of
confiscating the money because then the government can issue a
bond at the rate of interest lower than the market.
So, never put a floor, but, yes, put a ceiling in order to
ensure putting the eggs in different baskets.
Mr. Camp. Were there any cash incentives offered to workers
to go into these personal accounts?
Mr. Pinera. No, there was not a cash incentive from the
government, but what happened that the contribution rate in the
new system is lower than the contribution rate of the old
system. So, when the worker moved from the old to the new
system, he got a take home pay increase of around 4 to 5
percent. Not of government money, but of his own payroll tax
money because the new contribution rate was lower than the old
one.
Mr. Camp. I realize also that you testified to the
safeguard that if your savings don't get up to a certain level
when you opt to retire that the government then makes the glass
full. How did the people in Chile react to the concept that
income would depend on stock and bond performance? Can you talk
about that a little bit to the Committee, please?
Mr. Pinera. Initially, of course, there was lot of
questions, and that is why, as I said before, I employed almost
1 year of my time, after we had decided on this system, to
explain it to the workers. I went to hundreds of trade union
meetings, townhall meetings. And when I explained to people
that they should not invest--that is, that they have the choice
to invest in a very risk-adverse way, the people began to
understand. You see, when you tell people, ``Look, if you do
not like this, if you want to sleep very well, even though you
may have to eat a little less well, you can put all the money
in Treasury bills.''
So, when you tell people that you have a fallback position,
that if they are extremely risk averse, you can put all the
money in government bonds, then people say, ``OK, I have the
fallback position, but I would like to have some shares.''
And what happened, generally, sir, is that the 20-year-old
young person prefers a lot of shares, because he knows, as we
all know, that over a 40-year period, the share market has
given people a much better return than bonds.
But what I always tell workers who approach me in the
street--because they have seen me on television--that when they
are 50, 55, 60, they should begin to move to a fully bond fund
so that they can sleep very well in the years prior to their
65th birthday.
Mr. Camp. Thank you.
Chairman Archer. Mr. Matsui.
Mr. Matsui. Thank you very much, Mr. Chairman. Thank you,
Dr. Pinera.
I would like to follow up on what Mr. Rangel said. The
Chilean Deputy Secretary for Social Security, Secretary
Tambolini, was the one that Mr. Rangel was referring to. Now,
granted, under your system in Chile, one cannot require a
person not to retire under the law, but there is no question,
at least from press reports that I have read and have before me
right now from Chilean newspapers, that the Secretary did
recommend to the work force that they withhold their retirement
because there was a negative growth in the account at the time.
Now, are you denying that took place? You don't have to tell
me--I know that the government can't require it. I am just
saying that that was a recommendation. Isn't that the truth?
Mr. Pinera. Well, first, sir, I can deny absolutely that
Mr. Tambolini is the Secretary.
Mr. Matsui. I'm sorry. Say that again.
Mr. Pinera. He is not the Secretary.
Mr. Matsui. I said as Deputy Secretary.
Mr. Pinera. No, he is the Deputy Secretary.
Mr. Matsui. I'm sorry?
Mr. Pinera. He is the number two in the Ministry, not the
number one.
Mr. Matsui. All right.
Mr. Pinera. OK, I would like that to be clear.
Mr. Matsui. I'm just asking you, did he say that or not say
that?
Mr. Pinera. I don't know, sir, what every Chilean official
says. How can I deny or confirm what this number two person----
Mr. Matsui. Did you read it in the paper?
Mr. Pinera. No.
Mr. Matsui. So, you don't read the papers?
Mr. Pinera. No, I don't----
Mr. Matsui. All right, thank you.
I would feel a little more comfortable if the plan were
more than 19 years old. I am somewhat troubled. It sounds a lot
better than the prior system, and I certainly commend you and
those in the Pinochet government for instituting this new
system. Obviously it wasn't very good under the dictatorship
that existed prior to 1981. And so, this is much better.
But the issue for us is whether or not, in the next 30 or
40 years it is going to be a good system. And it appeared to be
very much tied to the economy of the country, particularly
since the country deals so much with Asia, and the Asian
financial markets. Because in the last few years, since 1995,
we have actually seen rather sluggish growth. And the fund, as
a result of that, has been somewhat sluggish. And would you
care to comment on that?
Mr. Pinera. Yes, sir. I disagree that it will have to hinge
on the performance of one economy because the funds are being
allowed increasingly to diversify internationally, and the
Chilean pension funds are investing a fraction internationally,
in the U.S. market, in the European market and so on. So,
ultimately it will be a worldwide portfolio.
So, of course, if you are telling me that in the next 40
years the world economy will be in crisis, I will grant you a
point. But, as you understand, you will have much more
important problems than the Chilean pension system.
Mr. Matsui. If I could just comment on this.
My problem on this is that, of course, I am reading off of
secondary documents, but a study by Sebastian Edwards of the
Chilean pension system said that throughout the eighties, 40
percent of the rate of returns were attributed to the
performances of just two electric utility companies. Is that
incorrect?
Mr. Pinera. That may be correct, sir.
Mr. Matsui. Well, if that is correct, then two companies
accounted for 40 percent of 11 percent of growth. Is that
correct? So, if those two companies had not had that kind of
growth----
Mr. Pinera. No, I have not done that calculation.
But, if so, those two companies are two of the largest
companies in Chile. They are private companies. They have
performed so well in the market. So, I definitely do not see
the point.
Mr. Matsui. No, no, I appreciate you being honest about
this.
So, two companies attributed to 40 percent of the growth of
the fund. And if those companies had faltered, perhaps the fund
would not have performed the way it did--but I appreciate that
because that shows the kind of risk that we are talking about,
and this system is the final safety net. This is the one thing
that obviously keeps that senior citizen out of poverty--now
let me just ask the last question.
Mr. Pinera. Just 1 minute, sir, I have not said that I
accept that judgment.
Mr. Matsui. But you did say it is true.
Mr. Pinera. No, I said that I don't know.
Mr. Matsui. All right.
Mr. Pinera. I said that I don't know. In principle, I
believe that it is wrong, because the total amount that the
funds can invest in the share is 25 percent of the fund. So, if
they can invest a total of 35 percent of the funds in shares, I
cannot see how two companies can be 40 percent. I think that is
an arithmetic mistake.
Mr. Matsui. I do believe that you said that, but I accept
your ambiguity on this issue.
Let me just--well, my time has run out.
Chairman Archer. Mr. Ramstad.
Mr. Ramstad. Thank you, Mr. Chairman.
Dr. Pinera, thank you very much for your testimony here
today. Your expertise is very impressive, and I really
appreciate your being here.
You said in your written testimony, and I am quoting now,
``there is no economic issue facing the world today that is
more important than converting unfunded PAY-GO Social Security
systems into fully funded systems of individual retirement
accounts.''
Given that statement and your experience and philosophy, I
was wondering if you could comment on the competing proposal
out there, the President's proposal, that would have the
government invest in equity positions in the capital markets?
Mr. Pinera. Well, first of all, I have the utmost respect
for the President of the United States, and second, I am very
grateful that the President invited me to speak at the White
House summit.
So, having said that, I believe that that proposal is very
bad. I believe that is going backward to the time when
government owned shares in the businesses of the country. I
believe that the whole world is going in precisely the opposite
direction. Government is taking care of problems of crime,
equality of opportunity, but not government investing in the
markets. I would not go so far as to say that is socialism
because socialism is the complete ownership of collective
assets. But that is clearly a step in that direction.
And so, as a Chilean, I am astonished that a country like
the United States would propose that the Federal Government own
shares and vote those shares in shareholder meetings of
business companies.
Mr. Ramstad. I would just respond, Dr. Pinera, that you are
in good company. Several weeks ago, our Federal Reserve
Chairman, who is highly respected, Alan Greenspan, sat in that
very chair and said exactly the same thing that you just did.
Let me ask you another question in my remaining minute or
two. You also said, in your testimony, that self-employed
workers may enter this system if they wish, it is permissive. I
have a high percentage of self-employed workers in my district.
Let me ask you, are there incentives for the self-employed to
establish USA accounts? And what happens if they don't? Is
there a safety net for them?
Mr. Pinera. Yes, but let me be very clear, sir, that that
is not a structure feature of the system. Twenty years ago we
didn't have the enforcement power to bring the self-employed
into the system. If I were doing it today, I believe that we
could do it.
So, for America, for example, I would definitely include
the self-employed in the new system as they are included today
in the old system. So, that is a very distinctive Chilean
characteristic because of the informality that was there 20
years ago. So, the self-employed can go into it, there is no
special incentive to do it. They are free to do it or not. And
there is a kind of welfare safety net for them also.
But I want to stress that in America, definitely if you go
to a system like this, the self-employed should be included in
the system.
Mr. Ramstad. Let me ask you a final question, Dr. Pinera.
How high are the administrative costs for the USA accounts? I
know David Harris will testify in a few minutes about the very,
very low administrative costs in Australia. How about the
Chilean experience?
Mr. Pinera. They are, today, around 1.2 percent of assets
managed coming down, of course, because that depends a lot on
the size of the economy, and the time the reform has been going
on. Since Chile is a country of only 6 million workers,
obviously, initially, the costs were much higher. But the long-
term perspective is that those costs will go down definitely to
a lower level than 1 percent especially given the enormous
advances in information technology. This is an industry very
intensive in processing millions of accounts. And, as we know,
the technological revolution is allowing today to process
information at very, very low costs.
Now, some people are confused, sir, on that because some
people take that cost proportion out of the contribution, and
it is generally that in a pay-as-you-go system. But in a fully
funded system, you must compute the cost as a proportion of
assets managed not as a proportion of the contribution. And in
that it is today around 1.2 percent, and it should go down, and
I believe it will go down more in the future.
Mr. Ramstad. Thank you, Mr. Chairman.
Chairman Archer. Ms. Dunn.
Ms. Dunn. Thank you very much, Mr. Chairman.
Welcome, Dr. Pinera. It is great to have you before our
Committee again today and to hear more about the system that
you established in Chile so many years ago.
I wanted to ask you sort of a big question, but before I
ask you, I would like to have you review for me what you said
in bits and pieces to other people about the retirement age
issue. In our current system, we are having a big battle over
whether retirement should stay at 65 years old. We have changed
it so it phases into 67. It is a big issue here, as big as
whether we should increase taxes to pay for our system, and
that sort of thing. And I was wondering, could you tell me,
once again, how the Chilean system treats retirement in a way
different from the way we do?
Mr. Pinera. Of course. That is a very, very important
question. I remember that when we were designing the system, I
was always astonished by the fact that we allow, in our free
societies, the political process the right to tell us when we
should stop working or not. We have so many other free choices
in our societies. You go into a supermarket, as we all do, and
you have enormous choice. But, in terms of retirement, the
political body decides a given year, 65, 62, 67.
What we did in Chile was basically to diffuse that issue by
allowing workers to retire at any moment if they had
accumulated enough money to fund a reasonable retirement
benefit, and we define it as 50 percent of last wages. It could
be 60. It could be 70. We said 50 percent.
And with that, you see, the whole issue has lost explosive
force, because it is people, ultimately, who decide when they
retire. We only keep the 65 for the minimum safety net. And if
you want to access the safety net, you must work until 65. But
if you are not accessing the safety net, you can retire at
whatever age you want as long as you are going to be able to
save enough to fund that annuity.
And this is very important, Ms. Dunn, because I have seen
so many people who simply want to go on working after 65. They
believe that they begin dying after 65 if they do not work. And
in America, if they do, they are penalized very strongly by the
tax system. In my country, basically they get the wage of their
job and the money that they are retiring from their accounts.
So, we have almost eliminated the concept of the retirement
age.
What we do have is a concept of a threshold to retire your
money. It is a threshold to retire money, not a threshold of
age. And, with the incredible medical advances that are
lengthening life in America and all over the world, I believe
that this can be a very important issue because people at 70 or
at 75 may want to work 1, 2, 3, 4 hours, and they should not be
penalized for doing that precisely because they are adding to
the labor force and contributing to the growth of the economy.
Ms. Dunn. And there is no earnings limit on them, either,
like we have on Social Security?
Mr. Pinera. Oh, no.
Ms. Dunn. The question that I--my big question, it is big
to me because you've viewed the American system for years now,
and you have a special viewpoint from which you observe what is
going on in our system. Would you share with us any thoughts
that you have had on the kind of system that we could employ
that would give the worker the maximum opportunity to invest in
diversified assets and, therefore, through compounding be much
better off than that worker is under our current system.
Mr. Pinera. Well, I believe that the concept that the
President has proposed of a universal savings account is a
great name. It is a wonderful name. The problem is that it is
not universal at all. Because, by definition, as I understand
it, it is a voluntary savings account, and I believe that the
poorest workers in America do not have money at the end of the
month to make voluntary savings, so the people who open a USA
account will be precisely those who are not at the bottom of
the income ladder, and they will get matching Federal funds.
So, if I could, very respectfully, propose something, I
would say, keep the name. Keep the USA account name, I love it.
But allow workers to put their FICA taxes into the account. And
specifically, I would allow the worker to put the full worker
contribution into the account.
As you know, the total contribution is 12.4 for old age and
disability. We are not debating disability. Let's keep
disability exactly as it is. In that case, the total
contribution is 10.6, 5.3 the worker and 5.3 the employer. My
suggestion would be, why don't you allow the worker to put the
full worker contribution, 5.3 percent of his wage, into the USA
account, and you keep the other 5.3 paid by the employer, to
finance the transition. So, the employers finance the
transition. That tax is kept for 10, 20, 30 years until all the
elderly benefits that are promised are paid. The worker 5.3
percent goes in full to a USA account. I believe that in that
case, the name will mean what it says. It will be universal. It
will be truly a system of universal retirement or savings
accounts for all American workers.
So, you have the name already. Put the money.
Ms. Dunn. OK, thank you very much.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Levin.
Mr. Levin. Welcome.
First, let me ask you about the investments because you
used rather strong language about the President's proposal, and
I don't think that you want to come across as doctrinaire. So,
let's understand the Chilean system.
What percentage of investments are in government-issued
securities? According to the report that we have from CBO, it
is 41 percent. Is that accurate?
Mr. Pinera. Yes, sir. I would say, yes.
Mr. Levin. OK, and then, 17 percent are in mortgage bonds,
correct?
Mr. Pinera. Yes, sir, private mortgage bonds.
Mr. Levin. OK, so that would be over half, close to 60
percent in those kinds of fixed securities.
Mr. Pinera. Yes, sir.
Mr. Levin. And then, it says that 28 percent is in domestic
equities, and, because of global turmoil, that exposure was
reduced by AFPs, Administradoras de Fondos de Pensiones, to
less than--in Chilean equities, was reduced to less than 20
percent. Is that accurate?
Mr. Pinera. Yes, sir.
Mr. Levin. So, I think that everybody should understand
that the contrast isn't so dramatic. These are funds that
invest with some considerable conservatism. Isn't that true?
Mr. Pinera. Absolutely, sir.
Mr. Levin. So, there is a further restriction by the
government on the investments, right? I mean, are these
restrictions from the government or are they self-imposed by
the AFPs?
Mr. Pinera. As I said earlier, sir, they are by law, and
they are only ceilings.
Mr. Levin. OK, but there are ceilings.
Mr. Pinera. Yes, but----
Mr. Levin. So, AFPs can't do anything that they want.
Mr. Pinera. As long as they do not invest more than the
allowed ceiling.
Mr. Levin. OK, so there are ceilings----
Mr. Pinera. Yes, sir.
Mr. Levin [continuing]. Imposed by the government.
Mr. Pinera. By you all, by the Congress, sir.
Mr. Levin. By the government.
Mr. Pinera. But not by the executive branch.
Mr. Levin. I don't care who does it. By the government. In
a sense, that is a form of socialism, no?
Mr. Pinera. No, sir----
Mr. Levin. I mean in your language----
Mr. Pinera. No, no, sir. Socialism, as defined by the
dictionary, is when the government owns businesses, productive
activities. The means of the--the exact words, of course, of
Marx, is the means of production.
If the government puts a ceiling on a portfolio of a
mandatory retirement system, that is regulation. I would grant
it all that that is a regulation. But we have regulation, and
we should have regulation.
Mr. Levin. OK, so----
Mr. Pinera. But that is not owning the means of production,
sir, at all.
Mr. Levin. And so, it is government regulation?
Mr. Pinera. Oh, yes. As traffic lights and many others.
Mr. Levin. All right.
Now, let me ask you--and I hope that others will get into
that because, as I understand it, there were even more
restrictions at the beginning.
Now, let me ask you about the percentage that goes for
expenses of the investment. According to CBO, the fees and
commissions consumed 23.6 percent of workers contributions in
1995 and reduced the average real rate of return over the
period of 1981 to 1995 from 12.7 percent to 7.4 percent. Is
that basically accurate?
Mr. Pinera. I am not sure, sir, because I do not compare
commissions to contributions, but commissions to assets
managed. As I said earlier----
Mr. Levin. Why don't you? I mean it is relevant to look at
the portion of an employee contribution that goes for fees and
commissions, isn't it?
Mr. Pinera. No, I believe, sir, that in the mutual fund
industry in America, you will never see an ad where they say
that the commission is this proportion of your contribution.
What they say is that the commission is this proportion of the
funds managed.
Mr. Levin. OK, I know, but that's what mutual funds
advertise. But we are looking at the comparison of this Social
Security system with the American Social Security system or any
other.
What percentage of assets is consumed by the administration
of Social Security?
Mr. Pinera. As I said initially, sir, 1.2 percent of assets
managed. And I understand, sir, your anxiety, but the point is
that a fully funded system is not the same as a pay-as-you-go,
that is why, in a fully funded system, investment systems, like
mutual funds, you always quote the commissions as a fraction of
assets managed.
Mr. Levin. I don't have time--I would like you to dig out
somewhere your understanding of what the asset-per-asset cost
of Social Security is in the United States. And this 1 percent,
is it 1 percent a year?
Mr. Pinera. One percent a year of assets managed.
Mr. Levin. So, over 20 years, it would be 20 percent.
Mr. Pinera. Well, yes, but each year, you get, sir, an 11-
percent rate of return. So, you get an 11-percent rate of
return, and you pay 1 percent for whomever is managing, and you
are very happy with 10.
Mr. Levin. OK, but that 11 percent isn't guaranteed.
Mr. Pinera. No guarantee, only 19 years. No, no guarantee,
but we have only had it for 19 years. But it is not guaranteed,
sir, because the future is not guaranteed, regrettably.
Mr. Levin. Thank you.
Chairman Archer. Mr. English.
Mr. English. Thank you, Mr. Chairman.
Dr. Pinera, I thank you for the opportunity to inquire. I
also especially want to thank you for your hospitality during
our recent congressional delegation to Chile in investigating,
among other things, this particular issue.
There are a couple of issues that I am particularly
concerned about. Going back to Mrs. Johnson's question of a
little while ago, what is the level of regulation of fund
managers? How successful has your system of regulation been,
and can you draw any conclusions from it that would be relevant
if we were to set up a similar system of fund managers and a
series of funds and give workers an opportunity to move their
assets between those funds? What level and nature of regulation
of those fund managers would be appropriate based on the
Chilean perspective?
Mr. Pinera. Yes, sir. Here I would like to be much more
careful because the level of regulation depends enormously on
the state of each country's capital market. And definitely my
country's capital market 20 years ago was completely different
from the best, most sophisticated capital markets in the world.
So this is an issue where definitely it should be different in
America than in Chile.
Now, what we did in Chile was to be very conservative. As
the gentleman, Mr. Levin, was asking me, and he was absolutely
right, I took enormous pains at the beginning of our system to
make it safe. Because when I went around the country discussing
the new system with workers, they, rather than asking me,
``Will we get 7, 8, or 9?'' They were always asking me, ``Is
there any chance that we will lose our money?'' You cannot
enjoy a high rate of return if you are also afraid that you may
lose all of your money.
So, the principle that I used, and I explained it on
television, this is a very structural, even revolutionary,
reform, but we did a very conservative, prudent execution.
So, at the beginning the regulation was very high. And it
has been going down over the years with experience, with the
working of the market. Even today, for example, I would say
that there is more regulation than I would like. In Chile, I am
on the record advocating a lifting of some of the regulation of
the first years because inertia has been kept down.
But, very frankly, sir, beyond saying that in America there
should be also some prudent rules of regulations, I would not
go so far as to suggest a specific one because I believe that
has to be done according to your capital market situation.
Mr. English. It seems to me, from our previous discussions,
that you have had a number of fund managers who have proven,
over time, to be insolvent and have had their portfolio taken
over and effectively broken up by the government. How has that
proceeded? Has it proceeded to your satisfaction in Chile? And
has Chile's system of regulation been able to shield individual
pensioners in this manner?
Mr. Pinera. Absolutely, sir, because we set up a system in
which there are two different legal and economic entities.
One is the managing company, and the other one is the
pension fund. The money of the workers is here in the pension
fund invested in a very conservative portfolio. The managing
company only manages the pension fund and charges a commission,
but it has no ownership, whatsoever, of the pension fund. So,
if a managing company spends more on salaries than they get on
commissions, the managing commission may lose its capital, but
not a penny of the workers' money is touched because the
workers' money is in a completely different legal and economic
and financial entity. And that is why, during 19 years, not a
penny of workers' money has ever been lost.
If a managing company has a problem, the supervisory body,
our Securities and Exchange Commission, simply takes charge for
60 days of the fund and tells the worker, ``100 percent of your
money is there, choose another company.'' But, the problems of
the managing company have nothing to do with the very safe
situation of the pension fund.
And I advocate that complete separation--that is not the
case in a bank, for example. In a bank the money is mixed
because the bank offers a rate of return a priori. In our
system, the rate of return is a derived rate of return--
whatever the portfolio gives goes to the worker. And when you
have that, the pension fund by definition cannot go bankrupt,
because you are not making a promise of a rate of return.
Whatever is the rate of return, minus the commission, goes to
the worker. So the rate of return can fluctuate, but the
pension fund, by definition, cannot go bankrupt as can a bank
who is offering a given rate of return to its depositors.
Mr. English. Thank you, Dr. Pinera. Thank you, Mr.
Chairman.
Chairman Archer. Dr. Pinera, does the 11 percent average
return include the commission, or is it 11 percent after the
commission has been paid?
Mr. Pinera. No, it is before the commission.
Chairman Archer. Before the commission.
All right. Thank you. Mr. Watkins.
Mr. Watkins. Dr. Pinera, good to see you again. It is
always very intriguing to listen to you. I enjoyed the trip to
Chile and visiting with a lot of the leadership. Also, I
enjoyed visiting with some of the Chilean workers.
I have been watching the eyes and some of the faces of the
people here as you explained the Chilean system. I think that,
if we put it to vote, a lot of the young people here would like
something like the Chilean system.
I might say that I did take a kind of sidestep out of the
group and visited with some of the individuals on the street
about the system in Chile. Overall, they had a strong feeling
that they like the system. Like many of us, they would like the
return on their investment to be even better. We understand
that.
I think that for the next generation, we're all trying to
find a way for them to have a high rate of return on their
investment. Also, we need to make sure that our elderly feel
secure if some structural changes are made along the way. I
believe that is the real bridge that we have got to cross.
I know that there are some different ways to move into a
structurally different system. I would like to ask you to
mention and explain some of the transitions. Like you said, the
glass is filled, is there a guarantee there, in the end, for
those who participate? We know that right now there are about
93 percent that have opted to go into the new system and about
7 percent have remained in the present system. They had the
choice. For those who make that choice to go in the new system,
will they, in the end, have a minimum-type benefit? What are
the guidelines for the minimum benefit? Would you mind going
through--I read part of it here, also,--the three steps in the
transition so that people might hear it?
Mr. Pinera. Well, yes. As I mentioned, sir, the first rule
of the transition, I believe, that is extraordinarily important
in America, is to guarantee the elderly that they will get
their benefits. Because, as you know, sir, the Social Security
system in America does not grant property rights to the elderly
people. There is a 1960 Supreme Court ruling called Nestor v.
Flemming in which the Supreme Court says that you do not have
property rights over your contributions. In other words, the
U.S. Congress can tomorrow change the benefit levels and the
worker cannot say that you are changing something that is mine.
So, in that sense, the elderly in America really do not have
the total certainty that they will have forever their benefits.
If you were to have a demographic crisis in the year 2010,
2015, or 2020, the U.S. Congress may decide--I hope not--but
may decide in that Congress to slash benefits. And the elderly
have no legal rights to their benefits. And this, I think, is
very serious, because this is called a Social Security system,
and I am not secure when my benefits depend on whatever is the
political composition or the political orientation of a
Congress of a year when I retire.
So, when we did it in Chile, the first thing, sir, was to
guarantee the elderly, with a law, that their benefits would be
financed by the government. That is, we basically gave them
property rights over that benefit.
The second rule, and this is very important, is the choice
between the old and the new system. I already explained that
you move from one system to the other with a recognition bond.
And the recognition bond, sir, is very important to people who
are 45, 50, 55 years old because the young people were willing
to move from the old to the new system even without a
recognition bond. As they do in America--you are always asking
young people in America, ``Would you move to the new system
even if the government were not to recognize--'' and they say
they would move tomorrow even with zero recognition bond.
But, someone who is 50 years old would have trouble
deciding whether to move or not if you do not recognize his
accrued rights under the old system. That is why we did this
recognition bond procedure. I remember that Chairman Greenspan,
to whom I explained this concept, testified to the fact that
the recognition bond mechanism is a very safe and very sound
mechanism to undertake a transition.
And the third rule, and finally, is that young workers, who
have never been in the labor force, enter the USA account
system. And this is important because we know that in 30, 40,
50, 60 years, whenever those who are still in the old system
fade away, at that moment you will have one universal system of
private, individual accounts with a safety net, with
regulations by the state, but, basically, a fully funded system
of individual accounts.
Mr. Watkins. You do have safety nets all the way?
Chairman Archer. The gentleman's time has expired.
Mr. Cardin.
Mr. McNulty.
Mr. Jefferson.
Mr. Becerra.
Mr. Becerra. Thank you, Mr. Chairman.
Dr. Pinera, I thank you very much for being with us again
here in this country and for providing us with your testimony.
And let me also applaud the accomplishments of the Chilean
people. There probably is no other country in Latin America
that has prospered and has done as well for its people in the
last decade or so as has Chile. So, I think that we have to
applaud them. And perhaps one of these days we will be able to
work together in reaching a free trade agreement which has been
discussed in the past.
I want to go through a little bit of the two systems that
Chile had and now has a bit because, to some degree, I think
what we face is somewhat different from what you encountered
when you had the monumental task in the late seventies to
reform your system. And I am looking more, at this point, at
what the Congressional Budget Office sent us in terms of its
analysis of some of the different systems out there.
In terms of Chile, they indicate that the system that was
originally set up in the twenties got to the point where it was
very poorly managed over the years, and the government had to
constantly raise benefits to keep up. And by the late
seventies, I am quoting, ``the system's assets were gone, and
it had become a pure pay-as-you-go system.'' Now, as you are
probably aware, in the United States, we don't have a pure pay-
as-you-go system. We have assets. Unlike the system that you
encountered in the seventies, we have a surplus right now of
some $100 billion this past year, and I believe that it is
somewhere between $600 or $700 billion over what we actually
need. And, as we continue forward for the next several years,
we will get into the trillions before we start to draw it down.
So, there is a difference there.
I was also notified by the CBO that there was a lack of
uniformity in the Chilean Social Security system. There were
over 100 different types of retirement regimes that as a
result, I am quoting again, ``total contributions by employers
and employees in 1973 varied between 16 and 26 percent of
wages.'' And that is far beyond what we have in our total
contribution between employer and employee which is 12.4
percent. If we were to do that, we would have to tax American
citizens beyond the 12.4 percent, something to the degree of
another 3 percent on top of that. If we were to go to 26
percent, we would have to double the taxes that Americans
currently pay into Social Security, which, of course, we are
not going to do. So, what you faced in the seventies certainly
is not where we are today.
And, as a result of those differences in the Chilean
retirement regimes, you had extremely large differences in
retirement benefits. ``Some workers,'' and I am quoting,
``could retire with a large pension at age 42, but many blue-
collar workers could not qualify for retirement benefits until
age 65. In addition, some, but not all pensions have automatic
cost-of-living adjustments.''
In 1955, the Chilean system had 12 active contributors per
retiree, so 12 people were working for every person that was
retired back in the fifties. By 1979, 25 years later, you only
had 2.5 workers per retiree. Now, you went from 12 workers per
retiree to 2.5 workers per retiree in 25 years. In 25 years, we
are going to go from what is already not a good number--about 3
to 4 workers, to about 2 workers. But it is going to take us 25
years to lose 1.5 or 2 workers. In 25 years, you lost 10
workers per retiree. Obviously, not everybody was dying as a
worker. I suspect that a lot of it had to do with the fact that
a lot of folks were evading the Social Security system and
going into the underground economy. We don't have that problem
as you had then. In fact, I think that one of the real things
that you saw in Chile is that the system had decayed to the
point where not only was the government having to increase how
much it would charge in taxes, contributions, but it was also
finding fewer people participating. The end result is that by
1980, you had a deficit equal to 2.7 percent of your GDP for
your Social Security system. In the United States, we currently
run a surplus. So, it is apples and oranges.
But, if you were to take the model that Chile has, and I
don't think that it is appropriate to do so directly, what you
did was you took that system where you had 16 to 26 percent
contribution taxes and you said, ``OK, you only have to
contribute 10 percent of your wages.'' This amount is much less
than the prior 16 to 26 percent, so I can imagine that
everybody said, ``That's great.'' Then you add 3 percent on top
of that for disability and the life insurance. That is 13
percent. Then I believe that you also--I indicated that the
Chilean system then took the employer contribution which
varied, I guess, from about 8 to 13 percent or above our 6.2
percent of employer contribution, and made that into a tax--not
a tax, I'm sorry, you converted that tax into an employee
increase in wages so that you wouldn't see a reduction in
employee overall wages. So, the employer portion of the tax
never went back to the employer directly. It went to the
employee to make sure that the base of wages did not fall. So,
in the end, you went from a system that went from 16 to 26
percent to a system that had 10 percent plus 3 percent, that's
13 percent, and then, if you include the employer portion that
had to be put from taxes onto an employer to wages of an
employee, that was another 8 to 13 percent. So, you went to a
system that had about 10, 3, that's 13, and then if you add 8,
that is 21 percent; if you add 13 it is 26 percent. So,
whatever way you cut it--if we were to try to do what you did,
we would have to increase the take that we get from employees
from the total of 12.4 percent shared equally between employee
and employer to something beyond that.
So, I think while you----
Chairman Archer. The Chair is constrained to tell the
gentleman that his time has expired. Perhaps we may have time
for a second round.
Mr. Becerra. And I will conclude there, Mr. Chairman.
In other words, the point that I think that there is a
difference between what the Chileans faced in the seventies and
what we face today.
Thank you, Mr. Chairman, and thank you, Dr. Pinera.
Mr. Pinera. Don't thank me, if I have not been able to
answer anything. So, thanks to you. [Laughter.]
Don't thank me, I wasn't able to----
Mr. Becerra. If the Chairman would yield me some time, I
would love to let you respond.
Mr. Pinera. Well, we Latins, we speak a lot.
Chairman Archer. I think that in fairness, the Chair should
accommodate Mr. Pinera to respond.
Mr. Pinera. First of all, I want to thank Mr. Becerra about
his initial comments about my country. And second, of course,
you have taken a big interest in the issue.
But I, sir, will not try to--I will take the side of your
President basically. That is, it is your President who has been
saying that you should save your country's system. So, if you
use words so strong as ``saving the system,'' I imagine that
you have some problem. So, your defense of no problem in
America, by trying to compare it to whatever problem the
Chilean system had, I really believe has been answered by your
own President. That is, you, too, have a problem. Is it the
same problem or not with Chile, that is completely irrelevant.
Mr. Becerra. That's irrelevant?
Mr. Pinera. Yes. The level of the problem is irrelevant
because what I am proposing is a solution. Because, for
example, France has even a worse problem than the United
States, so would it mean that this system would not work in
France? No.
The degree of the problem is not something that impinges
upon the importance and the benefits of the solution. It may
have a lot to do with the transition. But you do have a problem
in America. I do believe that a system of individualized
savings accounts is much better than the one you have today.
And my final comment, sir, will be that, precisely
because--and I do agree with you that your system today is not
as bad as the Chilean system was. The only difference is that
you have a window of opportunity to do this in a much less
exasperated way as we had to do in Chile.
Mr. Becerra. I agree with you.
Mr. Pinera. But that is not an argument at all for not
doing. It is just precisely that you can do it better, and I
admire, precisely, the leaders of your country that can pose a
discussion like this 10 years before you begin to have the
deficit so that you can solve the problem much better.
But, again, and I conclude, that has nothing to do with the
fact that the best solution is universal savings accounts but
filled with FICA taxes.
Mr. Becerra. And I understand what you said. I just was
saying that we have to be careful which templates that we use.
Thank you, Mr. Chairman.
Chairman Archer. The gentleman's time has more than
expired.
Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman, and Dr. Pinera, I want
to thank you for traveling here today to testify. You are very
articulate and very enthusiastic about your program which has
succeeded in your country. And I want to thank you for being
here.
I find that as we look at the issue of Social Security--
and, of course, our goal is not only to save Social Security,
but to make it secure for the next three generations and beyond
and all people, like my own parents, that are on Social
Security today, our system is secure for them. You know, for
these elderly and retiree, it is the new generation that is
just entering the work force that has the most at stake in
today's debate as we look for our solutions. And that is why
your input is so important.
Of course, usually when we look at what are the solutions,
everyone wonders how it will affect their own pocketbook when
it is their turn to receive benefits. There was a national
survey done last year, and they asked the 20-year-olds, a group
that we call the X generation, what they thought about Social
Security, and they discovered that more young people believe in
flying saucers than thought that they were going to receive
Social Security when it is their turn. So, there is also a
question of confidence in whether the Congress and the
President are going to work in a bipartisan way to save Social
Security, and I hope that we do because that is the challenge
that is before us.
As we have looked at Social Security and our own system--of
course, we have looked at our own system and how it impacts
individuals and their own pocketbooks, and we have seen some
places where our own system discriminates. And, actually, we
have an issue where there is a marriage penalty where a married
couple often receives less benefits than two single people. And
we have a story that is kind of part of the folklore about an
elderly married couple that gets divorced so that they have
more money to live on. And that is certainly something that we
do not want to see.
The question that I have for you and your system--you know,
where we have a system where sometimes in many cases where
elderly, married couples receive less benefits than two single
elderly people. Under your personal accounts, how do your
personal accounts treat married couples? Do husband and wife in
Chile, do they receive twice what one single person does under
their circumstances? Could you explain how married couples are
treated?
Mr. Pinera. OK. Well, it depends on whether both are
working or not. If only one is working, when he or she reaches
retirement, the law demands that he buy what we call a family
annuity. That is, he cannot go and say, OK, we need an annuity
for me, and if I die, forget the wife and forget the children.
No. He must buy the package that is defined by law. That is
called a family annuity so that if he were to die, the widow
and the orphans will be completely protected. OK?
Now, if both of them work, both of them have their own
personal account. And exactly the same situation happens. Now
when both of them work, what happens is that when they reach
retirement age, we give workers two payout options. One, the
one that is chosen by most workers, is simply to transform the
capital into an annuity for life so that they can live very
quietly because they know they will always have that money.
But we do give them a second option that is very
interesting, especially for married couples. That is that you
can keep the money in the account and make what we call
programmed monthly withdrawals. And they are programmed
according to the life expectancy of the family.
The big difference is that in the second case, if you were
to die a few years after you begin retiring your money, the
whole capital goes to your heirs as inheritance. And this is
very important, especially for a woman. You see, because in
that case, the woman, let's say that she works, she can get her
own annuity, maybe lower than the man because they live longer.
I must recognize that, but I cannot change that.
But at the same time she can get an inheritance from the
husband. So if the husband dies earlier than the woman, as they
generally do, and the woman works, the woman will get her own
annuity from her own personal account. And if the husband has
chosen the programmed--withdrawal option, she will also get the
inheritance of the husband's account, all those--everything he
accumulated, if he purchased an annuity plan, does that--If he
purchased an annuity plan, as I said, he must have a family
annuity. In that case, if I remember well, the wives get 50 or
60 percent of the annuity. It depends on the family annuity
plan.
He has some choice there, but he doesn't get--she doesn't
get 100 percent, she gets, say, 60 percent of the annuity.
Mr. Weller. And the children receive something as well?
Mr. Pinera. And the children under 18 receive, each one, 10
percent of the annuity of the husband.
Mr. Weller. OK.
Mr. Pinera. You see, so it's a family--we protect the
family. We do not allow individuals to say, forget the family.
No. The family is an entity. So he or she must buy what we call
a family annuity with the provision. But the beautiful thing
again is that the other person can have also a personal
account. And there is no penalty whatsoever--I am also very
surprised in America that sometimes when the wife works and
they both retire, there is a huge penalty on the married
working couple.
And we do know that we are going to a world where both
persons would probably work in the future. So you have
basically a penalty on a married couple working. And that is
something that is counter in treatment. Why you want to
penalize people who want to work? We, on the contrary--we allow
them to reap the full benefit of their savings, either in the
form of the annuity or in the form of the inheritance if it is
a monthly program withdrawal system.
Mr. Weller. We're concerned about that marriage penalty,
and there's one in the Tax Code as well.
Mr. Pinera. I know.
Mr. Weller. Thank you, Doctor.
Chairman Archer. Mr. McInnis.
Mr. McInnis. Thank you, Mr. Chairman. Mr. Chairman,
listening to the comments of our guest, the doctor here,
reminds me of people that continued to fight at the turn of the
century the need for buggy whips in buggies. We needed to
preserve that industry even though times had changed. I think
your program is excellent. And I don't understand why some of
my colleagues fight success. I don't understand where the
resistance to this is coming from.
I'm afraid that some of the resistance to what you're
saying is coming as a result of people who are too afraid to
admit that the past policies of this government under Social
Security have been a failure. That our system is a failure. And
that the egos--I think the egos of some of these people will
not allow them to say: ``All right, this has failed. Let's
improve it.''
But that's said, doctor. Let me ask you--I'm curious, what
happens with the young worker, say a worker who is 23 or 24 and
is injured on the job, so he has not had an opportunity to
accumulate--or killed on the job--has not had an opportunity to
accumulate any kind of savings? Then, in our country, for
example, the kids can get Social Security benefits and so. How
do you fund that? How do you fund those kind of things?
Mr. Pinera. Thank you for your first comment, sir. That is
a very interesting question. I can explain the complement to
the old age retirement system, to the passbook system, we ask
every worker to buy a disability and survivor insurance that is
taken as a group insurance by the company. That is, the moment
you enter into a company, you put 10 percent into the passbook,
and you put another one-half of 1 percent or a little higher,
and this company then makes a bidding process with an insurance
company to insure all the workers affiliated with this company
for disability and survival.
So if that worker were to die at 28, the insurance company
will have to give his widow a disability--a survivor pension.
If he were to become disabled, he will get for life a
disability pension. In other words, we have complemented an
old-age retirement system with a disability system, but a
disability system that is also with the same logic of market
discipline.
And this is very important, sir, because traditionally my
country and as I understand, in many countries in the world,
even though every decent people wants to give a disability
pension to someone who is really disabled, and as high as
possible, there is enormous fraud because disability is a gray
area. In some cases it is very clear. But in some cases it is a
gray area. And in some countries there is enormous abuse and
fraud in terms of disability.
What we do in Chile, the disability is not decided by a
government official, who has every incentive to give away the
benefit because he is not paying it, of course.
Mr. McInnis. Yes.
Mr. Pinera. So he feels very good, very well, giving away
the disability benefit paid by the taxpayers. The disability
decision is made in Chile by a board of six members: Two
representing the worker, who are members of the company, two
representing the life insurance company, that is trying to see
whether the person is really disabled because they will have to
pay--and if they disagree, they do not disagree if the person
is totally disabled----
Mr. McInnis. Yes, I know.
Mr. Pinera. If they disagree because it is basically a pain
in the back, then they go to two deans of medical schools, who
settle the issue. The disability rates have gone to less than
50 percent of what they were before because nobody dares to
abuse the system when they know that there will be a
countervailing force of someone saying, ``Let's look very
closely whether you are disabled or not.''
I remember I explained this only some months ago to the
Italian Prime Minister, and he was very happy because Italy has
just done a study, and do you know, sir, that they found
something like--I don't remember--it's 500 or 1,000 people who
were having disability payments for blindness but they arrived
to collect the check driving a taxi. In Italy they have blind
taxi drivers. [Laughter.]
And Mr. Prodi told me this extraordinary abuse, but some
political official is a friend of that person, and the person
simply, when the exam is done, he says I see nothing. OK. A
disability payment, paid by the General Treasury.
In our country, you see, the two representatives of the
insurance company will follow the person, and if they found
that he is driving a taxi the next day, he will not only be
retired from his disability payment, but probably he will face
some kind of--so it's very important also, sir, to really pay
to the disabled all the amount that they deserve. I believe any
decent person would like that, but also we must be careful not
to accept abuse and fraud with general taxpayers' money as it
happens in so many countries in the world.
I do not know in this country, sir.
Chairman Archer. Ms. Thurman.
Ms. Thurman. Thank you, Mr. Chairman. Doctor, how are you?
Mr. Pinera. How are you?
Ms. Thurman. I think I might be the last one unless they do
a second round. First of all, I want to associate my remarks
with some of my colleagues in thanking you for being here and
the successes that you have had. And as you can tell, this is a
lively debate between two parties as to where we think the
reforms should go and the best way to go. And so we're really
trying to understand the system.
I need to ask a couple of questions, and I happen to have
been with you when we talked a little bit about the transfer. I
want to understand because there was an important point that
you made earlier about the fact that employers no longer pay
into this system. This is now strictly up to the worker.
Correct?
Mr. Pinera. Correct. But it is always the worker who pays
the total FICA taxes. I know that in the law, people create the
illusion that half the contribution comes through the worker
and half from the employer. But really, every employer knows
and you, Ms. Thurman, know very well that the total
contribution ultimately comes from the worker productivity.
Anyone who is an employer takes into account the total cost of
the worker, and if the law says the employer must pay 6.2, what
the employer does is basically take down the wage of the
worker. So it has always been a total worker contribution. And
what we have done is to make it transfer.
Ms. Thurman. The issue here is that when you transformed
into the new system, the employer was told by the government
that they had to raise the wages to meet the percentage
difference in what they were contributing before.
Mr. Pinera. Yes. You're absolutely right.
Ms. Thurman. So they had to--the employer in some way does
pay?
Mr. Pinera. Yes. We call it relabeling. I don't like the
name. The government raising the wage. The government relabels
the employer contribution as worker contribution.
Ms. Thurman. But they said to businesses that they had to
raise it by 11 percent or whatever that was. Correct?
Mr. Pinera. Correct.
Ms. Thurman. So now the employee is paying into the system
10 percent of their wages. And then you said they have to buy a
disability and a family plan. And that is how much then? And
that's mandatory?
Mr. Pinera. Yes, that is mandatory.
Ms. Thurman. According to our CBSs, it is about 3 percent.
Mr. Pinera. Two point five. The final is 2.5, and yours is
2.4. So it is incredibly similar, the total amount.
Ms. Thurman. OK. So kind of back to one of the questions
that was asked earlier. On the disability part of it, while we
have a distant system with workers' compensation and other
things, but in the disability part, if a member of the family
is injured--the wage earner is injured--or they die, and there
is a disability and they die at a very young age, how are those
payments made? And who picks up that cost? Is it a risk shared
across their whole portfolio or everybody else's portfolio? How
does that work for the worker and his family? And how do they
receive those benefits? Do they buy it through an annuity? Do
they get a monthly stipend? What happens there?
Mr. Pinera. They get a monthly benefit for life paid by the
insurance company that has been receiving the premium. So if
the disability comes, the insurance pays the disability. It's
like any insurance. Basically, we have transformed the
disability system into a private insurance system, but
mandatory.
Ms. Thurman. OK.
Mr. Pinera. But let me be very clear that in America, I
believe, because of other reasons, that you maybe should keep
the disability system as it is today for a second reform. I
believe that it is much more logical to address the problem of
the old-age retirement system, that is the 10.6 percent, and
that's why my proposal very definitely is, allow workers to put
the full 5.3 percent FICA tax that goes to old age in what
President Clinton calls the USA accounts. And you will
immediately have the next month workers accumulating real money
in their account, with 5.3 percent of wage. Keep the other 5.3
as employer contribution to pay the transition cost, and keep
the disability system exactly like it is until you decide to
reform it later.
Ms. Thurman. I have one more question. I need to know what
happens to those self-employeds, that their businesses fail
when they are reaching older age. I mean, does the government
pick up a pension plan for them? Do they become kind of wards
to your country? I mean I don't understand what happens to this
group of folks out there.
Mr. Pinera. Well, as I said before, the self-employed were
not covered by the old system precisely because of an
enforcement problem, and therefore they were not covered by the
new system. So that is not the difference in Chile. But it is
here they are covered by the old system, you should cover it in
the new system. So really, for America, it's not very relevant
because really I would suggest this strongly that you keep
exactly what you're doing today. The self-employed in America
must pay the total 12.4 percent. So you simply keep the self-
employed paying the 12.4 percent, but with a difference that
now a fraction of that, 5.3, would go to an individual or to a
USA account.
Ms. Thurman. Thank you.
Chairman Archer. Mr. Lewis.
Mr. Lewis. Thank you, Mr. Chairman. Dr. Pinera, I
appreciate your testimony today. It's been very informative.
Who were the major opponents of your Social Security
reform? And what were they saying? And where are they today?
Can you give me a little list?
Mr. Pinera. Yes, sir. I would say definitely that there
were two groups. One basically of people disinformed, people
who wanted explanation. And I believe that is a very legitimate
thing. So as I said before, I did an extraordinary effort of
education and communication. And even though at the beginning
some trade union leaders were worried, when I visited them and
I went for a full year explaining them, at the end of the day
they were all in favor. And they are all in the passbook
system. Because if you have 93 percent of people there, by
definition, all the workers and the trade unions carry a
passbook.
The second group that I never was able to convince, because
you cannot convince them, are the vested interests. And who has
a vested interest? Basically, the bureaucracy that manages
these billions or trillions of money in a way that does not
respond to the direct interests of the people. The bureaucracy,
you can have no argument, because at the end of the day it is
true that you are taking their job away.
Now I do believe that they can find a job in the private
sector, but some people prefer to keep their job in the old
institution forever. So I must confess that the--not everyone,
huh, not everyone, I want to be clear--but I would say that the
people who had the power of taxing the worker for one-eighth of
its wage, one-eighth, 12.4 percent, is a huge taxing power, is
a huge power to control.
Well, those people didn't want to give it away. So it was
not a matter of argument; it was not a matter of the technical
point of disability or whatever it is. But why I am so
optimistic, sir, is that a representative of the people, the
Congressmen, in the last 8 years have approved completely the
system. There is not one party in Chile, represented in the
Chilean Congress, that is advocating dismantling the system.
So the representatives of the people have adopted the
system, have confirmed the system--of course are always
debating how to improve it. I do believe, sir, that every
system can be improved. My system is not perfect. It would be
incredible arrogance to believe that you cannot improve it. It
can be improved.
So the real, sir, sirs, force against this is those who do
not want to lose the bureaucratic power because at the end of
the day, this is a process of decentralizing power from the
bureaucracy to the people.
Mr. Lewis. I think you really hit the nail on the head.
We've had testimony here before us that, from those who feel
like that the American people just wouldn't use their hard-
earned dollars wisely if it was left up to them to make
individual choices. And I disagree with that. I think the
American people are really capable of using their money in wise
ways.
Thank you.
Mr. Pinera. Thank you, sir.
Chairman Archer. Mr. Shaw.
Mr. Shaw. Thank you, Mr. Chairman. Mr. Pinera, it is an
honor to have you before our Committee. I had the privilege of
listening to you twice now in Chile and now it's nice to see
you here in our Ways and Means room.
In looking over some of the figures and statistics that are
out there, both from the Congressional Budget Office and also
from your statement, I draw from your statement that the
mandatory minimum savings level of 10 percent was calculated on
the assumption of a 4 percent average net yield during the
whole working life so that the typical worker would have
sufficient money in his USA to fund benefits equal to 70
percent of his final salary.
Now, of course, you've exceeded that. You talked about 11
percent. In looking at our own stock market, the Standard &
Poor Index, if you had invested in that over the last 5 years,
you'd be looking at 18 percent, which means that the
opportunities are absolutely tremendous out there.
I also want to compare our system, in which we have 12.4
percent being paid in, shared by the worker and the employer,
in contrast to your 10 percent, I believe. And I understand
that's split between the employer and the employee also.
Mr. Pinera. No, it is paid by the worker because as I
explained, it's just a matter of how you label the
contribution.
Mr. Shaw. OK. But we've got 12.4 percent and you've got 10
percent, and where your worker is receiving 70 percent on the
average of what he or she has paid?
Mr. Pinera. Yes.
Mr. Shaw. Ours receive 42 percent. So how in the world can
we stick with our existing system knowing that it's headed down
the tubes, knowing that our grandkids are going to be paying
about 40 percent of what they earn just to take care of their
parents. And when you look at the great opportunity we have to
get so far ahead of the curve so that we can actually compete
with the results that you have produced for your country of
Chile--I say that just as an opening statement to you and how
much we appreciate your bringing your experience to the table.
I have two questions. One is, what is the qualification of
somebody to become a manager of a fund? And the second is, what
would you change about the Chilean system if you were the
architect of the American system?
Mr. Pinera. As I said, the principal of a private
individual account with a safety net, and with some degree of
prudent American regulation is a universal idea that can be
applied in the United States, can be applied in Chile, has been
applied in seven other Latin American countries already that
have followed Chile: Argentina, Peru, Colombia, Bolivia,
Salvador, Mexico and Uruguay.
So this proves the point this is a universal idea. It will
be applied in March of this year in Poland--Poland, the former
Communist country only 8 or 9 years ago--in March of this year
it is beginning a partial system of individual private
accounts.
A system like this was presented by the U.K. Government
precisely by my friend Peter Lilley some years ago as the basic
pension plan, a very good plan that Peter, of course, would
explain to you. So this is a universal idea.
What I would change, sir, in each country is, as I said,
the degree of regulation. I believe that your capital markets
are so much ahead of what they were in Chile that you can
provide workers more, maybe much more, choice. You can provide
them--you see, today you can even invest by the Internet. I
have seen, you see, programs that allow workers to choose their
portfolio in the Internet. There is a company, Financial
Engines, with a Nobel Prize winner devising portfolios adequate
to every person's preference about old age.
So regulation, sir, is something that I believe should be
studied, definitely according to what is the American
sophistication of capital markets. But the basic principle, I
want to emphasize once and again, that it's exactly the same. A
USA account with FICA taxes, not a voluntary one because that
is not universal by definition. In order to be universal, it
has to be with FICA taxes so that the poorer worker in America,
the person who is making the minimum wage and who is
contributing 12.4 percent to Social Security can also have a
USA account.
So that would be, sir, my respectful suggestion for the
United States.
Mr. Shaw. Very briefly stated, what is the qualification of
your managers?
Mr. Pinera. Oh no, the qualifications are prudent-man
qualifications, a given amount of capital, some track record of
never having any fraud. They are the same types of
qualifications probably you put in America for anyone who wants
to enter the financial industry.
I discussed this issue with Arthur Levy, Securities and
Exchange Commissioner, and we agreed very easily on the kind of
qualifications that should apply in a case like this. It's not
rocket science. It's just prudent-man qualifications for
someone who will manage financial resources of workers.
Mr. Shaw. Thank you.
Chairman Archer. Mr. Herger.
Mr. Herger. Thank you very much, Mr. Chairman. I want to
join, Dr. Pinera, in thanking you from the bottom of my heart,
and I know I speak for a number of Americans, for what you've
done, for the leadership you have done, and for the leadership
that the great country of Chile has done in moving forward on
this incredible problem that is facing so many of us, really
throughout the world, and certainly is coming to a head here in
the United States. So I thank you.
Some of the critics have brought up the concern of
administrative costs. Some critics have indicated they are
fearful if we were to switch over to a system such as you have
in Chile that perhaps administrative costs could be as high as
15 or 20 percent. Now I'm quoting them. This isn't what I'm
thinking. Yet I notice, I believe in your testimony you
mentioned that your administrative costs were running between 1
and 2 percent--1.2 percent----
Mr. Pinera. The figure is 1.2 percent of assets managed.
Mr. Herger. Of assets managed.
Mr. Pinera. It's so very important to define very clearly
with what you are comparing. You see, the critics try to
compare it with the total contribution as it is done in a pay-
as-you-go system. But I believe they are comparing apples with
oranges there. The real way to compare costs in an industry
that is investing money is with regard to assets managed, and I
repeat once and again, it is around 1.2, maybe 1.3 1 year, but
around 1.2, 1.3 percent of assets managed.
Mr. Herger. Of assets managed. I think it is interesting to
note that back in 1940 our own Social Security Administration's
administrative costs were equal to 74 percent of the benefit
outlays at that time, which is interesting. I see they've
fallen here recently to 9.8 percent. So even in the system that
we're using, currently using, in our current Social Security
system, our administrative costs are very high--just responding
to some of the critics in this area.
Would you have any estimate of what it is that people are
contributing? You mention 1.2 percent of the assets managed,
and I really think that is the proper way to look at it, but
would you have any idea what, if we were to try to switch from
apples and oranges to apples and apples, what the
administrative costs would be approximately?
Mr. Pinera. In America, much, much lower, sir. There are
different studies that mention that it could be so low, maybe
one-half percent of assets managed when the system is mature.
Not at the beginning. Remember that at the beginning, the
assets managed are very low. The first month is just the
month's contribution. But in a steady state, that is when the
system matures, I have seen some studies mentioning one-half of
1 percent.
But anyway, sir, I want to be, if I can make a point, I
believe it's completely wrong to look at this on the
perspective of administrative costs only. Let me tell you that
many, many years ago I had an encounter with a car that was
produced by East Germany. It is called the Trabant. You may not
even know it. It didn't run very often, but was called a car,
this Trabant. Now the Trabant cost very, cost very much money.
You could not compare a Mercedes-Benz of West Germany with the
Trabant of East Germany. Of course the Trabant is cheaper. The
problem is it doesn't run. [Laughter.]
So people prefer a Mercedes-Benz even though it is a little
expensive. So I prefer my money to be fully invested in the
market, getting a rate of return of 5, 6, 7, 8, 9, 10 percent.
I'm paying whoever is providing the service 1.2 percent. I have
no problem of paying someone a price if it is voluntary. That
is absolutely America. You pay a price if it is voluntary. So
why this focusing on the price, on the cost? And not on the
product?
It should be discussed in the context of the product. If
you get 11 percent--let me be frank, I would be willing to pay
5 percent commission to someone who gives me 11 percent a year.
And still I would be much, much better than with a 2-percent
rate of return that is the Social Security rate of return in
America. And zero percent for the young man who is entering
today.
So the whole debate about administrative costs, sir, is a
complete diversion. The important thing is the comparison
between the benefits and the costs, as in everything. So that's
my answer, sir. And finally, if anyone in America didn't like
to pay 1 or 1.2 percent to a mutual fund, that person should
stay with the Social Security Administration and pay a fraction
of 1 percent because really the cost is very low, but the
return is very low. In other words, if you want to buy a
Trabant, you can do it, but why are you willing to prohibit all
the rest of the workers of your country from buying a Mercedes?
So that is my answer to those people about administrative
costs, whenever they say, OK, stay in the old system: But why
are you willing to constrain the freedom of Americans to invest
what is their own money? We're talking about their wages; we're
talking about one-eighth of their wages that you took away from
them and put it in this pay-as-you-go, Bismarckian, 19th-
century system.
Mr. Herger. Thank you very much, Mr. Pinera. You have
convinced me, and I might mention in my younger days I had a
couple cars like you described. [Laughter.]
Chairman Archer. Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman.
Dr. Pinera, is it fair to say that when you transitioned
from your old system to the new system, there was a slight tax
increase for workers overall?
Mr. Pinera. No. Tax increase zero, sir. No, no, no. No tax
increase whatsoever.
Mr. McCrery. Well, for example, when the former employer
contribution was switched--labeled--again to salary for the
employee, didn't he have to pay income taxes on that salary?
Mr. Pinera. No, because the money you put in the passbook
is tax free. So it was tax free before; it is tax free
afterward. So the 10 percent, you take it from your salary
before paying income taxes. You make it harmless. And you put
10 percent here, your income tax base is 90. So it was tax free
before, it was paid by the employer. When you relabel it, it
goes on being tax free. So there is no tax increase whatsoever.
On the contrary, as we have already financed most of the
transition, the former transition tax that was part of the
payroll tax has been eliminated. That is the 5.3 percent that I
am suggesting in America, that you should keep inside the
system in order to pay the elderly, but after 10, 20, 30, 40,
50 years, you will have an extraordinary opportunity of
beginning the reduction of that tax until the day will come
when the last person who stayed in the old system fades away,
when you will be able to eliminate that tax. And that will be
something very good for the economy because it will have all
kinds of growth effect because you are eliminating a distortion
in the labor market.
Mr. McCrery. Would the 5.3 percent be paid by the employer
or the employee or both.
Mr. Pinera. Excuse me.
Mr. McCrery. Would the 5.3-percent tax be paid by the
employer or the employee or both? Transition tax?
Mr. Pinera. Today you have 5.3 paid by the worker, 5.3 by
the employer. OK?
Mr. McCrery. Right.
Mr. Pinera. What I will do in order to make it simple, the
5.3 of the worker should go into the passbook--5.3 into the
passbook immediately. The 5.3 of the employer is paying anyway
to the Social Security Administration. He should keep paying
it, for another 10, 20, 30, 40 years--paying the cost of the
transition. And when the cost of the transition goes to zero,
because some day it will go to zero in a system like this, if
you ask the young people to go into the new system, at that
moment, you can have a huge payroll tax reduction. In Chile, we
already had that payroll tax reduction to zero. In Chile, the
payroll tax is zero.
What we are debating now, is that since in the next years
we will begin to have a budget surplus as elderly people go
away, we are beginning to debate the elimination of the income
tax, paid as a dividend of the Social Security reform. Because
the day when the government does not have to pay benefits to
the elderly except the safety net, that will be a very small
amount, there will emerge a huge budget surplus. And there is
beginning a debate there, and we are following Chairman
Archer's leadership on that, and we are debating the eventual--
the eventual--elimination of the income tax with extraordinary
growth effect, and not only growth, also respect for the
privacy of the individuals.
Mr. McCrery. Mr. Chairman, that's a good idea, I think, for
us to follow. We ought not exact income taxes on payroll taxes,
which our system currently does. So I hope we follow that
example.
One more question. You talk about, in your paper, benefits
being taxed when they are withdrawn.
Mr. Pinera. Oh yes.
Mr. McCrery. How are they taxed? Just at the ordinary rate
at the time.
Mr. Pinera. At normal rate. You do not pay tax when you put
the money in, you pay tax when you take it out.
Mr. McCrery. When you take it out--OK.
Mr. Pinera. You pay taxes as if you were getting the money
from other sources. It is very simple. You don't pay when it's
in, you pay when it's out.
Mr. McCrery. Are there private pensions as well in Chile?
Mr. Pinera. No. Basically none, sir, because 20 years ago,
of course, there were very few people who could get private
pensions. And therefore most of the population was covered by
the Social Security system. I do know that in America you also
have private pension, and that is another very interesting
challenge to be resolved in America, but I have not studied it,
but some of my colleagues are studying, how to combine,
eventually, USA accounts filled with FICA taxes with 401(k)s,
IRAs and so on because eventually if you were to combine all
these accounts, the administrative costs of the whole system
will go down very much. So that an individual, instead of
having one 401(k), one IRA, one USA account, maybe he should
have only one account with different provisions for taking out
the money. Part of the money cannot be taken until retirement;
part of the money can be taken for some and specific things,
and so forth, and so forth. That is a challenge for your
country to eventually, not in the first reform, I would say
that is a second or a third reform, to eventually combine
everything and make it very simple and very clear to the most
common worker because something that has been, sir, a great
help to the workers in Chile is the extreme simplicity of this
system. The system is simple; it's a passbook. And you
accumulate money, and that's it.
There is no small--there is no, you see, hundreds of
difficult provisions for the worker to understand. The worker
understands so easily. Saving in a passbook, and you can get
the money when you reach retirement age or when you accumulate
enough money to have an early retirement.
Chairman Archer. The gentleman's time has expired.
Mr. Collins.
That completes inquiry by all Members currently present.
Dr. Pinera, thank you so much for taking your time to come and
share with us your experiences in Chile. We have to learn from
what has happened all over the world, and you've given us a
good start. We are very grateful for your appearance today.
Mr. Pinera. Thank you very much, Mr. Chairman.
Chairman Archer. Buenos suerte.
Mr. Pinera. Buenos suerte, gracias. Thank you very much to
all of you, sirs.
Chairman Archer. The Chair would like to take a recess for
lunch and return at 1 o'clock for our next witnesses. So we
will stand in recess until 1 o'clock.
[Whereupon, at 11:44 a.m., the Committee recessed, to
reconvene at 1 p.m., the same day.]
Chairman Archer [presiding]. The Chair would invite Hon.
Peter Lilley, Member of Parliament of the United Kingdom, to
take the witness chair. And we're really happy to have you here
with us. Thank you for bearing with us. I hope you got some
lunch. I apologize for detaining you for an extra period of
time.
M.P. Lilley is also Deputy Leader of the Conservative
Party, I believe, is that correct?
Mr. Lilley. That's correct.
Chairman Archer. And former Secretary of State for Social
Security in the United Kingdom. We're happy to have you here
today, and I think you understand the context of the hearings
by listening to some of the former witnesses' testimony and
questioning. So we'd be happy to receive your testimony with
the encouragement that you limit as much as possible your
verbal presentation. And if you have a written statement,
without objection, the entire statement will be printed in the
record. We're not going to keep a time limit on you on your
verbal presentation, but there will be, hopefully, adequate
time during the inquiry period to expand on whatever you would
like to say. So, welcome, and we'd be pleased to hear your
testimony.
STATEMENT OF RT. HON. PETER LILLEY, MEMBER OF PARLIAMENT,
UNITED KINGDOM; DEPUTY LEADER, CONSERVATIVE PARTY; AND FORMER
SECRETARY OF STATE FOR SOCIAL SECURITY
Mr. Lilley. Mr. Chairman, it's a great honor to be asked to
give testimony on this very important subject. In the context
of a mature economy like Great Britain, which I think may well
complement the evidence you've just heard from Chile and
demonstrate that in a mature economy it is also possible to
extend the benefits of personal ownership of savings and
investment to millions of people to the advantage of the public
finances.
Basically, there are only two ways of financing pensions.
One is to tax in work and use the taxes and charges to pay for
the pension of people who are already retired, with nothing
being saved or invested for the future. And that's the process
that is operated in most European countries. So that as they
have an increasing number of retired people and a declining
number of people of working age, the nightmare they face is the
increasing burden of tax on their economy and their working
population.
By contrast, in Great Britain, we put more emphasis on the
second method of financing pensions, encouraging people to save
and invest during their working life for their future pensions.
We've done that by enabling people to opt out of one component
of the Social Security pension--it's in two parts in the United
Kingdom, a flat-rate basic pension, which is the same for
everybody, and an earnings-related pension, which is related to
the amount they earn and therefore pay in payroll taxes during
their life--we allow people to opt out of that earnings-related
pension into company pension schemes--and that's been allowed
for a long time--and more recently into personal pension funds,
which are a bit like your individual retirement accounts.
About 60 percent of people who are eligible to opt out of
the state earnings-related pension do take advantage of that,
some 8 million into company schemes and over 5.5 million,
that's 10 times what we anticipated when we introduced the
scheme into personal pensions. Those who do opt out of the
state system, receive a rebate of their payroll tax, their
national insurance contribution as we call it, to finance a
private pension. And it's calculated as being sufficient to
provide at least an equivalent pension to that which they would
have obtained had they remained in the state system. And that
rebate is paid directly into their private fund. So it is
saved; it is invested; it goes into industry; it generates the
profits to pay for their pensions in 10, 20, 30 years time,
when they will retire, without imposing a burden of tax on the
economy, and meanwhile strengthening the economy through a huge
accumulation of investment funds.
The United Kingdom has now accumulated British-owned
pension funds amounting to $1.3 trillion. And that's not just
more than any other country in Europe, it's more than all the
other countries in the European Union put together have managed
to save and invest to meet their future pension needs. So it
puts us in a very advantageous position.
Now as a Member of Parliament, I often find myself on your
side of the table, Mr. Chairman. When I do, I get rather
restless about hearing people describe their successes, want to
hear them talk a bit more about the problems that they had to
go through. So I'll address straight away two problems which
have affected our pensions system in the United Kingdom, the
problem of misselling and the problem of the Maxwell theft of
pension funds.
Both were major scandals. But it is very important to
recognize that neither had any direct connection with our
decision to let people opt out of the state earnings-related
pension scheme into personal pensions.
Misselling was about unscrupulous salesmen persuading
gullible investors to transfer funds from one kind of private
pension provision, mainly their company scheme, the company
fund, into a personal pension, not about opting out of the
state system into personal pensions. Therefore, it is something
which could, I think, happen in principle in other countries
where there is no right to opt out of or receive an opt-out
rebate from the state system.
That abuse only became possible because we changed the law
which previously had permitted companies to make it a condition
of employment that their employees pay a certain sum into the
company pension scheme. And we liberated them so that they were
free not to do that if they didn't want to. And it was at that
stage that some people were persuaded to opt out of their
rather good company schemes into less good personal pensions.
They may still have been better off than if they had opted
back into the state scheme. But all of them are being
compensated, and not one of those investors will lose a penny
as a result of it.
The Maxwell scandal had even less to do with our system of
allowing people to opt out of the state scheme, when Robert
Maxwell, a former Labor MP, a millionaire, stole
450 million from the pension funds of the companies
he controlled. They were set up long before our present
arrangements and had nothing to do with it. But it did reveal
that there was a weakness in our regulatory system of how such
company funds were regulated and protected. We since addressed
that and made them more secure.
What is remarkable is that the Labor Party, who
traditionally believe in a pay-as-you-go state Social Security
provision and used the two scandals I have just referred to to
try and denigrate the system that we put in operation of
encouraging private provision, were forced to change their mind
because the system of private pension provision, allowing
people to build up private funds, were so popular and the
system has so many clear advantages for the public finances,
that there is now a consensus between the major parties in
Britain that we should go further in encouraging to opt out of
the state system and, where it is beneficial for them, into
personal or private provisions of one kind or another.
Indeed, the new government has just proposed that in about
5 years time, anyone with an income above 9,000 a
year, that's about $15,000 a year, is likely to find themselves
excluded from the state system. They would have to have a
private-funded pension. So it shows that is a system which has
broad acceptance in the United Kingdom.
I regret that they haven't gone further than that and taken
up the plan I announced when I was Secretary of State for
Social Security. And that was that all young people newly
entering the labor market should automatically be required to
have their own individual savings account, a bit like that
described by my friend Jose Pinera. They would receive a rebate
payable into their--sufficient to pay, not just for their
earnings-related pension but the basic state pension as well.
So that over a generation, as the young people displaced
older people who had retained the present system, we'd move
from a system of financing pensions partly out of taxation to
one where it was all funded by savings and investment. And that
would bring about the largest extension of personal ownership
of wealth that we've ever seen--greater even than that
resulting from the spread of home ownership. It would mean that
in the future, pensioners would participate directly in the
wealth and prosperity of the economy. It would give a massive
boost to the economy by boosting savings and investment. We
calculate that if that extra savings, which would be huge, were
to increase the rate of growth of the economy from its
estimated 2.25 percent by one-twentieth of 1 percent, to 2.3
percent a year, the whole system would be self-financing
because the extra growth would generate extra tax revenues to
make good any shortfall due to the rebates from the state
system.
So in short, we believe Social Security reform is about
much more than saving money for improving the public finances.
It should be about spreading independence, wealth and security
to everyone, including to those individuals who in the past
have not enjoyed that. And Britain has, I think, shown that
that can be done, even in a mature economy.
Thank you.
[The prepared statement follows:]
Statement of Rt. Hon. Peter Lilley, Member of Parliament, United
Kingdom; Deputy Leader, Conservative Party; and Former Secretary of
State for Social Security
``There are only two ways to finance the pensions of future
generations of retired people.
The first is to rely on taxing those who will be in work to
pay the pensions of those in retirement.
The second is to encourage people to save and invest during
their working life to pay for their future pensions.
Most European countries rely largely on the first method.
Almost all their pensions are paid out of taxes and charges
on those in work. This year's taxes are used to pay the
pensions of people already retired. Nothing is saved or
invested for the future. It is pay as you go.
So as the number of retired people rises and the number of
people of working age falls they face an increasingly onerous
burden of tax on their economies. That is the nightmare facing
most finance ministers in Europe and elsewhere.
By contrast the UK has persuaded the bulk of people to
build up pension funds for retirement. It allows and encourages
them to opt out of the State Earnings Related Pension Scheme.
Over 60 per cent of those eligible do opt out. They receive a
rebate of their payroll tax which is payable into an
occupational or personal pension. So their money is genuinely
saved. It is invested. It goes into industry to earn the
dividends which will pay their pensions in ten, twenty, thirty
years time when they retire--without imposing a burden of tax
on the economy and meanwhile strengthening it through a massive
build up of investment.
The total value of British owned pensions funds is now some
830 billion. That is $1.3 trillion.
That is not just more than any other country in Europe. It
is more than all the other countries in Europe put together
have saved and invested for their own pension needs. As a
result, the IMF calculated that if countries maintain their
present systems--by 2050 France and Germany would have
accumulated government debts nearly twice their national
income. By contrast the UK would have paid off its entire
national debt and accumulated a surplus.
Let me explain how the UK system works to bring this about.
The Social Security System provides for a two tier pension.
The first tier is a flat rate basic pension. Every employee
earning above the minimal threshold at which payroll tax (known
as National Insurance Contributions) becomes payable earns
entitlement to this basic pension. It is currently worth
64.70 per week for a single person and
103.40 for a married couple and is uprated each
year in line with inflation.
On top of that employees also earn entitlement to a State
Earnings Related Pension. As its name suggests, the pension
entitlement is proportionate to earnings.
SERPS pension rights accruing each year are proportionate
to eligible earnings. Eligible earnings are those between the
Lower and Upper Earnings Limits. The Lower Earnings Limit is
currently 64 per week, while the Upper Earnings
Limit is 485 per week. (People pay a National
Insurance Contribution on their earnings between those limits.)
Employees with earnings between those limits for 40 or more
years will receive a State Earnings Related Pension (on top of
the Basic State Pension) equivalent to some 20 per cent of
their average eligible earnings.
Since SERPS was established (in 1978) provision has been
made for some employees to be opted out of the scheme.
Employees who are opted out are entitled to a rebate of their
payroll taxes (which we call National Insurance Contributions).
This rebate is payable only into an approved pension scheme. It
is paid direct into the pension scheme and cannot be spent on
anything else by the employee.
The rebate is set at a level which is calculated to be
sufficient to ensure fund mangers can invest to provide for an
at least comparable pension. The rebate is currently set at 4.6
per cent of eligible earnings. The Government Actuary
calculates that this will be sufficient to generate a fund
sufficient to buy an annuity on retirement equal to the SERPS
pension. He assumes investments will yield 4.25 per cent per
annum in real terms.
Initially, the possibility of opting out existed only for
members of occupational pension schemes provided by employers.
Employers take the decision as to whether their scheme and all
its members should opt out of the state scheme. Most did choose
to opt out.
Typically employers running such schemes paid contributions
into their scheme and usually required employees to do so as
well (on top of the rebate from payroll taxes/national
insurance contributions).
In 1986 the Conservative government gave employees who were
not opted out of SERPS through membership of an occupational
scheme the right to opt out of SERPS into an approved Personal
Pension scheme. These were something like Individual Retirement
Accounts in the USA.
Anyone opting for a Personal Pension is entitled to a
rebate from their National Insurance Contributions. This is
payable direct into their Personal Pension. So it can only be
used to fund a pension not spent on personal consumption.
Five and a half million people have taken out approved
personal pensions. These are in addition to more than 8 million
who are members of opted out occupational pension funds.
People are of course free to put more into their private
pensions than just the rebate.
Problems.
I imagine the Committee will be at least as interested in
the problems we have had to tackle as in the success of this
approach.
The first problem was the problem of `misselling': pension
salesmen selling personal pensions to people who had a better
alternative. This was not the result of giving people freedom
to opt out of the State Scheme into personal pensions. The
initial rebate was set at a level sufficient to ensure that it
could fund a personal pension which was better than the State
scheme.
The problem arose from a separate change introduced at the
same time. This was the decision to give employees the right to
opt out of company pension schemes. Prior to 1986, employers
who ran occupational pension schemes could make membership of
their scheme a condition of employment and deduct from
employees' pay at source a premium payable into the fund. Most
employers with such schemes did make membership obligatory for
those eligible to join. Typically, they made employees pay
pension contributions of up to 10 percent of salary and many
added a similar sum themselves.
From 1986 employers could no longer force employees to join
their scheme. If employees wished they could leave the company
scheme and take out a personal pension. If they did, their
rebate of National Insurance would be automatically transferred
to the personal pension fund. They could also pay into their
personal pension the premium previously deducted from their own
salary. But most employers would not pay into the personal
pension the matching amount they had been paying into a company
scheme.
So anyone foolish enough to move from a generous company
scheme to a personal pension fund was almost bound to lose out.
Nonetheless, many were persuaded by unscrupulous salesmen, paid
on commission, to make this change.
Many employees were allegedly confused by government
advertising extolling the virtues of opting out of the State
scheme into personal pensions. They assumed that the government
was also recommending them to opt out of company pension funds
into private pensions.
In fact from the start legislation required salesmen to
make sure their product was appropriate to their customer's
circumstances. Consequently it was invariably illegal to
missell in this way. The Regulator has therefore required
companies to go through their files and reimburse any customer
who was missold a pension in this way.
This is a massive exercise. However, the Regulator has
given an assurance that no-one who was missold will lose out at
the end of the day. They will either be reinstated in their
original scheme or compensated.
The second problem was a massive theft from a company
scheme. In 1991 Robert Maxwell (a former Labour MP and head of
a complex business empire) was found dead leaving up to
450 million missing from the pension funds of his
companies. The pensions of 30,000 people seemed to be at risk.
In the event, sufficient monies were recovered to ensure all
pension entitlements will be paid in full. Nonetheless the
theft revealed apparent weaknesses in pension fund security. A
new framework was therefore established to ensure that adequate
funds are in place and that they would be safe in future. In
the last resort, a compensation fund would make good any
shortfall due to fraud.
Public Acceptability.
In the UK the Labour Party has traditionally favoured state
funded, pay-as-you-go pension provision. It was grudgingly
prepared to allow company schemes to opt out of the State
Earnings Related Pension scheme. But it was critical both of
the principle and the practice of allowing individuals to opt
out of the state scheme into personal pensions.
The emergence of the misselling problem and the Maxwell
scandal gave them ammunition to fire at private funded pension
provision. Despite that, the growing public popularity of
private pension provision, coupled with increasing awareness of
its long-term benefit to the public finances brought a gradual
change of heart. Labour now plans to encourage more people to
build up private funded pensions.
Consequently, there is now more of a political consensus in
Britain that private pension provision is a success; and that
where possible more people should be enabled to opt out of the
state system.
Proposals to Extend Private Provision of Pensions.
Before the last election Conservatives were seeking ways to
extend private pension provision.
In the late 1980s we gave members of company schemes the
right to save more than the standard amounts required by the
company. Employees could make Additional Voluntary
Contributions into their fund up to a certain amount out of
income tax free.
The then government also consulted on the idea of closing
the State Earnings Related Pension Scheme. That would have
meant everyone would in future be opted out and pay obligatory
premiums (rebated from National Insurance Contributions) into
personal or company schemes.
However, the government was persuaded that this would
damage the position of the low paid and those with variable
patterns of employment (as well as putting an increased burden
on businesses).
Because the SERPS scheme is earnings related, anyone on low
earnings who opted out would receive a small rebate. This would
be inadequate to cover the fixed costs of setting up and
running a personal pension. The government therefore kept the
State Earnings Related Scheme for people on low and
intermittent earnings.
Within that framework the only way to enable more people to
benefit from opting out is to reduce the costs and charges of
running a personal pension scheme.
The government therefore encouraged transparency--requiring
companies to publish their charges and costs in a standardised
form. This would enable competition to drive down costs. In
addition, regulations were streamlined especially for simple
standard schemes. And new and small companies who are typically
reluctant to set up company schemes (which have low costs) were
encouraged to set up Group Personal Pensions. These are a form
of personal pension, but the company can negotiate low charges
for its employees by arranging personal pensions for them.
The Labour government is essentially going down the same
route with what it calls Stakeholder Pensions. These will have
fairly standardised terms and a ceiling on costs.
However, there is a limit to how far costs can be reduced.
So such developments, welcome though they are, can only extend
the attractions of opting out of SERPS a little wider. Many low
paid would continue to find their rebates too small to set up a
personal pension.
Basic Pension Plus.
Before the May 1997 General Election, I published a
proposal which involved a radical step forward to enable all
new entrants to the labour market to opt out of SERPS.
This would involve extending funded provision to cover the
basic state pension as well as the earnings related pension.
Our Basic State Pension is flat rate. So if people are
allowed to opt out of it and enabled to save for an equivalent
private pension they must be given a flat rate rebate.
Such a flat rate rebate would enable everyone--even low
earners--to cover the fixed costs of setting up a pension fund.
So even low earners could then also opt out of SERPS and put
their earnings related rebate, however small, into the same
fund.
This could only come in gradually with the new generation
of young people entering the labour market We therefore
proposed a scheme called Basic Pension Plus.
It had three key elements.
First, the personal fund. Everyone in the new generation
would have their own pension fund to finance their basic
pension and more. They would choose an approved firm to manage
it. They would own their fund. And any amount not used to pay
for their pension could be passed on to their heirs.
Second, the rebate. They would receive a rebate from their
National Insurance contributions. Over their working lives it
would be sufficient to build up a fund big enough to pay their
basic pension. The Government Actuary calculated that
9 a week would be needed. So people would receive a
rebate of 9 a week (rising in line with inflation)
paid into their fund.
The third element was the Basic Pension Guarantee. The
State would guarantee that everyone would receive a pension at
least equal to their basic state pension (increased at least in
line with inflation). We called the scheme Basic Pension Plus
because it would have been the Basic Pension, plus a fund, plus
a rebate, plus a State Guarantee. Each fund should grow to
provide the basic pension. If for any reason a person's fund
was insufficient, the state would top up the pension it
provides. So they would still get their basic pension. Everyone
would be protected by the Basic pension Guarantee. No-one would
do less well than under the present state scheme.
And everyone would stand to do better, if as we hoped, the
economy and their investments did well. If returns are one per
cent higher than assumed they would get a pension nearly 30 per
cent above the basic pension. If the yield is 2 per cent
higher, the pension could be over 70 per cent better.
So a person on average wages would build up a fund which
should be worth 130,000 when they retire. That
would be sufficient to provide a pension of 175 a
week at today's prices. That is based on making the minimum
contributions over most of a working life. But once everyone in
work has their own fund they and their employers would be able
and encouraged to save more in their fund.
We would phase in the new system of funded pensions
gradually over a generation. Existing pensioners would not be
affected by the new scheme and would continue to receive their
state pensions (rising at least with inflation). Likewise the
current working generation would continue to build entitlements
to the basic state pension and be free to remain in or opt out
of SERPS during the rest of their working lives. The new Basic
Pension Plus system would apply to the rising generation--all
young people newly entering work plus those initially aged up
to their early twenties. They would receive rebates to build up
their pension funds over their working lives. So it would take
a generation to replace the present system. That means the
impact on public revenues of the rebates needed to fund
investment would grow very gradually over forty years.
In addition, we could halve that impact by reversing the
timing of tax relief on pensions for the new generation. Under
the current system contributions to pension funds attract tax
relief but pension income is taxable. That system would have
continued for the present generation. For the new generation
covered by Basic Pension Plus, I proposed that pension
contributions (including voluntary pension savings) be paid
from net income and all pension income be entirely tax free. As
far as the saver is concerned the new tax treatment was
equivalent to the old one (except for the lump sum) if the
saver's tax rate was the same in work and retirement. For the
pension providers it should have been possible to make the new
PEP style tax treatment far simpler and less onerous than the
current regime.
This proposed change in tax timing, combined with the
gradual phasing in of the new system, would make the impact on
public finances quite manageable. The net value of extra
investment would mount at only about 160 million a
year. And eventually, it would produce massive savings in
public expenditure reaching 40 billion a year. At
its peak the net revenue forgone would be less than the peak
cost of SERPS rebates, which we had already taken in our
stride. It would be a fraction of the savings resulting from
the UK's recent Pension Act which will ease the burden of state
pensions by some 13 billion a year. And the extra
rebates would be small relative to normal growth of tax
revenues. Moreover, if the huge extra funds available for
investment which would be generated by the scheme boosted
economic growth by just a twentieth of one per cent the scheme
would be entirely self-financing--though we did not take
account of this in costing the scheme.
To summarise:
Basic Pension Plus would come in gradually over a
generation
Everyone covered by the new system would have
their own pension fund
They would receive a rebate of 9 a
week to fund their basic pension.
They would be guaranteed to receive at least their
basic state pension (protected against inflation).
Employees would be opted out of SERPS and get a
second rebate worth five per cent of their earnings to fund
their second earnings related pension. Because everyone would
have a fund they would be able and encouraged to save more on
top.
Anyone on average earnings paying in just the
minimum contributions should accumulate a fund worth
130,000 by retirement, paying a pension of
175 a week in today's money.
Everyone would stand to benefit from good economic
and investment growth. An extra one per cent investment yield
would generate a pension 30 per cent higher. The economy would
be strengthened by a massive increase in long-term investment
funds.
Ultimately the taxpayer and the economy would be relieved
of the largest single item of public spending--some
40 billion a year. In short--British people would
have been able to look forward to secure pensions, higher
investment and low tax.
Chairman Archer. Thank you very much. That certainly gives
us another perspective, which is very helpful. I'm going to
recognize Mr. Shaw, the Chairman of the Social Security
Subcommittee for inquiry.
Mr. Shaw. Thank you, and I'd like to echo the Chairman's
appreciation for your presence here today.
Could you talk to us a little bit about your transitional
period, going from the old system to the new system? And how
long ago did you do that?
Mr. Lilley. The system was made easier by the fact that we
only introduced comprehensively an earnings-related element
into the pension system at the end of the seventies and
simultaneously allowed company schemes to opt out of that. We
then moved forward and allowed individuals, who perhaps didn't
work for a company which had a company pension fund, to opt out
of the state system into personal pensions in about--we passed
the law in 1986 and I think it became effective in 1988.
So it's over the last 10 years that we've seen the massive
growth of personal pension provision by people opting out of
the state system. And that obviously involved a transitional
period, but it was one that was easily accommodated in the
public finances and seems not to have been a issue really.
Mr. Shaw. Do you know, off the top of your head, what the
average retiree receives as a percentage of his salary that he
had when he retired?
Mr. Lilley. Well the state earnings-related pension is
designed that someone paying into it over their life will from
that portion of their Social Security pension alone get a
pension equal to 20 percent of the earnings that they've had
during their life, uprated by the growth of earnings throughout
the economy. And the basic pension actually doubles that on
average. So the state system provides a pension worth about 40
percent of earnings when people worked.
That's obviously when people opt out into private pensions,
by and large, they've done much better. So they get better
pensions than they would do if they had remained in that basic
state system.
Mr. Shaw. OK. Is that the individual savings accounts we
are talking about?
Mr. Lilley. Well, you have the option of remaining in the
state scheme, with its two components.
Mr. Shaw. And that's 40 percent.
Mr. Lilley. And that would give you about 40 percent.
Mr. Shaw. That's about what ours is. I think ours may be 42
percent, but it's close. What's the withholding rate on
percentage of salary?
Mr. Lilley. The----
Mr. Shaw. Paid into by the combined employer-employee
contribution.
Mr. Lilley. The earnings-related element, the bit that
you're to allowed to opt out of into private IRA-type account,
you get a rebate which is currently set at 4.6 percent of your
earnings. And that amount is set by the government actuary as
what he believes is necessary to provide you with a pension at
least as good as you would have got if you had remained in the
state scheme. And it assumes that the return on assets that you
will get in the private sector is 4.25 percent more than
inflation.
In fact, over the whole time this system has operated, the
average return on assets has been nearly 10 percent more than
the rate of inflation. And the average the last 50 years, since
the war, in private company schemes has been over 7 percent
more than inflation. So it's a very modest----
Mr. Shaw. So that the pension the retiree receives is
greatly more than the state system, which is around 40 percent.
So it's substantially higher than that.
Mr. Lilley. They should be better. Yes.
Mr. Shaw. The previous witness testified to us that the
Chilean model--it's about 70 percent as opposed to our 42
percent. And it sounds like your experience is somewhat
similar.
Mr. Lilley. Yes, it is in that direction. And of course,
once people have a private pension fund, the equivalent of an
IRA, then they can put in not just the rebate they get from the
state, but any additional money they want to, if they want to
have a higher pension still, and in increasing proportion. And
people do that.
Mr. Shaw. And it sounds like the Labor Party supports what
you're doing. They are going to actually expand it, not to the
extent you want to, but they are expanding it.
Mr. Lilley. That's correct. They have had to change their
opinion because it's popular with the public.
Mr. Shaw. Perhaps that will happen here. Thank you.
Mr. Lilley. In a democracy, the public often does influence
politicians.
Chairman Archer. The Chair now recognizes the Ranking
Minority Member on the Social Security Subcommittee, Mr.
Matsui.
Mr. Matsui. Thank you, Mr. Chairman.
Welcome Mr. Lilley.
I just want to understand the system. There are two tiers.
One tier is government financed, and the amount is $105 per
week when one retires, and that's automatically guaranteed. And
then there is the second tier, and one can opt a government
plan, employer plan or an individual plan. I guess the
individual plan is appropriate personal pensions. That's very
British.
What I want to know is--and help me with these numbers
because I'm just not quite sure whether these numbers are
accurate or not. About 20 percent of a worker's APP,
appropriate personal pension account, is consumed by
administrative costs? Is that still a correct figure or has
there been some improvement in that?
Mr. Lilley. Nobody knows what the average figure is, but a
figure of that amount has been suggested, about 20 percent. But
that includes three types of costs. The costs of managing
investments, much the same as you would experience here for
managing a mutual fund, less than one-half of 1 percent usually
of assets.
Then there is the cost of shilling, persuading someone to
save more than the minimum, which the government lays down. And
it is costly to persuade people to do things. We say in my
country, pensions are not bought, they are sold. The figures
you would get would be averaging that selling cost to people
who have been persuaded to do more than the government
requires.
And third, there is the cost of meeting the regulatory
burdens, which we have imposed, which are quite heavy, and
which we are not seeking to simplify to minimize those costs.
The government is proposing to put a ceiling equivalent to
1 percent of the assets invested. We tend, like Mr. Pinera, to
think in those terms. So it would be a lower cost than the
Chilean model.
Mr. Matsui. But that isn't agreed to yet? That's a proposal
being discussed? Is that right?
Mr. Lilley. That's correct.
Mr. Matsui. Approximately 40 percent of the workers in the
APP at one time or another switch, I understand, into a
different area, of mutual funds or whatever it might be. And
there is a transfer fee there, I understand. But approximately
every 4 years there is that transfer that occurs. What is the
cost on that? Do we happen to know?
And that's a separate cost from the administrative cost?
Mr. Lilley. Are you talking about transferring from a
company fund into a personal pension fund or----
Mr. Matsui. No. This would be within the APP itself.
Apparently, participants would transfer into another asset
area, whether it's equities or perhaps mutual funds. I
understand there is a cost to that, but perhaps----
Mr. Lilley. But all that sort of cost is included in the
number you first quoted.
Mr. Matsui. Oh. I wasn't aware of that because we have it
separate here. So in other words, that would be administrative
costs.
Mr. Lilley. It's part of the administrative costs.
Mr. Matsui. And then when one completes his work or her
work, then you annuitize the account, and, I understand that
it's an additional 10 to 15, up to perhaps 20 percent of the
cost of the assets in that situation? Is that a correct number?
Mr. Lilley. It's not a number I'm aware of or familiar
with. There is a cost; I would doubt very much it is remotely
as large as that.
Mr. Matsui. Did you know what the number might be because,
you see, one of the concerns, obviously, besides the issue of
fraud, and I want to get into that if I have a moment, is the
issue of what is the cost. In other words you have a
maintenance cost, a transfer cost, and a cost to annuitize. I
would just like to kind of get an idea of these costs. Let's
say there's $100 in this account on retirement, what percentage
of that has been used for all three of these particular areas?
Mr. Lilley. Yes. You're right. It is an important issue.
And clearly one wants to keep those costs to the minimum.
Mr. Matsui. Oh, I understand that.
Mr. Lilley. What we've tried to is say it doesn't matter
particularly what the breakdown is as long as the total is
assessed. We have moved to what we call transparency, requiring
the companies----
Mr. Matsui. Right.
Mr. Lilley [continuing]. To report all their costs, all
those you've mentioned----
Mr. Matsui. I understand that.
Mr. Lilley [continuing]. In a standardized form so that you
could see in a personal pension what proportion was being
absorbed by these costs if you kept it for a standard period of
time and it behaved in a standard fashion.
Mr. Matsui. I'm not suggesting anybody is trying to hide
it. I know there's transparency; there has to be transparency.
But I just wanted an idea of what the total cost would be. And
you do not seem to be able to provide that total.
Mr. Lilley. I can't give you the breakdown, but for
example, the government actuary, when he's calculating what the
rebate system should be in order to provide an equivalent
pension, takes into account what he considers a fairly standard
and typical level of costs, which I think is of the order of
1\1/8\ or 1\1/4\ percent of return on assets, fairly similar
therefore to what Mr. Pinera was talking about. And all those
costs average out at different schemes over the life of----
Mr. Matsui. My time has run out. I----
Chairman Archer. If you need to, we can come back on a
second round.
Mr. Matsui. Thank you.
Chairman Archer. The Chair will recognize Mr. Nussle, and
you'll be the last to inquire before we recess to go vote.
Mr. Nussle. Thank you, Mr. Chairman. And I appreciate your
coming to testify before us today. My curiosity is in the area
of your country's savings rate. Do you calculate the personal
accounts in the overall savings rate for your country? And the
other part of that question is, have you seen over the period
of time that you have instituted this more personal system, an
increase in the personal savings rate for your country? As I
understand it, that's one of our challenges here in the United
States. I believe Chairman Greenspan testified that we are
almost statistically at a zero for our savings rate for our
country, which is alarming. And what I'm wondering is whether
this has helped in the overall savings rate for Great Britain?
Mr. Lilley. There certainly has been a recovery in the
savings rate since we introduced it. But it would be very hard
to say whether that is cause and effect or just something that
happened at the same time. But the presumption must be that it
certainly helped and didn't hinder the recovery of savings in
Britain. I think they are better than America but still below
some other countries. And we believe if we could persuade more
of the population to save and invest in this way, that would be
beneficial further to improving our savings and investment
ratio.
Mr. Nussle. Do you have any statistics or figures to
describe the amount of people that have supplemented the
system, and have you been successful in persuading your
citizens to invest or contribute in addition to the amount
which is rebated from your government?
Mr. Lilley. I think, from memory, something like 30
percent, but is a rising proportion save more than the minimum
through appropriate personal pensions. And a substantially
higher proportion, the vast majority, of those saving through
company pension funds, save more than the minimum that the
government lays down.
Mr. Nussle. Thank you very much. Thank you, Mr. Chairman.
Chairman Archer. Mr. Lilley, if you will indulge us, we
must go vote and then we'll come back immediately. And if it's
not imposing too much on you, we ask you to remain and we will
be back in a very short time.
The Committee will stand in recess until we can vote and
return.
[Recess.]
Chairman Archer. We had two votes instead of one, and so it
took longer than I had anticipated. Now Mr. Shaw, would you
like to continue your discussion with Mr. Lilley so it can be
part of the record?
Mr. Shaw. I learned as much as I need to, sir. So I'll just
keep it to myself. [Laughter.]
Great testimony. I was talking to Mr. Lilley about the
Chilean model, and whether--and he said they were sort of going
along the same path without really realizing it. As he
expressed, they developed theirs before the Chilean model
became famous. I'm think I'm accurately ----
Mr. Lilley. Yes. We didn't specifically model ourselves on
Chile, and obviously the United Kingdom has a very different
economy, starting from very different circumstances, and
adopted a different, more gradualist route. I'm by temperament
a gradualist. I prefer to do things step by step and buildup.
In Chile, given the circumstances in which the Chileans found
themselves, it was probably better to go for a big bang
approach. That we were able to build up a growing proportion of
people opting out of the state system, building up private
pensions, the system became more and more popular and more and
more people have done so, and eventually it's captured the
political high ground and is now the consensus for both
parties.
Mr. Shaw. The Chileans had a different form of government
when they put this in place, didn't they, than the United
Kingdom?
Mr. Lilley. That's true, but it shows that it's not
something that has to be done against the grain of public
opinion. What it amounts to is giving people ownership of the
wealth which they are creating and spreading out wealth more
widely and harnessing the power of capitalism and compound
interest to enable people, who otherwise would have mediocre
pensions to have better pensions. Those things are rather
popular in a democracy.
Mr. Shaw. You mentioned to me that it took 5 years in order
to put this in place. You worked on it 5 years. Could you just
give us a little bit of a briefing as to the steps you went
through, the thought process, what happened, what we might
expect, how we could manage to do this in less than 5 years?
Mr. Lilley. I'm not sure that I mentioned 5 years. Perhaps
I said something that was misinterpreted. We started the
earnings-related scheme in 1978, and very early on gave people
the right to opt out of that scheme into private-company
schemes if they had them. And then in 1988, we introduced the
right to opt into appropriate personal pensions, and then
that's built up over a 5-year period or more to become a
popular and established part of our pension provision in this
country.
The next step that I was talking about would have been to
basic pension plus, where people could opt out of the whole
state provision and receive a much larger rebate and have a
much larger fund for something we only came up with at the end
of my 5-year period as the Social Security Secretary. We will
have to get back to power, I think, to implement it.
Mr. Shaw. Thank you.
Chairman Archer. Mr. Lilley, if I might inquire on a couple
of specific points. How do you pay for your basic pension
system?
Mr. Lilley. It's paid for through a payroll tax deduction,
called national insurance contributions. And they're now
roughly 10 percent paid by the employee, 10 percent paid by the
employer--20 percent in all. But that covers much more than
pension provision, it covers unemployment play, sickness pay,
and some of it is used to finance health care. So it is only a
portion of that that is used by the pension system and
therefore rebated to----
Chairman Archer. Are you able to roughly isolate how much
of it is required for the basic pension system?
Mr. Lilley. For the basic flat-rate pension, we estimated
that--in order to opt out, if you opted out and took a rebate,
we calculated, the government actuary recalculated, a rebate of
9 a week would pay over a working life for a
pension equivalent of a basic pension. But of course that has
the advantage of compound interest and investment building up.
It would be more than 9 a week that are currently
being used to pay for the basic pension of people who have
opted out.
Chairman Archer. But of the 20 percent, 10 on employer, 10
on employee, do you have any rough percentage that is required
to fund the basic pension amount that you talked about?
Mr. Lilley. It would be best part of half of it, I think.
Chairman Archer. The rest of it would be for sick pay and
for health and other items?
Mr. Lilley. And for the second pension for those who
haven't opted out.
Chairman Archer. All right. And after you have let people
opt out and you have also given them a refund, as it were, of
what they have paid in, as I understand it, you are creating a
void in the necessary stream of revenue to pay the current
retirees. Now how did you handle that? How did you handle the
transition?
Mr. Lilley. We just accepted that there would be less
revenue coming into the Treasury in respect to the people who
opted out. And that led to the shortfall, the government got
less revenues for a period, but in the long run, we all make
far greater savings on the expenditures it will have to make on
pensions. And that was possible within the government
financings at the time.
Effectively, it was a tax cut, specifically going to
pensions.
Chairman Archer. But for the short-term revenue gap, as it
were, you simply drew on other revenues coming into the
Treasury and used those to defray that shortfall. Is that a
fair----
Mr. Lilley. Yes. At the time when we introduced it, we were
in a position not dissimilar to you, I understand, where you
have a surplus on your national insurance funds. We had a
surplus on government finances. And the government was in
surplus overall, and therefore was able to do this with no
great difficulty in the second half of the eighties.
Chairman Archer. And then how does the next layer of
retirement benefits, which you mentioned, work? How much is
required out of payroll? And were there any transition costs in
that?
Mr. Lilley. We haven't implemented that at all. If they
move to a much more radical system, which I was talking about
at the end--all we've done is allowed people to opt out of the
earnings-related pension, and they receive a 5-percent rebate
from their national insurance contributions.
Chairman Archer. So the next layer to increase retirement
above that is paid for strictly by the worker on an independent
basis? Is that fair to say?
Mr. Lilley. Yes.
Chairman Archer. OK. Thank you very much. Mr. Collins, do
you have any questions to ask?
Mr. Collins. Yes, sir. Just a couple, Mr. Chairman.
I might have missed this, Mr. Lilley, in your comments. The
rebate for those who opt out, is it based on a percentage of
the contributions that have been made over the years?
Mr. Lilley. Yes, effectively, they are given a rebate equal
to just less than 5 percent of their earnings, which would
otherwise be being paid into the national insurance fund,
instead is paid direct into their pension funds.
Mr. Collins. What I'm speaking of, though, is previous
years contributions to the national insurance fund. When they
opt out of that, is there any rebate there?
Mr. Lilley. No. It's not retrospective. So that if for 10
years they've been in the state system, they would keep the
accrued rights that they built up in the state system, and when
they retire they will get modest pension for those 10 years
contributions, but only from the point that they opt out that
they get the rebate and get a personal pension instead of
future accrued rights in the state system.
Mr. Collins. OK. I better understand now.
You mentioned some of the things you haven't implemented
because you're out of power. Have there been any changes or
proposals in the national insurance since you lost that power
to the new power?
Mr. Lilley. Yes. The Labor government has tried to echo
some of our rhetoric about moving in the direction of more
funded private provision and less reliance on the state. They
haven't gone as far as I would have liked, but they have
recently published a document called ``Partnership in
Pensions,'' which is encouraging. They see it as a partnership
between private and state systems. The most radical proposal in
it is that anyone earning more than 9,000 a year,
$15,000 a year, will, from about 5 years time, pull it,
effectively have to opt for a personal or company pension and
won't have the option of a full earnings-related Social
Security--they will have the basic flat-rate pension, but they
will no longer be able to remain opted into the earnings-
related element of Social Security.
Mr. Collins. They haven't reversed the trend that you
started?
Mr. Lilley. No, no. They have continued in the direction
which we initiated and which they used to criticize vigorously.
But they found it was both popular and clearly on closer
inspection the right thing to do in the light of the public
finances.
Mr. Collins. Very good. Thank you. Thank you, Mr. Chairman.
Chairman Archer. Is there any further inquiry.
Mr. Shaw.
If not, Mr. Lilley, thank you so much for taking the time
to be with us today. I think you've made a significant
contribution to our learning process. And we hope to welcome
you back to the United States in the very near future or
perhaps we might be able to see you over in London.
Mr. Lilley. I welcome this either way.
Chairman Archer. We wish you well. Thank you.
Mr. Lilley. Thank you.
Chairman Archer. Our next witness is David Harris, a
research associate of Watson Wyatt Worldwide, Bethesda,
Maryland. Mr. Harris, welcome. We will be happy to hear your
testimony. We would--the Chair would strongly encourage you to
make your verbal testimony as concise as possible, hopefully
within 5 minutes, and your entire statement will be printed in
the record, without objection. So you may proceed.
STATEMENT OF DAVID O. HARRIS, RESEARCH ASSOCIATE, WATSON WYATT
WORLDWIDE, BETHESDA, MARYLAND
Mr. Harris. Thank you, Mr. Chairman, Committee Members.
Thank you for the invitation. It is indeed an honor today to
discuss the Australian retirement system, with particular
reference to individual superannuation retirement accounts.
Before joining Watson Wyatt Worldwide to examine with my
vice president and director, Dr. Sylvester Schieber, a number
of countries' approaches to Social Security reform, I was a
consumer protection and financial services regulator in
Australia. The expertise I, thus, bring to you today is drawn
not only from the Australian retirement savings experience, but
also from our examination of retirement systems in Asia,
Africa, Europe and the Americas.
What is striking about the Australian system is that the
political pressures are the reverse of those in the United
States. There is a Federal Labor government, a largely liberal
leaning administration, who has established and extended
individual retirement accounts in 1987 and again in 1992. This
policy is not only supported by organized labor but also is
actively encouraged by the leadership of Australian Council of
Trade Unions. Businesses and consumer groups also back the
changes.
Such a unified approach to reforming Australia's
superannuation system, or pension system, was due to possible
fiscal concerns about the impact of an aging population on
Australia's economy in the future. Moreover, organized labor
argued that the coverage of superannuation, which had been
narrowly confined to a relatively affluent 40 percent of the
work force, should also cover all workers through compulsory
employer contributions.
The consensus was to create a retirement system with three
distinct pillars. The first pillar is a means-tested, pay-as-
you-go, unfunded, old-age pension. The full pension payments
equate to 25 percent of male total average weekly earnings,
with revenues being generated from Federal taxation and
provided out of consolidated revenue. In recent years, this
benefit has been means tested by strong income and assets
tests, detailed in my written testimony.
The second pillar is a mandated individual account-based
system which received 7 percent of the employee's salary today
in excess of A$450 per month. The contribution level will
eventually rise to 9 percent by 2002. Additionally, workers
voluntarily can contribute an average of 4 percent on top of
the 7 percent currently.
Largely these accounts exist on an employer-sponsored
defined contribution basis. Workers can choose professionally
managed equity or bond funds, fixed income securities, or a
mix.
The third pillar, which sees again individual retirement
accounts created on a voluntary basis with contributions
largely received through savings rebates and taxation credits.
The superannuation model does not involve government
control to any great extent, with regard to investing moneys on
behalf of the individual accountholders. Except for the normal
standards of regulation associated with disclosure and
prudential solvency, effective competition between industry
participants has effectively driven down fees and increased
returns.
So that administrative costs today as a percentage of
assets under management have fallen into the range of 69 to 83
basis points in 1997.
Contrary to what is often argued in the United States, even
the small account holders in Australia can minimize charges and
maximize returns. For women and disadvantaged groups,
especially, regulation on superannuation or pension accounts
have developed to take account of seasonal or broken career
patterns. To reach these groups, the government had a rigorous
program of public education, which began with those who need to
be made aware of how to plan effectively for their retirement
through individual responsibility. This point is noted in
attachments 1 and 2, which are the public education material
that I worked on as a regulator and in past life.
One of the other issues that is important to note in my
address, is that effective regulation, modeled in part on SEC
regulations here in the United States, has meant that Australia
has immunized itself against large-scale misselling and
inappropriate selling practices relating to superannuation
accounts, which are noted in some other international models.
In effect, the long-term retirement outlook for Australians
living on Main Street is promising. Favorable returns,
comparatively low charges, and effective regulation have
generated public confidence in the existing system.
Today, Mr. Chairman, the Australian work force of just over
9 million people have established 18.7 million individual
accounts to help ensure their retirement prosperity. These
accounts already hold assets of A$364 billion, roughly US$203
billion. And this figure will grow rapidly in the next century.
Around 16 percent of these assets are invested abroad in
countries like the United States, and over 36 percent are
invested in equities and trusts.
An average worker in Australia today, Mr. Chairman, is a
shareholder, a shareholder in a company, a shareholder in his
or her own retirement future. And a shareholder in the economic
prosperity of the country that decided individual accounts with
investment choices was the most appropriate course to follow.
I would add that being part of generation X, I don't
believe in UFOs. I believe in individual retirement accounts,
so much so that I've decided to live in the United States
because I believe, that like Australia, the United States will
eventually follow a similar path.
Thank you.
[The prepared statement and attachments follow:]
Statement of David O. Harris, Research Associate, Watson Wyatt
Worldwide, Bethesda, Maryland
Mr Chairman, I am pleased to appear before the House Ways
and Means Committee to discuss the structure, success and
ongoing improvements to the Australian retirement model. I
would like to begin by sharing with you today how an
industrialized nation like Australia moved its retirement
system from a reliance on an unfunded pay-as-you-go (PAYG)
system towards a more fully funded, defined contribution
approach. I will then discuss the structure of the
superannuation (pension) industry, paying particular attention
to the issues surrounding asset allocation and administrative
costs. These details I am confident will add further clarity to
the debate on reforming social security which President Clinton
highlighted in his recent proposal. After that, I will look
briefly at some of the issues that surround maintaining the
integrity of the superannuation system, with particular
reference towards regulation, consumer protection and meeting
the special needs of women and minority groups. Finally, I will
conclude by linking the main features and aspects of the
Australian superannuation system with some of the arguments
associated with individual retirement accounts.
Developing and Nurturing an Individual Retirement System
For Australia, a country that at the beginning of the
twentieth century had one of the highest standards of living in
the world, the Old Age Pension, introduced in 1909, appeared to
be both a stable and viable approach to meeting an individual's
retirement needs in the future. Under the system a flat rate
benefit is provided which equates to a maximum of 25 percent of
male total average weekly earnings (MTAWE). Before the 1980s a
common mentality among retirees was that after paying taxes
over their working lives, they were entitled to an Old Age
Pension from the Federal Government.
In the early 1980s both politicians and bureaucrats alike
began to realize that the current Old Age Pension could not be
sustained with the rapid aging of the population. Simply put,
Australia could no longer afford a `non-earmarked PAYG Old Age
Pension' with its associated generous qualification
requirements.
Australia's demographics are similar to those in the United
States. Today, roughly 15 percent of the population is age 65
or over. Their share in the population is expected to rise to
23 percent by 2030. The percentage age 85 and over is expected
to more than double from around 2 percent today to more than 5
percent by 2030. Australia's aging population poses a threat to
the nation.
It may be surprising for some in the United States, but it
was the Australian Labor Party, a social democratic political
party, working with organized labor that generated the momentum
for change of Australia's retirement system. Elected in 1983,
Prime Minister, Bob Hawke, a former Australian Council of Trade
Unions President (the Australian equivalent of your AFL-CIO),
and his Cabinet began the task of restructuring Australia's
national retirement system. They began by ensuring the long-
term viability of the Old Age Pension, at its current level was
maintained. To this end, maximum payments per fortnight by the
mid 1980s would now be determined through the interaction of a
comparatively stringent income and asset tests. These income
and asset tests, as they stand today, are outlined in Table 1
and Table 2. At the current time, maximum payments per
fortnight are $347.80 ($US225.65) for a single pensioner and
$290.10 ($188.22) each for a pensioner couple.
Table 1: Summary of the Income Test Provisions of the First Pillar
------------------------------------------------------------------------
Maximum Payment
if Your No Payment if
Income Test Fortnightly Your Fortnightly
Income is Equal Income is Equal
to or Less Than to or More Than
------------------------------------------------------------------------
Single............................ $100.00 $806.40
Couple (combined)................. $176.00 $1,347.20
For each child.................... $24.00 add $24.00
------------------------------------------------------------------------
Source: Department of Social Security
Table 2: Summary of the Asset Test Provisions of the First Pillar
------------------------------------------------------------------------
Maximum Payment No Payment if
if Your Assets Your Assets are
Assets Test are Equal to or Equal to or More
Less Than Than
------------------------------------------------------------------------
Single, homeowner................ $125,750 $243,500
Single, non-homeowner............ $215,750 $333,500
Couple, homeowner................ $178,500 $374,000
Couple, non-homeowner............ $268,500 $464,000
------------------------------------------------------------------------
Source: Department of Social Security
In Australia's case, the Federal Government, with full
trade union support was able to convey to the nation
effectively the impending problems Australia would confront, if
it did nothing about addressing its pension system in the face
of its aging population. This theme of the realization and an
acceptance of a future retirement hurdle was best summarized in
the Better Incomes: Retirement into the Next Century statement
which expressed a commitment to:
`` `Maintain the age pension as an adequate base level of
income for older people' but went on to state that persons
retiring in the future would require a standard of living
consistent with that experienced whilst in the workforce.'' \1\
\1\ Senate Select Committee on Superannuation: `Safeguarding
Super,' June 1992, p.7, Canberra, Australia
For trade unions, which had strongly supported the election
of a Federal Labor government in 1983, increasing
superannuation coverage was seen as a major priority. Before
the introduction of a mandated, second pillar, superannuation
accounts, the extent of coverage was limited to roughly 40
percent of the workforce. Typically employees who were covered
by superannuation were employed in middle class, `white collar'
jobs where usually women and people from minority groups were
under-represented. By 1986 circumstances were ideal for the
introduction of a widespread employment based retirement
incomes policy. The situation was facilitated by the role
played by the Conciliation and Arbitration Commission in
setting wage increases for workers in the union sector.
Continuing pressure for wage increases and demands by the union
movement on the government for a comprehensive superannuation
policy combined to result in the introduction of award
superannuation. The Conciliation and Arbitration Commission set
a wage increase of 6 percent for the year, but provided that
half the increased wage was to be paid into individual
superannuation accounts.
By its action, the Conciliation and Arbitration Commission
in requiring compulsory contributions of 3 percent to be made
into individual superannuation accounts, award superannuation
was born. The trade union movement and the Federal Government
worked together in refining and improving the delivery and
regulation of superannuation products to employees. Moreover
trade unions did not simply advocate a policy of increased
superannuation coverage for their members but would become
specifically involved in the day to day operations of
superannuation funds. These funds were generally organized
around an occupation or industry and were sponsored by employer
and employee organizations. Fundamentally they were established
to receive the 3 percent mandated award contribution.
Most experts and politicians agreed that 3 percent was not
a sufficient level to generate adequate retirement income for
employees once leaving the workforce. On this basis the Federal
Government would again intervene in 1992 to reposition
Australia's long term retirement income strategy.
Structure of the Australian Superannuation Industry--Second Pillar
With a delay to the 1990-1991 wage case (centralized wage
fixing) occurring, where the ACTU and the Government supported
a further 3 percent round of award superannuation, the then
government realized that compulsory superannuation
contributions needed to be separate from wage setting
mechanisms. Some employees for example were not covered by
federal and state award wage setting guidelines which meant
that compulsory contributions, often did not apply to certain
professional and occupational groups.
In August 1991 the Government's Treasurer, the Hon. John
Dawkins MP, foreshadowed the Government's intention of
introducing a Superannuation Guarantee Levy that would commence
on July 1, 1992. In issuing a paper on the levy the Treasurer
indicated that such a scheme would facilitate:
a major extension of superannuation coverage to
employees not currently covered by award superannuation;
an efficient method of encouraging employers to
comply with their obligation to provide superannuation to
employees; and
an orderly mechanism by which the level of
employer superannuation support can be increased over time,
consistent with retirement income policy objectives and the
economy's capacity to pay.\2\
---------------------------------------------------------------------------
\2\ Senate Select Committee on Superannuation: `Safeguarding
Super,' June 1992, p.13, Canberra, Australia
---------------------------------------------------------------------------
Additionally in a statement Security in Retirement,
Planning for Tomorrow Today given on 30 June 1992, the
Treasurer reaffirmed the government's position and direction on
the aging of Australia's population and the need for compulsory
savings for retirement:
``Australia--unlike most other developed countries meets its
age pension from current revenues. Taxation paid by today's
workers is thus not contributing to workers' future retirement
security; the revenue is fully used to meet the annual cost
borne by governments. And, like most other people, Australians
generally undervalue savings for their own future retirement.
Private voluntary savings cannot be relied upon to provide an
adequate retirement security for most Australians. This is so
even with the very generous taxation concessions, which are
available for private superannuation savings. . . . . In the
face of these factors, changes are required to the current
reliance on the pay-as-you-go approach to funding widely
available retirement incomes. This means that we need now to
start saving more for our future retirement. It also means that
saving for retirement will have to be compulsory. It means that
these savings will increasingly have to be `preserved' for
retirement purposes. Lastly, the rate of saving will have to
ensure retirement incomes, which are higher than that provided
today through the age pension system. There seems to be a
general awareness in the community that something has to be
done now to meet our future retirement needs.''\3\
\3\ The Hon John Dawkins, MP, Treasurer: `Security in Retirement,
Planning for Tomorrow Today,' 30 June 1992, pp1-2, Canberra, Australia
The Superannuation Guarantee Charge Act 1992 encompassed these
views of the Treasurer and required that all employees contribute to a
complying superannuation fund at a level, gradually phasing in from 3
percent in 1992 to 9 percent by 2002. It should be noted that some
relief was provided for small business in how the levy was introduced,
based on the size of the annual payroll. If an employer chooses not to
pay the levy he or she will have a superannuation guarantee charge
(SGC) imposed on their business operations by the Australian Taxation
Office (ATO). By deciding not to meet the obligations under the Act, an
employer will not receive favorable taxation treatment in regard to
contributions made on the employees' behalf.
At the present time the levy is currently at 7 percent which will
increase progressively to 9 percent by 2002. The threshold for paying
this levy was based initially on the individual earning a minimum of A-
$450 (US-$294) per month. More recently employees may decide to opt out
of the system and take the contribution in cash up to a level of A-$900
(US-$587) per month.
Table 3: Details of the Prescribed Superannuation Requirements Linked
with the Mandated Second Pillar
------------------------------------------------------------------------
Employer's
Prescribed Rate
Period of Employee
Support (%)
------------------------------------------------------------------------
July 1 1997-June 30 1998............................ 6
July 1 1998-June 30 1999............................ 7
July 1 1999-June 30 2000............................ 7
July 1 2000-June 30 2001............................ 8
July 1 2001-June 30 2002............................ 8
July 1 2002-03 and subsequent years................. 9
------------------------------------------------------------------------
Source: Australian Taxation Office
In March 1996, the then Labor Federal Government lost office and
was replaced by a conservative, Liberal Coalition Government under
Prime Minister John Howard. It had been the intention of the Australian
Labor Party, with trade union blessing to further expand the compulsory
nature of superannuation by gathering a 3 percent contribution from
individual workers and providing an additional 3 percent to certain
workers who met pre-defined income criteria. In total this would have
meant that many workers' individual superannuation contribution
accounts would have been receiving total contributions of 15 percent.
Treasury estimates suggested that over a forty-year period these
contributions would finance a benefit equivalent to approximately 60
percent of one's salary on retirement.
With regard to the taxation of superannuation, Australia has
pursued a course which is quite unique and which on the whole I cannot
agree with, in terms of design and the overall rate of taxation
applied. Contributions to the funds are taxed at a rate of 15 percent,
along with possible additional taxation of 15 percent for members'
contributions who earn over $73,220. A tax of 15 percent is levied on
the investment income of the superannuation fund. Finally, the benefits
can be subjected to varying tax treatment of between 0 and 30% percent
at distribution.
Superannuation funds are managed in a highly efficient and
effective manner for members through a trustee structure. Life
insurance companies and fund managers, like those in the United States
play an active role in the management and investment of superannuation
fund assets. Additionally specialized administration companies have
developed services that allow superannuation fund trustees to outsource
much of their investment and administrative functions. Intense
competition has led to an environment of high returns being maximized
and relatively low administrative fees.
Varying measurements exist for evaluating the success of how
Australia has contained administrative costs, compared with other
international models. Keep in mind, that this is a system that is still
being phased in. As it matures, it is becoming increasingly efficient.
In a recent paper presented at the National Bureau of Economic Research
Conference, on the administrative costs of individual accounts systems,
Sylvester J. Schieber, Vice President, Watson Wyatt Worldwide and John
B. Shoven, Charles R. Schwab, Professor of Economics, Stanford
University made the following conclusions about Australia's cost
structure:
``The Association of Superannuation Funds of Australia
estimates that the average administration costs of their system
equal A-$4.40--i.e., U.S.-$2.85--per member per week. In U.S.
currency terms, administrative costs at this rate for a system
that held average balances of $1,000 would be nearly 15 percent
of assets per year. For a system that held average balances of
$5,000, it would drop to 3 percent per year. For one that held
average balances of $10,000, administrative costs would be 1.5
percent per year. By the time average account balances got to
be $30,000, administrative costs would be under 0.5 percent per
year.\4\
\4\ Schieber SJ & Shoven JB: `Administering a Cost Effective
National Program of Personal Security Accounts' (Draft), NBER,
Cambridge MA, December 4, 1998, p.16
Further evidence of the relatively low cost structure associated
with superannuation accounts in Australia is highlighted in Table 4
prepared by the Financial Section of the Australian Bureau of
Statistics, on behalf of Watson Wyatt Worldwide.
---------------------------------------------------------------------------
\5\ Ibid., p.17
Table 4: Administrative Costs as a Percent of Assets under Management in
Australian Individual Account Superannuation Funds during 1996 and 1997
\5\
------------------------------------------------------------------------
Number of members in the plan 1996 (percent) 1997 (percent)
------------------------------------------------------------------------
1 to 99........................... 0.689 0.619
100 to 499........................ 0.849 0.673
500 to 2,499...................... 0.803 0.797
2500 to 9,999..................... 0.854 0.837
10,000 or more.................... 0.922 0.846
-------------------------------------
Total......................... 0.900 0.835
------------------------------------------------------------------------
Source: Australian Bureau of Statistics, Belconnen, Australia Capital
Territory, tabulations of a joint quarterly survey done by the
Australian Bureau of Statistics and the Australian Prudential
Regulation Authority (APRA).
I would like to mention briefly that investment decisions and
strategies are developed solely between the investment managers and the
trustees of each superannuation fund. The Australian Government plays
no role in shaping directly or indirectly the investment decisions of
the individual superannuation fund but rather through regulation,
stresses the need for a sensible and sustainable investment strategy.
Regulations refer to this approach as the prudent man test. Further,
the September issue of the APRA Bulletin highlights that 36.2 percent
and 15.7 percent of the total superannuation assets of the A-$364.6
billion or US-$234.07 in superannuation assets are invested in equities
& units in trust and overseas assets. Clearly this level is deemed
acceptable by government, trustees and superannuation fund members
alike. A concise overview and asset allocation of the Australian
superannuation industry and as at September 1998, is provided in Table
5 and Table 6.
Table 5: Overview of the Australian Superannuation Industry--September 1998
----------------------------------------------------------------------------------------------------------------
Number of
Type of Fund Total Assets Number of Funds Accounts
($billion) (June 1997) (million)
----------------------------------------------------------------------------------------------------------------
Corporate............................................. 65.6 4,510 1.41
Industry.............................................. 24.8 108 5.67
Public Sector......................................... 78.5 86 2.69
Retail (including RSAs)--RSAs......................... 95.7 363 8.62
Excluded.............................................. 43.8 145,761 0.34
Balance of Statutory Funds............................ 56.0 ................. .................
Total Assets.......................................... 364.6 150,816 18.7
Directly Invested..................................... 98.7 ................. .................
Placed with Managers.................................. 142.5 ................. .................
Invested in Life Office Statutory Funds............... 123.3 ................. .................
-------------------
Total Assets...................................... 364.6 ................. .................
----------------------------------------------------------------------------------------------------------------
Source: APRA Bulletin, Australian Government Publishing Service, September 1998
Table 6: Asset Allocation of the Australian Superannuation System
------------------------------------------------------------------------
Asset Class Amount ($billion) % of Total
------------------------------------------------------------------------
Australian Assets................ ................. .................
Cash & Deposits.................. 26.3 7.2
Loans & Placements............... 17.9 4.9
Interest bearing Securities...... 90.8 24.9
Equities & Units in Trust........ 131.9 36.2
Land & Buildings................. 32.2 8.8
Other Assets..................... 8.1 2.2
Overseas Assets.................. 57.3 15.7
-------------------------------------
Total Assets................. 364.6 100
------------------------------------------------------------------------
Source: APRA Bulletin, Australian Government Publishing Service,
September 1998
The third pillar of Australia's retirement income system is
characterized by individual retirement accounts generated on a
voluntary basis through the private annuity, retail funds management,
and life insurance markets. Government taxation and concessional
rebates provided to certain taxpayers have seen this segment of the
retirement system grow in recent years. With regard to final benefits,
Australia allows these to be taken in the form of a lump sum or an
annuity. Past experience has seen lump sums, favored by many retirees
but with changes in recent tax laws, annuity and allocated pension
vehicles are increasing in popularity.
I would like to now turn briefly to the mechanics associated with
selling, distribution, and withdrawal of benefits from superannuation
accounts. One of the reasons why Australia has been so successful in
keeping administrative costs low and also avoiding the problems
associated with misselling is through effective and cost efficient
regulation. Strict rules govern how superannuation policies are sold
and switched. Moreover consumers are required to receive minimum levels
of information about the superannuation products at the time of sale
and also on a regular basis. Clearly it is felt that, as this is the
largest financial transaction that a consumer will enter into in their
life, effective disclosure should be provided to encourage transparency
in the transaction. Increasingly, superannuation account holders are
being provided with greater investment choices. Some retail funds for
example offer between 5-7 investment choices and proposed legislation
by the Federal Government will force employers to offer choice of
funds. Consequently, effective consumer protection strategies will
provide an important deterrent for any forms of mis-selling from
occurring.
I would now like to refer to Attachment 1 that depicts part of the
public education campaign that was initiated in 1994 and implemented
between 1995-1996 by various government departments. To build a better
understanding and stress the value of superannuation to individual
workers, the Federal Government initiated a comprehensive public
education campaign. This campaign harnessed both electronic and print
media to convey several main themes including the future benefits of
superannuation for the nation and the individual, information on how
the new mandated superannuation system functioned and how a regulatory
body was active in safeguarding superannuation assets. The estimated
cost of this campaign was approximately A-$11 million in 1995 or A-
$0.60 cents for every man, woman and child in Australia. When devising
this elaborate and integral public education campaign, the Federal
Government was committed to directing part of the campaign towards
women and ethnic minorities. An example of this specific element of the
campaign is presented in Attachment 2. For many years government
agencies like the Office of the Status of Women (OSW) had highlighted
genuine concerns that women were disadvantaged by the retirement
system, largely prior to compulsion. Although compulsion had increased
the overall superannuation coverage level of the workforce to 91
percent it was argued, many issues still remained in terms of
education, product structure and aspects surrounding divorce.
Conclusions
Australia, as a nation with close cultural, industrial, and
historical links with the United States has addressed already
many of the issues that are being discussed with regard to the
future of social security in the United States. Aspects of
choice of investment, the role of the government and the
private sector in the management of retirement and
administrative costs linked with individual accounts, have
largely been resolved. Today individual Australians wake up
knowing that they are contributing effectively to a retirement
vehicle that they own and control. Moreover these
superannuation accounts do not generate excessive fees and pay
poor returns. Rather superannuation and individual
participation in the system is seen to be the only option where
effectively Australians can shape and mould their future
retirement outlook into the next century. What is also
important to consider is that government, while establishing a
mandated individual retirement accounts system has not
infringed on the efficiency of the financial markets in
Australia, for generating the necessary returns of individual
accounts. Finally Senator Sherry, the former Chairman of the
Senate Select Committee on Superannuation in Australia
commented recently in Washington DC, that ``the government in
directly controlling Australian superannuation was not, an
option.''\6\
---------------------------------------------------------------------------
\6\ Consultations with leading Government and Industry
Representatives, January 20-22 1999
The views in this statement are those of the author and do not
necessarily reflect the views of Watson Wyatt Worldwide or any
of its other associates.
Chairman Archer. Mr. Harris, why did not Australia decide
to invest in government funds out of a government pension plan
in the private sector in order to be able to take advantage of
these benefits of compound earnings?
Mr. Harris. What's important to remember, Mr. Chairman, is
that the government had a first pillar old-age pension, and
when the government introduced the compulsory requirements,
first in 1987 and 1992, the government's view is quite clear,
and Senator Nick Sherry from the Senate Select Committee echoed
this several weeks ago when he was here in Washington, DC. He
said, and I agree with him, that there is no role for
government to decide on the investments of the individual. The
funds that are apparently being accrued in the superannuation
accounts today are controlled by fund managers and life
insurance companies. And the Australian view, as a former
bureaucrat, was that they are the best people, men and women in
Australia, who can generate the highest returns for our
individual retirees in the future, not the government.
Chairman Archer. Thank you very much.
Mr. Shaw.
Mr. Shaw. Generally, what is the extent of the regulations
that are involved as far as the investment limitations?
Mr. Harris. In Australia, unlike Chile, we don't have any
real barriers to investments. We adopt the prudent-man test,
and as a regulator we argued that the individual superannuation
funds should adopt an investment strategy, but there's no role
for government in telling them where to invest the money. What
we'd argue with superannuation accounts was that they had to
have suitable investment options or an investment strategy
which if you like minimized risk.
But we didn't want to see, for example, 100 percent of a
superannuation fund investing in fine art. What we wanted was
their investments to be diversified. So if you look on my
testimony, you'll see the overall superannuation assets of
Australia are well diversified, 16 percent into international
equities, and we argue in Australia that it is not in the
interest of the regulator to tell superannuation funds where to
invest money. The argument among my fellow regulators is this,
find investments that generate returns for the individual
retiree in the future.
Mr. Shaw. I'm trying to find the language as to
qualifications of investment managers. We've all had good
experiences with brokers and bad experience with brokers. And
there are some brokers who are good at selling, but I wouldn't
take their advice on where to put any money. Is there any type
of guideline or any type of certification of investment
advisers that you have, qualifications as to education,
background experience?
Mr. Harris. That's a very good point. One thing I'd like to
mention is that often we hear in the debate here in the United
States, how the individual retiree will be basically by
themselves or making these investments on their own. In
Australia, it's quite the contrary. We have 8,500 financial
planners, certified financial planners who actually get trained
at university now, university courses offered in financial
planning. These people work hand in hand with the individual
superannuant to develop and craft a retirement policy, a
retirement strategy in the long term for their needs.
Today, specifically, to the individual brokers, we have a
comprehensive licensing regime, which is currently being
developed in Australia and implemented, that exists in the
system. What we have is that we feel there has to be minimum
educational standards, generally of your high school level.
That's been increasing significantly to certifications based on
aptitude, mathematical ability, and general educational
standards.
I think what's important for Australia is that we have
avoided a large amount of misselling that other countries have
experienced on this basis. That is where we got, for example,
the know-your-client rules from the SEC, and we've modified
them accordingly.
Mr. Shaw. What concerns me the most is that we've got some
wage earners who are darned good workers, but they've never
lived in a house where anybody invested, and they know
absolutely nothing about it. They don't know the language of
it. The only thing they have invested in is the lottery. And we
want to be sure that they get good investment advice and that
there be some restraints on the type of things that they can
invest in. That's what's of concern to me.
Mr. Harris. Just to follow on that point. I think I agree
with your comments, Congressman. I think it is a concern. And
when initially our system was introduced, our investment
choices were limited or narrow, more narrow in the startup
phase. The balances were low, generally two to three investment
options are offered to individual retirees or planned retirees
in the future.
But what's happened as the balances have increased, the
financial knowledge and experience of the individual worker has
also increased. And what we're seeing--I come from a town like
Pittsburgh, I come from a town called Newcastle, steelworking,
hardworking community. What's been very interesting to note is
organized labor, the trade union people have come to the party
and provided educational seminars, come and assisted their
individual members in doing that.
Mr. Shaw. Do you find that organized labor is very
supportive of the plan?
Mr. Harris. Totally and absolutely 100 percent behind it.
Senator Nick Sherry, who visited here and talked to the Public
Pension Reform Caucus, is a former casino worker, a former
trade union official, and a former Trustee of the
superannuation plan, and is a current senator. That's a typical
example of where trade unions fully back the system. The reason
being was quite nicely put by Senator Sherry: Trade unions feel
that their members should have the same ability to have
retirement vehicles as their bosses, the senior employees. And
they are craving for financial responsibility.
All that regulators like myself did, Congressman, was build
the infrastructure of the vehicle. They are driving the vehicle
or the bus, and they are doing very well at it.
Mr. Shaw. Thank you very much.
Chairman Archer Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman. Mr. Harris, are there
general revenues in the pension fund?
Mr. Harris. This may be to do a brief overview again----
Mr. Matsui. You'll have to forgive me. I came in----
Mr. Harris. Yes, certainly. Just to explain again,
Australia for many years--an example is my mother. My mother
worked for 35 years, and the view was simply this, if she
worked for 35 years, paid her taxes into general revenue, or
consolidated revenue, she would be entitled to an old-age
pension. But when she came to retirement, the system changed
because we brought in a means test on income and assets, and
that meant that my mother, unfortunately, got a reduced
pension. And so, what we have seen now, increasingly, is the
burden shifting toward more responsibility.
The former government proposed a contribution of 15
percent--not just 9 percent by 2002--15 percent; 9 percent by
the employer, 3 percent by the employee and 3 percent by the
government. That's very important to note. Currently, the
legislation only stands at 9, but I foreshadow that will
increase to 12 within 5 years.
Mr. Matsui. So right now, the contribution is 3 by the----
Mr. Harris. Currently 7 by the employer, and 4 percent on a
voluntary basis by the employee.
Mr. Matsui. Now it's my understanding that 2002----
Mr. Harris. That the 7 percent is being progressively
ratcheted up. Back in 1992, when the legislation came in, we
initially introduced it at a level of 3 percent, and this is
very important for small business. And I know maybe some of
your constituency would be very interested in this.
Small business is a particular concern to the government
because an impact of bringing in compulsion and compulsory
contribution would be a cost. So we gave a little bit of a
holiday for 1 to 2 years for small business under $1 million in
payroll. The level would be increased at a slower rate.
So since 1992, the rates, Congressman, have been
progressively increasing from 3 percent. Currently, it's 7. By
2002, it will hit 9 percent. But what's important to stress
here is that public confidence is being generated in the
system. Australians are very much like Americans culturally,
philosophically and savings base. We don't generally save like
Americans. We enjoy a good time. And what's important to note
here is that there is a cocontribution developing on a
volunteer basis.
Mr. Matsui. But the 9 percent after 2002, would that remain
constant in perpetuity?
Mr. Harris. It is. It's foreshadowed that the employer will
have to obviously pay the 9 percent in perpetuity. There is
some argument, though, by the--your colleagues in the
Australian Labor Party that there should be an employee
contribution, a cocontribution, something like Singapore and
Malaysia. Where the employer's paying 9 percent, employees
should pay 3 percent contribution. And although it hasn't been
spoken of, they're currently in opposition. I think that
Australia will come back to that idea.
Mr. Matsui. Were you saying my colleagues in the Labor
Party?
Mr. Harris. Oh, colleagues, I apologize Congressman,
ideological colleagues. The Australian Labor Party has a close
affinity with the Democrats, I was told by Senator Sherry, an
Australian Labor Party politician.
Mr. Matsui. Thank you. I have no further questions.
Chairman Archer. Mr. Collins.
Mr. Collins. Mr. Harris, these are employer contributions,
but what is the income tax structure in Australia?
Mr. Harris. Income tax structure in Australia is a
progressive tax system based on income. We have generally a
higher level of taxation than in the United States. We don't
have indirect taxation of any form. We're talking about a goods
and services tax.
Our highest marginal tax rate is 47 cents on the dollar.
With regard to the taxation of retirement, we adopt a very
unique policy. We tax the contribution. We tax the income
generated on the fund. And then we tax the benefit. Now the
argument and the rationale was this.
Generally 15 percent contribution, 15 percent income, 15
percent benefit. If the people of a retiree or a Super
Washington plan to put money into a bank account, they'd be
getting taxed at 47 percent or 47 cents on the dollar. So when
they put their money in the Super account, it's perceived or
argued that it's at a concessional rate of taxation.
Mr. Collins. You mentioned that there's talk of going back
and having an employee deduction of possibly 3 percent.
Mr. Harris. Yes.
Mr. Collins. Is that due to the fact you see the fund
having trouble down the road? Do you see a shortage of funds?
Mr. Harris. Quite the contrary. I think the rationale
within Labor Party circles is that the employee should
explicitly make a contribution for their futures. As Dr. Pinera
stressed, whoever pays the contribution, it really doesn't
matter. It's salary sacrificed. But the argument in Australia
was that we were trying to generate individual accounts
ownership. And if it's perceived that only the employer is
contributing, it takes a little bit of the tarnish off if we
could get the cocontribution working together.
And what we're stressing now, public education campaigns
and you'll see it on attachment one and two is this person
watering a tree, and the tree is sprouting leaves which are
money. And it suggests that if the employee can be encouraged
to contribute to the individual accounts, he'll be a lot better
off in the future. But already on a voluntary basis, people are
making 4-percent contributions at the moment.
Mr. Collins. One last question. Does Australia have a
national debt?
Mr. Harris. We have a national debt which at this stage
quite off the top of my head, I think it's increasing at
something like A$176 billion. But that's off the top of my
head. Our external debt, just to give some brief historical
trends, Australia has always been a net importer of capital.
We're a large nation like the United States. We've only got 19
million people roughly in our tax base. So obviously we're now
considering a goods and services tax, an indirect form of
taxation.
But we have increasingly been relying on overseas capital
sources to modernize our economy.
Mr. Collins. Very good. Thank you, and thank you, Mr.
Chairman.
Chairman Archer. Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman. It's good to have you
with us, Mr. Harris. I just had a great opportunity to visit
your country a few weeks ago, and I was very impressed.
Just getting back again, you did mention earlier, and I
find it very ironic that the labor unions were actually one of
your very prime supporters when you were setting this up. And
it's ironic because here in our country, labor unions are
probably some of our strongest critics. Would you like to
comment on that why you think there might be a difference?
Mr. Harris. Ah, I've looked at these responses by the AFL-
CIO, and I've been puzzled by this reaction as well,
Congressman. I came to the United States in September 1997,
with a view that certainly organized labor would be very active
like Australia in pursuing the individual nurturing their own
retirement responsibility and building up their overall
savings.
I think the mentality amongst Australians was that we have
to ensure that the individual workers would not be exposed to a
demographic time bomb. That was their primary concern. Second,
it was the risk--the political risk of their counterparts in
Australia changing the laws related to old-age pensions and
seeing workers retiring largely like my mother with limited
savings because of her thinking that they would have an old-age
pension for life.
And so the unions stressed, I suppose, a responsibility.
This trend in unionism and organized labor is a trend that's
growing in Denmark. You can cite examples in the United
Kingdom. I think the third point is very interesting and the
distinction here is quite strongly put, organized labor unlike
in the United States, saw women union leaders who were actively
pushing this because it was the women and the minority groups
who are disadvantaged groups who are largely locked out of the
then voluntary system.
It was women leaders who had the foresight to say we have
to go down this path. We have to give people individual
responsibility. And sadly, no offensive criticism to the AFL-
CIO, but I generally don't get those sounds of responsibility
in most of their statements.
Mr. Herger. Well, thank you. And, again, I think this is a
very important point to emphasize. And I would hope that our
good friends in the labor movement hopefully would reconsider.
But as we look at it, when you look at the benefits that your
citizens have seen, we look around at Chile. We've heard from
them earlier today and others. It sounds like those in the
labor movement, the workers, really it's almost a win-win in a
major way for them.
And, again, I would be hopeful that they'll learn from the
great example that you and some of our other good allies have
set. So----
Mr. Harris. I think as a former organized labor official
myself, I'd be more than happy to talk to my organized labor
colleagues at any stage. Unfortunately, they seem not to return
my calls.
Mr. Herger. Well, thank you very much.
Chairman Archer. Does any other Member wish to inquire? If
not, thank you, Mr. Harris. We appreciate your input, and we,
again, learned a lot. And that will all be factored in when we
make our ultimate decision.
Mr. Harris. Thank you, Mr. Chairman.
Chairman Archer. I wish you well.
Mr. Harris. Thank you.
Chairman Archer. Our next witness is the new Director of
the Congressional Budget Office, Dan Crippen, who will be
making his first appearance before our Committee, and we
welcome you, and we'll be pleased to receive your testimony.
STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET
OFFICE
Mr. Crippen. I was aware, Mr. Chairman, of your admonition
to the last witness on being brief, and I will certainly try to
do that. I was actually quite attracted by Dr. Pinera's rule
this morning, the 3-minute rule. I'm not quite sure I'll make
that, but I will try to make your 5-minute rule.
Mr. Chairman and the rest of the Committee, thank you for
inviting the Congressional Budget Office to offer testimony
today on the important issue of Social Security reform,
especially as it's experienced in other countries.
In the interest of full disclosure, as you suggested, Mr.
Chairman, today is my fifth day on the job, and this is my
second appearance before a congressional committee despite the
fact that it's only 5 days. So I don't know exactly what it
says about my mental state, but I'm certainly pleased to be
here.
One of the reasons I returned to Congress, frankly, was the
prospect of reforming Social Security and Medicare, and I'm
very interested in working on those subjects. This is the first
time I've had a chance to present any of our results.
Our report on the experiences with Social Security
privatization abroad, which is the basis for my testimony
today, was written by Jan Walliser, a staff member who's now at
the International Monetary Fund. The report was released by CBO
before I arrived last week.
Obviously, many of your other witnesses today know a great
deal more about the reforms in their countries than even our
longer report reflects. However, I think a number of lessons
seem to apply when you look across countries.
One of those lessons, I believe, is quite simple--that is,
keep your eye on the ball. And the ball, Mr. Chairman, may not
be the trust fund. The establishment of and accounting for
trust funds have important implications. But the maintenance of
a trust fund has nothing to do with the ability to meet
obligations. In the countries that we examined that established
trust funds, as in the United States, there is no trust fund in
the commonsense meaning of the word--that is, no stash of
assets to be sold to meet obligations for retirees.
Let me give you just one example before I move on to our
report. In the Social Security Trustees' most recent report,
they estimate that the OASDI, Old-Age, Survivors, and
Disability Insurance Trust Fund will be exhausted roughly in
2032. However, the report also includes the fact that starting
in 2013, Social Security revenues from the payroll tax will not
be sufficient to meet the program's obligations.
If this was a trust fund in the traditional sense of the
nongovernmental world, assets in the trust fund could be sold
to cover the shortfall. However, the surpluses in the trust
fund have been loaned, as you well know, to the Federal
Government. And although special bonds have been issued to
indemnify the fund, there are no assets to be sold in the
classic sense of the word. Starting in 2013, the program's
expenditures will exceed revenues, and the government will
eventually have to go further into debt, raise taxes, or cut
spending to be able to send out Social Security checks. If this
was a funded program, those actions wouldn't be necessary.
So if trust funds, as I have suggested for our purposes
here today at least, are not reliable indicators of economic
effects, what role should we follow? Judging the desirability
of reform--indeed, judging the results of reform in these other
countries--depends critically on at least two related
questions. One I would suggest is: Can the reform help economic
growth? And second: Can the reform reasonably be expected to
work?
The first question is critical and, in many ways, is the
only ball worth watching in this game. It is ultimately the
size of the economy that determines our ability to support a
growing elderly population with fewer workers. The mechanism by
which resources are transferred from the working population to
retirees matters little in the macrosense. What matters most is
how much the working population creates, how big the economy
is, how big the pie is relative to the piece devoted to
retirees.
How does that translate in the context of Social Security
reform? One thing--perhaps one of the few things many
economists involved in this debate agree on--is that increasing
national savings should enhance productivity and, thereby,
economic growth. Increased savings can result from funding a
heretofore unfunded system. Increased savings can also result
in reduction of Federal debt held by the public.
The second question--Can we reasonably expect these
programs or reforms to work?--includes considerations of
practicality, cost and ease of administration, protection
against severe losses, fraud, the extent of regulation, and the
like.
Now finally to the punchline, Mr. Chairman. What do the
five countries we studied suggest as answers to the questions I
have posed? Can privatization help economic growth, and can it
be expected to work?
First, these countries had difficulty in funding a
retirement system controlled by the National Governments. They
had intended to fund their systems over time. However, their
good intentions were overcome by the ease with which trust
funds can be deployed for other government programs or to
expand retirement benefits.
One motivating force, indeed, for privatization in several
of these countries was the inability of the National
Governments to establish and maintain a true trust fund.
Second, the initial evidence, which is certainly based on less
than perfect information, suggests that privatization can help
increase net national savings by as much as to 2 to 3 percent
of GDP, gross domestic product, in the case of Chile and
perhaps 1.5 percent of GDP in Australia. The result depends
critically on the ongoing financing of the individual accounts
from future actions we can't yet foresee. If the government
pays for those accounts by issuing debt in the future, there
would be no increase in net national savings. However, if the
countries continue to build assets as they have in the recent
past, economic growth will continue to be improved.
Finally, administrative concerns, including costs, do not
appear to be insurmountable. Clearly, the structure and
regulation of the program are important factors. But after the
initial startup costs, it seems costs should not be much higher
than those currently experienced by managed mutual funds in the
United States--say, in the neighborhood of 100 basis points--
and could be as low as index funds, around 35 basis points,
which has been closer to the experience in Australia.
Mr. Chairman, the details of any reform are important, and
the United States is vastly different from any of the other
countries examined in our report. But we're all bound by one
truth: The larger the economy, the easier it will be to meet
our obligations to future retirees. The experience of other
countries suggests that privatization can help with that goal.
Thank you. Which rule did I abide by?
Chairman Archer. I think you did very well. You may have
established your own rule, but it's an acceptable rule.
Mr. Crippen. Thank you.
[The prepared statement follows:]
Statement of Dan L. Crippen, Director, Congressional Budget Office
Mr. Chairman and Members of the Committee, I am pleased to
be with you this morning to discuss the lessons from the
experience of other countries that have reformed their Social
Security system at least in part through privatization.
The retirement of the baby-boom generation in the United
States will put our Social Security program under financial
pressure, and a debate is now proceeding about how to pay for
retirement in a financially sound way. Many recent proposals
would allow workers to invest some portion of their earnings in
personal retirement accounts. The amounts accumulated in those
accounts would replace some of Social Security's benefits.
Because some of a worker's retirement income would come from
savings in his or her account rather than from a government
program, such plans would partly privatize Social Security.
Other countries face the same demographic and financial
pressures as the United States. In fact, for many countries,
the pressures are much more severe and immediate. Some have
already responded to those pressures by privatizing their
public pension systems to some extent, and their experience can
offer some lessons for the design of privatized pension
systems. The economies and pension systems of those countries
differ considerably from those of the United States, however,
and comparisons should therefore be made cautiously.
The Congressional Budget Office (CBO) recently released a
paper that reviews the experience of five countries--Chile, the
United Kingdom, Australia, Argentina, and Mexico--that have
introduced individual accounts to fully or partly replace their
public retirement system.\1\ Such plans are defined
contribution plans--that is, retirement income depends in part
on the uncertain returns on contributions to the accounts.
Other countries have relied on more traditional measures to
close the financing gap, such as changing benefit rules and
retirement ages or increasing payroll taxes, but those
countries were not included in our analysis.
---------------------------------------------------------------------------
\1\ See Congressional Budget Office, Social Security Privatization:
Experiences Abroad, CBO Paper (January 1999).
---------------------------------------------------------------------------
All five countries started out with some type of old-age
income support system. Those systems relied on ``pay-as-you-
go'' financing, in which taxes collected each year mainly or
entirely finance the benefits paid to retirees in the same
year. For example, in the United Kingdom (U.K.), a payroll tax
finances the government's expenditure for pensions (and other
benefits) in the same year. Three of the other countries also
generated most of the revenue for their pension systems by
earmarked taxes on wages before they reformed the system.
By contrast, systems with personal retirement accounts
prefund retirement income by requiring people to accumulate
savings during their working years. For example, Chile's system
requires workers to invest in personal retirement accounts from
which workers may withdraw money only after they retire. Moving
from a pay-as-you-go system to a prefunded private system,
however, imposes a financial burden on transitional
generations.
All five countries encountered the same set of issues in
privatizing their systems, and those issues are also relevant
to efforts to privatize the U.S. Social Security system.
Policymakers have to decide who would pay for the
transition between the pay-as-you-go system and a prefunded
system. The transitional generation must continue to support
retirees under the old system while saving for their own
retirement. That issue is obviously not unique to privatization
and must be faced in any reform of Social Security that moves
toward a prefunded system.
Some countries have required workers to shift to a
new system of private accounts, and others have allowed workers
to choose whether to join the new system or stay in the old
pay-as-you-go system. Allowing choice can mean that the pay-as-
you-go system lingers on and may (as in the United Kingdom)
entail some additional administrative problems. But it can also
help workers accept the change, particularly older workers who
have substantial accrued benefits.
Policymakers must decide whether to offer minimum
benefit guarantees and how generous the guarantees should be.
Without such guarantees, some people risk not having adequate
retirement income. Making such guarantees, however, imposes a
contingent liability on future taxpayers.
Countries must decide how to regulate investment
choices in the retirement system and how the retirement funds
may be used. Regulation may be needed to limit fraud and risk--
both the risk to retirees if investments turn sour and the risk
to taxpayers if the plan guarantees minimum benefits.
Regulations about how the retirement funds may be used, such as
conditions for withdrawal and whether annuities would be
mandatory, are also important. However, regulations also limit
an individual's choice about investment and retirement.
Types of Privatization Plans
The countries we examined followed one of three major
models in privatizing their pension systems. Chile, Mexico, and
Argentina used a model in which workers establish private
retirement accounts. The United Kingdom allowed its workers to
choose between the old pension system and the new system.
Australia based its system on employers' contributing to
retirement accounts for workers.
The Chilean Model
Chile, a pioneer in privatization, replaced its pay-as-you-
go system with a system based on private retirement accounts in
1981. New workers had to establish private accounts. Workers
already in the old system could choose to remain there or
switch to the new system and earn a more attractive return. To
encourage switching, the government compensated workers who did
so with ``recognition bonds'' that would be paid into a
worker's account at retirement. Workers with sufficient years
in the system were guaranteed a minimum retirement income of
about 25 percent of the average wage. Obligations to existing
workers were financed with general revenue and debt (the
recognition bonds).
Mexico and Argentina generally followed the same model as
Chile, with some modifications. In Mexico, for example, all
workers have been required since 1997 to join the new system
and save in private accounts. At retirement, however, workers
who have contributed to both systems may choose to receive
benefits from either system (but not both). Argentina has both
benefits that are financed on a pay-as-you-go-basis (similar to
those in Social Security) and private retirement accounts.
People who choose to contribute to private accounts receive an
additional pension that reflects their contributions to the old
system (like the recognition bonds in Chile).
The U.K. Model
The United Kingdom, when it began its reforms in 1986,
followed a different model. Its existing retirement system
already had a privatizing option; that is, people whose
employer offered a pension were allowed to opt out of part of
the government's pay-as-you-go system. Those who did so
received a rebate on their payroll taxes. The reform simply
extended that option by allowing workers who set up a personal
pension plan to opt out as well. Transition costs are financed
out of general revenue (possibly including debt) and by reduced
benefits in the government system.
The Australian Model
The third model is that of Australia, which chose to base
its reformed system on employers by requiring most of them to
contribute to workers' retirement funds. Unlike the other four
countries, Australia never had a Social Security-like system
funded by earmarked contributions. Instead, the government used
general revenues to pay for a means-tested pension that was not
regarded as an entitlement. Because the old system lacked a
specific entitlement, it did not require the government to
compensate workers for any benefits accrued under the old
system. However, if the reform succeeds in replacing the
government pension, it will be true in Australia, as in the
other countries, that one generation will pay for their
parents' as well as their own retirement.
Design Issues
The experiences of the countries that have already begun
their reforms highlight the importance of the design of the new
pension systems. Our analysis revealed three issues: the need
for additional information if a complex system is to work; the
need to regulate investment choices; and the need to regulate
withdrawals from the accounts.
Information Requirements of a Complex System
The reform in the United Kingdom demonstrates the
difficulties that can arise if the new system offers workers a
large array of choices and decisions to make but does not
ensure that the worker has sufficient knowledge to make
informed decisions. In the U.K. case, figuring out whether they
should stay in their employer-based plans or switch to the
newly available private accounts was difficult for many
workers. If they switched, they would lose accrued benefits in
the employer plans but would gain a more attractive return in
the private accounts. Under pressure from sellers of the
private accounts--including, apparently, some fraud--some
workers made poor decisions. The United Kingdom responded to
that problem with more careful regulation. Sellers of private
accounts now have to provide enough information to enable
workers to make a reasonable decision.
Regulation and Risk
Regulation of investment choices within the private
accounts differs among the five countries. Such regulation
could be important to protect either retirees or taxpayers, who
in many cases are on the hook to finance a minimum benefit
guarantee if investments in the accounts prove to have been
unwise. One would expect, therefore, that systems that
guarantee a minimum benefit would tend to have more regulation,
though that is not always the case.
Neither the United Kingdom nor Argentina has a contingent
minimum benefit. A worker whose investments went sour (and who
has worked long enough to qualify) would have to rely on a
basic pension that is not means-tested. The basic pension
therefore does not depend on how successful the worker's
investments are. The possibility of poor returns in the private
accounts does not explicitly impose any risks on taxpayers. Of
course, taxpayers still have to pay for the basic pension.
By contrast, the basic pension is means-tested in Chile and
Mexico. Workers in those countries can choose their investment
portfolio. (Australia also has a means-tested pension, but
employers choose the portfolio.) Consequently, workers in
Mexico and Chile have an incentive to invest in risky assets
offering high expected returns--the worker reaps all the
benefits if the gamble pays off and can rely on the basic
means-tested pension if it does not. Taxpayers in those
countries thus have a greater interest in ensuring that returns
on the private accounts do not fall too low. (Means-tested
pensions can also have other disadvantages: for example, they
can reduce incentives to work and save.)
The taxpayer thus bears part of the risk of poor investment
choices in Chile, Mexico, and Australia but not in the United
Kingdom or Argentina. One would therefore expect the United
Kingdom and Argentina to have little regulation and the others
to regulate investment choices more closely. As expected,
regulation of investment choices in the United Kingdom is
minimal, consisting mainly of the ordinary ``prudent man''
fiduciary standard. Chile and Mexico, however--as expected--
regulate investment choices quite heavily. The odd couple are
Australia and Argentina. In Australia, taxpayers bear some of
the risk of the accounts, but regulation is as light as in the
United Kingdom. In Argentina, by contrast, taxpayers do not
bear that risk, but regulation is as heavy as in Chile, which
has in other respects also been a model for Argentina.
Regulation of Withdrawals
In Australia, workers can ``game'' the system by
withdrawing all their money from the accounts at retirement and
spending it, for instance, by paying down their mortgage or
buying a new house. Housing receives special treatment under
the rules for the means-tested pension. Currently, most people
qualify for the pension. If that practice continues, the reform
will have made almost no difference to the government's costs
for retirement. Australia's experience suggests the importance
of establishing rules that govern when, how, and for what
purpose funds may be withdrawn from the accounts. Many
proposals for reform in the United States, for example,
prohibit lump-sum withdrawals and require workers to purchase
an annuity at retirement. Having such rules would avoid the
problem Australia encountered.
Administrative Costs
Most analyses of the administrative costs associated with
proposals to privatize pension systems examine the cost of
managing private accounts. That is, of course, only one part of
the cost of a proposal; both the current social security system
and any reformed system also impose administrative and
accounting costs on employers and workers. CBO is now
conducting a more detailed study of administrative costs in a
privatized system.
Comparing the administrative costs of managing private
accounts for the five countries is quite difficult. Some plans
take out administrative costs as an initial payment at the time
of investment, and other plans charge an annual fee. The
different fee mechanisms preclude any direct comparison,
particularly since most of the reforms are recent and the plans
have not matured. Nevertheless, a couple of lessons have
emerged.
First, fees and commissions of individual accounts appear
to be close to what managed mutual funds charge for individual
accounts in the United States. In Chile, account fees and
commissions are about 1 percent of the assets held in Chilean
pension accounts. A 1 percent charge is quite common for
managed mutual funds in the United States. The large accounts
in Australia that give limited choices to workers seem even
less costly, with fees approaching those that index funds
charge in the United States (about percent of assets). In
addition to managing investments, systems with individual
accounts need to collect and maintain data in more detail and
collect it more frequently than a large-scale public system
without individual accounts. Such systems therefore tend to be
more expensive than, for example, the U.S. Social Security
system.
The second lesson is that design choices seem to affect
management costs. In Chile and the United Kingdom, for example,
funds are marketed directly to individuals, which leads to
relatively high sales costs and little bargaining power for
purchasers. In addition, workers in Chile can switch funds
several times a year, and workers in the United Kingdom can
contribute sporadically and to several small accounts. All
those factors increase total administrative costs. In
Australia, by contrast, companies representing many individuals
and contracting on a more stable basis face much lower fees.
National Saving
All of the reform plans hoped to reduce strains on the
government's financing of retirement and, by encouraging
private saving, increase the national saving rate. That is an
important goal because the only way that real resources can be
put aside for retirement is through saving and capital
investment in plant and equipment and human capital (education
and training).
Because of limited information on what the governments and
workers would have done had the pension systems not been
reformed, estimating the reforms' exact impact on national
saving is difficult. In Chile and the United Kingdom, the
fiscal tightening associated with pension reform indicates that
the government offset little if any of the additional private
saving in personal retirement accounts. As a result, Chile's
national saving rate may have increased by 2 percent to 3
percent of gross domestic product (GDP). In Australia,
estimates indicate that under certain behavioral assumptions,
the reform might increase national saving by about 1.5 percent
of GDP in the long run. The saving effect of reforms in Mexico
and Argentina cannot yet be ascertained; however, the gains to
national saving are probably less in Mexico and Argentina than
in Chile.
A second important lesson from the countries we studied is
the difficulty of funding a retirement system controlled by a
national government. Several of the countries intended to fund
their systems over time. However, in each case the good
intentions were overcome by the ease with which trust funds can
be deployed for other government programs or to expand
retirement benefits. A motivating force for privatization,
again in all five countries studied, was the inability of the
national governments to establish and maintain a cache of
assets in a trust fund as we commonly understand it.
Conclusion
The aging of the population is not unique to the United
States--many countries are experiencing growing retirement
populations supported by fewer workers. Those facts mean, in
part, that the traditional pay-as-you-go pension and health
care programs for retirees will be strained. Other countries
have undertaken, and the United States is considering, reforms
to those programs to help ensure future benefits.
Judging the desirability of reform, indeed judging the
results of other countries' reforms, depends critically on at
least two related questions: Can the reform help economic
growth? And can the reform reasonably be expected to work?
The first question is critical. It is ultimately the size
of the economy that determines our ability to support a growing
elderly population with fewer workers. Increasing national
saving should enhance productivity and thereby economic growth.
Increased saving results from funding a heretofore unfunded
system with real assets, not increases in government debt.
The second question addresses considerations of
practicality, ease and cost of administration, protection
against severe losses, and the extent of regulation.
Our comparisons of the five countries suggest that:
Efforts by national governments to prefund
programs for retirement have not succeeded.
Prefunding through privatization offers an
opportunity to increase national saving and economic growth.
Administrative concerns, including cost, do not
appear to be insurmountable, but the details are important.
Suffice it to say, the United States is vastly different from
any of the countries examined here.
Chairman Archer. Thank you very much. As the Director of
CBO, you are challenged with the obligation to do an awful lot
of estimating and to have a completely clear crystal ball for
the future which makes your job a very difficult job.
But insofar as whether we have or have not saved Social
Security by whatever reform program we enact, would you do the
estimating of that, or will SSA do the estimating of that?
Mr. Crippen. Well, currently, Mr. Chairman, we rely quite
heavily on SSA, Social Security Administration, actuaries to
give us data like those they produce in their annual reports
and for the Trustees. We have some capability of our own,
although we're relatively new to the long-term projections.
Only in the past couple of years has CBO gone beyond the 5- or
10-year budget window to the more relevant, in this case,
longer term 15- and 75-year projections.
We aren't yet able to do completely independent analysis,
however, akin to what the Trustees do. One thing that I'm
interested in looking at, after I've had a few more than 5 days
on the job, is whether we want to--and before your Committee in
particular, the Committee with Social Security jurisdiction--
have a little more capability in the area of Social Security
estimations. I think both as a matter of economics as well as a
matter of trust fund accounting that the Congress may not want
to be in the position of relying solely on the Social Security
Administration.
Chairman Archer. Let me thank you. Let me inquire briefly
on some of the things that you said. You said there were no
assets to sell after the year 2032 based on the current
projections for the Social Security Trust Fund. And, of course,
that is a sine qua non because it is a pay-as-you-go system.
And in contrast--and correct me if what I'm saying in your
opinion is wrong, in contrast to the countries that you
examined where you say they intended to ultimately fund the
system, but politics got in the way of it--well, you didn't say
politics. I'll say politics got in the way of it. We never
intended to fund our Social Security Program in the United
States.
As I understand the history of it--Mr. Roosevelt will be up
shortly, and his grandfather designed the program--but as I
understand the program, it was never designed to be prefunded
but was designed to be a pay-as-you-go program with the fund
containing only enough to pay the benefits for 1 year. And if
there was money above the necessary benefits for 1 year, then
that money was available to basically do whatever we wanted to
with it, not to pay General Treasury obligations, but to
increase benefits or to give tax reduction on the payroll tax.
And our government also succumbed to the political
pressures. And as the money came in far in excess of the
benefit requirements annually, the Congress said, Oh, well,
this is a pay-as-you-go system, but we now have a lot more
money, we can increase the benefits. And that's what Congress
did over and over and over again.
And from the years 1968 to 1973, the Congress on an ad hoc
basis increased the benefit levels by 70 percent in that 5-year
period while inflation was running 4 percent per year so that
at the end of that 5-year period, real benefits were 50-percent
higher than they were in 1968. If you died in 1968 with the
same earnings record of someone who began to draw benefits in
1973, you would have witnessed one-third less in your benefits
than a worker with the same earnings record that retired in
1973.
So I just only point that out to support what you said that
politics is really something when it gets into the issue of
what you do and how it prevents the funding of a system
provided that it is based on the pay-as-you-go concept.
Fortunately, we finally decided that we better not do that
any more, and we've decided to let some surpluses buildup in
the fund. Now if in fact, and I take as a thesis of your
testimony that we would be far better advised in the future to
try to fund what will ultimately be our retirement plan than to
use a pay-as-you-go system. Is that a fair analysis of your
statement?
Mr. Crippen. Yes, Mr. Chairman. I think that to the extent
there's a consensus on Social Security reform, funding is
something everybody agrees we ought to be doing.
Chairman Archer. Do you have any concern about the Federal
Government investing Social Security Trust Funds in the private
sector as a government-owned and government-managed investment
program as a means of trying to prefund because if we're going
to prefund within the current so-called trust fund and make it
a real trust fund by prefunding it, then we're going to have to
find extra revenues to put into that fund, and then they're
going to have to be invested in the productivity of the private
sector if we're going to take advantage of this compounded
earnings which we've heard expressed so many times today.
Do you have any view as to whether that is a desirable
thing for whatever reason for the United States to do?
Mr. Crippen. I share some of the concerns that Chairman
Greenspan has expressed to this Committee and to others as well
about the ability of the government to make decisions that are
nonpolitical or without some kind of influence. Even in the
case of a large index fund--say, an S&P 500 fund--the
investment itself may not become a matter of congressional
interest or concern. But which companies are in the 500 index
is a matter of great concern. And if you're in the index, your
stock would probably perform much better than if you weren't in
the index. Even when we talk about broad indexes, it is
certainly possible for the government to make decisions based
on something other than pure economics. So I share Mr.
Greenspan's concerns with that.
If, however, as you suggest, we need to find a means to
save this money--something we haven't been able to do in the
United States or anywhere else thus far--we need to find a
means to be able to increase net national savings. We can't
continue to do what we're doing now, which is not increasing
net national savings.
Chairman Archer. Have you done any study at all of what
might be reasonably expected in the way of percentage return
from government-owned, government-managed funds?
Mr. Crippen. We have not that I'm aware of, Mr. Chairman. I
will ask my colleagues here as well. We have a couple of other
studies underway on Social Security, including one on
administrative costs in the United States. However, I'm aware
of some research along the lines you suggest, particularly by
Estelle James at the World Bank. She concludes that in
countries that have tried to run investment portfolios for
retirees, the more government control over those funds, the
lower the return.
Chairman Archer. Because Chairman Greenspan alluded to that
in his testimony. And whatever data you can give us in that
regard would be helpful to him, too. But if we do not do that,
if we do not make the trust fund operated by the Federal
Government, managed by the Federal Government and a true trust
fund by putting assets into it in advance and presaving, then
the only other option for prefunding is by having personal
savings accounts in it.
Is that a fair statement?
Mr. Crippen. Absolutely, Mr. Chairman. In fact, a number of
us who deal in the arcana of budget accounting tried to figure
out a way to do it short of actually sending the money back out
to retirees. And we haven't figured out a good way yet to
design one. I think equally important, the report we present
here today shows quite clearly that the countries that tried to
do it otherwise failed and indeed turned to privatization
because of precisely the reason you cited.
Chairman Archer. OK. Thank you very much. Mr. Shaw.
Mr. Shaw. Thank you, Mr. Chairman. Mr. Crippen, I want to
walk back through some of your testimony because I think that
this is a concept that's somewhat hard to grasp. But once you
grasp it, it's very obvious.
And that is what happens with putting surplus back into the
trust fund. Now the only financing of the existing system that
we have is that meager 2 percent interest that we pay ourselves
and the payroll taxes.
At some point, you start paying out more than you are
taking in. Right now it's 2013--that point can be extended out
a little bit by pumping some more money into it. But when you
pump more money into it, all you do is go out and buy more
IOUs. Then that money goes back into the Treasury, and it
either pays off the accumulated debt or the Congress spends it
or gives it on a tax break or something like that.
So the net effect is that you've really done very little to
delay the day of reckoning when the government is going to be
required to come up with general revenue to pay the benefit or
cut benefit.
Mr. Crippen. I think you've broken the code.
Mr. Shaw. Yes. Now that's something that people are not
understanding because people feel that if you put several
billions of dollars in there, you've increased the trust fund.
But the problem is it's like Old Mother Hubbard's cupboard.
It's bare because that money is flushed out, and how do you pay
the benefits? You have to go out and get general revenue so you
can pay yourself off so that you can continue to exist.
That curve that we keep looking at goes up slowly and comes
down rather quickly. As soon as you hit the top point of that
curve and start coming down, that is when really the only thing
that is going to contribute to paying off the benefits is the
little bit of interest that the trust fund is going to draw,
because everything else is going to have to come from general
revenue.
Mr. Crippen. Right.
Mr. Shaw. So this is a problem. This is a mentality, and
this is a mindset that we've got to get away from. And this is
why I feel that it is so important that we come up with some
type of a program where we can actually invest in some real
assets or let the people invest in some real assets so there is
something out there that they own. And it's not a question of
the government owing itself so that it can have a call on
taxpayers further down the line so that these taxpayers will
have to come in and pay off the debt of the unfunded
liabilities of Social Security. So it would certainly appear,
then, that that is the question. However, the President having
put that money in his plan hasn't really nudged that date by
very much, has he? Have you done calculations on that?
Mr. Crippen. We haven't, Mr. Shaw, finished yet. We're in
the process of trying to analyze the President's budget, which
we just received, as you did, a couple weeks ago. So we don't
have all of the data that we'll need. In fact, I saw yesterday
that the administration mentioned it was going to send
legislation, maybe by tomorrow, on how this transfer mechanism
will work. So we don't know exactly.
Mr. Shaw. The administration is going to send you
legislation?
Mr. Crippen. The administration mentioned yesterday that it
was going to send legislation--I thought they said Friday--to
make clear how the transfer mechanism would work. We can infer
from some of the tables how it works, but we're not sure.
Mr. Shaw. That would be very helpful for us.
Mr. Crippen. We could fill out some details as well. But,
again, we're not sure about our analysis. But it doesn't appear
that the 2013 date that you and I both referred to would change
significantly. The President's budget is not very clear about
what he intends to do on the Social Security benefit side. As
you know, in the State of the Union and partly in the budget,
he made some allusions to changing the benefits for widows and
others.
Mr. Shaw. But you're awaiting in the actual legislation so
you can score it. Because many have said that actually it will
set it back, and it will go down even quicker because of some
of the benefits. I don't criticize the benefits. But it does
create concern as to how we're going to extend it.
Perhaps if I could ask Mr. Matsui if he knows of the
legislation--if he's had a hand in it.
Mr. Matsui. Well, I'm not really able to discuss this any
further. I think you need to talk to others about this. I'll
chat with you later.
Mr. Shaw. OK. Thank you, gentlemen. Thank you, Mr.
Chairman.
Chairman Archer. Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman. Mr. Crippen, welcome
to the Committee. Congratulations on the new position. I really
don't have much. I just want to get into one area, and it's
probably just for the record.
We have this enormous surplus that's building up over the
next 15 years both in the budget and in the Social Security
account. And it's my understanding there's only four ways to
deal with this, and I've talked to a lot of economists and a
number of people.
One is doing what we have been doing with the Social
Security surplus, that is, using it to pay for government
expenditures. Obviously, if Mr. Greenspan is right, that's not
quite appropriate to do, it's better to save it for the future.
This is--we're talking about at least the Social Security
surplus.
Mr. Crippen. Most economists would agree with that.
Mr. Matsui. And that's exactly right. That's agreed upon
almost universally. Within that same category, we can use the
surplus for tax cuts, and Mr. Greenspan suggested that's not a
good alternative either because a tax cut is similar to an
expenditure in terms of the surplus.
After first and second is just putting it in the vault. As
the money comes in, put the dollar bills and coins in a vault.
That's nonsensical, but that's, I guess, an option. The fourth
is that you can go into the equity markets. You could just take
that money and throw it in the equity markets. A lot of folks
don't like that. The present proposal suggests making up about
4 percent of the market once it's fully phased in. But there's
a lot of problems with that, particularly if you throw the
whole $2.8 trillion. So those are the four. And the last way, I
understand it, is just dedicating the surplus to drawing down
the debt, and that's exactly what the President has proposed in
his package.
Unless you pick one of those four, and to me that sounds
like the most logical way to handle this to preserve the money
for the future, frankly I'm perplexed as to why nobody
understands or can't understand why this makes a lot of sense.
And at the same time, the savings on buying down the debt
can be used for other governmental purposes including Social
Security, which the President has proposed in his package. I
guess you can use it for further tax cuts down the road, or you
could use it for maybe lending money to the Russians or perhaps
buying more hardware or whatever the case may be.
But the President has decided to put that additional sum
toward buying down the debt and into the Social Security Fund
to shore it up, to pick up that 2.19 percent of payroll
shortfall.
And I'm not really asking you a question. I just want to
raise that and throw that out because the alternative to that
is not using the surplus at all or any of the proceeds off the
surplus. And that means one has to make cuts in the program and
the benefit levels, or increase the payroll taxes, or a
combination of both. And it would be my guess, given the way
the debate has gone, is that those two options are probably not
available at this time unless somebody wants to step out. But I
don't really see that as a viable option.
So if we really want to solve this problem without making
those cuts or tax increases, I just want to know what other
alternatives we might have. And I would just hope that those
that are being so critical and kind of vetting the President's
program would come up with another way to deal with this
because I'm certainly open, and I'm sure the President is, and
I'm sure the public is.
But we need to have more than just criticism. And I just
make that observation. I don't have any questions. I just
welcome you and look forward to working with you, and I
certainly appreciate the fact that you're here today.
Mr. Crippen. Thank you. Mr. Chairman, if I could, I have
just one remark in response, if that's appropriate.
Mr. Matsui. Certainly.
Mr. Crippen. It's simply that we have not, as I suggested,
completed our analysis of the President's budget. So I don't
know what he proposes, and we need some more detail. But I
think it's important to note that my predecessor made her final
testimony 2 weeks ago in which she presented a baseline report
for the upcoming year, as you know.
Mr. Matsui. Right.
Mr. Crippen. I think it's important to note that if we do
nothing, we will pay down the Federal debt.
Mr. Matsui. Right.
Mr. Crippen. So that is an option as well. I mean, the do-
nothing option may pay down Federal debt a lot. And so I just
want to make sure that, as part of your list of options, doing
nothing may be helpful.
Mr. Matsui. Right. In fact, some of my colleagues on both
sides of the aisles had suggested maybe that's the best thing
to do right now, given the fact that there's no consensus. But
certainly we want to try to see if we can use some of the
assets for the purpose of dealing with the most fundamental
issue that we have probably in this Congress.
But you're right. That is certainly an option, and it will
obviously aid the economy and aid the savings rate. Thank you.
Chairman Archer. Mr. Crippen, let me, if I may, just
piggyback for a moment. Many Members of Congress are confused
by the way we budget. The public is totally confused by the way
we budget up here.
There's no relationship to anything that you find in the
private sector that I know of. In order to try to make a little
more common sense out of it for understandability, we have two
kinds of debt. We have debt that is held by the trust funds of
this country, and that is legitimate Treasury bonds with the
full faith and credit and obligation of repayment by the
Treasury the same as EE bonds.
And we have the privately held debt which is sometimes
referred to as publicly owned debt--the debt that's held by the
private sector and not held by government. Both of those debts
are equally an obligation of the United States, are they not?
Mr. Crippen. Yes.
Chairman Archer. Is there any difference between them as to
the obligation to the United States?
Mr. Crippen. No, not that I'm aware of.
Chairman Archer. All right. Both of them are covered by the
debt ceiling, is that correct?
Mr. Crippen. Yes.
Chairman Archer. Have you had a chance to look at the
President's budget without necessarily knowing the details of
this budgetary scheme for Social Security?
Mr. Crippen. Yes and no. I mean, we have----
Chairman Archer. Well, I'm going to ask you a question, and
either you've seen it or you haven't seen it. But this refers
to the President's presentation in his budget.
Mr. Crippen. Right.
Chairman Archer. Does the total debt of the country go up
under his scheme, or does it go down?
Mr. Crippen. It would appear to go up.
Chairman Archer. OK, let's be very clear. Appear to go up--
now by his own figures, does it go up or does it go down?
Mr. Crippen. It goes up.
Chairman Archer. It goes up. And yet I read today again in
a news story by the Associated Press that the White House has
said they're paying the debt down by $2 trillion. How are the
American people supposed to understand that when you are
telling us that the President's own figures show that the total
debt of the United States goes up?
Mr. Crippen. Mr. Chairman, I don't know. I don't have a
good answer to that. Obviously, we all measure these things
relative to what, and we're in a position----
Chairman Archer. But under our system of budgeting, Mr.
Crippen, we are always judged by the baseline that CBO puts
out. We have been judged that way ever since we've been in the
majority. If we raise spending above the baseline, we've
increased spending. If we reduce spending below the baseline,
we've cut spending.
Mr. Crippen. Right.
Chairman Archer. The baseline is the determinator for
everything that we do here. Now relative to the baseline, does
the President's scheme raise the national debt?
Mr. Crippen. Yes.
Chairman Archer. It does. Clearly, it does by his own
announced document.
Mr. Crippen. Yes.
Chairman Archer. And yet they still can say they're
reducing the national debt. What does it do to debt service
charges in the future? What does his proposal do to debt
service charges in the future? Does it raise them or lower
them?
Mr. Crippen. On a gross basis, it would raise them.
Chairman Archer. It raises them. This is the matter of
concern to me and many of my colleagues. And I just think that
we've got to be open and use common sense with the American
people and not just shift around things within these budgetary
concepts.
I don't think we have a lot more time before we have to
vote. And so if you'll indulge us, we'll recess and vote and
come back as quickly as possible and continue with the hearing.
The Committee will stand in recess until we can come back from
the vote.
[Recess.]
Chairman Archer. What there is of it. Mr. Crippen, you
have, I think, made a contribution to the beginning of our
process of trying to determine what the best course is for us
in Social Security. We'll appreciate your continuing input. And
if you can get any data to us as to your evaluation of what
public investment--government investment of government funds in
the private sector has done in other areas, that would be very
helpful to us.
[The following was subsequently received:]
[GRAPHIC] [TIFF OMITTED] T6189.001
[GRAPHIC] [TIFF OMITTED] T6189.002
Chairman Archer. So I thank you very much, and I wish you
Godspeed in your work.
Mr. Crippen. Thank you. We need it. Invite us back again.
Chairman Archer. Our next witness is James Roosevelt, Jr.,
the grandson of Franklin Roosevelt, the founder of Social
Security, a system that on a bipartisan basis there is unified
support to save and to continue to make available for future
generations.
And since you are one of those future generations and
perhaps you've got others coming behind you, we'd be pleased to
receive your testimony.
STATEMENT OF JAMES ROOSEVELT, JR., ASSOCIATE COMMISSIONER,
RETIREMENT POLICY, SOCIAL SECURITY ADMINISTRATION
Mr. Roosevelt. Thank you, Mr. Chairman. I appreciate the
opportunity to discuss the issue of insuring retirement
security for future generations, and what the United States can
learn from the experiences of other countries.
As you've said, my name is James Roosevelt, Jr., and I'm
Associate Commissioner for Retirement Policy at the Social
Security Administration. Our Social Security Program is the
most successful program in the Nation's history, and its
financial health is now sound.
But if we do not address the long-range financing issues,
the trust funds which today have a balance of about $730
billion and are growing, would be exhausted in 2032. At that
time, payroll taxes would generate enough income to cover only
about three-fourths of benefit obligations.
As you know, the reason for the future strain on the
financing of our social insurance system is largely
demographic. When benefits were first paid in 1940, a 65-year-
old on average lived about 12\1/2\ more years. Today, that life
expectancy is about 17\1/2\ years and rising.
Further, the number of older Americans is expected to
double by the year 2030. Comparisons to other countries must be
done carefully. The life expectancy in the United States has
grown, but not as fast as in other countries. The fertility
rate in the United States has fallen, but not as much as in
many other developed countries.
So just as our demographics are not identical to those of
other countries----
Chairman Archer. Mr. Roosevelt, that's some of the best
news we've heard so far.
Mr. Roosevelt. That's true. And there are in my written
testimony some numbers to lay this out in more detail. Just as
our demographics are not identical to those of other countries,
our economies and our social institutions are not identical.
We also differ from other countries because we have already
taken some precautionary measures to buttress our Social
Security system. The National Commission on Social Security
Reform on which you served, Mr. Chairman, proposed reforms to
begin to prepare our Nation for the retirement of our baby boom
generation.
For these and other reasons, we are in a better position to
deal with our demographic challenges than many other nations.
Nonetheless, examination of the experience of other countries
can provide valuable insights. Let me mention just two examples
at this time.
Of special interest to the United States is the Canadian
decision to invest new funds in a diversified portfolio of
securities. That is, a combination of stocks and bonds. An
investment board for the Canadian pension plan will operate at
arm's length from government influence. Its private investments
reflecting a diversified portfolio will mirror broad market
indexes.
In Chile, as we've heard discussed earlier today,
fundamental social insurance reforms were made in 1981 when the
old Chilean system was close to bankruptcy. The current plan is
based on private retirement pension funds. No employer
contributions are made. Workers are required to make monthly
contributions equal to 10 percent of their wages plus 3 percent
for administrative fees and disability and survivor's
insurance.
Overall, the rate of return under the privatized Chilean
system from 1981 through 1998 has been 11 percent. But if you
factor in all costs, the real rate of return is 7.4 percent
through 1995, but it has declined since then.
The recent annual rates of return in Chile were negative in
2 of the last 4 years. In fact, the situation has deteriorated
to such a degree that the Deputy Secretary of Social Security
in Chile is encouraging workers who are eligible to retire to
postpone their decision until such time as losses in the
individual accounts may be reversed. I think it is safe to say
that no one here today would ever want to make such a
pronouncement to the American public.
Let me now turn to the administration's framework for
ensuring retirement security for future generations of
Americans that will help us reach a comprehensive solution for
extending Social Security solvency for at least the next 75
years.
The President has proposed steps that can be taken to
extend solvency through 2055. Specifically, the President
proposed first to transfer 62 percent of budget surpluses over
the next 15 years to Social Security and pay down the publicly
held debt which would strengthen our economy for the future.
Second, the President has also proposed that we invest a
portion of the 62 percent in the private sector to achieve
higher returns for Social Security. Funds would be invested in
broad market indexes by private managers, not the government.
Because such a small portion, never exceeding 15 percent of
the trust funds, would be invested in the private sector, the
risk to the trust funds would be minimal, and that risk would
be borne by the government, not by private citizens.
Finally, the President has called for the bipartisan effort
that will be needed to make the hard choices to ensure long-
range solvency. And I would note that this bipartisan
cooperation on long-range actions is what you have called for,
Mr. Chairman.
The President has also said that reducing poverty among
elderly women must be a priority as part of the solution. And
he has proposed eliminating the annual retirement earnings
test.
In conclusion, we can learn much from other countries
around the world in dealing with retirement security issues. At
the same time, we must chart our own course based on our own
experience and our own situation. The administration and the
Congress must work together to achieve a bipartisan package to
ensure the solvency of Social Security for at least the next 75
years.
We must use the window of opportunity provided by the
historic budget surpluses to strengthen the Social Security
system. We look forward to working with you and this Committee
in that effort. Thank you very much.
[The prepared statement follows:]
Statement of James Roosevelt, Jr., Associate Commissioner, Retirement
Policy, Social Security Administration
Good morning, Mr. Chairman and Members of the Committee. My
name is James Roosevelt, Jr., and I am the Associate
Commissioner for Retirement Policy at the Social Security
Administration. I appreciate the opportunity to appear before
you today to discuss Social Security reform lessons learned in
other countries. I am glad to be a part of the ongoing
discussions to save Social Security for the 21st century. There
is valuable information that can be gleaned from examining the
efforts to reform social insurance programs around the world.
In my testimony today I will briefly review for you Social
Security's long-range solvency situation in terms of the status
of the trust funds as well as changing demographics. I will
also discuss the demographics facing other nations, and a broad
range of reforms that have been implemented in other countries
to address those changes. This topic is quite relevant; as I
will discuss later, the Administration considered foreign
experience carefully in the process of developing our framework
to protect Social Security.
It is important to keep in mind that every country has its
own unique circumstances and that what is best in one country
may not be the best solution for our country. Each country
faces a different set of demographics and has a different set
of programs to support retirees, survivors and the disabled.
For example, merely comparing cash benefits without considering
health and housing supplements may provide a distorted picture.
Also, the social insurance tradition and the status of the
social insurance programs in different countries vary greatly.
We face a problem in this country, but we are fortunate in that
we do not face a crisis. Some countries have made radical
changes because their situations were more dramatic and
immediate.
Status of the Social Security Trust Funds
I'd like to take a moment to share with you the current
status of the Social Security Old Age and Survivors Insurance
(OASI) and Disability Insurance (DI) Trust Funds. The OASDI
Trustees monitor the financial health of Social Security--our
Nation's most successful family protection program.
According to the 1998 Trustees Report, the assets of the
combined funds increased by $88.6 billion, from $567.0 billion
at the end of December 1996 to $655.5 billion at the end of
December 1997. At the end of fiscal year 1998, the combined
funds had a combined balance of $730 billion. In 1997, the
Social Security trust funds took in $457.7 billion and paid out
$369.1 billion. Thus, over 80 percent of income was returned in
benefit payments. Administrative expenses in 1997 were $3.4
billion, or about 0.9 percent of benefits paid during the year.
Under the 1998 Trustees Report's intermediate assumptions,
the annual combined tax income of the OASDI program will
continue to exceed annual expenditures from the funds until
2013. However, because of interest income, total income is
projected to continue to exceed expenditures until 2021. The
funds would begin to decline in 2021 and would be exhausted in
2032.
In 2032, when the trust funds are projected to become
exhausted, continuing payroll taxes and income from taxes on
benefits are expected to generate more than $650 billion in
revenues (in constant 1998 dollars) for the Trust Funds in
2032. This is enough income to cover about three-fourths of
benefit obligations. And I want to stress that the President is
committed to seeing to it that this scenario never develops.
Changing Demographics
I have mentioned ``demographics'' in a general way, but I
have some specific facts to share with you that may be helpful
to our discussion today:
In the U.S. in 1995, the elderly population (aged
65 and over) was about 34 million, making up about 12% of the
population. In contrast, there were about 9 million aged people
in the U.S. in 1940, and then they accounted for less than 7
percent of the population.
And Americans are living longer. When benefits
were first paid in 1940, a 65-year old on average lived about
12 more years. Today, a 65-year old could expect to live about
17 more years and by 2070, life expectancy at age 65 is
projected to be an additional 20 years.
The elderly population growth rate is expected to
be modest from now through 2010, but it will increase
dramatically between 2010 and 2030 as the baby-boom generation
ages into the 65-or-older age group. For every 100 working age
people, there will be more than 35 people aged 65 and over by
2030.
In 1994, 60% of the elderly were women and 40%
were men. Among the oldest of these (85 or older), over 70%
were women and fewer than 30% were men.
Clearly, many millions of people are depending on us for
strong and decisive action to preserve and protect the multi-
tiered structure of retirement income security. President
Clinton stated that we must act now to tackle this tough, long-
term challenge.
Foreign Demographics
Certainly it is no secret that other countries are facing
similar demographic issues, some far more serious than ours. In
the U.S., we will have 21 people aged 65 and over for every 100
American workers next year. But in Japan, for every 100
workers, there will be more than 24 people aged 65 and over.
Belgium, France, Greece, Sweden and Italy will likely have
higher ratios of aged persons to workers than we will. Our
elderly person to worker ratio would be higher today if not for
the baby boom.
Life expectancy is also increasing around the world and is
expected to continue to do so. In the United States and the
United Kingdom, life expectancy at birth has increased by about
6 years from the early 1950's to the late 1980's. Over the same
period, life expectancy at birth has increased by about 10
years in France, Italy and Greece, 13 years in Spain, 8 years
in Switzerland and 7 years in Germany.
Further, the fertility rate in developed countries needs to
be about 2.1 to maintain a stable population, and only Ireland
is at that level or projected to be there. The impact of
increasing longevity and decreasing fertility is indicated by
the percent of population over 65. When compared with some
other developed nations, the percent of the U.S. population
over 65 is relatively low and the relative position of the U.S.
is not projected to change in the next twenty years. In Italy,
for example, elderly residents represented 14.1 percent of the
total population in 1990, with projected growth to 20.9 percent
in 2020. 11.7 percent of the population was over 65 in Japan in
1990, and is projected to grow to 24.2 percent in 2020. Here in
the U.S., 12.6 percent of us were over 65 in 1990; we are
projected to reach just 16.3 percent in 2020.
Differences in Social Policy
Just as our demographic picture is not identical to that of
other developed countries, we differ in other important ways as
well. For example, our Social Security program is a relatively
small piece of this country's Gross Domestic Product (GDP)--in
1998, Social Security expenditures were 4.6 percent of GDP. In
many countries, social insurance represents a far larger
proportion of GDP.
We also differ from other countries in our approach to
changing demographics because we were foresighted enough to
begin to prepare our Nation for the retirement of our baby
boomers with the 1983 Social Security Amendments. The 1983
amendments paved the way to move from a pay-as-you-go approach
to partial advance funding.
For all of these reasons, we in the U.S. are in a somewhat
better relative position to begin to deal with the challenges
presented by our changing population than are many other
nations. In addition, other countries have different income
support and social service programs. Therefore it is sometimes
difficult to make direct comparisons with what other countries
are doing or have already done. Nonetheless, examination of the
experience of foreign countries provides interesting and
valuable insights, and there is much we can learn.
International Approaches to Reform
Let me turn now to a discussion of how other countries are
dealing with these demographic changes. Sweden and the United
Kingdom have made recent changes in their old-age pension
programs. Canada is also making changes. Of course, Chile is
another, oft-cited model for retirement income reform and
Australia has added a new element to their very different and
interesting social insurance structure. I would like to talk
about each of these countries, beginning with what is going on
in Canada.
Our neighbors to the north have recently enacted
legislation to deal with their changing population. When the
Canada Pension Plan was introduced in 1966, the face of
Canada's population was entirely different than it is today. A
quickly growing senior population, a generation soon to retire,
and a rapidly shifting economy resulted in the Canadian
government's adoption of a number of reforms to strengthen
Canada's retirement income system.
Of special interest to us in the United States is the
Canadian decision to invest new funds in a diversified
portfolio of securities--that is, a combination of stocks and
bonds. This recent legislation allows the fund to build an
eventual reserve of 4-5 years of benefits and moves the Canada
Pension Plan system away from a pay-as-you-go plan toward a
more fully funded system.
The new investment board for the Canada Pension Plan is to
operate at arm's length from government influence, with the
stock investments reflecting a diversified portfolio, which
will be selected passively, mirroring broad market indexes. We
will be watching Canada carefully as it deals with questions
concerning corporate governance. For example, regulations have
not yet been issued on whether or how shares owned by the
Canada Pension Plan will be voted.
Another country that invests part of its government pension
fund in stocks is Sweden, which has been making such
investments since 1974. About 13 percent of the surplus funds
were invested in stocks in 1996, the latest data available.
These investments represent about 4 percent of total Stockholm
Exchange market capitalization. The funds are directed by large
boards that represent government, business, and labor.
Let me talk a little more about Sweden's program. Under the
new Swedish system (now being implemented), basic and
supplementary pensions will be phased out and replaced by a
single, earnings-related pension. In addition, 2 percent of
earnings will be invested in individual ``premium accounts.''
These premium accounts will be privately managed, under public
supervision, and permit a wide range of investments. Payroll
contributions will be held in a conservatively invested account
until the administrative process is completed and they are
credited (with interim returns) to each worker's chosen
account. Since this program is brand new, we will be watching
its implementation with great interest.
The United Kingdom has about 10 years of experience with
individual retirement accounts. Starting in 1988, the British
system allowed workers to ``contract out'' the earnings related
portion of their two-tier pension program in order to set up
tax-deferred ``personal pensions.'' Thus, under this system,
privatization is voluntary. However, there are weaknesses to
their system. The British system has diverted funds away from
occupational or government defined benefit plans to defined
contribution plans, shifting risk to the individual. In
addition, workers with low wages or sporadic work histories do
not seem to be well protected. The British government has
recently proposed substantially revising their system to
address this issue. We will be watching with interest to see
what steps the United Kingdom takes to improve their retirement
income protection program.
In addition, the British government has had difficulty
regulating the sale of private pensions; misleading and
sometimes fraudulent sales tactics may have adversely affected
as many as 20 percent of those who opted for personal pensions.
Also yet to be resolved is how best to set up an effective
regulatory mechanism whereby investors can seek redress and
compensation.
It would appear that social insurance reform plans that
involve direct selling of investment instruments raise many
difficult issues. Arthur Levitt, Chairman of the Securities and
Exchange Commission, recently cautioned that under a mandatory
individual accounts program, uninformed investors won't be able
to capture the potential for greater returns because ``they
risk making poor decisions, perhaps through ignorance or
because they fall prey to misleading sales practices.''
And let me say a couple of things about the fundamental
reform of the Chilean social insurance system. It is worth
pointing out that the situation in Chile prior to reform looked
nothing like the situation we are facing today. Chile's
demography was vastly different in that it had, and still has,
a relatively young population, a fertility rate substantially
above ours, and a 9-to-1 ratio of workers to retirees when the
change was made. Further, as you know, the old Chilean program
was close to bankruptcy when it was overhauled in 1981.
The plan is based on private retirement pension funds
administered by private pension fund management companies.
There are no employer contributions under the new plan, but
workers are required to make monthly contributions equal to 10
percent of their wages into individual savings accounts. There
is an additional 3 percent contribution for administrative fees
and disability and survivors insurance. Transition costs were
funded in part by selling off a vast array of nationalized
companies.
This is not to say, however, that the experience of Chile
does not hold some lessons for the United States. While the
Chilean reforms did respond to some of the problems inherent in
the old system, some serious concerns remain. Some of the
difficulties are:
about 40 percent of workers are not contributing
regularly;
80 percent of the self employed are not
participating;
administrative fees are high but choice in
investments is limited due to regulation;
and rates of return in recent years are too small
to cover administrative fees.
The overall real rate of return under the privatized
Chilean system from its inception in 1981 through the end of
1998 is 11 percent. However, the overall real rate of return is
not what every worker is getting. After considering
administrative costs, including withdrawal fees and costs of
annuitization, the real rate of return through 1995 was 7.4
percent and is still declining.
In the last 4 years, annual rates of return in Chile have
been low or negative. In fact, the situation has deteriorated
to such a degree that in October the Deputy Secretary of Social
Security in Chile, Patricio Tombolini, encouraged workers who
are eligible to retire to postpone their decision until such
time as the market losses could be reversed. I think it is safe
to say that no one here today ever wants to have to make such a
pronouncement to the American public.
Another country that has made recent changes to its pension
system is Australia. Australia's system is quite different from
the United States'. Australia has approached the problem of
improving retirement income not by expanding public programs,
but by imposing a mandate on all employers to offer at least
one contributory retirement plan to all employees. Employers
are required to make contributions to these funds at the rate
of seven percent of employee earnings in 1999, rising to 9
percent in 2002-2003. Many employers make contributions that
are above and beyond what is required. The plans are fully
portable and managed by the private sector. They are paid out
at age 55, some as pensions but the majority as lump sums which
can be annuitized. This supplements a very generous, wealth-
tested retirement benefit funded through general revenues
payable at age 65. The Australian approach to individual
accounts was implemented in 1992 and is scheduled to be
complete in 2002.
This brief review has illustrated the great diversity of
the retirement income protection plans around the world. While
I do not want to over-generalize about what we can learn from
international experience, one observation I can make is that
when countries have individual accounts as part of their
national retirement system, lower earners, intermittent
workers, and women tend to have less favorable outcomes than
others. However, in many nations, this problem is offset by the
provision of a great variety of income support and social
service programs offered to the elderly. Where such programs do
not exist, or are very limited such as in Chile, the affected
workers may be severely disadvantaged.
President's Response Reflects Foreign Experience
Three weeks ago, in his State of the Union address,
President Clinton proposed historic steps to ensure the
solvency of Social Security. When putting together his
framework for a solution to the long-range Social Security
solvency problem facing our country, President Clinton wanted
to increase national savings to reduce burdens on future
generations and reduce publicly held debt. His plan, therefore,
draws on the approach taken by Canada and other countries and
State and local pension systems in this country to diversify
the fund portfolio. Through the provision of Universal Savings
Accounts (USA accounts), the President's framework draws on the
experience of countries that have added individual retirement
accounts as a voluntary supplement to social insurance
protection.
Specifically, the President proposed the following three
actions to solve the Social Security program financing problem:
Transfer 62 percent of projected federal budget
surpluses over the next 15 years--about $2.8 trillion--to the
Social Security system and use the money to pay down the
publicly held debt, which would strengthen our economy for the
future. Thus the President's plan provides for debt reduction
while giving Social Security the benefit of the gains from
reducing publicly held debt.
Invest a portion of the trust funds, which would
never exceed about 15 percent, in the private sector to achieve
higher returns for Social Security. Funds would be invested in
broad market indexes by private managers, not the government.
A bipartisan effort to take further action to
ensure the system's solvency until at least 2075. There are
hard choices that we must face. To assure confidence in Social
Security it is important to bring the program into 75-year
actuarial balance.
The President's first two steps will keep Social Security
solvent until 2055, and bipartisan agreement on the hard
choices could extend that solvency at least through 2075.
President Clinton also said that reducing poverty among
elderly women must be a priority as part of this comprehensive
solution. While the poverty rate for the elderly population is
approximately 11 percent, for elderly widows it's 18 percent.
In addition, he proposed eliminating the retirement earnings
test, and strengthening Medicare. These proposed actions
constitute a solid framework for ensuring retirement security
for current and future generations of Americans, and I would
like to review them now in some detail.
First, the President's plan would require that transfers be
made from the U.S. Treasury to the Social Security trust fund
each year for 15 years. The annual funds transferred would be
specified in law, so that by 2015, about $2.8 trillion would be
allocated to save Social Security. A portion of these funds
would be invested in the private sector each year, from 2000
through 2014, until such time as 14.6 percent of the Trust
Funds are in private investments. The remainder, 85.4 percent,
would continue to be held in government securities. Thus, for
example, in 2032, 94 percent of benefit payments will come from
tax revenue and interest on government securities with only six
percent from private investments.
Stocks over time have returned about 7 percent annually
after inflation, while bonds have yielded about half as much.
Diversifying the trust fund investment to include stocks would
produce more investment income and reduce the projected
shortfall. It would provide a higher rate of return with no
risk to the individual and minimum risk to the trust funds.
Under the President's proposal, total investment in the
private sector would account for around 4 percent or less of
the U.S. stock market over the next 30 to 40 years. This share
of the market is equivalent to the share that Fidelity manages
today. State and local pension funds now represent more than
twice that figure--about 10 percent--of total stock market
investments. If State and local pensions had not, years ago,
gone in the direction of a diversified portfolio, then States
and localities would have had to increase taxes or curtail
pensions significantly. State and local government pension
plans now hold roughly 60 percent of their total investment
portfolios in the private sector.
The Administration understands the importance of providing
appropriate safeguards to avoid politicizing the investment
process; under the President's proposal, the Administration and
Congress together would craft a plan that ensures independent
management without political interference. We believe that this
can be done, especially if the Federal Reserve Board and the
Thrift Savings Plan Board serve as models.
The President's framework does not merely protect Social
Security--it reduces publicly held debt and increases the
savings rate. Paying down publicly held debt would cause new
capital formation to occur; it will reduce debt servicing costs
as well. As Alan Greenspan recently asserted, ``reducing the
national debt--the publicly held debtis a very important
element in sustaining economic growth.'' He added, ``as the
debt goes down, so do long-term interest rates, so do mortgage
rates, and indeed economic growth would be materially enhanced
as a consequence.'' Finally, paying down publicly held debt
provides Government with flexibility to respond to future
conditions. That is, if the government later decides to finance
some obligations by issuing new publicly held debt--for
example, redeeming Social Security assets--it would be possible
to do so without threatening future economic performance.
Second, in addition to strengthening Social Security and
Medicare, the President has proposed Universal Savings
Accounts, separate from Social Security, to help every American
build the wealth they will need to finance longer lifespans.
Under the President's framework, we will reserve 12 percent of
the projected surpluses over the next 15 years--averaging about
$33 billion per year, so that every worker can have a nest egg
for retirement. These accounts, proposed by the President,
would be matched on a progressive basis. Today, the vast
majority of pensions and savings go to the top one half of the
population by income, leaving only a small percentage for the
lower 50 percent by income. USA accounts, separate from Social
Security, will mean hundreds of dollars in targeted tax cuts
for working Americans, with more help for lower-income workers.
Conclusion
In conclusion, let me say we have much in common with many
countries around the world as we face the demographic
challenges we are discussing today. It is important to learn as
much as we can from their experiences. It seems clear that many
foreign nations are looking to strengthen their savings rates
and provide for advance funding. The President's proposals for
protecting Social Security are consistent with these goals. The
President's proposals represent a solid framework for ensuring
retirement security.
The President's plan is a sound approach for protecting
Social Security. It uses the budget surpluses--the first the
nation has enjoyed in more than a generation--to help preserve
a program that is of overriding importance to the American
public. The Social Security program in the United States has
been a resounding success. It has lifted the elderly out of
poverty. Today without Social Security about half of the
elderly would be living in poverty. With Social Security that
number has been reduced to 11 percent. This is a program worth
protecting and must be protected.
The Administration and the Congress worked together
successfully to achieve a robust economy. The Administration
and the Congress must now work together to achieve a bipartisan
package to ensure the solvency of Social Security for at least
the next 75 years. We must use the window of opportunity
provided by the budget surpluses to move us closer to a
financially secure system. We look forward to working with this
Committee to strengthen the Social Security system for the
future.
Chairman Archer. Thank you, Mr. Roosevelt.
Mr. Shaw.
Mr. Shaw. Mr. Roosevelt, you mentioned that the President's
plan would keep the trust funds solvent for 75 years. What is
your definition of solvency?
Mr. Roosevelt. Well, the steps that the President has
proposed would keep the Social Security Trust Funds solvent
until 2055, Congressman. He has said that there is a need for a
bipartisan effort to reach agreements on steps that would bring
it all the way to 75 years.
Mr. Shaw. Well, I understand that. But what's your
definition of solvency? That's what I'm concerned about.
Mr. Roosevelt. Solvency, as I've used it as a working
definition, is to continue to pay current benefit levels as
promised under the law.
Mr. Shaw. And where will we get the money to make those
payments in cash?
Mr. Roosevelt. Since 1983, we have been in a program where
we combine a pay-as-you-go method and some degree of
prefunding.
Mr. Shaw. What type of prefunding?
Mr. Roosevelt. Well, the prefunding involved in the credits
to the trust fund that are represented by government
securities.
Mr. Shaw. So it's your testimony that solvency includes
paying the Federal Government paying off the Treasury bills
that are in the trust fund, is that correct?
Mr. Roosevelt. It includes the steps that the President has
suggested with the use of the surplus so that there will be
funds to continue to pay benefits through 2055 and then
additional steps so that we will have the funds to pay the
benefits for the next 75 years.
Mr. Shaw. How is it going to pay those Treasury bills off?
Mr. Roosevelt. Well, if we follow the plan that the
President has put forward, we will be paying down the publicly
held debt so that there will be more capital available in the
economy and more income to the Social Security Trust Fund.
Mr. Shaw. More capital in the economy. But it's going to
require an infusion of tax dollars into the trust fund to
retire the Treasury bills, is that correct? I mean, that's a
simple yes or no. The answer is yes because when payroll taxes
no longer can take care of the obligations of the trust fund,
then the trust fund starts to liquidate the Treasury bills. And
the only way it can liquidate the Treasury bills is to get tax
dollars, is that correct? I just want to be sure that we've got
some truth in accounting here. I mean, we----
Mr. Roosevelt. As we know, at the point where there is not
sufficient income from the pay-as-you-go method, it will be
necessary to use the interest from the trust funds and then to
redeem the Treasury bills.
Mr. Shaw. So it will be necessary to start using tax
dollars at a future date, is that not correct?
Mr. Roosevelt. It would be necessary if we reach that
point, depending on the other decisions that we make, to redeem
those bonds for Treasury funds. And those bonds, of course, are
backed by the full faith and credit of the U.S. Government.
Mr. Shaw. Which is the taxpayer?
Mr. Roosevelt. Which is the U.S. Treasury funded by the
taxpayer.
Mr. Shaw. Which is the taxpayer. Each one of us who pays
taxes are backing the full faith and credit of the Federal
Government. There's no question about that.
Mr. Roosevelt. Absolutely, Congressman.
Mr. Shaw. Good. Are you in the loop on this legislation
that the last witness talked about?
Mr. Roosevelt. I am not aware of any legislation that's to
be filed imminently. No, I'm not.
Mr. Shaw. Well, this Committee would be very interested in
seeing this legislation. And, hopefully, we would be interested
in supporting it.
Mr. Roosevelt. I will pass that word along to the
administration.
Mr. Shaw. OK. Thank you, Mr. Roosevelt.
Chairman Archer. Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman. I thank you for being
here, Mr. Roosevelt. I want to get to the Chilean issue, if I
may. And you did speak on it, and I was not here. I was coming
in the room when you were speaking in your opening remarks on
it.
But could you tell me what the overall cost of the Chilean
individual account might be in terms of percentage of the asset
itself taking into consideration transfer cost, the cost of
maintenance, and setting up an annuity from the Chilean fund.
Do you happen to have those statistics? I know that some other
people who will follow you do. But if you happen to have them,
I----
Mr. Roosevelt. Congressman, are you talking about the
administrative costs of running that system?
Mr. Matsui. Right, exactly, and maybe just those two, the
administrative costs and the costs of setting up an annuity
account beyond that because I wasn't able to really get that
from you.
Mr. Roosevelt. The figures that I have seen indicate that
the rate of return is reduced from 11 percent to about 7.4
percent by the administrative costs. So that would take about
3.6 percent of the rate of return for administrative costs.
Mr. Matsui. OK. Let me ask you about the President's plan
here. The administration is buying down debt with a sizable
portion of the surplus, and it also is not using any of the
general revenues in this portion for government spending. But
they will in fact have additional moneys coming in through the
savings on the reduction of the debt service. Is that my
understanding?
Mr. Roosevelt. Yes, that is my understanding.
Mr. Matsui. And what does that come to in dollar terms, do
you recall, $2.1 trillion or $2.7 trillion?
Mr. Roosevelt. Of the money to be transferred to the OASDI
Trust Funds, about $2.1 trillion would reduce the publicly held
debt.
Mr. Matsui. I guess what I was asking, maybe I didn't state
that right--but the total amount of the additional funds going
into the Social Security system would be about $5.1 or $5.2
trillion over that period up to 2055. Is that correct, or am I
wrong about that? It would be $2.7 trillion plus the debt
service savings going into it. Could you give me that number?
Mr. Roosevelt. The number I have is that the amount
transferred to the OASDI Trust Funds through 2014 would be
about $2.7 trillion. Of course, additional interest and
dividend income would come to the trust funds as a result of
this transfer.
Mr. Matsui. See, this is where I'm confused because Mr.
Aaron, who is with the Brookings Institution, has suggested
that you have $2.7 trillion of the surplus, and I just want to
get this because there's a lot of confusion out there even
among my colleagues on our side of the aisle. The figure is
$2.7 billion of the surplus that will be used to buy down the
debt.
And go ahead. I'm asking you to help me frame the question.
Mr. Roosevelt. All right. I think what we're doing here is
that $2.1 trillion of the amount transferred to the OASDI Trust
Funds would be used to buy down the debt.
Mr. Matsui. Mr. Aaron uses a figure of about $2.5 trillion
over the period of 2055. Does that number mean anything?
Mr. Roosevelt. He is an economist which I am not, so I
think that that number probably does mean something. But I'm
not in a position to validate it one way or another.
Mr. Matsui. Well, I'm sorry. I probably shouldn't even have
raised that. I probably was asking the wrong individual. So I
apologize to you for that. I just wanted to try to clarify it,
and obviously I haven't been able to, but not through your
fault.
Mr. Roosevelt. Well, thank you. I think perhaps one of the
other witnesses who is an economist will be able to.
Mr. Matsui. I have no further questions. Thank you. I yield
back.
Mr. Archer. The gentleman yields back the balance of his
time.
Mr. Becerra.
Mr. Becerra. Thank you, Mr. Chairman. Mr. Roosevelt, let me
just ask you one or two questions, and then I'll yield back my
time. Dr. Pinera in his testimony earlier today mentioned that
the President's proposed universal savings accounts were not
really universal, or at least he made that statement that they
weren't really universal. And one of those reasons was that you
couldn't use the money for whatever purpose you chose. They
weren't really private accounts with private decisionmaking
vested in the individual.
Can you explain to me if there is a universal character or
give me your comment on whether or not there's a universal
character to the USA accounts that the President has proposed?
Mr. Roosevelt. The USA accounts, as the President has
suggested them, are intended to be for retirement security as
I'm sure you're aware, Congressman. It has always been intended
in the planning of the Social Security system that there be
three parts to retirement security with Social Security as a
foundation, private pensions for those who have access to them,
and private savings for retirement as opposed to other things
that it's perfectly worthwhile to have private savings for.
So the universal savings accounts that the President has
suggested are for retirement security. They're separate from
Social Security, but they're still intended for retirement
security.
There are in other models around the world--Australia, for
example, which I discuss in my statement, has accounts that can
be used for any purpose, and they meet a more pure private
account approach. But they don't necessarily meet the
retirement security test. In Australia, the majority of people
retire at 55 and spend down their entire account by the time
they're 65, at which time they become eligible for a generous
means-tested age pension. That's not what we're aiming for in
this country. We're aiming for dealing with people's longevity.
Mr. Becerra. A final question. The situation in Chile last
year evidently there were statements made by high-level
government officials and those who ran the private accounts or
the investment funds that some individuals should hold off in
retiring until a later date until the market recovered a bit.
Give me a little bit more detail on that because I know Mr.
Pinera seemed to indicate that he wasn't--when Mr. Matsui asked
him about that, he didn't at least indicate that he was in
agreement with what Mr. Matsui was saying with regard to that.
Mr. Roosevelt. Yes. Well, of course, Mr. Pinera has been
here in Washington in recent years. Patricio Tambolini who is
the Deputy Secretary of Social Security who actually runs the
system now in Chile has made the suggestion publicly and in the
press in Chile that people not retire in the near future
because the accounts have declined, and that they should wait
and hope that they recover.
Mr. Becerra. What's the effect of that? What do you mean by
they declined?
Mr. Roosevelt. The actual value of the accounts in 2 of the
last 4 years has had a negative rate of return so that some
workers will have suffered from their accounts actually going
down rather than building up for their retirement.
Mr. Becerra. Would it cause a situation where if you have
two similar individuals, two twin brothers who have worked the
same amount of years, same type of employment, same amount of
investment. One chooses to retire on x date when the fund, the
market is still doing fairly well, then another chooses to
retire at a later point in time when the market has gone down.
Even though they have similar records that they would be
receiving different types of retirement pensions?
Mr. Roosevelt. That is the problem that they would face if
one retired in 1995 when there had been a number of good years,
he would have done much better than his twin brother who
retired in 1998 when there had been 2 out of 3 bad years and
had not regained the losses.
Mr. Bacerra. Thank you. Thank you, Mr. Chairman. I yield
back.
Mr. Shaw. Mr. Chairman.
Chairman Archer. Mr. Shaw.
Mr. Shaw. I'd like to go back to some of the earlier
questioning because there's some other testimony that's been
received that would really conflict with the testimony of this
particular witness. I want to see if I can try to get it
straightened out.
Earlier, the witness right before you, Mr. Crippen,
testified that the debt ceiling was actually going to increase
under the President's program. I believe you were in the room
and heard him testify to that. I have here the testimony of
David Walker before the Senate Finance Committee on February 9,
just a few days ago.
And he not only testifies as to the increase of the debt,
but he shows a graph where the increase is far above the
baseline. Now how do you reconcile that with your response that
you just had to Mr. Matsui's question with regard to how you
were going to finance that, I think that you said savings on
the servicing the debt. Do you stick with that testimony
despite the fact that clearly--according to these--we're going
to see increased debt under the President's program?
Mr. Roosevelt. I do, Congressman, because what the
President's framework would do is pay down the publicly held
debt. The increase in the overall debt including government
obligations to the trust fund simply acknowledges the debt that
we already have to meet our obligations.
And actually, Mr. Walker did speak to that on February 9,
and he said that debt held by the public and debt held by the
trust funds represent very different concepts. Debt held by the
public approximates the Federal Government's competition with
other sectors in the credit markets, and this affects interest
rates and private capital accumulation and further interest on
the debt held by the public is a current burden on the
taxpayers.
In contrast, debt held by the trust funds performs an
accounting function. It does not compete with private sector
funds in the credit markets.
Mr. Shaw. Let me respectfully disagree with you. I think
you were talking about obligations of the Federal Government to
the trust fund. It has the full faith and credit of the Federal
Government.
Now how do you differentiate that from what's owed the
public? It's money that's owed. Isn't that correct?
Mr. Roosevelt. They certainly are obligations, and there's
no suggestion here that we would ever renege on that. It's a
question of whether this----
Mr. Shaw. We're talking about total debt. And whether it's
due to the trust fund or due to the public as a whole, it's
still debt of the Federal Government which has to be accounted
for. And it does go above the baseline, and it does increase
the debt.
Mr. Roosevelt. There's no question but that it does do
that. On the other hand, as Mr. Walker pointed out, the
President's proposal reduces debt held by the public which
reduces net interest cost, raises national saving and
contributes to future economic growth.
Mr. Shaw. Well, I would suggest that the statement that you
have made in the context that you made it in reply to Mr.
Matsui is simply false. It's simply not true that this is all
going to be all paid off and taken care of, because of the fact
that you've reduced the public debt, and that you're not going
to have the expense of this debt when this debt is still due to
the trust fund.
Mr. Roosevelt. It's certainly true, Congressman, that
compared to current law, the debt ceiling would have to
increase. On the other hand, any way in which we spend the
surplus would bring about the same result. So the only way that
would not happen is if we used the surplus only to reduce debt.
Mr. Shaw. You know, it's very curious. One thing you talk
about as far as putting that money into the trust fund in the
first place or putting that surplus because we pump it out the
other end and take in Treasury bills. So that money's sitting
out there again.
You could pump it through several more times, couldn't you?
Mr. Roosevelt. I don't--that's not my understanding. Now
I'm not a budget expert. I believe that's my colleagues at OMB
or Treasury.
Mr. Shaw. I mean, from an accounting standpoint, if you do
it again, I mean, the money's back. So you can either pay down
the debt, or you can run it through the trust fund again and
create more IOUs.
Mr. Roosevelt. Once it's used to spend down public debt----
Mr. Shaw. This is the problem with the system that we have,
and it shows how it is subject to gimmicks--and it's nothing
but a gimmick. What we need to look at and concentrate on on
our whole discussion with regard to this is cash flow. And that
means we have to concentrate on that point in time when there
is not enough money coming into the Social Security Trust Fund
to pay its obligations. And that's what we've got to look at
because beyond that point, it's just a question of the
obligation of the taxpayers of this country, and it changes a
whole nature of the system that your grandfather created.
Mr. Roosevelt. I think we can agree that that's why we need
to work toward a bipartisan solution.
Mr. Shaw. Good way to end. Yes, sir.
Chairman Archer. Thank you very much, Mr. Roosevelt.
Mr. Roosevelt. Thank you for the opportunity, Mr. Chairman,
Members of the Committee.
Chairman Archer. We will continue to be working with you in
your capacity over at SSA in trying to resolve this on a
bipartisan basis.
Mr. Roosevelt. I'm very much looking forward to it, and I
appreciate the opportunity to have had a discussion with you
earlier this afternoon as well.
Chairman Archer. Thanks. Mr. Shaw will preside over the
hearings for the rest of the afternoon.
Mr. Shaw [presiding]. We have three more witnesses. Would
there be any objection to hearing them as a panel? I would like
then to invite the three remaining witnesses to the witness
tables as a panel. Dr. Peter Orszag who's president of Sebago
Associates from Belmont, California.
We have Professor Eric Kingson who is from the School of
Social Work at Syracuse University, Syracuse, New York. And
Stephen Kay, economic analyst, Latin America Research Group,
Federal Reserve Bank of Atlanta, Georgia.
We have the testimony of each of you which will be made a
part of the record without objection. And we would invite you
to summarize as you might see fit.
Dr. Orszag.
STATEMENT OF PETER R. ORSZAG, PRESIDENT, SEBAGO ASSOCIATES,
INC., BELMONT, CALIFORNIA
Mr. Orszag. Thank you. Mr. Chairman and Members of the
Committee, my name is Peter Orszag. In addition to running an
economics consulting firm, I teach economics at the University
of California at Berkeley.
It is an honor to appear before this Committee to discuss
Social Security reform and the lessons that we may be able to
draw from other countries' experiences. My testimony will focus
on the United Kingdom which is the only G-7 economy with direct
experience in individual accounts, and a country that has
adopted partial privatization. So unlike Chile, the United
Kingdom has moved partially to privatization. It, therefore,
provides a unique environment for us to study the operation of
such accounts.
The key point of my testimony is that a decentralized
approach to individual accounts has proven to be quite
expensive in the United Kingdom, significantly more expensive
than previous estimates have suggested and significantly more
than anyone would have predicted based on the costs of similar
financial products in Britain.
As my written testimony notes, there are three sources of
cost in any system of individual accounts. I want to focus
briefly on the component I call transfer costs since that is
the one most frequently overlooked.
Transfer costs measure the costs from switching financial
providers during a working career. Most previous analyses have
ignored the cost of transferring funds. The evidence, however,
suggests that they are significant.
In the United Kingdom, annual management fees are often
frontloaded, and individuals charge more for the first year or
two in the account than for subsequent years. Such frontloading
is at least partly due to the cost of acquiring and advising
new customers which itself is the result of the complexity and
decentralized nature of the system.
To see how such frontloading could affect total costs over
a working life, consider the following example. Assume, again,
just as an example, that a firm charges $300 for the first year
that an individual is in an account and $50 for each additional
year. Then an account held for 40 years with a single provider
would cost an average of $56.25 per year.
But an account held for 20 years with one provider and then
20 years with another provider would cost an average of $62.50
per year. More frequent switching would produce higher average
costs per year.
If one ignored the fact that workers transferred accounts
as previous estimates have, costs would appear to average
$56.25 per year, but that would underestimate the charges that
were actually paid by the worker who transferred the account.
As the example illustrates, transfer costs are only
relevant if workers actually switch accounts. The evidence from
the United Kingdom suggest that they do so relatively
frequently. Of all the individual accounts held in 1993, 40
percent were transferred by 1997. So very frequent transfers.
As part of a World Bank project, two colleagues and I have
constructed a detailed database of firm level costs on
individual accounts in Britain. This project is documenting the
transfer costs I have mentioned along with other sources of
costs in the U.S. system.
While our results are not yet final, our bottom line is
that a decentralized approach to individual accounts like the
one in the United Kingdom is expensive. Again, much more so
than previous estimates have suggested, much more so than the
20-percent figure that was mentioned this morning, and much
more so than we would have predicted based on other similar
financial products in Britain.
Therefore, in addition to evaluating the fundamental issue
of whether individual accounts should be adopted, it is
critical to evaluate what type of individual accounts should be
created if the Nation decides that such accounts are a good
idea in general.
In making such decisions, I hope the U.K. experience with
decentralized accounts proves helpful to you. Finally, I would
like to note two other lessons from the United Kingdom. First,
costs can be imposed on consumers in a wide variety of ways,
and consumers often don't understand all of the charges that
are imposed.
As one market analyst in the United Kingdom has argued,
``Pension plans have a blithering array of charges including
bid offer spreads, reduced allocations of premiums, capital
units and levies, annual fund charges, policy fees and
penalties on transfers, early retirement and other events. In
examining the administrative costs of individual accounts, we
must, therefore, be careful to include all such costs.'' That
is the purpose of our World Bank project.
Second, investor protection and investor education are very
important, as the so-called misselling schedule illustrates. In
that scandal, financial providers gave misleading advice to
thousands and thousands of U.K. holders of individual accounts
and are now being forced to provide an estimated $18 billion in
compensation to the individuals who were misled.
Thank you, Mr. Chairman, and I would welcome your questions
following other remarks.
[The prepared statement follows:]
Statement of Peter R. Orszag,\1\ President, Sebago Associates, Inc.,
Belmont, California
Mr. Chairman and members of the Committee, my name is Peter
Orszag. In addition to running an economics consulting firm, I
teach economics at the University of California, Berkeley.\2\
It is an honor to appear before this committee to discuss
Social Security reform and the lessons that we may be able to
draw from experiences in other countries. My testimony will
focus on the United Kingdom, which is the only G-7 economy with
direct experience in individual accounts. It therefore provides
a unique environment in which to study such accounts, which are
perhaps the most contentious issue in the Social Security
debate here.
---------------------------------------------------------------------------
\1\ Peter Orszag is the President of Sebago Associates, Inc., and a
lecturer in economics at the University of California, Berkeley. He
served as Special Assistant to the President for Economic Policy at the
National Economic Council, and as a Senior Economist and Senior Advisor
on the Council of Economic Advisers, from 1995 to 1998. He holds a
Ph.D. in economics from the London School of Economics.
\2\ During the current or preceding two fiscal years (the period
covered by the Rules of the House), Sebago Associates, Inc., has held
two contracts with the Federal government. One contract, which is no
longer active, was to assist the Office of Policy Development in
technical preparations for the White House conference on Social
Security. Another contract, which remains active, is to provide
economic analysis on Social Security to the Securities and Exchange
Commission. Neither contract has provided funding for the detailed
analysis of administrative costs in the U.K. individual account system
that forms the basis of this testimony. The project on U.K.
administrative costs is funded through a contract held by Sebago
Associates, Inc., with the World Bank.
---------------------------------------------------------------------------
My testimony this morning has two purposes:
To describe the U.K. system of individual
accounts, and
To discuss a World Bank study that I am conducting
with two colleagues on administrative costs in the U.K., and
examine why previous studies have underestimated those costs
One of the key points of my testimony is the importance of
comprehensively measuring the administrative costs associated
with individual accounts. These administrative costs are
important because, all else equal, they reduce the net return
investors receive on their contributions. A comprehensive
approach to measuring costs is particularly important in
situations, such as in the U.K., in which costs are imposed in
a baffling variety of ways.
As part of a World Bank project on administrative costs in
the United Kingdom, Dr. Mamta Murthi (of the World Bank), Dr.
Michael Orszag (of Birkbeck College in London), and I are
completing a detailed study applying this comprehensive
approach to U.K. data. In particular, we have constructed a
detailed database of firm-level charges on individual accounts,
which is an important step forward in understanding both the
level and causes of such costs. We hope to release a summary of
our results in several weeks. Our preliminary estimates
indicate that the administrative costs on individual accounts
in the U.K. are significantly higher than previous estimates
have suggested.
The evidence from the U.K. suggests that, in the debate
over individual accounts in the United States, it is
particularly important to consider the structure of any such
accounts. The U.K. has adopted a decentralized approach to
individual accounts, in which workers hold individual accounts
with private financial firms, with no regulations on fees. That
approach has generated high administrative costs. Other
approaches to individual accounts--such as a centralized
approach modeled after the Thrift Savings Plan--would likely
involve lower administrative costs.
My testimony concludes with a brief discussion of the
lessons that American policy-makers could draw learn from the
British experience.
I. Overview of the U.K. Social Security system
Since 1988, the British government has allowed individuals
to opt out of the state-run Social Security system and into
individual accounts. The state-run system consists of two
tiers: a flat-rate basic state pension and an earnings-related
pension. The first tier is provided through the government to
all workers who have contributed to the system for a sufficient
number of years. The second tier, which can be managed by an
individual, his or her employer, or the government, depends on
an individual's earnings history.
Tier I benefits
The first tier of the U.K. Social Security program is
called the Basic State Retirement Pension (BSP). Under the BSP,
a portion of the National Insurance Contribution (NIC) payroll
tax finances a flat-rate benefit for retirees. In other words,
this basic benefit is the same for all qualified retirees,
rather than varying with an individual's earnings history. The
full benefit payments amount to about $105 per week per person.
The BSP is similar to the ``flat benefit'' that was proposed as
part of the Personal Security Account plan, one of the three
plans put forward by the Gramlich Commission in 1997. (Under
that plan, the flat benefit would have been initially set at
$410 monthly in 1996, roughly the same amount as the BSP in
Britain.)
Tier II benefits
The second tier of the U.K. system offers three different
alternatives to workers: the government-run system (SERPS),
individual accounts, or employer-provided accounts.\3\ Those
who choose either of the latter two options receive a rebate on
their payroll taxes that is then deposited into either an
individual account or employer-provided pension. In this sense,
the system is similar to some of the voluntary opt-out
proposals for individual accounts in the United States (e.g.,
the Moynihan-Kerrey bill). The options for the second tier are:
---------------------------------------------------------------------------
\3\ The self-employed are not required to participate in the second
tier (earnings-related) component.
---------------------------------------------------------------------------
SERPS. Roughly one-quarter of British workers
currently choose the most basic option, the state-run State
Earnings-Related Pension Scheme (SERPS). SERPS is similar to
the U.S. Social Security system: it is a publicly funded pay-
as-you-go system, with benefits based on earnings history and
funding provided by the NIC payroll tax.
When it was first introduced in 1978, SERPS was relatively
generous. Over time, however, reforms have made the program
less attractive, especially to middle- and upper-income
workers. The maximum SERPS benefit is currently about $200 per
week, and the average benefit is under $30 per week. The
majority of Britons who remain enrolled in SERPS today earn
less than $15,000 annually.
Individual accounts. Individuals can opt out of
the SERPS system by opening an Appropriate Personal Pension
(APP), which is an individual account held with a private
financial firm. About 25 percent of workers in the U.K.
currently hold such individual accounts.
Employer-based pensions. Individuals can also opt
out of the SERPS system by participating in an employer-
sponsored pension plan. About half of all workers participate
in such plans plan (often referred to as ``occupational
pensions''). Roughly 85 percent of all employer pension plans
in the U.K. are defined-benefit plans--a higher percentage than
in the United States.
The U.K. system thus allows workers to choose among the
state-run pay-as-you-go system, individual accounts, and
employer-provided pensions.
Individual accounts in the U.K. and the mis-selling controversy
Since it provides the only example of individual accounts
among the G-7, and since it is very similar in culture and
general outlook to the U.S., the U.K. may offer particularly
trenchant lessons for the debate here. This section therefore
explores the British individual account system in more detail.
About one-quarter of workers in the U.K. opt out of the
state-run system and into individual accounts. The government's
payroll tax rebate finances contributions into individual
accounts equivalent to roughly 3 percent of average (mean)
annual earnings for workers covered by the U.S. Social Security
system. Roughly half of account holders contribute an
additional amount on top of the government rebate. Thus, the
contributions being deposited into individual accounts in the
U.K. are at least as large as those being considered for
individual account plans in the United States.
British workers can hold individual accounts with a variety
of financial firms. The system is thus decentralized, with
significant marketing and advertising costs. It lacks the
economies of scale in administrative costs that a more
centralized system could offer.
The market in the U.K. is dominated by insurance firms,
largely because insurers can offer certain related products
(e.g., annuities). It is also very competitive, a fact
underscored by the withdrawal of several high-profile firms
from the market because of keen competition. For example, in
the face of intense competition, Fidelity withdrew from the
personal pension market in 1993 and transferred its existing
accounts to another provider. But it is worth noting that
strong competition has not resulted in low administrative
costs, as discussed below.
Competition has sometimes been taken to extremes, however.
Perhaps most notably, misleading sales practices created the
so-called mis-selling controversy. When individual accounts
were introduced in 1988, few analysts thought that they would
present regulatory difficulties. After all, the British
financial services industry was, by and large, a reasonably
safe place to invest, and the 1986 Financial Services Act had
established a system of self-regulation combined with heavy
penalties for conducting unauthorized investment business.
As it turned out, however, the U.K. experienced substantial
difficulties with the movement to individual accounts. In what
has become known as the mis-selling controversy, high-pressure
sales tactics were used to persuade members of good
occupational pension schemes (especially older, long-serving
members) to switch into unsuitable individual accounts. Many of
these people switched from a good occupational scheme into an
individual account less favorable to them. Sales agents had
often sought too little information from potential clients, and
then provided misleading information to those clients. Their
firms did not keep adequate records to defend themselves
against subsequent mis-selling claims. Miners, teachers, and
nurses with relatively generous occupational pensions were
among the main targets of sales agents.
In reaction to the controversy, the U.K. government has
imposed stricter rules for providing advice on the transfer of
funds from occupational to individual accounts, required
providers to disclose their fees and commissions, and insisted
that the firms compensate investors who had been given bad
advice. Total compensation is projected to amount to 11 billion
($18 billion) or more. Despite these steps, there is some
evidence of continuing problems. For example, an undercover
investigation by the Guardian newspaper in London recently
discovered that, ``Britain's biggest life assurer, the
Prudential, was at the centre of a new controversy last night
after a Guardian investigation revealed it is continuing to
attempt to mis-sell pensions.'' Prudential agents engaged in a
variety of prohibited activities, such as quoting future growth
figures banned by the Financial Services Act and showing
deliberately misleading statistics to reporters from the
Guardian.\4\
---------------------------------------------------------------------------
\4\ The Guardian, August 10, 1998.
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II. Administrative and other costs in a system of individual
Individual accounts are perhaps the most controversial
issue in the current debate over Social Security reform in the
United States. And the administrative costs associated with
such accounts are particularly contentious, with proponents
claiming that costs will be relatively low and opponents
claiming that costs will be high.
Costs can be imposed on consumers in multiple ways, and
therefore measuring them accurately is complicated. This
problem is particularly acute in the U.K. The Congressional
Budget Office, in a recent report, noted that in Britain,
``Given the variety of plans and portfolios, clearly assessing
the overall cost of fees and commissions is difficult.'' \5\
Another market analyst has argued that, ``Pension plans have a
bewildering array of charges, including bid/offer spreads,
reduced allocations of premiums, capital units and levies,
annual fund charges, policy fees and penalties on transfers,
early retirement, and other events.'' \6\
---------------------------------------------------------------------------
\5\ Congressional Budget Office, Social Security Privatization:
Experiences Abroad, January 1999, page 92.
\6\ John Chapman, ``Pension plans made easy,'' Money Management,
November 1998, page 88.
---------------------------------------------------------------------------
Our approach to the myriad variety of costs in an
individual account system is to compute a summary charge ratio.
The charge ratio reflects all the various costs imposed on
account holders and expresses them on a comparable basis. It
does this by measuring how much of an individual account's
value is dissipated by costs over an entire working life--
regardless of the source of the cost. A charge ratio of 20
percent, for example, indicates that administrative and other
costs reduce the value of an account by 20 percent over a
typical career, relative to an account with zero administrative
costs.
It is important to note that charges can be high because
profits are high or because underlying costs are high. The
competitiveness of the individual account market and the exit
of some providers suggest that the market is not excessively
profitable. It is thus likely that the charge ratio primarily
reflects underlying costs, rather than unusually high profits
for providers. Some examples of the underlying costs affecting
the charge ratio include sales and marketing; fund management
charges; regulatory and compliance costs; record-keeping; and
adverse selection effects.
A decentralized approach to individual accounts, like the
one in the U.K., is expensive. And all the costs are reflected
in the charge ratio.
Decomposing the Charge Ratio
The charge ratio can be broken down into three components,
corresponding to the costs charged by a single financial
provider during a working life (accumulation ratio); additional
costs from switching financial providers during one's working
life (transfer ratio); and costs upon retirement from
converting the account into an annuity (annuity ratio).
1. The accumulation ratio captures fund management and
administrative costs for a worker contributing funds to a
single financial provider throughout her career. It does not
include any costs from switching providers (which are instead
captured by the transfer ratio).
2. The transfer ratio measures the costs from switching
funds during a working career. It is computed as the ratio of
funds received at retirement by an individual switching
providers during a working career, to the funds that would have
been received at retirement by the same individual if she had
not switched providers at all. It does not include the ongoing
costs of holding an account with a specific provider (which are
captured by the accumulation ratio). Most previous analyses
have ignored the costs of transferring funds. The evidence,
however, suggests that such costs are significant.
3. The annuity ratio reflects the losses from annuitizing
an account upon retirement. It measures the ratio of private
annuity yields to theoretical yields from population mortality
tables. Annuity costs reflect both adverse selection (that
those choosing to purchase annuities tend to have longer life
expectancies than the general population) and cost loadings
(administrative costs of providing annuities, which are over
and above the administrative costs captured by the accumulation
ratio).
Previous cost estimates--both for the U.K. and other
countries with individual accounts--have not included all these
components. They have therefore underestimated charges. For
example, it is often noted that accumulation costs in the U.K.
and elsewhere average about 100 basis points per year, and they
reduce the value of an individual account by 20 or 25 percent
over a typical career. This figure, however, does not
incorporate the effects of transfer costs and annuitization
costs.
A comprehensive approach to measuring costs--as well as
benefits--is essential to evaluating properly the pros and cons
of individual accounts, and the various ways of structuring
such accounts. And a comprehensive approach to costs must
include all three components of the charge ratio: accumulation,
transfer, and annuitization costs. Only by including all the
relevant factors can we make an informed choice about different
approaches to Social Security reform.
I want to focus briefly on the transfer cost, since it is
the component most frequently overlooked. The experience in
Chile has indicated that transfers across Administradora de
Fondos de Pensiones (AFPs), the individual account providers in
Chile, occur relatively frequently. But in Chile, the fee
structure is regulated. And under the typical method of
charging fees, transfers do not impose additional costs on
consumers: Deposits in the AFPs are charged a one-time
contribution fee when the initial deposit is made, but are not
subject to subsequent fees even if the account is transferred
to another provider. That fee structure obviates the need to
worry about transfer costs, since costs do not depend on
whether the account is held with a single AFP or switched many
times over a career.
In the U.K., by contrast, costs often do depend on whether
accounts are transferred. In particular, management fees are
often front-loaded: an individual is charged more for the first
year or two in an account than for subsequent years. The front-
loading is at least partially the result of the complexity and
decentralized nature of the system, which raises the costs of
customer acquisition (through marketing costs, commissions to
advisers and salespeople, and the cost of providing accurate
and disinterested information to those interested in
switching).
Financial providers in the U.K. impose transfer costs in a
variety of ways. For example, some (albeit only a small number)
charge an explicit fee on those leaving a fund. Some impose a
``capital levy,'' in which contributions for the first year or
two are termed ``capital units'' that have substantially higher
costs than subsequent ``accumulation units.'' Although this
practice is becoming less common, it is still used by several
insurance companies. The FT Personal Pensions 1998 handbook
recently argued that ``the ONLY reason for having capital or
initial units is so that the planholder will not realise
exactly what the charges are.'' \7\ These types of fee
structures impose additional costs on those transferring
accounts, despite the claim by many financial providers in the
U.K. that they impose no such additional charges.
---------------------------------------------------------------------------
\7\ Financial Times, Personal Pensions (Pearson Professional,
1997), page 9.
---------------------------------------------------------------------------
To see how front-loading could affect total costs over a
working life, consider the following example. Assume, merely as
an example, that financial firms charge $300 for the first year
of an account, and $50 for each additional year. Then an
account held for 40 years with the same provider will cost an
average of $56.25 per year, but an account held for 20 years
with one provider and then 20 years with another provider will
cost an average of $62.50 per year. More frequent switching
would produce even higher average costs. For example, switching
three times would generate an average cost of $75.00. If one
ignored the fact that the worker switched providers, costs
would appear to average $56.25 per year, which would
underestimate the charges for the worker who transferred
accounts.
As the example illustrates, transfer costs only raise costs
if individuals switch providers--and raise costs more the more
frequently individuals switch. The evidence suggests that they
do so relatively frequently. According to data from the 4th
Personal Investment Authority's Persistency Survey, of all the
regular premium personal pensions sold by company
representatives and held with financial companies in 1993, 14.5
percent were transferred within one year, 25.4 percent were
transferred within two years, 33.8 percent were transferred
within three years, and 39.4 percent were transferred within
four years. In other words, roughly 40 percent of the
individual accounts held in 1993 were transferred within four
years.
The impact of such transfers on costs, moreover, can be
significant. A recent Money Management survey published in the
U.K. concluded that--including the costs of transferring
accounts--the annual cost would be roughly 250 basis points.\8\
Over the course of a working career, an annual fee of 250 basis
points would consume substantially more of the funds in an
account than the 20 or 25 percent figure often cited for
privately managed individual accounts. (That 20 or 25 percent
figure is predicated on an annual cost of 100 to 125 basis
points. It reflects only accumulation costs, and excludes both
transfer costs and annuitization costs. The Money Management
article finds a much higher figure merely by including transfer
costs. It excludes annuitization costs, which would raise the
total cost even further.)
---------------------------------------------------------------------------
\8\ John Chapman, ``Pension plans made easy,'' Money Management,
November 1998, page 88.
---------------------------------------------------------------------------
In the paper we expect to release by early March, my co-
authors and I will document these transfer costs, along with
the other two sources of costs (accumulation and annuitization
costs) in the U.K. system. Again, our preliminary results
indicate that costs are significantly higher than previous
estimates have suggested.
III. Conclusion
Accurately measuring the costs associated with individual
accounts is crucial to a full and fair evaluation of whether to
create such accounts, and, if so, how to structure them. A
comprehensive measure of costs in the U.K. suggests that these
costs are high, and significantly higher than previous
estimates have suggested.
Costs depend on the structure of individual accounts. For
example, some proposals for individual accounts in the United
States would aggressively take advantage of potential economies
of scale through centralized provision (as in a Thrift Savings
Plan approach, under which workers would hold their accounts
with a single or limited number of providers). Others would
allow individuals more choice through decentralized provision
(as in an Individual Retirement Account approach, under which
individuals would be allowed to choose their own financial
provider). Furthermore, the individual accounts could be
mandatory or voluntary, and fee structures could be regulated
or unregulated. It is therefore worth emphasizing that:
The U.K. system involves decentralized, privately
managed accounts and annuities. Most analysts agree that such a
system is substantially more expensive than a centralized
system (such as the Thrift Savings Plan for Federal government
employees in the United States).\9\ A centralized system would
obviate the transfer costs highlighted in my testimony, as well
as the incentives to mislead consumers that created the mis-
selling controversy in the U.K. Such benefits, however, may
come at the potential cost of reduced choice for consumers.
---------------------------------------------------------------------------
\9\ See, for example, Estelle James, Gary Ferrier, James Smalhout,
and Dimitri Vittas, ``Mutual Funds and Institutional Investments: What
is the Most Efficient Way to Set Up Individual Accounts in a Social
Security System?'' presented at NBER Conference on Social Security,
December 4, 1998; and National Academy of Social Insurance,
``Evaluating Issues in Privatizing Social Security, Report of the Panel
on Privatization of Social Security,'' Washington 1998, available at
www.nasi.org.
---------------------------------------------------------------------------
The U.K. system of individual accounts and
annuities is voluntary. In the U.K., individuals can choose
whether to participate in the system of individual accounts and
annuities. Mandatory accounts and annuities might lead to
reduced adverse selection effects and less complexity. The
effect of a mandatory approach in reducing costs, however, is
difficult to assess. It is likely to be most significant in
reducing the adverse selection costs associated with
annuities--which is not a substantial component of the total
charge ratio in the U.K. It is thus relatively unlikely that a
mandatory approach (as long as it remains decentralized) would
have dramatically different costs from the U.K.
The U.K. system does not regulate fees. In Chile,
AFP fee structures are regulated: AFPs can impose only certain
types of fees on customers. The U.K. system does not have such
regulations (although it does have new disclosure requirements
on fees). The lack of fee regulation in the U.K. has produced a
wide variety of fees, many of which consumers do not fully
understand, and has also facilitated front-loaded costs that
impose additional costs on individuals switching accounts.
Regulating the fee structure may address some of these
concerns, albeit at the potential cost of reduced supply (if
the fee regulations are too restrictive, providers may be
unwilling to offer accounts to customers). In considering
whether to regulate fees, it is important to remember that fees
are high fundamentally because a decentralized, privately
managed system is expensive to run. Fee regulations cannot
change that. If costs are high, but fee regulations do not
allow financial firms a reasonable return on their activities,
we are unlikely to see many financial firms participating in
the market. Fee regulations thus offer a temporary palliative,
not a full long-term solution, to high underlying costs.
It is perhaps instructive that because of the mis-selling
controversy and the high administrative costs of individual
accounts, the system of privately managed individual accounts
may be losing favor even in Britain. The U.K. government
recently released a Green Paper that advocates reducing the
incentives for low earners to opt out of SERPS and into
individual accounts, while also creating a new type of
employer-provided pension with regulated fees that is designed
for middle-income workers.
The U.K. experience thus vividly warns us that if
individual accounts were adopted in the United States, we would
have to pay careful attention to their design to ensure that
administrative and other costs are not unduly high, and to
avoid the regulatory failures associated with misleading sales
practices. The study that I am completing with my colleagues
from the World Bank and Birkbeck College will provide a more
detailed examination of the administrative costs. But one
lesson is already clear: A privately managed approach is likely
to produce high administrative costs, and unless it is overseen
by a strong and effective regulatory body, could result in
abuses similar to the mis-selling controversy. In addition to
evaluating the more fundamental issue of whether individual
accounts should be adopted, it is therefore critical to
evaluate what type of individual accounts should be created if
the nation decides that such accounts are a good idea in
general. In making such decisions, I hope the U.K. experience
proves helpful to you.
Thank you, Mr. Chairman. I would welcome questions from you
or other members of the Committee.
Mr. Shaw. Dr. Kingson.
STATEMENT OF ERIC KINGSON, PROFESSOR, SCHOOL OF SOCIAL WORK,
SYRACUSE UNIVERSITY, SYRACUSE, NEW YORK
Mr. Kingson. Thank you, Mr. Chairman. It's a pleasure to
appear before this distinguished panel.
My name is Eric Kingson. I'm a professor at the Syracuse
University School of Social Work. I've previously served as
staff to two commissions that have looked at Social Security
reform issues. With your permission, I will enter my written
testimony for the record, and summarize key points in the
verbal testimony.
I think you've wisely chosen to look at the foreign
experience. I will do my best to offer a few suggestions.
One lesson that comes from the foreign experience is that
we're really not alone, and we're really not that bad off
either. Most industrialized nations are experiencing population
aging, as tables 1 and 2 suggest, and in fact, their rates of
population aging are much greater than our own. They anticipate
higher rates of so-called age dependency rates in 2030.
Second, that more people are reaching old age and living
longer once getting to old age is a success. It's not a crisis.
It's a challenge. It's not a defeat.
I have to say that some of the presentations today, almost
sound as if we had done something horrible by spawning the
largest healthiest group of old people in the world--that
population aging worldwide is a disaster, that it doesn't
represent the best of what nations have done in terms of
investing in public education, biomedical research in terms of
opening up opportunities for life with a future, that somehow
it has created a crisis that we have to manage. In my judgment,
this emphasis on crisis is often used to argue for radical
reform to Social Security rather than calling for more
realistic assessments of how to address population aging and
the real pressures it creates on pension systems.
There's another lesson. I don't think we're doing so bad as
a country. When we look at our statistics relative to other
industrial nations, our per capita GDP are considerably higher.
In 1996, per capita GDP in the United States was $28,000
compared to $21,000 in Germany, and $19,000 in the United
Kingdom.
Our population is generally younger. Government expends
considerably less of the GDP--all sources of government--than
is true in the great majority of other highly industrialized
nations. And we've entered a period of relatively favorable
budget circumstances and relatively favorable economic growth.
In short, we're well positioned to address some of these
challenges, and we ought to think about how much we have done
positively and not overstate the worries associated with
population aging.
Third, this is fundamentally a discussion of values, and
that hasn't been well acknowledged. There are competing views
of the extent to which retirement income protection for
Americans should be based on shared responsibility through a
social insurance mechanism, or on a more privatized approach in
which individuals are entirely responsible for their
retirement, disability and survivorship.
Part of the discussion and part of the framing of the issue
relates to that. We've heard from Mr. Pinera this morning. As
he makes clear, application of the Chilean model would create a
very different system. He describes the need for reform. Mr.
Pinera says a specter is haunting the world. It is, he says, a
``specter of bankrupted, state-run pension systems. The pay-as-
you-go pension system has reigned supreme through most of the
century, but it has a fundamental flaw, one rooted in false
conceptions of how human beings behave. It destroys at the
individual level.''
Well, that's a point of view, and it has its merits. But
it's a very different point of view from those who would
suggest that we ought to have a mixed retirement income system
as we do today as opposed to substantially individual
responsibility at its base.
Now I think if I believed all that I had heard this
morning, I would be very inclined to not give my testimony
today. We've heard wonderful things about the virtues of
privatization. But we haven't looked at any of the downsides,
and we haven't looked at any of the costs. What are we willing
to give up to move to private accounts? Are we willing to give
up the mild redistribution that exists within Social Security
that protects low-income workers? We don't have a lot of
experience worldwide with these private approaches--only 10,
15, 20 years, and in short, we have a paucity of data on how
they would work if applied to this large country of ours.
We do, however, have an interesting experiment going on in
the State of Texas in three counties which gives some idea of
some of the problems that might result from any kind of
privatization.
In January 1981, three counties withdrew their public
employees from Social Security--Galveston, Matagorda and
Brazoria counties. The Galveston plan covers roughly 3,500
current employees and 5,000 former employees. Contribution
rates are set slightly above the combined payroll tax
contribution rates for Social Security. The funds are invested
conservatively, and they've yielded a rate of return roughly
the same as the Social Security system over this period of
time, a little bit less.
The virtues of the Galveston plan--as are the virtues of
all these privatizations around the world--have been talked
about by those who would encourage a full privatization and a
shrinking from some of the traditional commitments in Social
Security.
The Cato Institute mentions that retirees are receiving far
greater benefits under this plan than they would have gotten
under Social Security. Another think tank, the National Center
of Policy Analysis, suggests the Galveston plan provides a much
larger postretirement income for Social Security.
Well, it sounds too good to be true. And in fact, it is too
good to be true. A more sober analysis by SSA's Office of
Policy as well as a draft GAO report discussed in USA Today
points to some of the flaws in the system.
Women and low-income workers are not well served by the
plan. This is true of many privatizations. Low-wage workers
would give up the benefit tilt that they receive in Social
Security and would receive considerably less in an asset-
accumulation system.
Spouses and divorced spouses are not covered. There are no
guaranteed benefits for widows as well. High-income single
long-term employees win in this system, and they win big
perhaps. Analysis by Social Security's Office of Policy which
we have on tables 9 and 10 of the formal testimony shows that
the distribution of benefits in the Galveston plan runs counter
to our social insurance system.
On that table, if you look at it, you'll see initially that
certain workers do much better under the Galveston system.
High-income workers who are single and very high-income workers
who are married do well initially under this plan.
But over time, their income erodes because this plan does
not provide inflation protection for workers. So that over 15
years, benefits of middle-income married workers shrink from
being 82 percent of what Social Security would provide to 52
percent. The benefits for very high-income married people
shrink from 108 percent to 69 percent.
In addition to this inflation risk, you have very
substantial longevity risks in this type of plan. You can
outlive your asset. There is no requirement that you accept an
annuity in the plan.
One of the dangers of this plan is that we could undermine
the entire notion of retirement savings. All of us like and
wish to promote savings. But to base a Social Security system
first and foremost on an asset accumulation system poses huge
dangers for the concept of retirement savings. Any one of us
could have a child who's ill faced with that kind of situation,
we would naturally want to go into our retirement savings. No
Member of Congress would consider it unreasonable to open up
the retirement savings system once developed for that kind of
an emergency. As well intentioned as that would be, we would
shortly be losing the notion of a retirement income system
altogether or risking that notion. So there are both downsides
and upsides to the various privatization approaches.
What we haven't looked at today also are some of the more
moderate reforms that might be considered in other nations, and
we haven't considered the great success of Social Security and
what it does do for the 44 million Americans, including 3
million children, who receive benefits each month.
We've also really not talked about what those Members who
I've heard advocate for privatization are willing to give up in
Social Security. As a citizen, I'd be curious to know who would
win and who would lose. Are we willing to give up benefits for
women--for married women or for spouses in order to move toward
an idealized private system?
Finally, I'd suggest we shouldn't lose sight of the moral
dimension of Social Security. A public Social Security Program,
to paraphrase former Senator Bill Bradley, is one of the best
expressions of America's community.
Indeed, much more is at stake in this discussion than bend
points, percents of taxable payrolls, years of exhaustion.
There's something at stake about the notion of what we owe each
other as a society, as a national community which ought be
brought into the discussion. It's important that in the process
of addressing long-term reform that we not lose sight of the
moral dimension of the program. Thank you.
[The prepared statement follows:]
Statement of Eric Kingson,\1\ Professor, School of Social Work,
Syracuse University, Syracuse, New York
Mr. Chairman and other distinguished members of the House
Ways and Means Committee, it is an honor to appear before your
panel.
---------------------------------------------------------------------------
\1\ Eric Kingson, Professor, School of Social Work, Syracuse
University, Sims Hall, Syracuse, New York 13244 315-443-1838
[email protected]
---------------------------------------------------------------------------
My name is Eric Kingson. I am a professor at the Syracuse
University School of Social Work. My scholarship and research
address the political and economic consequences of population
aging, including examinations of Social Security policy, the
aging of the baby boom cohorts and cross-generational
obligations. Previously, I directed a study for the
Gerontological Society of America in 1984-5 which examined
various ways of framing policy discussion about the aging of
America, and I served as an advisor to the 1982-3 National
Commission on Social Security Reform and to the 1994 Bipartisan
Commission on Entitlement and Tax Reform.
Many lessons can be drawn from the experience of other
countries with population aging and reform of their public
pension systems. I would like to bring the following to your
attention as you explore ways of addressing the financing
problems of Social Security:
Lesson: We are not alone. And we're not so bad
off, either.
Examining the foreign experience, as your Committee has
appropriately chosen to do, places our nation's concerns about
the future of Social Security in an important context. It
suggests that the population aging and pension reform
challenges our nation faces are, comparatively speaking, quite
manageable.
Industrial democracies are aging and projected to continue
to do so, but generally at a faster rate than the United
States. Comparative data published by the Organization for
Economic Co-operation and Development (OECD) indicate that
today there are approximately 19 persons aged 65 and over in
the United States per hundred persons of working ages, compared
to 18 in Canada, 24 in Germany, 24 in France, 26 in Italy, 24
in Japan and 24, in the United Kingdom. By 2030, when the
youngest of the U.S. baby boomers will reach age 65, the
elderly dependency ratio will grow to 37 in the United States,
39 in Canada, 39 in France, 49 in Germany, 48 in Japan, and 39
in the United Kingdom (see table 1). In other words, while the
elderly dependency ratio trends show increases across all OECD
countries, compared to the United States, most European OECD
countries and Japan already have a substantially larger
proportion of their population aged 65 and over. Moreover, they
anticipate further significant growth--generally at a rate that
is faster than our own--in the relative size of the elderly
population during the next 30 years (Kalish and Tetsuya,
1999).\2\
---------------------------------------------------------------------------
\2\ The total dependency ratio--the ratio in the OECD table of the
population aged 0-14 and 65 and over as a percent of working aged
persons--is perhaps a better measure of the economic pressures
associated on future workers attending to caring for non-working
persons. These data suggest that some of the cost of a growing elderly
population may be offset by the relative decline in the proportion of
the population aged 14 or under. However, much of the cost of raising
children occurs in the context of the family and government
expenditures on the old are substantially larger on a per capita basis.
Moreover, the elderly and the total dependency ratios both fail to
acknowledge changing patterns in labor force participation (e.g.,
increased participation by married women), the contributions--real and
potential--of the old to the workforce. But regardless, the same point
stands when OECD data on the total dependency ratio is examined. The
overall burden for U.S. workers is projected to increase between 2000
and 2030 at a slower rate than that of the major industrial nations and
to be equal to or lower than the dependency ratios projected for 2030.
Interestingly, our overall dependency ratio in 2030 (68) is projected
to be roughly the same as it was in 1960, when our per capita GDP and
standard of living was less than it is today and still less than what
we project for 2030.
---------------------------------------------------------------------------
Lesson: That more people are reaching old age, and
living longer, once getting there, is a success, not a crisis;
is a challenge, not a defeat.
Elsewhere and in the United States, population aging is an
indication of successful outcomes of century-long investments
in the growth of economies, education, pensions and bio-medical
and public health advances. These changes have resulted in
declines in childhood diseases and deaths earlier in the
century and in higher standards of living throughout the course
of life. Changes accompanying industrialization also contribute
to declines in fertility and to population aging. Obviously,
the expected increases in the proportion of the population that
is considered old, and in life expectancies at age 65 (see
tables 2 and 3), bring challenges. But it should not be
overlooked that they also bring new opportunities for enriched
life, continued learning and engagement through employment and
community service in the growth of economies and communities.
This is not to suggest that we do not face a significant
financing problems, needing to be addressed through prudent
policymaking. But the politics of Social Security reform is not
well-served by exaggerated claims of impending disaster brought
on by population aging.
Lesson: As a prosperous society we are well-
positioned as we cross the threshold of Social Security reform.
Our per capita income is among the highest, $27,821 in 1996
U.S. dollars, as compared to the equivalent of $20,533 in
France, $21,200 in Germany, and $18,636 in the United Kingdom
(see table 4). As noted, our population is generally younger
than that of other fully industrialized societies. Importantly,
government expends considerably less of the GDP than the great
majority of other highly industrialized societies (see tables 4
and 5) and, due in large measure to the prudence exercised by
this Committee, we have entered a period of relatively
favorable growth and government budgeting. Other nations carry
much higher tax burdens than the United States (see tables 5
and 6). Our federal expenditures, as a percent of GDP, are
generally much lower than other OECD nations--21.6 percent in
1996, compared to 44.7 percent in France, 32.1 percent in
Germany, 47.9 percent in Italy, 45.2 percent in Sweden, and
39.9 percent in the United Kingdom. In short, compared to our
major trading partners, our economy is large and it will be yet
larger in the future. Moreover, we have considerably more room
to respond to the challenges of an aging society--if we so
choose--through application of the budget surplus in the Social
Security reform process and, if desired in the future, through
additional tax revenues.
Lesson: It is important to acknowledge explicitly
that values and choice of primary policy goals matter in the
reform of public pension systems.
Approaches to the financial reform of retirement income
systems reflect value preferences and differences with regard
to the primacy of achieving retirement income security for the
citizenry versus other important goals, such as increasing
national savings and rewarding work effort. They can reflect
deep divisions in the philosophy of the extent to which the
individual versus the national community should bear the risks
of preparing for their retirement, disability or survivorship.
Nowhere is this seen better than in the differing views of
those supporting social insurance approaches as the foundation
of retirement, disability and survivorship income security, as
opposed to those who would seek to replace Social Security with
various privatization plans.
Shared responsibility and securing protection against what
President Franklin D. Roosevelt termed the ``hazards and
vicissitudes of life'' inform the traditional view of Social
Security program (Heclo, 1998). Providing widespread protection
to individuals and their families is, within this framework,
the fundamental purpose of any social insurance program.
Promoting financial security--with associated values of
maintaining dignity and strengthening families and community--
has primacy over other policy goals. From this perspective,
stabilizing financing and assuring benefits that are adequate
and can be counted upon regardless of inflation, business
cycles and market fluctuations are central objectives for
reform. Strong commitment exists here for maintaining the
moderate redistribution that seeks to provide a minimally
adequate floor of protection for those who have worked for many
years at relatively low wages. This commitment to widespread
protection provided rationale for decisions made earlier in the
life of the program to enable workers nearing retirement age to
receive full benefits even though they had made relatively
small contributions. This was also done each time benefits were
increased, so that those nearing retirement age became eligible
for the new benefits. But because the basic structure and major
benefit liberalizations in Social Security have generally been
in place for a number of years, future retirees will not reap
such large returns. However, had Social Security failed to
blanket-in workers approaching retirement--the system's
adequacy goal would have been compromised. And to have done so
would not have been fair in another sense since the economic
welfare of workers retiring earlier in the history of the
program was generally far worse than that of future retirees.
Strong belief in the primacy of individual responsibility
and freedom of choice as the preeminent organizing values of
society underlie the views of those who advocate the
privatization of retirement income systems based on social
insurance principles. Where the advocates of social insurance
programs see greater market risks as an accompaniment of
privatization, the advocates of privatization see higher
returns, greater control over retirement resources and less
political risk (e.g., legislative decisions to reduce
benefits). The emphasis, here, is on maximizing rates of return
and reducing the role of government in a market economy. While
safeguards may be built in for the most disadvantaged, these
systems in their design provide substantially greater reward to
those with higher earnings. At heart, there is a belief that
the market is an entirely efficient and fair way of
distributing goods and services and that social insurance
programs are undermining of free markets. Jose Pinera, former
Minister of Labor and Social Security in Chile from 1978 to
1980 and Co-Chairman of the Cato Project on Social Security
Privatization, advocates for the extension of the Chilean model
with the following assertion:
A specter is haunting the world. It is the specter of
bankrupt state-run pension systems. The pay-as-you-go pension
system that has reigned supreme through most of this century
has a fundamental flaw, one rooted in false conceptions of how
human beings behave: it destroys, at the individual level, the
essential link between effort and reward--in other words,
between personal responsibility and personal rights. Whenever
that happens on a massive scale and for a long period of time,
the result is disaster. (Pinera, 1995/96)
Pinera advocates that privatization of public Social
Security programs will empower workers and ``mean a massive
redistribution of power from the state to individuals, thus
enhancing personal freedom, promoting faster economic growth,
and alleviating poverty, especially in old age'' (Pinera, 1995/
96).
As Pinera makes clear, application of the Chilean model or
a parallel system of private accounts would undermine of the
central purposes of the current program and would represent a
decision to implement a very different set of values and policy
goals.
Lesson: Things aren't always what the most
committed advocates of privatizing Social Security claim.
Advocates of the Chilean and other private models no doubt
believe them to be superior. It is not my intention in this
testimony to discuss the Chilean or other such models in
detail. Instead, I would suggest that in giving serious
attention to these plans, it is important to assess their
strengths but also carefully explore their downside--including
expanded market risks, increased risk for women, high
administrative costs, longevity risks, inflation risks,
political risk to the maintenance of a retirement income
program, and structured regressivity and political risks for
low income workers. Some examples:
Greater market risk. While long run returns on
equities have generally been quite good, a privatized system
shifts risks from government to the individual, exposing
individuals and their families to substantial market risk--
especially those who are not sophisticated investors. No doubt,
in the long run, many workers--especially those who never marry
and always earn high incomes--may do better in various private
plans. But ``no promises can be made about what will happen to
an individual's nest egg in the few years, months or even days
before retirement'' (Williamson and Kingson, 1997). In the
short run, returns have been known to stagnate or to be
negative. I doubt that we would like to have at the foundation
of the nation's retirement income system, an approach requiring
people to time their retirements to bull markets. This point is
also made by economist Lester Thurow's observation in a
February 1, 1999, USA Today column. Thurow writes about the
tradition of Japanese employers to provide retirees with a lump
sum distribution when they retire and the investment risk this
tradition poses for retirees:
Individuals are not given monthly pensions from their company
pension funds but a lump-sum cash distribution when they
retire. They could, if they wished, put all of that money into
the stock market. But think of what happened to those who did
exactly that before 1990. In 1990, the Japanese stock market
went down from 39,000 to 13,000. and it is still near 13,000
eight years later. Two-thirds of their prospective pension
disappeared for at least a decade, and maybe forever. (Thurow,
1999)
Increased Risks and Inequity for Women. On
average, women live longer, earn less than men,\3\ experience
discontinuities in their labor force participation as a result
of caring for children, and are more likely to work part-time.
Shifting from Social Security--a defined benefit plan which
incorporates benefits for divorced and married spouses,
benefits for widows (and widowers), annual cost-of-living
adjustments and a benefit formula favorable to low-income
persons--to a plan where benefit amounts more nearly reflect
prior contributions is, on balance, disadvantageous to women
(Rix and Williamson, 1998). For example, under some
privatization proposals, lump sum distributions may be allowed
at retirement age. Under the Chilean plan, on reaching
retirement age, workers have the option of withdrawing funds on
a regular basis or purchasing an inflation-indexed life
annuity. Lump sum distributions and the Chilean withdrawal
option pose greatly increased risk for women of outliving their
resources. Alternatively, such inflation indexed annuities,
while addressing of inflation, disadvantage women relative to
men because women's monthly annuity amounts are actuarially
reduced to account for their longer life expectancies (Kay,
1997).
---------------------------------------------------------------------------
\3\ The earnings of full-time year round female employees was
roughly 74% of comparable male earnings in 1996. Moreover, women are
more likely to be out-of-the labor force or employed part-time as
compared to men (Rix & Williamson, 1998).
---------------------------------------------------------------------------
High administrative costs. Privatization plans
have been criticized for having high administrative costs
relative to Social Security. (The cost of administering Social
Security is about 0.9 percent of program expenditures.) Stephen
Kay (1997) testified before your Subcommittee on Social
Security that ``if you count the amount workers contributed and
deduct commission charges, an individuals real average rate of
return over the'' 1982 to 1995 period in the Chilean system was
7.4 percent, not the 12.7 percent figure that advocates of the
plan like to use. Teresa Ghilarducci (1997) similarly testified
that marketing and administrative fees are an estimated 15 to
30 percent in the Chilean system and an estimated 20% in the
privately administered defined contribution plans that workers
were encouraged to join in the United Kingdom in lieu of
continued participation in the State Earnings-Related Pension
Scheme (SERPS) or alternative occupational plans. The big
winners here seem to be the companies that administer these
programs, for example, a 22 percent profit in 1995 alone for
the companies (AFPs) \4\ administering the accounts of Chile's
covered workers (Ghilarducci, 1997).
---------------------------------------------------------------------------
\4\ Administradora de Fondos de Pensiones.
---------------------------------------------------------------------------
Longevity and Inflation Risks. In planning for
retirement, individuals must deal with two important
uncertainties--they do not know how long they will live; they
do not know the extent to which inflation may eat into their
assets. Social Security addresses these risks by assuring a
stream of monthly income that maintains their purchasing power
from year to year, no matter how long someone lives. As noted,
privatization plans that allow for lump-sum distributions or
other non-inflation indexed distributions undercut the economic
security and adequacy goals driving a system such as Social
Security. They do not and cannot provide adequate protection
against such risks.
Retirement Security Risks. Privatization plans
inevitably pose a political risk to the retirement income
security of individuals and the societal goal of underwriting
an adequate retirement for the citizenry. A private plan based
on defined contribution principles creates huge temptations for
individuals and members of Congress and other political
leaders. Though intended as retirement income savings, it is
only a matter of time when the distribution rules will be
liberalized to allow for medical or other emergencies; perhaps
for the laudable goal of making a down-payment on a home. Few
individuals with a critically ill child needing expensive
medical care would question the value of cashing in their
retirement savings to give their child a chance for a healthy
life. Few members of Congress would consider such a change to
be unreasonable. Yet, once such an exception is made, the goal
of maintaining a retirement program would be seriously
compromised.
Regressivity and Political Risks for Low Income
Workers. The principles of a privatized system which place
individually-owned accounts as the foundation of a retirement
income system. By doing so, privatization would ``place low-
and moderate-income workers at significant political risk. As
Social Security is currently structured''--with its emphasis on
providing widespread and adequate protection to the entire
population--``low-income workers get a better return than high
wage workers on their contributions, a factor that keeps
millions of the elderly out of poverty during their retirement
years. But in separating out the interests of higher-income
workers from the public portion of the program, privatization
schemes ensure erosion of political support for the program's
redistributive role--an outcome which would further increase
the economic and social distance between rich and
poor...Privatization may be a bad idea for most Americans, but
not necessarily for everyone--at least if we assume that the
winners in the ``privatization lottery'' do not have a stake in
promoting the well-being of the rest of society. Though trading
off some surety of protection, [on average] the most affluent
workers would likely do better under privatization plans--at
least in so far as they do not experience serious declines in
their earning capacities during middle age'' (Williamson and
Kingson, 1997).
Data Risk. With the exception of Chile and the
United Kingdom, most experiments with moving from public
pensions to privatized alternatives (i.e., defined contribution
approaches) are quite recent. Even Chile and the United Kingdom
have only 10 years experience; hardly enough time to tell
whether these systems will work for their citizens. Hence we do
not have a basis, as yet, for determining their long-term
success or their ability to meet the needs of retirees once
these systems mature, when many more retirees will depend on
them.
Lesson: A home-grown alternative to Social
Security provides an excellent example of the false claims of
its advocates and the risks of adopting the Chilean and other
privatization models.
We do not need to search far and wide to see the effects of
privatizing Social Security. Privatization has taken root in
three Texas counties--Galveston, Matagorda, and Brazoria.
In January 1981,\5\ these counties withdrew from the Social
Security program, implementing, instead, a defined benefit plan
for county employees. The Galveston Plan covers roughly 3,500
current employees and 5,000 former employees (persons who
receive or are eligible to receive benefits). Contribution
rates are slightly higher under the Galveston Plan--a combined
employee/employer pre-tax contribution of 13.2 percent (6.1
percent for workers and 7.8 percent for the county) on earnings
up to $82,160 compared to the 12.4 Social Security payroll tax
contribution on earnings up to $68,400 in 1999. (Additional
contributions can be made by workers to their retirement
accounts.) The Counties make investment decisions and utilize
the same investment company. Having chosen to pursue a
conservative investment strategy, the rates of returns from
1981 to 1997 are comparable to those received by the Social
Security OASDI, a 4.62 percent real rate of return on average,
compared to 4.88 percent for Social Security (Social Security
Administration, January 28, 1999).
---------------------------------------------------------------------------
\5\ The 1983 Amendments to the Social Security Act foreclosed the
option for public employee pension systems to withdraw from the
program.
---------------------------------------------------------------------------
The virtues of the Galveston Plan are being loudly
proclaimed by organizations advocating for privatization. An
announcement on the CATO Institute's website notes:
In 1981 employees of Galveston and two other counties in
Texas voted to opt out of the federal Social Security system in
favor of a private alternative. At a [Cato Institute] Policy
Forum on ``Opting Out of Social Security: How Galveston County
Did It,'' Donald Kebodeaux and E. J. Myers, who helped to
design the private system, reported that retirees are receiving
far greater benefits than they would have gotten under Social
Security and maintained that Galveston County's plan could
serve as a model for the entire United States. (Cato website,
1999)
A similarly pro-privatization think-tank, the National
Center for Policy Analysis, issued a report that claims:
Employees of three Texas counties are enjoying rapid growth
in their retirement incomes, better benefits than those offered
by Social Security and the satisfaction of knowing that the
money deposited in their accounts belongs to them and will be
there when they retire. Privatizing Social Security is not a
distant dream; for some Americans it is a present reality.
Fairness and true social security demand that all Americans
have the same opportunity. (National Center for Policy
Analysis, 1996).
In short, as the policy brief suggests the Galveston Plan
``provides a much larger postretirement income than does Social
Security.''
Sounds too good to be true. And it is! The Galveston Plan
has advantages for certain workers--for some disabled workers
and especially for high-income single workers without any
dependent children. It also allows for the accumulation and
passing on of an asset. But, it also has very significant
drawbacks common to many other privatization plans.
Women and low-income workers are not well served
by the plan. Since the Galveston Plan's retirement benefits are
based on what workers accumulate in their accounts during their
term of county employment, low wage workers have lost the
benefit of the tilt in the Social Security benefit formula
which provides proportionately larger benefits to those working
for many years at low wages. Women and others who are likely to
be intermittent or short-term employees, earn less and lose
important Social Security coverage, which, unlike the Galveston
plan, stays with them as they move from job to job. Moreover,
the plan does not require spouses to select a joint survivor
annuity. And, unlike Social Security, there are no spouse
benefits and there are no guaranteed benefits for divorced
spouses.
High-income, single, long-term employees win.
Analysis by Social Security's Office of Policy (see table 9)
shows that the distribution of benefits in the Galveston Plan
runs counter to a social insurance program designed to provide
widespread and adequate protection to the entire population.
The potentially big winners in Galveston are long-term
employees with high salaries; but there potential good fortune
comes at a price--considerably less security for most of their
co-workers. Interestingly, USA Today (Welch, February 3, 1999)
discusses the preliminary findings of a GAO report that seems
to confirm the SSA findings--``The GAO study did credit the
alternative investment plans with producing better long-term
retirement benefits in many cases for higher income workers,
those earning more than $51,263 a year. But it said low income
workers generally fare better under Social Security. And it
said its calculations showed mixed results for the middle
income workers: Though many may receive higher initial benefits
under the Alternative Plans, the inflation adjustment built
into Social Security benefits each year may erode that
advantage over time and make Social Security a better deal.''
Certainly, it is if the goal is to provide a floor of
protection for the entire population.
Substantial longevity and inflation risks exist.
Workers and eligible survivors can outlive their retirement
benefits because they can take benefits in the form of a lump-
sum distribution or fixed annuity. Equally concerning,
inflation can erode their benefits since the plan does not
include annuities that are indexed to inflation. A Social
Security Administration memo notes that Galveston plan benefits
would lose 46 percent of their purchasing power in 20 years
with yearly inflation averaging three percent. While the SSA
table of illustrative benefits for workers at different
earnings levels indicates that ``initial benefits offered under
the Galveston Plan are higher than under Social Security for
single workers at the middle, high and very high earnings
levels,'' after ``20 years of inflation all of Galveston's
benefits are lower relative to Social Security'' (January 28,
1999; also see tables 9 and 10).
Undermining of goals of retirement income
security. The Galveston Plan allows employees to withdraw all
their savings when they leave their county jobs. That is, these
funds do not have to be rolled over into another retirement
account. The plan also specifics a number of unforeseen
emergencies (e.g., illness, casualty loss) under which the
employee may go into some or all of the accumulated funds. This
flexibility places employees under increased risk of inadequate
retirement income.
Arguably better disability protection for some and
worse for others. Initial benefits for single individuals
without dependent children and very high income persons with
two dependent children are higher and there is no disability
waiting period. But, again, the redistributive benefit tilt
doesn't apply to low-income workers and benefits for all
persons with disabilities are not protected against inflation.
And workers are not covered during periods of unemployment or
for more than 12 months if their disability is a result of
mental illness.
A mixed story on survivors benefits. Life
insurance benefit triples the worker's salary (with a maximum
benefit of $150,000 and a minimum benefit of $50,000), and the
balance of a worker's retirement account can be passed on,
without regard to whether the worker has children, is married
or has other dependents. Again, single workers, without
dependents, who die do well (at least from the point of view of
an economist's moneysworth analysis). But lost is the surety of
family protection for families with very young children,
especially those with low and moderate incomes.
In sum, this home-grown privatization plan illustrates some
of the potentially deleterious outcomes that would follow from
large-scale privatizing of Social Security.
Lesson: We would do better to set our sights on
examining some of the more moderate reform approaches
implemented or under consideration by nations choosing to
maintain their commitment to social insurance as the foundation
of their retirement income systems.
Some nations are pursuing modest reductions in the long-
term generosity of their pension systems through changes in
their benefit formula requiring more years of earnings to
calculate the basic benefit (e.g., Spain, France); in slight
adjustments to their inflation indexing procedures (Finland,
Japan and Germany). Some countries have introduced increases in
contribution rates (Canada, Finland, France) (Kalisch and Aman,
1999). Canada, having recently decided against privatizing its
social insurance program (Canadian Pension Plan), is seeking to
expand the funded portion of its contributory, earnings-related
social insurance program and is diversifying its investments to
gain advantage from higher rates of return in its equity market
(Kalisch and Aman, 1999; also see Ycas, 1997).
Lesson: Many OECD nations are responding in
incremental ways to changes in family structure and the labor
force.
Most OECD pension systems are contributory, with
eligibility and benefit amounts linked to previous work. Hence,
the increased labor force participation of women, the early
retirement trend of older men, the growth of part-time and
intermittent work and the decline in long-term employment and
job security all have implications for pension outcomes. Women
in OECD nations are more likely to have gained rights to
benefits from past work, than as a spouse. Partial pensions are
being used by some nations (e.g., Denmark, Japan, Luxembourg,
Germany) to ease the transitions from work to retirement. As we
do through the Social Security Delayed Retirement Credit, some
nations reward continued work with permanent benefit increments
for delaying acceptance of a benefit past normal retirement.
Finland, Sweden, and the United Kingdom do not limit the number
of years that workers may receive pension adjustments for
delaying their retirements. In terms of retirement age
policies, most often it is directed at bringing the early and
normal retirement ages of women in line with (e.g., Australia,
Belgium, Germany, Hungary, Japan, Portugal and U.K.) or closer
to (Switzerland, Czech Republic, Italy) the ages of early and
normal retirement for men, something that parallels what the
United States did with the enactment of the 1961 Amendments to
the Social Security Act, which gave men the same right women
were afforded in 1956, to retire with an actuarially reduced
benefit as early as age 62. Indeed:
There are relatively few examples of policy changes to
increase the statutory retirement age for both men and women in
OECD countries. Where this is planned, it is usually to bring
the retirement age above the current age of 60 (as in the case
of Japan, Hungary and the Czech Republic). Italy will increase
the male retirement age from 63 to 65 by the year 2000 at the
same time as the female age is increasing from 58 to 60 years.
Only the United States has a firm policy to increase the
pensionable age beyond 65... (Kalisch and Aman, 1999)
Divorce rates have increased and with this trend the
adequacy of public pensions for divorced women has emerged as a
policy concern. Belgium has responded by guaranteeing that
divorced spouses will receive an old-age pension at age 60 that
is at least equivalent to 37.5% of the former spouse's earnings
during their marriage. Some nations (e.g., Belgium,
Switzerland) provide credits that partially offset losses in
pension benefits as a result of time spent out of the labor
force caring for young children or disabled relatives (Kalisch
and Aman, 1999). Australia actually has a separate benefit
payment for persons giving care to functionally disabled
persons under age 16 or to functionally disabled social
security pensioners (Ycas, 1997).
Lesson: There is much that is sound about Social
Security.
In our search for solutions to current financing
problems,\6\ we should bear in mind the great success and
popularity of our nation's universal and public Social Security
program. It provides widespread and basic protection to
America's families and employees, covering 149 million workers
and their families and paying benefits to 44 million persons.
Included among its 44 million beneficiaries are three million
children under 18 who receive benefits each month. It is the
main source of disability and survivors protections for
America's families. For a 27 year old couple with two children
under age 2 and with earnings equal to average wages, Social
Security is the equivalent of a life insurance policy in excess
of $300,000; a disability policy in excess of $200,000. It
provides Americans with the equivalent of $12.1 trillion
dollars in life insurance protection, more than the entire
value ($10.8 trillion) of all the private life insurance
protection in force. It is the only pension protection
available to six out of ten working persons in the private
sector.
---------------------------------------------------------------------------
\6\ As the Committee knows, under intermediate assumptions as
reported in the 1997 trustees report, the combined OASDI trust fund is
estimated to be able to meet its commitments until 2029. However, it is
not in actuarial balance for the 75 year period over which long-range
estimates are made. Tax returns (payroll tax receipts and receipts from
taxation of benefits) will be exceeded by outlays in 2013. Total
income, including interest earnings, is expected to exceed expenditures
through about 2021 and the combined OASDI trust fund is able to meet
all its commitments until 2031. Under the most commonly-accepted
intermediate assumptions there is a projected 2.19 percent of payroll
short-fall (-5.42 percent of payroll shortfall under the high cost
assumptions and a +0.25 percent of payroll surplus under the low cost
assumptions.) This deficit represents a roughly 14 percent shortfall
over the 75-year estimating period; a 25% shortfall after 2031. Since
the deficit years fall in the middle and end of the estimating period,
the short-falls in the out years are substantially larger than
suggested by the overall 2.19 percent of payroll estimate (i.e., -5.62
percent of payroll from 2048-2072).
---------------------------------------------------------------------------
Social Security has transformed old age in America. For the
middle class, it provides the foundation of a secure
retirement, ideally to be built upon by other pension coverage,
private savings, sound investments, accumulated equity in their
homes and, for some, work in their later years. But even for
those who are relatively well off, say the roughly 4.9 million
elderly households with incomes between $20,001 and $33,777 in
1996, Social Security provides nearly half of the total income
(see table 4) going to their homes. For the bottom 60 percent
of the elderly income distribution--those 14.7 million
households with incomes under $20,000 in 1996, Social Security
provides over 70 percent of all household income (see table 7).
Indeed, absent Social Security, the poverty rate among the old
would increase to roughly 50 percent (see table 8). And
importantly, the security of beneficiaries is protected by
annual cost-of-living protection which assures that benefits,
once received, maintain their purchasing power into advanced
old age--the point in time when elderly persons, especially
widows, are often at greatest economic risk. Indeed, it is the
adequacy features--the desire to provide widespread protection
and do a bit more for those who have worked many years but at
low wages--of Social Security which have driven the program's
success.
Lesson: We should not lose sight of the moral
dimension of Social Security.
A public Social Security program is, to paraphrase former
Senator Bill Bradley, the best expression of community in
America today. Indeed, more is at stake in this discussion than
the technical aspects of how to address the financing problems
of Social Security. Behind all the discussion of ``bend
points,'' ``year of exhaustion,'' ``dependency ratios,'' and
``percents of taxable payroll,'' this debate is fundamentally
about our sense of responsibility to each other; about the
basic protection that each working American should be assured
of for themselves and their families in old age, disability or
on the death of a loved one; about the mix of public and
private efforts we should encourage to assure that security. In
a very fundamental way it is an expression of the moral
commitment of our nation to serve as our brothers' and sisters'
keepers; to honor thy mothers and fathers. In the process of
addressing long-term financing problems, it is important that
we not lose sight of this moral dimension of the program which
is one of the joining institutions of our society.
References
Board of Trustees (April 30, 1998), 1998 Annual Report of the
Trustees of the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds.
Congressional Budget Office (January 1999), ``Social Security
Privatization: Experiences Abroad.
Ghilarducci, Teresa (September 18, 1997), Statement before the
Subcommittee on Social Security of the House Ways and Means Committee
``Hearing on the Future of Social Security for this Generation and the
Next--Experiences of Other Countries.''
Kay, Stephen (September 18, 1997), Statement before the
Subcommittee on Social Security of the House Ways and Means Committee
``Hearing on the Future of Social Security for this Generation and the
Next--Experiences of Other Countries.''
Heclo, Hugh (September 1998), ``Political Risk and Social Security
Reform,'' Social Security Brief, National Academy of Social Insurance.
Kalisch, David W. and Tetsuya Aman (1999 off website), ``Retirement
Income Systems: The Reform Process Across OECD Countries,'' OECD.
National Academy of Social Insurance (1998), Evaluating Issues in
Privatizing Social Security.
National Center for Policy Analysis (1999), Policy Brief 215.
Pinera, Jose (Fall/Winter 1995/1996), ``Empowering Workers: The
Privatization of Social Security in Chile,'' Cato Journal.
Rix, Sara E. and John B. Williamson (1998), ``Social Security
Reform: How Might Women Fare?,'' Issue Brief, Public Policy Institute
of AARP.
Social Security Administration, Office of Policy (January 28,
1999), The Galveston Plan.
Thurow, Lester (February 1, 1999), ``Clinton snookers Republicans
at their own economic game,'' USA Today, p. 15A.
US Department of Health and Human Services (Washington, D.C:
January 1996), Income of the Population 55 and Over, Social Security
Administration, Office of Research and Statistics.
US Department of Health and Human Services (Washington, D.C:
January 1998), Income of the Population 55 and Over, Social Security
Administration, Office of Research and Statistics.
Ycas, Martynas (1997), ``International Updates,'' Social Security
Bulletin, Vol. 60, No. 3, pp. 53-60.
Welch, William M. (February 3, 1999), ``Study may show pitfalls of
investing Social Security,'' USA Today.
Williamson, John B. and Eric R. Kingson (January 10, 1997), ``The
Pitfalls of Privatization,'' Boston Globe.
Table 1. Elderly and Total Dependency Ratios
----------------------------------------------------------------------------------------------------------------
Elderly dependency ratio \1\ Total dependency ratio \2\
-----------------------------------------------------------------
1960 2000 2030 1960 2000 2030
----------------------------------------------------------------------------------------------------------------
United States................................ 15.4 19.0 36.8 67.4 52.0 68.0
Australia..................................... 13.9 16.7 33.0 63.2 48.0 62.6
Austria...................................... 18.6 23.3 44.0 52.1 49.3 71.4
Canada........................................ 13.0 18.2 39.1 70.5 48.3 69.0
Denmark...................................... 16.5 21.6 37.7 55.8 49.1 67.0
France........................................ 18.8 23.6 39.1 61.3 52.8 67.9
Germany...................................... 16.9 23.8 49.3 47.4 46.7 75.1
Greece........................................ 12.3 25.5 40.9 52.0 48.8 66.3
Italy........................................ 13.3 26.5 48.3 47.9 47.8 72.7
Japan......................................... 9.5 24.3 44.5 56.6 47.2 70.5
Mexico....................................... -------- 7.0 14.8 -------- 61.5 48.1
Portugal...................................... 12.7 23.5 38.7 59.1 46.4 59.8
Spain........................................ 12.7 23.5 41.0 55.1 45.3 64.8
Sweden........................................ 17.8 26.9 39.4 51.8 57.9 70.4
Switzerland.................................. 15.5 23.6 48.6 51.5 49.6 77.0
Turkey........................................ 6.7 8.9 16.2 81.4 57.9 48.6
United Kingdom............................... 17.9 24.4 38.7 53.7 54.0 68.0
----------------------------------------------------------------------------------------------------------------
\1\ Population aged 65 and over as a percent of working age population.
\2\ Population aged 0-14 and 65 and over as a percent of working age population.
Source: OECD.
Table 2. Percentage of the Population Aged 60 and Over.
------------------------------------------------------------------------
2000 2030
------------------------------------------------------------------------
OECD Countries \1\
United States............................. 16.5 28.2
Australia................................ 15.3 27.7
Austria................................... 21.5 34.5
Belgium.................................. 22.5 32.2
Canada.................................... 16.8 30.2
Denmark.................................. 20.4 32.1
Finland................................... 19.8 30.9
France................................... 20.2 30.1
Germany................................... 23.7 35.3
Greece................................... 24.2 32.5
Iceland................................... 14.9 26.0
Ireland................................... 15.7 22.9
Italy.................................... 24.2 35.9
Japan..................................... 22.7 33.0
Luxembourg............................... 21.2 29.5
Netherlands............................... 19.0 33.4
New Zealand.............................. 15.9 26.8
Norway................................... 20.2 29.6
Portugal................................. 19.8 29.7
Spain..................................... 20.6 30.9
Sweden................................... 21.9 30.0
Switzerland............................... 21.9 31.0
United Kingdom........................... 20.7 29.6
Other Countries
Argentina................................ 13.7 19.3
Brazil................................... 7.7 16.9
Chile..................................... 9.8 20.8
China.................................... 10.2 21.9
Columbia.................................. 6.7 18.0
Mexico................................... 6.6 15.7
Russia.................................... 18.7 24.9
Venezuela................................ 6.4 15.5
------------------------------------------------------------------------
\1\ Excluding Czech Republic, Hungary, Poland and South Korea
Source: OECD National Accounts, Main Aggregates, Volume 1, January 1998.
Table 3. Life Expectancy at Age 60 by Gender \1\
------------------------------------------------------------------------
Female Male
-------------------------------------------
1960 1995 1960 1995
------------------------------------------------------------------------
United States.............. 19.5 22.9 15.8 18.9
Australia.................. 19.4 23.7 15.6 19.5
Austria.................... 18.6 22.9 15.0 18.7
Canada...................... 19.9 24.3 16.8 19.9
Denmark.................... 19.1 21.4 17.2 17.6
France..................... 19.5 24.9 15.6 19.7
Germany.................... 18.5 22.5 15.5 18.1
Greece..................... 18.9 22.8 17.0 19.9
Italy...................... 19.3 23.5 16.7 19.0
Japan...................... 17.8 25.3 14.8 20.3
Mexico..................... 18.1 22.4 16.8 18.9
Portugal................... 18.6 22.0 15.9 18.0
Spain....................... 19.2 24.1 16.5 19.5
Sweden..................... 19.3 23.9 17.3 19.8
South Korea................. -------- 20.1 -------- 15.5
Switzerland................ 19.2 24.5 16.2 20.0
Turkey...................... 15.9 18.1 14.7 15.8
United Kingdom............. 19.3 22.9 15.8 18.9
------------------------------------------------------------------------
\1\ Data refer to given year or closest available year.
Source: OECD, Health Data, 1997.
Table 4. GDP Per Capita in 1996 U.S. Dollars \1\
------------------------------------------------------------------------
------------------------------------------------------------------------
United States....................................... 27,821
Australia........................................... 20,376
Austria............................................. 21,395
Belgium............................................. 21,856
Canada.............................................. 21,529
Denmark............................................. 22,418
Finland............................................. 18,871
France.............................................. 20,533
Germany............................................. 21,200
Greece.............................................. 12,743
Iceland............................................. 23,242
Ireland............................................. 23,242
Italy............................................... 19,974
Japan............................................... 23,235
Luxembourg.......................................... 32,416
Netherlands......................................... 20,905
Norway.............................................. 24,364
Mexico.............................................. 7,776
New Zealand......................................... 17,473
Portugal............................................ 13,100
Spain............................................... 14,954
Sweden.............................................. 19,258
South Korea......................................... 13,580
Switzerland......................................... 25,402
Turkey.............................................. 18,636
United Kingdom...................................... 18,636
OECD--Total \2\..................................... 20,289
OECD--Europe \3\.................................... 17,630
European Union...................................... 19,333
------------------------------------------------------------------------
\1\ Based on purchasing power
\2\ Excluding Czech Republic, Hungary, Poland and South Korea
\3\ Excluding Czech Republic and Hungary
Source: OECD National Accounts, Main Aggregates, Volume 1, January 1998.
Table 5. Central Government Expenditures
------------------------------------------------------------------------
Expenditures as a Health, Education &
percent of GDP Income Security as a
---------------------- percent of total
expenditures \1\
1980 1996 ---------------------
1980 1996
------------------------------------------------------------------------
United States.............. 20.7 21.6 50.8 53.1
Australia.................. 33.3 39.1 71.6 70.0
Canada..................... 21.0 -------- 45.6 48.6
Denmark.................... 31.3 35.3 57.1 54.9
France..................... 37.4 44.7 70.2 --------
Germany.................... -------- 32.1 69.4 --------
Greece..................... 24.7 29.1 51.5 35.4
Italy...................... 39.1 47.9 50.7 --------
Japan...................... 14.8 -------- -------- --------
Mexico..................... 10.7 14.0 44.3 50.2
Portugal................... 28.7 38.8 48.4 --------
Spain...................... 23.7 36.2 69.1 49.5
Sweden..................... 37.6 45.2 63.9 60.5
Switzerland................ 18.7 25.4 64.4 71.7
Turkey..................... 15.5 24.6 23.8 19.0
United Kingdom............. 36.4 39.9 45.8 51.7
------------------------------------------------------------------------
\1\ Refers to education, health, social security, welfare, housing, and
community amenities.
Source: World Development Report 1998/99, World Bank
Table 6. General Government Total Outlays as a Percentage of Nominal GDP
------------------------------------------------------------------------
1970 1980 1990 2000 \1\
------------------------------------------------------------------------
United States.............. 30.0 31.4 32.8 31.1
Australia.................. -------- 31.4 34.8 33.3
Canada..................... 34.1 39.2 46.7 41.2
Denmark.................... -------- 55.0 56.0 52.5
France..................... 38.5 46.1 49.8 53.5
Germany.................... 38.3 47.9 45.1 46.3
Greece..................... -------- 30.4 48.2 41.1
Italy...................... 32.8 41.9 53.6 48.8
Japan...................... 19.0 32.0 31.3 39.0
Mexico..................... -------- -------- 17.2 13.5
Portugal................... 19.5 23.2 40.6 44.1
Spain...................... 21.6 32.2 42.5 40.3
Sweden..................... 42.8 60.1 59.1 58.1
Switzerland................ -------- -------- 41.0 49.3
Turkey..................... -------- -------- 27.9 25.2
United Kingdom............. 37.2 43.4 41.8 40.0
------------------------------------------------------------------------
\1\ Estimates and projections.
Source: OECD, Economic Outlook, December 1998, OECD.
Table 7. Importance of Various Sources of Income to Elderly Households, 1996*
(All members over age 65)
----------------------------------------------------------------------------------------------------------------
QUINTILES
-----------------------------------------------------------------------
All Aged Units
Units Under $8,157- $13,008- $20,001- $33,778
$8.156 $13,007 (Q2) $20,000 (Q3) $33,777 (Q4) and over
(Q1) (Q5)--
----------------------------------------------------------------------------------------------------------------
Number of Units (in 24.6 4.9 4.9 4.9 4.9 4.9
millions)...................
Percent of Total Income
From:**
Social Security.......... 40.3 80.7 80.4 65.8 47.3 20.6
Railroad Retirement...... 0.5 0.1 0.6 0.8 0.9 0.
Government employee 8.1 0.9 1.9 4.9 9.5 10.0
pension.................
Private pension/annuity.. 9.9 1.6 4.0 8.9 13.4 10.4
Income from assets...... 18.0 2.7 5.7 9.5 14.8 25.0
Earnings................. 20.0 1.2 3.0 6.6 11.7 31.5
Public Cash Assistance.. 0.7 11.4 2.1 0.7 0.2 0.0
Other.................... 2.1 1.3 2.3 2.8 2.4 2.2
----------------------------------------------------------------------------------------------------------------
* All members of households are 65 or over. Aged units are married couple living together--at least one of whom
is 65--and non-married persons 65 or older.
** Details may not sum to totals due to rounding error.
Source: US Department of Health and Human Services, Social Security Administration, Office of Research,
Evaluation and Statistics, Income of the Population 55 and Over (Washington, D.C: 1998, pp. 123).
Table 8. Elderly Households* Below Poverty Line in 1994, With and Without Social Security Benefits, Among
Households Receiving Social Security Benefit
----------------------------------------------------------------------------------------------------------------
African-
All Aged American Hispanic White Women
Units Elderly Elderly Elderly not
Units Units Units Married
----------------------------------------------------------------------------------------------------------------
65 and Over
Number of Units* with SS Benefits (in millions).......... 23.9 1.9 0.9 19.6 9.9
PERCENT **
Below Poverty Line.................................. 14 29 21 10 20
Kept Out of Poverty by Social Security.............. 42 39 40 42 44
Total Below Poverty Without Social Security......... 54 69 61 53 64
85 and Over
Number of Units* with SS Benefits (in millions).......... 2.5 0.2 0.1 2.2 1.7
PERCENT**
Below Poverty Line.................................. 17 30 25 15 20
Kept Out of Poverty by Social Security.............. 49 47 46 50 48
Total Below Poverty Without Social Security......... 66 76 71 65 68
----------------------------------------------------------------------------------------------------------------
Source: US Department of Health and Human Services, Social Security Administration, Office of Research and
Statistics, Income of the Population 55 and Over (Washington, D.C: January 1996), p. 123
* Aged units are married couple living together--at least one of whom is 55--and non-married persons 65 or
older.
** Details may not sum to totals due to rounding error.
Table 9. Initial Monthly Retirement Benefits in 1998 Dollars*
------------------------------------------------------------------------
Galveston Social
Family/Earner Type Plan \1\ Security
------------------------------------------------------------------------
Single
Low....................................... $ 733 $ 763
Middle................................... 1,700 1,267
High..................................... 2,402 1,689
Very-high................................ 3,489 1,974
Married
Low....................................... $ 670 $1,139
Middle................................... 1,555 1,895
High..................................... 2,197 2,522
Very-high................................ 3,192 2,948
------------------------------------------------------------------------
Indirect source: Social Security Administration, Office of Policy;
American United Life Insurance Company Annuity Table for the Galveston
PLan 1/25/99.
* Italic numbers indicate the Galveston Plan offers a benefit that is
higher than Social Security's.
\1\ It is assumed that retirement benefits under the Galveston Plan are
paid in the form of a life annuity, and in the case of a married
couple, through joint-contingent annuity with rights of survivorship
with its equivalent to \2/3\ of a single-life annuity. Galveston and
Social Security retirement estimates assume that all workers retire in
the year 2045 at age 65. Low and Middle earning workers begin
employment at age 20 and work 45 years under each system. High and
Very-high earning workers begin employment at age 22 and work 43 years
under each system. In the year 2045, the normal retirement age for
Social Security is 67, and therefore, the Social Security benefits
presented in this report reflect the benefit reduction due to early
retirement. The categories for this table represent earnings at the
following percentiles in the year 2045: Low = 10th, Middle = 50th,
High = 75th, Very-high = 90th.
Direct Source: The Galveston Plan, Social Security, Office of Policy,
January 28, 1999.
Table 10. Galveston's Monthly Retirement Benefit as % of Social
Security's Over Time (assuming 3% inflation) * \1\
------------------------------------------------------------------------
Initial After 15 After 15
Family/Earner Type Benefit years years
------------------------------------------------------------------------
Single
Low............................... 96 % 61 % 52 %
Middle............................ 139 % 88 % 76 %
High.............................. 142 % 90 % 77 %
Very-high......................... 177 % 112 % 96 %
Married
Low............................... 59 % 37 % 32 %
Middle............................ 82 % 52 % 45 %
High............................... 87 % 55 % 47 %
Very-high......................... 108 % 69 % 59 %
------------------------------------------------------------------------
* Italic numbers indicate where the Galveston Plan offers a benefit that
is higher than Social Security's.
\1\ See footnote 1 in table 9.
Source: The Galveston Plan, Social Security, Office of Policy, January
28, 1999.
STATEMENT OF STEPHEN J. KAY, ECONOMIC ANALYST, LATIN AMERICA
RESEARCH GROUP, FEDERAL RESERVE BANK OF ATLANTA, ATLANTA,
GEORGIA
Mr. Kay. Thank you, Mr. Chairman, and distinguished Members
of this Committee. Thank you for this opportunity to testify.
My name is Stephen Kay, and I'm an economic analyst in the
Latin America Research Group at the Federal Reserve Bank of
Atlanta. I spent 5 years researching and writing about the
process of Social Security reform in Argentina, Brazil, Chile
and Uruguay. I'm here as a private citizen, and the views that
I will express are my own and do not reflect the views of the
Federal Reserve Bank of Atlanta or the Federal Reserve System.
Chile's system of defined contribution individual
investment accounts has received international acclaim and has
served as a model for the rest of Latin America. Other
countries in the region, including Argentina and Uruguay, have
also implemented systems with individual accounts. However,
unlike Chile, these plans include a universal pay-as-you-go
benefit and joining the private system remains optional.
Chile's reform has been praised for its relative
transparency and simplicity and its role in promoting the
development of Chile's capital markets. However, Chile's new
private system has experienced its share of problems, and we
can benefit by studying both its strengths and weaknesses.
There are three elements of this reform that deserve particular
attention.
One, the system's high transition and administrative costs.
Two, its risk and uncertainty regarding future benefits. And
three, its distributional consequences. First, let's look at
the transition and administrative costs. The transition costs
to a private system are enormous because governments must
continue to pay benefits while contributions are diverted to
private accounts.
Transition costs in Chile are currently almost 3.8 percent
of GDP annually. By any measure, Chile's new pension system has
been expensive to run and expensive to join. High
administrative costs are translated into high commission
charges. In 1997, 18 percent of an average Chilean's pension
fund contributions went toward the administrative fee, and
flat-rate commissions made these fees proportionately more
burdensome for low-income groups.
Chile's Government is currently debating a number of
measures that could lead to lower commission charges. But even
if these charges were cut in half, they would still represent a
significant burden.
The secondary concern is market risk. Pension benefits bear
the risk of poor investment returns. Projections for future
returns which will determine pension benefit range between 3
and 5 percent. Pension benefits will vary dramatically
depending on which, if any, of these forecasts hold true.
For example, a 3-, 4-, or 5-percent annual return on
retirement savings in Chile would lead to benefits representing
44, 62, or 84 percent of preretirement earnings for men. One
city estimated that in order to achieve the goal of the 70
percent earnings replacement rate, the system would have to
have returns of around 4.5 percent.
Finally, there are distributional consequences of the
system. Perhaps the most striking change concerns the treatment
of women. In the old pay-as-you-go system, the disparity in
benefits between men and women was smaller. Because women tend
to earn less and spend more years of their lives in unpaid
labor, women spent fewer years accumulating capital in their
accounts.
When they purchase an annuity upon retirement, men and
women are placed in separate actuarial categories. So women
receive lower benefits because of their greater longevity.
Therefore, even if a man and woman have identical earnings and
contribution histories, a woman purchasing an annuity will
receive 90 percent of what a man would receive.
I want to conclude by saying that while we can learn a lot
by studying pension reform in Chile and other Latin American
countries, we're not yet in a position where we can evaluate
the long-term performance of these programs. These new systems
are still in the early and relatively easy phase of capital
accumulation.
Current pensions under the new Chilean system are not an
indicator of future retirement benefits because current
benefits are largely funded by special government bonds issued
to compensate for contributions made to the old pay-as-you-go
system.
The true test will begin 30 years in the future when the
first generation of workers who have spent their entire careers
contributing to the new private system begins to retire. Thank
you.
[The prepared statement follows:]
Statement of Stephen J. Kay, Economic Analyst, Latin America Research
Group, Federal Reserve Bank of Atlanta, Atlanta, Georgia
My name is Stephen Kay. I am an economic analyst in the
Latin America Research Group at the Federal Reserve Bank of
Atlanta. Prior to joining the Federal Reserve Bank of Atlanta
last year, I spent several years conducting research on social
security reform in Argentina, Brazil, Chile, and Uruguay. I am
here as a private citizen, and the views outlined below are my
own, and do not reflect the views of the Federal Reserve Bank
of Atlanta, or the Federal Reserve System.
Chile's 1981 pension privatization has garnered a great
deal of international attention, receiving praise for its
relative transparency and simplicity, and its role in promoting
the development of Chile's capital markets. However Chile's new
system of individual savings accounts has experienced its share
of difficulties, which also merit our attention. The new system
has been criticized for its high operating expenses, commission
charges, and transition costs, as well as its low rates of
compliance and its distributional impact on women. By studying
the strengths and weaknesses of Chile's new private system, we
are better able to understand the potential risks and rewards
of defined contribution social security systems that are based
upon individual savings accounts.
Background
Prior to recent reforms, South America's social security
systems were in varying degrees of disarray: aging populations
and massive evasion by both employers and workers meant that
fewer contributors were supporting more pensioners, surpluses
had been wasted on bad investments, benefits were highly
inegalitarian and financed regressively, deficits were
mounting, administrative performance was poor, and payroll
taxes were among the highest in the world.\1\ Social security
systems were also organized into multiple sub-systems, each
with its own administration and benefits structure.
By the end of the 1980s (Latin America's ``lost decade'' of
economic development) there was consensus in the region that
reform was necessary; however intense political conflict arose
over the direction of reform. Reforms in the Southern Cone of
South America ranged from partial privatizations in Argentina
(1993) and Uruguay (1995), to a short-lived privatization
effort in Brazil.
Chile became the pioneer of privatization when the Pinochet
dictatorship implemented the world's first-ever social security
privatization in 1981. Under the tripartite ``pay-as-you-go''
(PAYG) model used in most of the world (including the United
States), a combination of payroll taxes on workers and
employers, and government contributions (when necessary) are
used to fund social security benefits. In Chile's new defined-
contribution system, workers are required to contribute 10% of
their salaries to individual investment accounts, where funds
are invested by private pension fund companies in closely
regulated portfolios. An additional 3 percent of a worker's
salary goes toward commission fees and a disability and
survivors' insurance premium. Pension fund companies must
guarantee profitability relative to the average profitability
in the pension fund industry. The self-employed are not
required to join a pension plan (only about 10% do), and the
military and police have kept their relatively generous
defined-benefit PAYG systems.
In Argentina and Uruguay, democratically-elected
governments found little popular support for a Chilean-style
reform, and consequently both reforms differ from Chile's
privatization in two significant respects. First, both systems
maintain a universal public pay-as-you-go benefit, while
Chile's PAYG system is being gradually phased-out. Second,
membership in the private system is optional for Argentine and
Uruguayan workers (although workers in Uruguay must make
contributions to a pension fund on earnings between $800 and
$2500). In Chile the new private system was optional when it
was introduced (there was a financial inducement to join), and
it has been mandatory for all workers entering the labor force
since the reform.
Administrative Costs
Chile's new private system is plagued by high
administrative costs, which are in part passed on to workers in
the form of high commissions. Commissions have come down from
their peak of 8.69% of taxable salary in 1984 to around 2.96%
in 1997 (these include a disability and survivors' insurance
premium of around 0.7%). High costs are expected during the
start-up phase of a new pension fund industry. However in 1997,
commission charges alone still accounted for around 18% of a
worker's total contribution. Although its founders expected
that competition would lead to lower commission costs, this has
not occurred, and expenses generated by marketing have helped
keep costs high. The recent trend in the industry is toward
greater concentration, as three firms (out of a total of
eight), controlled 73% of all affiliates in 1998.
Marketing and operations costs have been high as Chilean
pension funds have engaged in expensive sales campaigns to
capture workers from competitors. 28% of affiliates in Chile
switched pension funds in 1996. Marketing costs absorb between
30% and 40% of all operating costs. Roughly a third of these
administrative costs are generated by salespersons seeking to
persuade workers to switch funds.\2\ The government has
recently enacted measures aimed at reducing the number of
transfers by making the process of switching pension funds more
complicated. Chilean regulators are also considering a number
of steps to lower commissions, including a plan to allow lower
group-rate commissions (which are currently prohibited), and a
proposed rating system where pension funds would be ranked
according to charges and service provided. In 1998, commission
fees as a percentage of contributions dropped an average of 8%.
Upon retirement, workers face a number of options. The
accumulated funds may be used to purchase an annuity indexed
against inflation, or pensioners can elect to receive a
``programmed pension,'' paid directly by the pension fund
company, based on the accumulated funds in an amount that is
reassessed every year based upon the fund's investment
performance. Workers may also elect to withdraw funds in a lump
sum, as long as they leave enough capital to purchase an
annuity in the amount of 110% of the minimum pension. These
options give workers greater control over their funds, but they
pose the risk that workers may outlive their income (in the
case of a programmed withdrawal), or spend a large portion of
their retirement income at once and be left with a pension just
slightly above the minimum. The annuities market in Chile has
not functioned well, with no provision in place for group
contracts. Since these options are complex, workers are exposed
to intense selling pressure by insurance agents who may charge
as much as 4% of the value of the contracts.\3\ In the Chilean
system, government guarantees against inflation are provided
for life annuities which can be purchased upon retirement
(until workers purchase annuities they are exposed to the risk
that inflation could diminish their capital).\4\
Retirement pensions granted in the next few years are not
indicative of future benefits because between 60% to 75% of the
funds accumulated in these individual accounts will come from
government ``recognition bonds.'' These bonds are paid to
pensioners upon retirement in recognition of past contributions
made to the old public system, and carry a real interest rate
of 4%.\5\ The true test will come in another thirty years, when
workers who have contributed exclusively to the new system
begin to retire.
Returns and Pensions
Since its founding, Chile's private system claims to have
achieved an impressive average annual return on investment. The
figure usually cited shows that the pension funds have produced
a real average annual return of 11% since 1981, but these are
gross returns, without consideration of investor-paid
commission expenses. Once commissions are factored in, the real
average return is considerably lower. For example, while the
simple real average annual return on invested pension funds
between 1982 and 1995 was 12.7%, this figure does not
incorporate the commission charges that workers pay on
contributions. If you consider the amount workers contributed
and deduct commission charges, an individual's real average
annual rate of return over this period would be 7.4%. The
disparity between these two figures illustrates how commissions
affect the rate of return. Over shorter periods of time, the
impact on the rate of return is even greater since contributors
may earn negative or very low returns for several years
(imagine the impact of an 18% load).\6\ Furthermore, fixed
commissions are a source of regressivity in the new system
because these fees consume a proportionately greater percentage
of the contributions of low-income workers.\7\ The high cost of
pension fund accounts for poor people led the World Bank to
suggest that poor people might be better served by saving for
retirement in bank savings accounts.\8\
Each pension fund company offers just one investment fund,
and these funds are required to deliver returns comparable to
their competitors over a twelve-month period, or make up the
difference from their reserves. Funds are required by law to
deliver a real return that is no less than 50% of the industry
average, or 2% below the industry average, whichever figure is
lower. As a result, there is little divergence among returns as
each fund seeks to emulate the returns of its competitors. In
order to encourage pension funds to take a longer term view and
avoid the ``herd effect'' of uniform returns, the government is
considering extending the time period over which relative fund
pension fund performance is measured. However any movement away
from uniform portfolios has to be weighed against the risk of
workers receiving lower returns by choosing poorly-managed
funds.\9\
While the system has achieved high annual returns thus far,
their sustainability is uncertain. Chile's high returns
resulted from specific macroeconomic circumstances in the
1980s. The economy had hit a low point in 1982 when real GDP
fell by 14%. After the banking crisis in 1981-83, real interest
rates were very high. Pension funds invested heavily in
government debt instruments, and when real rates fell, they
realized large capital gains. Pension funds increased
investment in equities in the 1990s, and high real returns came
mostly from the impressive performance of the stock market.\10\
Stock prices increased in part because of pension fund
demand,\11\ and conversely, were adversely affected in 1998 by
the decision of pension funds to cut their holdings of Chilean
shares in half (from 28% at the end of 1997 to 14% at the end
of 1998). Pension fund returns over the past four years have
averaged under 2% before commissions.
Regulations on minimal profitability and requirements that
each pension fund company can only administer one fund have
restricted diversity among fund portfolios as pension funds
have largely produced similar returns.\12\ Until now, pension
fund companies have been limited to offering just one
investment portfolio, even though individuals have different
tolerances for risk according to their ages. For example, an
individual close to retirement might want to have a portfolio
largely composed of bonds, while a younger worker's asset mix
would be invested heavily in stocks. In July, a World Bank
report criticized Chile's pension fund managers for not
offering a wide enough asset mix. The danger of this was
brought home last fall, when the average pension fund had lost
9.9% between January and September (the year-end rally in
financial markets cut the average loss to 1.1%), a development
that no doubt caused hardship for individuals planning to
retire last fall. The government now plans to allow pension
funds to offer a fixed-income fund that will only be open to
workers with ten or fewer years left until retirement. This
fund will not be available to all workers, reportedly because
of fears that this would generate an exodus from existing
pension funds.\13\ The government is also considering
permitting the introduction of other investment portfolios
aimed at younger workers.
Predictions for future returns, which will determine
pension benefits, range between 3% and 5%. Pension benefits
will vary dramatically depending on which, if any, of these
predictions hold true. For example, a 3%, 4%, or 5% annual
return on retirement savings in Chile would lead to benefits
representing 44%, 62%, and 84% of pre-retirement earnings for
men.\14\ One study estimated that for Chile to achieve the
system's goal of a 70% earnings-replacement rate, the system
would have to have annual returns of around 4.5% (leading
numerous analysts to suggest that the 10% workers contribution
might not be sufficient to generate a 70% earnings-replacement
rate \15\).
Impact on Women
Perhaps the most striking distributional consequence of
moving to a system of individual accounts concerns the
treatment of women. In the old PAYG system, the disparity in
benefits between men and women was smaller. When compared to
PAYG systems, the private social security systems in South
America disadvantage women by strictly linking benefits with
earnings, and placing men and women in separate actuarial
categories. Because they tend to earn less, spend more years of
their lives in unpaid labor, and have greater longevity, women
purchasing annuities upon retirement will systematically
receive lower benefits than men.
In a forthcoming study, economist Alberto Arenas de Mesa
and sociologist Veronica Montecinos project the rates of return
that women would need in order to achieve the same pensions as
men. For example, assuming identical wages and years of
contribution, a woman retiring at age 65 and purchasing an
annuity would receive approximately 90% of what a man would
receive. When we consider the actual disparities in income
profiles and years of contribution, the differences are even
more striking. The authors cite a 1992 study that found that a
typical woman retiring at age 60 and purchasing an annuity
after earning a 5% annual rate of return would receive a
replacement rate of 57% of her former salary, while a man
retiring at age 65 would receive 86%.\16\
Non-Compliance
Many believed that the private system would reduce evasion
because workers have a greater incentive to contribute to their
own personal retirement accounts than to a PAYG system.
However, evasion persists. Only 60 to 62% of workers are
covered by the new system, figures that are similar to the old
system.\17\ In August of 1998, just over half of workers
covered by the new system (55.3%) made contributions to their
accounts.\18\ The compliance rate also varied by income level.
Funds which catered to lower-paid workers received
contributions from 45-55% of their worker-contributors, while
those serving higher paid workers had a compliance rate of 80-
90%.\19\ To further illustrate the problem of non-compliance,
as of December 1995 over 35% of the 5.4 million contributors to
the private system had accumulated less than $500 in their
accounts, while more than half had less than $1228 in their
accounts.\20\
Part of the compliance problem may be related to a moral
hazard incentive in the program for workers not to comply. The
government provides a subsidy to workers who contribute for at
least twenty years but do not accumulate enough capital to earn
a minimum pension. This provides an incentive for individuals
to evade by contributing just enough to qualify for a minimum
pension, but no more, thereby shifting the funding burden to
the taxpayers. The minimum pension is approximately 30% of the
average salary, and is currently around $120 a month for those
under the age of 70. Government subsidies for the minimum
pension will rise dramatically in the future, as some estimate
that the number of affiliates who will not save enough to
receive a minimum pension could be as high as 70%.\21\
Capital Markets, Growth, and Savings
According to economist Nicholas Barr, the effects of a
funded pension system on national savings, and hence economic
growth is ``arguably the most controversial area'' of this
debate, and he suggests that the ``experience of countries in
the West is inconclusive both theoretically and empirically.''
\22\ Increased pension fund savings are likely to be offset by
a decline in government savings as payroll taxes are diverted
to private accounts. Individuals expecting a larger retirement
benefit may also elect to save less in other ways.
Although some have claimed that privatization explains the
meteoric rise of Chile's national savings rate (which climbed
from around 15% of GDP in the 1980s to 27% in 1995), recent
studies negate this claim.\23\ One study argues that Chile's
rapid economic growth is the primary reason for the increased
savings rate, with the pension reform contributing to growth in
the savings rate equivalent to 3% of GDP.\24\ Arrau argued that
increased corporate savings resulting from Chile's 1984 tax
reform played a large role in boosting Chile's savings rate,
and that the private pension system's direct contribution to
the increase was around 1% of GDP.\25\ Another study concurred,
concluding that ``A very popular perception in Chile and in
international circles is that the introduction of a privately-
administered pension system based on individual capitalization
has been the driving force behind the growth in national
savings. However the principal sources of increased savings in
Chile are elsewhere: in private enterprise and the
government.'' \26\
There is agreement that shifting to a funded pension system
has contributed to the deepening of Chile's domestic capital
markets, which in turn has had a positive impact on economic
growth.\27\ In a country like the U.S., with its well-developed
capital markets, the same process may not occur. As economist
Sebastian Edwards put it, ``It is not clear that these
mechanisms that have benefited Chile will be there in other,
more developed countries.''\28\
Transition Costs
In a defined contributions system with individual accounts,
workers stop paying social security contributions to the
government, but the government will continue to owe benefits to
individuals belonging to the old PAYG system. This shortfall in
revenue can only be financed through cutting other areas of
government spending, raising taxes, cutting benefits, extending
the retirement age, and/or by issuing debt. The Chilean reform
did many of these things. Prior to privatizing, the Chilean
government raised the retirement age to 65 for men and 60 for
women and eliminated special early retirement programs. The
government ran budget surpluses, privatized state-owned
industries, and issued bonds that were purchased by the new
pension funds. Since ``recognition bonds'' (recognizing past
contributions to the old PAYG system) are not issued to workers
until retirement, the transition costs are incurred over an
extended period of time. In 1996, the transition costs were
3.7% of GDP, and are expected to range between 3% and 4% of GDP
over the next five years.\29\ If welfare pensions, minimum
pensions, and the deficit in military and police pension funds
are included, the 1997 figure would be 5.5% of GDP.\30\ As the
transition costs grew in the 1980s, they consumed relatively
greater percentages of social spending, while expenditures on
health and education were cut (social spending has increased
since Chile's return to democracy).\31\
Conclusions
Prior to their recent reforms, social security systems in
the Southern Cone of Latin America suffered from financial and
administrative problems that we in the United States have not
encountered, and debates over reform were informed by
fundamentally different political and economic realities. By
most measures, governments in Latin America had failed to
provide adequate social security coverage. Privatization has
offered an alternative strategy that has been pursued, to
varying degrees, throughout most of the region. This statement
has outlined some of the costs, risks, and distributional
consequences associated with the Chilean reform. Continued
study of the pension reforms in Chile and the rest of Latin
America would contain valuable lessons for all of us as we
proceed along the path of reform.
Endnotes
1. For a description of the ills of Latin America's social security
systems see Mesa-Lago, Carmelo. 1994. Changing Social Security in Latin
America. Boulder: Westview.
2. Fidler, Stephen. 1997. ``Lure of the Latin Model,'' Financial
Times, 4-9-97.
3. Gillion, Colin, and Alejandro Bonilla. 1992 ``Analysis of a
National Private Pension Scheme: The Case of Chile,'' in International
Labour Review. Vol. 131, No.2, 1992, p.171-195. Also see Vittas,
Dimitri. 1995. ``Strengths and Weaknesses of the Chilean Pension
Reform.'' Mimeo. Financial Sector Development Department, World Bank.
4. On the risk of inflation and defined-contribution savings
accounts, see Barr, Nicholas. 1992. ``Economic Theory and the Welfare
State: A Survey and Interpretation'' in Journal of Economic Literature.
Vol. 30 (June 1992), p.741-803 and Barr, Nicholas. 1987. The Economics
of the Welfare State. Stanford: Stanford University Press.
5. Arenas de Mesa, Alberto, and Veronica Montecinos. Forthcoming
(1998). ``The Privatization of Social Security and Women's Welfare:
Gender Effects of the Chilean Reform.'' Forthcoming in Latin American
Research Review.
6. Shah, Hemant. 1997. ``Toward Better Regulation of Private
Pension Funds.'' Paper presented at the World Bank, LAC Division, 1-16-
97.
7. See Arenas de Mesa, Alberto. 1997. Learning from the
Privatization of the Social Security Pension System in Chile:
Macroeconomc Effects, Lessons and Challenges. Dissertation. University
of Pittsburgh, Pittsburgh (March) 1997. Arenas de Mesa quantifies how
commission charges affect low and high income earners.
8. Bridge News, 1998. ``Chile Press: World Bank Study Says Asset
Mix in AFPs Lacking.'' Story #14616, 7-23-98.
9. Queisser, Monika. 1998. ``The Second-Generation Pension Reforms
in Latin America'' in OECD, in Maintaining Prosperity in an Ageing
Society, OECD Ageing Working Papers 5.4. P.58.
10. See Vittas (1995).
11. On the impact of pension fund demand on stock prices, see
Uthoff, Andras. 1997. ``Reformas de los Sistemas de Pensiones y Ahorro:
Ilustraciones a Partir de la Experiencia Chilena,'' in Ahorro Nacional:
La Clave Para Un Desarollo Sostenible En America Latina. Madrid:
Instituto de Relaciones Europeo-Latinoamericanas (IRELA).
12. Diamond, Peter, and Salvador Valdes-Prieto. 1994. ``Social
Security Reforms,'' in Barry P. Bosworth, Rudiger Dornbusch, and Raul
Laban eds., The Chilean Economy: Policy Lessons and Challenges
Washington D.C.: Brookings Institute.
13. Ruiz-Tagle, Jaime. 1998. ``Jubilo o Tristeza? El Futuro del
Nuevo Sistema de Pensiones en Chile,'' in Problemas Actuales y Futuros
del Nuevo Sistema de Pensiones en Chile. Santiago: Fundacion Friedrich
Ebert.
14. The figures on the rate of return and benefits are from Gillion
and Bonilla (1992). Cheyre predicts a 5% annual return (see Cheyre,
Hernan 1991. La Prevision en Chile, Ayer y Hoy. Santiago: Centro de
Estudios Publicos).
15. See Gillion and Bonilla (1992 p.186) and Barr (1994 p.213).
16. Arenas de Mesa, Alberto, and Vernica Montecinos.
1999. ``The Privatization of Social Security and Women's Welfare:
Gender Effects of the Chilean Reform,'' forthcoming in Latin American
Research Review, volume 34, No. 3. Arenas de Mesa and Montecinos
project that a woman working 70% of a ``normal'' 45-year career (having
remained outside the labor force due to family responsibilities), would
receive 32% to 46% of her working salary (assuming 5% annual returns).
In order to receive a 70% replacement rate, she would have to have an
average annual return between 7.7% and 10%.
17. See Fidler (1997).
18. Salomon Smith Barney. 1998. ``Private Pension Funds in Latin
America-1998 Update.'' Salomon Smith Barney Industry Report, December,
1998.
19. These figures are from 1990. See Barr (1994 p.212).
20. See Shah (1997).
21. See Ruiz-Tagle (1998).
22. Barr, Nicholas, 1994. ``Income Transfers: Social Insurance'' in
Barr, Nicholas, ed., Labor Markets and Social Policy in Eastern Europe:
The Transition and Beyond. New York: Oxford. See page 214.
23. For an analysis and summary of recent work on the relationship
between pensions and the savings rate in Chile, see Uthoff (1997).
24. Gavin, Michael, Ricardo Hausmann, y Ernesto Talvi. 1997. ``El
Comportamiento del Ahorro en America Latina: Panorama y Consideraciones
Globales,'' in Ahorro Nacional: La Clave Para Un Desarollo Sostenible
En America Latina. Madrid: Instituto de Relaciones Europeo-
Latinoamericanas (IRELA).
25. See Arrau, Patricio 1996. Nota Sobre El Aumento del Ahorro en
Chile. CEPAL: Santiago. The 1% figure is cited in Titelman, Daniel.
1997. ``Impacto De Los Fondos De Pension En El Proceso De Ahorro
Interno'' in 1er Seminario Internacional Sobre Fondos De Pensiones.
Buenos Aires: Asociacion Internacional de Organismos de Supervision de
Fondos de Pensiones.
26. Agosin, Manuel R., Gustavo Crespi T. y Leonard Letelier S.
1997. Analisis sobre el aumento de ahorro en Chile. Office of the Chief
Economist, Inter-American Development Bank, Red de Centros de
Investigacion, R-309. My translation.
27. See Holzmann, Robert 1997. On Economic Benefits and Fiscal
Requirements of Moving from Unfunded to Funded Pensions. Santiago:
ECLAC. Also see Barr (1994 p.214). Barr reports that according to some
commentators, ``this is the only substantial benefit of the pension
reform which could not have been achieved by redesigning the old PAYG
system.''
28. See Fidler (1997).
29. See Asociacion Internacional de Organismos Supervisores de
Fondos de Pensiones, 1996. Reformas a los Sistemas de Pensiones. Buenos
Aires: SAFJP. See p.85.
30. Interview, 2-3-99, Alberto Arenas de Mesa, Ministry of Finance,
Chile.
31. Vergara, Pilar. 1994. ``Market Economy, Social Welfare, and
Democratic Consolidation in Chile,'' in Smith, William et al eds.,
Democracy, Markets, and Structural Reforms in Latin America. New
Jersey: Transaction--North/South Center. See page 254. Also see Gillion
and Bonilla (1992 p.192-195).
Mr. Shaw. Thank you.
Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman. I appreciate the
testimony of all three of you.
Mr. Kay, you are right; I asked the gentleman who spoke on
behalf of the Chilean system from the Cato Institute about this
as the system is only 19 years old. It hasn't even gone through
one generation yet. And it is great that he is enthusiastic
about the program in representing the Cato Institute throughout
the United States as well. But the fact of the matter is that
it is untested. We had high growth in the first 10 years of the
new system, and now we are starting to see staggered growth or
unstable growth in Chile and some of the Latin countries. As a
result of that, the true test is probably going to be over the
next 30 or 40 years, as you suggest, and I appreciate that.
When do you think that we will be able to get a definitive
feeling on whether the Chilean system is actually working and
we can evaluate it fairly?
Mr. Kay. As I said, there is a lot of uncertainty. No one
knows, of course, what returns are going to be. We will have to
wait 30 years, until people begin to retire and successive
generations begin to retire, draw down their accounts, and
purchase annuities. If the Chilean markets continue to do well
in the way they have in the past, then nobody will have
anything to worry about--for those who have contributed,
because there is a compliance problem as well. But Chilean
markets benefited from some very unusual circumstances over the
past 15 years that may or may not be repeated.
The system was developed with the idea that a 4-percent
return or a 4.5-percent return would be enough to get a 70-
percent earnings replacement rate. So, I don't think anybody
expects the kinds of returns that have happened in the eighties
to be sustained, so 4 percent would be good. This is where the
experts disagree. Some say that 5 percent is a realistic
expectation; others say 3 percent.
Mr. Matsui. Right. I appreciate that.
Dr. Kingson, you were saying that we ought not to be so
down on the system that we have here in this country, if I am
not mistaken. I was kind of back and forth. I apologize. Our
system now has been in place for about 65 years. Obviously, it
was more of a widows and orphans fund at the beginning, but it
has matured, obviously, into kind of a safety net income
security program for seniors and the disabled and for survivor
purposes.
How would you rate our system, again, for the record?
Mr. Kingson. I would rate it as a tremendous American
success----
Mr. Matsui. I appreciate that.
Mr. Kingson [continuing]. And one that remains quite
popular, across all ages, in fact, although we acknowledge that
there is concern about its future and that there is work to be
done. It is very important.
Mr. Matsui. I appreciate that, because I think all of us
are aware of the fact that we do have a demographic problem,
and we need to address that issue in a good-faith way. I know
all of you feel the same way, and all of us do as well.
Mr. Orszag, in terms of the--and I couldn't get this out
of--perhaps maybe I didn't try hard enough, but out of the
witnesses prior to you. What is really the cost of maintenance
of the Chilean system? We have got, basically, three issues of
cost. One is the cost of maintenance of the system; that is,
the cost of financial advisors and the cost of fees. The second
is, when a transfer occurs, I guess that is an additional fee.
Then, three, when you annuitize the program, particularly if
you give CPI or at least an inflationary increase, that does
add to the cost.
Then perhaps you could also discuss whether there is a
differential between men and women. Since women live longer in
Chile and the United States, are women penalized? Do they get a
lower rate, even though they have the same dollars fund at the
end of the retirement period? Perhaps you can respond to those
two or three questions I asked.
Mr. Orszag. Sure. My research has focused mostly on the
United Kingdom, but the apparatus for analyzing individual
accounts will apply to any system.
Mr. Matsui. Right.
Mr. Orszag. So it can just as well apply to Chile. Again,
you have an annual management fee, which is the one that is
referred to effectively as adding up to about 18 or 20 percent.
In Chile, there are regulations on the fee structure. There are
only certain types of fees that are allowed. It turns out that
the way that the fees are typically imposed, which is a one-
time fee of, say, 18 percent, regardless of whether you then
switch AFPs or financial providers. This structure means that
transfer costs are effectively zero in Chile, despite
relatively rapid transferring across AFPs. That, again, just to
emphasize, is not true in the United Kingdom----
Mr. Matsui. Right.
Mr. Orszag [continuing]. Where people are hit for those
transfers.
Mr. Matsui. Could you just tell us what that number is--and
I know my time has run--but could you tell me that number?
Mr. Orszag. In the United Kingdom?
Mr. Matsui. United Kingdom, yes.
Mr. Orszag. In the United Kingdom, again, our estimates are
very preliminary, but it is looking like that may well double
the figures that were discussed this morning.
Mr. Matsui. OK. Then if you can finish?
Mr. Orszag. Sure. Then, on Chile, again, the transfer costs
are zero. The annuitization cost we have to be somewhat careful
about. There are two different costs that are associated with
annuities. One is an administrative cost, and the evidence I
have seen from Chile is probably on the order of magnitude of
2, 3, 4, 5 percent, that kind of range, although the estimates
vary.
There is another kind of annuitization cost--I haven't seen
estimates for Chile--which is quite prominent both in the
United States and in the United Kingdom, which is people who
purchase annuities tend, on average, to live longer than the
rest of the population. So if you were a typical person and you
went to buy an annuity, you would effectively be penalized
because the annuity provider would say, oh, no, the people who
normally buy annuities live longer than you do, and we are not
going to give you as much. So there is an additional cost. I
haven't seen those figures for Chile. In the United Kingdom and
in the United States, that can often be 10 or 15 percent.
Mr. Matsui. Of the entire asset?
Mr. Orszag. Of the entire value of the asset.
In terms of the men versus women, while it is true that the
value per year is lower for women, again, the reason that it is
lower is that, on average, they are expected to live longer. So
if you look at lifetime benefits, there shouldn't really be a
difference. What it does mean is that, if a woman dies
prematurely, she will not get as much as she would have
otherwise. I would note in the United Kingdom, if you annuitize
an appropriate personal pension, the annuity value has to be
the same for a man and a woman. So that doesn't occur. But,
again, that kind of differentiation by gender is intended to
equate lifetime benefits, and that means, because of different
life expectancies, that the annual benefit has to be different
for men and women.
Mr. Matsui. Thank you. My time is up. Thank you.
Mr. Shaw. Mr. Becerra.
Mr. Becerra. Thank you, Mr. Chairman, and thank you to the
panelists for staying and being so patient with us.
Let me ask a couple of quick questions, so I can get to the
heart of one final question that I would like to ask. First, in
regards to Chile and the fact that the annuities that you are
eligible to take out or to draw down works against women, is
there anything that the Chilean system does to try to
compensate for the fact that the treatment of women will be
worse than that for men? Does anyone know?
Mr. Kay. As Mr. Orszag was saying, by saying it is better
or worse, I was pointing out it was different. In a pay-as-you-
go system you didn't have this differential that you get when
you place men and women in separate actuarial groups. But if
you draw down--for anyone who draws down--you can purchase an
annuity or you can draw down your pension based on your life
expectancy. So, since women tend to live longer, they would
also get a lower benefit. But anybody who survives drawing down
their benefit is eligible for a minimum pension in Chile.
Mr. Becerra. Which, unfortunately, probably a lot of women
in Chile qualify for, the minimum pension, since they probably
don't have high salaries.
Mr. Orszag. If I could just comment briefly on
annuitization, if a similar system is created in the United
States, there is a very difficult sort of issue that will have
to be addressed, which you are touching upon, involving whether
or not men and women should have different annuity rights;
whether annuitization should be mandatory, which would be one
way of dealing with, what is called, the adverse selection or
the issue I mentioned regarding different life expectancies,
and a whole set of very difficult tradeoffs. For example, by
making annuities mandatory, you might solve this adverse
selection problem of people with different life expectancies
choosing to purchase annuities, but you would be forcing
someone who knew, say, that they had cancer to convert their
accumulated $500,000 account balance into a portion of that for
a year, and then have it be gone.
Mr. Kingson. When we talk about Chile or other countries, I
think it is very important to recognize we are in a very
different context and our Social Security system is quite
different. We are not facing a system which hasn't been able to
maintain its payments; it has never missed a payment. We are
not facing the kinds of problems the Chilean system faced.
Mr. Becerra. In fact, it was interesting, because that was
the point I tried to make when Dr. Pinera was here. They
started their pension system, the PAY-GO system, before we
started ours, about 10 or so years before we did. They had
tremendous problems, such that, by the time 1980 rolled around,
they had no more money. In fact, they were broke.
We have been operating under a sort of PAY-GO and now a
prefunded. Yet, we have a surplus. So they started before us
having sort of the same system. Yet, theirs didn't go well;
ours has gone fairly well. At least we are in surplus, and we
are now trying to deal with the problem that is still 30 years
out. So there is a difference between what Chile experienced
and what we are experiencing now.
Mr. Kingson. The Chilean system also is far less than
perfect. I think Dr. Kay would know the precise numbers, but
roughly half the work force, maybe 60 percent, is covered in
Chile. The military is still in their own defined benefit plan.
They have chosen not to go into this privatized plan.
Mr. Becerra. Mr. Kay, you have mentioned something about
the administrative costs--actually, Mr. Orszag did as well. But
Mr. Pinera seemed to think that they were insignificant, the
administrative costs, and you are saying that they are a
percent of the contributions that people make into these
accounts.
Mr. Kay. Mr. Pinera was measuring costs as a percentage of
assets under management, a management fee on assets managed.
But the commission costs are charged to individuals as a basis
of their contributions to the system. So that is why workers
have been paying roughly--it came down slightly this year and I
used the 1997 figure--18 percent of their total contributions
to pension funds as administrative charges. It is often
expressed as 10 percent going to their accounts. The whole 10
percent goes into their accounts, and then an additional, for
1997, 2.2 percent went to a management fee. So it is a
significant cost for workers who are seeing that money
disappear, and that is why you have the difference that Mr.
Roosevelt cited with respect to returns between 1982 and 1995.
Average annual returns, if you average a simple average, not a
weighted average, of each year's annual return, were 12.4
percent. But if you take into consideration the commission
charges, it brought returns down to 7.4 percent.
Mr. Becerra. What are the administrative fees that Social
Security incurs right now?
Mr. Orszag. Relative to that 18 percent, on a comparable
figure, it is about 0.8 percent.
Mr. Becerra. So less than 1 percent versus 18 percent cost?
Mr. Orszag. Right.
Mr. Becerra. OK. Significant.
Thank you very much. Thank you, Mr. Chairman.
Mr. Shaw. It seems that, from this panel, we are not even
talking about the same plans that we have been talking about
earlier today. Mr. Lilley and Mr. Pinera had testified to us
that the workers retiring in both the United Kingdom and in
Chile, through these personal savings accounts, end up
maintaining their income at about 70 percent of what it was
when they were working. Do you dispute that?
Mr. Orszag. If I could actually comment on that, for
example, looking at the appropriate personal pensions, which is
the individual account component, in the United Kingdom, we
don't know. It has only been operating for 10 years. Basically,
no one has retired under that system yet. Disproportionately
young people opted out of the existing system and into
individual accounts. They still have 20, 30 years for that.
Mr. Shaw. All right. Let me ask you this then: Is that
account building up faster than the Social Security Trust Fund,
which yields 2 percent here in this country?
Mr. Orszag. The rate of return on that account has been
roughly the rate of return on the equity market, which has been
about 10 percent per year.
Mr. Shaw. Now that is opposed to 2 percent here.
Mr. Orszag. Well, however, the Social Security system in
the United Kingdom is still in its very early years. As in any
early year of a pay-as-you-go system, the rates of return are
very high, just as they were at the very beginning of the----
Mr. Shaw. But you were just telling us that the charges of
putting the money in are very high. So how could you come to
that conclusion?
Mr. Orszag. I'm sorry?
Mr. Shaw. The initiation cost for putting the money, you
have been critical of the plans for having some frontloaded
expenses that are very high.
Mr. Orszag. That is right.
Mr. Shaw. So if you follow that through, it would seem
that, the older the plan is, the better the return.
Mr. Orszag. It is not clear that--the reason I am
emphasizing this--it is not clear that individuals will wind up
better off under the individual accounts than they would have
under the state-run system.
Mr. Shaw. How long do you suggest we watch it before we
decide whether it is a good thing?
Mr. Orszag. Well, if I could just----
Mr. Shaw. Whether we decide 10 percent is better than 2
percent?
Mr. Orszag. No, if I could just add as to why that is,
first of all, there is the misselling cost, $18 billion that
firms will have to make up to individuals. It is only because
the government stepped in and insisted that the firms make that
up to individuals that it is even possible they will be better
off.
Second, the government has provided additional incentives
to workers to opt out of the existing system. There is a recent
paper by the Social Security Administration that looks in
detail at how much benefits are saved by having people move out
of the system versus how much the tax rebates are. The net cost
to the U.K. Government is about 16 billion, or
roughly $22 billion. It is not surprising that, if you get $22
billion from the U.K. Government through additional tax
incentives, and then you are made whole through $18 billion
from private providers, which the government insists on, those
things combined could make you slightly better off. But, again,
these are all projections of how much compensation will
ultimately be paid----
Mr. Shaw. Let me switch over to Mr. Kay, and ask you how
you would react to his testimony, which says--and it is being
critical, actually, to the Chilean model by saying that women
only get 56 percent, where under our plan they only get 43
percent. How do you respond to that? Which is better? That is
19 years old.
Mr. Orszag. I understand. A higher replacement rate, all
else equal, is better, but one has to worry about, in Chile,
for example, those figures don't include--Mr. Kay also
mentioned the high cost of the transition, the bonds that were
issued to recognize benefits accrued under the previous system.
In doing a full accounting of whether a movement to an
individual account system makes sense or not, one would want to
include the cost of those bonds, or else you are comparing
apples and oranges. If you included the cost of financing those
bonds, at least the academic supposition is----
Mr. Shaw. Those are transitional costs that show up----
Mr. Orszag. That is correct.
Mr. Shaw. And it is something that we are going to have to
face here, too, one way or the other. If we are going to
maintain the level of benefits, which everyone that I know of
and everyone that I talk to wants to do, then I think there is
going to be a certain amount of pain in the transition that we
are going to have to face.
Mr. Orszag. I think that that is exactly right,
Congressman. There is a tradeoff to be made. Basically, under
any pay-as-you-go system, by giving very high rates of return
early in the system, all subsequent generations are made worse
off. We don't escape that tradeoff by moving to individual
accounts. What you do is you tilt it between one future
generation and another in different ways.
Mr. Kingson. Congressman, our first----
Mr. Shaw. Let me give the next question to Dr. Kingson
because I do have a question here for you. You say you staffed
one of the commissions, so you are familiar with the lifeline
and with the life of the Social Security system as we know it
now. You testified that you have looked at some of the European
models, and we are better off than a lot of them. Well, a lot
of them are a disaster. I understand that in Italy, for
instance, that they are just a few years from having a horrible
problem because of decreasing birth rates.
With regard to where this thing is going to break down, in
30 years my children will retire, and they will be looking for
some type of pension plan. Their children, my grandchildren,
will have to contribute to some system, unless there is a
radical departure from where we are. We all agree that the
Social Security system is one of the wonderful things about
America, and we can certainly support that.
Now if we were to stick with the existing system, what
percentage of their pay would my grandchildren have to pay to
be sure that my children's pension is adequate, or if I am
lucky enough to still be a burden to them and be hanging
around, also to take care of me?
Mr. Kingson. It depends on the choices the Congress makes.
Mr. Shaw. I am talking about under the existing system.
Mr. Kingson. Well, it depends. We have the choice--
respectfully, the Congress has the choice between----
Mr. Shaw. As it is today. As it is today, without any
change in legislation.
Mr. Kingson. Well, the current payroll tax is 6.20 percent
on employer and employee.
Mr. Shaw. Right, 12.4.
Mr. Kingson. If the current system--and I would just put
this background to answer your question: As you know, the
current system is projected to have sufficient funds to meet
all obligations through 2031 and about three-quarters
thereafter, Congressman.
Mr. Shaw. Let me interrupt you just 1 minute.
Mr. Kingson. So, clearly, some----
Mr. Shaw. I am not asking you another question. I am just
interrupting. I have just been told that Dr. Orszag has a
commitment over at the Capitol at 4. So if no one has any
additional questions for him, I would like to excuse him----
Mr. Orszag. Thank you very much.
Mr. Shaw [continuing]. So that we don't inconvenience him
any further. Thank you for taking the time to be with us.
Go ahead, Doctor.
Mr. Kingson. Thank you, sir.
Clearly, we need to do something. I have faith that the
Congress will do something, some combination of changes. The
President has put a proposal forward that has some merit,
considerable merit. There are other possible ways of doing
this. If one wanted to use cuts in benefits, moderate cuts in
benefits, they are available through retirement age changes or
through changes in the benefit formula. I am not suggesting
that is what we should do. They are there, if we wanted to----
Mr. Shaw. Back up and answer my question. What percentage
of their earnings would my grandchildren have to be paying 30
years from now to take care of their parents and their
grandparents, if their grandparents are still alive?
Mr. Kingson. I cannot tell you precisely, sir. I can tell
you that I have two children who will retire in 2045 and 2049,
and we share the concern that it be there, but we certainly
need----
Mr. Shaw. I have heard the figure 30 to 40 percent. Is that
correct?
Mr. Kingson. That is absolutely wrong.
Mr. Shaw. Well, what would you say then? Throw a figure out
for us.
Mr. Kingson. We are looking at a system which is running
right now at about 4.6 percent of GDP; furthest out on the
problem, it would go up to somewhere in the neighborhood of 6.9
percent, if we made no other changes in benefits.
Mr. Shaw. You are talking about GDP. I am talking about
their earnings. Right now it is 12.4 percent. What would it
have to be to be a fully funded system? That is a simple
question. If you don't know the answer, I can understand. I
don't know the answer.
Mr. Kingson. Well, I can say I don't know precisely. I
think it would be somewhere in the neighborhood--we are looking
at 25-percent shortfall, 33 percent out in the year 2070. So we
would probably need, if one only chose to do it through payroll
taxes, which would not be terribly wise, I would probably need
at the far end--you would need nothing until 2030; we would
need something in--we would need clearly payroll taxes after
then. And at the farthest end, out in 2070, it would probably
be about 18 percent.
Mr. Shaw. You are saying it would only go up less than 6
percent, 5.5 to 6 percent?
Mr. Kingson. I believe in 2070--roughly out there--we are
looking at about a 6 percent of payroll shortfall. I think it
is 5.81, if I remember correctly.
Mr. Shaw. That is interesting.
I would like to make this observation with regard to the
testimony we heard, and particularly yours, Dr. Kingson. I look
at today's testimony as a bright light of opportunity, that we
do have an opportunity to do better. The fact that these
programs are popular in these other countries I think is a very
good thing. It is something that we should be somewhat hopeful
for.
I don't know of any Member of Congress that wants to
increase the payroll taxes, nor do they want to decrease the
benefits. The President has said as much; I just said as much.
So we need to look at what other countries are doing and try to
get some of the things that we think are working.
Obviously, I know of no pension that invests only in the
type of investments which our government invests in. It is
pitifully low. It is criminally low. The Social Security system
that we have today is still well; it is viable, and it is going
to take care of my mother, but it is not going to be around to
take care of people beyond that without an awful lot of pain
for those who are in the work force. That is what we have got
to do. That is what we have to search--for better investment
opportunities. Because I know of nothing we can do--if we are
unwilling, which we are, to increase the taxes, if we are
unwilling, as we are, to decrease the benefits, then we have
got to look at the investments structure. That is the only
thing left. If you have a rabbit to pull out of the hat that
you want to tell us about, we will be glad to listen to you for
the rest of the afternoon.
Mr. Kingson. I won't pull a rabbit out of a hat, but I
would suggest that the new Director of CBO noted that there is
no escaping the fact that current generations of workers
support nonworking people. It doesn't matter whether we prefund
a Social Security system or we go pay-as-you-go; the burden
falls on current workers to care for their children and for
nonworking adults. Therefore, it becomes critical to invest in
the economy. We have some choice with respect to the mechanisms
we use, but we still have current workers having to pay for
them, whether we have a prefunded system or not.
Mr. Shaw. And I think our job, our mission, here is to be
sure that our grandchildren are cared for in such a way that
they are not overburdened with this, so that we could end up
with an intergenerational problem in this country. If we do
nothing, our children will turn our pictures to the wall and
say, ``Shame, shame, shame.'' So I think we are going to do
something, and I have great hope that we will.
I appreciate you all waiting so long. I appreciate your
testimony and your willingness to come before this Committee.
We are now adjourned.
[Whereupon, at 4:26 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of Joseph G. Green, Toronto, Ontario, Canada
WEP Modification Proposal
Background
Historically, years ago, government employees in the US,
(local, state and federal) could not belong to the Social
Security System and also be part of a government pension plan.
Since government pensions then were higher, most employees
elected to join the appropriate government plan and not social
security. As of 1984, Congress mandated that ALL workers must
belong to the Social Security System.
However, Congress realized that these civil servants would
retire, having paid in only the minimum of 40 quarters or a
little more, but at a much higher social security rate than
those pensioners who had joined the system 20 or more years
before (but contributed when the rate was much less).
Therefore, beginning in 1984 and thereafter, the pensioners
with a non-covered pension would in effect get their full non-
covered pensions plus much higher social security benefits than
would those workers who had contributed to social security for
many more years before 1984, when maximum was less than half of
today's $1,326 (as of January 1997).
Thus, pensioners retiring in the 1990s and thereafter, with
a full non-covered pension, would enjoy a proportionately
larger social security benefit than those who had contributed
for many more years but had contributed less.
To adjust this situation, when Congress amended the Social
Security Act in 1983, it wrote into the statue a provision to
offset this unintentional oversight for those with a
SUBSTANTIAL non-covered pension. This provision is known as The
Windfall Elimination Provision (WEP).
The Statute
Provision 113-WEP--of the 1983 Social Security Amendments
PL98-21, stipulates that a pensioner entitled to social
security benefits and also having a non-covered pension (all
foreign pensions are obviously non-covered by social security)
will have $50 deducted from his/her monthly social security
benefit for every $100 he/she receives from the non-covered
pension. The law further states that those whose social
security computation falls under the WEP cannot lose more than
half of their entitled social security benefit. This law went
into effect as of January, 1986. Anyone drawing social security
benefits prior to that date is not affected.
The Practical Application for Overseas Pensioners
Congress never even considered American pensioners and how
WEP would affect them if they are living overseas and are
entitled to social security and get also a small or partial
foreign pension. We abroad are adversely affected TWICE!
In the first place, our social security was frozen when we
elected to leave the United States and relocated abroad at a
time when social security monthly benefits were less than half
of what they became in the 1990s. For example, in 1973, maximum
social security benefits were only $550 per month. As of
January, 1997, the maximum Social Security benefit is $1,326.
American pensioners abroad entitled to a small or partial
foreign pension, have their already frozen social security
benefit of $550 or less further reduced up to half as a result
of applying the WEP. Thus, anyone falling under the WEP in the
United States enjoys a full non-covered pension of a $1,000 or
more monthly, and even at maximum, can only lose up to half of
today's maximum of $1,326 when applying the WEP formula.
However, the overseas pensioner who winds up with a modest
foreign pension of as little as $200-400 monthly has his/her
frozen social security benefit of 20 or more years ago further
reduced, up to half, netting him or her only a few hundred
dollars per month.
This is a gross inequity and needs modification. In the
first place, many overseas pensioners have paid into the Social
Security system for many years. When they relocated abroad,
they were certain that upon retirement their full social
security due them would be guaranteed. Secondly, the Windfall
Elimination Provision was only intended for those with a
SUBSTANTIAL, non-covered pension. In today's economy. getting
$400-600 of a monthly non-covered pension cannot be considered
as being substantial. For many, their meagre foreign pension,
together with their low, frozen social security is their only
means of income. Having their entitled social security cut in
half because they also are entitled to a modest, or partial
non-covered pension causes an unfair hardship. This also places
the overseas pensioner in an unequal situation relative to his
fellow pensioner residing within the United States, falling
under the WEP.
Modification Sought
To correct this inequity, Congress is petitioned to modify
the Windfall Elimination Provision as follows:
l) Anyone whose non-covered pension is $600 or less shall
be exempt from the Windfall Elimination Provision.
2) Anyone whose non-covered pension is between $600-$1,200
shall have his/her first $400 exempt before applying the WEP
formula.
3) Anyone whose non-covered pension is $1,200 or above
shall have his/her monthly social security benefits fully
computed in accordance with the WEP provision.
This proposal would greatly ease the inequity that now
exists between pensioners residing at home or abroad. At the
same time it would retain the spirit of the law; namely
reducing the social security benefits of only those who have a
SUBSTANTIAL non-covered pension, in addition to a substantial
benefit from social security.
Information from the Heritage Foundation:
Australia's Privatized Retirement System:
Lessons for The United States by
Daniel J. Mitchell, McKenna Senior Fellow in Political Economy
and Robert P. O'Quinn, Policy Analyst
Like the United States, Australia has been confronted by a
dual crisis in its government-run old-age pension system.
Benefits payments to an aging population threatened to consume
ever larger amounts of Australia's budget according to
projections in the 1980s, yet the Australian Social Security
system clearly was unable to provide an adequate income for
retirees.
In 1986, in an effort to address these serious problems, a
left-of-center Labor government began to implement an
innovative retirement system based primarily on mandatory
private savings in plans called ``superannuation \1\ funds.''
This system, which in 1992 became known as the Superannuation
Guarantee, continued to be modified and expanded and now
features three key elements. First, workers contribute a set
percentage of their income through their employer to private
savings plans. By 2002, when the system is fully implemented,
all workers will be required to set aside 9 percent of their
income in a superannuation fund of their choice (see Appendix
1). This mandatory savings can be augmented by tax-favored
voluntary contributions. Second, upon retirement, workers will
have accumulated a large nest egg from which to draw a secure
and comfortable annual income. Third, a safety-net program
guarantees that all retirees will receive an income that at
least matches the income they would receive under the original
government-run program.
Even though Australia's private retirement savings plan is
still very young, it is quite popular. The benefits which have
begun to materialize herald a significant long-term improvement
in the Australian economy. For example:
More income for retirees. In the future, average-
wage workers should be able to retire with two to three times
the income they would have had under the original government-
run system, depending on the level of additional voluntary
savings and the earnings performance of the superannuation
funds.
Increased national savings. The overall savings
rate could climb by more than 3 percent of gross domestic
product (GDP) by 2020. Already, private savings in
superannuation funds have skyrocketed, rising from Au$40
billion \2\ (US$28 billion) in 1985 to Au$304 billion (US$240
billion) as of June 1997.
Reduced pressures on the budget. Because
eligibility for taxpayer-financed age pensions is now means-
tested,\3\ the higher incomes made possible by privatization
will lead to substantial budget savings. Government spending on
age pensions will reach only 4.72 percent of GDP in 2050, one-
third less than would have been needed had the government
chosen to provide an American-style universal Social Security
retirement benefit. (In the United States, Social Security
retirement outlays are expected to consume 5.59 percent of GDP
by 2050.)
The United States faces many of the same challenges that
Australia confronted in trying to ensure an adequate retirement
income for its aging population.\4\ The U.S. Social Security
system is expected to begin running a deficit by 2012. As the
baby-boom population approaches retirement, policymakers
grapple with a serious dilemma: How can they reform Social
Security to give American workers a comfortable and secure
retirement while addressing the system's massive long-term
deficit?
As a model for reform, Australia's transition from a
government-run benefits program to a system based on private
savings was a resourceful answer to the challenges the
Australian government faced. Like similar privatization efforts
in Chile and Great Britain, Australia's system offers
legislators in the United States several key lessons for
reforming the troubled Social Security system.\5\
Why Australia Had to Reform Its Pension System
The government-run old-age pension system in Australia was
created in 1909 to help lower-income retirees. The government
progressively began relaxing means-testing and moving toward a
universal age pension after World War II.\6\ By 1983, all
Australians over the age of 69 received a full age pension
regardless of income, and the rules for men 65 to 69 years old
and women from 60 to 69 years old were so lax that almost all
of them qualified for a full age pension as well.
This Social Security system was just one part of a massive
expansion of government's role in the Australian economy
between 1901 and 1983. Among other things, policymakers tried
to promote industrial development through high tariffs and
subsidies to manufacturers. The government nationalized most
energy, telecommunications, and transportation companies. It
also created a highly centralized system of wage bargaining,
known as the Award System, in which employer organizations,
labor unions, and the government jointly established wages and
working conditions across entire industries based on concepts
of ``social justice'' rather than on market conditions. The
economic impact of these policies, not surprisingly, turned out
to be negative. Australia's per capita GDP went from the
highest in the world in 1900 to 14th by 1980.\7\
This long-term decline, as well as fears of a more
immediate economic crisis, drove the newly elected Labor
government in 1983 to implement fundamental changes in
Australia's economic policies. Then-Treasurer Paul Keating best
summarized the challenges facing Australia:
We must let Australians know truthfully, honestly, earnestly,
just what sort of international hole Australia is in.... If
this government cannot get...a sensible economic policy, then
Australia is basically done for. We will end up being just a
third rate economy.... Then you are gone. You are a banana
republic.\8\
As part of the new Labor government's comprehensive
economic reform program, the Social Security system was given a
thorough re-examination. Prime Minister Bob Hawke and Treasurer
Paul Keating found that government policy discouraged private
savings and left too many Australians dependent on Social
Security age pensions as their primary source of retirement
income. Moreover, these policies were causing adverse
consequences for the nation's economy. The dire problems
confronting Australian policymakers included the following:
Less than 40 percent of all workers participated
in public or private pension plans (superannuation funds)
before 1983, and coverage was limited to government employees,
financial sector workers, professionals, and senior business
executives.\9\
Accumulated retirement savings generally could not
be transferred from one employer's superannuation fund to
another when an Australian changed employment.
This lack of portability, along with the
preferential tax treatment of lump-sum distributions--95
percent of lump-sum distributions from superannuation funds
were tax exempt--often meant that superannuation merely
provided high-income Australians with a way to acquire
virtually tax-free income upon changing employment.
Dependence on Social Security age pensions
contributed to reduced national savings and depressed economic
growth. Indeed, Australia's national savings rate had declined
from an average of more than 25 percent in the early 1970s to
16.1 percent in fiscal year 1991-1992.\10\
The population was growing older. From 1994 to
2051, the number of Australians 65 or older will climb from
11.9 percent to about 23 percent of the total population.
The growth in the aging population also means that
dependence on Social Security age pensions would threaten long-
term fiscal stability. Age pension payments consumed 3.44
percent of GDP in FY 1982-1983 and were projected to rise
dramatically as the population aged, potentially reaching 6.8
percent of GDP by FY 2049-2050 if Australia continued on the
path to a universal age pension like the U.S. Social Security
program.\11\
[GRAPHIC] [TIFF OMITTED] T6189.003
The Private Savings Solution
To address these serious problems, the Labor government
decided to restructure Australia's retirement policy.
Policymakers decided that a new system should satisfy three
goals:
1. Provide more retirement income for future retirees,
2. Increase national savings, and
3. Reduce long-term pressures on the budget.
The government concluded that the best way to achieve these
goals was to reduce the scope of government tax-and-transfer
schemes and instead promote greater individual reliance through
a system of mandatory private savings. As a result, the Labor
government took the following steps during its 13 years in
power:
Means-testing of age pensions. In 1983, the Labor
government reversed the trend toward a universal old-age
pension and strengthened means-testing for age pensions. The
existing income-based means test was extended to Australians
age 70 or over. A new asset-based means test also was imposed
(see Appendix 2).
Superannuation portability and penalties for pre-
retirement withdrawals. To encourage Australians to preserve
their superannuation savings until retirement, two new rollover
vehicles were created in 1983--approved deposit funds and
deferred annuities. These vehicles allowed Australians to keep
their superannuation savings when they changed jobs. In
addition, a 30 percent tax was imposed on lump-sum withdrawals
from superannuation funds before age 55.
Award Superannuation. In 1985, the Labor
government reached an agreement with Australia's chief labor
organization, the Australian Council of Trade Unions, to seek a
universal 3 percent contribution for each employee to a
superannuation fund in lieu of a general wage increase through
the Award System. In 1986, the Industrial Relations Commission
endorsed this agreement and incorporated this employer mandate
into all future labor contracts. As of July 1991, 72 percent of
all employees were covered by Award Superannuation.
Superannuation Guarantee. In 1992, the government
introduced the Superannuation Guarantee (SG) to expand Award
Superannuation to cover virtually all workers.\12\ Under SG,
every employer is required to contribute a prescribed minimum
on behalf of each employee to a superannuation fund. The
required minimum contribution was set at 3 percent of an
employee's earnings in FY 1992-1993 and will rise gradually to
9 percent by 2002-2003.\13\ Savings in superannuation funds are
fully vested and portable between employers. Under current law,
savings in superannuation funds must be preserved until
retirement after age 55.\14\
In March 1996, Australians elected a Liberal Party-National
Party coalition government which made further reforms in the
system in May 1997. These included:
Tax relief. To promote additional non-compulsory
private savings, the tax burden was lowered on savings. During
the 1998-1999 fiscal year period, individuals will be allowed a
7.5 percent tax credit of up to Au$225 (about US$177) and a 15
percent tax credit in 1999-2000 and beyond of up to Au$450
(US$355). These credits will apply to savings income and/or
additional voluntary contributions to superannuation
accounts.\15\
Consumer choice. Private-sector workers were given
the right to choose a fund from at least five options into
which their employers would deposit their superannuation
savings. As of July 1, 1998, these options must include (1) any
relevant industry superannuation fund, (2) any corporate
superannuation fund, (3) at least one retail superannuation
fund, and (4) a new kind of superannuation fund--the Retirement
Savings Account (RSA)--provided by the bank or financial
institution receiving an employee's pay. RSAs are low risk/low
return capital guaranteed funds offered by banks, building
societies, credit unions, and life insurance companies.\16\
More retirement income. To maximize the amount of
savings in each superannuation account (and therefore the size
of the annuity that could be purchased), early hardship
withdrawals are prohibited, and the preservation age before
which no withdrawals could be made will be raised from 55 in
2015 to 60 by 2025.\17\
Gender neutrality. The government age pension
program was modified to ensure equal treatment for men and
women. Currently, women may receive age pensions at age 61
while men must wait until age 65. As of 2013, neither sex will
be able to qualify for the government safety-net program until
age 65.\18\
Retaining the Safety Net
Although there is a strong consensus in Australia that
individuals should be responsible for saving for their own
retirement, a safety net will remain in place to ensure that no
one will be worse off under the privatized system. In effect,
every retiree is guaranteed an age pension equal to 25 percent
of the average worker's wage--exactly what was available before
privatization.\19\
Moreover, the means-testing provisions for the government
age pension are extremely generous. Even though almost all
retirees will have some income from their superannuation
savings, more than 33 percent of senior citizens in 2050 will
get a full age pension from the government.\20\ All told, a
full 75 percent of the elderly population in 2050 will have
their private savings income supplemented by full or partial
government benefit payments.\21\
These generous payments reflect Australia's primary goals
in adopting mandatory superannuation: boosting retirement
incomes and increasing national savings. Reducing government
spending was a lower priority. And while there will be
significant long-term budget savings, they will not be nearly
as large as they could have been with a stricter means-testing
policy, a more rapid implementation of the SG savings mandate,
and elimination of the gap between the SG preservation age and
the qualification age for age pension payments.
The Results Of Successful Reform
By every possible measure, the Australian move to
privatization thus far must be considered a success. The Labor
Government had committed itself to establishing a system that
would satisfy three major goals: providing more income for
retirement, increasing savings, and reducing long-term
pressures on the budget. As the following information
illustrates, Australia is well on its way toward achieving
those goals.
More Income for Future Retirees
Increasing the level of private savings will result in
significantly higher retirement income for Australian workers.
Predicting exactly how much higher is, of course, difficult
because retirement income under the private system will depend
on the earnings performance of the superannuation funds as well
as the level of additional voluntary contributions. Yet even
pessimistic scenarios show that privatization will boost old-
age income substantially.
[GRAPHIC] [TIFF OMITTED] T6189.004
The Australian Treasury's Retirement Income Modeling Task
Force, for instance, computed that average-wage workers who
made no voluntary contributions and earned only 4 percent in
real returns each year (a modest figure, since the average over
the last 10 years has been 5.5 percent) will be able to retire
with nearly twice as much income as they would have had under
the old government-run system.\22\ More realistic assumptions,
such as higher average returns and some degree of voluntary
savings, have demonstrated that privatization easily could mean
more than twice as much, and perhaps about three times as much,
retirement income for the average Australian worker. As
Appendix 3 illustrates, the benefits for different demographic
examples are similarly startling.
Increasing National Savings
The amount of funds in superannuation accounts has soared
from 17 percent of GDP in 1985 (Au$40 billion) to more than 55
percent of GDP in 1997 (Au$304 billion). By 2020,
superannuation assets are projected to reach more than 100
percent of GDP (Au$1,525 billion, or US$1,202 billion).\23\
Policies to boost the level of voluntary savings also seem
to be highly successful. One-third of superannuation deposits
in the most recent reporting period, for instance, came from
unforced employee contributions.\24\ All told, superannuation
is projected to increase Australia's national savings rate by
at least 3 percent of GDP.\25\
[GRAPHIC] [TIFF OMITTED] T6189.005
A Reduction in Long-Term Budget Pressures
Age pension reform and the growth of superannuation funds
will have a long-term positive impact on Australia's fiscal
position. Before reform, Australia had an almost universal age
pension. The Australian Treasury's Retirement Income Modeling
Task Force estimates that outlays for a universal age pension
would have consumed 6.76 percent of GDP in FY 2049-FY 2050.\26\
Because the Labor government strengthened means testing for age
pensions and initiated the Superannuation Guarantee, however,
age pension outlays will be only 4.72 percent of GDP in FY
2049-FY 2050.
[GRAPHIC] [TIFF OMITTED] T6189.006
Potential Future Changes
Australian policymakers are largely satisfied with the core
components of their newly privatized retirement system. Across
the political spectrum, legislators understand the flaws of the
old government tax-and-transfer scheme and recognize that
private savings can provide a more comfortable and secure
retirement for the nation's senior citizens. Nonetheless, some
features of the new system continue to provoke debate, and it
is certainly possible that changes may be made in the near
future. The issues that are most likely to attract reform are:
The tax treatment of superannuation. The coalition
government announced that it will conduct a complete review of
Australia's tax code. Many lawmakers believe the tax laws are
needlessly complex and impose unnecessarily harsh penalties on
work, savings, and investment. It is therefore possible that,
as part of comprehensive reform, Australia might choose to
follow the lead of other nations with private retirement
systems and abolish taxes on superannuation contributions and
annual fund earnings, taxing withdrawals upon retirement
instead.\27\ In other words, rather than impose the 15 percent
tax on workers' contributions made by employers as well as the
high income surcharge, it might make contributions to
superannuation funds tax deductible. Moreover, both the 15
percent tax on interest and dividend income in superannuation
funds and the 15 percent tax credit on withdrawals after
retirement would be repealed. These changes would accelerate
the accumulation of assets within members' superannuation funds
during their working years and reduce their dependence on the
age pension after retirement. This approach would also ensure
that the Australian tax code does not put a disproportionately
heavy burden on income that is saved.
A mandate that superannuation assets be used to
finance retirement income. Australians can manipulate the
current system in two ways to increase their age pension
payments from the government. First, the gap between age 55,
when SG benefits can be withdrawn, and age 65 (age 61 for
women), when age pension payments commence, could tempt some
Australians to use their superannuation funds to finance early
retirement and then rely on taxpayer-financed age pensions
after age 65. The coalition government previously agreed to
raise the SG preservation age from 55 in 2015 to 60 in 2025,
but this leaves a gap of five years. Pension experts advocate
eliminating this gap to prevent citizens from ``double-
dipping.'' In addition, current law allows retirees to make
large lump-sum withdrawals from their superannuation funds.
This may tempt some workers, even those who work until age 65,
to dissipate their retirement funds by purchasing ``big
ticket'' consumption items immediately and then relying more
heavily on taxpayer-financed age pensions. In order to ensure
that retirement savings are used for retirement income, the
government may decide to require that at least a portion of
superannuation funds be used to purchase an annuity which would
provide a minimum level of income in regular increments over
time.
Parallels to Privatized Retirement Systems in Chile and Britain
As various nations around the world rush to privatize their
retirement systems and secure retirement income for their
senior citizens, Americans continue to fear for the future of
their Social Security system. Reformers can learn much from
studying what other countries are doing. And though an
exhaustive comparison of the systems is beyond the scope of
this paper, it is worth noting how Australia's system compares
with those of Chile and Great Britain, two other countries
whose privatization efforts have attracted considerable
attention.
Chile privatized its old-age system in the early 1980s,
replacing a tax-funded income-transfer scheme with a system
based on mandatory individual savings. The amount of savings
mandated for retirement accounts in Chile is 10 percent, which
is quite similar to Australia's 9 percent superannuation
charge. Chile's system, however, has advantages and
disadvantages. On the positive side, Chile imposes a simple and
neutral tax treatment on retirement savings. Moreover, it
imposes the savings mandate directly on the worker instead of
using the employer as a middleman. Since labor economists are
virtually unanimous in recognizing that employer-financed
benefits (such as payments into pension funds) come out of
worker compensation, the Chilean approach deserves applause for
its honesty. However, Chile's pension funds are subject to
excessive regulation, a drawback which has the effect of
limiting diversity and creating higher than necessary
administrative costs as funds compete for customers on the
basis on non-performance criteria.
Britain has a two-tiered retirement system. The first tier
is an almost universal flat-rate benefit provided by the
government. The second tier depends on earnings, and workers
can choose to use the government system or select a private
pension alternative. Only 17 percent of workers have elected to
stay in the government-run program thus far, while 73 percent
have decided to divert 4.6 percentage points of their payroll
tax into a private fund. Two differences between Australia's
system and Britain's are worth highlighting. First, the system
in Great Britain is best categorized as partial privatization
(though the Labor government may propose more complete
privatization sometime next year), while Australia's has been
more sweeping. However, Australia's privatized system, like
Chile's, does not compare favorably in terms of tax treatment.
The British government does not tax contributions to the
accounts or the annual earnings of the accounts. Instead, it
imposes one layer of tax at the time of withdrawal.
Lessons for American Social Security Reformers
The United States and Australia are similar in many
respects. In Australia, 11.9 percent of the population is 65 or
older, compared with 12.7 percent in the United States. Both
are high-income, developed countries with stable democratic
governments. The overall size and structure of their
governments are also similar: General government outlays in
1996 were 36.9 percent of GDP in Australia and 35.8 percent of
GDP in the United States. It is therefore reasonable to surmise
that reformers in the United States would draw lessons from the
Australian experience in reforming Social Security. Indeed,
when Australia's Labor government first embarked on this
policy, it faced obstacles that are not unlike those that exist
in the U.S. It had, for instance:
1.6 million retirees receiving government age
pensions, a large majority of whom were apprehensive about any
change in the existing system, and
A highly skeptical working-age population of 8.4
million employees, many of whom doubted that politicians would
make changes that would enhance their retirement.
[GRAPHIC] [TIFF OMITTED] T6189.007
Nevertheless, Australia overcame these challenges through
an innovative privatization program combining mandatory
contributions to private pension plans with means-testing of
Social Security age pension benefits.
Some of the steps Australian policymakers took are
applicable to the United States as well. To reform the Social
Security system successfully, U.S. policymakers should:
1. Be honest about the shortcomings of the current system.
The Labor government issued a series of reports, culminating in
Security in Retirement--Planning for Tomorrow Today in 1992,
which stressed that working-age Australians could not expect
the federal government to provide them with adequate retirement
incomes in the future.\28\
2. Appeal to self-interest. Australian leaders Bob Hawke
and Paul Keating stressed that superannuation was the key to
obtaining higher retirement incomes. In other words, working-
age Australians needed to accumulate far greater private
savings than they had in the past if they were to be secure in
their retirement years.
3. Appeal to national interest. The Labor government
reminded Australians about their country's low national saving
rate compared to other developed countries, informing them that
age pension reform and the Superannuation Guarantee, along with
other macro-economic and micro-economic reforms, would
accelerate Australia's economic growth and create new job
opportunities.
4. Protect existing beneficiaries. Policymakers realized
that benefit reductions for existing retirees or those near
retirement would be a major political liability for reform.
Even though benefit reductions would generate immediate budget
savings, such outlay reductions would jeopardize the immense
long-term benefits to citizens and the nation from
privatization.
5. Avoid relying on appeals that the reform is needed to
balance the government's books. The fiscal benefits from
introduction of the Superannuation Guarantee were presented
almost as an afterthought in Australia. Unlike in the United
States, where politicians focus on the need for individuals to
sacrifice through higher payroll taxes and lower benefits to
solve the federal government's fiscal problems, discussions in
Australia stressed how comprehensive reform would benefit
individuals by accelerating economic growth now and increasing
retirement incomes later.
There are many other features of the Australian system that
offer valuable lessons to Social Security reformers because the
two countries are so similar. But it is also worth noting the
differences between the United States and Australia. One big
difference is that it is easier to change government policy in
a parliamentary system, in which one party generally controls
all the levers of power, than in a presidential system of
checks and balances. Australia has a unique mixture of British
parliamentary and American constitutional traditions,\29\ so it
is not as easy for Australia to change policies as it is for
other parliamentary nations such as Great Britain. Nonetheless,
it is still easier to make policy changes than it would be for
policymakers in the United States with its presidential system
of checks and balances.
Pension reform in Australia was facilitated as well by the
Award System of highly centralized collective bargaining.
Indeed, the unions were one of the biggest advocates of using
private savings to boost retirement income. Although this
system of collective labor negotiations has been partially
deregulated since 1996,\30\ it helped the Labor government to
introduce mandatory private retirement savings to the
workforce. Needless to say, such a system does not exist in the
United States.
Finally, the U.S. and Australian governments fund their
Social Security retirement benefits through different methods.
Australia funded its old system, and pays for the safety net
portion of the new system, out of general tax revenues. In the
United States, Social Security benefits are financed through
payroll taxes. This significant difference actually could prove
to be an advantage for reformers in the United States since
policymakers could privatize the system by diverting some or
all of current payroll taxes into private accounts, rather than
by trying to impose a new savings mandate on American workers.
Conclusion
Privatization has been a huge success in Australia: Workers
will be able to retire with higher incomes, the government has
significantly reduced long-term budget pressures, and the
economy will benefit by a dramatic increase in savings. Like
other nations around the world, Australia recognized in the
1980s that replacing the government's tax-and-transfer old-age
retirement scheme with a private retirement system based on
mandatory savings was a win-win proposition. Because Australia
is in many ways politically and demographically similar to the
United States, American policymakers would be well advised to
learn the lessons of Australia's successful reforms.
APPENDIX 1.
How Australia's Superannuation Guarantee (SG) Works
Annual Savings Requirement.
Currently, 6 percent of income must be saved in a
superannuation fund. This rate will rise to 7 percent on July
1, 1998; 8 percent on July 1, 2000; and 9 percent on July 1,
2002. The charge is imposed on the first Au$90,360 (US$71,273)
of pre-tax cash employment compensation; it is adjusted
annually to keep pace with inflation (see Chart 6).
Collection of SG charge.
Employers are responsible for withholding superannuation
charges and depositing them in a fund selected by the worker.
The burden of the charge clearly falls on the worker since it
is part of total employee compensation, much as the individual
income tax in the United States is a burden on workers even
though it normally is withheld and sent to the Internal Revenue
Service by employers.
[GRAPHIC] [TIFF OMITTED] T6189.008
Types of SG funds.
According to the March 1997 Insurance and Superannuation
Commission Bulletin, there are 137,808 superannuation funds in
Australia.
Excluded funds. The majority of all superannuation
funds are small self-managed pension plans, known as excluded
funds, containing fewer than five members. Taken together,
excluded funds have 228,000 members and control 10.5 percent of
all superannuation assets.
Trustee-managed funds. In contrast, 16.1 million
Australians are members of larger, trustee-managed
superannuation funds. There are four types of trustee-managed
funds: corporate, industry, public-sector, and retail.
1. Corporate funds typically are set up by large private-
sector employers. These funds have 1.4 million members and
control 20.9 percent of all superannuation assets. The number
of corporate funds is declining as more employers are meeting
the SG mandate through retail funds.
2. Industry funds are sponsored jointly by multiple
employers and labor unions in an industrial sector. These
funds, originally set up to receive the 3 percent Award
Superannuation contributions, now have 5.7 million members and
control 6.3 percent of all superannuation assets.
3. Public-sector funds are established for employees of
federal, state, and local government. They have 2.55 million
members and control 23.2 percent of all superannuation assets.
Some public-sector funds are not fully funded.
4. Retail funds, or public offer funds, are provided by
financial institutions such as banks, insurers, and securities
firms. Sold through intermediaries to those eligible to
contribute to superannuation funds or holding superannuation
savings for retirement, they typically are organized as master
trusts, allowing members to direct their contributions among a
number of mutual fund investment options. Currently, the 402
retail funds have more than 6.5 million members and control
24.2 percent of all superannuation assets.
Annuities.
About 15 percent of superannuation assets are held by life
insurance companies, usually on behalf of retirees.
Today, most corporate funds as well as almost all excluded,
industry, and retail funds are defined contribution plans in
which the member bears the investment risk. Many public-sector
funds remain defined benefit plans in which the sponsoring
employer is liable for pension payments to retirees regardless
of whether accumulated contributions and earnings in the fund
are sufficient to cover the pension payment liabilities. In
March 1997, only 16 percent of all member accounts were in
defined benefit funds. However, because most public-sector
funds are defined benefit plans, 52 percent of all assets held
by non-excluded funds were in defined benefit funds.\31\
[GRAPHIC] [TIFF OMITTED] T6189.009
SG asset allocation and return.
Overall, SG assets are allocated under management as shown
in Chart 7. The Insurance and Superannuation Commission (ISC)
reports that the average real rate of return for all
superannuation funds was 5.5 percent for the 10 years ending on
June 30, 1996.\32\
SG regulation.
Superannuation funds fall under the supervision of the
Insurance and Superannuation Commission to ensure that fund
managers do not engage in self-dealing or other forms of
imprudent behavior. The ISC takes a light-handed approach,
relying primarily on a high degree of disclosure of funds'
policies and performance to members. Other than a 5 percent
ceiling on in-house investments, the government imposes
virtually no regulations or restrictions on the investment
decisions of superannuation funds.
SG taxation.
The tax treatment of superannuation is needlessly complex
and excessive. Employees must pay a 15 percent income tax on
employer contributions to their superannuation accounts.
Workers earning more than Au$70,000 (approximately US$55,216)
must pay an additional surcharge of up to 15 percent on
employer contributions to their superannuation accounts.\33\
Workers also must pay a 15 percent income tax on any interest
or dividend earnings in their accounts. Withdrawals from
superannuation accounts upon retirement are subject to
Australia's income tax less a 15 percent credit. This credit is
designed to partially offset the taxation imposed on both the
original contributions and fund earnings.\34\
APPENDIX 2.
Australia's Government Benefits Payments and Means-testing Provisions
Age Pension Benefits
------------------------------------------------------------------------
Maximum Biweekly Payment
------------------------------------------------------------------------
Single................................... Au$347.80 (US$274.34)
Couple (each)............................ Au$290.10 (US$228.83)
------------------------------------------------------------------------
Age pensioners may also receive rent or
residential care assistance, a pharmaceutical allowance, a
telephone allowance, or a remote area allowance.
Income and Assets Tests
The pension rate is calculated under both income
and assets tests. The test which results in the lower rate is
applied.
Social Security payments are not counted as a part
of income.
------------------------------------------------------------------------
Full Age Pension if No Age Pension if
biweekly income is biweekly income is
Income Test equal to or less equal to or more
than than
------------------------------------------------------------------------
Single......................... Au$100.00 Au$806.40
(US$78.88). (US$636.09)
Couple (combined).............. Au$176.00 Au$1,347.20
(US$138.83). (US$1,062.67)
------------------------------------------------------------------------
The effective marginal tax rate on income over the
amount for the maximum payment is 50 percent (single) and 25
percent (each for a couple).
------------------------------------------------------------------------
Full Age Pension if No Age Pension if
Assets Test assets are equal to assets are equal
or less than to or greater than
------------------------------------------------------------------------
Single, homeowner.............. Au$125,750 Au$243,500
(US$99,192). (US$192,073)
Single, non-homeowner.......... Au$215,750 Au$333,500
(US$170,184). (US$263,065)
Couple, homeowner (combined)... Au$178,500 Au$374,000
(US$140,801). (US$295,011)
Couple, non-homeowner Au$268,500 Au$464,000
(combined). (US$211,793). (US$366,003)
------------------------------------------------------------------------
The effective marginal tax rate on assets over the
amounts for the maximum payment is 7.8 percent.
APPENDIX 3
[GRAPHIC] [TIFF OMITTED] T6189.010
Endnotes
1. In Australia, the term superannuation refers to funded
retirement income plans.
2. For the purposes of this discussion, all amounts will be given
in Australian (Au) dollars first, with their equivalent value in U.S.
dollars following, at the average exchange rate in March 1997 of
Au$1.00 = US$0.7888.
3. Means-testing refers to policies that restrict government
benefits to those with lower incomes.
4. Daniel J. Mitchell, ``Creating a Better Social Security System
for America,'' Heritage Foundation Backgrounder No. 1109, April 23,
1997.
5. For more information on reform in other nations, see Louis D.
Enoff and Robert E. Moffit, ``Social Security Privatization in Britain:
Key Lessons for America's Reformers, Heritage Foundation Backgrounder
No. 1133, August 6, 1997; Daniel Finkelstein, ``The Policy and
Political Lessons of Britain's Success in Privatizing Social
Security,'' Heritage Foundation Committee Brief No. 30, September 29,
1997; and Jose Pinera, ``Empowering Workers: The Privatization of
Social Security in Chile,'' Cato Institute Cato's Letters No. 10, 1995.
6. Over time, Australia incorporated age pensions into a broader
system that also provided income support payments to the disabled, the
unemployed, and low-income families. Unlike Social Security in the
United States, which is funded through dedicated employer-employee
payroll taxes, the Australian Social Security system is funded from
general federal revenue primarily through an individual income tax, a
company income tax, and a wholesale sales tax. Although Australian
states levy payroll taxes on employers, state payroll taxes are
unrelated to the Australian Social Security system. In addition, age
pension payments are not related to earnings, as they are in the U.S.
Instead, the payments are a flat amount equal to approximately 25
percent of the average earnings for male workers. Married couples
receive a flat rate benefit equal to approximately 40 percent of the
average wage.
7. Paul Kelly, End Of Certainty: The Story of the 1990s (St.
Leonard's, New South Wales: Allen-Unwin, 1994).
8. The ``banana republic'' comment was made during a radio
interview with John Laws on May 14, 1986.
9. Saving for Our Future, statement by Ralph Willis, M.P.,
Treasurer of the Commonwealth of Australia, May 9, 1995, p. 1.
10. The Australian government's fiscal year runs from July 1
through June 30. See V. W. FitzGerald, National Savings: A Report to
the Treasurer, June 1993, p. 2.
11. Ibid.
12. The few remaining exclusions include workers under age 18 and
over age 65, temporary foreign workers, and those with very low
incomes.
13. The superannuation requirement applies only to the first
Au$90,360 of income. For income above that level, the decision to save
is voluntary.
14. The Labor government also had plans for additional mandatory
savings. It decided in 1995, for instance, that all employees would
begin making mandatory co-contributions of 1 percent of earnings in FY
1997-1998, rising to 3 percent of earnings in FY 1999-2000, to their
superannuation accounts. The government simultaneously proposed
matching this contribution with a government contribution of up to 1
percent of an employee's FY 1998-1999 earnings, rising to 3 percent of
earnings in FY 2000-2001. These projected changes were repealed by the
coalition government elected in 1996.
15. Budget Measures, 1997-1998, Australian Treasury, May 13, 1997,
pp. 186-187.
16. Ibid., pp. 189-191.
17. Ibid., pp. 192-194.
18. Budget Measures, 1996-1997, Australian Treasury, May 1996.
19. Married couples under the old system received an age pension
equal to 40 percent of the average worker's wage.
20. Preliminary projections by the Retirement Income Modeling Unit
of the Australian Treasury, by facsimile to authors.
21. Ibid.
22. Ibid.
23. George P. Rothman, ``Aggregate Analysis of Policies for
Accessing Superannuation Accumulations,'' available at the Retirement
Income Modeling Task Force Web site: www.treasury.gov.au/organisations/
rimtf.
24. Media release, Insurance and Superannuation Commission, July 6,
1997.
25. Data supplied to authors by Vince FitzGerald. See also Phil
Gallagher, ``Assessing the National Saving Effects of the Government's
Superannuation Policies,'' available at the Retirement Income Modeling
Task Force Web site: www.treasury.gov.au/organisations/rimtf.
26. Data supplied to authors by the Treasury's Retirement Income
Modeling Task Force.
27. This tax treatment (deductible contributions and taxable
withdrawals) is known as the ``IRA approach'' to savings. Another
simple and neutral tax regime for long-term savings is to tax
superannuation contributions, but then to impose no tax on earnings and
eventual withdrawals. This ``municipal bond approach'' is economically
equivalent to the ``IRA approach.'' Neither approach, of course, makes
the mistake of taxing the annual earnings of the fund.
28. Statement delivered by John Dawkins, M.P., Treasurer of the
Commonwealth of Australia, June 30, 1992.
29. Like the United States, Australia has a written constitution, a
federal system in which states delegate specific and limited powers to
Canberra, and courts with the power to rule specific acts of the
federal or state parliaments unconstitutional. Like Great Britain,
Australia has a responsible government under which the Prime Minister
and state Premiers must command majority support in the lower houses of
their respective parliaments. Australia has a Senate elected by the
people through a proportional system. Because Australian governments
seldom command a majority in the Senate, Prime Ministers--like U.S.
Presidents--are forced to bargain with independent minor party and
opposition Senators to secure enactment of their programs.
30. Australia's competitiveness is still hampered by the remnants
of centralized labor markets, which helps to explain why unemployment
remains over 8 percent. Along with high marginal tax rates, further
deregulation of Labor markets continues to be a challenge for
Australian policymakers.
31. David M. Knox, unpublished manuscript, University of Melbourne,
July 1997.
32. ``Superannuation Investment Performance,'' Insurance and
Superannuation Bulletin, Insurance and Superannuation Commission,
Canberra, September 1996, p. 19.
33. The surcharge is 1 percent for each $1,000 of taxable income
exceeding $70,000, up to a maximum of 15 percent for taxable incomes
exceeding $85,000.
34. For lump-sum withdrawals under a reasonable benefit limit of
Au$434,720 (US$342,907), a tax rate of 16.7 percent (30 percent income
tax plus a 1.7 percent Medicare levy less a 15 percent tax credit) is
applied. For lump sums exceeding the reasonable benefit limit, the
marginal income rate (including the Medicare levy of 1.7 percent) is
applied. For annuity purchases under a reasonable benefit limit of
Au$869,440 (approximately US$685,814), annuity payments are taxed at
the marginal income rate less a tax credit of 15 percent. The 15
percent tax credit does not apply to the portion of annuity payments
attributable to the amount exceeding the reasonable benefit limit or to
lump-sum withdrawals exceeding the reasonable benefit limit.
Social Security Privatization in Britain: Key Lessons for America's
Reformers
Introduction \1\
Many young Americans are becoming increasingly anxious
about the future of their Social Security benefits. Their fears
are not misguided. Based on the latest official estimates,\2\
Social Security benefit costs will exceed contributions within
15 years. Assuming the Social Security Trust Fund assets in
government bonds are fully paid, the system will be unable to
pay promised benefits by the year 2029. Clearly, it is a system
badly in need of reform.
At the same time, workers in Britain, traditionally the
closest ally of the United States, enjoy a veritable treasure
trove of private pension funds. Britain's pension pool--already
worth over 650 billion (over $1 trillion U.S.
dollars)--is rapidly approaching the value of the country's
annual economic output. In fact, it is larger than the pension
funds of all other European countries combined.\3\
The reason? Instead of being locked into a rigid,
financially troubled government-run system, millions of British
workers can take advantage of a law that permits them to invest
a portion of their payroll taxes in private retirement plans.
Consequently, at a time in which young workers in the United
States can expect only lower--even negative--returns on the
taxes they pay into the current Social Security system,\4\
workers in Britain enjoy solid returns from a substantially
privatized pension system that allows them to invest a portion
of their payroll taxes in private stocks and equities. In
Britain today, about three-quarters of all workers are enrolled
in private pension plans.\5\ In the United States, however,
private-sector workers are not allowed to invest any portion of
their 12.4 percent Social Security payroll tax in private
stocks and equities or private retirement plans for their
future retirement; all of their payroll taxes must go into the
U.S. government's Social Security system with little guarantee
that this ``investment'' will pay off down the retirement road.
Britain's Quiet Pension Revolution
The British social security reform effort tackled many of
the problems that plague the U.S. Social Security system.
Before Members of Parliament and other leaders could suggest
solutions, however, they had to recognize that the government
system had serious problems. Their solution was to enact a two-
tiered system that offered security, flexibility, and a
positive return on the investment of mandatory payroll tax
money.
Under the British system of social security, a first tier
pays a flat-rate basic pension, and a second tier pays pension
benefits based on earnings while in the workforce.\6\ All
eligible employees are entitled to a safety net Basic State
Pension, but they also have a choice: remain in an American-
style government pension program called the State Earnings
Related Pension Scheme (SERPS) or divert a specified portion of
their payroll taxes (known as ``national insurance
contributions'') into a private company-based plan or personal
pension plan. In this second tier, British employees must be
enrolled either in SERPS or an approved private pension plan.
If they opt out (``contract out'') of SERPS, they give up that
portion of their government benefit when they retire, but they
also can receive a bigger and better pension with higher
returns on their private investments. Workers may contract back
into SERPS, with certain restrictions, if they are unhappy with
the private option.
By restructuring their state pension system and allowing
consumer choice and competition among private pension plans,
the British have managed to amass huge retirement savings while
controlling entitlement spending. According to Roderick Nye,
director of the London-based Social Market Foundation, the
Organization for Economic Cooperation and Development (OECD)
``estimates that by 2030 the UK will have paid off its entire
national debt; in France and Germany, where earnings related
pensions are paid out of contributions from those currently in
work, the national debt will have doubled to exceed national
income if current pension policies are maintained.'' \7\ John
Blundell, general director of London's Institute for Economic
Affairs, reports that ``Every European Union state except
Britain has a huge overhang of debt, driven by the political
bribe of offering something for nothing. We are probably no
more virtuous as a people, but we have a far happier financial
horizon.'' \8\
[GRAPHIC] [TIFF OMITTED] T6189.011
The U.S. Advisory Council Report \9\
In the United States, by contrast, members of the Social
Security Advisory Council were tasked in 1994 with studying
ways to ensure the long-term solvency of the Social Security
system.\10\ The council's report, released in January 1997,
proposed several solutions, including a partial privatization
of the 62-year-old U.S. system, routinely dubbed the deadly
``third rail'' of American politics because of its politically
sacrosanct character. Even though the report's major proposals
differed in crucial details, the Advisory Council urged
unanimously that Social Security funds be invested in private
stocks and equities to help ensure solvency and generate a
higher rate of return on Americans' tax dollars.
One of the proposals endorsed by five of the 13 members of
the Advisory Council contains elements that closely resemble
the key components of the reformed British system. Under this
proposal, 5 percent of the existing Social Security payroll tax
would be used to foster the creation of private pension
accounts.\11\ Although the Advisory Council report outlines a
broad proposal for reform, the British experience offers a more
detailed guide that can help Congress expand private pension
opportunities in the United States and avoid pitfalls on the
path to Social Security reform.
To help them prepare their report, members of the Advisory
Council had been briefed on the experiences of other countries,
and several economists and scholars had suggested that Congress
and the Clinton Administration use Chile's successful reforms
of 1981 as a model for reform in the United States.\12\ But
even though the Chilean effort is impressive and valuable as a
design, the political and economic conditions in Chile at the
time of its reforms were very different from those in the
United States today. Thus, Chile's usefulness as a relevant
model for reform in the United States is limited.
In terms of culture, Britain is closer to the United States
than is Chile. The British and American people have similar
demographic and economic problems, a common language, and deep
historical ties. Thanks to these similarities, Congress and the
Administration can rely on the lessons learned from the
successful British experiment to assure a solid and prosperous
retirement for future generations of Americans.\13\ But there
is little time to waste. The longer policymakers delay in
making the necessary changes, the more likely American
taxpayers will have to make up for current unfunded liabilities
within a shorter period of time.
Britain's Brighter Financial Future
The failure to tackle entitlement spending, especially
public pensions, threatens several countries in Western Europe
with the associated mountainous and unsustainable levels of
public debt. In 1995 and 1996, for example, the governments of
Italy, France, and Germany tried, but failed, to reform their
state pension systems. The British are a bright exception.
Today, Britain ranks behind only the United States and
Japan in the sheer size of its financial assets. Frank Field,
cabinet minister for welfare reform in the Labor government and
former chairman of the Social Security Committee of the House
of Commons, recently observed that the ``pension industry is
one of Britain's most successful corporate sectors, alone
accounting for much of the country's financial power. Unlike
our European counterparts, who often hold pension assets in the
book reserves of company accounts, Britain's fund assets are
released into the world's capital and currency markets.''\14\
In January 1996, then-Social Security secretary Peter
Lilley explained how well Britain's position on pensions fared
when compared with those of other developed countries:
The OECD forecast each country's national debt assuming they
continue with their present pensions systems and levels in
taxes and charges. By 2030 in France and Germany, the national
debt will have about doubled and will exceed national income.
In Japan, which is ageing particularly fast, debt will reach
three times national income. By contrast, Britain's second tier
funded pensions place us in a unique position. The OECD
forecasts that we will have paid off our entire national debt
and started to build up assets.\15\
[GRAPHIC] [TIFF OMITTED] T6189.012
Britain's promotion of private pensions has been combined
with a careful but decisive reduction in the growth of the
state pension system. The present value of the country's ``net
public pension liabilities'' is estimated at 5 percent of gross
domestic product (GDP), which is noticeably below comparable
figures for the United States and such other economic giants as
Germany and Japan.\16\ The lesson for the United States is
clear: Carefully planned and executed policies governing
entitlements can have a positive impact on the overall
financial health of the country, particularly its public debt.
This partially privatized pension system has made
substantial gains for British workers and retirees over the
past decade. From 1986 to 1995, the gross rate of return for
median private pension funds was 13.3 percent per annum.\17\
Data supplied by 1,500 pension funds in 1996 for company based
retirement plans showed that 50 of Britain's largest
occupational funds registered returns of 10.5 percent overall
and 16.4 percent in British equities. A large sample of smaller
firms registered returns of 11 percent overall and 17.1 percent
in British equities.\18\
[GRAPHIC] [TIFF OMITTED] T6189.013
The Crucial Lessons
Britain's experiment in social security reform has
accomplished several major goals. It has helped control
entitlement spending; it has raised the standard of living for
elderly persons; and it has given young people broad personal
choice in deciding how best to invest their own money and
control their own futures. The British experience, therefore,
offers many valuable lessons for the U.S. Congress:
Offering the choice of enrolling in private
pension plans is likely to be very popular. Today, about 73
percent of British workers are in private plans; only 17
percent are left in SERPS.\19\ Of the private pension holders
in Britain today, 5.6 million have opted out since 1988 to open
appropriate personal pension plans (the British version of tax-
favored individual retirement accounts).\20\
Structural reform can mean a substantial increase
in the standard of living of retirees. From 1979 to 1993, the
average incomes of British pensioners (before housing costs)
rose by 60 percent--more than for any other segment of the
British population. The largest increase in retirees' income
during this period came from private pensions and investment
income.
Social Security reform involves providing
acceptable tradeoffs for younger workers. Moving from a
financially troubled pay-as-you-go system to a funded system
that relies heavily on private stocks and equities involves a
price for younger workers: They will have to pay not only for
their own benefits, but for those of the older generation of
retirees as well. The British experience shows that younger
workers are prepared to accept that tradeoff. They believe they
would be better off in a portable system of personal pension
plans with solid rates of return on investment than in a system
plagued by political manipulation, politicians' broken
promises, and incessant threats of higher taxes or reduced
benefits.
Effective rules must be put in place to protect
consumers and prevent fraud and abuse during any transition
period. Even the British experience has not been trouble-free.
Without effective consumer protection, too many British workers
moved from more generous employer-based plans, diverting a
portion of their payroll taxes to less generous personal
pension plans. The transition to personal pension plans
initially was marred by instances of fraud and abuse,
misrepresentation of private plan options, and inadequate
disclosure of administrative costs and risks. To their credit,
British officials recognized these problems and acted to
correct them.
It is important to focus on structural reform, not
short-term budgetary savings. Reforms should make significant
structural changes in the Social Security system, but their
implementation should be timed so that current beneficiaries
and workers will not be harmed. The British success in
carefully crafted pension reform has been reinforced by solid
guarantees to workers and retirees. With rising pension incomes
and strong returns on private investment, the British reforms
have proven to be a good deal for ordinary people. Congress
should structure Social Security reform so that, on balance, as
many Americans as possible will be better off with reform than
without it.\21\
Major structural reform can win bipartisan
support. One of the most remarkable lessons of the British
experience is that structural reform is possible in a Western
democracy long committed to social insurance. Outside the
normal inter-party sniping typical in a democracy, there has
been a remarkable degree of bipartisan support in recent years
for Britain's opting-out system, and the new Labor government
under Prime Minister Tony Blair is likely to consolidate and
extend these reforms. The Labor Party has long supported
private occupational pension plans and has published no plans
to dismantle the privatized program now in place. ``Labour is
not going to change that,'' notes Paul Johnson of the London-
based Institute for Fiscal Studies. ``All it is committed to is
continuing to raise the basic pension in line with prices.''
\22\ Labor's leadership has been considering how, not whether,
to expand private pension options for British workers and their
families.\23\
Certain technical considerations must be addressed
to make reform successful, and the British experience can
provide solid guidance in these areas. Specifically,
policymakers will have to decide such issues as how to pay the
inevitable transition costs, how to calibrate the degree of
income transfer from younger workers to retirees, how to
clarify the economic value of a basic government pension, and
how to integrate part-time or low-income workers into a newly
privatized system.
How the British Pension System Works
Britain's state pension program represents a complex
accretion of policies and programs enacted and implemented by
Conservative and Labor governments since the end of World War
II.\24\ Today's system is grounded statutorily in the National
Insurance Act of 1946, a major initiative of the postwar Labor
government of Prime Minister Clement Attlee, which replaced
Prime Minister Winston Churchill's Conservative government in
1945.\25\
[GRAPHIC] [TIFF OMITTED] T6189.014
Under the National Insurance Act and subsequent
legislation, all British workers with earnings above a ``lower
earnings limit'' (LEL) and their employers contribute to a
National Insurance Fund. These contributions are roughly
equivalent to the payroll taxes used to finance Social Security
and Medicare in the United States.\26\ Combined employer and
employee payments range from 15 percent to 22 percent of
earnings, with the proportion of the employer contribution
rising as a worker's income increases. Employees contribute if
their earnings fall between a lower earnings limit of
62 ($99.20) per week and an upper earnings limit,
or UEL, of 465 ($744) per week. An employee's
contribution is 2 percent of earnings up to the LEL and 10
percent of earnings in excess of the LEL. Employers at this LEL
pay 3 percent of all earnings. At the upper earnings limit, the
employee contributes 2 percent of all earnings up to the LEL
and 10 percent of all earnings up to 465 ($744) per
week (the UEL). The employer, however, contributes 10 percent
of all earnings for these high-income employees. The employee
pays no additional payroll tax on earnings above the UEL, and
the employer continues to pay 10 percent of the employee's
earnings with no upper limit.
The National Insurance Fund is managed by the Department of
Social Security, which administers a variety of social programs
as well as the state (national) pension system. The fund pays
out pension benefits as well as unemployment benefits, and both
depend on the employee's record of contributions.\27\ Like the
U.S. Social Security system, it is run on a pay-as-you-go
basis: Current ``contributions'' (taxes) pay for current
``expenditures'' (benefits). The National Insurance Fund's
accounts are held at the Bank of England, but it has no
borrowing authority; by law, the fund must maintain a positive
balance for the payment of pensions and other government
benefits, and its money may be invested only in government and
``local authority'' municipal stocks.\28\
A Two-Tiered System
Over 10 million retirees are enrolled in Britain's pension
system. This system has two distinct levels, or tiers: (1) the
Basic State Pension and (2) the State Earnings Related Pension
Scheme (SERPS) or private pension options. Workers may opt out
of the second tier of the state pension system, but not the
first.
Tier #1: The Basic State Pension.
All British workers, subject to age and eligibility
requirements, are entitled to the Basic State Pension, often
referred to as the Old Age Pension. Today, the Basic State
Pension pays single retirees 62.45 ($99.92) and
couples 99.80 ($159.68) per week.
Beyond the Basic State Pension, the elderly also may be
entitled to Income Support, a means-tested welfare program
based on income and financed separately through general
revenue. In addition, the elderly poor are eligible for the
Council Tax Benefit, a form of assistance to offset property
tax payments, and a housing subsidy called a Housing Benefit
that is available to the poor on a sliding scale. Those
officially designated as elderly poor, for example, are
entitled to a subsidy equal to 100 percent of their housing
costs. For older pensioners, the level of Income Support is
likely to exceed the Basic State Pension, and the older the
pensioner, the wider the disparity. Of the more than 10 million
retirees in Britain, approximately 1.5 million receive some
Income Support and another 2 million receive means-tested
assistance with their housing costs.\29\
Traditionally, increases in the state pension were tied to
wage increases. In the 1960s, the Basic State Pension was
equivalent to 20 percent of average earnings. In the 1980s,
however, in an effort to control soaring costs, the British
government broke the link between pension and wage increases
and substituted price increases as the basis for future pension
increases. Such price increases, similar to adjustments in the
Consumer Price Index in the U.S. Social Security system and
Civil Service Retirement System, are generally slower than wage
increases. Thus, even though the purchasing power of the Basic
State Pension has not changed, it is now the equivalent of 14
percent of average earnings.\30\ Because of the changes made in
1989, however, British retirees--unlike retirees in the United
States--no longer are penalized by the ``earnings rule,'' which
reduces the state pension if a worker chooses to work past the
age of retirement.\31\
Tier #2: The State Earnings Related Pension Scheme or Private
Pension Options.
Workers may enroll in SERPS, often referred to as the
``additional'' state pension, or invest part of their payroll
tax in an approved pension plan. It is mandatory that employees
enroll in one of these options.
Established by the Labor government in 1978, the SERPS
component of the state pension system was designed to give
retirees more generous benefits related to the real value of
employees' earnings. Because of the disparity in future
retirement prospects between British workers with occupational
pensions and those without, SERPS was, in effect, an attempt to
level the playing field for British retirees who were not
enrolled in private occupational pension plans.
Only British workers employed by a company and with
earnings above the LEL are eligible for retirement benefits
under SERPS. Self employed workers and the unemployed are not.
Like the Basic State Pension, SERPS is financed by payroll
taxes on a pay-as-you-go basis.\32\ It was designed to provide
for a pension based on 25 percent of the average of the best 20
years of earnings (later amended to 20 percent) in addition to
the basic flat-rate pension funded out of the National
Insurance Fund.
How British Workers May Opt Out of SERPS
British workers may contract out of SERPS (but not the
Basic State Pension) and enroll in an approved occupational
pension plan or certain types of personal pension plans.\33\
According to the Department of Social Security, ``The
Government's view is that where people are able to provide for
themselves they should be encouraged to do so.'' \34\ Two
private options are available for workers who opt out of SERPS:
an occupational pension plan based on employment and a personal
pension plan similar to an individual retirement account.
Occupational plans. In consultation with employers, workers
may substitute an occupational pension plan for the second tier
of coverage, with a portion of their payroll taxes (national
insurance contributions) used as a rebate to offset the cost of
a private ``occupational pension scheme.'' The value of this
tax rebate of payroll taxes (national insurance contributions)
varies over the years and is determined periodically by the
secretary of state for social security based on the
recommendation of the British Government Actuary. Today,
employers receive a rebate of 3 percentage points on their
payroll taxes, and employees receive a rebate of 1.6 percentage
points of earnings for money paid into an employer-sponsored
pension plan.
Beyond the tax rebate, employers may contribute an amount
above the basic contribution required to contract out of the
government pension system and receive tax relief. An employee
may contribute up to 15 percent of his regular earnings to such
a plan tax-free.\35\ The tax-free limit for employer and
employee contributions combined is 17.5 percent of employee
earnings. Today, the average contribution rate for such
occupational plans (or schemes in British parlance) \36\ is 5
percent of earnings by the employee and 10 percent by the
employer. These contributions receive tax relief at the highest
marginal rate of income tax for both the employee and the
employer. Additionally, the investment returns are free of both
income and capital gains taxes.
Occupational plans must be approved by the government, but
they are managed privately. They may be defined benefit plans
based on years of service and final salary or defined
contribution plans based on contributions to a fund and a
return on investment. All, however, must provide--in the
judgment of the British government--benefits at least as good
as those available under SERPS.
When private companies contract out of SERPS, usually in
consultation with employees or their representatives, their
managers and workers give up their state pension benefits under
the program. In contracting out, however, the company must
provide a ``guaranteed minimum pension'' for each worker that
is roughly equal to the benefits he would have had under SERPS.
If private companies and their workers wish to buy back into
SERPS at a future date, they may do so. This requires that the
private-sector trustees pay a special ``state scheme premium''
to the Department of Social Security, after which the
department restores the SERPS benefits to the employees.\37\
Most private company plans set up after consultations with
employees or trade union representatives are defined benefit
plans in which workers' pensions are calculated on the basis of
years of work and a final salary amount based on an average of
earnings over a certain period of years before retirement.
Employers also may offer an extra (``top-up'') pension plan
above the standard occupational plan, but neither the
contribution nor the investment income from such an additional
plan receives any tax advantage. Today, industry-wide and
company-wide occupational pension plans that combine tax
advantages with an employer's contribution typically provide
the best pensions for British workers and make British retirees
among the most financially comfortable in the world.\38\
Occupational pension plans existed long before the modern
state pension system. In Britain, they can be traced as far
back as 1375.\39\ By the 1960s, approximately half of all
British workers were covered by such plans,\40\ which are
governed by a rich body of law.
Under the Pensions Act of 1995, the British government
requires indexation of occupational pension payments, with
benefits increased according to inflation or up to a maximum of
5 percent annually, whichever is the lesser amount.\41\ The
government also imposes a minimum funding requirement to
guarantee coverage of the value of the benefits and a system to
compensate employees if the sponsoring employer becomes
insolvent or employees lose pension funds because of illegal
actions on the part of employers.
Men and women enrolled in such plans must be treated
equally. In addition, they have a legal right to transfer their
pension rights either from one company plan to another or to a
personal pension plan. Occupational plans may invest no more
than 5 percent of their assets in the employer's company, are
to be actuarially re-evaluated every three years, and must
permit persons to pay tax-free ``additional voluntary
contributions'' into their pension funds. These funds are
managed, subject to trust law, by a board of trustees that may
invest the funds or appoint a fund manager to make the
investments. To receive favorable tax treatment, these plans
must receive contributions from employers; must meet certain
benefit levels; must be set up as irrevocable trusts separate
from employers; and must spell out clearly the rights and
obligations of workers, trustees, and employers.\42\ For
example, British employers today may not force employees to
join company-based pension plans.
As noted, these private pension plans must satisfy a legal
``requisite benefits test'' by providing benefits roughly equal
to those provided by SERPS. Plans also are certified by the
Pension Schemes Office, an agency of the Inland Revenue
(Britain's equivalent of the U.S. Internal Revenue Service). In
the case of an employer-sponsored ``money purchase scheme'' (a
defined contribution plan), the total contribution must be at
least at the level of the contracted-out rebate, currently set
at 4.6 percent of earnings. Typically, the employer will fund a
pension on a matching basis with the employee, and a typical
scheme will have a 5 percent employee and a 5 percent employer
contribution. Today, 62 percent of all British pensioners and
70 percent of pensioner couples have an occupational pension.
During the 1979 to 1994 period, the incomes from such pension
plans rose by 60 percent.\43\
Personal pension plans. The second option available to
British workers, both employees and the self-employed, is to
contract out of SERPS and enroll in an appropriate personal
pension (APP) plan. These ``money purchase'' plans are
sponsored by various organizations, including banks and
building societies (mortgage companies), insurance companies,
unit and investment trusts (mutual funds), and mutual
associations or ``friendly societies.'' Under current law, if a
worker is already enrolled in an occupational plan and getting
a rebate, he may not enroll in an APP also.
Workers who want to participate in an APP must continue to
pay the national insurance contributions, but the Department of
Social Security then pays a tax rebate from these payroll taxes
(currently 4.6 percent of earnings) into an APP of the worker's
choice.\44\ This rebate is the minimum permissible level of
contribution to such a personal pension plan, although workers
may make additional contributions as well.
From 1988 to 1992, to encourage contracting out to private
pension plans, the government offered workers not only the
standard rebate, but also an additional 2 percent ``incentive
tax rebate.'' In 1993 and 1994, the government reduced the
standard tax rebate from 5.8 percent to 4.8 percent of earnings
and replaced the generous additional 2 percent incentive rebate
with a 1 percent incentive rebate for persons over 30. In 1994,
for example, this enabled these workers to receive a total
annual tax rebate of 5.8 percent of earnings. Today, the
standard tax rebate is 4.6 percent. This combination of tax
rebates, incentive rebates, and tax relief for contributions to
personal pension plans has made these plans especially
attractive to younger British workers.
Moreover, workers who contract out of SERPS to open up
their own APPs do not give up their SERPS benefits from
previous working years; their future pension is simply
recalculated on the basis of their earnings during the period
of SERPS membership.\45\ At the same time, to qualify for
government approval and tax relief, a personal pension plan
must (1) be government-certified; (2) meet minimum contribution
standards; (3) use accumulated funds to purchase an annuity at
a specified retirement age; and (4) provide an annuity for
widows, widowers, and children.\46\ Annuities may be purchased
from approved insurance companies or friendly societies of the
worker's choice.
Personal pension plans have some strong advantages:
Popularity and portability. As noted previously,
personal pension plans--fully portable and characterized by a
variety of investment options in stocks and equities--appeal
strongly to young working people (both male and female), the
self-employed, and workers not enrolled in occupational pension
plans. Studies show that, on the basis of the tax rebates
alone, younger workers, especially those in their 20s and 30s,
can expect a pension that is twice that provided by SERPS.\47\
Based on 1994-1995 estimates, the Department of Social
Security reports that personal pension plans have appealed
generally to workers with modest incomes, that 60 percent of
persons enrolled in these plans were under 30 years of age, and
that 37 percent were women.\48\ It is estimated that about a
quarter of all British workers now have personal pension
plans.\49\
Contracting out of the state pension system to enroll in a
personal pension plan is not good for everyone, however. For
older workers, the Department of Social Security warns that
opting out of SERPS in favor of personal pension plans normally
is not wise: ``At present, when people come within 15 to 20
years of retirement, they will nearly always do better in SERPS
than in an appropriate personal pension scheme...because the
rebate of national insurance contributions is paid at a flat
rate and does not take into account the age of the person
contracting out.'' \50\
[GRAPHIC] [TIFF OMITTED] T6189.015
The attraction of personal pensions is not difficult to
explain. Under current law, the amount a person may contribute
each year to his personal pension tax-free depends on his age.
A person 35 or younger can deposit up to 17.5 percent of his
annual ``pensionable'' earnings tax-free; the older a person
is, as Table 4 shows, the more he can contribute with tax
advantages on a progressive scale. Employers also may
contribute to personal pensions and receive a tax break. This
option has become increasingly popular: As of 1993, 75 percent
of all new private pension plans were personal pension
schemes.\51\
Flexibility. A worker does not have to contract
out of SERPS to open a personal pension. A worker can remain in
SERPS (``contract in''), forego the payroll tax rebate, and
still take out a tax-free personal pension plan, subject to
certain limitations, to supplement his retirement earnings.
Persons enrolled in occupational pensions also can use personal
pension plans as a way to receive ``transfer payments'' from a
private plan from previous employment.\52\ Under current law,
income from a personal pension can be paid to a worker at any
time from age 50 to age 75, at which time a worker must
purchase an annuity. These rules give workers flexibility in
retirement and an opportunity to increase the returns on their
investments. Pensions normally are taxable, but there are
exceptions. Up to 25 percent of the money in a worker's
personal pension fund can be taken as a tax-free lump sum upon
retirement, and that lump sum can be left tax-free to his
spouse and children upon his death.
Although the Department of Social Security is responsible
for the regulation of occupational pensions, the Personal
Investment Authority, a special agency that reports to the
British Treasury, exercises regulatory responsibility for
personal pensions.\53\
Britain's Tax Policy Toward Pensions
Pensions in Britain are taxable, but the government
encourages workers and employers--particularly in plans that
are contracted out of the state pension system--to make
contributions to private pension plans with significant tax
relief. A worker can receive tax relief for personal
contributions to an occupational pension plan of up to 15
percent of earnings, and both capital gains and investment
income from the plan are tax-free. Likewise, a worker who
contributes to an APP receives full tax relief on his
contributions of 17.5 percent of earnings, or more, depending
on age, and any investment income and capital gains are also
exempt from income and capital gains taxes. Again, subject to
certain limits, lump-sum pension benefits paid on retirement or
death are tax-free.
The British government encourages personal savings in other
ways as well. A worker can make additional voluntary
contributions to an employer's occupational pension plan, or
``free standing'' additional voluntary contributions outside of
an employer's plan, and receive tax relief for such
contributions, subject to certain rules, as long as they do not
exceed 15 percent of annual earnings.\54\ People can open up
Personal Equity Plans (PEPs) and deposit up to
6,000 ($9,600) per year, with the interest and
capital gains on these investments tax-free, subject to certain
restrictions. Britons also can deposit up to 3,000
($4,800) in a Tax Exempt Special Savings Account (TESSA) in the
first year, and more limited amounts over a period of two to
five years, and receive tax-free interest. Not surprisingly,
the British savings rate is roughly twice that of the United
States.
The new Labor government, according to its election
platform, will continue to support tax policies that encourage
savings and investment. In 1995, Labor leader Tony Blair
declared that there could be ``more private funding'' of
pensions while the government would continue ``to provide a
minimum guarantee for all.'' \55\ This year, Frank Field, the
new cabinet minister for welfare reform, called for expanded
private pensions based on compulsory contributions for
employers and employees and a phasing out of a component of the
existing state pension program.\56\ Field has said that
Labour should agree to the winding up of SERPS (the second
tier of the state pension system) so that every taxpayer will
be paying into a funded pension scheme. These new individually
owned schemes should run alongside a state pay-as-you-go
scheme, the bill for which, thanks to Mr. Lilley [then
Conservative cabinet minister for social security], is
reasonable for taxpayers.\57\
According to its party platform, Labor ``will introduce a
new individual savings account and extend the principle of
TESSAs and PEPs to promote long term saving. We will review
corporate and capital gains tax regimes to see how the tax
system can promote greater long term investment.''\58\
How the British Improved their Pension System
Pension reform, a staple of British politics since World
War II, in recent years has been driven by growing demographic
and fiscal pressures.\59\ Today, just as in the United States,
the ratio of people working to the number of people retiring is
declining. This deterioration is not as serious as it is in
other West European countries,\60\ but British officials also
realize that it will accelerate when today's baby boomers are
well into retirement. Therefore, they are drafting
comprehensive proposals to cope with this eventuality now.
Today, spending on the elderly (estimated at over
40 billion, or $64 billion, in 1996-1997) is the
largest item in the British social security budget.\61\ The
level would have been even higher, however, and the resultant
financial pressures on the British taxpayers more severe if
Parliament had not acted to improve and open up the system,
thereby ensuring, as David Willetts, M.P., has observed, ``that
we avoid the more melodramatic scenarios of a crisis in public
finance for older people.'' \62\
The key steps in Britain's social security reform have
included:
1. Improving the living standards of the elderly;
2. Expanding personal choice;
3. Slowing the growth of the state pension system;
4. Curtailing future tax increases;
5. Establishing equity; and
6. Protecting consumers.
Improving the Living Standards of the Elderly
State pension benefits provided about 60 percent of
pensioners' income in the early 1980s, but this level had
fallen to about 50 percent in the early 1990s.\63\ In the
meantime, generous private pension options more than filled the
gap. Today, largely as a result of government policy, almost 90
percent of British pensioners have private incomes over and
above the Basic State Pension.\64\
[GRAPHIC] [TIFF OMITTED] T6189.016
Between 1979 and 1995, the income of British pensioners
increased in real terms by 60 percent--the largest increase
among any group in Britain.\65\ Not surprisingly, as a
proportion of the population, the percentage of pensioners who
are among the poorest citizens shrank dramatically.\66\ From
1982 to 1992, home ownership among British pensioners jumped
from 47 percent to 60 percent.\67\ On the basis of a
comparative analysis conducted in 1993 by actuaries on behalf
of the Department of Social Security, British pensioners, given
the combination of state and tax-favored private pension
options, generally were better off than their counterparts in
Germany, the leading economic power in Europe.\68\ From 1979 to
1993, as noted in Table 5, the biggest jumps in the income of
British pensioners came from occupational pensions (133
percent) and investment income (123 percent). Thus, the
available evidence ``suggests that the income position of UK
pensioners to the rest of society has been gradually
improving'' \69\ and that this improvement is largely
attributable to growth in the ``private provision'' of
pensions.\70\
Expanding Personal Choice
Parliament's single most important reform in the Social
Security Act of 1986 was to expand the private tier of the
British pension system, further encouraging British citizens to
provide for their own retirement by enrolling in government-
certified appropriate personal pension plans.
[GRAPHIC] [TIFF OMITTED] T6189.017
As noted, APPs have been extraordinarily popular,
especially with younger British workers.\71\ Before this option
was introduced, workers had to join an occupational pension
plan in order to secure a retirement income higher than that
provided by the state pension system. As of 1992, most of the
participants in occupational pension plans had been males with
consistent work histories.\72\ With new personal pension
options, younger workers, especially women, could contract out
of SERPS into a personal plan and receive a substantial tax
rebate, an initial incentive rebate of 2 percent, and tax
relief for contributions. The number of persons with personal
pensions jumped dramatically from approximately 1.9 million in
1988 to 5.5 million in 1993,\73\ thereby reducing the long-term
liabilities of the British state pension system.
Slowing the Growth of the State Pension System
During the high inflation periods of the 1970s, state
pension increases had been indexed to wage increases, which
normally outpaced price increases and thus generated tremendous
costs. In 1981--in the middle of a recession--Parliament broke
the link between wage increases and pension increases by
deciding to index pension increases to prices, which were
rising faster than earnings. In addition to ensuring that
government pensions at least would keep up with general
inflation, substituting price indexation for wage indexation
has had a profound and continuing impact on controlling costs.
Since 1980, this change alone has saved British taxpayers
nearly 9 billion ($14.4 billion).
The future savings from this adjustment, according to Paul
Johnson, will prove to be even more dramatic:
Starting from where we are the Government Actuary (1995)
estimates that spending on the basic pension will reach
47 billion [$75.2 billion] in 2030 and remain about
constant thereafter. With earnings indexation from the present
spending would rise to 80 billion [$128 billion] in
2030 and 107 billion [$171.2 billion] in 2050. With
price indexation National Insurance Contribution rates would
need to be barely changed by 2030, but with earnings indexation
they might have to rise by nearly ten percentage points.\74\
Curtailing Future Tax Increases
In a move to ease the future burden on British taxpayers,
Parliament enacted the Social Security Amendments of 1986, which took
effect in 1988 and lowered the SERPS replacement rate from 25 percent
to 20 percent of the best 20 years of earnings. Although this reduction
in the base calculation for the state pension was structurally
significant, the impact was lessened because it did not affect any
British worker retiring before the year 2000. Nonetheless, from the
standpoint of future costs, the 1986 changes were significant. As Paul
Johnson reports, ``The Government Actuary estimated that the reforms to
SERPS would cut future spending such that by 2033 the National
Insurance Contribution rate could be three percentage points lower than
it would otherwise have been.'' \75\
Establishing Equity
Under the original British state pension system, the official age
of retirement was 65 for males and 60 for females. The Pensions Act of
1995, however, equalized the age of retirement at 65 for both men and
women.\76\ Women became eligible for a state pension at age 60 in 1940,
a time in which most women were married and dependent, and when few had
any independent opportunity to become eligible under British law for a
government pension.\77\ Today, however, British women account for
almost half the workforce, and--just as in the United States--changing
conditions in the workplace, growing equality in the private sector,
and the fact that women live longer than men have encouraged a change
in the law.\78\
This simple change will ease demographic pressures on the pension
system, reduce costs, and discourage both age and sex discrimination.
Like other British reforms, the age equalization provisions are to be
implemented gradually, with age of retirement increases in six-month
increments to be phased in between 2010 and 2020. The government
estimates that this change alone will save taxpayers 15
billion ($24 billion) by 2025.\79\
Protecting Consumers
The Pensions Act of 1995 also strengthened previous legislation and
established a more comprehensive system of consumer protection for
persons enrolled in occupational schemes, including:
More rigorous disclosure of funds and assets;
Greater accountability of fund managers to employees;
A requirement that professional advisers report to plan
trustees rather than to employers;
A new solvency requirement for pension plans; and
A compensation system to cover losses from fraud.\80\
The Pensions Compensation Board, a panel appointed by the secretary
of state for social security, finances the compensation fund with a
small levy on pension plans.\81\ Oversight and enforcement of these
rules is vested in the Occupational Pensions Regulatory Authority
(OPRA), a government agency accountable to Parliament. OPRA can
investigate problems in occupational pension plans, maintain a register
of personal and occupational plans, secure information from pension
plans, appoint or suspend trustees in troubled plans, institute
proceedings, and impose civil monetary penalties for breaches of
pension law.\82\ Disputes between occupational pension fund trustees
and employers and trustees of other pension plans can be settled by the
pensions ombudsman, an independent agent created by Parliament in 1990,
giving both employers and private pension plans an alternative to
costly litigation.\83\
In the 1980s and early 1990s, there was insufficient protection of
British consumers against fraud in private plans. Much of the impetus
for recent regulatory reform was occasioned by the 1992 Maxwell Affair
in which officers of a prominent publishing firm had misappropriated
employees' pension funds.\84\ There also was misrepresentation (``mis-
selling'') of personal pension plans. Too many British workers made bad
investment decisions as a result of bad advice from unscrupulous
salesmen.
The problem was not so acute for workers who opted out of SERPS and
opened up a personal pension plan.\85\ The major difficulties centered
on those who switched from occupational pension plans, in which
employers were making a substantial contribution to their employees'
plans, to personal pension options without such employer contributions.
Too many workers made these decisions without a full explanation of the
financial consequences of moving from a company plan to a personal
defined contribution plan.
The Future of Pension Reform in Britain
The largely successful pension reforms of the 1980s have
established the groundwork for the next stage of pension
reform: more expansive private options for the next generation
of British workers. Members of Parliament--whether Labor or
Conservative, and despite partisan differences--are committed
to more extensive pension reform.
The New Labor Government's Reform Agenda
During the 1980s, Labor opposed the Conservative
government's reforms in state pension system benefits,
particularly those affecting SERPS, and criticized its
regulation of personal pensions as inept. Although the new
government has not unveiled a comprehensive reform agenda yet,
the Labor Party is committed in principle to preserving the
Basic State Pension as the foundation of the retirement system;
it also opposes a means test for the basic pension and favors a
sustainable second level of funded pensions, compatible with
the demographic changes facing the country and based on a
``high level of contributions.'' \86\ Labor is not committed,
however, to restoring SERPS to its original form.\87\
Most important, the new government has voiced no opposition
to workers' contracting out of the state pension system and
receiving a tax rebate on their national insurance
contributions for doing so.
Broadly, Labor envisions a new system of funded pensions
for people without occupational pensions based on competition
among pension providers. According to Labor Party literature,
funded pensions ``are capable over time of producing the best
returns each individual can achieve from their hard earned
savings. They have the potential to give people a real sense of
ownership--an identifiable stake in their own pension--which
will generate the contribution needed for retirement
security.'' \88\ Labor has given the name ``stakeholder
pensions'' to the second tier of pensions. Although formally
committed to occupational pensions, it wants to make pension
arrangements more understandable while promoting a variety of
pension plans outside the standard financial services industry,
including multi-employer plans and plans sponsored by employer
and employee organizations, local Chambers of Commerce, and
friendly societies.\89\
Labor is expected to retain personal pensions but also to
regulate them more closely: ``We want to make sure that the six
million people who are currently in so-called appropriate
personal pensions do not see so much of their hard-earned
savings being eaten up in excessive costs and charges.''\90\
Pension policies also should promote long-term savings: ``That
is why we are developing plans for Individual Savings Accounts
that would enable people to save for the medium and the long
term.''\91\ Labor also is encouraging pension plans to offer
life insurance to their members at competitive rates and
promises to develop a ``Citizenship Pension'' for persons with
low wages and uneven work experience.\92\
Conservative Pre-Election Proposals
In March 1997, just before the general election, Secretary
of State for Social Security Peter Lilley outlined the
Conservatives' comprehensive plan for further restructuring the
British state pension system.\93\ According to reporters at the
Financial Times, ``The move would represent the most radical
reform of the welfare state since world war two.'' \94\
Significantly, noted Woodrow Wyatt of The Times, Labor's new
minister of state for welfare reform was impressed with the
basic idea: ``Frank Field immediately recognized the virtues of
Peter Lilley's plan for a gradual move into compulsory and
properly funded private pension schemes.'' \95\
The Conservative proposal, targeting new workers in 2001,
contains three elements:
A new privatized basic pension to replace the
government earnings-related pension. Every young person
entering the workforce would be guaranteed a Basic State
Pension. This pension would be funded out of the existing
national insurance contributions (payroll tax), just as the
current system is today, but would be run as a private plan,
not as a government program. In value, it would be at least
equal to the current Basic State Pension and indexed to prices,
as the basic pension is today. The current SERPS component of
the British pension system would be phased out.
A tax rebate. Every young person entering the
workforce would receive rebates. The size of the first--a
rebate from national insurance contributions--would be
determined by the calculations of the Government Actuary, an
agency of the Department of Social Security, and indexed to
inflation. Under the government's calculations, an initial
rebate of 9 ($14.40) per week would be required to
establish a basic pension. In addition, young people entering
the workforce would receive a tax rebate of 5 percent of their
wages, which would go into the new privatized pension system.
These rebates could be put into an occupational pension plan or
a personal pension plan.
A portable personal pension. All young people
would have privately managed pension funds that they, not the
state or their employers, would own. Under the projections of
the Government Actuary, the initial rebate of 9 per
week would be enough for the average wage earner to build up a
fund worth 130,000 ($208,000) upon retirement,
which would finance a tax-free pension of 175
($280) per week at today's prices.\96\ In any case, regardless
of the performance of these plans, the government would
underwrite them so that persons would be guaranteed payments
equal to the current Basic State Pension.\97\ According to The
Times, the expanded provision of personal pensions
will allow people to own the whole of their pensions, instead
of trusting some future government to abide by its
predecessors' promises. Everyone will have a visible stake in
the economy--and their pensions should rise in line with
economic growth instead of merely with inflation. Unless the
economy collapses or pension funds are run by crooks, most
people will be much better off in retirement. And the
government's guarantee limits the risk.\98\
The Conservatives' proposed change in pension policy would
bolster private investment, reduce the burdens of the
government's own pension system, and stimulate economic growth.
In adopting a universal compulsory savings proposal,
Conservatives moved closer to Labor.\99\
Although criticizing the specific Conservative reform,
Labor also is working on a set of reforms that would expand
personal pensions.\100\ There is interest within the Labor
Party in enabling trade unions to sponsor and manage private
pensions plans.
The British system has had its share of problems, and there
are ample opportunities to make that system work better.
Nevertheless, despite their partisan differences, officials
have arrived at a broad consensus on pension policy. Says Dr.
Ann Robinson, director general of the National Association of
Pension Funds, ``There seems to be general agreement that
funded pensions are superior to pay as you go and that the
benefit of such pensions should be more widely available,
particularly to those individuals with lower incomes and less
regular work records.'' \101\
Reality defines this new consensus. Today, British workers
have a real choice: They can put all their payroll tax into a
government-run pension, or they can use a portion of their
payroll tax to earn higher returns on their private
investments. Overwhelmingly, they have chosen the second
course. Thus, Labor recognizes the popularity of existing
private options and the recent legislation governing them.
Reports Paul Johnson:
While there remains disquiet on the left of the party, the
leadership appears broadly content with the shape of the
pensions legislation as it now stands. Such cross party
agreement is of course important for the health of a policy on
something as long term as pension provision.\102\
Social Security: Similar Problems Require Similar Solutions
The 1997 Social Security Advisory Council report is a
starting point for the emerging debate in the United States
over what is needed to assure the long-term solvency of Social
Security. But this not simply a quantitative issue. Congress
also must focus on assuring both the quality of the retirement
available to older Americans and an adequate income for the
aged and for disabled American workers and dependent survivors
of deceased workers. Although benefits for current pensioners
and those near retirement age should be protected, today's
demographic, economic, and political realities demand a full
and fair debate on the kind and quality of pension options
workers should carry into the next millennium.\103\
Like the British state pension program, Social Security is
a system of pay-as-you-go financing in which current benefits
are paid from current payroll taxes. Designed in the 1930s and
amended over the years, the system has served its purpose but
now is showing signs of financial weakness that require a basic
review of its structure and method of financing. The British
experience offers Congress strong lessons and strategies for
success.
The Demographic Time Bomb
The basic problem confronting Social Security is not
disputed by anyone: The simple demographic reality is that the
ratio of workers to retirees will have fallen from a ratio of
20:1 in 1950 (and 3:1 in 1990) to a ratio of 2:1 by about 2025
or 2030.
Congress should note that the British system also has
undergone fiscal and demographic strains. As David Blake of the
University of London's Pensions Institute has written, ``It had
been clear for several years that the financial structure of
the national insurance scheme was unsound.''\104\ Although
Britain's demographic pressures are not as heavy as those in
other European countries, they have been a major factor in
British entitlement reform and have served to drive the debate
about overhauling the state pension system and expanding
private pension options. Peter Lilley observes,
When the Welfare State began there were five working people
contributing to support one pensioner. By the year 2030, for
every five working people there will be three pensioners. The
only way to ensure decent pensions without burdening future
taxpayers is through saving and investing to pay for
pensions.\105\
For the United States, the rapid aging of the population
has a relentless logic of its own, overrunning easy solutions
and political quick fixes. In 1990, 21 percent of the U.S.
population was 55 years old or older. By 2010, when the baby-
boom generation begins to retire, that portion of the
population will have grown to 25 percent. By 2030, it will have
jumped to 30 percent. This problem is manageable, however, and
strategies to cope with it can be hammered out over the next
few years with time to spare. In effect, this is what the
British have started to do, thus making their experience
directly relevant to the solution of the difficulties in the
United States. But political will is essential.
The High Costs of Congressional Inaction
For Americans, it is important to note that political
paralysis carries with it an unacceptably high price.
Specifically, if Congress and the Administration fail to reform
Social Security, the country will face four overriding and
continuing problems:
Problem #1: Heavy future tax increases on younger working
families or lower benefits for retirees. Taxes are not keeping
up with Social Security benefits, and current contribution
rates will not--and cannot--sustain promised benefit levels.
Based on the latest official estimates, benefit costs will
exceed contributions within 15 years. By the year 2029,
assuming that Social Security Trust Fund assets in government
bonds are fully paid, the system will be unable to pay promised
benefits. These estimates are from the middle range of the
official trustees' reports, yet the situation could be worse.
Based on recent experience, the time frames are likely to be
shortened. As noted in Table 6, the trend in official
projections of the depletion of the Social Security Trust Fund
shows the year of exhaustion now progressively closer since
1983--the last time Congress addressed Social Security
financing.
Likewise, the growing tax burden to sustain the entire
British social security system,\106\ including state pensions,
was a driving factor in the enactment of reforms in the 1980s.
Britain's state pension program has struggled, however, with
ever-higher costs since 1946. By the early 1950s, the national
insurance contributions were not enough to cover program costs;
and by 1965, the costs of the state pension system were twice
what British officials had predicted originally.\107\
The popular backlash during the 1970s against Labor's
economic policies--policies that contributed simultaneously to
high unemployment and high inflation--propelled the
Conservatives, led by Margaret Thatcher, into power in 1979.
The Conservatives started fashioning a social policy consistent
with their pro-growth economic objectives, including changes in
the state pension system and reductions in the tax burden on
future generations.\108\ Parliament's major initiative in this
area, the Social Security Act of 1986, allowed expanded
contracting out of the state pension scheme and effected a
crucial change in the formula for government pension increases.
The result: Britain now ``stands almost alone in having no
serious increase in future tax burdens predicted as a result of
an aging population,'' in the words of Paul Johnson. ``To some
extent this reflects a rather less dramatic aging profile than
that seen in most countries. But the most important aspect has
been the determined way in which the government has bitten the
bullet in recognizing possible future problems early on and
tackling them in a radical and effective manner.''\109\
[GRAPHIC] [TIFF OMITTED] T6189.018
Not surprisingly, fiscal conservatism also guides the new
Labor government in its approach to the pensions issue:
Labour believes that pensions policy can only be secure and
sustainable if it takes place within a framework of sound
public finances. We are not proposing measures here which place
any demands on the public purse that are not already envisaged
in the published Public Expenditure Plan; but there is ample
scope for making better use of taxpayers' resources already
committed.\110\
As noted, the Conservatives have proposed a sweeping
privatization of pensions that, if enacted, would save British
taxpayers an estimated 40 billion ($64 billion) per
year by 2040.\111\ Thus far, Labor does not appear ready to
reverse course and support big taxes on British citizens to
shore up the old state pension system.\112\ It remains to be
seen exactly how the Labor government will continue the
momentum toward private pension expansion.
[GRAPHIC] [TIFF OMITTED] T6189.019
Problem #2: A decreasing rate of return for working
families. American workers face a decreasing rate of return on
contributions paid by workers as Social Security matures. The
average American worker retiring at age 65 in 1950 received a
real annual rate of return of about 20 percent on all taxes
paid under the Federal Insurance Contributions Act (FICA),
while workers retiring at age 65 in 2005 and beyond will
receive a real annual rate of return of less than 2
percent.\113\
The situation is different for British workers, who can
take a portion of their ``payroll taxes'' and opt out of SERPS.
Well-established British private pension options already
increase the rate of return on workers' investments. Annual
real returns were nearly 9 percent during the 1980s,\114\ and
the trend is improving in the 1990s. Dr. Oonagh McDonald,
fellow at the Center for Financial Services at the University
of Leeds and a former Labor member of Parliament, notes that,
between 1984 and 1993, the ``real returns on UK pension funds
were almost the highest in Europe with an average real return
of 10.23 percent...with up to 80 percent invested in
equities.'' \115\ In Britain, company plans are not tightly
restricted by the government with respect to the kinds of
investment options available. In 1993, 27 percent of British
pension funds were invested in overseas equities.\116\
The situation could be even better for future workers if
the British government succeeds in expanding private investment
opportunities. Projecting future income in U.S. dollars, the
Conservatives' 1997 pension privatization proposal, as noted,
would enable a British worker making average wages and paying
in a minimum of contributions to accumulate a personal fund
worth $208,000 upon retirement at age 65 and to secure a tax-
free pension of $1,120 per month.\117\ According to Peter
Lilley, ``If returns are 1 percent higher than assumed,
[British workers] will get a pension nearly 30 percent above
the basic pension. If the yield is 2 percent higher, the
pension could be over 70 percent better.'' \118\
Problem #3: A further erosion of public confidence in
Social Security. In the United States, there is a growing lack
of confidence, especially among younger workers, in the
assumption that Social Security will be able to pay promised
benefits. A notable survey reveals that young Americans believe
they are more likely to encounter alien spaceships than future
payments from Social Security.\119\ Although this may reflect a
more general disillusion with the red tape of inept
bureaucracy, it also is understandable that many Americans
would like to remove their Social Security funds from the grasp
of a politically driven and deficit-plagued Congress and
Administration. Moreover, younger Americans increasingly want
more control over how and where their pension savings are
invested.
Problem #4: A lower standard of living for working and
retired Americans. The United States cannot retain its high
standard of living without a higher level of savings. There is
growing recognition that the overall savings rate in the United
States is too low. Failure to secure higher savings will
guarantee a lower standard of living for too many of America's
77 million baby boomers and succeeding generations.
Even though Britain's savings rate is higher than that of
the United States, and even though--because of its partially
privatized pension system--it now has more funds for future
retirement than any other European country, senior officials
are still not satisfied. ``The problem with state schemes is
that they are pay as you go,'' says Peter Lilley. ``Nothing is
saved or invested for the future. People may think their
National Insurance Contributions are being saved in a fund to
pay their pensions. In fact, what they put in goes straight out
to the taxman.'' \120\ Recent proposals to expand personal
pensions, advanced by both Conservative and Labor spokesmen,
are designed to promote an even higher rate of savings and
investment in the future.
Twelve Lessons for the United States
The British have grappled successfully with the major
problems that now plague the U.S. Social Security system,
particularly the fiscal pressures that accompany an aging
population. Roderick Nye argues that ``Britain is not alone in
facing this demographic and fiscal time bomb, but it may have
made the greatest strides in addressing the problem.'' \121\
John Blundell of the Institute for Economic Affairs notes that
``For a large part, older Britons are not a financial burden on
the next generations. They have saved through various market
instruments. They are in this sense quite different from their
continental counterparts.'' \122\
Congress and the Administration can learn at least 12 key
lessons from Britain's very productive political and economic
experience:
Lesson #1: Don't underestimate either the appeal of freedom
of choice or the popularity of personal pension investments.
When the British government gave workers the chance and the tax
relief to opt out of one part of the government pension system
in favor of alternative private plans, it was not clear how
many would take advantage of the option. It proved to be vastly
more popular than anyone--even optimistic proponents of the
policy--ever imagined.\123\ Congress therefore should not
underestimate the popularity of a Social Security reform
program that would let individuals and families own and control
their own money and their own future retirement. Many
Americans, wrestling with an outdated federal tax code that
penalizes savings and investment,\124\ already are trying to
plan safely for retirement. From 1984 to 1993, the number of
employment-based 401(k) plans alone jumped from 17,000 to
154,000.\125\ Today, 43 percent of adult Americans own stocks;
more than 50 percent of investors are below age 50; almost half
of these are women; and most have incomes between $40,000 and
$100,000 per year.\126\
Lesson #2: Combining a flat pay-as-you-go defined benefits
program with a fully funded set of private options can work
more effectively for workers and retirees than a one-tier
system. The British have a flat-rate Basic State Pension with a
mandatory ``additional'' second tier that includes funded
private options. The second tier thus offers the opportunity to
opt out of the state pension system into either a funded
defined benefit plan or a defined contribution private pension
plan. The British experience, especially since 1988, shows that
such a system can function more effectively than the standard
single-tier, pay-as-you-go system and give workers superior
benefits with a lower unfunded government liability. It also
presents Congress with a solid basis for developing the proper
administrative framework needed to construct a new program that
combines defined benefit and defined contribution elements.
By initiating a similar reform of Social Security, Congress
can help alleviate the inevitable fiscal pressures caused by
the retirement of America's 77 million baby boomers--men and
women who will begin to reach retirement age in 2010. By
mandating a funded second tier, the British government has
partially funded the pension benefits for Britain's baby
boomers and is preparing new proposals to fully fund the
benefits of the next generation of workers. The Conservatives'
1997 plan not only would increase private pension funding, but
also would simplify the process for contracting out for private
plans and allow a greater variety of contracted-out private
plans as long as they pass a government quality test.
Lesson #3: In any structural reform of Social Security,
make sure to protect current beneficiaries, proceed carefully,
and frame policies for a more prosperous future. Careful review
of the British experience--including the rationale behind the
most recent proposals to expand private pension options--will
show Congress how to make the proper changes. For example, in
making specific adjustments in the existing government pension
system in the 1980s and 1990s, such as cutting back on the
generosity of SERPS or equalizing the age of retirement,
Parliament took pains to make sure that changes would affect
future workers and retirees and that current beneficiaries or
workers remained largely insulated from their effects.
Although cutting back on the state pension system,
Parliament established a superior alternative for British
workers, enabling them to receive tax rebates and contract out
into private company plans or open personal pension plans with
higher rates of return and the likelihood of higher retirement
income. Between 1988 and 1992, Parliament further encouraged
individuals to open up personal pensions with an incentive
rebate of 2 percent and tax relief for contributions to such
funds. This made personal pension options a good deal for
ordinary workers. As Frank Field has written, ``While it would
be foolish to idealize private pensions as the answer to all
our problems, they have been unique in their ability to provide
generous pensions for a lucky and growing proportion of the
population.''\127\ By doing it right--proceeding carefully,
protecting current beneficiaries, and establishing guarantees
for current workers--Congress also can avoid the need to make
extensive revisions several years down the road.
Lesson #4: Don't let the problem of transition costs delay
change; be candid about the costs and spell them out. Personal
freedom is not without cost, and moving from a government
social insurance system to a pension system that is either
partially or fully privatized inevitably will incur a
transition cost: The younger generation taking advantage of
private pension options will pay not only for its own
retirement, but also--through taxation--for that of the older
generation. If the goal of reform is to move to a superior
Social Security system, it is essential that the issue of
transition costs be faced honestly.\128\ They will have to be
paid in any case, and officials should ensure their credibility
and enhance the public debate by being clear about the actual
costs of change.
Once again, the British example is worth emulating. The
movement to personal pension plans, for example, is costing
British taxpayers an estimated 3 billion ($4.8
billion) annually, but the transition is projected to reduce
the country's future pension liabilities.
The crucial groundwork for even larger future savings was
established by the significant pension reforms of the 1980s. In
promoting a further expansion of private options in 1997, Peter
Lilley has outlined clearly how the full transition to private
pension options--phased in over a generation--is to be
financed. First, all young people entering the British
workforce would continue to pay national insurance
contributions to the state pension system, but they also would
receive a rebate of 9 ($14.40) per week, indexed to
inflation, and a rebate of 5 percent of any earnings paid into
the National Insurance Fund that they have allocated to their
personal pension funds. Second, the tax treatment of personal
pension contributions would be changed; contributions to
personal pensions would become taxable income, thus raising an
additional 8 billion ($12.8 billion) in revenue per
year. Future pension income would be tax-free. According to
Lilley, ``The proposed changes in tax timing, combined with the
gradual phasing in of the new system, will make the impact on
public finances quite manageable.''\129\
Lesson #5: Explain to taxpayers that there are great public
as well as private benefits in moving toward a system based on
private savings accounts. As the British experience indicates,
there are solid financial opportunities for workers and
retirees in moving toward a privatized system. But there are
great public benefits as well. For example, the latest
Conservative proposal for phasing out SERPS in favor of more
private pension plans would result eventually in savings to
British taxpayers of 40 billion ($64 billion) per
year.\130\ Labor's Frank Field argues that a universal system
of private pensions would reduce the need for welfare and thus
cut welfare costs: ``the universal nature of personal private
pensions would lift the great majority of pensioners free from
dependence on state support.'' \131\ On balance, such public
and private opportunities clearly outweigh the costs of staying
in an unreformed system financed by higher taxes and plagued by
ever lower rates of return on those taxes.
Lesson #6: Clarify the amount of basic pension in a two-
tiered system and give careful consideration to the desirable
degree of redistribution. The British system, by establishing a
funded tier of private pensions, limits the intergenerational
transfers from young workers to old retirees in that current
workers are required to save ahead for their pension benefits.
These benefits will be affected at least somewhat by these
savings and the investment income they produce. The current
U.S. system provides for redistribution between higher and
lower wage earners (based on the weighted benefit formula)
\132\ and between generations (based on the inflation-indexed
pay-as-you-go scheme). If Congress changes Social Security to a
two-tiered system, the amount of the basic pension and the
method for indexing should be calibrated with great care.
Even though the partial privatization of the British state
pension system enjoys broad support, some critics are concerned
that the Basic State Pension has become too low. The flat
benefit structure allows for the maximum redistribution between
high and low wage earners, but if it is set too low, it can
become a problem if pensioners receiving only the basic pension
fall below the poverty level. Paul Johnson observes,
The advent of Personal Pensions has provided a new pensions
savings instrument for millions of previously uncovered people.
If we believe people have the right to make choices then we
have to accept that they will sometimes make the wrong choices.
With an adequate social safety net they can be protected from
the worst of them. But it is important not to lose sight of the
importance of providing that safety net.'' \133\
Another inescapable issue in designing a first tier of
government benefits is the eligibility criteria for the basic
pension. If earnings over the normal working life are required
for eligibility, as in the British system, then it seems that
the basic pension should be set to provide a reasonable floor
of retirement above the poverty level. If a universal minimum
income for the elderly is to be provided regardless of work or
contribution history, this floor logically might be set at a
lower level, although the formal provision of a second-tier
pension or means-tested welfare benefits will still be
necessary.
Lesson #7: Realize that covering low-income or part-time
workers with a defined contribution system of personal pensions
may not be easy. Yet another inevitable difficulty is how to
address the problem of an entire class of part-time or low-paid
employees who move in and out of the workforce. These persons
do not earn enough to invest significantly in private equity
funds or stocks. Moreover, according to Andrew Dilnot, director
of the Institute for Fiscal Studies, most private-sector fund
managers in Britain show little enthusiasm in marketing to
these people.\134\ Considering the special characteristics of
this sector of the workforce, Congress might wish to consider a
privately managed defined benefit plan with investments in
safer government securities or limited stock options.
Lesson #8: Realize that Social Security represents only one
aspect of the current income transfer from young working
persons to older retired persons. In any reform of Social
Security, the legal relationship between financing and benefits
in both Social Security and Medicare must be taken into
account.\135\ Today, for every $1 paid into the Medicare
program by the elderly, young working families pay roughly $5
in payroll taxes and general revenues. If the considerable
intergenerational transfer of funds from younger workers to
older retirees is to remain through the current Medicare
program, this transfer should be a factor in calculating the
amount of intergenerational transfer in the Social Security
pension benefits system.
Lesson #9: Understand that establishing a tier of mandatory
savings in a national pension system can improve the overall
savings rate of the economy. In the first quarter of 1997, the
personal savings rate in the United States was 5.1
percent.\136\ Britain does much better: about twice the rate in
the United States. In addition, the personal savings rate in
Britain has changed very little during the past 15 years: It
was 11.8 percent in March 1982 and 11.7 percent in September
1996, and ranged from a low of 5.4 percent in 1988 to a high of
12.9 percent in 1982.\137\ In contrast, the savings rate of
Americans has been on a general downward slope over the past 15
years: It was 8.5 percent in March 1982 and 5.2 percent in
September 1996, and ranged from a high of 9.3 percent in June
1982 to a low of 2.8 percent in March 1994.\138\
Meanwhile, the relentless amassing of private pension funds
has given Britain broader opportunities for economic growth.
The buildup has been impressive. In 1970, for example, pension
assets in both Britain and the United States amounted to 17
percent of GDP. By 1985, Britain had surpassed the United
States with assets at 47 percent of GDP compared with 37
percent for the U.S. By 1990, British pension funds had reached
55 percent of GDP, compared with 43 percent for the United
States.\139\ Over the past several years, the size of the
British pension pool has been growing rapidly. Between 1980 and
1988, real annual growth in pension fund assets averaged 13.3
percent, compared to 8.8 percent for the United States.\140\
Today, with a working population of slightly less than 23
million people, Britain has amassed more than $1 trillion in
pension reserves--a stunning achievement and more than the rest
of the European Union combined. As Field notes, ``This gives
Britain a head start in terms of personal savings that in turn
will pave the way for higher investment.'' \141\
The size of the British funds represents only a fraction of
private pension assets in the United States; the U.S.
workforce--producing 25 percent the world's gross national
product--is well over 100 million. Yet despite its enormous
size and productivity, the overall rate of savings among
American workers remains a matter of genuine concern. Over the
long term, Americans will have to increase both their personal
savings and their domestic investment rates if the United
States is to compete favorably in the global economy. Mandatory
personal savings plans or funded pension schemes could help
increase these ratios. Although broader economic considerations
should not be the only factors pension designers weigh, they
cannot and should not be ignored.
Lesson #10: Make sure that workers and retirees are
protected against fraud, abuse, and the mismanagement of
private pension funds, but don't over-regulate. Several
problems in Britain could have been avoided or minimized with
stronger disclosure rules and an effective oversight body.
Frank Field also notes the need for commonsense rules: ``Lots
of these changes are simple consumer protection measures that
place a duty on fund managers to disclose relevant information
on fees, capital growth and leaving penalties in an agreed
format.'' \142\
Too many British workers were hurt by unscrupulous salesmen
who sold on a commission basis, exaggerated rates of return,
promised levels of benefit that could not be realized, or
failed to disclose the extent of their commissions or the
administrative costs of their plans. The Securities and
Investment Board, the senior regulatory agency for Britain's
financial services industry, responded by changing its
regulatory framework, establishing guidelines for marketing,
requiring descriptions of plan offerings and administrative
costs and commissions in plain language, and forcing companies
to disclose accurate projections based on reasonable
assumptions concerning investment yields. Even though effective
government action has cleaned up the industry, these scandals
initially soured the public on the private pension industry and
led more than 500,000 citizens to seek compensation for losses
from the British government.\143\
As part of any change in the U.S. Social Security system,
Congress must decide on the ultimate goals for reform and then
construct the appropriate regulatory and organizational
framework to achieve those goals. If Members of Congress are
serious about expanding the market in private pensions, they
should not authorize federal micromanagement. The current
regulatory regime in the United States is not the appropriate
mechanism for securing the necessary safeguards for a new
nationally mandated system of private savings plans. Even some
British analysts fear that, in their well-intentioned effort to
protect consumers, British officials may have overshot that
objective. British tax policy governing pensions is far too
complex, and the regulatory regime governing company pensions
and private investments in Britain today is much too
cumbersome. As Dr. Ann Robinson recommends,
The Government must tackle the mass of regulation which
surrounds the provision of occupational pensions. Of course,
members require security, but does it really take hundreds of
often incomprehensible regulations to insure that pensions are
paid? The cost to employers is formidable and the complexity
confuses employees.\144\
Professor David Simpson, economic adviser to Standard Life
Assurance Company of the United Kingdom, argues that British
regulatory authority should be more streamlined; that
prescriptive regulation of the ``selling process'' should be
replaced by careful monitoring of the industry and tough
enforcement of fair trading laws; and that the government
should be engaged in disseminating information on comparative
plan performance to promote consumer awareness and foster
competition.\145\
In this respect, Members of Congress would be wise to
review the existing Federal Employees Health Benefits Program
(FEHBP) for federal government employees, as well as the rules
that govern the private investment options for federal
employees in the Federal Employees Retirement System. The
FEHBP, in particular, is an excellent example of a program with
a high degree of personal choice and market competition that at
the same time maintains effective, but not burdensome, rules to
guard beneficiaries against fraud or mismanagement.\146\ The
general success of both these programs can restore public
confidence in the federal government's capacity to administer
competent, targeted regulation in similar public programs.
As a technical matter, with any move toward a privatized
Social Security system, Congress will have to examine how new
federal regulatory efforts can be meshed with existing
institutions like the Pension Benefit Guaranty Corporation, a
federal agency created by the Employee Retirement Income
Security Act of 1974 to guarantee payment of basic pension
benefits earned by American workers.\147\ Finally, Congress
should consider what kind of federal re-insurance requirements
or government guarantees should accompany any expansion of
private or personal pension options under Social Security
reform, just as the British government proposed in its 1997
pension reform package.
Lesson #11: Incorporate ways to give young workers the
opportunity to set up personalized pension accounts that can
rebuild their confidence in Social Security. The erosion of
confidence in Social Security among Americans is indisputable.
Part of the reason surely is that Americans in general have
lost confidence in the federal government.\148\ Personalized
pension savings accounts, owned and controlled by workers and
subject to reasonable regulation and market competition, would
help to bridge this confidence gap. It therefore is crucial
that Congress take great care in educating the public on the
options available to them. Public confidence must be instilled
in any government agency that is created to oversee and enforce
compliance with regulations to protect the rights of the
members of a privatized Social Security program. Otherwise,
this regulatory effort will meet similar skepticism.
More important, the pre-funding of pensions obviates the
need to depend on politicians' promises to pay future benefits.
This becomes especially meaningful when the U.S. Treasury needs
to begin paying off bonds to meet the need for Social Security
benefits within the next 15 years.
While Congress and the President are working to bring the
deficit under control, as promised, they should look for ways
to insulate a large portion of Social Security funds from
short-term political decisions. Legally protected private
pensions that are gaining interest in personal accounts can
reduce the anxieties of retirees over the historic inability of
Congress and the President to meet their budgetary obligations
under politically imposed time constraints.
Lesson #12: Recognize that personal pension options can
give workers flexibility in deciding on the age of retirement.
Almost all Social Security proposals call for increasing the
normal retirement age, but such changes are proposed despite a
glaring inconsistency: Even though the retirement age in the
U.S. system is scheduled to increase gradually from 65 to 67 as
a result of the 1983 Social Security amendments, American
workers continue to retire earlier each year. Although this
trend has slowed during the past ten years, the age at which
retirees take their first Social Security old age pension has
been on a downward slope since the 1940s.\149\
Once again, Britain has experienced a similar pattern. Over
the past several years, there has been a reduction in the
number of men over age 55 in the workforce. The prevalence of
defined benefit pension plans, based on final salary, is a
contributing factor, for these plans become progressively
richer as the years pass. Employers, to ease the company
burden, encourage employees to take early retirement.\150\ As
David Willetts, a member of Parliament, has argued,
This is a dangerous absurdity. Society might be able to
handle the relatively modest and gradual increase in life
expectancy. The strains, however, become serious if at the same
time as life expectancy is increasing people leave the
workforce when they are younger and younger. The de facto
retirement age for men is rapidly moving down into the mid-50s.
But the right policy is for retirement age to move gradually
back upwards into the mid-60s and beyond.\151\
As Willetts points out, in the British case at least, this
is a major economic benefit resulting from an expansion of
personal pensions based on a defined contribution: ``This is
one of the most important yet least understood arguments in
favor of encouraging personal pension ownership--it immediately
creates an incentive for someone to stay on in work for as long
as possible.'' \152\
It is, of course, not entirely clear what would occur if
American workers had more control over their own retirement
funds. Cultural factors, financial incentives, and behavioral
changes all complicate retirement policy. Whether a larger
number of older workers would choose to participate in the
economy to a greater degree than is now the case because of
today's complex retirement earnings test is a question that is
not easily answered. But by allowing workers to contribute more
to their own retirement accounts, Congress also might enable at
least some of them to take early retirement or reduce their
hours of work to accommodate their desired lifestyles. Or it
might give them a powerful new incentive to change careers and
work even longer, harnessing their wealth of experience and
enhancing the productivity of the U.S. economy.
Conclusion
The British experience with state pension reform offers
Congress and the Clinton Administration useful guidelines for
designing changes in the U.S. Social Security system. This is
especially true of Britain's Social Security Act of 1986, which
broadened the options for British workers to allow them to opt
out of the State Earnings Related Pension Scheme and showed
that government can move from a traditional social insurance
system to a partially funded system of private pensions.
Reflecting on their own national experience, the editors of The
Times have noted that
Britain has nothing like the ``pensions time bomb'' that some
other European countries face. Because this country's
demographics are more favorable, and the pension age for women
is to be raised, we shall have a healthier ratio of workers to
pensioners. Because the basic state pension has been linked to
prices rather than earnings, it costs the state less. And
because the British have saved more for their retirement in
occupational and private pensions than the rest of the EU put
together, the burden on the taxpayer will be smaller.\153\
Using the 1997 Social Security Advisory Council Report as a
starting point for the national debate, Congress and the
President have time to consider and model a variety of
solutions to the problems currently plaguing the system in the
United States. But they have no time to waste. The longer
policymakers delay, the more the taxpayers must make up for the
current unfunded liabilities in a shorter period of time.
Educating the American people on the current Social Security
program and honestly discussing its problems in forums and town
hall meetings around the country will take some time, not only
because of its complexity, but also because several myths
surround the issue.
Coming to a national bipartisan consensus on the best
approach to retirement in the 21st century, as well as
developing a sound plan for transition to a new system, will
take time. Any peripheral changes in the system, such as
adjustments in the Consumer Price Index, should be based on
their own merits, not tied inextricably to an agreement on
future changes in the retirement program. Serious reform will
tax the political imagination of both Democrats and
Republicans. If Congress and the President make a genuine
effort, however, systemic change could be in place before the
year 2000. Meanwhile, Congress should avoid standard short-term
political fixes at least until the overall framework for reform
has been developed.
Britain has become a showcase of serious reform. The
British have made mistakes and have scored impressive successes
in changing their retirement system. Reformers in the United
States can learn from both. Considering the strong cultural,
linguistic, and historical ties between the United States and
Britain, as well as their somewhat comparable demographic,
fiscal, and political situations, Parliament's record can
provide Congress with important lessons based on valuable
insights. Perhaps best of all, Members of Congress and Members
of Parliament can discuss these lessons face to face.
APPENDIX
Further information on Britain's government pension system
and private pension plans is available on the following World
Wide Web addresses.
BRITISH GOVERNMENT PENSION AGENCY LINKS
The Benefits Agency, which is responsible for paying state pension
benefits: http://www.dss.gov.uk/ba/
The Contributions Agency, which is responsible for payment and
recording of national insurance contributions: http://www.dss.gov.uk/
ca/index.htm
The Department of Social Security, which administers Britain's
social security system, for data and research on pension-related
topics: http://www.dss.gov.uk/asd/index.htm
The Employers Charter, a code of conduct for Britain's government
pension agency personnel in dealing with employers: http://
www.open.gov.uk/charter/employ.htm
General government links to British and international government
pension agencies: http://www.econ.bbk.ac.uk:80/pi/vl/govorg.html
The Inland Revenue, Britain's tax collection agency (the equivalent
of the IRS), for information on pension topics: http://www.open.gov.uk/
inrev/irhome.htm
The Securities and Investments Board, which is responsible for
regulation of investment vehicles: http://www.sib.co.uk/
PRIVATE PENSION PROVIDERS
The Association of Unit Trusts and Investment Plans: http://
www.iii.co.uk/autif/facts/pep--pen/
Independent Advice Ltd., a commercial retirement advisory and
planning service based in Britain: http://www.independent-advice.co.uk/
ia/pensions.htm
Infoseek, a Web site offering a list of British pension firms:
http://uk.infoseek.com/infosk/owa/pkg--search.p--cat--search?in--cat--
id=474
Moneyworld, a financial magazine, for articles on private pensions
and additional links: http://ww.moneyworld.co.uk/
Money Management, a weekly magazine covering Britain's private
pension issues: http://www.fee.ifa.co.uk/
The National Association of Pension Funds Limited (NAPF), the main
organization for companies involved in designing, operating, investing
funds, and advising occupational pension plans in Britain: http://
www.napf.co.uk
The Pensions Institute, Britain's most prominent pension research
organization, based at Birkbeck College, University of London, for a
list of private pension providers: http://www.econ.bbk.ac.uk:80/pi/vl/
ppa.html
POLICY AND RESEARCH INSTITUTES
The Adam Smith Institute, a private, independent economic policy
institute that promotes market-based economic reform: http://
www.cyberpoint.co.uk/asi/
The Institute for Fiscal Studies, a British think tank that
publishes work on the British pension system: http://www1.ifs.org.uk/
research/index.htm#Pensions
Pensions Virtual Library, which offers a large collection of links
on pensions: http://www.econ.bbk.ac.uk:80/pi/vl/index.html
Endnotes
1. The authors would like to thank several individuals in Britain
who provided valuable information and comments, especially Dr. David
Blake, The Pensions Institute, Birkbeck College, University of London;
Peter Barnes, Department of Social Security; Bill Birmingham, National
Association of Pension Funds Limited; Drs. Eamonn Butler and Madsen
Pirie, Adam Smith Institute; Andrew Dilnot, Institute for Fiscal
Studies; Daniel Finkelstein, Conservative Research Department; Dr.
David Green, Institute for Economic Affairs; Bernard Jenkin, M.P.; and
Roderick Nye, Social Market Foundation. The views and opinions
expressed herein (and any errors) are those of the authors alone.
2. Communication from the Board of Trustees, Federal Old Age and
Survivors Insurance and Disability Insurance Trust Fund (Trustees'
Report), House Doc. 105-72, 105th Cong., 1st Sess., April 24, 1997, pp.
28-29.
3. Peter Lilley, Secretary of State for Social Security, press
statement, March 5, 1997, p. 1.
4. For a discussion of this issue, see Stuart M. Butler, ``A
Consumer's Checklist for Social Security Reform Plans,'' Heritage
Foundation F.Y.I. No. 141, April 29, 1997; see also Daniel J. Mitchell,
``Creating a Better Social Security System for America,'' Heritage
Foundation Backgrounder No. 1109, April 23, 1997.
5. Andrew Dilnot, Richard Disney, Paul Johnson, and Edward
Whitehouse, Pensions Policy in the UK: An Economic Analysis (London:
Institute for Fiscal Studies, 1994), p. 9.
6. Personal communication from Sharon White, First Secretary of
Economic Affairs, British Embassy, April 13, 1997. On the popularity of
contracting out, see remarks of Iain Duncan-Smith, M.P., in The Daily
Mail, April 13, 1994, p. 8.
7. Roderick Nye, ``Pension Reform: Is Britain the Model?'' The
Financial Times (London), April 15, 1996, p. 16.
8. John Blundell, ``The EMU Threat to Our Pensions,'' The 1996
Annual Newsletter of the European Union of Women, p. 4.
9. For a brief discussion of the Social Security Advisory Council
report, see Robert E. Moffit, ``Reforming Social Security:
Understanding the Council's Proposals,'' Heritage Foundation F.Y.I. No.
128, January 24, 1997.
10. Although there was some general agreement regarding needed
changes, there was not a consensus on any long-term solution.
11. ``The best of the three plans proposed in January by a
commission that examined Social Security recommended a British-like
plan with a safety net of basic benefits and an additional private
savings account program.'' ``Retirement: Unthinkable Thoughts,'' The
Florida Times Union (Jacksonville), March 17, 1997, p. A-18. Carolyn
Weaver, a member of the Social Security Advisory Council and director
of Social Security and Pension Studies at the American Enterprise
Institute, dubbed Britain's achievement a ``quiet revolution.'' For her
account of the Advisory Council's privatization option, see Carolyn L.
Weaver, ``Creating a New Kind of Social Security,'' The American
Enterprise, January/February 1997.
12. Chile's experience with privatization inspired the more
dramatic 1997 British reform proposals. The most notable work on the
success of the Chilean system is that of Dr. Jose; Pinera, labor
minister of Chile from 1978 to 1980. See Jose Pinera, ``Empowering
Workers: The Privatization of Social Security in Chile,'' Cato's
Letters, No. 10 (1996). See also Peter Passel, ``How Chile Farms out
Nest Eggs; Can Its Private Pension Plan Offer Lessons to the US?'' The
New York Times, March 21, 1997, p. C 27.
13. Heritage Foundation analysts long have argued that the British
experience is a fruitful source of wisdom on Social Security reform.
See, for example, Peter Young, ``Britain Improves Social Security: A
Model for the U.S.,'' Heritage Foundation International Briefing,
December 2, 1985.
14. Frank Field, Private Pensions for All: Squaring the Circle
(London: The Fabian Society, 1993), p. 15.
15. Quoted in letter to the author from Roderick Nye, director of
the Social Market Foundation, July 10, 1997. According to Nye, these
observations were ``based on the OECD Economics Department Working
Paper No. 156, Ageing Populations, Pensions Systems and Government
Budgets: How Do They Affect Saving? Published in 1995.''
16. ``The outstanding feature of the UK pension system is that,
under current policies, public expenditure on pension provision will
remain modest, compared with other industrial economies. For example,
[International Monetary Fund analysts] Chand and Jaeger (1996) estimate
the present value of the difference between the UK's public pension
expenditure and revenue up to 2050 is 5 percent of GDP with existing
policies and contribution rates. This compares with a ratio of 26
percent for the US and above 100 percent in Japan, Germany and
France.'' Alan Budd and Nigel Campbell, The Roles of the Public and
Private Sectors in the UK Pension System, Her Majesty's Treasury, at
http://www.hm-treasury.gov.uk/pub/html/docs/misc/pensions.html.
17. The annual increase in the retail price index during that same
period was 4.6 percent. Personal communication from Peter Barnes,
Department of Social Security, April 2, 1997.
18. The WM Company, 1996 UK Pension Fund Industry Results, 1997.
19. Budd and Campbell, The Roles of the Public and Private Sectors
in the UK Pension System.
20. Personal communication from Sharon White, op. cit.
21. Interview with Daniel Finkelstein, director, Conservative
Research Department, British Conservative Party, London, March 6, 1997.
22. Paul Johnson, ``Brown Is Just Starting, He'll Get Much
Tougher,'' The Evening Standard, May 7, 1997, p. 18.
23. Jill Sherman, ``Brown to Stay on Cautious Route,'' The Times
(London), March 6, 1997, p. 9.
24. In 1909, prodded by Liberal Chancellor (later Prime Minister)
David Lloyd George, the British government established a limited
pension that provided a meager weekly sum for persons aged 70 years and
older.
25. The postwar Labor initiative on government pensions was rooted
in the work of Sir William Beveridge, a member of the Churchill
Ministry whose 1942 report, Social Insurance and Allied Services,
became the basis for the modern British state pension system.
26. These figures are for the fiscal year covering April 6, 1997,
through April 5, 1998. The dollar equivalent is based on an exchange
rate of $1.60 for the British pound, based on February 1997 data. The
actual exchange rate on any given date is dependent on supply and
demand for currencies in the foreign exchange markets.
27. Disability benefits in Britain are paid out of general
revenues.
28. Social Security Department Report: The Government's Expenditure
Plans 1997-1999, presented to Parliament by the Secretary of State for
Social Security and Chief Secretary to the Treasury by Command of Her
Majesty, March 1966, p. 8.
29. Paul Johnson, The Reform of Pensions in the UK, manuscript,
Institute for Fiscal Studies, 1996, p. [2].
30. Steve Bee, Prudential Corporation, Presentation to the
Committee on Social Security, House of Commons, February 1997, p. 3.
31. David Blake, Pension Schemes and Pension Funds in the United
Kingdom (Oxford: Clarendon Press, 1995), p. 66.
32. In practice, SERPS payments are funded not only from payroll
taxes, but also from general revenues.
33. Under the National Insurance Act of 1959, which took effect in
1961, private employers and employees were able to contract out of the
State Graduated Retirement Pension Scheme, the ``additional'' state
pension program that existed before SERPS was established in 1978.
``About 4.5 million employees had been contracted out. These, nearly
twice the number expected, included most public service and
nationalized industry workers, and about a quarter of the employees who
were members of private occupational schemes.'' Blake, Pension Schemes
and Pension Funds, p. 15.
34. Social Security Department Report, p. 41.
35. There are higher tax-free contributions ranging from 20 percent
to 27 percent for older workers from 51 to 74 years of age. Blake,
Pension Schemes and Pension Funds, pp. 87-88.
36. In the British context, the word ``scheme'' does not connote
anything sinister, as it would in American usage; it merely refers to a
program or plan. SERPS is called a ``contracted in'' scheme.
37. Under the Pensions Act of 1995, effective in 1997, there will
be new statutory standards governing the administration of occupational
pensions, including pension payments and exchanging pensions for lump
sums, and a new statutory standard for private pension plans. For an
updated discussion of the process of ``contracting out,'' see Pensions
Act 1995: Contracting Out Made Simple (London: National Association of
Pension Funds, 1997).
38. Blake, Pension Schemes and Pension Funds, p. 156.
39. Personal communication from Professor David Simpson, economic
adviser to Standard Life Assurance Company of the United Kingdom,
February 28, 1997. The schemes were devised by medieval guilds: ``The
first recorded occupational pension scheme was that of the Guild of St.
James of Garlekhithe of London in 1375.'' Blake, Pension Schemes and
Pension Funds, p. 27.
40. Johnson, The Reform of Pensions in the UK, p. [2].
41. Association of Consulting Actuaries, The Changing Face of UK
Occupational Pensions in Smaller Companies, September 1996, p. 24.
42. State, Occupational and Personal Pension Arrangements in The
United Kingdom (London: National Association of Pension Funds, 1997),
pp. 8-9.
43. Reshaping Our Social Security System, Conservative Government
Talking Points, March 1997, p. 22.
44. National Insurance Fund Long Term Financial Estimates: Report
by the Government Actuary on the Third Quinquennial Review Under
Section 137 of the Social Security Act of 1975, ordered by the House of
Commons to be printed January 31, 1995, p. 30.
45. Blake, Pension Schemes and Pension Funds, p. 211.
46. Until 1996, a person enrolled in an appropriate personal
pension could start using it between the ages of 50 and 75 but had to
do so by purchasing an annuity. With the Pensions Act of 1995, new
arrangements were set up for these pensions so that persons could
``draw down'' income from their fund and defer purchase of an annuity
up to age 75. By allowing people to defer annuity purchases, current
law enables them to get the best returns on their investment and avoid
having to retire when annuity rates may be at historic lows.
47. Johnson, The Reform of Pensions in the UK, p. [12]. See also
Richard Disney and Edward Whitehouse, The Personal Pensions Stampede
(London: Institute for Fiscal Studies, 1992).
48. Department of Social Security, Personal Pension Statistics:
1994/95 (London: Crown Copyright, 1996), pp. 4-6.
49. ``Personal pensions are much more attractive than other options
for younger workers. SERPS is less generous to them, and contributions
to a personal pension are more valuable because there is a longer time
to retirement for investment returns to compound.'' Dilnot et al.,
Pensions Policy in the UK, p. 28.
50. Social Security Department Report, p. 45.
51. Blake, Pension Schemes and Pension Funds, p. 159.
52. Ibid., p. 162.
53. The Personal Investment Authority currently regulates about
4,000 firms providing personal pensions. David Simpson, Regulating
Pensions: Too Many Rules, Too Little Competition (London: Institute of
Economic Affairs, 1996), p. 30.
54. Employers are prohibited from contributing to these
instruments.
55. ``Britain in the USA,'' The British Media Review, September 28,
1995.
56. ``Britain: Tomorrow's Pensioners,'' The Economist, March 8,
1997, p. 64.
57. Frank Field, ``Working for Pensions That People Trust,'' The
Daily Telegraph, March 6, 1997.
58. New Labour: Because Britain Deserves Better (London: Labor
Party, 1997), p. 13.
59. Interview with Bernard Jenkin, M.P., Westminster, March 5,
1997.
60. ``We in the UK can expect to see the smallest deterioration in
our support ratio. We got old first.'' Peter Lilley, Winning the
Welfare Debate (London: Social Market Foundation, 1995), p. 36.
61. Reshaping Our Social Security System, op. cit.
62. David Willetts, The Age of Entitlement (London: Social Market
Foundation, 1993), p. 11.
63. Christopher Downs and Rosalind Stevens-Strohmann, Risk,
Insurance and Welfare: The Changing Balance Between Public and Private
Protection (London: Association of British Insurers, 1995).
64. Reshaping Our Social Security System, p. 3.
65. Ibid., p. 22.
66. Ibid.
67. Paul Johnson, Richard Disney, and Gary Stearns, Pensions 2000
and Beyond, Vol. 2 (London: Institute for Fiscal Studies, 1996), p. 53.
68. Alistair B. Cooke, The Campaign Guide 1994 (London:
Conservative Central Office, 1994), p. 27.
69. Downs and Stevens-Strohmann, Risk, Insurance and Welfare, p.
63.
70. Ibid., p. 61.
71. ``The success of the personal pensions has surprised the
government. In 1988, the government estimated that at most 1.75 million
people would leave SERPS and take out personal pensions. By the end of
1990, more than 4.5 million people had taken out personal pensions.''
Blake, Pension Schemes and Pension Funds, p. 253.
72. For a description of the demographics of Britain's occupational
pensions, see ibid., pp. 99-110.
73. Reshaping Our Social Security System, p. 24.
74. Johnson, The Reform of Pensions in the UK, p. [5].
75. Ibid.
76. Another factor in the enactment of the equalization of age
provision was a 1990 judgment by the European Court of Justice, a
judicial body of the European Union, that males and females should be
treated equally with respect to their pensions.
77. Under the state pension system, a married woman is eligible for
60 percent of her husband's basic retirement pension. A 1978 change in
British law, the Home Responsibilities Act, reduced the number of years
for persons (especially women) whose work opportunities were limited
because of the need to care for dependents at home.
78. British women draw pensions, on average, nine years longer than
men do.
79. Reshaping Our Social Security System, p. 27.
80. Today, the new compensation system will cover losses up to 90
percent in cases of fraud or bankruptcy. The Compensation Board is
required to satisfy itself that there are ``reasonable grounds'' to
believe there has been a ``reduction in the scheme's assets due to an
offense involving dishonesty.'' According to Barnes, ``This is a less
stringent test than that adopted in criminal cases. Action by the Board
should not prejudice any separate criminal proceedings.'' Personal
communication from Peter Barnes, op. cit.
81. For 1997 to 1998, the levy is 0.23 (roughly 37
cents) per plan member.
82. Personal communication from Peter Barnes, op. cit.
83. Ibid.
84. For an excellent summary of the Maxwell scandal, see Blake,
Pension Schemes and Pension Funds, pp. 261-279.
85. According to Paul Johnson of the Institute for Fiscal Studies,
two major studies of the problem showed that (1) more than 90 percent
of workers opting out of the SERPS program to set up personal pensions
were making rational economic decisions; and (2) they would ``be at
least as well off'' with a personal pension plan as they would
remaining in the government program. The difficulty took place in
switching among private-sector plans: ``The real problem of ill
informed choices leading to undesirable outcomes has been among members
of occupational schemes leaving their schemes in order to join personal
pensions. The trouble is that in doing so they have lost their
employer's contributions to the scheme. Only in rather special
circumstances will this sacrifice be worthwhile.'' Johnson, The Reform
of Pensions in the UK, p. [15].
86. ``Security in Retirement,'' in Road to the Manifesto (London:
Labor Party, 1996), p. 3.
87. Whatever the final shape of its future pension reform, Labor
clearly is not going backward: ``We have already suggested that SERPS
could not easily or sustainably be rebuilt in its present form. New
funded pension schemes could produce better returns for the same
contribution level for many people.'' Ibid., p. 6.
88. Ibid., p. 3.
89. Ibid., p. 5.
90. Ibid., p. 4.
91. Ibid., p. 5.
93. Much of the inspiration for the Conservative proposal comes
from the work of the Adam Smith Institute, a prominent free-market
British think tank. For a thorough discussion of the privatization of
Social Security programs, see Eamonn Butler and Madsen Pirie, The
Fortune Account: The Successor to Social Welfare (London: Adam Smith
Institute, 1995). See also Eamonn Butler and Matthew Young, A Fund for
Life: Pension and Welfare Reform in Practice (London: Adam Smith
Institute, 1996).
94. Robert Preston, James Blitz, and William Lewis, ``Tories Plan
to Privatize Pension Provision,'' Financial Times (London), March 6,
1997, p. 1.
95 Woodrow Wyatt, ``Is Blair's Tory Party Up to It?'' The Times
(London), May 13, 1997.
96. Lilley press statement, p. 2.
97. Preston et al., ``Tories Plan to Privatize Pension Provision,''
p. 28.
98. ``The Pension Plan'' (editorial), The Times (London), March 6,
1997, p. 19.
99. ``Up until yesterday the Government rejected the idea of
universalizing compulsory pension savings, saying that voters would see
it as a tax increase. That argument is now truly dead and buried.''
Field, ``Working for Pensions That People Trust,'' op. cit.
100. Philip Webster and Jill Sherman, ``Tory Aim Is One Hundred
Seventy Five Pound Tax Free Pension,'' The Times (London), March 6,
1997, p. 1.
101. Ann Robinson, ``Labour Faces an Age Old Problem,'' The
Parliamentary Monitor, May 1997, p. 7.
102. Johnson, The Reform of Pensions in the UK, p. [9].
103. The authors believe that the current focus for revision should
be the Old Age Pension scheme. Even though the disability program has
some serious problems, these programs should be considered separately;
the present disability and survivor benefits and financing mechanisms
should not be a part of this review.
104. Blake, Pension Schemes and Pension Funds, p. 13.
105. Lilley press statement, p. 1.
106. According to former secretary Lilley, 1997 British government
spending on all social security benefits, including pensions, amounts
to 93 billion, or approximately $149 billion in today's
U.S. dollars. This costs every working person in Britain 15
($24) per day. Reshaping Our Social Security System, p. 1.
107. Ibid., p. 3.
108. Daniel Finkelstein, ``The System of Social Security in Great
Britain,'' manuscript, September 28, 1995, p. 11.
109. Johnson, The Reform of Pensions in the UK, p. [7].
110. Road to the Manifesto, p. 2.
111. Lilley press statement, p. 3.
112. According to Roderick Nye, director of the Social Market
Foundation, ``Many of us fear dismantling chunks of the social safety
net that we may one day rely on ourselves. But there is a growing
disinclination to fund new entitlements or more claimants through
increased taxes.'' Nye, ``Why Lilley May Deserve a Statue,'' The
Independent, February 2, 1996.
113. C. Eugene Steurle, Retooling Social Security for the 21st
Century (Washington, D.C.: Urban Institute, 1994).
114. Blake, Pension Schemes and Pension Funds, p. 452.
115. Oonagh McDonald, The Future of Continental European Private
Pension Funds and Their Impact on the Equity Markets (London: Apax
Partners and Company, December 1996), p. 10.
116. Budd and Campbell, The Roles of the Public and Private
Sectors, p. 13.
117. Projected in British currency, ``An individual on average
earnings would, after 44 years, have built up a pension fund from their
9 pounds plus 5 percent rebates amounting to 130,000 pounds at today's
prices, using the Government Actuary's Department's assumptions, for
example, assuming a four and a quarter percent real rate of return. A 1
percent higher rate of return would increase the fund by about 30
percent.'' Basic Pensions Plus: A Technical Note, Conservative
Government Talking Points, March 6, 1997, p. 4; see also Lilley press
statement, p. 2.
118. Lilley press statement, p. 2.
119. ``Social Security: The Credibility Gap,'' an analysis of a
Third Millennium survey conducted by the Luntz Research Companies in
conjunction with Mark Siegel and Associates, September 1994. The survey
covered young adults from 18 to 34 years of age.
120. Lilley press statement, op. cit.
121. Nye, ``Pension Reform: Is Britain the Model?''
122. Blundell, ``The EMU Threat to Our Pensions.''
123. Finkelstein interview, March 6, 1997; Jenkin interview, March
5, 1997; and interview with Andrew Dilnot, director of the Institute
for Fiscal Studies, London, March 6, 1997.
124. For a description of the bias against savings in the complex
U.S. federal tax code, see Mitchell, ``Creating a Better Social
Security System for America,'' p. 27.
125. ``President Clinton Announces Pension Security Steps,'' press
statement, Pension Benefit Guaranty Corporation, March 31, 1997, p. 1.
126. Donald Lambro, ``Anemic Personal Savings Rate,'' The
Washington Times, February 27, 1997.
127. Field, Private Pensions for All, p. 7.
128. Jenkin interview, March 5, 1997.
129. Lilley press statement, p. 3.
130. Ibid.
131. Field, Private Pensions for All, p. 14.
132. Under the current Social Security formula, low wage earners
receive a 58 percent replacement rate (the percentage of covered pre
return earnings); average wage earners receive a 42 percent replacement
rate; and high wage earners receive a 28 percent replacement rate.
133. Johnson, The Reform of Pensions in the UK, p. [20].
134. Dilnot interview, March 6, 1997.
135. See Stanford G. Ross, Domestic Reforms: The Importance of
Process (Washington, D.C.: Urban Institute, 1996).
136. ``U.S. Economic Review,'' WEFA Econometrics, May 1997.
137. Data extracted from tables compiled by the Office of National
Statistics in the United Kingdom and the U.S. Department of Commerce.
138. Ibid.
139. E. P. Davis, Pension Funds (Oxford: Oxford University Press,
1995), p. 55.
140. Ibid.
141. Field, Private Pensions for All, p. 16.
142. Ibid., p. 20.
143. Interview with David Green, Institute for Economic Affairs,
London, March 6, 1997.
144. Robinson, ``Labour Faces an Age Old Problem,'' op. cit.
145. Simpson, Regulating Pensions, pp. 81-82.
146. For an account of the Federal Employees Health Benefits
Program, see Stuart M. Butler and Robert E. Moffit, ``The FEHBP as a
Model for a New Medicare Program,'' Health Affairs, Vol. 14, No. 4
(Winter 1995), pp. 47-61.
147. The Pension Benefit Guaranty Corporation insures the pensions
of over 42 million workers in about 50,000 pension plans.
148. ``Why Don't Americans Trust the Government?'' The Washington
Post/Kaiser Family Foundation/Harvard University Survey Project, 1996.
149. U.S. Social Security Administration, Annual Statistical
Supplement, 1996, Table 6B5.
150. Willetts, The Age of Entitlement, p. 12.
151. Ibid.
152. Ibid.
153. ``The Pension Plan,'' op. cit.
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