[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]




                               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
RON LEWIS, Kentucky

                     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



Advisories announcing the hearing................................     2


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



                      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:]



                                                CONTACT: (202) 225-1721

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.


    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.''


    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.


    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.


    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 
    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 
    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 ***



                                                CONTACT: (202) 225-1721

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, 
    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 
    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 
    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 
    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 
    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 
    So, with that format, welcome. We are happy to have you 
here, and we will be pleased to hear your testimony.


    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 
    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 
    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 

    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 

                             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 
    \3\ World Bank, Averting the Old Age Crisis (1994).
    Chile used five methods to finance the transition to an USA 
    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 
    \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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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 
    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 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 
    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 
    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 
    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 
    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 
    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 
    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. 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 


    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 
    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 
    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 
    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.

    I imagine the Committee will be at least as interested in 
the problems we have had to tackle as in the success of this 
    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 
    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 
    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 
    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 
     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 
     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 
    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 
    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 
    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 
    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 
    Chairman Archer. The Chair now recognizes the Ranking 
Minority Member on the Social Security Subcommittee, Mr. 
    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 
    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 
    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 
    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 
    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 
    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 
    Mr. Shaw. The Chileans had a different form of government 
when they put this in place, didn't they, than the United 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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 
    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
                                                        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 

          ``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 

    \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
   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 
    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.


    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 
    \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 
    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 
    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 
    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 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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 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 
    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 
    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 
    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 
    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.
    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 

               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 
    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 
     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 
    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 
    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 
     80 percent of the self employed are not 
     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 
    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.


    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 


    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 
    Mr. Shaw. What type of prefunding?
    Mr. Roosevelt. Well, the prefunding involved in the credits 
to the trust fund that are represented by government 
    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 
    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 
    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 
    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, 
    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 
    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 
    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 
    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 
    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 
    Mr. Archer. The gentleman yields back the balance of his 
     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 
    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 
    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 
    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 
    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.

                   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 

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 
    \4\ The Guardian, August 10, 1998.

      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 
    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 
    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 
    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 
    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 
    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 
    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 
     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.


    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 
    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 
    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 
    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 
    \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 
    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, 
    \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/
    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 
     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, 

     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, 
    \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 
     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 
     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 
    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, 

    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 
    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 
     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 
    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 
    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 
    \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 
     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.


    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)
                                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
Percent of Total Income
    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
    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
                                                            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
     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
     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
** 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
    Low.......................................        $ 733        $ 763
     Middle...................................        1,700        1,267
     High.....................................        2,402        1,689
     Very-high................................        3,489        1,974
    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
     Low...............................       96 %       61 %       52 %
     Middle............................      139 %       88 %       76 %
     High..............................      142 %       90 %       77 %
     Very-high.........................      177 %      112 %       96 %
     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.




    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 
    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 
    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 
    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 
    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 
    [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.


    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 
    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\


    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 
    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\


    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.


    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-
    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 
    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, 
    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 
    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, 
    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 
    How would you rate our system, again, for the record?
    Mr. Kingson. I would rate it as a tremendous American 
    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 
    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 
    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 
    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 
    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 
    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 
    Mr. Shaw. I have heard the figure 30 to 40 percent. Is that 
    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 
    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


    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 
    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 
    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 
     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 
    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 

    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 
     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 

                      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 
    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 
     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 
     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 
    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.

    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\

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.

                        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 

    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 
    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.

    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 
    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 
    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.


    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.

                           Types of SG funds.

    According to the March 1997 Insurance and Superannuation 
Commission Bulletin, there are 137,808 superannuation funds in 
     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.


    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\

                    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 
     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 


    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, 
    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 
    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/
    24. Media release, Insurance and Superannuation Commission, July 6, 
    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 

                            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 
    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\

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\

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 
     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 
     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 
     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 

    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 

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 
    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\

    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 
     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 
    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 
    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\

    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 

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.

    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 
    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 

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 

    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 
    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\

    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 

    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.

    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 
    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 
    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 
    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 
    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 
    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.


    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.


    Further information on Britain's government pension system 
and private pension plans is available on the following World 
Wide Web addresses.


    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/
    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://
    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/
    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://
    Independent Advice Ltd., a commercial retirement advisory and 
planning service based in Britain: http://www.independent-advice.co.uk/
    Infoseek, a Web site offering a list of British pension firms: 
    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://
    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/


    The Adam Smith Institute, a private, independent economic policy 
institute that promotes market-based economic reform: http://
    The Institute for Fiscal Studies, a British think tank that 
publishes work on the British pension system: http://www1.ifs.org.uk/
    Pensions Virtual Library, which offers a large collection of links 
on pensions: http://www.econ.bbk.ac.uk:80/pi/vl/index.html


    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. 
    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 
    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 
    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 
    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 
    55. ``Britain in the USA,'' The British Media Review, September 28, 
    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, 
    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. 
    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.