[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
INVESTING IN THE PRIVATE MARKET
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SOCIAL SECURITY
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
MARCH 3, 1999
__________
Serial 106-13
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
57-507 CC WASHINGTON : 1999
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Social Security
E. CLAY SHAW, Jr., Florida, Chairman
SAM JOHNSON, Texas ROBERT T. MATSUI, California
MAC COLLINS, Georgia SANDER M. LEVIN, Michigan
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
J.D. HAYWORTH, Arizona LLOYD DOGGETT, Texas
JERRY WELLER, Illinois BENJAMIN L. CARDIN, Maryland
KENNY HULSHOF, Missouri
JIM McCRERY, Louisiana
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisories announcing the hearing................................ 2
WITNESSES
U.S. Department of the Treasury, Hon. Lawrence H. Summers, Ph.D.,
Deputy Secretary............................................... 7
______
Goldberg, Hon. Fred T., Jr., Skadden, Arps, Slate, Meagher &
Flom, LLP...................................................... 70
Investors Services of Hartford, Inc., Hon. Maureen M. Baronian... 38
Lehrman Bell Mueller Cannon, Inc., John Mueller.................. 87
National Committee Tto Preserve Social Security and Medicare,
Martha A. McSteen.............................................. 86
Reischauer, Robert D., Brookings Institution..................... 48
Tanner, Michael, Cato Institute.................................. 41
Weaver, Carolyn L., American Enterprise Institute................ 66
White, Lawrence J., New York University.......................... 32
SUBMISSIONS FOR THE RECORD
California State Teachers' Retirement System, Sacramento, CA,
Emma Y. Zink, statement........................................ 110
Century Foundation, New York, NY, statements..................... 111
Credit Union National Association, statement..................... 127
Executive Intelligence Review News Service, Richard Freeman, and
Marianna Wertz, statement...................................... 128
MFS Investment Management, Boston, MA, David Oliveri, statement.. 131
National Conference of State Legislatures, Gerri Madrid and Sheri
Steisel; National Association of Counties, Neil Bomberg;
National League of Cities, Doug Peterson; United States
Conference of Mayors, Larry Jones; Government Finance Officers
Association, Tom Owens; National Association of State
Retirement Administrators, Jeannine Markoe Raymond; National
Council on Teacher Retirement, Cindie Moore; National
Conference on Public Employee Retirement Systems, Ed Braman,
joint letter and attachment.................................... 146
National Taxpayers Union, Alexandria, VA, Peter J. Sepp,
statement...................................................... 147
Plan Sponsor, Greenwich, CT, Chris Tobe, statement............... 151
INVESTING IN THE PRIVATE MARKET
----------
WEDNESDAY, MARCH 3, 1999
House of Representatives,
Committee on Ways and Means,
Subcommittee on Social Security,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10 a.m., in
room 1100, Longworth House Office Building, Hon. E. Clay Shaw,
Jr. (Chairman of the Subcommittee), presiding.
[The advisories announcing the hearing follow:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
February 24, 1999
No. FC-8
Archer Announces Social Security Hearing on
Investing in the Private Market
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
investing Social Security's Trust Funds in the stock market. The
hearing will focus on the effects of government-directed and
individually directed investments. The hearing will take place on
Wednesday, March 3, 1999, in the main Committee hearing room, 1100
Longworth House Office Building, beginning at 10:00 a.m.
Oral testimony at this hearing will be from invited witnesses only.
Witnesses will include experts in Social Security and investment
policy. However, any individual or organization not scheduled for an
oral appearance may submit a written statement for consideration by the
Committee and for inclusion in the printed record of the hearing.
BACKGROUND:
Over the next 75 years, Social Security is expected to face a
funding shortfall equal to 2.19 percent of taxable payroll.
Traditionally, the gap between Social Security's income and costs has
been filled by increasing payroll taxes, reducing benefits, and/or
borrowing from the public. However, policy experts are now seeking new
approaches to strengthen Social Security's finances. Leaders of both
parties, including the President, have supported increasing the
program's income by investing a portion of Social Security's excess tax
receipts in the stock market. These surpluses are currently invested in
special issue Treasury bonds, which earn an average annual yield of 2.8
percent. According to the President's 1994-96 Advisory Council on
Social Security, stock investment would earn a real annual yield of 7
percent.
Although there is agreement that investing in stocks would help
restore Social Security's long-term solvency, how the investments
should be directed remains a key focus of debate. The President has
proposed that a portion of the Trust Funds be invested directly by the
Federal Government in the private sector. Some Members of Congress and
other experts argue that investments should be directed by individuals
through personal retirement accounts. While, in comparison with
personal retirement accounts, investing a portion of the Social
Security Trust Funds directly in the private market may reduce
individual exposure to risk, some experts, including Federal Reserve
Chairman Alan Greenspan, have warned it would lead to political
interference in private financial markets and corporate decision
making.
In announcing the hearing, Chairman Archer stated: ``The
President's proposal to invest in the private market as a solution to
Social Security's problem is a breakthrough. While the White House and
I may differ on who should own and control these investments, we need
to carefully consider the benefits and risks of each approach as we
move forward to save Social Security.''
FOCUS OF THE HEARING:
The hearing will focus on the economic, political, and social
effects of private market investing by the Federal Government and by
individuals.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Wednesday,
March 17, 1999, to A.L. Singleton, Chief of Staff, Committee on Ways
and Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
public at the hearing, they may deliver 200 additional copies for this
purpose to the Committee office, room 1102 Longworth House Office
Building, by close of business the day before the hearing.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. All statements and any accompanying exhibits for printing must
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1
format, typed in single space and may not exceed a total of 10 pages
including attachments. Witnesses are advised that the Committee will
rely on electronic submissions for printing the official hearing
record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. A witness appearing at a public hearing, or submitting a
statement for the record of a public hearing, or submitting written
comments in response to a published request for comments by the
Committee, must include on his statement or submission a list of all
clients, persons, or organizations on whose behalf the witness appears.
4. A supplemental sheet must accompany each statement listing the
name, company, address, telephone and fax numbers where the witness or
the designated representative may be reached. This supplemental sheet
will not be included in the printed record.
The above restrictions and limitations apply only to material being
submitted for printing. Statements and exhibits or supplementary
material submitted solely for distribution to the Members, the press,
and the public during the course of a public hearing may be submitted
in other forms.
Note: All Committee advisories and news releases are available on
the World Wide Web at ``http://www.house.gov/ways__means/''.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
***NOTICE--CHANGE IN HEARING STATUS***
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-9263
FOR IMMEDIATE RELEASE
February 26, 1999
No. FC-8-Revised
Full Committee Hearing on Wednesday,
March 3, 1999, on Investing Social
Security in the Private Market to be
Held at the Subcommittee Level
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the full Committee hearing on investing
Social Security in the private market, previously scheduled for
Wednesday, March 3, 1999, at 10:00 a.m., in the main Committee hearing
room, 1100 Longworth House Office Building, will now be a hearing of
the Subcommittee on Social Security.
All other details for the hearing remain the same. (See full
Committee press release No. FC-8, dated February 24, 1999.)
Chairman Shaw. If the Members and guests would take their
seats, we will convene this morning's hearing. We have a long
agenda, and we would like to complete it giving adequate time
to all our guest witnesses this morning.
Today, we will explore how market investments might improve
Social Security for women, minorities, and all Americans. The
benefits of investing are not lost on the American people. A
new Congressional Research Service study I am releasing today
estimates that 83.6 million Americans--that is about 1 in 3--
will own stock in 1999. Last weekend, I noted on NBC a news
story about the growing number of minority households saving
and investing. In fact, women and hardworking families are
increasingly recognizing the power of savings and investment as
part of their retirement planning. Today, 1 in 3 households
earning between $25,000 and $50,000 own mutual funds, and 53
percent of all mutual fund investment decisions are made
entirely or in part by women, who are even more likely than men
to see retirement as their investment goal.
As usual, the American people are way ahead of the Congress
and ahead of the President. When asked last month, everyone--
men, women, Republicans, Democrats, Independents--agreed that
individuals could properly manage personal retirement accounts
better than the government if created as part of a Social
Security reform.
The numbers weren't even close. Women trusted individuals
over government by a 2-to-1 margin, and even among Democrats,
52 percent favored personal savings versus only 35 percent who
wanted the government to control those investments.
To his credit, the President proposed a framework for
modernizing Social Security's financing. He supports market
investments to boost Social Security returns and new savings
accounts, and we agree with the President.
While we disagree with the President about who should own
and control these investments, we need to carefully consider
the benefits and risks of each approach as we move forward to
save Social Security.
We should all ask ourselves several questions as we listen
to witnesses today. What role does savings and investment have
in Social Security's future? If we begin saving real assets,
who should decide what investments are made, workers and
families or the government? And, if we choose the investment
route, what protections, if any, are needed to limit risk,
prevent fraud, and maintain the security that has been the
hallmark of Social Security for the past 60 years.
Getting the right answers to these questions will move us
another step forward on the path to reform, so let us get to
business, let us get down to work, and most of all, let us work
together.
Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman. I appreciate your
comments. I appreciate the fact that we are having this hearing
today.
As all of us know, Social Security is probably the most
fundamentally important program that the Federal Government has
been involved in probably the whole history of our government.
It provides the safety net for 260 million Americans, past and
future. It takes care of not only the basic retirement benefits
of all Americans when they reach 62 or 65 years old, but also
provides survivors benefits when the breadwinner in the family
dies. We had a witness that the Chairman was gracious to allow
about 3 weeks ago who actually testified that without those
survivors benefits when her father died, she would not have
been able to attend college. And she is now proceeding to
graduation. There are 1 million cases like hers.
It also provides disability benefits for many Americans,
and in many families, the breadwinner might become permanently
disabled at a very young age. Social Security takes care of
that individual's family.
And so this is an issue of paramount concern I think to all
of us as Americans and obviously as legislators. And so I
appreciate the fact that we are finally getting down to the
issue of how we are going to make sure that we protect the
Social Security system as we know it.
We need to move away from the rhetoric and the attacks on
the President's program and the countercharges, and we need to
really get down to fundamental business. And it is my hope that
now we can begin in earnest to talk about these issues.
And I might point out there was a study that was released
by the General Accounting Office on Friday that talked about
the Galveston, Texas, plan, one of the few communities in the
United States which has its own privatized retirement system. I
would urge people to look at the GAO study, because it is very
critical of the Galveston plan.
And just yesterday, the National Committee To Preserve
Social Security and Medicare released a study by John Mueller.
John Mueller is an economist who for the last decade has had
his own accounting firm. Prior to that, for a number of years,
he was the chief economist to the Republican Conference, and
the head of the Republican Conference at the time was none
other than former Representative Jack Kemp, not one of the most
flaming liberals in America. And his study which was actually
commissioned by Martha McSteen, who, as all of us know, was the
Administrator of the Social Security Administration from 1983
to 1986, during which time we reformed the system, and who
happened to have been appointed by none other than President
Ronald Reagan.
So this is not a partisan issue. It is an issue I think all
of us, whether Democrats, Republicans, conservative, liberals,
or moderates, want to be involved in.
But I might just point out a couple points in the study
commissioned by the National Committee To Preserve Social
Security and Medicare.
One is that the study has discovered that there are no
persons currently alive in America today who would benefit from
privatizing Social Security. In fact, the only winners would be
realized starting from the year 2025 on. And those winners
would be single males.
We are only talking about male individuals born 25 years
into the future who will benefit from individual accounts.
Women are losers. Minorities, low-income people, are major
losers if we should privatize Social Security. And one of the
big problems, of course, is the fact that those people who are
trying to make a determination about whether to privatize or go
with the current system fail to take into consideration that
when you consider the Social Security benefit structure, you do
so over a 75-year period, and the growth rate is low over that
period. Whereas, when it comes to considering investment in the
equity markets, they use a more recent study of the equity
markets.
But last and most importantly, I hope the witnesses,
particularly in the first panel, will respond to the issue of
who is going to pay for the transition costs--the $8 trillion
transition costs that are involved in making sure that current
and future beneficiaries receive the same level of benefits.
I might just in closing point out that one witness who will
testify has said that we need to privatize a significant part
of the Social Security system. And then buried in the analysis
there is a temporary tax on the payroll of 1.52 percent, a
temporary 1.52-percent tax, that is not a major part of the
program that is being discussed. The temporary tax is for 75
years. I wish that we in Congress could get by with calling a
tax of 75 years a temporary tax, but that is a permanent tax.
And no one is going to be able to convince me otherwise.
We need to discuss this issue in a rational, intelligent
fashion. And I look forward to this, and hopefully, this will
be the start of the kind of dialog that is so necessary if we
want to protect the Social Security system as we know it. And I
look forward, as the Chairman said, to Secretary Summers'
testimony and the two other panels as well.
Thank you, Mr. Chairman.
Chairman Shaw. Thank you, Mr. Matsui.
Our first witness is Hon. Lawrence Summers who is the
Deputy Secretary of the U.S. Department of the Treasury.
Welcome. We are pleased to have you at this hearing. Your
full testimony will be made a part of the record as all the
witnesses' testimony, and we would welcome you to summarize as
you see fit.
Mr. Summers.
STATEMENT OF HON. LAWRENCE H. SUMMERS, PH.D., DEPUTY SECRETARY,
U.S. DEPARTMENT OF THE TREASURY
Mr. Summers. Thank you very much, Mr. Chairman and Members
of the Subcommittee, for this opportunity to testify on behalf
of the administration's proposal and to share some of our
thoughts on the crucial questions you raised in your opening
statement, Mr. Chairman, regarding the benefits of investment
of a portion of the trust funds.
We have a great opportunity in this country right now, with
$4.8 trillion in surpluses projected over the next 15 years. We
have a great challenge with an aging society that will put much
greater pressure on our Social Security and Medicare Programs.
It is the essence of the President's approach to use the
opportunity to meet the challenge by contributing the surplus
to the Social Security Investment Funds and modernizing the way
in which the Social Security Trust Fund is invested.
This proposal has the crucial benefit of essentially
eliminating the national debt sometime between 2010 and 2020.
That is very important for the future of our country, because
of what it means for the performance of our economy. The $3\1/
2\ trillion that would otherwise go into the sterile asset of
government debt will be available to substitute for foreign
borrowing and trade dislocations, to invest in tools for
American workers, to invest in new homes for American families.
It is also very significant to the fiscal foundation of
this country, because essentially eliminating that national
debt reduces an amount equal to between 2\1/2\ and 3 percent of
the GNP that we otherwise have to spend on interest. And that
is an amount sufficient to meet the challenge of rising Social
Security costs.
The President's proposal of contributing the benefits of
debt reduction to the Social Security Trust Fund assures that
that fiscal foundation we have laid for solvency turns into a
legal commitment to meet the obligation to future Social
Security beneficiaries. The President's proposal thus
strengthens both our economy and the Social Security system by
taking advantage of the opportunity of the surplus to meet the
challenge of an aging society.
A particular focus of this hearing, Mr. Chairman, is on, as
you made very clear, the question of the investment of Social
Security Trust Funds and more generally the best way in which
to take advantage of the returns that the stock market offers
for future retirees.
The administration, as you know in its budget separate from
its proposal for Social Security, has proposed a system of USA
accounts that would make universal private pension coverage, an
insured investment vehicle to permit wealth accumulation for
all Americans.
While this, along with other steps to promote pension
portability and availability, is I think an important step in
strengthening our overall national retirement security system,
in the remainder of my opening statement, I want to concentrate
on the question of investment in equities.
As Mr. Matsui noted, Social Security has been our most
successful national social program. And it is very important
that we preserve it in an effective and strong form.
Investments in equities can do that. If you look at
essentially all defined benefit pension plans, whether in the
private or in the public sector, they take advantage of the
opportunities that equities offer. They do that because it
makes possible providing larger benefits with smaller
contributions.
The relatively limited proposal that the administration has
put forward, to invest 15 percent of an augmented trust fund in
equities, would itself be sufficient to obviate the need for
what would otherwise be a 5-percent across-the-board benefit
cut starting in 2030 or a year-and-a-half increase in the
retirement age.
Is this something that can work? In terms of risks, we
believe the risks are easily controlled. The trust fund--only
15 percent of the trust fund is to be invested in equities. In
a year like 2030, 72 percent of benefits will come from the
payroll tax stream. Only 28 percent will come from the trust
fund. Of that 28 percent, only 15 percent, or about 4 percent
of the total, will be related in any way to equity investments.
So the system is secure.
Can this be done with integrity? We believe that a
combination of an independent public board, whose only mandate
is to choose private investment managers whose only freedom is
to invest in market indices on a nondiscretionary autopilot
basis, affords the possibility of investment with integrity and
without interference.
There has, as you know, Mr. Chairman, been considerable
discussion of the State and local experience in this regard.
And I would only note that many of the State and local statutes
prescribe economically targeted investing or other such
practices. Whereas, we contemplate legislation that would
proscribe this; and that the legislation we contemplate, unlike
any in the State and local experiences, would provide for
investment only along the lines of market indices with no
discretion.
Finally, Mr. Chairman, you raised in your opening
statement, this is something we can obviously get into more in
the questions, the issue of collective investment versus
investment by individuals as part of the Social Security
system. And I would suggest that a collective investment
approach has three important virtues relative to an individual
one.
First, it is safer for individuals. In 1974, for example,
the stock market declined by more than 50 percent in real
terms. Somebody who retired at that moment would see half their
benefit having eroded. With the defined benefit approach, the
risks of the stock market would still be there but that would
be spread over the long term and borne by the Federal
Government rather than individual beneficiaries.
Second, administrative costs. Experience with mutual funds
in the United States, with the private Social Security systems
in Britain and in Chile, all suggests that the costs of an
individual approach would be likely to eat up as much as 20
percent or more of account accumulations over a 40-year period.
In contrast, Social Security with equity investments would
continue to pay out 99 cents out of every dollar received in
the form of benefits.
Third, a collective approach preserves the basic defined
benefit progressive structure of Social Security, which has
been so important in transforming the lot of the Nation's
elderly, who were the group most frequently in poverty a
generation ago; and today are the group in our population that
is least frequently in poverty.
I might conclude with this thought, Mr. Chairman. The
benefits of collective investment that I just described are
often juxtaposed with concerns about the integrity of that
collective investment. I have suggested that I believe those
concerns can be addressed with independent management and
indexing.
But it is important I think to recognize that any system of
government-administered individual accounts that apply to
millions of Americans would still carry with it many of the
same risks of interference. There would still be the
possibility of investment rules for the basic equity fund that
would divert investments into less productive purposes or that
would prescribe certain forms of investment holding. And so the
opportunity for the political process to meddle would be there,
whether it was a nationally run system of individual accounts
or a collective investment scheme.
To be sure, I believe those risks can be controlled. But I
do not believe those risks provide a strong basis for choosing
between a collective and a more individual approach. Whereas, I
do believe that the benefits of administrative simplicity, the
benefits of progressivity, and the benefits of risk sharing do
mean that in the Social Security pillar of our retirement
security system, we are best off with an approach like the one
that the President has put forward.
Thank you very much for this opportunity, Mr. Chairman.
[The prepared statement follows:]
Statement of Hon. Lawrence H. Summers, Ph.D., Deputy Secretary, U.S.
Department of the Treasury
Mr. Chairman, Members of the Committee, I appreciate the
opportunity to appear today to discuss President Clinton's
proposal to ensure the financial well-being of the Social
Security and Medicare programs and improve the retirement
security of all Americans.
The advent of an era of surpluses rather than deficits has
radically transformed our national debate about entitlements.
The terms of all of the earlier tradeoffs in the entitlements
debate have been eased--provided we seize the opportunities now
available to us. The President's framework for Social Security
both recognizes the brighter present reality, and moves us well
along the road toward seizing the opportunities currently
available, if we can work together on a bipartisan basis.
Today I will first briefly describe the President's
program. I will then devote the bulk of my remarks to the issue
of the President's proposal to raise the rate of return earned
by the Social Security trust funds by investing part of the
surplus in equities.
The President's Proposal
According to the Office of Management and Budget, the
surpluses in the unified budget of the federal government will
total more than $4.8 trillion over the next 15 years. This
presents us with a tremendous opportunity. At the same time, we
are also facing a tremendous challenge: the aging of the
``babyboomers'' is projected to put enormous strains on the
Social Security and Medicare systems, on which so many retirees
depend.
The natural approach would be to take advantage of this
opportunity to meet the challenges facing us. This is the
objective of the President's plan.
The President's framework devotes 62 percent of these
projected budget surpluses to the Social Security system. Of
the roughly $2.8 trillion in surpluses that will go to Social
Security, about four-fifths will be used to purchase Treasury
securities, the same securities that the Social Security system
has invested in since its inception. The remaining one-fifth
will be invested in an index of private-sector equities. These
two actions will reduce the 75-year actuarial gap from its
current level of 2.19 percent of payroll by about two-thirds,
to 0.75 percent of payroll. And they push back the date at
which the Social Security trust funds are projected to be
exhausted, from 2032 to 2055.
Substantial as that accomplishment would be, it is critical
that we do more. Historically, the traditional standard for
long-term solvency of the Social Security system has been the
75-year actuarial balance. A 75-year horizon makes sense
because it is long enough to ensure that virtually everyone
currently participating in the system can expect to receive
full payment of current-law benefits. Attaining this objective
will require additional tough choices. But the objective is
both important and obtainable. To reach it, the President has
called for a bipartisan process. We believe that the best way
to achieve this type of common objective is to work together,
eliminating the need for either side to ``go first.''
In the context of that process, we should also find room to
eliminate the earnings test, which is widely misunderstood,
difficult to administer, and perceived by many older citizens
as providing a significant disincentive to work. In addition,
it is critical that we not lose sight of the important role
that Social Security plays as an insurance program for widows
and children, and for the disabled. As President Clinton said
last month: ``We also have to plan for a future in which we
recognize our shared responsibility to care for one another and
to give each other the chance to do well, or as well as
possible when accidents occur, when diseases develop, and when
the unforeseen occurs.'' That is why the President has proposed
that the eventual bipartisan agreement for saving Social
Security should also take steps to reduce poverty among elderly
women, particularly widows, who are more than one and one-half
times as likely as all other retirement age beneficiaries to
fall below the poverty line.
In addition to shoring up Social Security, the President's
plan would transfer an additional 15 percent of the surpluses
to Medicare, extending the life of that trust funds to 2020. A
bipartisan process will also be required to consider structural
reforms in this program. The Medicare Commission is expected to
report soon on these important issues.
The President would also use 12 percent of the surpluses to
create retirement savings accounts--Universal Savings Accounts
or USA accounts--and the remaining 11 percent for defense,
education, and other critical investments. The President will
be announcing further details regarding the USAs soon.
At the same time, the President proposes to strengthen
employer-sponsored retirement plans in a variety of ways. The
President's budget addresses the low rate of pension coverage
among the 40 million Americans who work for employers with
fewer than 100 employees by proposing a tax credit for start-up
administrative and educational costs of establishing a
retirement plan and proposing a new simplified defined benefit-
type plan for small businesses. Workers who change jobs would
benefit from the budget proposals to improve vesting and to
facilitate portability of pensions. In addition, the retirement
security of surviving spouses would be enhanced by the
President's proposal to give pension participants the right to
elect a form of annuity that provides a larger continuing
benefit to a surviving spouse and to improve the disclosure of
spousal rights under the pension law.
Benefits of the President's Approach
In essence, the President is proposing that we use the
Social Security and Medicare trust funds to lock away about
three-quarters of the surpluses for debt reduction and equity
purchase, and ensure that they are not used for other purposes.
This would have three key effects:
First, it would greatly strengthen the financial
position of the government. If we follow this plan, by 2014, we
will have the lowest debt-to-GDP ratio since 1917 and will free
up a tremendous amount of fiscal capacity. The reduction in
publicly held debt will reduce net interest outlays from about
13 cents per dollar of outlays in FY99 to about 2 cents per
dollar of outlays in 2014. Under the President's program, the
decline in interest expense resulting from debt reduction will
exceed the increase in Social Security expense through the
middle of the next century.
Second, it would strengthen significantly the
financial condition of the Social Security and Medicare trust
funds. Indeed, it would extend the life of the Social Security
trust funds by more than 20 years, to 2055, and extend the life
of the Medicare Hospital Insurance trust funds to 2020. Meeting
our obligation to the next generation of seniors should be the
number one priority in allocating the surpluses.
And third, it would substantially increase
national saving, which must be a priority in advance of the
coming demographic shift. By paying down debt held by the
public and investing in equities, the President's program will
create room for about $3.5 trillion more investment in
productive capital. In effect, this will be the reverse of the
``crowding out'' that occurred during the era of big deficits.
With government taking a smaller share of total credit in the
economy, interest rates will be lower than otherwise would be
the case. The implications of lower interest rates will be
profound. Not only will individuals be able to borrow for
mortgages, school loans, and other purposes at lower rates, but
importantly, businesses will be able to finance investments in
productive plant and equipment at the lower rates. And the
resulting larger private capital stock is the key to increasing
productivity, incomes, and standards of living. Ultimately, one
reason why this program is sound economically is that it will
result in a more robust private economy, which will expand our
capacity to make good on our Social Security and Medicare
promises. This increase in public saving also has beneficial
implications for our balance of payments side. Reduced
government borrowing would lead to a reduced dependence on
foreign financing, and an improvement in our status as a net
debtor to the rest of the world.
Benefits of USA Accounts
Social Security, strengthening employer-sponsored
retirement plans, and creating USA accounts are key pillars of
the President's proposal to provide financial security to
retirees. We believe that USA accounts will provide a
significant stimulus to private savings, by enabling millions
of Americans to begin to set aside some money for retirement.
The President's proposal aims to deal more broadly with the
challenges of an aging society by expanding individual access
to retirement saving. As I noted earlier, the President
proposes to devote 12 percent of the surpluses to establishing
a new system of Universal Savings Accounts. These accounts
would provide a tax credit to millions of American workers to
help them save for their retirement. Workers would qualify for
a progressive tax credit match against their own contributions.
For example, a low-income worker may receive a dollar for
dollar match up to a cap. In addition, low- and moderate-income
workers will qualify for an additional tax credit, even if they
make no contribution themselves.
Overall, the USA program would be considerably more
progressive than the current tax subsidies for retirement
savings--where higher bracket taxpayers get higher subsidies.
This proposal would contribute significantly to national
savings, because it will produce retirement savings for
millions of low- and moderate-income people who do not have
access to pensions. The tax credit match will provide a strong
incentive for workers to add their own saving to accounts.
Investing Part of the Surplus in Equities Would Raise the Rate of
Return Earned by the Social Security Trust Funds
As I have mentioned, the President has proposed
transferring 62 percent of projected surpluses to Social
Security, and investing a portion of these transferred
surpluses in equities.
To date, the trust funds have been invested exclusively in
U.S. Government bonds. While these bonds are essentially risk-
free, they have the corresponding downside that they have
historically paid a lower rate of return, on average, than
other potential investments. Between 1959 and 1996, the average
annual rate of return earned on stocks was 3.84% higher than
the rate earned on bonds held by the trust funds.
Currently, the pension savings of many upper income
Americans are invested in private plans that earn these higher
equity returns. The higher equity returns can potentially make
it possible for these Americans to have more upon retirement.
We believe that it is important to give all Americans, even
those of low and modest means, the opportunity to enjoy these
potential benefits from stock market performance.
Raising the rate of return on the trust funds would mean
that the Social Security system could be brought into long-term
actuarial balance with smaller reductions in benefits, smaller
increases in revenue, and/or less transfer of surplus. The
President's plan for investing in equities will reduce the
actuarial gap by an estimated 0.46 percent of taxable payroll--
and thus will close roughly one-fifth of the problem we face
over the next 75 years. If one were to try to achieve the same
actuarial impact of equity investments through alternative
measures, we would have to immediately reduce the COLA on
Social Security benefits by 0.3 percentage points. The equity
investment in the President's package achieves as much for the
financial soundness of the system as would moving the normal
retirement age up by about an extra year and one-half for
participants who reach age 67 in 2022. If we delayed until 2030
to make the changes necessary to set Social Security back on a
sound actuarial footing, the required across-the-board cut in
benefits would be 5%.
Investing part of the trust funds in equities would also
bring Social Security into line with the ``best practice'' of
both private and public sector pension plans. Among large
private-sector defined benefit plans (those with more than 100
participants), more than 40% of total assets were invested in
equities in 1993; this number has risen significantly since
then. Nearly all state pension plans also now invest in
equities. In 1997, state and local government plans invested
64% of their portfolios in equities.
Would Equity Investments Add Risk to the Trust Funds?
I see two broad concerns regarding trust fund investment in
equities. These concerns are legitimate, but we believe they
are manageable, and should not stop us from achieving the
potential enhanced returns of equities.
First, stock returns are more volatile than the returns on
the government bonds held by the trust funds. However, the
trust funds are well-situated to bear equity risk, because they
have long--or indefinite--time horizons. The trust funds would
be capable of riding out the ups and downs of the market,
because they receive the cash flow from payroll taxes, and
because of the cushion provided by the trust funds' bond
holdings.
More specifically, investing only 15 percent in equities
seems to us to be a prudent balance between receiving the
potentially greater return from equities and keeping the
investment small enough so that the trust funds are not overly
exposed. This 15 percent allocation to equities is much smaller
than the customary allocation to equities in either public or
private pension plans. Moreover, 85% of the trust funds will
still be invested as before in risk-free Treasury securities.
In addition, the equity investments and disinvestments that
we are proposing will be smoothed in incremental additions over
15 years. In any year, investments or disinvestments are
projected to be less than 0.5% of the stock market. Incremental
investments and disinvestments--rather than total divestiture
at one time--will help to mitigate the risk from adverse price
movements.
Finally, in the near term, all benefits will continue to be
paid out of payroll and other taxes. Furthermore, under current
law, even in 2032 payroll and other taxes will be sufficient to
pay for the lion's share--about 72%--of Social Security
benefits. The remaining 28% of benefits will be paid out using
the assets of the trust funds. As only 15% of the trust funds'
assets would be invested in equities, only about one sixth of
this 28% would be backed by equities. In short, even in 2032,
only about 4-5% of payments from the trust funds will be backed
by private sector investments.
Ensuring the Integrity of Investment Decisions
The second concern is that of political influence on trust
fund investment decisions. Any system of collective investment
can and must address these concerns. We believe that we can
successfully work with Congress to design a system that is free
from political influence. We need to strike the right balance,
so that we can earn the higher potential returns to equities,
by finding a way to take care of these legitimate concerns.
That is why we will work with Congress to design a system
that observes five core principles. These five core principles
will establish several levels of protection.
First, the share of trust fund assets invested in equities
ought to be kept at a very limited level. We have proposed that
equity investment be limited to 15 percent of trust fund
balances. This will be important to limit the trust funds'
exposure to price movements from equity investments, and to
ensure that collective investments never account for more than
a small fraction of the stock market. During the first years of
the program, from 2001 to 2014, Social Security would own, on
average, only 2% of the stock market. On average through 2030,
Social Security would own approximately a 4% share of the total
stock market.
Second, the investments should be independently managed and
non-political. We suggest that trust fund managers be drawn
from the private sector through competitive bidding and that
the trust fund managers be overseen by an independent board.
There should be wholly independent oversight of investment, in
order to shield the trust funds from political influence.
Third, the sole responsibility of the independent board
would be to select private sector managers through competitive
bidding. Private sector management will provide a further
degree of political insulation. Moreover, Social Security
beneficiaries deserve the same efficient management and market
returns that people receive for their private pensions and
personal savings.
Fourth, equity investments should be broad-based, neutral
and non-discretionary. Assets should be invested
proportionately in the broadest array of publicly listed
equities, with no room for discretion in adding or deleting
companies and no room for active involvement in corporate
decisions. We have proposed that the funds be invested in a
total market index, which would encompass a broad range of
stocks. In addition, the managers should be on autopilot in
investing the funds; they should have little or no discretion
in the investment of trust fund assets, so they cannot ``time
the market'' or pick individual stocks.
As a shareholder the trust funds should be entirely
passive. One way to accomplish this might be to mandate that
proxies be voted in the same proportions as other shareholders.
Fifth and finally, collective investment needs to be
achieved at the lowest cost available. This will be important
both to obtain the highest possible returns and to further
enhance the system's transparency and independence. Indexed
investment is less expensive than active management. In
addition, given the large size of the potential equity
investments by Social Security, we would expect to pay very low
asset management fees.
Let me emphasize our belief that there should be zero
government involvement in the investment. We will work with
Congress to design a system that is completely insulated from
political pressures.
The Experience of State and Local Governments
As I mentioned earlier, virtually all state pension funds
now invest in equities. In 1997, state and local government
plans invested 64% of their portfolios in equities, up from 56%
in 1996. State and local pension plans now hold fully 10
percent of the overall stock market. By contrast, the Social
Security trust fund equity investments would total only 15% of
the trust funds, and would represent, on average, about a 4% of
the equity market.
Some have suggested that the trust funds might fall short
of earning market returns, based on the experience of state and
local pension plans. I would emphasize first that the
experience of state plans is really not directly comparable to
what we are proposing for Social Security. State plans do not
generally operate under the kinds of restrictions that are
envisioned under the President's proposal. That is, the
statutes governing state plans do not generally require that
investments be made only through indexed funds, with a clear
prohibition against adding or subtracting equities from the
index. Many state pension plans are actively managed, and some
have explicit investment goals. As a result, the experience of
these plans may not be relevant as a guide for what Social
Security's experience would be.
Our preliminary analysis of the available data suggests
that, over the period 1990-1995, public plans actually received
returns that averaged two basis points higher than private plan
returns (this difference is statistically indistinguishable
from zero). Although in earlier periods (from 1968 to 1983) the
performance of public pension funds was slightly inferior to
that of private pension funds, this difference is also not
statistically significant. More importantly, this very slight
difference in performance during earlier periods can be
explained by the fact that public pension funds generally
allocated a far smaller portion of their portfolios to
equities, and in some cases were statutorily prohibited from
buying any equities.
The returns to trust fund investments to this date would
not stack up well in this comparison of earnings of public and
private pension funds. Because the trust funds have been
invested exclusively in government securities until now, both
public and private pension funds would likely have outperformed
the rate of return earned on trust fund investments.
Advantages of Collective Investment of Social Security
There are three key advantages to having the trust funds
invest collectively in equities for the American people. These
advantages relate to the ability of defined benefit plans to
bear market risk, minimize administrative costs, and achieve
progressivity. Defined contribution plans, such as the
proposals for individual accounts, are less able to realize
these objectives. In addition, the potential political risk
from collective investment in equities through the trust funds
is not very different from the political risk that could arise
from investing in equities through defined contribution plans.
An advantage of collective investment in equities through
the trust funds is that periods of poor equity performance
could be spread over many generations of current and future
Social Security participants. By contrast, during a market
downturn, participants in a defined contribution system could
be forced to choose between postponing retirement and a
severely reduced retirement income. For example, for the year
that ended with the third quarter of 1974, the S&P500 declined
by 54 percent in real terms. By placing the risk of a market
downturn in the trust funds, we can greatly reduce this risk to
beneficiaries. Additionally, we have proposed limiting Social
Security's equity holdings to 15% of the trust funds. As I
noted earlier, this means that only 4% of benefits payments
would be backed by the performance of equities.
The second advantage of collective investment in equities
is that the returns to trust fund investments in equities would
likely be higher than the returns to equities held in
individual accounts. This is primarily because it would be much
more costly to administer a defined contribution plan than it
would be to administer a defined benefit plan. The trust funds
would expect to pay very low asset management fees, because of
the large size of the trust fund asset pool. These asset
management fees could be comparable to, or lower, than the 1
basis point (0.01%) currently paid by the federal employees'
TSP plan for private management of the equity-indexed ``C
Fund.''
By contrast, administrative costs for a system of defined
contribution plans held in the private sector could be
comparable to the commissions and fees charged by equity mutual
funds today. The average equity mutual fund currently charges
between 100 and 150 basis points for administrative and
investment management services. Costs of this magnitude could
significantly reduce the balance that could be accumulated in
an individual account. According to our estimates,
administrative costs of 100 basis points would reduce by 20
percent the total account accumulations at the end of a 40-year
career. Collective investment through the trust funds would
avoid the need to pay the administrative costs associated with
individual accounts.
The experience of individual accounts in Britain and Chile
illustrates how significant these risks and costs can be. In
Britain, many personal pension plans take more than 5 percent
of contributions in administrative charges.
Chile also has had high administrative costs. According to
the Congressional Budget Office (CBO), fees and commissions of
the Chilean pension system amounted to 23.6 percent of
contributions in 1995. As a result, according to the CBO,
Chilean workers who invested their money in an individual
account in 1981 received an internal real rate of return of 7.4
percent on that investment through 1995, despite average real
returns of 12.7 percent to pension fund investments. Even in
the best of circumstances, however, costs will be higher for a
system of individual accounts than for collectively investing
trust fund assets.
The third advantage of collective investment is that it is
progressive. This is one of the most important features of
Social Security: benefits are greater, as a percentage of
wages, for low-income workers than high-income workers. By
investing in equities, we are able to maintain this critical
feature of progressivity and avail Americans of modest means of
the higher returns that have historically accrued to equities.
In addition to these key advantages, one might note that,
with regard to the concern about political influence, this
concern also exists for individual accounts. Most individual
account proposals have suggested some centralized plan
structure, both in order to reduce administrative costs and to
help familiarize tens of millions of Americans with the range
of possible investment vehicles. These individual account plans
would create a large pool of money under a single manager, or a
handful of managers. This pool of money would not look very
different from the Social Security trust funds. With any
centralized pool of assets there is the potential for those
pursuing a political agenda to try to influence it.
We can all be encouraged by the history of the Thrift
Savings Plan (TSP), whose investments have not been subject to
political influence. We believe that some of the features that
have protected the TSP system so well are worth emulating.
These include the TSP system's independent board, its private
sector managers, and the rule that equity investments can only
be made by tracking an index.
Conclusion
In conclusion, it will be critical to have the
Administration and Congress work together to address the needs
of future generations. We need to keep the promises that we
have made to retirees, without unduly burdening younger
generations. We want to work with you, on a bipartisan basis,
to implement the President's program.
I believe that we can find a safe and prudent way to
participate in the enhanced returns in equity markets.
Thank you. I would welcome any questions.
Chairman Shaw. Thank you, Dr. Summers. I have just a few
questions. You mentioned in your initial remarks that the
President's plan would virtually eliminate the national debt.
Does that include the part of the national debt held by the
Social Security Trust Fund?
Mr. Summers. I am sorry, Mr. Chairman. I should have spoken
more precisely. It would eliminate the debt of the Federal
Government to the public, which is the debt that potentially
crowds out other investments and which is the debt that
represents a fiscal burden on taxpayers.
The intra-Federal Government securities would still exist,
but they would simply be there in recognition of a liability
that is already there for the Federal Government, namely the
liability to meet future benefits.
Chairman Shaw. So it is a liability to the general public,
particularly the working people who have paid into Social
Security. The debt is still there, and it is a debt to the
public, is that correct?
Mr. Summers. There would be no--the--whatever is done, the
public has an obligation to meet future Social Security
obligations.
Chairman Shaw. Yes.
Mr. Summers. There is no new obligation incurred by the
public, and the obligation that the public now has to meet a
national debt, which comprises just under 50 percent of the
GNP, would be, over time, eliminated, of course, assuming the
projections came true in the context of the President's
proposal.
Chairman Shaw. Dr. Summers, it can be argued that if you
take the Social Security Trust Fund completely off of budget--
if Congress did it--if the President did it--that we wouldn't
be looking at a surplus, we would be looking at, indeed, a
deficit. The math on that is very clear. We all agree that that
is the case. So it can be argued that the surplus has already
gone through the Social Security Trust Fund in the form of FICA
taxes, because that goes into the unified budget. So the 62
percent that the President runs through the Social Security
Trust Fund and then comes out the other end, and pays off the
publicly held debt--in other words, exchanging government-held
debt for publicly owned debt--that money has already been
through the trust fund. So what would be the effect if you ran
it through two or three times before you came to the end game
of retiring the public debt? That would have the effect of
putting more IOUs into the trust fund, is that not correct?
That is a simple ``yes'' answer, I believe. So what we are----
Mr. Summers. I don't think--I am not 100 percent certain I
understood the whole question, Congressman, but I don't----
Chairman Shaw. Well, let me repeat it then.
Mr. Summers. But I don't think the effects are as you
describe. I think the effects of the President's proposal would
be to reduce the interest burden that taxpayers would have to
finance from its current--from what would have been a level of
a few hundred billion dollars in 2015 to a number that would be
a few tens of billion dollars at that time, while at the same
time, which, in turn, would both provide the increased national
savings and the increased government budget space to make room
for meeting our Social Security obligations.
Chairman Shaw. Let me ask you a question. Let me you ask
you for just a simple ``yes'' or ``no'' answer. When the 62
percent goes through the Social Security Trust Fund that has
the effect of putting more Treasury bills, more IOUs, in the
trust fund, is that correct?
Mr. Summers. That is correct.
Chairman Shaw. And if you were to take that when it comes
out the other side and run it through there again, it would
have the same effect, is that not correct? And if you were to
run it through again, it would have the same effect, is that
not correct?
Mr. Summers No, I don't----
Chairman Shaw. You don't think so. I am a CPA, not an
economist, so maybe I am looking through more realistic glasses
than you are. But the question is, I think, a very simple one,
and one is if you have already double counting, why not triple
count, if it is going to do any good? Or why not count four
times if it is going to do any good? I am not trying to trash
the President's plan. I think that he has opened the door
toward investment in the private sector, and I compliment him
for that. And he has come forward with a plan, even though we
don't have it in the form of legislation. It is not a complete
plan. I think that he has certainly has made a very material
contribution to the process that we are going to try to go
through. But the question of what happens in the year 2013 is
what bothers me. And that is at the time, whether you say it is
2013 or 2016, whatever it is, that is the date in which we have
to start calling in these IOUs, because that is the date that
the FICA taxes can no longer take care of existing benefits.
And when you get past that date, the taxpayers are going to
have to chip in because those IOUs are being cashed in, and
that is the situation that worries me. And I think when you
talk about 2030 or 2050, down here at the base, the taxpayers
have already been skinned by the time you get down to that
point. At that point, you either have to increase the FICA tax
or you have to tap into the general fund or you have to get
more Treasury bills and more IOUs out there to borrow money in
order to cash in the ones that are in the trust fund. That is
what is troubling, and that is the problem that I see with the
President's plan or the primary problem that I see with the
President's plan.
Mr. Summers. Congressman, I see and I think understand your
concern, and let me just respond in this way. Take 2016, at the
end of the 15-year contribution period that the President
envisions. You are quite correct that the payroll tax stream in
that year will not be sufficient to meet the benefits stream.
And that is why it is contemplated, by the way in the current
situation without the President's budget as well, that the
benefits would, at that point, be financed from the trust fund,
which does, indeed, as you suggest, hold Treasury bills.
And so you ask the question, well what is there really,
because in some ultimate sense benefits in 2016 have to be
financed nationally from resources that we generate in 2016.
What is important about the President's proposal is that by
providing for the running down of the national debt, it
provides an offsetting benefit to taxpayers. That offsetting
benefit to taxpayers is the fact that they no longer have to
meet the tax burden that is associated with what would
otherwise be an interest bill of several hundred billion
dollars.
And so the same level of tax effort will make it possible
to meet the Social Security benefits and provide for the
continuation of unified surplus. And it is that that is salient
about the President's proposal. The benefits and the greater
solvency of Social Security and ability to meet Social Security
obligations derive from the running down of the national debt.
Now, some will ask, well, why not run down the national debt
and not do the business with putting the benefits of running
down the national debt into the Social Security Trust Fund. And
I think there are two important virtues of the President's
approach: one, in a political sense. And I hesitate to give
Members of this Subcommittee advice on anything political. I
think it is generally--I think it is generally felt that by
associating debt reduction with Social Security, we create a
much stronger and more salient lockbox than would otherwise be
available to assure the preservation of the surpluses.
Second, if we do succeed in scaling down very substantially
our interest costs, there is a question as to where the
benefits of that should go, and the President wants to make the
decision now before other temptations tempt that that should go
to Social Security. And that is what is accomplished by the
political act, the administrative act of committing those
surpluses to the Social Security Trust Fund.
There would be no possibility of triple or quadruple
counting, because we only have this unified surplus once. We
have the unified surplus. We make the contribution of the
unified surplus to Social Security. We are not retiring the
debt two, three, or four times. And so the only amount that can
be contributed from the unified surplus to Social Security is
what comes from the unified surplus and there--that is where
the President has chosen the 62-percent figure.
Chairman Shaw. I would respectfully disagree with you that
there is not double or triple counting here, because if you
start out with the basic premise that the surplus is caused by
the excess of FICA taxes over the amount of benefits, then you
have to say that is where the surplus came from. And if you say
that is where the surplus came from, then I think that the
argument is easily made that is already gone through the Social
Security Trust Fund, and we are just simply running it through
a second time.
But let us move on, because there is one other part of your
testimony that I do want to address. You made three comments
with regard to an individual retirement or a private savings
account or whatever you want to call it. Those are good points,
and those are points that we are discussing; those are points
that we are also concerned about. And I think those are points
that we will be able to answer. And if we are able to answer, I
would want the President and the Treasury to take another close
look at additional proposals, which would safeguard those
retirement accounts, and would really hold them separate and
guarantee the return which would be no less than what the
beneficiaries are receiving today, adjusted for inflation. And
if we can do that, and we can also permanently fix Social
Security in the process, I would hope that the President would
keep an open mind and take a very close look at this, and
become an ally in our efforts to try to accomplish these goals.
I can tell you this Subcommittee desperately wants to work
with the President in this area, and we will continue our
efforts to communicate with the President. Anything the
President sends down, I can tell you, will be received with
respect and courtesy toward the President, certainly by this
Subcommittee. We will have thorough hearings on it, as we are
today, on the President's plan. And we would wish nothing more
than to work with the President as partners in reforming Social
Security.
That should be this President's legacy, and that should be
the legacy of the 106th Congress.
Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman. I just want to say
about you, Mr. Chairman, I have never heard you say anything
really negative in the sense of the trashing the President's
plan. I just wanted to acknowledge that, because I have
concerns about some of our colleagues on your side of the aisle
in particular, but you yourself have been very, very balanced
in your approach. I just want to make that statement for the
record and to you personally.
Do you support the President's plan?
Mr. Summers. Yes.
Mr. Matsui. Do you want to bring it up to the Congress?
Mr. Summers. Out of--let me just say out of professional
judgment----
Mr. Matsui. Let me ask my question. Will you let me ask my
question?
Mr. Summers. Excuse me.
Mr. Matsui. You support the President's plan. You said,
``yes.'' Now, are you going to put it in legislative language?
I know there's been some requests for that by some of our
leadership just for the purpose of perhaps looking at it. Are
you interested in going beyond the rhetoric or do you want to
actually introduce it?
Mr. Summers. I think the President and all of us in the
administration are engaged in a very active process of
discussion with Members of Congress in both parties, in both
Houses, as to how best to take this forward, and whether we----
Mr. Matsui. In other words, it is not your intent then to
bring up specific language? I just want to get a sense of where
you are--because I am getting tired of trying to find out
whether you are interested or not interested, because we are
going to start drafting our own plan if, in fact, you are not
interested. We keep defending your plan, but I want to know
what you are going to do?
Mr. Summers. I don't think we have made a definite--I don't
think we have made a definite----
Mr. Matsui. Do you support your plan?
Mr. Summers [continuing]. Decision on that.
Mr. Matsui. Oh, do you support your plan?
Mr. Summers. Yes.
Mr. Matsui. Yes, but you still haven't decided anything
definite.
Mr. Summers. About what?
Mr. Matsui. About how much support you are giving to your
plan?
Mr. Summers. Oh, I think we are--I think our support for
this approach is a total support--is total support for this
approach, Congressman. And on the question of a specific bill,
I will have to--we will have to--we will have to come back to
you.
Mr. Matsui. So you may change your bill? So I shouldn't be
so supportive, because in case you pull the rug from under us I
have to be a little careful, is that what you are saying?
Mr. Summers. No, I think I am only--not at all--I think the
commitment to this approach is complete. I think the only
question is whether embodying it at this point before there has
been more discussion in a specific legislative draft is
something that the White House is or is not going to choose to
do----
Mr. Matsui. I really don't care, Larry, what you do,
because whether you introduce your plan or not doesn't make any
difference. But I wish you would be consistent. That is the
only thing I am asking in terms of private discussions in these
matters.
Let me turn to another subject--the concept of making sure
that investments in the equity market by the government are
protected. Undoubtedly, you are working on something there. Is
that my understanding?
Mr. Summers. Protecting the investments--absolutely.
Mr. Matsui. Yes, in other words, so that you don't let a
political interference occur?
Mr. Summers. Certainly, we are.
Mr. Matsui. And how far along are you?
Mr. Summers. I think we have given a great deal of thought
to that, and I think we have identified as crucial aspects the
four protections that I mentioned in my testimony: investment
on a limited scale; an independent board; a requirement that
the investment take place by private managers; and that the
private managers only be permitted to invest in large across-
the-board indices, and not make selections with respect to
individual securities. And I think those four protections
embody our basic approach.
Mr. Matsui. OK, I have no further questions.
Chairman Shaw. Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman. Mr. Summers, we are--
I was interested in your dialog with the Chairman over the
double counting and triple and quadruple counting, and I think
the Chairman was correct in saying that you could if you wanted
to just take the cash that you get from the Social Security
Trust Fund, when it initially purchases government securities,
and purchase another set of government securities, which you
call for in your plan.
Then you get more cash, and in your plan you use it to buy
down the debt, publicly held debt. But you could go ahead,
reissue it to the trust fund again, if you wanted to. Now, you
don't call for that, but I think the Chairman is correct in
saying that you could just add more debt to the trust fund, and
that would, on paper, solve the Social Security crisis.
The problem, of course, would come in the outyears, when
you have to redeem those securities and pay the benefits with
trust fund moneys. But one thing that I think you need to
clarify for this Subcommittee, and I think I am right in saying
this, if I am not, please correct me, but I think in your plan
there is an explicit link between the amount of debt issued to
the Social Security Trust Fund and the amount of public debt
that is retired. Is that correct?
Mr. Summers. Yes, in the sense that the President's plan
proceeds by taking the currently projected retirements of
Federal debt and assuring that 62 percent of those are
transferred to the Social Security Trust Fund. And now, I may
have--I may not have fully understood.
Mr. McCrery. I think it is 62 percent of the anticipated
surplus.
Mr. Summers. Of the anticipated surplus, but the surplus--
--
Mr. McCrery. That would be used to buy down the publicly
held debt.
Mr. Summers. If you don't do anything--if nothing happens,
and the surplus just materializes, what happens is that because
we have got a surplus, we--debt securities come due, we pay
them off. And because we have a surplus, we don't issue new
debt securities, and so the public debt falls.
Mr. McCrery. Right.
Mr. Summers. So that sort of happens on autopilot, that the
public debt falls when you run a surplus, almost by the
definition of a surplus. What the administration proposes to do
is to take 62 percent of that reduction in the debt, 62 percent
of the debt that would no longer be outstanding, and make the
transfer to the Social Security Trust Fund. Clearly, and
perhaps this was the point I didn't appreciate sufficiently in
the Chairman's question, clearly if you simply just made up new
government bonds and placed them in the Social Security Trust
Fund that would be some kind of accounting entry that wouldn't
correspond to any economic reality. The reason the President's
proposal has economic reality is that what is being put in the
Social Security Trust Fund is not some figment of the
imagination. It is a portion of the savings that are being
realized by running down the debt that is held by the public.
Mr. McCrery. But is there no explicit link between the
amount of money that is put into the trust fund and the amount
of publicly held debt that is redeemed?
Mr. Summers. Sixty-two percent of the publicly held debt
that is redeemed is then put in the trust fund.
Mr. McCrery. Yes, but you said that there was--that you
hated to advise this Subcommittee on the politics, but that it
was--that it would be more difficult for us to use the money
for anything other than reduction of the publicly held debt
because it was linked to Social Security.
Mr. Summers. Oh, yes.
Mr. McCrery. Oh, yes, well----
Mr. Summers. Right now, what we say is that 62 percent of
the reduction in publicly held debt goes to the trust fund. In,
and so when you contemplate the maintenance of the surplus, not
pursuing new spending policies that would dissipate the
surplus, the argument can always be made that if you dissipate
the surplus, then you are disadvantaging the trust fund. That
money is no longer available for the trust fund. It is no
longer there for the trust fund.
On the other hand, if you don't have such a provision, then
the argument is always there then why don't we just run down
the national debt a little less and have a new spending program
or have a new whatever-it-is program. So, in effect, you are
using the Social Security as a kind of guarantor to assure what
we would regard as prudent behavior in preserving the surplus
in the future.
Mr. McCrery. Well, that is not clear to me at this point,
at least not from your response. And I don't have time to
follow up, but let me just point out to you that even though
you do call for Congress to proscribe some sort of political
targeting of investments, you obviously know that a law is just
a law and any future Congress can change the law with a simple
majority vote. Certainly, those of us who do have some
reservations about the government investing directly in the
stock market are not too assuaged by a law being passed, and it
won't happen.
Mr. Summers. I can appreciate the concern, and the only
point I would add on that is as we do with respect to the caps
in the budget process, there are a variety of kinds of
procedural protections that can be put in place that would
require much more than a simple majority. It would require
extraordinary majorities and so forth to make any kinds of
changes.
But I think one also has to rely on, and I think we have
seen a lot of political experience to suggest this, that once
one has a set of procedures the idea that Social Security funds
are being tampered with is one that I suspect would be
sufficiently politically explosive so as to discourage that
tendency in the future.
Mr. McCrery. Thank you.
Chairman Shaw. Mr. Doggett.
Mr. Doggett. Thank you very much, Mr. Chairman. Will
investing 15 percent of the trust fund in the private sector
increase Social Security administrative costs, since Social
Security has been so very efficient in the past?
Mr. Summers. We believe that in contrast to an individual
account approach that the effects would be very small. The
costs of managing moneys of this size are in the range of a few
basis a most; that is to say, less than one-tenth of 1 percent
annually of the moneys that have been invested.
And so I think the basic economy, whereby Social Security
pays out in the range of 99 cents out of every dollar that it
receives is something that could be preserved.
In contrast, with even relatively efficient individual
accounts, you could easily find yourself, and again, I don't
mean to make a firm estimate because it depends on how it is
done, in the range of as much as 20 percent of the account
accumulation over 40 years going to pay various kinds of
administrative costs. I think if you add the costs all in
Britain and Chile, the figures are actually somewhat larger
than 20 percent, although that is something that people argue
about and no doubt with information technology, there will be
some possibilities for improvement. But I think the costs could
be rather large.
Mr. Doggett. A multitude of voices have expressed concern
about the declining savings rate in the country. Do you believe
that the President's proposals for the USA accounts will
address that concern?
Mr. Summers. I certainly do believe that in an important
sense, Congressman, savings, like life insurance, is sold, not
bought. And you have to provide people with an incentive to
save for the future. It's something that can be marketed as a
savings vehicle. You know somewhere in the neighborhood, we are
refining the estimate of 75 million Americans who have no
pension, no 401(k), no IRA, and really are not part of that leg
of that retirement security system. And I think by making these
savings accounts universal, we can get a lot more people
started on savings and correct what I think is a perhaps our
Achilles' heel, along with education issues, in a period of
remarkable prosperity. In the last quarter of last year, we
actually had a negative personal savings rate in this country
for the first time since the Depression. And there is a lot to
disagree about here, but my guess is on a bipartisan way, we
ought to be able to agree that that negative personal savings
rate at a time of plenty is something that we should be working
to address.
Mr. Doggett. How do you view the proposal to just take
Social Security off budget in phases, leaving the trust fund
interest available, at least on paper, for more spending and
more tax cuts?
Mr. Summers. With, to be honest, Congressman, considerable
concern. I think compared to the approach that the President
favors, it has at least two important disadvantages. One, it
would result in less fiscal prudence, more room for dissipating
the surplus, and as a consequence, leave us with a larger tax
burden to pay interest bills in the future at the time when our
society is challenged by aging.
Second, by not providing in any way for fortifying the
trust fund with the benefits of debt reduction, it wouldn't do
anything to strengthen the claim of future Social Security
beneficiaries, and, therefore, it wouldn't really provide any
of the kind of credibility and solvency that the system
requires.
Mr. Doggett. Thank you very much.
Mr. Summers. Thank you.
Chairman Shaw. Mr. Portman.
Mr. Portman. Thank you, Mr. Chairman. Mr. Secretary, just
following on to Mr. Doggett's question on personal savings and
the USA accounts, I couldn't agree with you more, and I think
this panel, on a bipartisan basis, shares your concern about
the fact that many Americans do not have a 401(k), do not have
an IRA, do not save adequately for their retirement, or have
opportunities to do so. I would respectfully suggest that the
USA accounts isn't the right way to do that, because I think
you will find as you do your economic analysis, that will
displace private savings, and, in fact, won't be leveraging
those very private dollars about, which should be government
policy. And we can aggressively go after this problem by
reforming our pension system, by allowing people to contribute
more, by offering tax credits, by allowing portability, by
doing the catchup contributions that you have supported in the
past. And so I would just say that there may be a better way to
get at this, another way to skin the cat that is much more
effective in terms of the taxpayers contribution here. Let us
not bring the government into a position of taking the place of
our employers and, instead let us expand private savings. I
hope you will take a look at that.
Mr. Summers. Congressman, just on that.
Mr. Portman. Yes.
Mr. Summers. We certainly will take a look at all those
proposals, and I think the vast majority of what you said with
respect to the private pension system, we would certainly
support. My only comment on that would be that, for the 73
million who are now out of the system, I think if anyone wants
to reach them on a nearly universal basis, some supplement to
the system is appropriate. But I think it is very important--
and this is something we have been very much focused on--that,
in the design of any supplement to the system for those people,
that we not do anything that is other than strengthening the
existing employer-based system. And that is certainly very much
a focus of ours.
Mr. Portman. I think we will find that difficult. And we
have talked about this before with some of your folks and with
the Secretary in his testimony here. But we would love to work
with you on that. I would say also, along the lines of what Mr.
Matsui said earlier, we would love to see the details on the
USA account. If it indeed is only for retirement and only for
an annuity, I think a lot of us would feel differently about
it.
And I know there are still decisions to be made and we
would love to see some legislative proposals on that and to
work with you on it so it is not for first-time home buyers, it
is not for education, it is not for other things that--although
very important--don't help the solvency of the Social Security
problem or backstop Social Security.
On your proposal, I think we should respect the ideas and I
concur with my colleagues who said that, including the
Chairman. We do have some concerns and one is, as you know and
you have said and the President has stated many times, this
does not solve the problem over the 75-year period. It is not a
proposal to solve Social Security under the timeframe in which
we have to work.
Second, the paying down of the debt issue. I have listened
carefully and we have talked to some of your people about it. I
have tried to understand this. I think the bottom line is this
is a policy and a political decision, as you say. If we want to
reduce debt, we can reduce debt, whether we do it with the
trust fund or without. Linking it to Social Security may make
it more likely that, indeed, the benefits of reducing the
service and the debt go back to the trust fund. It may not.
These are tough decisions. I don't think it necessarily is
an integral part of this proposal one way or the other, but I
would just sort of leave that almost to the side and focus,
instead, on how do we get to that 75 years.
On the higher rate of return, I commend the administration
for doing that. And I think most of my colleagues do, on both
sides of the aisle. Some of us believe that there are better
ways to do it in terms of directing it by the individual, but I
guess the question I would ask you with regard to individual
accounts, and you have talked about the importance of the
higher rate. You say there would otherwise have to be a 5-
percent benefit cut, there would otherwise have to be at least
a year and a half rise in the age, just doing what you all do,
which is the 15 percent.
If you indeed believe that the higher rate of return is so
important, isn't there a way to have the same benefits you talk
about with regard to the government investing, doing it through
individuals making that decision, and bringing it back into the
Social Security system?
Mr. Summers. There may be. We are certainly opening to
considering a variety of suggestions that may be put forward. I
think the concerns that that has to address are that the
proposal we make preserves the defined benefit structure. So
that if the stock market goes down 50 percent in some year, it
is not the retiree whose benefits are getting scaled back by
one-half.
Mr. Portman. Yes. I would just say, with regard to that, I
suppose one could say the same thing about the government-
direct investment, because the stock market will go up and down
and there is a larger risk pool----
Mr. Summers. Surely, but the--it is like----
Mr. Portman [continuing]. But some of these same issues
would have to be addressed.
Mr. Summers. Well, I don't think quite, Congressman. It is
like the difference in the private sector between having a
defined benefit pension plan and having a defined contribution
pension plan.
Mr. Portman. Except that it depends how you set it up, of
course. If you indeed have the individual making the decision,
but bring it back into Social Security, taking, as the Chairman
said earlier, into account a safety net or a floor. There may
be a way to design it so that you minimize those risks, just as
you would with investments.
Mr. Summers. Those are--no. Those are----
Mr. Portman. It would be directed by the government.
Mr. Summers [continuing]. Those are obviously issues that
would have to be considered. As I say, the focus--the virtues
that we believe are achieved by the collective investment which
have to be considered in the context of all approaches, are the
virtues that the individuals not at immediate risk from the
fluctuation, the administrative costs virtue, and the
preservation of an overall progressive structure. And there is
always the question of what other possible ways are there of
preserving those things.
Mr. Portman. OK, my time is up. I would just thank you all
for keeping this on the table and suggest that, with regard to
the studies that were referenced earlier, there are various
ways to do individual accounts, including addressing all three
of those concerns and I hope that we can work together on a
bipartisan basis. Otherwise, I don't see us getting to a deal
this year. I thank the Secretary.
Mr. Summers. I think we can. I think we can all agree that
any satisfactory resolution here has to be both bipartisan,
bicameral, and, if you like, bibranch, involving both the
executive and the Congress.
Mr. Portman. Stop there with the ``bi's.''
Chairman Shaw. Bicameral may be a very hard thing to get
over.
Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman, and Mr. Secretary, I
want to congratulate you on what I saw is a very flattering
article in a national magazine. It was a nice photo, as well.
And I have always wanted to meet somebody who saved, so
congratulations.
Mr. Summers. Don't believe everything--with respect, don't
believe everything you read in the papers, Congressman.
[Laughter.]
Mr. Weller. Well. And just building on some of the comments
by Mr. Portman and some of my colleagues regarding savings, of
course, as we are talking about Social Security, private
savings as a supplement to Social Security, of course, I also
share that concern and I hope, particularly when it comes to
the idea of a catchup mechanism and IRAs and 401(k)s,
particularly for working moms who are off a payroll while they
are home taking care of the kids and have an opportunity to
make up those contributions later on. I hope we can work
together in a bipartisan way.
And I just want to better understand the President's
proposal regarding Social Security. As I understand it, he
wants to take 62 percent of the surplus, set that aside until
we come up with some solution for saving Social Security. And
then he wants to take 25 percent of the Social Security Trust
Fund and invest that in corporate America. That is essentially
the proposal as I understand it. And I am just trying to get a
better understanding of what the President considers as part of
the surplus.
I know my Governor and State legislators would want to ask
this question. In the President's budget, it is my
understanding that you want to essentially take about a $5
billion tax on the States' share of the tobacco settlement. And
is that part of the surplus?
Mr. Summers. I am going to have--I apologize, Congressman.
I am going to have to give you an answer in writing to that
because I just don't--OK?
[The following was subsequently received:]
No, it wasn't part of the surplus. The Administration did
not propose to collect the money. The basis of the state
lawsuits against tobacco companies was to recover tobacco-
related costs to the Medicaid program. Because Medicaid costs
are shared between the Federal government and the state
governments, the Administration had an obligation under Federal
Medicaid law to ``recoup'' part of the state settlements.
Having said that, we had hoped to work with the States and
Congress to reach an agreement waiving Federal claims to these
funds in exchange for a commitment by the States to use the
tobacco settlement payments for certain activities including
public health and children's programs.
The Administration was extremely disappointed that the
Congress failed to require States to use even a portion of the
funds collected from the tobacco companies to prevent youth
smoking. Even though 3,000 young people become regular smokers
every day and 1,000 will have their lives cut short as a
result, most States still have no plans to use tobacco
settlement funds to reduce youth smoking. This bill represented
a missed opportunity by the Congress to protect our children
from the death and disease caused by tobacco. The
Administration will closely monitor State efforts in this area,
and will continue to fight for a nationwide effort to reduce
youth smoking through counter-advertising, prevention
activities, and restrictions on youth access to tobacco
products.
Mr. Weller. OK.
Mr. Summers. The people at OMB handle the budgetary
treatment on that and I just don't know the answer. I don't
know the answer to your question. It is possible that a note
will be handed to me with the answer to your question, but I
don't know it.
Mr. Weller. OK, well. I would like to know that because
that $5 billion tax on Illinois and other States----
Mr. Summers. We will get back to you on that.
Mr. Weller [continuing]. It is my understanding you may
consider that part of the budget.
The second is the President proposes $165 billion tax
increase as part of his budget proposal. Is that tax increase
part of the surplus?
Mr. Summers. Well, certainly, all the elements in the
President's proposal, both the revenue raisers that I think you
may have been referring to and the targeted tax cuts contained
in the President's budget all enter into the calculation of the
unified surplus.
Of course, the President, just to clarify one point, the
President's proposal was that he believed we could use 62
percent as part of a framework for resolving Social Security.
Mr. Weller. Yes. I understand--excuse me.
Mr. Summers. But his position continues to be that we
shouldn't use any of the surplus--I think this is a crucial
point--we shouldn't use any of the surplus until we are
successful in finding a framework for resolving Social
Security.
Mr. Weller. Well, reclaiming my time, Mr. Secretary, but--
so if Congress did not pass $165 billion in tax hikes,
essentially you are saying the surplus would be smaller.
Because you are counting that $165 billion in tax increases in
the President's budget as part of the budget when you talk
about the unified----
Mr. Summers. I am not--I think, clearly, if you didn't pass
other components, the surplus wouldn't materialize in the way
you suggested.
Mr. Weller. OK.
Mr. Summers. I don't think by the--certainly by the
definitions we would use, I don't think the President's budget
contains anything like $165 billion in tax increases. There may
be differences in how we and you view certain of the items from
the point of view of accounting, as to whether they are taxed
or not.
Mr. Weller. Mr. Secretary, the Joint Committee on Taxation
has analyzed the President's budget and they said that there is
$165 billion in what you call revenue raisers, but most people
call tax increases.
Mr. Summers. Well, some of that goes, I think, to some of
the moneys associated with the tobacco settlement, as you
suggested.
Mr. Weller. Yes. In trying to better understand the
President's proposal on Social Security also, so far you have
declined to actually offer any specifics on a proposal beyond
its part of the surplus and the trust fund. As I understand it,
some of the options that Congress and the President have looked
at and talked about behind closed doors, does the
administration support or oppose a tax increase as part of the
Social Security solution? Just support or oppose?
Mr. Summers. We don't think that is the primary way to go.
Mr. Weller. OK. Benefit cuts?
Mr. Summers. We think that it is necessary--we can even go
a long way, out to 2055----
Mr. Weller. Just support or oppose.
Mr. Summers [continuing]. With the administration's
proposal. The remainder has to be worked out in the bipartisan
process.
Mr. Weller. OK. Eligibility age. Do you support or oppose
changes in that?
Mr. Summers. All has to be addressed in the context of the
bipartisan process.
Mr. Weller. Raising the cap above the $72,000?
Mr. Summers. Bipartisan process.
Mr. Weller. OK. So you are open to all these ideas, then, I
take it? So you are open to cutting benefits----
Mr. Summers. We believe the primary thrust----
Mr. Weller [continuing]. You are open to raising taxes?
Mr. Summers. Well.
Mr. Weller. How about means testing? Are you open to that
idea or do you support or oppose means testing?
Mr. Summers. I think the President has indicated very great
concerns in that area.
Mr. Weller. OK.
Mr. Summers. The remainder, most of the other things you
have mentioned, I think, are things that could be looked at in
a bipartisan process.
Mr. Weller. OK.
Mr. Summers. But we think the thing to do first is to set
aside that surplus and get----
Mr. Weller. To reclaim my time, there are some last couple
options, Mr. Secretary. Personal accounts as part of Social
Security. Not as a supplement to, but as part of. Do you
support or oppose?
Mr. Summers. Don't have a--not something that can be judged
in the abstract without looking at whole proposals.
Mr. Weller. You are open to that. So you are open to tax
increases. You are open to benefit cuts. You are open to
changing the eligibility age. Means testing--you don't seem to
like that idea. You are open to personal accounts. Your
response to the question.
Mr. Summers. Open to. We believe the place to go with this
is 50 years with the President's proposal and it can be a
bipartisan process behind that. My guess is many, probably most
of those items on the list would be things that neither nor----
Mr. Weller. But you are not saying no to any of those
ideas.
Mr. Summers [continuing]. Neither we nor other participants
in a bipartisan process would choose to go, but I don't think
it is appropriate to start trying to prejudge that. I didn't
mean to suggest----
Mr. Weller. OK.
Mr. Summers [continuing]. I did not mean in any way to
suggest receptivity to any of those things in my answer, only a
desire not to prejudge that bipartisan process.
Chairman Shaw. The time of the gentleman has expired.
Mr. Weller. Thank you, Mr. Chairman.
Chairman Shaw. Mr. Tanner.
Mr. Tanner. Thank you, Mr. Chairman. Mr. Secretary, thank
you for being here, and I want to follow up on just a couple of
things and see if we can put it in some sort of perspective.
You mentioned the two types of debt that comprise the
``national debt.'' One is interagency debt, that debt that the
Treasury owes to the Social Security Trust Fund because the
Social Security Trust Fund transferred FICA taxes to the
Treasury that were used for some public purpose, consistent
with the law.
The other $3.56 trillion is debt that is owed to
nongovernmental agencies, to people, to banks, to institutions,
a third of which is owned by foreign interests. Now, as you
were talking about paying down the debt, I hope you were
talking about paying down this debt that actually is real, that
we pay interest on every year; last year to the tune of $246
billion. That is the debt that is real.
Now, in terms of this interagency debt. Call it what you
will. You could call it a certificate, an interest-bearing
certificate, whatever. What I characterize that as is basically
a call on future tax dollars that says we are going to honor
these obligations. You can quantify them with certificates or
bonds or notes or bills. They could have an interest rate of 20
percent or an interest rate of 1 percent. It doesn't really
matter because it is--you can quantify it any way you like, but
it is a call on future tax dollars to the extent that we have
Social Security defined benefits in the law, given a person
reaches a certain age.
Would you take issue with anything that I have said?
Mr. Summers. No, I would entirely agree and I thought you
put it very accurately. And, frankly, Congressman, the next
time I have occasion to try to explain this, I will steal some
of what you just said.
Mr. Tanner. Well. This is homespun logic from my point of
view because I have to simplify things, I think, so that I can
understand them and, more importantly, explain to people.
Now, when we talk about saving Social Security, however one
characterizes it, if we use the surplus, whether it comes in
from Social Security FICA taxes, whether it comes in through
increased income taxes because of the great economy, or
whatever, there is this finite amount of money coming to the
U.S. Treasury. If we retire this $3.56 trillion debt, we not
only are in a better position at some future date when the
Social Security bubble hits to borrow to pay it and we plus
have the benefit of whatever interest payments we are then
saving at that later date because we have paid or redeemed or
retired this outstanding debt that we have to pay interest on
every year.
Now, as it relates to that idea, I want to commend the
President's plan. I would just simply say, I don't think that
we go far enough. I realize the political realities, but I
would like to go much farther and to say all surpluses that are
being paid into the Social Security Trust Fund now would be
used to retire this $3.5 or $3.6 trillion debt. That would--you
don't have to get into double or triple accounting. You just
say everything that comes in that we don't need, we will begin
to retire this outstanding indebtedness.
We will be in a much better position in the future if we do
that, in my opinion, than if we have an across-the-board tax
cut. Nobody ever talks about using the surplus, whether it be
in Social Security or on the budget to pay back some of what we
have borrowed in the last 20 years. Nobody talks about that,
but that is what ought to be done. It is what a business would
do.
But we have all of these ideas about what we are going to
do with this great projected surplus, but you very seldom hear
somebody say, you know what? We ought not to leave this debt to
our kids. What we really ought to do is pay down some of this
so we will be in a position to either, one, borrow the money at
that time in the future when we owe the Social Security Trust
Fund or we can use the moneys that we have saved on interest to
do it.
I wanted to ask one other question about individual
accounts and about the so-called clawback provision that I have
read about. I don't understand it. But we can get into that at
a later time, because I see my time has expired. Thank you for
being here.
Mr. Summers. Thank you.
Chairman Shaw. Mr. Hulshof.
Mr. Hulshof. Thank you, Mr. Chairman. Mr. Secretary,
welcome. Following up on my friend from Tennessee's question,
in his homespun way, which was a good way to define it, you are
not suggesting, are you sir, that the internal government debt
is not real? I mean, the fact is that the full faith and credit
of the U.S. Government supports that internal government debt,
does it not?
Mr. Summers. It is a commitment that will surely be
honored. It is not a commitment that has impacts on the real
economy in the same way because it is purely intragovernmental,
just as, for example, there is a big thing about General
Motors. There is a big difference between debt that General
Motors shareholders owe the public and debt that Buick owes
Chevrolet, both of which are internal to General Motors. And
that is the kind of distinction that I think Mr. Tanner was
trying to draw in his comments and that I had drawn in my
earlier comments.
Mr. Hulshof. And, certainly, recognized that a man of your
intelligence and expertise in this area and even some Members
on this Subcommittee that understand that, but back home, when
people talk about paying down the debt, they don't understand
sometimes the nuances that we speak of.
In fact, let me ask you. Last week we had the head of the
General Accounting Office who testified, perhaps sitting in the
same seat you are, Mr. Walker, who said that if Congress did
nothing and allowed current law to operate that the Federal
debt would be paid down more than if we adopted the President's
plan. Do you agree or disagree with Mr. Walker's statement?
Mr. Summers. If Congress did nothing for the next 15 years,
chose no new spending programs, chose no new tax cut programs,
indeed, I suspect, the debt would be reduced more rapidly. I
would, again, defer to others on the political question, but
would respectfully suggest the possibility that the likelihood
of Congress doing nothing in the face of multihundred billion
dollar surpluses is perhaps not so great. And that is why the
precommitment of the contributions to Social Security that the
President envisions seem to us to be so very important, both in
terms of prudent fiscal policy, running down the debt, and in
terms of what it means to the future of the Social Security
system.
Mr. Hulshof. Mr. Secretary, let me follow up on a point
that you made in your testimony and then my friend from Texas
made, Mr. Doggett, who has raised some concerns with other
witnesses and other panels about the administrative costs. You
mentioned that--and others have pointed out--that the
administrative costs for personal accounts can be as high as 15
to 20 percent or you said possibly even higher.
But is this not the case that back in 1940--and clearly we
understand now from the trustee's report that the
administrative costs that the Social Security Administration
has now is around 1 percent and you mentioned that as well. But
back in 1940, it is my understanding that the Social Security
administrative costs were equal to 74 percent of the benefit
outlays. In fact, a short 5 years after that, these costs had
fallen--the administrative costs had fallen to about 10
percent. Do those numbers ring true with you? And I see some
staff--I thought I saw a head nodding behind you. You may want
to confer with your staff.
Mr. Summers. I am not familiar with the 1940 experience,
but I am familiar with the argument that the costs will come
down over time. And no doubt there would be some tendency in
that direction. The system in Chile has been in place for some
15 years and the costs there are in the range of 20 percent.
The mutual fund industry has been in place for nearly 50
years and it continues to be the case that the typical mutual
fund in the United States involves costs on the order of 100 to
150 basis points. If you work that out over the 20 years over a
40-year lifetime, it would represent about 20 percent of a
lifetime's costs. But, no doubt, there would be some
improvements and that is something that should be factored in.
There would also be startup costs that actually aren't
reflected in the 20-percent figure.
Mr. Hulshof. OK. With all due regard to the Ranking Member
who, I think, has been very forceful and has been working on
this many years, those of us who may ask questions about the
President's plan not necessarily are trashing or being
critical, and yet I think there are legitimate questions.
And probably my final question to you would be this. Social
Security has always been self-financed. Payroll taxes are
sacred. And yet it is my understanding--and please correct me
if I am wrong--that, were the President's plan to be
implemented, that we would then be using general revenue funds,
that is income taxes, and no longer would we have this firewall
or distinction. Is that true? And what are your views regarding
using general revenue funds to save Social Security?
Mr. Summers. I think the President's plan with its use of
unified surpluses does represent an innovation in financing
Social Security, but one that is very different from general
revenue financing as it has historically been contemplated.
Very different because one is not envisioning taking on a new
set of obligations. Very different because the financial
contribution is temporary rather than some commitment to the
tax stream permanently. And very different because what is
being contributed is a surplus that is being used to directly
pay for itself, that is it is directly paying for the
contributions by reducing future interest burdens.
So, yes, I think it does represent a departure, but I would
argue an appropriate departure in light of the opportunity that
is presented by the very large surpluses that we will have, not
forever, but that we now appear likely to have for some number
of years going forward.
Mr. Hulshof. Thank you.
Chairman Shaw. OK. Dr. Summers, I have one question on an
area that we haven't covered. In the President's budget, I
believe he talked about the elimination of the earnings limit
on Social Security. You have been quoted as to raising the
earnings limit. What is the position of the administration or
is the administration open on both areas?
Mr. Summers. I haven't seen myself quoted. My understanding
was that our position was that the earning's limit should be
eliminated.
Chairman Shaw. OK. I thank you. And I want to thank you for
your testimony. If there is one thing that I have really gotten
out of it is that the administration is not drawing lines in
the sand. And I think that is terribly important that none of
us draw lines in the sand at this particular point. Your
openness and frankness to this Subcommittee is appreciated. We
appreciate your testimony.
Mr. Summers. Thank you very much, Mr. Chairman. And let me
just say that I appreciated this opportunity to testify, and I
neglected in my opening comments to thank Mr. Matsui for his
role in ensuring that the administration had an opportunity to
raise many of its concerns in this context. And to look forward
very much to, as I think we have all emphasized, working on a
bipartisan basis with you, along with Mr. Matsui and his
colleagues on these very critical issues. And I think there is
a lot that we can agree on on a bipartisan basis, but I think
there are also some very real issues that we are going to have
to resolve where, at this point, there do appear to be some
differences in perspective.
Thank you very much.
Chairman Shaw. Dr. Summers, if the administration shares
the goals of Chairman Archer and me as Chairman of this
Subcommittee, the determination to solve the Social Security
problem and solve it today, I am convinced that we will do so.
Thank you very much.
Mr. Summers. Thank you.
Chairman Shaw. Next, we have a panel of witnesses. We have
Lawrence White. Dr. Lawrence White is professor of economics at
Stern School of Business at New York University; Hon. Maureen
Baronian, who is vice president and principal of Investors
Services of Hartford, Inc., Hartford, Connecticut, and is
former State representative in the Connecticut General Assembly
and former trustee, Investment Advisory Council in the State of
Connecticut; Michael Tanner, director, Health and Welfare
Studies, the Cato Institute; Dr. Robert Reischauer, who is the
senior fellow, economic studies, at the Brookings Institution,
a former Director of the Congressional Budget Office; Dr.
Carolyn Weaver, director of Social Security and Pension
Studies, the American Enterprise Institute and a former member
of the Advisory Council on Social Security; and Hon. Fred
Goldberg, Skadden, Arps, Slate--I am having trouble with this--
Meagher and Flom, former Commissioner for the Internal Revenue
Service and former Assistant Secretary for Tax Policy of the
U.S. Department of the Treasury.
We have all of your written testimony, which will be made a
part of the permanent record, without objection, and we would
ask you to proceed as you see fit.
I would like to make an announcement at this time that this
Subcommittee will recess at 12 and then reconvene again at 1. I
hope that doesn't inconvenience any of our witnesses.
Dr. White.
STATEMENT OF LAWRENCE J. WHITE, PH.D., PROFESSOR OF ECONOMICS,
STERN SCHOOL OF BUSINESS, NEW YORK UNIVERSITY
Mr. White. Thank you, Chairman Shaw, Members of the
Subcommittee. I am pleased and honored to be invited to testify
before your Subcommittee today.
The future of the Social Security Program is one of the
most important public policy issues that currently face our
Nation. The program has been a valuable source of old age and
disability support for tens of millions of Americans. It has
had a substantial and worthwhile redistributive component, but
it is also burdened with latent financial problems that
threaten its future. Further, the basic structure of the Social
Security Program remains widely misunderstood.
In my written testimony, I have offered a 12-step plan for
understanding Social Security, its problems, and some real and
not-so-real solutions. I will try to summarize that testimony
this morning.
First, as Deputy Secretary Summers repeatedly said, Social
Security is a defined benefit plan. The benefits of a worker
are linked through a complicated formula to his or her income
during his or her working life. The structure of this defined
benefit and strength of this defined benefit program is in the
Congress' promise to pay those benefits.
Second, the program, as we all know, is financed through
wage taxes. It is a pay-as-you-go program. There is no direct
link between what a worker pays in and what he or she receives
in benefits. There are no canned goods piling up as resources
as a result of a worker's contributions. In this context, it is
the net annual cash flow of the program that is the crucial
concept. Currently, this net annual cash flow is positive. It
is running about $80 billion a year. But as Chairman Shaw
indicated, around the year 2013, that cash flow will start to
become negative. That is the crucial crunch-point for the
Social Security Program. Not the year 2032, which is when what
one often reads, but the year 2013. And for Social Security,
this is an eyeblink.
Next, the presence of Treasury bonds in the so-called trust
fund adds absolutely nothing to the strength of the program.
They are not canned goods. For this defined benefit program,
the strength of the Social Security Program is the promise of
the Congress to make good on promised benefits. In this
context, as Deputy Secretary Summers indicated, President
Clinton's proposal to use 2 trillion dollars' worth of future
surpluses to buy back public debt, debt that is held in the
hands of the public, is clearly going to provide the kinds of
beneficial consequences for the U.S. economy that Deputy
Secretary Summers indicated. It is basically a good idea.
But then placing those repurchased Treasury bonds in the
Social Security Trust Funds does absolutely nothing. It does
not add to the strength of the fund. It is window dressing, at
best. As Deputy Secretary Summers indicated, it is a marker
indicating that the repurchasing of the debt is going on.
Now the plan to purchase about 700 billion dollars' worth
of private sector securities at least does provide real
resources for the program. But I think there are real and
substantial problems to having the Social Security
Administration do the investing of these $700 billion. There
are huge problems of choice as to what they should invest in,
how should they invest. And I think these decisions are subject
to potential abuse. This worries me greatly.
Also, and this is an area that has received much less
attention, to the extent that the Social Security
Administration would do the investing, they would be limited to
the 10,000 largest publicly traded companies in the U.S.
economy. The millions of other smaller enterprises in the
country that are not publicly traded would see none of this
investment flow.
There is another way. It is a personal savings account
approach that I think would be valuable as a component of the
Social Security Program. The devil is in the details. I am not
going to propose a specific plan, but there are two important
principles that should be observed. First, a PSA Program should
be voluntary. Second, it should be structured along the lines
of the current IRA Programs. That means a wide choice of
investment vehicles and bringing a regulated financial
institution with fiduciary obligations into the picture.
This PSA component would allow individuals, families, to
tailor their choices to their knowledge, their information,
their age, their family status, their tolerance for risk, and
other personal considerations. For the less sophisticated, less
knowledgeable, for risk-averse individuals, there would be the
familiar FDIC-insured bank account. As of 1991, almost half of
IRA funds were invested in bank accounts or similar type
instruments.
The stock market is not for everyone and an IRA-type
approach recognizes that. And it would have the advantage that
these types of investments would be rechanneled by the banks
and other financial institutions to those millions of smaller
enterprises that are not going to see a penny out of any Social
Security Administration-directed investments.
A potential objection to the PSAs are their transactions
costs. I do not believe this is a real objection. I am greatly
impressed with the ability of the private sector financial
institutions to structure low-cost accounts, perhaps with some
limitations to deal with the transactions costs problem.
In summary, Mr. Chairman, procrastination and delay in
instituting reform of the Social Security Program can only make
the necessary eventual reforms more costly and more difficult.
I urge the Congress to act quickly.
Thank you for this opportunity.
I'll be happy to answer questions.
[The prepared statement follows:]
Statement of Lawrence J. White, Ph.D.* Professor of Economics, Stern
School of Business, New York University
Chairman Archer, Members of the Committee: I am pleased and
honored to be invited to testify before your Committee today.
---------------------------------------------------------------------------
* During 1995-1996 I was a consultant to the Investment Company
Institute on the subject of Social Security reform.
---------------------------------------------------------------------------
The future of the Social Security program is one of the
most important public policy issues that currently face our
nation. The program has been a valuable source of old-age and
disability support for tens of millions of Americans. It has
had a substantial and worthwhile redistributive component. But
it is also burdened with latent financial problems that
threaten its future. Further, the basic structure of the Social
Security program remains widely misunderstood.
In the interests of advancing the debate, let me offer:
A TWELVE-STEP PLAN FOR UNDERSTANDING SOCIAL SECURITY, ITS PROBLEMS, AND
SOME REAL AND NOT-SO-REAL SOLUTIONS
ONE To understand what Social Security is, it is useful to
start by explaining what Social Security isn't. Imagine an
extremely simple ``retirement plan'': A worker saves 10% of her
income during each year of her working life and with those
savings consistently buys canned goods, accumulating them in a
large closet. Then, during her retirement, she eats the canned
goods.
This is clearly a metaphorical retirement plan, with many
practical drawbacks. But it has two important features: The
worker has invested in real resources (the canned goods). And
there is a direct connection between what she has contributed
to her retirement plan and what she eventually receives from
it. In the terms of modern pension phraseology, hers is a
defined contribution pension plan.
TWO To make the above example slightly more realistic, let
us instead imagine that the worker, so as to avoid the
inconvenience of piling up 40 years of canned goods herself,
pays that same 10% of her income each year to her local grocer,
who in turn hands her an ``I.O.U.'' for the sum and promises to
deliver the appropriate amounts of canned goods upon her
retirement. So long as the grocer remains honest and
economically viable, this retirement plan is essentially the
same as the previous one. The worker is still investing in real
resources, only one step removed: She has claims on real
resources. And she still has a defined contribution plan.
THREE It is only a modest modification of step two to have
the worker instead invest that 10% of her annual income in
corporate stocks and bonds, which again are claims on real
resources; or to have her invest in mutual funds, which
purchase those claims on her behalf; or to have her place her
annual 10% of her income in a bank, which then lends it out in
the form of business loans. We have now virtually replicated a
modern IRA or 401(k) retirement plan, with claims on real
resources and a defined contribution retirement plan.
FOUR Contrary to much popular perception, the Social
Security program bears absolutely no resemblance to the
retirement plans described in steps one, two, or three.
Instead, the retirement benefits that a worker is statutorily
promised are linked loosely, through a quite complicated
formula, to the wages that she receives during her working
life. In this important sense, Social Security is a defined
benefit program.
FIVE The financing for the Social Security program comes
from abroadly based tax on wages: 6.2% of a worker's annual
wages (up to a maximum wage base of $72,600, as of 1999) is
paid by the worker, and another 6.2% is paid by the worker's
employer. But there is no direct link between what a worker and
her employer pay into the program and the benefits that she
receives when she retires. The money that current workers pay
into the Social Security system is mostly paid directly out to
current retirees. It is a pay-as-you-go system. There is no
piling up of canned goods, or (more realistically) of claims on
real resources for any worker, as a consequence of that
worker's Social Security contributions.
SIX In this pay-as-you-go framework, the ``net'' annual
aggregate cash flow of the Social Security program--the annual
wage tax payments into the program, minus the annual payments
to retirees--is the crucial concept. In recent decades this net
annual aggregate cash flow has been positive: Workers (and
their employers) have been paying more into the program than
retirees have been pulling out. This cash-flow surplus has been
``transferred'' to the U.S. Treasury and has been used as just
another source of revenue to support the other spending
activities of the Federal Government (e.g., defense spending,
farm subsidies, interest payments on the national debt, etc.);
in essence, the Social Security cash-flow surplus has been used
to offset partially the net deficit that the U.S. Government
has been running on the remainder of its activities. That cash-
flow surplus has not been invested in real resources that would
be the equivalent of the canned goods of step one or the claims
on real resources of steps two or three.
In recognition of these transfers, the Treasury has duly
created appropriate amounts of special bonds and credited them
to the Social Security ``Trust Funds.'' The bonds even ``pay''
interest (which just involves the creation of still more
Treasury securities and the crediting of them to the Trust Fund
account). But the presence of these Treasury securities in the
Social Security Trust Funds does not add anything real to the
basic financial position of the Social Security program. The
statutory promise by the Congress to pay benefits to retirees
(current and future) is already present. The presence of these
Treasury securities does not provide the Social Security
program with any additional real resources that can be used to
make benefit payments. The Treasury securities are not canned
goods or claims on real resources; they are just another set of
promises-to-pay by the Congress.
Further, even if one thought that the presence of the
Treasury securities in the Trust Funds did somehow represent a
stronger commitment by the Congress to make good on its
promises to retirees, the amounts of Treasury securities in the
Trust Funds are far short of the sums necessary to fulfill all
promises to retirees. (This shortfall is due, of course, to the
pay-as-you-go structure of Social Security: The Treasury
securities have been created only when the program has run
aggregate annual surpluses, rather than when the statutory
obligations to future retirees have been created.)
SEVEN For this pay-as-you-go structured program, the true
fiscal ``crunch'' will occur in the year 2013, when the net
annual aggregate cash flow becomes negative; i.e., when the
annual payments by workers and their employers fall short of
the annual payments to retirees. This fiscal pattern will arise
because of the longer lives of retirees and other demographic
and economic characteristics of the American population. It is
at this point that the Social Security program will cease being
a net surplus program, and fiscal transfers into the program
will be required. If the statutory promises to retirees are to
be honored, taxes will have to be raised, or other Federal
Government spending will have to be reduced, or more Treasury
debt will have to be issued to the general public (or less debt
will be bought back from the general public, depending on the
Federal Government's overall budgetary position at that time).
Or the promises will have to be modified (e.g., later
retirement ages, or reduced payment benefits, etc.)
The presence or absence of the Treasury securities in the
Trust Funds at this point will make absolutely no difference to
the true fiscal position of the program or the necessary
actions that will have to be taken in order to continue to
honor the statutory promises to retirees.
This point in time--2013--is only fourteen years away,
which is a mere ``eyeblink'' for the Social Security program,
since fundamental fairness requires that any changes to the
program (e.g., a delay in retirement ages) should be gradually
phased in, over a long period of time. Also, it is far sooner
than the year 2032, which is the date on which most media
accounts of Social Security's problems have focused. This
latter year is the date when the Trust Fund's Treasury
securities will be ``exhausted'' (in ``cover'' the net negative
annual cash flows of the previous two decades). But, again, the
presence of the Treasury securities will have made absolutely
no difference with respect to the necessary fiscal actions of
those previous two decades; and, as of 2032, the net negative
annual cash flow of the Social Security program will be about
$750 billion ($250 billion in constant 1998 dollars), or over
1.8% of U.S. GDP in that year.
EIGHT An understanding of the Social Security's pay-as-you-
go structure also helps focus attention on what actions
actually do provide real improvements in the program's finances
and what actions constitute mere window dressing. For example,
the Clinton Administration has proposed to use $2.7 trillion of
federal budgetary surpluses over the next 15 years to support
Social Security. Of this sum, about $700 billion is to be used
by the Social Security Administration directly to buy private-
sector securities. The remaining $2 trillion would be used to
repurchase Treasury securities from the general public, with
the bonds then being ``deposited'' in the Social Security Trust
Funds.
Let us analyze the latter actions first. The use of $2
trillion to repurchase outstanding Treasury securities is a
sensible policy action. It will add to the U.S. economy's
saving rate and encourage greater private sector investment,
thereby leading to higher levels of productivity, income, and
wealth. But the placement of the repurchased bonds in the Trust
Funds is pure window dressing. The presence of extra bonds in
the Trust Funds will make no difference with respect to the
actions that must be taken after 2013.
This perspective also clarifies an often-suggested
``solution'' to Social Security's problems: raising the
combined employee/employer tax rate to about 14.4% of the wage
base (as compared to the 12.4% combined rate today). Contrary
to the claims of the advocates of this action, this wage-tax
increase would not permanently solve Social Security's
problems. It would simply delay by about five years (to 2018)
the ``crunch'' point at which the net annual aggregate cash
flows would become negative. This action would achieve nothing
real for Social Security between now and 2013 (it would just
increase the net annual aggregate cash-flow surplus of the
program and add Treasury securities to the Trust Funds). The
added tax revenues coming into the program would sustain cash-
flow surpluses between 2013 and 2018. But the cash outflows
after 2018 would then overwhelm this somewhat larger stream of
cash inflows. And the additional tax on wages would make the
hiring of labor more expensive, add to the distortion of labor
markets, and drive more employment arrangements ``off the
books'' and into the gray or underground economy.
NINE The proposal to channel $700 billion into stocks and
bonds is slightly more promising. At least this action would
channel claims on real resources into the Social Security
program. But it would not alter the fundamental ``defined
benefit'' structure of the program.
Further, as many other commentators have pointed out,
having the Social Security Administration invest the funds
(which could eventually total about 4% of U.S. corporate value)
could potentially open the door to political influence as to
the choice of companies in which Social Security invests.
Should the program invest in just the S&P 500? Or in all
publicly traded companies? What about overseas-based companies?
What about companies that have been convicted of criminal
violations? What about tobacco companies? etc. Unfortunately,
the record of a number of the states in their investment
policies and actions with respect to state employees' pension
funds is not reassuring. Perhaps the Federal Government's
record would be better; but perhaps not.
Further, should Social Security also invest part of its
funds in debt securities? What kinds of debt securities? Only
corporate debt? What about state and local government debt
obligations? What about securitized home mortgages? Securitized
commercial real estate mortgages? Securitized credit card debt?
Securitized auto loans? The varieties of debt securities are
many, and the advocates of each kind will surely not hide their
enthusiasm for their variety.
Another important and unavoidable drawback to this route,
and one that has gained much less attention, would be the
restricted investment focus of such a program. Even if the
Social Security program were somehow able to invest in a broad
index of all publicly traded companies in the U.S., this focus
would still restrict the program's investment flows to the
10,000 or so largest companies in the U.S. Neglected would be
the millions of smaller enterprises in the U.S. that are not
publicly traded and that get their financing primarily through
debt finance--i.e., through loans from banks and other
financial intermediaries. Until such loans become regularly
securitized (the way that home mortgage-based securities are
easily bought and sold today), these millions of smaller
enterprises will be cut off from the Social Security investment
flows. And even with securitization, it seems likely that an
index-fund orientation for Social Security would largely or
entirely bypass this sector.
TEN There is another way. A system of personal savings
accounts (PSAs), as a component of the Social Security program,
would be a valuable step toward moving the program in the
direction of a defined-contribution structure that would bring
greater personal choice and responsibility, while maintaining
an acceptable level of redistribution.
A large number of PSA variants have been proposed, and for
a program as complex as Social Security truly ``the devil is in
the details.'' Rather than advocate a specific plan, I will set
forth two important principles that should guide any structure.
First, a PSA plan should be voluntary. Though many Social
Security participants will be eager to embrace PSAs, others
will be reluctant. That choice should be available.
Second, the PSAs should be structured along the lines of
the current investment retirement account (IRA) program. That
is, a wide choice of investment vehicles and instruments,
including bank accounts and similar depository instruments,
should be available to PSA participants; and the PSA should be
registered at a regulated financial institution, such as a
bank, a savings institution, a credit union, an insurance
company, a stock brokerage firm, or a mutual fund company.
ELEVEN This broad-choice structure would have many
advantages. First, it would give participants a wide range of
opportunity to tailor their investments to their knowledge and
information, their age and family status, their tolerances for
risk, and other personal considerations. This broad-choice
structure would be especially valuable for the less
sophisticated, less knowledgeable or very risk-averse
participants who would prefer to keep their PSAs in a familiar
FDIC-insured bank account or similar instrument. It is
noteworthy that as of 1996, over a quarter (26.3%) of the funds
in IRA plans were in deposits in banks, thrifts, or credit
unions or in similar instruments in insurance companies; as
recently as 1991 this percentage was 47%.
Second, it would bring a regulated financial institution,
with fiduciary obligations and responsibilities, into the
picture. Advising the customer as to the suitability of
proposed investments with the customer's other circumstances is
a major such responsibility. It is noteworthy that there have
been no reported scandals or political calls for reform with
respect to the way that the IRA program is structured.
Third, it would provide strong incentives for the creative
and competitive forces of the financial services sector to
develop appropriate investment instruments and to educate the
program's participants as to the merits of those instruments.
Fourth, to the extent that individuals would choose to
invest their funds in bank accounts or similar vehicles, this
route would provide a financing channel for those millions of
enterprises in the U.S. that are not publicly traded and that
would not benefit from investments in any form of index fund
that is restricted to purchasing the securities of publicly
traded companies. This strong advantage would not be present if
the Social Security Administration directly invested the funds
or if PSA participants were limited to a handful of index-fund
products (as is true for the Thrift Savings Plan that serves as
the retirement plan for employees of the Federal Government).
A potential drawback to a wide-choice PSA structure might
be the transactions costs of maintaining these accounts. I am
not convinced that this would be an insurmountable barrier.
First, with a wide range of instruments and vehicles open to
participants, there would be competition among providers to
offer low-cost accounts, perhaps in return for agreed-upon
restricted ability to move funds around, as is the case for
bank certificates of deposit. The prospects for attracting
these flows, present and future, should be an attractive one
for many financial institutions. Second, as an interim measure
for low income workers whose PSA contributions might initially
be small, the Federal Government might stand ready to serve as
the accumulator of, say, the first three years of PSA
contributions, after which they would revert to the IRA-like
structure described above.
TWELVE In summary, the Social Security program is a major
feature of today's economy. Current retirees rely on it; future
retirees expect it. But the program does have serious latent
problems.
Reforming the program will not be easy. Social Security is
complex, and its basic structure is widely misunderstood. There
are many vested interests that will be affected by any changes.
But reform is necessary.
A central component of any reform should be a system of
voluntary personal savings accounts (PSA) accounts that are
patterned on the current investment retirement accounts (IRAs),
with a wide choice of instruments and vehicles and the
involvement of a regulated financial institution. These PSAs
would serve as the basis for bringing the Social Security
program into a better funded position and for allowing the
program to make a greater contribution to this country's
saving, investment, and efficient use of resources.
Procrastination and delay in instituting reform of the
Social Security program can only make the necessary eventual
reforms more costly and more difficult. I urge the Congress to
act quickly.
Thank you. I will be happy to answer questions.
Chairman Shaw. Thank you, Dr. White.
Ms. Baronian.
STATEMENT OF HON. MAUREEN M. BARONIAN, VICE PRESIDENT AND
PRINCIPAL, INVESTORS SERVICES OF HARTFORD, INC., HARTFORD,
CONNECTICUT; FORMER STATE REPRESENTATIVE, CONNECTICUT GENERAL
ASSEMBLY; AND FORMER TRUSTEE, INVESTMENT ADVISORY COUNCIL,
STATE OF CONNECTICUT
Ms. Baronian. Thank you. Chairman Shaw, Ranking Member
Matsui, and Members of the Subcommittee, thank you for inviting
me to be here today. As a member of the Investment Advisory
Council for the State of Connecticut from 1987 to 1995, I have
seen firsthand the results of allowing governments to invest
directly in private equity markets. I can only hope that my
experiences will help enlighten this Subcommittee as it
considers President Clinton's proposal to invest a portion of
the Federal Social Security surplus in private markets.
Almost 10 years ago, on March 22, 1990, the State of
Connecticut retirement and trust funds joined with members of
the United Autoworkers, some existing members of Colt
management, and a few other private investors to complete a
buyout of the Colt Firearms division of Colt Industries, Inc.
In all, the State placed $25 million in State pension funds
into this buyout: $17.5 million in CF Holding and $7.5 million
in CF Intellectual Properties which owns the Colt trademark.
This investment gave the State of Connecticut a 47-percent
share of Colt Manufacturing.
Unfortunately, in less than 2 years, on March 18, 1992, CF
Holding Corp. filed for chapter 11 bankruptcy. Fortunately, the
State pensions loss was ``limited to only'' $21 million, after
the Colt trademark was sold to the Economic Development
Authority of Connecticut 2 years later.
While it is not uncommon for pension funds to lose money on
the investments they make, the case of Connecticut's investment
in Colt is an example where politics, not prudence, led to the
failed investment.
For months leading up to the investment, Connecticut
newspapers were filled with editorials and news reports on the
financial crisis facing Colt Manufacturing, a company that
employed 950 people. Colt finances were in disarray, it lacked
positive cash flow, it had low reserves, and it was suffering
from a bitter 4-year strike by its labor union which had
resulted in a $10 million fine by the National Labor Relations
Board.
Not only was Colt in trouble, industry analysts pointed to
a shrinking market for firearms, growing international
competition, and an increasing threat of liability claims
against firearm manufacturers. Colt was clearly a failing
company in a shrinking industry--not exactly the type of
company a pension manager would normally seek to invest $25
million.
Colt's financial problems were well-known to the State and
to the Investment Advisory Council. In fact, the State Economic
Development Authority had been trying to find a buyer or
investor for Colt Manufacturing for years. Unfortunately, no
venture capitalists or private money managers would touch Colt
Manufacturing with a 10-foot pole. So why did a majority, 7 out
of 10, of the Investment Advisory Council, vote in favor of
investing in Colt Manufacturing? Politics.
While the supporters of the IAC and the State Treasurer
wrapped this investment in rhetoric of ``prudence,'' ``due
diligence,'' and ``careful consideration,'' there was no
question that the primary reason for this investment was
political, for example, to save the 950 UAW workers from
certain unemployment.
Shortly after the State buyout of Colt, the Hartford
Courant ran an editorial noting that the State Treasurer,
Francisco Borges, had told the editors that the Colt investment
was not, ``to make money for the State, but to save jobs.''
Upon announcement of Colt's bankruptcy, Mr. Borges issued a
press release that bemoaned the bankruptcy of Colt, ``despite
our best efforts in saving the company from demise or
dismantling 2 years ago.''
These two statements are very enlightening--the State's
investment in Colt was not about higher returns for the State
pension funds, it was not about sound investment practices, it
was about saving a company from certain ``demise.'' Like I
said, it was politics over prudence.
As a former member of the State of Connecticut's House of
Representatives and as a firsthand witness of the hearings and
deliberations of the Investment Advisory Council, I am well
aware of the difficulty in shielding State investment funds
from political influence. The failed investment in Colt is only
the starkest and most dramatic example of the effect of
politics on investment decisions.
During my tenure on the IAC, our investment decisions were
limited by legislative action, by the State of Connecticut
limiting our investment in companies located in Northern
Ireland and South Africa, and by rules requiring us to consider
the ``environmental records'' of companies in which we invest.
Even more troubling, the influence of State investment
funds is not limited to the investment decisions of the State,
but also is affected by the active role of the State in the
governance of the companies in which the State invests. In
fact, the State used to have a person in charge of voting the
State's proxies at shareholder meetings, thus ensuring that the
State's restrictions on investing in various foreign countries
or the State's concerns over environmental or other matters
were heard at such meetings.
My experience with the State of Connecticut pales in
comparison to the meddling politics could ultimately play were
the Federal Government to invest Social Security surpluses in
private markets. Connecticut's pension was equal to
approximately $8 billion at the time we invested in Colt--a
paltry sum compared to the trillions that could ultimately be
invested by the Federal Government.
Would the Federal Government be able to resist the
temptation to invest in suffering steel companies to save jobs?
Would the government be able to resist the temptation to limit
its investment to ``union-friendly'' companies? Would the
government be tempted to meddle in the pay scales of the
companies it invests in to lower wage disparities between
management and labor? Would the Federal Government be able to
add weight to its antitrust cases by threatening to divest in
companies it files cases against? Or, worse yet, would the
Federal Government pursue antitrust cases against companies it
owns share of? I fear not, and for that reason, I strongly
oppose allowing the Federal Government to invest surplus funds
in private markets.
Mr. Chairman, the United States has been a shining example
of the benefits of the free enterprise system to the rest of
the world. As a result of the success of our system, countries
around the world have divested their government's ownership in
private companies. France is exiting Renault, England has sold
British Airways, and Germany is divesting in Lufthansa. And
there are many other examples.
I am baffled that the President would now move our
government in the opposite direction and follow the disastrous
and the discredited example of foreign governments by buying
shares of private corporations.
I thank you, Mr. Chairman, and Members of the Subcommittee
for listening to my testimony.
Thank you.
[The prepared statement follows:]
Statement of Hon. Maureen M. Baronian, Vice President and Principal,
Investors Services of Hartford, Inc., Hartford, Connecticut; Former
State Representative, Connecticut General Assembly; and Former Trustee,
Investment Advisory Council, State of Connecticut
Chairman Shaw, Ranking Member Matsui and Members of the
Subcommittee, thank you for inviting me to be here today. As a
member of the Investment Advisory Council (IAC) for the State
of Connecticut from 1987 to 1995, I have seen first hand the
results of allowing governments to invest directly in private
equity markets. I can only hope that my experiences will help
enlighten this Committee as it considers President Clinton's
proposal to invest a portion of the federal Social Security
surplus in private markets.
Almost 10 years ago, on March 22, 1990, the State of
Connecticut Retirement and Trust Funds joined with members of
the United Auto Workers, some existing members of Colt
management, and a few other private investors to complete a
buyout of the Colt Firearms Division of Colt Industries, Inc.
In all, the State placed $25 million in State pension funds
into this buyout ($17.5 million in CF Holding and $7.5 million
in CF Intellectual Properties--which owns the Colt trademark).
This investment gave the State of Connecticut a 47 percent
share of Colt Manufacturing.
Unfortunately, in less than two years, on March 18, 1992,
CF Holding Corporation filed for Chapter 11 Bankruptcy.
Fortunately, the State Pension's loss was ``limited'' to
``only'' $21 million--after the Colt trademark was sold to the
Economic Development Authority of Connecticut two years later.
While it is not uncommon for Pension funds to lose money on the
investments they make, the case of Connecticut's investment in
Colt is an example where politics, not prudence led to the
failed investment.
For months leading up to this investment, Connecticut
newspapers were filled with editorials and news reports on the
financial crisis facing Colt Manufacturing--a company that
employed 950 people. Colt finances were in disarray, it lacked
positive cash flow, it had low reserves, and it was suffering
from a bitter four-year strike by its labor union which had
resulted in a $10 million fine by the National Labor Relations
Board (NLRB).
Not only was Colt in trouble, industry analysts pointed to
a shrinking market for firearms, growing international
competition and an increasing threat of liability claims
against firearms manufacturers. Colt was clearly a failing
company in a shrinking industry--not exactly the type of
company a pension manager would normally seek to invest $25
million.
Colt's financial problems were well known to the State and
to the Investment Advisory Council. In fact, the State Economic
Development Authority had been trying to find a buyer or
investor for Colt Manufacturing for years. Unfortunately, no
venture capitalists or private money managers would touch Colt
Manufacturing with a ten-foot pole. So why did a majority (7 of
10) of the Investment Advisory Council vote in favor of
investing in Colt Manufacturing? Politics
While the supporters in the IAC and the State Treasurer
wrapped this investment in the rhetoric of ``prudence,'' ``due
diligence,'' and ``careful consideration,'' there was no
question that the primary reason for this investment was
political--i.e., to save 950 UAW workers from certain
unemployment.
Shortly after the State buyout of Colt, the Hartford
Courant ran an editorial noting that the State Treasurer,
Francisco Borges, had told the editors that the Colt investment
was not ``to make money for the state but to save jobs.'' Upon
announcement of Colt's bankruptcy Mr. Borges issued a press
release that bemoaned the bankruptcy of Colt ``despite our best
efforts in saving the company from demise or dismantling two
years ago.'' These two statements are very enlightening--the
States investment in Colt was not about higher returns for
state pension funds, it was not about sound investment
practices, it was about saving a company from certain
``demise.'' Like I said, it was politics over prudence.
As a former member of the State of Connecticut's House of
Representatives and as a first hand witness of the hearings and
deliberations of the Investment Advisory Council, I am well
aware of the difficulty in shielding state investment funds
from political influence. The failed investment in Colt is only
the starkest and most dramatic example of the effect of
politics on investment decisions. During my tenure on the IAC,
our investment decisions were limited by legislative action by
the State of Connecticut limiting our investment in companies
located in Northern Ireland and South Africa, and by rules
requiring us to consider the ``environmental records'' of the
companies in which we invest.
Even more troubling, the influence of state investment
funds is not limited to the investment decisions of the State,
but also is effected by the active role of the State in the
governance of the companies in which the State invests. In
fact, the State used to have a person in charge of voting the
States proxies at shareholder meetings, thus ensuring that the
States restrictions on investing in various foreign countries
or the States concerns over environmental matters were heard at
such meetings.
My experience with the State of Connecticut pales in
comparison to the meddling politics could ultimately play were
the federal government to invest Social Security surpluses in
private markets. Connecticut's pension was equal to
approximately $8 billion at the time we invested in Colt--a
paltry sum compared to the trillions that could ultimately be
invested by the federal government.
Would the federal government be able to resist the
temptation to invest in suffering steel companies to save jobs?
Would the government be able to resist the temptation to limit
its investment to ``union-friendly'' companies? Would the
government be tempted to meddle in the pay scales of the
companies it invests in to lower wage disparities between
management and labor? Would the federal government be able to
add weight to its anti-trust cases by threatening to divest in
companies it files cases against? Or worse yet, would the
federal government pursue anti-trust cases against companies it
owns shares of? I fear not, and for that reason, I strongly
oppose allowing the federal government to invest surplus funds
in private markets.
Mr. Chairman, the United States has been a shining example
of the benefits of the free enterprise system to the rest of
the world. As a result of the success of our system, countries
around the world have divested their government's ownership in
private companies: France is exiting Renault, England has sold
British Airways, and Germany is divesting in Lufthansa. I am
baffled that the President would now move our government in the
opposite direction and follow the disastrous and discredited
example of foreign governments by buying shares of private
corporations.
Chairman Shaw. Thank you, Ms. Baronian.
Mr. Tanner.
STATEMENT OF MICHAEL TANNER, DIRECTOR, HEALTH AND WELFARE
STUDIES, CATO INSTITUTE
Mr. Michael Tanner. Thank you, Mr. Chairman, Mr. Matsui,
and distinguished Members of the Subcommittee. I want to start
off by saying how pleased I am to have the opportunity today to
talk to you about Social Security reform and how particularly
pleased I am that the Clinton administration has had the
courage to bring this issue forward, to touch the third rail of
American politics and engender a real debate about the future
of Social Security. I am also very pleased that the Clinton
administration has recognized that investment in private
capital markets must be part of any Social Security reform.
That said, I must disagree with the details of how the
President would go about this and that, rather than allowing
individuals to invest, the President would allow the Federal
Government to do the investing.
Allowing the Federal Government to purchase stocks would
give it the ability to obtain a significant, if not a
controlling, share of virtually every major company in America.
Experience has shown that even a 2- or 3-percent block of
shares can give an activist shareholder influence over the
policies of publicly traded companies. The result could
potentially be a Federal Government that intervenes in how
corporations conduct their affairs, making those decisions on
the basis of political passions, rather than on the best
interests of the company, the economy, or the shareholders.
The experience of State employee pension funds suggests
that governments have difficulty resisting the temptation to
meddle in corporate affairs. For example, in the late eighties,
State employee pension plans in California and New York were
primarily responsible for the election of a new board chairman
for General Motors. And according to a 1990 report by the U.S.
House of Representatives Committee on Labor, State employee
pension plans were increasingly using their clout and voting
their shares to influence the corporate role in environmental
improvement, humanitarian problems, and economic development.
But even if the government could remain passive, its very
ownership of large blocks of stock would, in effect, create
situations favoring certain stockholders and corporate
managers.
As the General Accounting Office has pointed out, if the
government did not exercise its voting rights, other
stockholders would find their own voting power enhanced and
could take advantage of government passivity. The GAO also
warns that regardless of whatever stock voting rules are
adopted when the program begins, Congress can always change the
rules in the future. Experience with various budget agreements
and caps should indicate that no Congress can bind future
Congresses as to what they may do.
The second problem is the whole question of social
investing, which is the question of even if the government can
avoid directly using its equity ownership to influence
corporate governance, there is likely to be an enormous
temptation to allow political considerations to influence the
type of investments the government makes. I think you have just
heard an example of that.
The whole idea of this can best be summed up in a task
force on social investing convened by Mario Cuomo--then-
Governor Mario Cuomo--of New York, who held that public
employees were merely one stakeholder in their pensions, along
with the rest of society and therefore, the trustees of public
pensions were entitled to balance the interest of society
against the interests of the public employee.
Using that criterion, they rejected the idea that
investments should be made solely on the basis of maximizing
immediate returns, and instead, should focus on ways to
maximize the direct and indirect returns to all stakeholders,
including the larger society and the economy.
Other States have taken that to heart, and today
approximately 42 percent of State, county and municipal pension
systems have restrictions targeting some portion of investments
to projects designed to stimulate the local economy or create
jobs. In addition, 23 percent of pension systems have
prohibitions against specific types of investments, such as
companies that failed the meet the MacBride Principals in
Northern Ireland; companies that do business in Libya or other
Arab countries; companies that are accused of pollution, unfair
labor practices, failing equal employment opportunity
guidelines; alcohol, tobacco and defense industries; and even
companies that market infant baby formula in the Third World.
In the few moments I have left, I just want to caution
against one misunderstanding. And that is that the Federal
Thrift Savings Program can be in any way compared to the idea
of government investment of Social Security Trust Funds. The
Thrift Savings Program is a defined contribution program with
individually owned accounts. Workers have a property right in
their account, which is not true of Social Security.
There is the case of Fleming v. Nester in 1960. The U.S.
Supreme Court held that individuals have no legal right to
their Social Security benefits. And allowing the government to
invest a portion of Social Security revenues in capital markets
would do nothing to change this. Therefore, a government-
invested Social Security Program would be far more akin to the
defined benefit State employee pension systems that I have been
describing in which the individual is not the sole interest of
the investors.
Because workers have no ownership rights to their pension
funds, the government has no fiduciary duty to those workers.
The situation may be even worse than the Social Security
system, since the exclusive benefit rule, which the IRS imposes
on State employee systems, would not be applicable to the
Social Security system.
Finally, I would just mention that the Thrift Savings
Program is transparent as a defined contribution program.
Individual workers can see the result directly of any change in
government investment. That would not be the case under Social
Security, where the costs of social investing would be hidden
within the entire system.
I thank you very much.
[The prepared statement follows:]
Statement of Michael Tanner, Director, Health and Welfare Studies, Cato
Institute
Mr. Chairman, Distinguished Members of the Committee:
My name is Michael Tanner and I am the Director of Health
and Welfare Studies at the Cato Institute, as well as Director
of Cato's Project on Social Security Privatization. I very much
appreciate the opportunity to appear before you today and
discuss the problems inherent in any attempt to allow the
government to invest Social Security funds in private capital
markets.
First, let me begin by saying that I appreciate President
Clinton's proposal for Social security reform. The president
deserves enormous credit for having the courage to tackle this
most contentious of political issues. I also commend the
president for recognizing that private capital investment must
be central to any reform of Social Security. That recognition
could form the basis for moving forward in a bipartisan way to
ensure that future retirees will be able to retire with the
same security as their parents and grandparents.
That said, however, as currently formulated, there are
serious problems with the presidents proposal and with the
entire concept of allowing the federal government to invest
directly in private capital markets. Superficially, that
approach offers some attraction. It promises the advantages of
higher returns through private capital investment, while
spreading individual risk and minimizing administrative costs.
In reality, allowing the government to control such an enormous
amount of private investment, in the words of Federal Reserve
Chairman Alan Greenspan, ``has very far reaching potential
dangers for a free American economy and a free American
society.'' \1\
The Current System
Social Security is currently running a surplus. In 1996,
for example, Social Security taxes--both payroll taxes and
income taxes on benefits--amounted to $385.7 billion. Benefit
payments and administrative expenses totaled only $353.6
billion, resulting in a surplus of $70.8 billion.\2\ Under
current law, that money must be invested solely in U.S.
government securities. The securities can be any of three
types: government securities purchased on the open market;
securities bought at issue, as part of a new offering to the
public; or special-issue securities, not traded publicly. In
actual practice, virtually all the securities purchased have
been special-issue securities, \3\ which earn an interest rate
equal to the average market rate yield on all U.S. government
securities with at least four years remaining until maturity,
rounded to the nearest one-eighth percent--an average of
approximately 2.3 percent above inflation.
By contrast, equities have earned an average 7.56 percent
real rate of return over the past 60 years. Some have suggested
that the government should be allowed to invest a portion of
the Social Security surplus in equities rather than government
securities, allowing the Social Security system to reap the
benefits of the higher rate of return.\4\
Proposals for Government Investing
The idea of allowing the government to invest excess Social
Security funds in private capital markets is not a new one. As
early as the 1930s, fiscal conservatives warned that unless
private securities were included in the government's portfolio,
the trust fund would earn less than market returns. But they
also realized that if the government invested in private
securities, it would lead to large-scale government ownership
of capital and interference in American business. Sen. Arthur
Vandenberg (R-Mich.) warned that ``it is scarcely conceivable
that rational men should propose such an unmanageable
accumulation of funds in one place in a democracy.'' \5\ In the
end, Congress rejected not only government investing but any
system of full funding, establishing a pay-as-you-go program in
which nearly all the taxes paid by current workers are not
saved or invested in any way but used to pay benefits to
current retirees.
Two factors brought the concept of government investing
back into public debate. First, following a series of Social
Security reforms in 1983, the Social Security system began to
run a modest surplus. Second, demographic trends made it clear
that the program's pay-as-you-go structure was not sustainable.
Proposals for government investment first appeared in
legislation in the early 1990. The idea received widespread
public attention when 6 of the 13 members of the 1994-96
Advisory Council on Social Security recommended the investment
of up to 40 percent of the Social Security Trust Fund in
private capital markets.\6\ As Robert Ball, author of the
proposal, put it, ``Why should the trust fund earn one third as
much as common stocks?'' \7\
However, this approach is fraught with peril.
Corporate Governance
Allowing the federal government to purchase stocks would
give it the ability to obtain a significant, if not a
controlling, share of virtually every major company in America.
Experience has shown that even a 2 or 3 percent block of shares
can give an activist shareholder substantial influence over the
policies of publicly traded companies.\8\
The result could potentially be a government bureaucrat
sitting on every corporate board, a prospect that has divided
advocates of government investing. Some have claimed that the
government would be a ``passive'' investor--that is, it would
refuse to vote its shares or take positions on issues affecting
corporate operations. Others, such as the AFL-CIO's Gerald
Shea, have suggested that the government should exercise its
new influence over the American economy, claiming that
government involvement would ``have a good effect on how
corporate America operates.'' \9\
The experience of state employee pension funds suggests
that governments may not be able to resist the temptation to
meddle in corporate affairs. For example, in the late 1980s,
state employee pension plans in California and New York
actively attempted to influence the election of a new board
chairman for General Motors.\10\ According to a report by the
U.S. House of Representatives, state employee pension plans are
increasingly using their clout to influence ``the corporate
role in environmental improvement, humanitarian problems, and
economic development.'' \11\
Supporters of government investment claim that the
government would remain a passive investor, refusing to vote
its shares. However, that would require an extraordinary degree
of restraint by future presidents and congresses. Imagine the
pressure faced by a congress if the government were to own a
significant interest in a company that was threatening to close
its plants and move them overseas at the cost of thousands of
jobs. Could politicians really remain passive in the face of
such political pressure?
Even if the government remained passive, its very ownership
of large blocks of stock would, in effect, create a situation
favoring certain stockholders and corporate managers. As the
General Accounting Office has pointed out, if the government
did not exercise its voting rights, other stockholders would
find their own voting power enhanced and could take advantage
of government passivity.\12\
The GAO also warns that regardless of what stock voting
rules are adopted when the program begins, Congress can always
change the rules in the future.\13\
Social Investing
Even if the government avoids directly using its equity
ownership to influence corporate governance, there is likely to
be an enormous temptation to allow political considerations to
influence the type of investments that the government makes. In
short, should the government invest solely to earn the highest
possible return on investments, or should the government
consider larger political and societal questions?
The theory behind social investing was perhaps best
explained in a 1989 report by a task force established by then
Governor Mario Cuomo to consider how New York public employee
pension funds were being invested. The task force concluded
that state employee pension funds should not be operated solely
for the benefit of state employees and retirees. In the opinion
of the task force, those employees and retirees were only one
among several groups of ``stakeholders'' in state employee
pension programs, others being ``the plan sponsor; corporations
seeking investment capital from the pension fund; taxpayers who
support the compensation of public employees, including
contributions to the pension fund; and the public, whose well
being may be affected by the investment choice of fund
managers'' (emphasis added).\14\ Using that criterion, the task
force rejected the idea that investments should be made solely
on the basis of maximizing the immediate return to the pension
trust. Instead, pensions should be invested in a way that
maximizes ``both direct and indirect returns'' to all
stakeholders, including ``the larger society and economy.''
Therefore, the task force concluded, state employee pension
funds should be guided into economic development projects
beneficial to the state of New York.
Most state employee pension funds are subject to such
social investing. Alaska may have been the first state to
require social investing, with a requirement in the early 1970s
that a portion of state pension funds be used to finance home
mortgages in the state.\15\ The Alaska example also illustrates
the dangers of social investing. A downturn in the local real
estate market cost the fund millions of dollars that had to be
made up through other revenue sources.
Throughout the 1970s and 80s, social investment
increasingly came to be a part of state pension programs.\16\
It became a subject of widespread public debate in the mid-
1980s with the question of South African divestment.
Eventually, 30 states prohibited the investment of pension
funds in companies that did business in South Africa. Today,
approximately 42 percent of state, county, and municipal
pension systems have restrictions targeting some portion of
investment to projects designed to stimulate the local economy
or create jobs. This includes investment in local
infrastructure and public works projects as well as investment
in in-state businesses and local real estate development.\17\
In addition, 23 percent of the pension systems had prohibitions
against investment in specific types of companies, including
restrictions on investment in companies that fail to meet the
``MacBride Principles'' for doing business in Northern Ireland,
companies doing business in Libya and other Arab countries;
companies that are accused of pollution, unfair labor
practices, or failing to meet equal opportunity guidelines; the
alcohol, tobacco, and defense industries; and even companies
that market infant formula to Third World countries.\18\
A nearly infinite list of current political controversies
would be ripe for such restrictions if the federal government
began investing Social Security funds. Both liberals and
conservatives would have their own investment agendas. Should
Social Security invest in nonunion companies? Companies that
make nuclear weapons? Companies that pay high corporate
salaries or do not offer health benefits? Companies that do
business in Burma or Cuba? Companies that extend benefits to
the partners of gay employees? Companies that pollute?
Companies that donate to Planned Parenthood? Investment in
companies ranging from Microsoft to Nike, from Texaco to Walt
Disney, would be sure to engender controversy.
Supporters of government investment suggest two ways to
avoid the problem of social investing. First, they propose the
creation of an independent board to manage the system's
investment, a board that would operate free of any political
interference. However, Alan Greenspan, who should be in a
position to know about board independence, has said that he
believes it would be impossible to insulate such a board from
politics. Testifying before Congress on proposals for
government investment, Greenspan warned:
I don't know of any way that you can essentially insulate
government decisionmakers from having access to what will
amount to very large investments in American private industry.
. . . I know there are those who believe it can be insulated
from the political process, they go a long way to try to do
that. I have been around long enough to realize that that is
just not credible and not possible. Somewhere along the line,
that breach will be broken.\19\
Indeed, the difficulty of shielding investment decisions from
political considerations was illustrated, unintentionally, by one of
the supporters of government investment, Jonathan Cohn, writing in The
New Republic. ``It would be easy to prohibit manipulation of the market
for political reasons,'' Cohn wrote. ``All you would have to do is
assign responsibility for the investments to a quasi-independent body,
then carefully limit how it can make investment decisions.'' \20\ In
other words, the new agency would be independent except that Congress
would set restrictions on its investment decisions.
Supporters of government investment suggest a second means of
avoiding social investment: the investment would be made only in index
funds, eliminating the choice of individual stocks. However, that does
not eliminate social investment questions, since there would remain the
issue of what stocks should be included in the index, whether an
existing index or a new one created just for Social Security.
The Federal Thrift Savings Program: An Imperfect Analogy
Supporters of government investing often cite the federal
thrift savings program as an example to show that government
pension funds can avoid politicization. It is true that, so
far, the TSP has avoided social investment and interference
with corporate governance. However, there are several important
differences between the TSP and a government-invested Social
Security program.
Perhaps most importantly, the TSP is a defined-contribution
program with individually owned accounts. Workers do have a
property right in their account, which is not true of Social
Security. In the case of Fleming v. Nestor (1960), the U.S.
Supreme Court held that individuals have no property right in
Social Security. Allowing the government to invest a portion of
Social Security revenues in capital markets would do nothing to
alter that.
Therefore, a government-invested Social Security program
would be far more akin to defined-benefit state employee
pension plans. A 1990 congressional report concluded that while
workers acquire an interest in pension funds once they are
vested, they have no legal ownership rights. The report went on
to note that it would be equally incorrect to say that
government ``owned'' the funds because the government's
discretion in spending or disposing of the funds is limited
under state trust law and the Internal Revenue Code.\21\ The
report concludes that there is no exclusive ownership by either
party,\22\ and that ownership, in any case, may be unimportant
because ``public defined benefit pensions are entitlements
granted by governments that can be modified or taken away.''
\23\
Because workers have no ownership right to their pension
funds, the government has no fiduciary duty to the workers. The
situation may be even worse for a government-invested Social
Security system. For all the social investment practices
discussed above, state employee pension funds have been
somewhat restrained by the ``exclusive benefit rule,'' an
Internal Revenue Service ruling that requires tax-exempt trusts
to operate solely for the benefit of the trustees.\24\ The
applicability of that rule to government pension funds is
extremely limited, however, since the tax exemption status of
the trust is irrelevant. The employer--being the government--is
already tax exempt. Therefore, the only potential enforcement
mechanism is for the IRS to disqualify the plan, meaning that
workers would be taxed on the employer's contribution. Because
such a penalty would fall on innocent third parties, the threat
is seldom invoked. It is even more unlikely to be invoked in
the case of a government-invested Social Security system. It
would certainly be unfair to do so--to impose a huge new tax on
every American worker because the government mismanages the
investment of its funds. Of course, that assumes an IRS
independent enough to take action against the federal
government's own investment decisions. As a result, unlike the
TSP, there appears to be no legal barrier to social investing
under a government-invested Social Security program.
Second, as a defined-contribution program, the TSP is
transparent. Benefits are dependent on the return to their
investment, not on an arbitrary benefit formula. Therefore, the
workers have a direct interest in ensuring that investments are
made solely to maximize their returns. Workers can see exactly
how an investment decision impacts their retirement benefits.
Under a government-invested Social Security program, benefits
would be defined by law and would be only indirectly affected
by individual investment decisions. Therefore, workers would
have little incentive to resist social investing. They would
have no direct interest in whether investments are made solely
to maximize returns or for other purposes.
Finally, the TSP is a voluntary program. If workers are
dissatisfied with investment practices under the program, they
can refuse to participate. Therefore, fund managers have an
incentive to maximize returns. Failure to do so will result in
a loss of business. In contrast, a government-invested Social
Security system would be mandatory. Workers would be forced to
continue contributing 12.4 percent of their income to the
system, no matter how dissatisfied they were.
Clearly, then, there are both legal and market restraints
on the TSP that would not exist under a government-invested
Social Security system. Indeed, the TSP model would seem to
argue for exactly the opposite, a system of individually owned,
privately invested accounts. Only such a system would replicate
the TSP's safeguards--property rights, a fiduciary
responsibility, transparency, and an ability to remove funds
from a nonperforming investor.
A Nonsolution
Finally, it is important to recognize that allowing the
government to invest Social Security funds in private capital
markets will do nothing to solve most of Social Security's
problems. Yes, it will help preserve Social Security's
solvency. But it will do nothing to increase the near zero or
negative rate of return that can be expected by today's young
workers. It will do nothing to redress the inequities of the
current system that penalize working women, the poor, and
minorities. It will do nothing to give low income workers the
opportunity to accumulate real wealth. And, it will do nothing
to give Americans ownership over their retirement benefits.
The president is right: we need to take advantage of the
higher rates of return available through investment in private
capital markets. But that should be done not through government
investment, but through individual accounts.
Thank you.
Footnotes
1. Testimony of Alan Greenspan before the Senate Committee on
Banking, July 21, 1998.
2. 1998 Report of the Board of Trustees of the Federal Old-Age
Survivors and Disability Insurance Program (Washington: Government
Printing Office, 1998).
3. Robert Myers, Social Security (Philadelphia: University of
Pennsylvania Press, 1993), p. 142.
4. Supporters of government investing may actually be understating
the difference in returns. Under the current system, the interest
attributed to the government securities does not actually represent a
cash transfer but is attributed to the Social Security Trust Fund,
which makes the interest more notional than real. When the time comes
that payments must be made from the trust fund, the federal government
will have to appropriate the attributed interest from general revenues.
Thus, like the government securities themselves, the interest payments
do not represent real current wealth, merely a promise by the
government to tax future generations of workers. In contrast, if the
government invested in equities or other assets outside the government,
any return would result in a real increase in the system's assets.
5. Congressional Record, Vol. 81, Part 2, 75th Congress (March 17,
1937), p. 2324.
6. Report of the 1994-1996 Advisory Council on Social Security,
Volume I: Findings and Recommendations (Washington: Government Printing
Office, 1997), pp. 25-28.
7. Peter Passell, ``Can Retirees' Safety Net be Saved?'' New York
Times, February 18, 1997.
8. Theodore Angelis, ``Investing Public Money in Private Markets:
What Are the Right Questions?'' Presentation to a conference on
``Framing the Social Security Debate: Values, Politics, and
Economics,'' National Academy of Social Insurance, Washington, D.C.,
January 29, 1998.
9. ``Quoted in Michael Eisenscher and Peter Donohue, ``The Fate of
Social Security,'' Z Magazine, March 1997.
10. U.S. House of Representatives, Committee on Education and
Labor, Subcommittee on Labor-Management Relations, ``Public Pension
Plans: The Issues Raised over Control of Plan Assets,'' Committee
Print, June 25, 1990; U.S. House of Representatives, Committee on
Education and Labor, Public Pension Plans: The Issues Raised over
Control of Plan Assets, p.49.
11. Ibid.
12. General Accounting Office, ``Social Security Financing:
Implications of Government Stock Investing for the Trust Fund, the
Federal Budget, and the Economy,'' Report to the U.S. Senate Special
Committee on Aging, April 1998, p. 62.
13. Ibid.
14. Our Money's Worth: Report of the Governor's Task Force on
Pension Fund Investment (Albany: New York State Industrial Cooperation
Council, June 1989), p. 20.
15. Jennifer Harris, ``From Broad to Specific: The Evolution of
Public Pension Investment Restrictions,'' Public Retirement Institute,
Arlington, Va., July 1998.
16. For a thorough discussion of state employee pension systems and
their investment policies, see Carolyn Peterson, State Employee
Retirement Systems: A Decade of Change (Washington: American
Legislative Exchange Council, 1987).
17. James Packard Love, Economically Targeted Investing: A
Reference for Public Pension Funds (Sacramento: Institute for Fiduciary
Education, 1989).
18. Love, Economically Targeted Investing; Peterson, State Employee
Retirement Systems.
19. Testimony of Alan Greenspan.
20. Jonathan Cohn, ``Profit Motives,'' New Republic, July 13, 1998.
21. U.S. House of Representatives, Committee on Education and
Labor, Public Pension Plans: The Issues Raised over Control of Plan
Assets, pp. 44-46.
22. Ibid., p. 52.
23. Ibid., p. 50.
24. Internal Revenue Manual, Examination Guidelines Handbook, Sec.
711.1.
Chairman Shaw. Thank you, Mr. Tanner.
Dr. Reischauer.
STATEMENT OF ROBERT D. REISCHAUER, SENIOR FELLOW, ECONOMIC
STUDIES, BROOKINGS INSTITUTION
Mr. Reischauer. Thank you, Mr. Chairman. I appreciate the
opportunity to participate in this hearing.
During the past few weeks, the President's framework for
dealing with the surpluses project for the next 15 years has
generated a good deal of controversy and even more confusion.
For this reason, I have attached to my prepared statement my
analysis of his proposal, and I ask that this analysis be
included in the record of this hearing along with the paper
that my Brookings colleague Shanna Rose has prepared that
describes how Canada has gone about investing its Social
Security reserves in equities.
Overall, I think the President's framework is a prudent
approach. He would reserve 59 percent of the surpluses
projected for the next 15 years for debt reduction, or, looked
at another way, he would channel 71 percent into an improvement
in the net financial position of the Federal Government. That
larger estimate adds in the equities purchased for Social
Security. Looked at still another way, the President would
reserve 82 percent of the projected surpluses to boost national
savings.
Given the inherent uncertainty of budget projections, I
think the President has been wise to refrain from devoting more
than a small portion of the projected surpluses to commitments,
such as tax cuts or spending increases, that from a practical
standpoint may be politically irrevocable.
It is an unpleasant yet inescapable reality that there are
three, and only three, ways to close Social Security's long-run
deficit: taxes can be raised, benefits can be reduced, or the
return on the trust fund's reserves can be increased. Given
this reality, it's important to compare proposals to invest a
portion of Social Security's reserve in private securities with
the realistic alternatives.
While there are legitimate concerns with this option, which
I will discuss in 1 minute, there are also problems with the
alternatives, whether they be raising payroll taxes, increasing
the wage base, increasing the age at which unreduced or initial
benefits are paid, or reducing the size of the annual cost-of-
living adjustments.
There are two good reasons why it makes sense to invest a
portion of the trust fund's reserves in private securities.
First, such a policy would boost the earnings on the reserves
and thereby reduce the benefit cuts and payroll-tax increases
that will be required to deal with Social Security's long-run
problem.
Second, easing the restriction that requires Social
Security to invest its reserves exclusively in government
securities would provide workers with a fairer return on their
payroll-tax contributions, one that was closer to the benefits
that these contributions make to the Nation's economy. To the
extent that the reserve accumulation adds to national savings,
it generates total returns for the Nation equal to the average
return from private investment, which runs about 6 percent
above the rate of inflation. By paying Social Security a lower
return, a return that is projected to average about 2.8
percentage points over the next 75 years, the system denies
workers a fair return on their contributions.
However, some legitimate concerns have been raised about
investing trust fund reserves in private securities. Many fear
that such investments could disrupt financial markets. Others,
as you have heard from my colleagues here, are worried that
politicians in both the executive and legislative branches will
be tempted to use reserve investment policy to interfere with
markets or to meddle in the activities of private companies.
If there were no ways to reduce the risk of political
interference, to a de minimis level, it would be imprudent to
propose private investment of a portion of the trust fund's
reserves. And I would be a strong opponent of such a policy.
But fortunately, institutional safeguards can be created to
provide the necessary protections. Such an institutional
framework should have five elements.
First, an independent agency, modeled after the Federal
Reserve Board, should be created and charged with the task of
managing the trust fund's investments. Second, this agency
should be required to select, through competitive bids, several
private-sector fund managers, each of whom would be entrusted
with investing only a portion of the trust fund's reserves.
Third, these managers should be authorized only to make passive
investments, that is, investments in securities of companies
chosen to represent the broadest of market indexes.
In other words, there would be no picking and choosing of
individual stock, and the index would not reflect just a
portion of the market, such as the Dow Jones or the Standard &
Poor's 500, but rather, the entire range of stocks that are
traded on the major exchanges.
Fourth, Social Security investments should be comingled
with the funds that private accountholders have invested in the
same index funds that the managers, chosen by the board, would
offer to the public.
And finally, the fund managers should be required to vote
Social Security's shares solely to enhance the economic
interest of future Social Security beneficiaries. All of these
elements should be established in legislation. Of course, any
law that Congress enacts it can change. But the President would
have to sign that bill. And I believe that a powerful
constituency would develop to support a hands-off policy toward
trust fund investment.
I believe that this set of institutional arrangements
should be sufficient to insulate trust fund investment
decisions from political interference. There are those who
disagree with this judgment and who think the only way to
achieve higher returns on Social Security's reserves is to
place these reserves in the hands of individuals who would
invest them through personal accounts.
But that approach raises some very difficult questions,
such as: Would individual accounts place an unacceptable amount
of risk on individuals who are ill prepared to bear that risk?
What would happen to the social assistance now provided through
Social Security under a system of individual accounts? After
all, Social Security is the most effective and the least
controversial antipoverty program that the Nation has. Would
administrative costs eat up a large portion of the returns in a
system of personal accounts? The numbers that Secretary Summers
discussed actually were low compared to the Chilean and British
experiences. Could the system avoid excessive complexity, and
would such a system be politically sustainable?
I think the answers to these questions make personal
accounts an inappropriate way to provide American workers with
a secure, predictable, and inflation-protected foundation upon
which their other retirement income should be built.
Thank you, and I'll be happy to answer any questions at the
end of this panel.
[The prepared statement and attachments follow:]
Statement of Robert D. Reischauer,* Senior Fellow, Economic Studies,
Brookings Institution
Mr. Chairman and Members of the Subcommittee, I appreciate
this opportunity to discuss with you the issues raised by
proposals to invest a portion of Social Security's reserves in
private securities. My statement addresses three questions:
---------------------------------------------------------------------------
* This statement draws on Countdown to Reform: the Great Social
Security Debate, by Henry J. Aaron and Robert D. Reischauer (The
Century Foundation Press, 1998). The views expressed in this statement
should not be attributed to the staff, officers, or trustees of the
Brookings Institution.
---------------------------------------------------------------------------
Why do the Administration and others believe it
would be helpful to diversify the portfolio of assets held by
the Social Security trust fund?
What legitimate concerns are raised by investing
trust fund reserves in private securities? and
Are there ways to address these concerns?
Why invest in private securities?
It is an unpleasant yet inescapable reality that there are
three, and only three, ways to close Social Security's long run
fiscal deficit. Taxes can be raised, benefits can be reduced,
or the return on the trust fund's reserves can be increased.
Recently, some have suggested that a fourth way exists, one
that avoids unpleasant choices. This route would be to devote a
portion of the projected budget surpluses to Social Security.
However, transferring resources from the government's general
accounts to Social Security would only shift the locus of the
inevitable adjustments. Rather than boosting payroll taxes or
cutting Social Security benefits sometime in the future, income
taxes would have to be higher or non-Social Security spending
lower than otherwise would be the case.
Because neither the public nor lawmakers have greeted the
prospect of higher taxes or reduced spending with any
enthusiasm, the option of boosting the returns on Social
Security's reserves is worth close examination. While higher
returns can not solve the program's long run financing problem
alone, they can make the remaining problem more manageable.
Since the program's inception, the law has required that
Social Security reserves be invested exclusively in securities
guaranteed as to principal and interest by the federal
government. Most trust fund holdings consist of special
nonmarketable Treasury securities that carry the average
interest rate of government notes and bonds that mature in four
or more years and are outstanding at the time the special
securities are issued. In addition to their low risk, these
special issues have one clear advantage. They can be sold back
to the Treasury at par at any time--a feature not available on
publicly held notes or bonds, whose market prices fluctuate
from day to day. They also have one big disadvantage--they
yield relatively low rates of return.
It is not surprising that, when the Social Security law was
enacted, policymakers viewed government securities as the only
appropriate investment for workers' retirement funds. They were
in the midst of the Great Depression. The stock market collapse
and widespread corporate bond defaults were vivid in people's
memories. Many believed that a mattress or a cookie jar was the
safest place for their savings.
For many years, the restriction placed on trust fund
investment made little difference because Congress decided,
before the first benefits were paid, to forgo the accumulation
of large reserves that were anticipated under the 1935 law.
Instead, Congress voted in 1939 to begin paying benefits in
1940 rather than 1942, boost the pensions of early cohorts of
retirees, and add spouse and survivor benefits. The system was
to operate on a pay-as-you-go basis.
Legislation enacted in 1977 called for moving from pay-as-
you-go financing to ``partial reserve financing'' with the
accumulation of significant reserves. These reserves failed to
materialize because the economy performed poorly. Further
legislation in 1983, together with improved economic
performance, subsequently led to the steady growth of reserves.
By the end of 1998, the program had built up reserves of $741
billion, roughly twice annual benefits. Under current policy,
these reserves are projected to grow to more than $2.5
trillion--about 3.4 times annual benefits--by 2010. As reserves
have grown, the loss of income to Social Security from
restricting its investment to relatively low-yielding special
Treasury issues also has increased.
The restriction that has been placed on Social Security's
investments is unfair to program participants, both workers
paying payroll taxes and beneficiaries. To the extent that
trust fund reserve accumulation adds to national saving, it
generates total returns for the nation equal to the average
return on private investment, which runs about 6 percent more
than the rate of inflation. By paying Social Security a lower
return--a return projected to be only 2.8 percent more than
inflation over the next 75 years--the system denies workers a
fair return on their investment. As a consequence, either the
payroll tax rate has to be set higher than necessary to sustain
any given level of benefits or pensions have to be lower than
would be the case if the program's reserves received the full
returns they generate for the economy.
The restriction placed on the trust fund's investments has
had another unfortunate consequence. It has added considerable
confusion to the debate over alternative approaches to
addressing Social Security's long-run fiscal problem. Advocates
of various privatization plans argue that their approaches are
superior to Social Security because they provide better returns
to workers. In reality, the returns offered by these structures
look better only because the balances they build up are
invested not in low-yielding Treasury securities but rather in
a diversified portfolio of private securities. If Social
Security were unshackled, its returns would not just match, but
almost certainly exceed, those realized by the various reform
proposals.
There exists a very simple mechanism for compensating
Social Security for the restrictions that are placed on its
investment decisions. Each year, Congress could transfer sums
to the trust fund to make up the difference between the
estimated total return to investment financed by trust fund
saving and the yield on government bonds. This could be
accomplished with a lump sum transfer or by agreeing to pay a
higher interest rate--say 3 percentage points higher--on the
Treasury securities held by the trust fund. The transfer
required to make up the shortfall in 1998, when the average
trust fund balance was approximately $700 billion, would have
been about $23 billion, more than two and one-half times the
amount that is transferred to the trust fund from income taxes
on benefits.\1\
---------------------------------------------------------------------------
\1\ This estimate is based on the difference between the estimated
long-run returns on government securities and private assets, not on
the actual differences during 1998.
---------------------------------------------------------------------------
While general revenue transfers to social insurance plans
are commonplace around the world, they have been controversial
in the United States.\2\ Some would oppose such a transfer,
arguing that general revenue financing would weaken the
program's social insurance rationale through which payroll tax
contributions entitle workers to benefits. Others would object
to the tax increases or spending cuts needed to finance the
general revenue transfer. Still others would question the
permanence of such transfers, especially if the budget debate
begins to focus on maintaining balance in the non-Social
Security portion of the budget, out of which the transfers
would have to be made.
---------------------------------------------------------------------------
\2\ General revenues have been used in Social Security in limited
ways. The allocation of revenues from income taxation of Social
Security benefits is an application of general revenues. So were
payments made to provide Social Security earnings credits for the
military. In addition, when minimum Social Security benefits were
eliminated in 1981, they were preserved for those born before 1920 and
financed through a general revenue transfer.
---------------------------------------------------------------------------
An alternative approach would be to relax the investment
restrictions on Social Security and allow the trust fund to
invest a portion of its reserves in private stocks and bonds.
Such investments would increase the return earned by the
reserves and reduce the size of future benefit cuts and payroll
tax increases. Shifting trust fund investments from government
securities to private assets, however, would have no direct or
immediate effect on national saving, investment, the capital
stock, or production. Private savers would earn somewhat lower
returns because their portfolios would contain fewer common
stocks and more government bonds--those that the trust funds no
longer purchased. Furthermore, government borrowing rates might
have to rise a bit to induce private investors to buy the bonds
that the trust funds no longer held.\3\ Nevertheless, the
Social Security system would enjoy the higher returns that all
other public and private sector pension funds with diversified
portfolios realize.
---------------------------------------------------------------------------
\3\ With $3.7 trillion in outstanding debt, an increase in
borrowing costs of ten basis points (0.1 percentage points) would raise
annual federal debt service costs by $3.7 billion.
---------------------------------------------------------------------------
Concerns about investment of trust fund reserves in private securities
In 1935, Congress ruled out trust fund investments in
private stocks and bonds for good reasons. First, policymakers
were concerned that the fund's managers might, on occasion,
have to sell the assets at a loss, a move that would engender
public criticism. Second, they feared that if the fund had to
liquidate significant amounts of securities, these sales might
destabilize markets, depressing the value of assets held in
private portfolios and upsetting individual investors. An even
more important consideration was that they feared that
politicians--like themselves--might be tempted to use reserve
investment policy to interfere with markets or meddle in the
activities of private businesses.
The concerns that Congress had in 1935 were certainly
legitimate ones. But conditions have changed over the past 64
years in ways that reduce their saliency. Stock and bond
markets are far larger, less volatile, and more efficient now
than they were in the 1930s. Trust fund investment activities,
therefore, are less likely to disrupt markets. Moreover, the
trust fund is unlikely to be forced to sell assets at a loss
because the fund has significant and growing reserves, most of
which under the various proposals that call for trust fund
investment in private securities would continue to be held in
special Treasury securities. The trustees would almost
certainly sell the fund's government securities to get past any
short-run gap between benefit expenses and revenues.
On the other hand, the pressures special interests place on
lawmakers and the stresses imposed by reelection are probably
greater now than they were in the past. For these reasons, many
justifiably continue to be concerned about possible political
interference in trust fund investment activities. Chairman
Greenspan of the Federal Reserve Board has stated that he does
not ``believe that it is politically feasible to insulate such
huge funds from government direction.'' Others have been less
judicious, charging that equity investment by the trust fund
``amounts to nationalization of American industry'' and ``would
threaten our freedom.''
Those who oppose trust fund investment in private
securities point to the record of some private and state
government pension funds that have chosen to use social, as
well as economic, criteria to guide their investment policies.
In addition, some of these pension funds have voted the shares
of companies whose stock they own to further social objectives,
ones that might sacrifice some short- or long-run profits. The
fear is that the Social Security trustees might be subject to
similar pressures. Congress could force them to sell, or not
buy, shares in companies that produce products some people
regard as noxious, such as cigarettes, alcoholic beverages, or
napalm. Similarly, Congress could preclude investments in firms
that engage in business practices some regard as objectionable,
such as hiring children or paying very low wages in the
company's foreign factories, polluting the environment, or not
providing health insurance for their workers. Critics also fear
that the trust fund might retain shares in such companies and
use stockholder voting power to try to exercise control over
these firms.
Safeguards to protect trust fund investment decisions from political
pressures
If there were no effective way to shield trust fund
investment decisions from political pressures, the advantage of
higher returns that a diversified investment strategy would
yield would not be worth the price that would have to be paid.
However, experience suggests both that concerns about political
interference are exaggerated and that institutional safeguards
can be constructed that would reduce the risk of interference
to a de minimis level.
A number of federal government pension funds now invest in
private securities. They include the Thrift Saving Plan for
government workers and the pension plans of the Federal Reserve
Board, the U.S. Air Force and the Tennessee Valley Authority.
The managers of these pension funds have not been subject to
political pressures. They have pursued only financial
objectives in selecting their portfolios and have not tried to
exercise any control over the companies in which they have
invested.
Of course, the fact that the managers of smaller government
pension funds have not been subject to political pressures
provides no guarantee that the much larger and more visible
Social Security system would enjoy a similar fate. Special
interests might seek Congressional sponsors for resolutions
restricting investments more for the publicity such limits
would provide their cause than for any economic impact the
directive might have if carried out. In addition, some Members
might feel obliged to propose restrictions against investing in
corporations that have been found to violate anti trust laws,
trade restrictions, workplace health and safety regulations, or
other federal limits. Political pressures might cause others to
pressure the trustees to exclude investments in companies that
have closed a plant in their district and moved their
production facilities and jobs abroad.
For these reasons, it would be essential to enact
legislation that would create a multi-tiered firewall to
protect trust fund investment decisions from political
pressures, one that would forestall efforts by Members of
Congress or the executive branch from using trust fund
investments to influence corporate policy. The first tier of
such an institutional structure should be the creation of an
independent agency charged with managing the trust fund's
investments. This board--which could be called the Social
Security Reserve Board (SSRB)--could be modeled after the
Federal Reserve Board, which for over eight decades has
successfully performed two politically charged tasks--
controlling growth of the money supply and regulating private
banks--without succumbing to political pressures. Like the
governors of the Federal Reserve, the members of the SSRB
should be appointed by the president and confirmed by the
Senate. To ensure their independence, they should serve
staggered terms of at least ten years in length. Congress
should be empowered to remove a board member from office only
if that member was convicted of a serious offense or failed to
uphold their oath of office, not because Congress disliked the
positions taken by the member. As is the case with the Federal
Reserve Board, the SSRB should be given financial independence.
This could be ensured by allowing it to meet its budget by
imposing a tiny charge on the earnings of its investments.
Under such an arrangement, neither Congress nor the executive
branch could exercise influence by threatening to withhold
resources.
A second tier of protection should be provided by limiting
the discretion given to the SSRB. The primary responsibility of
the board should be to select, through competitive bids,
several private sector fund managers, each of whom would be
entrusted with investing a portion of the fund's reserves.
Depending on the amount invested, somewhere between three and
ten fund managers might be chosen. Contracts with the fund
managers would be rebid periodically and the board would
monitor the managers' performance.
A third tier of insulation from political pressures should
be provided by authorizing fund managers only to make passive
investments. They would be charged with investing in
securities--bonds or stocks--of companies chosen to represent
the broadest of market indexes, indexes that reflect all of the
shares sold on the three major exchanges. In other words, the
trust fund's investment would be in a total stock market index
such as the Wilshire 5,000 or Wilshire 7,000 index. If bonds
were included in the investment mix, the appropriate guide
might be the Lehman Brothers Aggregate (LBA) index. Unlike
actively managed mutual funds, there would be no discretion to
pick and choose individual stocks and, therefore, no window
through which political or social considerations could enter.
A fourth layer of defense should be provided by requiring
that Social Security's investments be commingled with the funds
that private account holders have invested in index funds
offered by the managers chosen by the SSRB. These private
investors would object strenuously if politicians made any
attempt to interfere with the composition of the holdings of
their mutual fund.
Fifth, to prevent the SSRB from exercising any voice in the
management of private companies, Congress should insist that
the several fund managers selected by the SSRB vote Social
Security's shares solely to enhance the economic interest of
future Social Security beneficiaries.
To summarize, this set of five institutional restraints
would effectively insulate fund management from political
control by elected officials. Long-term appointments and
security of tenure would protect the SSRB from political
interference. Limitation of investments to passively managed
funds and pooling with private accounts would prevent the SSRB
from exercising power by selecting shares. The diffusion of
voting rights among several independent fund mangers and the
requirement that the managers consider economic criteria alone
would prevent the SSRB from using voting power to influence
company management. In short, Congress and the president would
have no effective way to influence private companies through
the trust fund unless they revamped the SSRB structure. That
would require legislation which would precipitate a national
debate over the extent to which government, in its role as
custodian of the assets of the nation's mandatory pension
system, should interfere in the private economy. Framed this
way, there would be strong opposition to such legislation.
While nothing, other than a constitutional amendment, can
prevent Congress from repealing a previously enacted law, the
political costs of doing so would be high. Furthermore, if
Congress is disposed to influence the policies of private
businesses, it has many far more powerful and direct
instruments to accomplish those ends than through management of
the Social Security trust funds. The federal government can
tax, regulate, or subsidize private companies in order to
encourage or force them to engage in or desist from particular
policies. No private company or lower level of government has
similar powers.
Conclusion
Allowing the Social Security system to invest a portion of
its growing reserves in private assets will increase the
returns on the trust fund balances and reduce the size of the
unavoidable payroll tax increases and benefit reductions that
will be needed to eliminate the program's long-run deficit.
Concerns that political interests might attempt to influence
trust fund investment decisions are legitimate but
institutional safeguards can be enacted into law that would
reduce the possibility of such interference to a de minimis
level.
The President's Framework for the Budget Surplus: What Is It and How
Should It Be Evaluated?
The federal budget registered a surplus in fiscal year
1998, the first in 29 years.\1\ The budget for the current
fiscal year, 1999, will also end in surplus, producing the
first back-to-back surpluses since 1956-57. OMB projects that,
if tax and spending policies remain unchanged (the baseline
projection), significant surpluses will persist for several
decades. To ensure that this unexpectedly favorable fiscal
outlook is neither squandered nor frittered away, President
Clinton laid out in his fiscal year 2000 budget proposal a
framework for dealing with the projected surpluses of the next
15 years. The president's framework, which is multi-faceted and
complex, has proven difficult for even seasoned budget analysts
to explain.
---------------------------------------------------------------------------
\1\ This note uses the terms ``surplus'' and ``total surplus'' in
place of the more cumbersome ``baseline unified budget surplus.'' They
refer to the sum of the Social Security surplus and the surplus in the
government's other accounts. All of the figures are from OMB.
---------------------------------------------------------------------------
The president's framework
Assuming the economy performs as the Administration
projects, that OMB's estimates of future mandatory spending are
correct, and that tax and spending policies are not changed,
budget surpluses totaling $4.854 trillion will be realized over
the fiscal 2000 to 2014 period (Table 1). Both Social Security
and the government's non-Social Security accounts will register
sizeable surpluses over this period (Figure 1).
Table 1.--The Baseline Surplus and the President's Framework
(fiscal years 2000-2014)
----------------------------------------------------------------------------------------------------------------
Baseline Surplus $ billions President's Framework $ billions Percent
----------------------------------------------------------------------------------------------------------------
Total....................................... $4,854 Total......................... $4,854 100
Non-Social Security..................... (2,153) Debt reduction.............. (2,870) 59
Social Security......................... (2,701) * Increased discretionary (481) 10
spending.
USA accounts................ (536) 11
Equity investments for (580) 12
Social Security.
Added financing costs....... (387) 8
Addendum:.....................
Additional Treasury $2,184
securities for Social
Security.
Additional Treasury $686
securities for Medicare HI.
----------------------------------------------------------------------------------------------------------------
* Includes $5 billion from the Postal Service.
[GRAPHIC] [TIFF OMITTED] T7507.027
Under the president's framework, 59 percent of this
projected baseline surplus would be reserved to reduce debt
held by the public.\2\ The remaining 41 percent would be
available to commit now to current and future needs. The
president's budget proposes using this portion of the surplus
to increase discretionary spending, contribute to new personal
retirement accounts for workers (USA accounts), and buy
equities for the Social Security trust fund. Other policymakers
have suggested that all of the surplus not devoted to debt
reduction be used to cut taxes or expand discretionary and
entitlement spending. This would be inconsistent with the
allocation in the president's framework because the portion of
the surplus used to buy equities for the Social Security trust
fund is equivalent to debt reduction. The equities would be
liquid assets that could easily be sold, and the proceeds used
to redeem debt. Thus, under the president's framework, only 29
percent of the surplus is available for such initiatives.
---------------------------------------------------------------------------
\2\ The percentages used in this note are percents of the baseline
surplus. The Administration's descriptions of the framework calculate
percentages of the surplus excluding the added financing costs that
arise when a portion of the surplus is not used to reduce debt.
---------------------------------------------------------------------------
Under the president's framework, special Treasury
securities equal in value to the amount by which debt held by
the public is expected to be reduced over the 15 year period
would be credited to the Social Security and Medicare HI trust
funds (addendum, Table 1). These bonds would be in addition to
the special Treasury securities the trust funds receive when
Social Security and Medicare remit their annual surpluses to
the Treasury. The additional securities credited to the trust
funds would be registered as budget outlays under a change the
president proposes to make in current budget accounting
rules.\3\ The exact amounts that will be credited to the trust
funds each year will be specified in legislation enacted in
1999. Therefore, the actual reduction in debt held by the
public under the president's framework may end up being more or
less than the value of the securities added to the trust funds.
If the economy proves to be weaker than expected or
policymakers boost spending or cut taxes more than the
president has proposed, the reduction in debt held by the
public could be considerably smaller than the transfers made to
the trust funds.
---------------------------------------------------------------------------
\3\ This change is necessary to ensure that the projected unified
budget balance is reduced by the transfers and the resources can not be
spent again. Under current accounting rules, a transfer from the
general accounts to the trust funds would not affect the balance in the
unified budget because it would be an outlay from one account and an
offsetting receipt in another.
---------------------------------------------------------------------------
The goals of the president's framework
The president's framework has at least four different broad
objectives.\4\
---------------------------------------------------------------------------
\4\ In addition to these broad objectives, the president's
framework has objectives that are more tactical in nature such as to
free up resources for increased discretionary spending after fiscal
year 2000 and to check the impetus for large across-the-board tax cuts.
---------------------------------------------------------------------------
First, it is an effort to ensure that a large fraction--
roughly 82 percent--of the baseline surplus projected for the
next 15 years contributes to national saving by paying down
debt held by the public, purchasing equities for the Social
Security trust fund, and boosting the retirement saving of
workers (USA accounts).
Second, it is an attempt to establish a budgetary
environment in which debt reduction is politically sustainable.
Many believe that, without some restraints, lawmakers will
enact tax cuts and spending increases that dissipate the
projected surpluses. To thwart this, the president has wrapped
his policy of debt reduction in the protective armor of
initiatives to strengthen Social Security and Medicare.
Third, the president's framework is an initiative that
shifts some of the burden for supporting future Social Security
and Medicare benefits to the government's general funds. This
is accomplished by crediting the Social Security and Medicare
HI trust funds with more Treasury securities than the funds--
surpluses warrant. These infusions of obligations mean that
less of the long-run imbalances between future benefit costs
and payroll tax receipts in Social Security and Medicare will
be closed through payroll tax hikes and benefit cuts in those
programs and more will be financed through slower growth in
other program spending and higher levels of general taxes than
otherwise would occur.\5\ The equities purchased for the Social
Security trust fund will reduce the adjustments that Social
Security and the balance of government together will have to
make in the future.
---------------------------------------------------------------------------
\5\ In the short run, increased borrowing from the public
represents a third alternative. Such borrowing, however, would lead to
higher debt service outlays which eventually would require higher taxes
or spending cuts.
---------------------------------------------------------------------------
Fourth, the president's framework is an effort to improve
the prospect that Congress and the president can reach
agreements on measures that address the long-run solvency
problems facing Social Security and Medicare. It does this by
reducing the programs' funding shortfalls through the provision
of additional bonds to the trust funds. Because the shortfalls
will be smaller, fewer painful measures--payroll tax increases
and benefit reductions--will be needed to close the remaining
imbalances. For example, without the president's infusion of
extra bonds into the Social Security trust fund, benefit cuts
and payroll tax increases equivalent to 2.19 percent of taxable
payroll--a politically undigestible mouthful--would be required
to close the program's estimated 75 year imbalance. With his
policy, the adjustments would shrink to a size that lawmakers
might more readily swallow--about one percent of payroll.
Some critics have suggested that, by reducing the long-run
shortfall, the president's framework could undercut the
pressure on policymakers to act. But the president has not
claimed that his framework represents a full response to Social
Security's long-run financial problem. It buys time but does
nothing to lower future Social Security benefit promises. The
higher returns earned by equity investments and the interest
earnings on the additional bonds will boost the program's
revenues modestly. But, as the president has acknowledged,
other measures will be needed to complete the package.
The impact of the president's framework on public debt and Social
Security reserves
Under the president's proposal, the level of the debt held
by the public would fall from an estimated $3.670 trillion at
the end of fiscal 1999 to $1.168 trillion at the end of 2014,
or from 41.9 percent of GDP to 7.1 percent of GDP, the lowest
share of GDP since 1917 (Table 2). Whether this represents a
major or modest reduction depends critically on what one thinks
would happen to the budget surpluses if the president's
framework were not adopted. Of the many possibilities, the
following three scenarios encompass the range of plausible
alternatives:
Save Total Surplus. Under this scenario, all of
the budget surplus would be ``saved,'' that is, used to pay
down debt held by the public. If this happened, all of the debt
held by the public would be retired by 2013.
Save Social Security Surplus. Under this scenario,
the surpluses in the Social Security accounts would be used to
pay down debt held by the public.\6\ The surpluses in the non-
Social Security accounts would be devoted to tax cuts and
spending increases. Debt held by the public would amount to
$1.149 trillion or about 7 percent of GDP by the end of fiscal
2014 under this scenario.
---------------------------------------------------------------------------
\6\ This would net out the $12 billion deficit that the
Administration projects the non-Social Security accounts will register
in fiscal year 2000.
---------------------------------------------------------------------------
Dissipate Surplus. Under this scenario, all of the
unified budget surplus would be dissipated through tax cuts and
spending increases. Debt held by the public would not decline,
but rather would rise a bit to $3.849 trillion for reasons that
relate to the way credit programs are treated under current
budget accounting rules.
Most analysts who are familiar with the pressures facing
lawmakers consider the ``Dissipate Surplus'' scenario to be the
most likely. In other words, they believe that most, if not
all, of the projected budget surplus will be dissipated if some
enforceable framework for protecting the surplus is not
enacted. Compared to this situation, the president's framework
is a model of fiscal prudence. Over the next five, ten, and
fifteen years, the president's plan would reduce the levels of
public debt by $464 billion, $1.341 trillion and $2.681
trillion, respectively, compared to the levels that would exist
if all of the surplus was dissipated on tax cuts and spending
increases.
The president's framework would reduce the level of debt
held by the public marginally less than would be the case under
the scenario in which all of the Social Security surpluses were
devoted to debt reduction. Specifically, public debt in 2004,
2009, and 2014 would be higher by roughly $249 billion, $317
billion, and $19 billion, respectively, under the president's
framework. However, the equity investments provided to the
Social Security trust fund under the president's framework,
which are functionally equivalent to debt reduction, would
amount to $768 billion by the end of 2014.\7\ Counting these
assets, the net liabilities of the government under the
president's framework would be lower after 2008 than those
under the scenario in which the Social Security surplus was
devoted exclusively to debt reduction.
---------------------------------------------------------------------------
\7\ This includes investments of $580 billion plus reinvested
earnings of $188 billion.
[GRAPHIC] [TIFF OMITTED] T7507.026
The president's proposal would reduce the debt held by the
public over the next five, ten, and fifteen years by about $364
billion, $1,068 billion and $1,168 billion less than would be
the case if all of the total budget surplus were devoted to
paying down federal debt.
Reserves in the Social Security trust fund would be larger
under the president's framework than under any of the
alternative scenarios because additional Treasury securities
and equities would be credited to the trust fund and these new
assets would generate interest, dividends, and capital gains.
By 2014, the trust fund balance would be augmented by about
$3.752 trillion.
General fund support for Social Security and Medicare under the
president's framework
Some have argued that the president's framework--which will
credit the Social Security trust fund with equities and the
Social security and Medicare HI trust funds with special
Treasury securities in excess of those due them in return for
their annual surpluses--represents a sharp break with past
policy, which they interpret as requiring that these programs
be financed exclusively through payroll tax receipts and
interest earnings on the trust fund reserves that accumulate
when payroll tax receipts exceed benefit costs.\8\ The
additional securities and the equity investments that the trust
funds will receive represent general fund support for these
social insurance programs. They will postpone the dates at
which the trust funds become insolvent. The additional Treasury
securities will not, however, reduce the size of the
adjustments that the government will have to make in the
future, nor will they affect the timing of these adjustments.
Rather than forcing adjustments--tax increases or spending
cuts--within the Social Security and Medicare programs, the
trust funds will redeem their added securities; the Treasury
will have to come up with the resources by increasing general
revenues, reducing the growth of non-Social Security, non-
Medicare spending, or borrowing from the public, which would
push up debt service costs.
---------------------------------------------------------------------------
\8\ In fact, general revenues have been and are used for Social
Security and Medicare HI in limited ways. A portion of the income tax
receipts that derive from including Social Security benefits in the
taxable income of upper-income recipients is transferred to each trust
fund. Payments made to provide Social Security earnings credits for the
military were taken from general revenues. In addition, when minimum
Social Security benefits were eliminated in 1981, they were preserved
for those born before 1920 and financed through a general revenue
transfer.
---------------------------------------------------------------------------
There are political, historical, and economic
justifications for the president's proposal to shift some of
the burden for supporting future Social Security and Medicare
benefits to general revenues. The political arguments were
alluded to previously. One is that the transfer of securities
to the trust funds, which creates a future general fund
obligation, when combined with the proposed budget accounting
change, will make a policy of debt reduction politically
sustainable. A second argument is that by shifting some of the
burden for adjustments onto the general funds the dimensions of
the long run problems facing these two programs will be reduced
to magnitudes that politicians may find more manageable.\9\
---------------------------------------------------------------------------
\9\ An alternative way of trying to protect Social Security
surpluses for debt reduction would be to exclude the Social Security
accounts from all budget discussions and presentations, as former
Representative Livingston and others have proposed, and focus the
debate on the on-budget surplus.
---------------------------------------------------------------------------
The historical justification is that an infusion of general
revenues represents compensation for the fact that, during the
early years, Social Security and Medicare payroll taxes were
used to support benefits that more appropriately should have
been paid for out of general revenues because these benefits
were more social welfare than social insurance.
The 1935 Social Security Act set pensions for those
retiring during the program's first few decades at very meager
levels--ones that were commensurate with the modest payroll tax
contributions the first cohorts of retirees were expected to
make. The initial beneficiaries in 1942 would have received a
maximum monthly pension of $25 (in 1998 dollars); the first
workers to receive full pensions under the 1935 law--those
turning 65 in 1979--would have received pensions of less than
$250 a month (in 1998 dollars). Under this parsimonious
approach, large trust fund balances would have accumulated and
these reserves would have generated interest income that would
have helped pay future pensions.
In 1939, Congress decided to begin paying benefits in 1940
rather than 1942, raise pensions, and add spouse and survivor
benefits to the worker pensions established in the 1935 law.
Benefits for these early cohorts were boosted periodically
thereafter. These decisions were made to ameliorate a broad
social problem--widespread poverty among the elderly whose
earnings and savings had been decimated by the Great
Depression. The 1939 and subsequent reforms reduced the amount
of general revenues needed to support the welfare program for
the aged. They provided income support to millions without the
stigma of welfare or the inequities associated with the inter-
state differences in welfare payment levels that characterized
the Old Age Assistance program.\10\ While the arguments for
providing more generous pensions than the original Social
Security Act called for to those turning 65 during the four
decades after 1940 was certainly defensible, it imposed a
burden on the Social Security system that would have been more
appropriately placed on general revenues.
---------------------------------------------------------------------------
\10\ Old Age Assistance (OAA)--which was replaced by the
Supplemental Security Income (SSI) program in 1974--was an open ended
federal grant that reimbursed states for a share of their welfare
expenditures for the indigent aged. Even with the expansion of Social
Security, OAA provided benefits to more elderly than did Social
Security until 1949 and distributed more money than the pension system
did until 1951.
---------------------------------------------------------------------------
The implementation of Medicare followed a similar pattern.
Starting in 1966, those age 65 and older who were eligible for
Social Security benefits--and their spouses, if they were age
65 or older--became eligible for Medicare benefits even though
they had not contributed a penny in Medicare payroll taxes to
the HI trust fund. The first cohorts of workers who will have
paid HI payroll taxes for their entire careers will become
eligible for benefits only after 2005.
An economic justification for some general revenue
contribution to the Social Security program arises from the
difference between the benefit Social Security's surpluses
provide to the nation's economy and the return that is earned
by the trust fund on its reserves.\11\ Additions to national
saving generate a real return to the economy of at least 6
percent. Social Security surpluses, however, earn less because
the trust fund is required to hold its reserves exclusively in
special Treasury securities that, over the long run, are
projected to pay an average real return that is under 3
percent. To provide workers with a fair return on the portion
of their payroll taxes that bolsters the trust fund reserves,
policymakers could allow Social Security to invest its reserves
in higher yielding assets, agree to pay a higher rate of
interest on the special Treasury securities held by the trust
fund, or credit the trust fund with additional bonds. The
president's framework represents a mixture of the first and
third of these alternatives.
---------------------------------------------------------------------------
\11\ This justification is irrelevant for Medicare, both because
roughly 30 percent of the program is supported through general revenues
and because the trust fund balances are small and not expected to grow
significantly in the future.
---------------------------------------------------------------------------
The ``double counting'' issue
Many lawmakers and some analysts have criticized the
president's framework not only for its complexity but also
because it engages in what they consider to be ``double
counting.'' Specifically, they object to the fact that the
president's plan seems to commit 159 percent of the budget
surplus--59 percent to pay down debt held by the public; 12
percent to buy equities for the Social Security trust fund; 29
percent for USA accounts, new discretionary spending, and
associated debt service costs; and 59 percent to provide
additional Treasury securities to the Social Security and
Medicare HI trust funds (Figure 2). They charge that it is
budget legerdemain to use the same dollar to both pay down debt
and boost reserves in the Social Security and Medicare HI trust
funds, as appears to be the case under the president's
framework.
But using budget surplus dollars to redeem debt is
fundamentally different from devoting these surpluses to tax
cuts or increased spending. In the latter situations, the
benefit of the use is external--it flows to taxpayers or
program beneficiaries. In the case of debt reduction, the
government is reducing its external liabilities. In effect, it
is strengthening its balance sheet by buying assets (government
bonds held by the public). By crediting the trust funds with
these assets, as is done under the president's framework, the
benefit of the improvement in the government's balance sheet is
directed towards preventing future payroll tax increases and
benefit cuts rather than towards general tax cuts or spending
increases for other government programs. The exchange, however,
is not a wash--that is, the increase in the total liabilities
of the non-Social Security, non-Medicare portion of the budget
would be modestly larger than the reduction in the program
adjustments necessary to meet future Social Security and
Medicare benefit commitments.\12\
---------------------------------------------------------------------------
\12\ The liabilities would be higher because interest earned on the
added securities will boost the trust fund's reserves by about $800
billion over the period. This increase in reserves will not be offset
by a reduction in public debt.
[GRAPHIC] [TIFF OMITTED] T7507.028
Conclusion
The prospect of growing budget surpluses over the next
several decades, together with the expiration of the
discretionary spending caps and pay-as-you-go rules after
fiscal year 2002, has created a need to establish some
framework for dealing with the nation's fiscal good fortune.
Absent such a framework, fiscal discipline could break down and
a feeding frenzy of tax cuts and spending increases could
erupt. If so, the surpluses could be dissipated by addressing
immediate needs that, in retrospect, could appear trivial when
compared to the priorities that emerge over the next two
decades.
The president has proposed one framework for dealing with
the projected surpluses; other policy makers have put forward
alternatives. Senator Domenici (R-NM), chair of the Senate
Committee on the Budget, has recommended that all of the Social
Security surpluses be reserved for debt reduction and that only
the projected surpluses in the non-Social Security accounts be
available for current commitment. Representative Kasich (R-OH),
chair of the House Committee on the Budget, has suggested that
commitments can be made now to cut taxes (or increase spending)
as long as those initiatives (and the resultant financing
costs) do not absorb more than 43 percent of the projected
budget surplus for any year.\13\ This percentage is the
fraction of the aggregate fifteen year surplus that would
remain, under the president's framework, if the additional
Treasury securities credited to the Social Security trust fund
and the equity investments were excluded.
---------------------------------------------------------------------------
\13\ After their initial statements, Senator Domenici and
Representative Kasich have been less specific about the parameters of
their proposals.
---------------------------------------------------------------------------
Over the next five years, the framework suggested by
Senator Domenici would make much less available for current
commitment than would the approaches of the president or
Representative Kasich. This is because little of the expected
surplus over the next few years is contributed by the non-
Social Security portion of the budget (Table 3 and Figure 3).
Over the 2009 to 2014 period, the Domenici framework is the
most generous because well over half of the projected surpluses
for that period arise from the non-Social Security accounts. In
fact, Social Security surpluses peak in 2012 and decline
thereafter. The president's framework is the most restrictive
over the entire 15 year period because it commits 71 percent of
the projected surpluses to debt reduction and equity
investments for Social Security.
Table 3.--Resources Available for Current Commitments under Alternative Frameworks for the Surplus
[fiscal years 2000 to 2014 ($ billions)]
----------------------------------------------------------------------------------------------------------------
2000-04 2005-09 2010-14 2000-14
----------------------------------------------------------------------------------------------------------------
Save entire surplus............................................. $ 0 $ 0 $ 0 $ 0
President's framework *......................................... 259 469 676 1,404
Domenici's framework............................................ 125 636 1,403 2,164
Kasich's framework.............................................. 356 680 1,051 2,087
----------------------------------------------------------------------------------------------------------------
* Excludes debt reduction and equity investment.
[GRAPHIC] [TIFF OMITTED] T7507.029
Projections of federal revenues and spending, even under
unchanged policy, are notoriously inaccurate. The economy can
perform significantly better or worse than expected. The
fraction of economic output represented by tax revenues can
trend up or down for reasons that are difficult to predict.
Similarly, spending on entitlement programs such as Medicare
and Medicaid can speed up or slow down for reasons that are
hard to explain even in retrospect. Figure 4, which illustrates
the changes that have occurred over the last four years in the
Congressional Budget Office's baseline projections, after
subtracting out the effects of policy changes, underscores this
reality. While on balance the unexpected shocks of the past
four years have acted to improve the fiscal outlook, the
opposite was the case during the 1980s and early 1990s. That
less fortunate pattern could be repeated in the future. Given
this uncertainty, the economic benefits of debt reduction, and
the challenges that the babyboomers' retirement will pose for
the nation, a framework like the president's represents a
prudent approach to fiscal policy for the first two decades of
the 21st century.
[GRAPHIC] [TIFF OMITTED] T7507.030
Legislated Changes to the Canada Pension Plan
Shanna Rose *
Canada's Retirement Income System
Canada's retirement income system has two main components:
the Old Age Security Program and the Pension Plans. In 1997,
each program provided approximately $22 billion in retirement
income.\1\ The government also offers tax-assisted private
savings in Registered Pension and Retirement Savings Plans.
---------------------------------------------------------------------------
* Research Assistant, Economic Studies, The Brookings Institution.
\1\ All monetary figures are expressed in Canadian dollars.
---------------------------------------------------------------------------
The Old Age Security Program, which guarantees Canadian
seniors a basic level of retirement income, was established in
1952, replacing a provincial, means-tested benefit system that
had existed since 1929. The program consists of Old Age
Security (OAS), a flat benefit for all Canadians age 65 and
over who meet residence requirements; the Guaranteed Income
Supplement, a means-tested benefit for low-income seniors; and
the Spouse's Allowance, a means-tested benefit for low-income
spouses of OAS recipients and widows/widowers age 60 to 64.\2\
The Old Age Security Program is financed from general revenues.
---------------------------------------------------------------------------
\2\ In 2001, the OAS and GIS will be consolidated into one benefit,
called the Seniors Benefit, with stricter means-testing.
---------------------------------------------------------------------------
The other main component of Canada's retirement income
system consists of two parallel public pension plans, the
Canada Pension Plan (CPP) and the Quebec Pension Plan (QPP).
Both are mandatory, earnings-related social insurance programs
financed on a pay-as-you-go basis. The CPP applies to all of
Canada except those living in the province of Quebec. The two
plans have the same contribution rates and benefit formulas.
Quebec recently amended its pension plan so as to conform to
the changes made to the CPP's benefits and contribution rates
mentioned below. The following discussion of the newly created
Investment Board, however, applies only to the CPP.
The Canada Pension Plan
Approximately ten million Canadians currently pay into the
CPP and 3.7 million receive benefits. The early, normal, and
late retirement ages are 60, 65, and 70, respectively.\3\ The
CPP provides a pension of 25 percent of the average of the
contributor's highest monthly pensionable earnings, adjusted
for growth in wages. The formula for calculating average
earnings ``drops out'' the years in which the worker earned the
least (15 percent of all years up to seven years) to account
for unemployment, school attendance, etc. The formula also
excludes years of absence from the labor force due to
disability and child-rearing.
---------------------------------------------------------------------------
\3\ The pensions of Canadians who continue paying into the CPP
until age 70 are raised by six percent for each year worked after age
65. After age 70 Canadians are no longer required to contribute to the
CPP.
---------------------------------------------------------------------------
Until now, CPP fund reserves have been invested exclusively
in nonnegotiable provincial government securities, earning the
federal long-term bond rate of interest. The CPP presently has
reserves equal to approximately two years' worth of benefits,
or nearly $40 billion, as mandated. A 1993 actuarial report
projected the depletion of the fund by 2015, assuming the
established schedule of contribution rates was followed.
Canada Pension Plan Investment Board Act
In December 1997, following two years of extensive
nationwide public ``consultations,'' the Canadian Parliament
passed the Canada Pension Plan Investment Board Act. The
legislation, effective April 1, 1998, established the Canada
Pension Plan Investment Board, an independent panel to oversee
the investment of pension funds in the stock and bond markets.
The Board will invest the reserve fund in a diversified
portfolio of securities beginning in February 1999. The new
investment policy requires the Board to secure the ``maximum
rate of return without undue risk of loss.''
The Investment Board will be subject to investment rules
similar to those governing other Canadian pension funds. The
Board is permitted to invest as much as 20 percent of its
assets in foreign securities, although some policy makers want
to relax this regulation so as to allow the Board to better
fulfill its mandate to maximize returns. Eventually, the share
of CPP funds invested in provincial securities will be limited
to the proportion held by private and provincial pension funds
in Canada. As a transitional measure, provinces will be given
the option of rolling over existing CPP bonds, upon maturity,
for a 20-year term at the same rate of interest they pay on
their market borrowings. For the first three years, provinces
will also have access to half of the new CPP funds the Board
invests in bonds. The Board is required to act as a ``passive''
investor for at least the first three years, investing its
stock holdings in broad market indexes, so as to help smooth
the transition.
The Investment Board, which is accountable to the public
and the government, will provide Canadians with quarterly
financial statements and annual reports. The Board will also
hold public meetings in participating provinces at least every
two years.
Appointment of the Board of Directors
On October 29, 1998, the Canadian Minister of Finance, in
consultation with participating provincial finance ministers,
named the 12 directors who will serve on the CPP Investment
Board. The directors will serve staggered three-year terms.
Prominent businesswoman Gail Cook-Bennett was selected as the
chair. Ms. Cook-Bennett holds a Ph.D. in economics from the
University of Michigan. She is a director of several major
Canadian companies and served on the Ontario Teachers' Pension
Plan Board--now one of Canada's largest institutional
investors--when it was first permitted to invest in equities in
1990.
Concerns about the Investment Fund
Concerns that the fund will use its market power to
pressure corporations, or that the fund might succumb to
pressures to invest in politically favored ventures, led the
government to postpone the effective date for the CPP
Investment Board Act from January 1 to April 1, 1998. This
delay allowed Canada's Senate Banking Committee to hold
hearings on the development of regulations relating to the
board's operation.
Another concern is that the Canadian stock market is not
broad enough or large enough to deal with all of the new
pension money that will be generated by scheduled increases in
contributions. Although only a small trickle of pension funds
will be available for investment in 1999, the stock fund will
grow by about $10 billion a year thereafter, according to
government projections. Canadian stock indexes lack the breadth
of U.S. indexes, making it difficult for investors to track the
market accurately. Moreover, many of Canada's largest companies
are subsidiaries of foreign concerns, the shares of which are
not traded on the Canadian exchanges.
Other Changes to the CPP
The Canada Pension Plan Investment Board Act is part of a
broad overhaul of the CPP designed to keep the program solvent
in the wake of baby-boom retirement. Today, there are about 3.7
million Canadian seniors; by 2030, there will be 8.8 million.
According to Prime Minister Jean Chretien, ``this major
overhaul makes us the first industrialized country to ensure
the sustainability of its public pension system'' well into the
21st century. The other major changes to the CPP are outlined
below.
Changes in the Benefit Structure
An estimated 75 percent of the changes to the CPP will fall
on the financing side, and 25 percent on the benefit side. The
administration and calculation of some benefits will be
tightened so as to slow the growth of costs. The formula for
converting previous earnings to current dollars will be changed
to reduce average pensionable earnings slightly. This change
will be phased in over two years.
The administration of disability and death benefits has
been altered in several ways. Eligibility for disability
benefits is now contingent on CPP contributions in four of the
last six years, whereas previously it was contingent on
contributions in five of the last 10 years or two of the last
three years. Rather than being based on maximum pensionable
earnings at age 65, disability benefits are to be based on
maximum pensionable earnings at the time the disability occurs
and then price-indexed until age 65. The one-time death benefit
still equals six times the monthly retirement benefit of the
deceased worker, but the maximum has been lowered from $3,580
to $2,500, where it will be frozen (this change was favored
over the option of eliminating the death benefit entirely).
Changes have been implemented to limit the extent to which new
beneficiaries may combine survivor's benefits with either
retirement or disability benefits.
Changes in Contribution Rates
Over the next six years, the contribution rate will
increase from the current 5.85 percent rate to a ``steady-state
rate'' of 9.9 percent of contributory earnings. This rate is
shared equally by workers and their employers. By contrast, a
1995 actuarial report projected that, without any changes to
the pension plan, the contribution rate would have to rise to
14.2 percent by 2030. The Basic Exemption, below which no
contributions are paid, is to be frozen at the current year's
level of $3,500; this measure will widen the earnings base,
since the upper limit (currently $35,800, approximately
corresponding to the average wage) will continue to rise
according to the established formula. All contributors are to
receive regular statements about their CPP contributions.
The Ministers of Finance have the authority to alter
contribution rates, in connection with a triennial review,
through regulation. If stocks perform poorly, contributions
will be increased to offset losses. If the market does well,
the profits will help obviate future rises in contributions,
and may even lead to a reduction.
Unchanged Aspects of the CPP
The future benefits of persons age 65 or older on December
31, 1997 are unaffected by these changes, as are those paid to
persons under age 65 who received benefits before January 1,
1998. The early, normal, and late retirement ages remain
unchanged. All benefits except the lump-sum death benefit
remain indexed to inflation.
Investment Fund Projections
The government has projected, based on ``prudent
assumptions,'' that the new fund will generate an average long-
run return of 3.8 percent above inflation. Within a few years,
the investment board is expected to become the country's
largest stock-market investor. The total CPP account is
projected to grow from $37 billion at the end of 1997 to about
$90 billion at the end of 2007; of that amount, $60 billion to
$80 billion would be available for management by the board. By
2017, the investment fund is expected to have amassed a reserve
of roughly five years' payout, compared to the current two
years' worth of benefits, moving the CPP from a pay-as-you-go
system to a more fully-funded one.
Chairman Shaw. Thank you, Dr. Reischauer.
Dr. Weaver.
STATEMENT OF CAROLYN L. WEAVER, PH.D., DIRECTOR, SOCIAL
SECURITY AND PENSION STUDIES, AMERICAN ENTERPRISE INSTITUTE;
AND FORMER MEMBER, 1994-1996 ADVISORY COUNCIL ON SOCIAL
SECURITY
Ms. Weaver. Thank you, Mr. Chairman.
In current discussions of investing Social Security in the
stock market, the choice between centralized investment and
personal accounts is sometimes portrayed as a choice between
two different investment policies, two ways of skinning the
same cat and improving investment returns for workers.
When viewed in this way, the debate quickly turns to
administrative structures and costs. And then it seems logical
to some to go with centralized investment because it would
appear easier and quicker and cheaper than turning the problem
over to 100 million or more people.
While administrative structures and costs are worthy of
careful attention, in my view, they distract attention from the
more fundamental issue, which is whether centralized
investment, even if cheaper and perfectly managed--and I used
quotation marks on the word cheaper--can deliver the range of
economic benefits offered by a system of personal accounts?
Economic, social, and political benefits, I should say.
I believe the answer is no. In my written testimony, I
identify some of the key differences between centralized
investment and personal accounts and highlight the benefits of
personal accounts that I believe cannot be achieved through
centralized investment. I will briefly summarize those now.
First, personal accounts offer the prospect of higher rates
of return and more secure retirement incomes for younger
workers and future generations. Centralized investment offers
the prospect of more revenue for the trust funds, with no
assurance that enhanced revenues will flow back to benefit any
particular worker or cohort of workers.
Second, personal accounts are built on private ownership.
Workers would own their contributions and investment earnings.
Centralized investment would not change the statutory basis of
workers' claims to future benefits in any way.
Third, personal accounts would allow low-wage workers to
accumulate financial wealth through Social Security and share
in the benefits of capital ownership. With centralized
investment, Social Security would continue to offer all workers
long-term benefit promises.
Fourth, personal accounts would reduce workers' reliance on
government benefit promises and the political risk to which
their retirement incomes are now exposed. With centralized
investment, workers' entire income from Social Security would
continue to be politically determined.
In fact, with centralized investments, you would have new
margins for political influence, those surrounding investment
decisions on the one hand and, if trust fund reserves are
swelled through an investment strategy involving centralized
investment, there would be new pressures to increase benefit
obligations, the type of pressure that could not come to bear
on a system of personal accounts funded with workers'
contributions.
Fifth, with personal accounts, it is clear who bears the
risks and reaps the rewards of stock market investment. Workers
do. These risks would be mitigated by the government safety net
that buttresses all proposals for personal accounts. With
centralized investments, it continues to be unstated and thus
entirely unclear who bears the risks or reaps the reward.
Financial risks are present under both systems. Spreading or
sharing them through centralized investment cannot reduce or
eliminate financial market risk.
Sixth, personal accounts would allow workers to tailor the
risk of their investment funds or portfolios to meet their
personal needs and circumstances, depending on their age, other
private savings, and the like. With centralized investment, the
government would impose on workers a level of risk they may be
ill equipped to bear. This would be most disadvantageous to
low-wage workers.
Seventh, personal accounts would create a system that is
fully funded at all times and immune to the vagaries of
uncertain demographic trends. Centralized investment leaves our
quasi pay-you-go system in place and thus leaves Social
Security exposed to all of the financial dangers to which it
presently is exposed.
Eighth, personal accounts would enhance public
understanding about Social Security and facilitate retirement-
income planning. Workers would have something they could
understand and buildupon. Centralized investment leaves Social
Security opaque and would have no effect on workers' ability to
plan for retirement.
Finally, even as a means of investing in private markets, a
system of personal accounts offers clear benefits. It offers an
inherently decentralized and highly competitive mechanism for
channeling investment funds into capital markets. Centralized
investment would require the development of new and untested
structures that could withstand political pressures to use the
government's control over large amounts of capital investment
to affect the distribution of wealth and income in society.
This is a tall order and one that I believe cannot be filled.
Before closing, I would like to reiterate and stress a
point that Michael Tanner made. There has been a lot of talk
about how the Thrift Savings Plan provides a good model for
centralized investment and how it is structured to minimize
political influence. It is critical to note, however, that the
central defining characteristic of the Thrift Savings Plan,
which you all well know, is individual accounts that are
privately owned. It is a voluntary 401(k)-type plan for Federal
workers.
The congressional conferees who crafted that original
legislation made clear that it was ``the inherent nature of the
thrift plan that precluded political manipulation and the
private ownership of those accounts,'' not any particular
structure of investment managers and financial safeguards.
Thank you.
[The prepared statement follows:]
Statement of Carolyn L. Weaver, Ph.D., Director, Social Security and
Pension Studies, American Enterprise Institute; and Former Member,
1994-1996 Advisory Council on Social Security
In current discussions of investing social security in the
stock market, the choice between centralized investment and
personal retirement accounts is sometimes portrayed as the
choice between two investment strategies--two ways of improving
investment returns for workers--in effect, two ways of skinning
the same cat. When viewed in this way, the debate quickly turns
to administrative structures and costs. It then seems quite
natural, to some at least, to conclude that a government-
controlled investment strategy makes sense since it would seem
to be easier, quicker, and cheaper than turning the problem
over to 100 million or more people.
While administrative structures and costs are worthy of
careful attention, these issues distract attention from the
more fundamental issue: In particular, can centralized
investment, even if ``cheaper'' and perfectly managed, deliver
the range of economic benefits offered by a system of personal
accounts? I believe the answer is no.
In the testimony that follows, I identify the key
differences between personal accounts and centralized
investment, highlighting the benefits of the former approach
that can not be achieved with the latter. To avoid confusion, I
use the term ``personal accounts'' to mean a system of personal
retirement accounts that are owned by workers, fully funded
with a share of their payroll taxes, and invested in private
stocks and bonds. By ``centralized investment,'' I mean a
government-run program of investing a share of trust fund
reserves directly in stocks, where the government, or its
appointed board, decides how much of the reserves to invest in
stocks, which investment classes or funds to invest these
monies in, which financial institution(s) to rely on to manage
how much of the social security portfolio, and how proxies are
voted, among other important matters.
The key differences between personal accounts and
centralized investment are these:
Personal accounts offer the prospect of higher
rates of return and more secure retirement incomes for younger
workers and future generations. Centralized investment offers
the prospect of more revenues for the trust funds.
Personal accounts are built on private ownership:
workers would own their contributions and investment earnings,
and typically could pass any balances along to heirs.
Centralized investment would not change in any way the nature
of workers' claims to future benefits, which is statutory at
base, not contractual.
Personal accounts would allow low-income workers
to accumulate financial wealth and to share in the benefits of
capital ownership. With centralized investment, social security
would continue to offer workers, high-and low-income alike,
long-term promises by government.
Personal account would reduce workers' reliance on
long-term benefit promises and the political risks to which
their retirement incomes are now exposed, risks that currently-
scheduled benefits will not be met in full when they come due.
With centralized investment, workers' retirement incomes from
social security would continue to be politically determined.
With personal accounts, it is clear who bears the
risks (and reaps the rewards) of stock market investment--
individual workers do. These risks would be mitigated by the
design of the government safety-net that buttresses all
proposals for personal accounts. With centralized investment,
it is unstated and thus entirely unclear who bears these risk
(or reaps the rewards). Financial risks are present under both
systems. ``Spreading'' or ``sharing'' risks through centralized
investment can not reduce or eliminate them.
Personal accounts would allow workers to tailor
the riskiness of their investment funds to their personal needs
and circumstances--their willingness and ability to take risk,
given their age, their work prospects, their private pensions
and other savings, and other important factors. With
centralized investment, the government would decide how much
risk workers must bear through social security. This would be
most disadvantageous to low-wage Americans.
Personal accounts would create a system that is
fully funded at all times and immune to the vagaries of
uncertain demographic trends. Centralized investment leaves our
quasi pay-as-you-go system in place, and thus leaves social
security exposed to all of the financial dangers (and thus
political uncertainty) to which it presently is exposed.
Personal accounts would depoliticize social
security to a considerable extent. Centralized investment would
have no effect on the political nature of social security's
benefit and tax structure and yet would create many new margins
for political influence--those surrounding investment
decisions--and, by swelling trust fund reserves, would create
new pressures to increase benefit obligations.
Personal accounts would be consistent with
significant pre-funding of social security and with a
substantial increase in saving and capital investment.
Centralized investment, and the structures necessary to
sustain/regulate it, place sharp limits on the extent to which
social security can be pre-funded and contribute to national
saving.
Personal accounts would enhance public
understanding about social security and facilitate retirement
income planning--they would give workers something they could
understand and build upon. Centralized investment would leave
social security opaque and have no effect on workers' ability
to plan for retirement.
Personal accounts can be structured to respond to
the changing needs and circumstances of American women.
Centralized investment would have no impact on social
security's current (outdated) benefit structure.
This list, which is not exhaustive, is suggestive of the
significant benefits that can be expected to flow from a system
of personal accounts independent of the benefits of such a
system as a pure ``investment strategy.''
As a means of investing in private markets, personal
accounts also offer clear benefits. A system of personal
accounts would provide an inherently decentralized, competitive
mechanism for funneling investment funds into financial
markets, which would allow these funds to flow toward their
highest valued uses while spurring the development of new
investment products and services for small savers. Centralized
investment would require the development of new and untested
structures that could withstand political pressures to use the
government's control over investment capital to affect the
distribution of wealth and income and society. To prevent
political influence on investments and on matters of corporate
governance, which would undermine the efficiency of capital
investment and possibly rates of return on trust fund
investments, these structures would have to be capable of
withstanding such pressures on a sustained, long-term basis.
This is a tall order and one that I do not believe can be
filled.
Here it is worth noting that the Thrift Saving Plan for
federal employees does not provide a model for how centralized
investment could be organized to minimize the risk of political
interference, as often suggested by proponents of centralized
investment. The Thrift Saving Plan is a voluntary pension plan
for federal employees, whose central defining characteristic is
that which proponents of centralized investment seek to
preclude in social security--individual accounts that are owned
by workers. The TSP is the public-sector counterpart to the
wildly popular 401(k) plan. Workers decide whether to
participate, how much to contribute (up to stated limits), and
how to invest their funds among three investment options. (As
an aside, the plan has assets that are a small fraction of what
social security would need to invest.)
The Congressional conferees who crafted the original
legislation made clear that it was ``the inherent nature of a
thrift plan'' that precluded the possibility of ``political
manipulation.'' In their words, ``...the employees own the
money. The money, in essence, is held in trust for the employee
and managed and invested in the employee's behalf.... This
arrangement confers upon the employee property and other legal
rights to the contributions and their earnings.''
This is precisely the kind of plan proponents of personal
social security accounts would like to see offered to the rest
of American workers, one based squarely on private ownership
and real capital investment. Whether the government should
administer the accounts or narrow the investment options so
sharply (the typical participant in a 401(k) plan has six or
more options) are matters worthy of debate, but they are of
secondary importance to establishing a plan that gives working
men and women the opportunity to accumulate real financial
wealth through social security--an opportunity that would be
denied with centralized investment.
Ultimately, the debate about whether the government should
invest in private equity or individual workers should be
allowed to do so boils down to the question of whether workers
will be allowed to build financial wealth through social
security and to capture the benefits of stock market
participation. With centralized investment, it doesn't matter
how many ``fire walls'' you build, how ``independent'' the
investment board is, or whether the government subcontracts
with one or ten firms to manage one or ten funds, at the end of
the day, workers would still accumulate benefit promises to be
made good by future taxpayers, rather than investment funds of
their own. While proponents of stock market investment--both
those endorsing personal accounts and those endorsing
centralized investment--agree on the higher expected returns to
stocks and on the associated risks, we part company on the
question of whether these risks should be made explicit,
whether workers or the government should decide how much risk
to take, and whether workers or an account in the federal
treasury should capture the higher expected returns to risk
taking.
Conclusion
Changes in the economic and demographic landscape since the
1930s create the need--and the development of modern financial
markets creates the opportunity--to transform social security
into a vital program that is of economic value to the workers
it covers and to the nation as a whole. U.S. financial markets,
which channel literally trillions of dollars each year into
productive investments, have developed a wide range of
investment products and services attractive to ordinary working
men and women. Allowing workers to invest a portion of their
social security taxes in private capital markets and to draw on
these products and services to build retirement protection
holds the potential for not only enhancing retirement income
security but also generating a stronger national economy in the
twenty-first century. The time is right to move away from our
low-yielding system of income transfers toward a system of true
retirement pensions--personal retirement accounts fully funded
with a share of workers' payroll taxes.
Chairman Shaw. Thank you, Dr. Weaver.
Mr. Goldberg, if you would correct my pronunciation of your
law firm, I would appreciate it.
STATEMENT OF HON. FRED T. GOLDBERG, JR., SKADDEN, ARPS, SLATE,
MEAGHER & FLOM, LLP; FORMER COMMISSIONER, INTERNAL REVENUE
SERVICE; AND FORMER ASSISTANT SECRETARY FOR TAX POLICY, U.S.
DEPARTMENT OF THE TREASURY
Mr. Goldberg. Skadden, Arps is fine, Mr. Shaw. Thank you
very much.
Chairman Shaw. Thank you.
Mr. Goldberg. I believe there are three keys to Social
Security reform. First, and most important, is keeping faith
with current retirees and those about to retire. Second, is
maintaining the basic defined benefit structure and enhancing
the Social Security safety net. And third, is providing for a
universal system of private retirement accounts.
You and your colleagues who endorse PRAs, private
retirement accounts, as part of an effort to preserve and
protect Social Security are right on the mark. PRAs should plan
an important role in shoring up Social Security but they are so
much more. They will be of most benefit to low-income workers,
blue collar union members, single parents, working mothers, and
minorities. And they will create the universal infrastructure
for future policies to create wealth and opportunity for all
Americans.
Now, I agree with those if you direct government investment
in the markets is a bad idea. Since Dr. Reischauer already has
been ganged up on, I will forgo the opportunity to beat on what
I hope is a very dead horse.
The question that I would like to talk about is that
private accounts may be a terrific idea, a terrific policy,
maybe good politics, but at the end of the day the question is
whether it's possible to institute a workable system. Since
testifying before this Subcommittee last year, I have had the
pleasure of working with Professor Michael Graetz of Yale Law
School on a paper that addresses in detail the design of a
workable system of private accounts. A copy of that paper,
which is prepared under the auspices of NBER, National Bureau
of Economic Research, Inc., accompanies my testimony.
By building on an existing system, universal private
accounts can be implemented in a way that minimizes costs,
distributes those costs fairly, imposes no additional burden on
employers, meets the expectations of participants for
simplicity, security and control, and is flexible enough to
accommodate a wide range of policy choices, and can accommodate
changes in those policy choices over time.
Due to time constraints, I won't begin to try to describe
the system we have laid out in the paper. I would be happy to
answer questions. I would also be happy to work with you and
your staff on implementation issues. My testimony addresses
three particular comments and suggestions we have received
dealing with flexibility and the like in the light of the
hearing this morning, I would like to mention two topics
briefly not covered in my written testimony.
The first has to do with Secretary Summer's comments about
the alleged cost of private accounts. He indicated that those
accounts could cost as much as ``20 percent.'' While I'm not
sure of the analysis that he has gone through, I believe what
he is doing is taking all of the costs to administer a given
year's contribution over a 40-year period and summing those
costs back to the present without discounting. Now, the math
may be correct, but that in my judgment is a misleading
statement.
If you work through his numbers and if you work through the
numbers of those who have looked at the cost of administering
private accounts, including those who question the wisdom of
that policy on the merits, I believe the universal view is that
a simple system of private accounts that provides workers with
some reasonable modicum of choice, safety, and security, and
ease of understanding can be implemented for a cost of under 50
basis points a year spread across all accounts. It can be done
in a price-effective way.
Second, unfortunately, Mr. Matsui has left, but I would
like to comment very briefly on the study he referenced about
how private accounts will benefit no one. It is a terrific
study. It demonstrates that with the right assumptions, you can
prove the world is flat. They assume complete privatization,
they assume all of the burdens of transaction costs are imposed
on low- and middle-income workers, and, gee, there's a problem,
right. Well, the Earth is 6 inches by 6 inches and 1 inch deep
across. It is a flat square. And the reason I mention that is
that in this discussion it's important to look at assumptions.
It is very easy for any of us at this table to take any
proposal, make up the assumptions, and conclude there is no way
it's working.
We assume the government's going to pick and choose
individual stocks. That's a terrible idea. You have, I think,
honestly tried to come up with safeguards. And if this is going
to work, I think it's important to get beyond the kind of
outlyer, assume ridiculous assumptions that prove it won't work
and get back to the center, where the program can be discussed
reasonably.
I am absolutely convinced that thanks to public- and
private-sector systems and information technology, it is now
possible to implement a system of private--a universal system
of private accounts that minimizes costs, distributes those
costs fairly, imposes no additional burden on employers, and
meets the expectations of everyday Americans and can
accommodate whatever policy choices you collectively make with
respect to funding, with respect to voluntary add-ons, with
respect to tax-incentive-based add-ons, with respect to
guaranteed minimum benefits. The technology is there to make
private accounts work.
This wasn't true 20 years ago, and it certainly was not
true in 1935. When we talk about the difficulty of private
accounts, it's important to put those questions in perspective.
In 1935, there were no Social Security numbers, there were no
payroll taxes, there was no computer-based financial
infrastructure, all records were entered and maintained by
hand. And yet they made Social Security work. By comparison,
private accounts are easy.
If you go back, and you read the debates in the thirties,
those who opposed private accounts are using exactly the same
kind of arguments used by those who opposed Social Security in
1935.
Thanks to your leadership, thanks to the leadership of the
administration in coming out with a specific set of proposals,
many of which I disagree with. But they had the courage to come
out with something. It is now possible to craft a bipartisan
package that maintains defined benefits, protects current
retirees, and has a universal system of private accounts.
The question should be debated on the merits. Those who
oppose private accounts should not hide behind the excuse of
administrative costs.
Thank you very much.
[The prepared statement follows. The ``NBER Working Paper
Series'' is being retained in the Committee files.]
Statement of Hon. Fred T. Goldberg, Jr., Skadden, Arps, Slate, Meagher
& Flom, LLP; Former Commissioner, Internal Revenue Service; and Former
Assistant Secretary for Tax Policy, U.S. Department of the Treasury
Mr. Chairman and Members of the Committee, it is a pleasure
to appear today on the subject of investing Social Security
funds in the private capital markets. I have three
observations:
Private Accounts
There are three keys to Social Security reform: (i) keeping
faith with current retirees and those about to retire; (ii)
maintaining the basic defined benefit structure and enhancing
the safety net; and (iii) private retirement accounts (PRAs).
You and your colleagues--Republicans and Democrats,
Representatives and Senators--who endorse PRAs as part of an
effort to preserve and protect Social Security are right on the
mark. You deserve public respect and support for your wisdom
and courage in embracing a concept that was political heresy
only several years ago. While PRAs figure prominently in the
debate over Social Security, they are much more. PRAs will be
of most benefit to low income workers, blue collar union
members, single parents and working mothers, women and
minorities; they will also provide the infrastructure for
policies to create wealth and opportunity for all Americans.
Direct Government Investment
Second, I agree with those who view direct government
investment in the markets as a bad idea. All human experience
teaches us that government is certain to misuse its ownership
of private capital. Maybe not today, maybe not tomorrow, but
someday for sure. Those who cite experience with the Thrift
Savings Plan as proof that the government can make direct
investments without political interference should know better.
Their failure to cite contrary state experience is, at best,
misleading. It's also downright silly to suggest that what has
been true (perhaps), must always be true. Most importantly,
they fail to acknowledge the obvious--individual workers own
their Thrift Savings Plan accounts. It's theirs. The funds
don't belong to the government. This is a primary reason why,
at least to date, the Thrift Savings Plan has been able to
resist pressures for politically correct investment policies.
The Plan is not investing the government's money; it's
investing the workers' money.
A Workable System
Third, PRAs may be great policy, but the question is
whether it's possible to implement a workable system. Since
testifying before this Committee on the subject of private
accounts last June, I have had the privilege of working with
Professor Michael Graetz of the Yale Law School on a paper
addressing in detail the design of a workable system of private
accounts. That paper is being published in a forthcoming volume
of papers presented at a conference sponsored by NBER. A
working draft of our paper accompanies my testimony.
By building on existing systems, universal PRA's can be
implemented in a way that: (a) minimizes costs, and distributes
those costs fairly; (b) imposes no additional burden on
employers; (c) meets the expectations of participants for
simplicity, security and control; and (d) is flexible enough to
accommodate a wide range of policy choices, and changes in
those choices over time.
Due to your time constraints, I won't describe the system
we have proposed, but would be happy to answer any questions
you have. We would also be happy work with you and your staff
on implementation issues. In light of recent events and
comments we have received, however, I would like to mention
three matters: (i) the need for flexibility, (ii) the role of
the IRS, and (iii) workers' investment options.
The Need for Flexibility
The wide range of policy recommendations that have surfaced
during the past year demonstrate that flexibility should be the
hallmark of any system for implementing private accounts. With
this in mind, the approach described in our paper would
accommodate any of the policy choices listed below (reflecting
a wide range of proponents), and would also accommodate changes
in those policies over time:
funding through a carve-out of payroll taxes
funding from general revenues
integrating Social Security's traditional defined
benefits and the returns generated by private accounts (with or
without guarantees)
using general revenues to fund universal private
accounts outside the four corners of Social Security
any type of funding formula (for example, a fixed
or progressive percent of covered wages; a fixed or phased-out
flat dollar amount)
integrating private accounts with existing
retirement plans or accounts
voluntary additional contributions
tax incentives to encourage additional
contributions
spousal rights (at the time accounts are funded,
on divorce, or at distribution)
a wide range of investment options and payout
alternatives.
While each of us has his or her own views on these policy
questions, the key is that the implementation of private
accounts should accommodate any of these choices--and, equally
important, should accommodate changes in these choices over
time. The system described in our paper meets these objectives.
Role of the IRS
The IRS receives substantially all of the information
necessary to set up and fund private accounts, and we have
recommended that workers select their investment options on
forms filed along with their tax returns. We believe this
approach minimizes the burden on workers, places no burden on
employers, minimizes delays in funding, minimizes costs to the
Federal government, and maximizes flexibility (e.g.,
progressive funding and tax incentives for voluntary
contributions).
It is important to make clear, however, that under the
system we describe, participants would not deal directly with
the IRS on any matters relating to their PRAs. Likewise, the
IRS would not be involved in any way in the ongoing
administration of accounts or providing information to
participants.
We do not share the concern that some have expressed over
``perception'' problems if workers make investment elections on
their tax returns. These concerns, however, should not be a
barrier to the implementation of PRAs. While the IRS already
collects most of the information necessary for setting up and
funding PRAs, the idea of having the IRS share that information
with another Federal agency (such as Social Security) with
responsibility for setting up and funding private accounts may
be worth exploring.
Worker Investment Options
Most commentators have recommended one of two approaches to
providing for investment options. Some have suggested using a
Thrift Savings Plan model, where workers would be offered a
limited number of investment alternatives that is easy to
understand, limits risk, and won't cost much. Others have
rejected this approach and have suggested instead that workers
invest in qualified funds sponsored by the private sector. For
the reasons summarized in our paper, we have rejected this
``either-or'' approach, and have concluded that a two-tier
system is preferable. Workers should be permitted to invest in
a limited number of low cost options sponsored by the Federal
government and administered by the private sector--workers
should also be permitted to invest in qualified funds directly
sponsored and managed by the private sector, subject to
appropriate regulation.
Conclusion
Thanks to private and public sector systems and information
technology, it is now possible to implement a system of
universal private accounts that minimizes costs and distributes
those costs fairly; imposes no additional burden on employers;
meets the expectations of everyday Americans for simplicity,
security and control; and can accommodate a wide range of
policy choices. This was not true twenty years ago--and surely
was not true in 1935 when Social Security was first enacted.
Which brings me to my final observation.
As noted in our NBER paper, it is important to put the
administrative challenge of private accounts in perspective.
Recall what the world was like when Social Security was
enacted. There were no Social Security numbers. There was no
payroll tax withholding. Many Americans didn't have a
telephone. There were no computers--information was entered by
hand, records were maintained on paper, correspondence was
delivered by mail. There was no computer-based financial
infrastructure. Implementing Social Security under those
conditions was hard; by comparison, implementing universal
private accounts would be easy. Those who oppose private
accounts today sound much like those who opposed Social
Security in 1935.
Thanks to your leadership--and thanks to the
Administration's leadership in coming forward with its
proposals--bi-partisan action can lead to a universal
infrastructure for the creation of private wealth that will
benefit all Americans, especially those who've been left behind
and those who are struggling to make ends meet. Some may oppose
that policy, but they should do so on the merits, not hide
behind the excuse of administrative costs.
Chairman Shaw. Well, thank you, Mr. Goldberg, and thank
this entire panel. We will recess. Those of you on the panel
that can remain with us, we would appreciate it so that our
Members can ask questions that might be on their mind or make
traditional speeches, as we very often do.
As to the final panel, if for some reason you cannot remain
with us, your full testimony would be made a part of the
record. But we are hopeful that you will be able to stay and
deliver it to us in person.
We will now recess for 1 hour. We will reconvene at 1
o'clock in this room.
[Whereupon, at 12 noon, the Subcommittee recessed, to
reconvene at 1 p.m. the same day.]
Chairman Shaw. I apologize. The delay was outside of my
control. I apologize to you, Mr. Matsui, and to the witnesses.
Would you care to inquire?
Mr. Matsui. Thank you, Mr. Chairman. That was quick.
Let me ask--Mr. Goldberg, I'm sorry I wasn't here for your
testimony. I had to go out, but you were somewhat critical and
concerned with the National Committee To Preserve Social
Security's testimony or at least their study. Could you just
very quickly reiterate, if you had reiterated, or restate your
concerns. And, again, I apologize. I wasn't here.
Mr. Goldberg. Mr. Matsui, my ill-mannered comment was----
Mr. Matsui. You are never ill-mannered, but just go ahead.
Mr. Goldberg. They basically--it demonstrates that if you
make the correct assumptions, you can prove the world is flat.
And essentially, if you look the modeling that they did, in
terms of the underlying assumptions, for example, immediate and
complete privatization, imposing all transition costs on low-
income workers, eliminating survivability of the assets in
event of early death, they have managed to design a system that
screws just about everybody. But that is not the point of the
exercise. The point of the exercise is to look for systems that
meet the needs of low-income workers and middle-income workers
and families where the income earner dies at a relatively early
age. And I think that it reflects a problem in the discussion
generally, that if the object is to prove, design a system that
doesn't work, all of us can do that very well.
Mr. Matsui. Don't get me wrong. I want you to have as much
time as you want. My time is somewhat limited, although there's
only two of us here. So maybe not. [Laughter.]
Let me ask you, though, now I haven't reviewed your plan,
but just taking the basic assumptions that are made in the
National Committee's study, one is that there is a unfunded
liability.
Mr. Goldberg. That's correct.
Mr. Matsui. And that unfunded liability, from what I
understand from Mr. Reischauer--no, I guess it was either Mr.
Aaron or Mr. Reischauer who said it could be anywhere from $3.5
trillion to $8 trillion. And I know that Secretary Rubin has
said it is $8.5 trillion, and he didn't give a range, he just
said $8.5 trillion.
These numbers are so large it's hard to even amortize, but
the individual who came from the American Enterprise Institute,
Ms. Weaver, I believe it was, she tries to amortize this
unfunded liability, although she doesn't state what the amount
is. And she comes to the conclusion that over 75 years you have
to increase payroll taxes by 1.52 percent. How do you propose
doing it with your private accounts?
Mr. Goldberg. Mr. Matsui, in terms of the testimony today,
what I was talking about was a much more pedestrian set of
questions about could you do private accounts at all. I think
that is an important question.
Mr. Matsui. So OK----
Mr. Goldberg. But now once you get to the funding issues
you are raising, the way I see things unfolding at this point
is that the administration and, on a bipartisan basis, majority
of the Congress have concluded that somewhere around 60 percent
of projected surpluses over the next number of years should be
used to help bolster or shore up Social Security.
And I think we get into all sorts of arcana about
accounting and double accounting. I think that is too confusing
for people. The way I understand what is being said, is we are
going to take general revenues over the next number of years
and use those general revenues one way or another to try to
shore up the Social Security Program by investing in the market
or by transferring Treasury IOUs or setting up private
accounts. I believe that that 60 percent of the projected
surplus would go a long way to solving the actuarial problem.
Beyond that, it is my judgment that at the end of the day,
other choices are going to have to be made on the revenue side
or on the benefits side. But I'm not sure the political process
can get there yet. But the 60 percent gets you a long way down
the road.
I would get there by using them to fund a private accounts
system for all the reasons I have said. I think the benefits of
private ownership, the ability to craft policies to help low-
and middle-income workers--the benefits there are so
overwhelming, that is the direction I would go in using the
surplus. At the end of the day, I think we are all going to
have to make some choices.
Mr. Matsui. Let me say this, Fred. One of my problems, and
I again don't know if you have a complete plan in that pamphlet
you showed. You do or don't?
Mr. Goldberg. It is just the plumbing. Just how to make
them work.
Mr. Matsui. I will tell you what my problem is. And it's
great. I understand what you are saying now, and I apologize
for not having been in the room when you testified.
My real problem is, if you are saying that private accounts
are good versus the current system, I suppose if you were
setting the system up from scratch and you didn't have the
unfunded liability and a few other things, maybe you can even
make that case, but that's in a vacuum. Right now you have such
little things as survivors benefits, you obviously have
disability benefits. Obviously, we are not addressing in your
pamphlet those issues, and no one is expecting you to, but
talking about private accounts, individual accounts, in a
vacuum is like taking the President's program and saying
because it has deficit reduction it's a great plan. But you
have got to look at the overall plan.
See, that's where part of my frustration is. Not at you,
but just generally in discussing private accounts. My time is
running out but I want to ask Representative Baronian this
question: I know that in Connecticut when Colt Manufacturers
did get a rather sizable investment from the pension program,
there was a significant amount of interference mainly because
of the way the pension system was set up. I don't know if it
currently still is, but the Governor and the Treasurer, who are
elected officials, had a significant role. And they, in other
words, had almost the legal ability to interfere. In the PERS,
California Public Employee Retirement System, back in the
seventies there was a problem when Treasurer Unruh was the
State Treasurer, but they really straightened that out through
legislation.
And you will find that the PERS system in California is
pretty free of political interference. Now maybe you haven't
done that yet in Connecticut. Maybe you have cleaned it, maybe
you have made the changes after the Colt issue?
Ms. Baronian. Well, I have to say I think that they did do
some, but as far as I know--for instance, they have another
investment, $100 million investment in a piece of real estate
in downtown Hartford that still hasn't produced any returns at
all. But what I'm saying is, is that I don't think there's been
too much done. They had a Connecticut programs fund, and that's
where this money came out of within the treasury.
I do believe that they still could interfere with----
Mr. Matsui. Let me just say this. I believe somebody said
this at one of the hearings we were at--that I suppose you
could even interfere with the Federal Reserve Board if we had
the political will and wanted to make a scene about it. So, if
you are saying that anything can happen, I agree with you,
anything can happen. But what Mr. Reischauer and Dr. Aaron and
a number of others are working on is a way to come up with a
structure for government investment in the equity markets, a
fail-safe system that will result in political repercussions
if, in fact, you violate it.
And that is why we don't mess around with the Chairman of
the Federal Reserve Board. There have been attempts over the
last decade to influence him, but we get criticized for that,
so we back down. What you want to do is set up a system where
the political process will insulate the fund managers and the
investment bankers from that process.
Now maybe in Connecticut you don't have that. I believe we
do in California.
Ms. Baronian. Well, California has a highly sophisticated
method. I don't believe that the Federal Government would--I
would like to think that they could--but I doubt it.
Mr. Matsui. Anybody could make that kind of a statement: I
wish it would happen but it doesn't happen.
Ms. Baronian. I don't think you can insulate a board that
is going to be appointed by politicians. And the Federal
Reserve has enjoyed hands off with the exception of, probably,
Richard Nixon, who wanted to do something in 1972.
But it could happen. And things change. Unless it's in the
Constitution, legislation can be retracted, corrected, and so
forth.
Mr. Matsui. I don't want to belabor this because we are
going to get circular in our discussion, but even the
Constitution could be violated. I mean, I can probably cite
instances. So anything can happen as long as human beings are
the ones that are conducting life. But the reality is that we
are trying to insulate the process, and maybe Connecticut
doesn't work, but in other cases we have seen it work.
I just want to thank all of you. I know my time is expired.
Thank you, Mr. Chairman.
Chairman Shaw. Mr. Doggett.
Mr. Doggett. Thank you very much. Mr. Tanner, is it your
view that ideally we should replace the Social Security system
with a system that relies exclusively on individual accounts?
Mr. Tanner. Yes it is, as the primary system. And then I
believe that any safety-net system should be funded out of
general revenues.
Mr. Doggett. Basically, a welfare system for meeting kind
of the basic needs of the poorest people in the society?
Mr. Tanner. That's right. We should insist that no senior
should ever fall below a minimally acceptable level of
retirement. But I believe that the best way to finance such a
system is taxing across all classes of income and all classes
of assets, not to focus on a regressive payroll tax as the
primary way to do that.
Mr. Doggett. Thank you. Mr. Goldberg, do you share that
view?
Mr. Goldberg. No, sir, I do not.
Mr. Doggett. What is your view about the appropriate mix of
government involvement and individual decisionmaking?
Mr. Goldberg. I think that the defined benefit structure, a
progressive defined benefit structure of the current Social
Security system is where we have been and where we should stay
forever. I think it says something about how we deal with each
other and I think it's terrific. I think over and above that, a
system of private--a universal system of private accounts that
puts in place structure for building private wealth for all
Americans is so important. And I think, with all due respect to
Congressman Matsui, I think maybe we are being too honest now
about all of the numbers, and we are not paying enough
attention to the barriers to wealth creation for workers. So I
would do both. I would keep your basic program in place----
Mr. Doggett. Are your comments to be viewed then as an
endorsement of the President's USA account approach?
Mr. Goldberg. I think that it is--none of us know what the
approach is. I think that in the current environment, I think
that the better place to begin is to try to integrate private
retirement accounts, a universal system of private retirement
accounts, as part of Social Security. I think that is going to
be easier to do. I think it is going to put in place a system
that is going to be better able to address lots of retirement
issues that we run into down the road.
And so I would prefer to link it to retirement.
Mr. Doggett. You would take it out of the 12.4 percent?
Part of that you would allocate to individual accounts?
Mr. Goldberg. I think there are a couple of ways to do it.
One is to carve out a proportion 12.4 percent. The other way to
do it is to fund them through general revenues. A third way to
do them at the end of the day is some combination. And I think
that the numbers work better than we are giving them credit
for. I personally think that some adjustments in the benefits
may ultimately and/or method of revenues need to be addressed.
That is heresy at this point, but I think at the end of the day
that's going to be part of the truth.
But I think the numbers with the surplus let's you keep a
very strong defined benefit program that enhances the safety
net at the bottom, let's you fund meaningful private accounts,
let's you fund those private accounts on a progressive basis,
such as what Senator Santorum's bill--I think you can do it, I
think it would be very close.
Mr. Doggett. You would have to reduce the defined benefits
under the defined benefit program?
Mr. Goldberg. I think you may. I think collectively the
judgment may be that is a good decision. I don't think you have
to do it. If you don't do it, I don't think you are going to
get all the way to the end solution. But I think you can get a
long way toward the end solution without ``cutting benefits''
at all. I think you may, as you look at this, you may make the
judgment at the end of the day that if the private account
piece is a effective enough, you can make some modest
adjustments in terms of accelerating the age change to 67,
adjusting the cap--I know these are terrible things to talk
about now, and you don't have to do any of them. The point is,
you can do none of those, you can use the surplus to create
private accounts to give you an infrastructure to deal with
issues affecting low- and middle-income workers, and to say we
have done terrific work. We are not finished, but we have done
terrific work.
Mr. Doggett. Let me ask Dr. Reischauer if he agrees with
that?
Mr. Reischauer. Basically, no. I think that the foundation
for retirement income in this country should be a defined
benefit program. I would agree with Fred, if we had a defined
benefit program now which I thought was overly generous, but
the defined benefit program that we do have pays the average
new retiree something between $9,000 and $10,000 a year, which
isn't a tremendous amount of money by anyone's standard. This
is given in the form of an annuity, an inflation-protected
annuity.
When we move over to private accounts, there is no
guarantee that the balances would annuitized or that there
would inflation adjustment associated with them. And, barring
the possibility that we funded them out of new revenues, we
would have to cut back on that basic foundation to finance
them, that is if we carved them out. Now Fred might be in favor
of increasing contributions, as we call them, euphemistically,
rather than taxes, to fund his private accounts. That would be
a different wrinkle on things. Maybe he and I could reach some
agreement over this. But I think what we have now is a very
modest and a very essential program that provides society with
a lot of benefits as well as individuals with security that
couldn't be found through private accounts.
Mr. Doggett. Thank you. Thank you, Mr. Chairman.
Chairman Shaw. Mr. Doggett. You don't have to rush there.
There's nothing that says that the legislation could not have
some safety nets in it itself. I think that the legislation
could be drawn in such a way that it would fulfill the three
problems that Dr. Summers referred to in his testimony and that
you are referring to in yours. These safety nets can be
designed by the Social Security system. So clearly, we could
answer your objections in those areas.
Mr. Reischauer. You could, but a lot of the proposals that
are out there don't. And you have to ask some more questions
about the pensions that would be provided through private
accounts. One of those questions is, how much variability do
you want to have in your foundation retirement income program
across cohorts and across individuals within any single cohort?
In a private account, how much you get out the other end
depends critically on what you investment choices have been. We
know that some people are risk averse and some are real risk
takers. You will find in a private account system that two
individuals earning exactly the same amount of money,
contributing the same amount to the system but investing in
different types of assets, end up with hugely different
pensions at the end of their working lives.
Similarly, because of fluctuations in asset values over
time, you can find that a cohort that retires a few years after
another cohort, could end up with 40 or 50 percent larger or
smaller benefits. There is a role for such retirement saving in
our society, and I am not opposed to it. But we do have
alternative vehicles. We have private pension plans, we have
IRAs, we have individual savings, which, if you want to play
that game, we can encourage.
Chairman Shaw. Well, in addition to the investment
philosophy of the individual worker, it also would depend on
the time picked for retirement. Obviously, in a downturn of the
market, there would be some problems. But those we certainly
have to address. We don't want to tell a worker who works with
his hands that at age 65, 67 or whatever it is, that work a few
more years and let the stock market go back up. Obviously, we
have got to address those problems and try to anticipate that.
And in that regard, Dr. Reischauer, I would appreciate if
you would make a list of all the objections that you would have
to the individual accounts so that we might try to address that
in any legislation that comes out that uses individual
accounts. The more we can learn about the problems, the more
warts we can find on our own theories, the more we can
anticipate and try to correct them in advance. And the more you
can do that, the more you can bring people along in order to
try to get a system that answers everybody's problem. I think
that would be very helpful.
Mr. Goldberg, we start out by using the surplus. Do you see
a day, and if so when would this be, that the FICA tax would be
sufficient so that the surplus would no longer be needed to
fund the individual retirement accounts?
Mr. Goldberg. I don't think you get there, Mr. Shaw. I
think that with the demographics, unless you are talking about
raising the FICA tax, which I think would be a bad mistake.
Chairman Shaw. No. We are not.
Mr. Goldberg. But at the current 12-plus percent, I think
they--you are going to end up using, if you don't want to
change revenues and you don't want to change benefits, then, as
Dr. Reischauer says, you are going to be using general
revenues, I believe, for the foreseeable future to cover Social
Security, regardless of how you decide private accounts or
govern investment.
I don't think you can get there.
Chairman Shaw. Mr. Tanner, do you agree with that
statement?
Mr. Tanner. Yes, I think that you end up in a situation in
which you have demographics down the road that an unfunded
liability that Alan Greenspan estimates at $9.5 trillion. So
everybody's got a different number. But you have a sufficient
unfunded liability that the surpluses you have projected until
2013 will not be enough to deal with that.
Chairman Shaw. Let me see if I have asked the right
question. And that question is, that obviously the FICA tax is
going to be necessary to continue to fund Social Security
system for those that are already in it, who don't have time to
build up any individual retirement account. There will come a
time when the individual retirement accounts would become the
larger supporter of the retirees. Do you see a situation down
the line where the FICA tax, having paid over the period of a
working career, would be sufficient to invest in these equities
so that the surplus would be freed up? That's the question.
Mr. Reischauer. We seem to have a little bit of role
reversal going on here. I think your question is, If somehow we
could absolve ourselves of the unfunded liability--pay for it
through income taxes or something else--and say to every 20-
year-old entering the system, we will guarantee you a
disability insurance policy and you will contribute into a
private retirement account, would you need a payroll tax as
high as 12.4 percent to achieve expected benefit levels 40
years from now? You would need one much lower tax rate.
Chairman Shaw. You what?
Mr. Goldberg. You would need a lower--you wouldn't have to
have 12.4 percent. It could be a much lower number.
Chairman Shaw. You can see that the FICA tax actually could
be lowered after a number of years if we create individual
retirement accounts.
Mr. Goldberg. But I assume that the $9 trillion of unfunded
liability was lifted off the system's back somehow. And that is
a huge assumption.
Mr. Tanner. One caveat, though, when we are talking the
$9.5 trillion unfunded liability. That is to preserve the
current system. If you move to a system of individual accounts,
where you stop incurring additional debt as of whatever date
you set, that unfunded liability is actually less than the $9.5
trillion.
Chairman Shaw. It would go down in time.
Mr. Tanner. You wouldn't accumulate----
Chairman Shaw. The transition period is going to be tough.
There's no question about that.
Mr. Tanner. Absolutely. That's a cost that you have run up
regardless. The cost of moving to the private system should not
be looked at as a net new cost when you compare it to the total
unfunded liabilities within the current system. It is a
actually a smaller cost. In many ways you could liken it to
refinancing your mortgage, where, if you pay your points up
front, it is certainly painful to have to do that this year,
but in the long run, you pay out a lot less because you have
gotten a lower interest rate. This would be roughly the same
thing. You would have to move forward in many of those expenses
and pay them the next 25 or 30 years, but the total amount that
you pay out will be less under any scenario.
Thank you.
Chairman Shaw. Mr. Cardin.
Mr. Cardin. Thank you, Mr. Chairman. I appreciate all of
your appearances here today. I think that last round of
questions is very misleading in many respects. And that is, the
unfunded liability reflects the current situation. If we were
to try to set up private accounts, or private plans, or a
private system, you need to deal with the current liabilities.
You are not going to put away enough in reserve to deal with
that, and if you then take away from the 12.4 percent that
currently is paid into the Social Security trust system, you
are either going to be increasing your unfunded liability or
you are going to change the system for the people who are
currently in the system, which means reduced benefits.
Mr. Tanner. Only in the short term. In the long term, it
would be less. For example, if you allowed me out of Social
Security today into a private system, you would no longer be
accruing unfunded liability to me, which go on every day that I
live and pay into the Social Security system. There's an
increase in unfunded liability.
Mr. Cardin. If I am 60 years old, and you are saying, Gee,
I can now go into this new system, thank you, and if I don't go
into the new system, you are only going to get a 20-percent
reduction in benefits or some other amount in order to make
these figures right, that isn't much of a deal for me, at 60
years of age.
I understand your point, but I think we make too light of
the fact of the unfunded liability. It is not as simple, say,
if we just got rid of it. You can't get rid of it, number one.
And number two, it affects people at different age brackets
differently because there are people who are very young, yes,
who could benefit if they do what you say, but most Americans
aren't in their twenties and thirties today.
Most Americans are working and have already paid into the
Social Security system and are expecting some benefits from
what they have paid into the Social Security system. And in
addition to dealing with that age group, you have to figure out
how to deal with the unfunded liabilities, and if we start
diverting from the concept that current workers pay primarily
for people who are retired, it presents a whole set of
transitional problems.
Mr. Tanner. What I'm suggesting, Congressman, is that that
cost you have to bear regardless of whether you move to a
privatized system or whether you try to preserve the current
system. The difference is, in the long term, it will always be
less to move to a privatized system.
Mr. Cardin. But it is complicated if you take out a dime of
the 12.4 percent that currently goes into the system. It just
makes it that much more difficult to meet the future
liabilities for every dollar you take out of that system.
Mr. Reischauer. Can I just put a footnote onto this without
taking away from your time? [Laughter.]
I disagree with Michael that it would be less in a
privatized system. There are two questions here. Are you going
to increase the funding of the system be it privatized or
collectivized? And second, what are you going to allow the
reserves, be they held in private accounts or collectively, be
invested in? If you give Social Security the same freedom to
invest in a broad spectrum of assets, it is not cheaper to do
this through private accounts than it is to do it collectively.
In fact, just the reverse would be the case because
administrative costs would be less for a collective system than
for a individualized system.
Mr. Cardin. I appreciate that.
Fred Goldberg, I first thank you for--and I have deep
respect for your views, although I do take issue with your
citing of the thrift-savings plans as being somewhat irrelevant
to all of our discussions here today on collective investments.
And I am somewhat amazed at the concern for collective
investments by the trustees to get a better return for the
Social Security system collectively.
Because it seems to me that is just about risk free as far
as the system is concerned. Over time, they are going to do
better, and everyone acknowledges that they will do better. And
as far as manipulation, you sort of dismissed the thrift
savings plans, which could be a vehicle for mischief, and has
not been a vehicle for mischief. And you sort of dismiss the
recommendations made by Treasury that in setting up these
accounts, there would be a Federal Reserve-type firewall
created and that there would be private investment counselors
who would make all the investments and they could only invest
in indexed, generic funds.
Why are you so concerned about that?
Mr. Goldberg. I really do respect Dr. Reischauer and the
administration's efforts to create these firewalls. And I think
that you don't sort of make up arguments to blow them away. It
is my judgment and observation that at the end of the day,
despite all of the good faith and all of the efforts that are
put into place to build the firewall, I believe someday,
sometime there will be efforts to breach that firewall. I
believe the efforts to breach that firewall can, in may
respects, be as harmful as an actual breaching of that firewall
because of the market uncertainties that they create.
Mr. Cardin. But it would require a change in underlying
law, which any Congress can always change any law at any time.
It can change Social Security at any time. We always run that
risk that even if we develop whatever plan we want to, the next
Congress might change that plan. Nothing is ever in concrete,
and I agree with you that nothing is ever in concrete.
But if we build these protections in the basic law that we
create, it just seems to me there is something wrong about
saying that we have trustees of the Social Security system and
we don't let those trustees do what any other fiduciary would
do, and that is, mindful of the purpose of the fund, mindful of
safety, maximize the return to the system. And we don't let our
trustees do that. That seems contrary to a fiduciary
responsibility. That seems like we are manipulating.
Mr. Goldberg. We are going around in circles. I believe
that there is a measurable risk that at some point in time the
government will misuse those funds, and I believe history tells
us that is actually close to a certainty. But there is a second
point here that I personally feel more strongly about. This is
the one chance I believe we collectively, the country, will
have to make a choice about our collective retirement system.
And I believe that if we make that choice to say we are going
to let the government invest in the markets, and we therefore
are choosing not to create----
Mr. Cardin. Excuse me, not government, allowing the
managers or trustees----
Mr. Goldberg [continuing]. The Dr. Reischauer system, we
are going to go with that system and there is going to be no
political interference, terrific. I believe that we are making
a choice not to create an infrastructure that will let us build
wealth for all Americans. And I think that the opportunity cost
in saying we are comfortable with these safeguards and
therefore we are going to rely on IRAs and Keoughs and employer
plans and private savings, we will leave 20 to 30 to 40 percent
of the American people behind forever. And I think this is the
once chance to say, let's not leave them behind.
Mr. Cardin. I think we are in agreement. We are in
agreement. I think we have to strengthen the proposal that the
President has come in with the universal savings accounts. I
think we have to make that much more available to all wage
earners, particularly lower wage earners, so that we do get
private savings and retirement from private wage earners. I
think we can do a better job than the President's proposal in
that regard. So I think we might be in agreement on that.
But to me that is not inconsistent with preserving the
basic concept of Social Security and allowing it to be
adequately financed. And to allow it to get a better return to
me carries out that objective but doesn't answer your concern
and my concern about strengthening income security for all
Americans, particularly those at more modest wages. I don't
want to lose that opportunity either.
If we just strengthen Social Security and don't deal with
the other part, I agree with you.
Mr. Goldberg. Take Dr. Reischauer's proposal. Give all
workers, in effect, defined contributions--pieces of that
single investment portfolio have some kind of guarantee top-out
that they don't get what they get. Yes, you are getting pretty
close. But it is theirs. They own it.
Mr. Cardin. I don't want to agree with everything you just
said, but I think we are getting closer, and I think that is
one of the purposes for these hearings, quite frankly. And I
really do congratulate Chairman Shaw because he has been very
open to listen to all points of view. And there is certainly a
lot of merit to increasing more private savings and retirement
for Americans. I agree with you completely on that point, and I
don't want to see the debate on Social Security end without us
first strengthening Social Security, but also dealing with the
issue that you raise.
Mr. Chairman, thank you for your patience.
Chairman Shaw. Thank you, sir. Mr. Tanner.
Mr. Tanner of Tennessee. Thank you, Mr. Chairman. I'm glad
we are talking about increasing the national savings rate in
whatever form. I have just one question, and apologize for my
lack of understanding. But as it relates to individual
accounts, I've heard the term ``clawback'' feature at the end
of the workers days, could any of you all explain what is meant
by that and how it would operate?
Mr. Tanner.
Mr. Michael Tanner. There are essentially two ways to look
at it. You are targeting a certain level of benefits between
the private, individual account portion and the government's
defined benefit portion. That they would in some way total to a
particular level of benefit. And then you can either raise or
lower the government portion to reach that level, or you can
tax back the private portion to bring it down so that the total
level is in some way. But some way it claws back a portion of
the benefit from these accounts.
I think it is a poor way to go because it deprives people
of the potential higher rates of return that they could get in
private investment accounts.
Mr. Reischauer. Let me try and add a little bit to Mr.
Tanner's----
Mr. Tanner of Tennessee. Yes, I think this is an important
point.
Mr. Reischauer. Establishing private accounts in and of
themselves does nothing to reduce Social Security's
expenditures or liabilities. And so some advocates of private
accounts have said, well, we will let people build up the
balances in their private accounts and, depending on how big
those balances are, we will reduce their Social Security
benefit. And that's the clawback.
So in Marty Feldstein's plan, you would reduce Social
Security's payment for an individual by $3 for every $4
produced by his private account. And this is the way you go
about solving Social Security's problem in the long run.
Mr. Goldberg. Mr. Tanner, I might add, and I think Bob's
description is right. This is not an uncommon mechanism. The
notion of integrating defined benefit arrangements and defined
contribution arrangements. The private sector does it. For
example, they may integrate private-sector retirement plans and
Social Security, for example. You can integrate defined
contributions----
Mr. Tanner of Tennessee. Well, we have setoffs now in
government programs.
Mr. Goldberg. You have setoffs now. I think that describing
it as ``clawback'' has this rather harsh notion to it. I think
a setoff mechanism or an integration mechanism is a little bit
more benign.
Mr. Reischauer. Attacks. [Laughter.]
Mr. Goldberg. Attacks. That is even uglier in some
quarters, but----
Mr. Tanner. There is a difference between two types of
proposals, one of which adjusts the government-provided Social
Security level of benefits in comparison to the private
accounts to ensure that no one falls below an acceptable level
of benefit. The other, in essence, penalizes people whose
accounts perform very successfully and who get a very high rate
of return and claws back a portion of that even in excess of
what is necessary to do that. And they use that to fund, in the
Marty Feldstein proposal, part of the transition.
Mr. Tanner of Tennessee. Yes, I would like to be around
that day when you take $3 out of every $4 from somebody who
invested wisely and listen to the proponents who say that is
all right. I don't know. Thank you.
Chairman Shaw. There is one provision that I would just
like to comment on briefly. That is the proprietary interest
that people would have in their individual retirement accounts.
If we were to go that route, if someone should die prior to
receiving the benefits, they would have something that they
could leave to their heirs.
Under existing law, there is no vested interest in the
Social Security system. It is just faith in the political
process that it is going to be there for you. And that faith
has been well placed throughout the years. But if you die, you
not only lose your life, you lose whatever you paid into the
Social Security system with the exception of certain death
benefits, which don't compensate you for the amounts that you
may have invested.
This type of accumulation of wealth for the lowest income
people among us is something that this Subcommittee should
consider in its deliberations of reforming the Social Security
system.
This has been an excellent panel. I think all of us have
benefited greatly by your presence, and we thank you very much.
And thank you for waiting past the recess.
The final panel today, is Martha McSteen who is the
president of the National Committee To Preserve Social Security
and Medicare, former Acting Commissioner of the Social Security
Administration, and John Mueller, who is a senior vice
president and chief economist of Lehrman Bell Mueller Cannon,
Inc., in Arlington, Virginia.
We welcome both of you, and thank you for staying with us
as long as you have. As with previous panels, we have your full
testimony, which will become a part of the record. And you
might proceed in the way you see fit.
Ms. McSteen.
STATEMENT OF MARTHA A. MCSTEEN, PRESIDENT, NATIONAL COMMITTEE
TO PRESERVE SOCIAL SECURITY AND MEDICARE; AND FORMER ACTING
COMMISSIONER, SOCIAL SECURITY ADMINISTRATION
Ms. McSteen. Mr. Chairman, Mr. Tanner. As you know, there
have been many claims and counterclaims in recent months about
privatizing Social Security. For the public, and I'm sure many
Member of Congress, the puzzle has been, which claims are solid
and sound, and which are less so. More than 1 year ago, the
National Committee concluded that the most valuable service we
could provide the country and the Congress regarding Social
Security was to commission the most rigorous, objective,
professional, and exhaustive analysis possible of how
privatization would impact this and future generations.
The report we released yesterday, ``The Winners and Losers
of Privatizing Social Security,'' uses the most sophisticated
computer model in existence, the EBRI/SSASIM model, developed
by the Employee Benefit Research Institute and the Policy
Simulation Group. I am pleased the author of our report,
economist John Mueller, is here to answer your questions about
its conclusions because they provide a clear and critical
warning about the Social Security reforms you may consider.
Some of them, like privatized accounts, sound attractive but
the numbers we know now simply don't add up.
Every demographic group alive today would face retirement
with fewer benefits under a system of privatized accounts in
large part because of the heavy and inescapable costs of
financing the transition from Social Security to a privatized
system. Women, no matter what age, marital status, employment
history, or income level, comprise the largest group of losers
from privatization. For African-Americans living today, the
average household would lose about half of its retirement
benefits under any plan to privatize Social Security.
These are burdens and risks that today's and tomorrow's
retirees should not have to bear, Mr. Chairman.
[The prepared statement follows:]
Statement of Martha A. McSteen, President, National Committee To
Preserve Social Security and Medicare; and Former Acting Commissioner,
Social Security Administration
Mister Chairman, Congressman Matsui, members of the
Committee, good morning. As you know, there have been many
claims and counter-claims in recent months about privatizing
the Social Security.
For the public, and I'm sure many members of Congress, the
puzzle has been which claims are solid and sound and which
claims are less so.
More than a year ago, the National Committee concluded that
the most valuable service we could provide the country and the
Congress was to commission the most rigorous, objective,
professional and exhaustive analysis possible of how
privatization would impact this and future generations.
The report we released yesterday, ``The Winners and Losers
of Privatizing Social Security,'' uses the most sophisticated
computer model in existence--the EBRI/SSASIM model, developed
by the Employee Benefit Research Institute and the Policy
Simulation Group.
I'm pleased the author of our report, Economist John
Mueller, is here to answer your questions about its
conclusions, because they provide a clear and critical warning
about the Social Security reforms you may consider.
Some of them, like privatized accounts, sound attractive,
but the numbers--we know now--simply don't add up. Every
demographic group alive today would face retirement with fewer
benefits under a system of privatized accounts, in large part
because of the heavy and inescapable costs for financing the
transition from Social Security to a privatized system.
Women--no matter what age, marital status, employment
history or income level--comprise the largest group of losers
from privatization. For African-Americans living today, the
average household would lose about half of its retirement
benefits under any plan to privatize Social Security.
These are burdens and risks that today's and tomorrow's
retirees should not have to bear, Mister Chairman. Thank you
very much and I would now like to introduce John Mueller, the
study's author, to address the specifics of the report.
Ms. McSteen. I would like now to introduce John Mueller,
the study's author, to address the specifics of the report.
John.
STATEMENT OF JOHN MUELLER, SENIOR VICE PRESIDENT AND CHIEF
ECONOMIST, LEHRMAN BELL MUELLER CANNON, INC., ARLINGTON,
VIRGINIA
Mr. Mueller. Thank you. Mr. Chairman, Members of the
Subcommittee. I appreciate the chance to testify on Social
Security reform. I am especially grateful for your openness,
Mr. Chairman, in seeking out what you called warts upon the
private accounts proposal. And I'd like to tell you about a
couple of them that I found.
In fact, I'd like to call the Subcommittee's attention to
what I consider to be a serious problem. To anyone who has
closely followed the Social Security debate over the years,
it's become increasingly obvious that the quality of analysis
has lagged far behind the importance of the subject. Congress
is being asked to make informed judgments about proposals for
sweeping changes that would affect the retirement security of
American families for at least a century, yet most studies
about who would win and who would lose from such proposals have
been seriously flawed.
Claims that most households would fare better if pay-as-
you-go Social Security were replaced by individual retirement
accounts depend on three basic errors.
First, projections for returns in the financial markets are
not consistent with the economic projections for Social
Security. One example of that was the 1994 to 1996 Social
Security Advisory Council and its report, which projected, as
the Social Security Administration does, that future economic
growth will be about 1.4 percent, down by almost two-thirds
from the past, but that stock market returns would continue at
nearly 7 percent on top of inflation.
The model that we used shows that this implies that the
stock market would rise over the next 70 years to equal 468
years' worth of earnings. And by the time some of the people in
the report retired, it would be selling for 1,063 years' worth
of earnings, simply because of the inconsistency between those
two sets of forecasts. It is inadmissible to speak of Social
Security in the future tense while speaking of the stock market
in the past tense.
The second problem, which is also universal, is that
examples for winners and losers are typically based on what is
called the ``unisex flat earnings assumption,'' which assumes
that all workers at every age, men and women, earn the same
amount of money, and that this is equal to something called the
average wage index. According to Census data, this assumption
overstates the average earnings of American women by nearly 100
percent because that simply does not comport with the facts.
The third problem with most studies is that the transition
tax inherent in any move away from pay-as-you-go Social
Security is understated or even ignored by assuming that
funding retirement benefits through general revenues is somehow
less costly than funding it through the payroll tax.
To correct these errors, I used an advanced Social Security
policy simulation model called SSASIM. This model was developed
by Policy Simulation Group, initially under contract with the
Social Security Administration, and has been intensively
developed through the efforts and in partnership with the
Employee Benefit Research Institute. SSASIM is now used by
several Federal agencies, including SSA, OMB, Treasury, and
GAO, though not, as far as I know, here on Capitol Hill.
The study compares the impact of Social Security reform on
those born in four different years: 1955, which is the middle
of the baby boom; 1975, the smallest birth year in Generation
X; 1990, which is the largest birth year in the so-called echo
of the baby boom; and finally, 2025, to show the longer term
effect of Social Security reform. I constructed a sample
population of 128 individuals based on census data, varying by
sex, marital status, earnings, race, and mortality.
I compared benefits and rates of return under three
different plans: one plan for complete privatization phased in
over one lifetime, and two traditional methods of balancing
pay-as-you-go Social Security. Comparing the experience of the
four generations under the three different plans illustrates
the whole range of policy choices facing the Congress today:
everything from balancing the current pay-as-you-go system to
various degrees of partial privatization to complete
privatization.
I tested four different sets of assumptions, from the most
extreme to the most realistic, and conducted 1,000 case random
simulations for each household. As for the results, SSASIM
shows, as I mentioned, that the low expected returns for Social
Security are not due to its pay-as-you-go funding but rather to
the assumption of slow future economic growth, which would
equally reduce stock market returns. The model shows that
future average real returns would have to be about 4.7 percent
instead of 6.7 percent. And there is a similar problem with the
assumptions for interest rates.
The study also shows, however, that for everyone now alive,
your financial market assumptions don't make much difference.
Because of the transition tax, every group now alive faces
substantial losses from partial or full privatization. Those
born in 2025 could gain only under the most extreme
assumptions, that is stock market price earnings ratios
surpassing 1,000. All four birth years would be substantially
better off with even a scaled back version of the OASI Program
than with full or partial privatization.
The largest group of losers is women, including every birth
year, income class, and marital status. The only groups
avoiding losses under realistic assumptions would be unmarried
men and a few high-income, two-earner couples as long as they
are born far enough in the future to avoid the transition tax.
These groups would break even.
Substantial losers include unmarried women, married
couples, especially one-earner couples, and African-American
households, among which the largest losses would be for single
mothers.
Thank you, Mr. Chairman, I know I have gone over my time
slightly. I apologize. I would be happy to answer any of your
questions.
[The prepared statement follows:]
Statement of John Mueller, Senior Vice President and Chief Economist,
Lehrman Bell Mueller Cannon, Inc., Arlington, Virginia
Thank you, Mr. Chairman. I'd like to describe for you a new
study on ``Winners and Losers from `Privatizing' Social
Security'' I've just completed. The report is sponsored by the
National Committee to Preserve Social Security and Medicare.
This is my fourth paper on Social Security reform sponsored by
the National Committee.
For the past decade I've been a principal of a financial-
markets forecasting firm. I first became involved in the issue
of Social Security reform in the 1980s, when I served as
Economic Counsel to the House Republican Caucus under Jack
Kemp. Like many Reagan Republican conservatives, I began with
the conviction that pay-as-you-go Social Security ought to be
``privatized.'' But analyzing the facts and sifting the
arguments turned me around. I was surprised to discover that
Social Security is one of those cases, like national defense,
in which the government is necessary to perform a role that the
private markets alone cannot--in this case, providing the
``foundation layer'' of retirement security. Social Security
was never intended to grow so large as to ``crowd out''
investment in the private capital markets, or the even more
important investment in raising and educating future citizens.
But the current study clearly illustrates why moving in the
opposite direction--``privatizing'' Social Security--would be a
big mistake.
The current project was undertaken in co-operation with the
Employee Benefit Research Institute (EBRI) and Policy
Simulation Group. Under Dallas Salisbury, EBRI has performed a
valuable service to the nation's debate over Social Security.
As part of its Social Security Project, EBRI has helped to
develop a Social Security policy simulation model called
``SSASIM.'' SSASIM has been developed by Martin Holmer of
Policy Simulation Group, at first under contract with the
Social Security Administration, then most intensively in
partnership with EBRI. The National Committee recently joined
EBRI in its effort effort to develop SSASIM, by funding two
important features that had not yet been incorporated: the
model's ability to calculate stock-market returns consistent
with long-term economic projections, and to include Social
Security benefits for spouses and survivors of covered workers.
SSASIM is now arguably the most advanced Social Security policy
simulation model in existence. Martha McSteen of the National
Committee asked me to use the model to undertake the current
study of winners and losers under ``privatization.''
To anyone who has closely followed the debate over Social
Security, it has become increasingly obvious that the quality
of analysis has lagged far behind the importance of the
subject. Congress is being asked to make informed judgments
about proposals for sweeping changes that would affect the
retirement security of American families for at least a
century. Yet most studies about who would win and who would
lose from ``privatizing'' Social Security have been flawed by
at least three serious errors.
The first error is that projections for returns on stocks
and bonds are inconsistent with projections for Social
Security. Projections for Social Security are typically based
on the ``intermediate'' assumptions of the Social Security
Actuaries, which envision a sharp slowing of economic growth
over the next 75 years--partly on the assumption that the
United States will reach ``zero population growth.'' However,
projections for the stock and bond markets are usually based on
the past performance of those markets, during a period when the
economy and the population were growing almost three times as
fast. Putting the two together leads to absurd results. Right
now Wall Street is wondering how long the stock market can
maintain its record level of about 30 times annual earnings.
Under the projections adopted by the 1994-96 Social Security
Advisory Council, the Standard and Poor's 500-stock Index would
surpass 500 years worth of earnings in the next 75 years. By
the time some of the people in this study retire, each share of
common stock would be assumed to be selling for over 1,000
years' worth of earnings. (See Graph 1.) SSASIM calculates that
to be consistent with the Actuaries' intermediate economic
projections, rates of return on common stocks would have to be
about 2 percentage points lower than the Advisory Council
projected: 4.7% a year instead of 6.7% a year above inflation.
In the study I point out a similar inconsistency in the
projections for bond yields.
[GRAPHIC] [TIFF OMITTED] T7507.019
The second kind of error concerns the earnings of American
households. Nearly all examples used in the debate over Social
Security assume that the average worker--man or woman--has
earnings at every age equal to something called the ``Average
Wage Index.'' But Census data show that this is not the case.
Earnings vary widely by age, sex, marital status, and
education. Moreover, the average man can expect about 1 in 5
zero-earnings years, and the average woman about 1 in 3--time
spent outside the labor market due to unemployment, illness, or
family responsibilities. Taking these factors into account, we
find that the average man does have lifetime average earnings
slightly more than the Average Wage Index--but the average
women has lifetime earnings equal to about 53% of the Average
Wage Index (Graph 2). This means that most studies have
overstated average annual earnings of women by almost 100%.
This makes a huge difference in calculating benefits under
Social Security and individual accounts. Yet this erroneous
method has been widely used even by the Social Security
Administration.
[GRAPHIC] [TIFF OMITTED] T7507.020
The third kind of error concerns treatment of the
``transition tax'' involved in any move away from pay-as-you-go
Social Security. ``Pay-as-you-go'' means that each generation
of workers pays for the benefits of its parents. That's why the
first generations covered by Social Security received rates of
return far above the long-term average. It also means that if
pay-as-you-go Social Security were ended, the last couple of
generations would have to pay twice: they would keep paying for
their parents' Social Security benefits, while receiving
drastically reduced benefits, or no benefits, themselves; at
the same time, they would have to save for their own retirement
through individual accounts (Graph 3). If pay-as-you-go Social
Security were phased out over one lifetime, this ``transition
tax'' would fall partly on the Baby Boom, but especially on
``Generation X'' and the children of the Baby Boom.
This ``transition tax'' far exceeds any changes in payroll
taxes and/or Social Security benefits that would be necessary
to balance the existing pay-as-you-go system. The reason is
simple: paying once for retirement is always cheaper than
paying twice. Those who favor ending pay-as-you-go Social
Security have resorted to various tricks of creative accounting
to try to disguise the ``transition tax.'' These techniques
generally involve income tax credits, or borrowing against
general revenues, or some combination. But creative accounting
can only try to disguise the cost of retirement benefits; it
cannot change that cost by a single penny. Likewise, income-tax
credits only shuffle the cost around without changing it.
SSASIM is especially suited to a study of this kind,
because it permits us to sidestep the errors I've just
described. First, the model makes it possible to project
financial market returns that are consistent with projections
for the economy. The model can also realistically account for
transaction costs involved in investing in stocks and bonds,
and in purchasing the private annuities that would have to
replace Social Security. Second, SSASIM also makes it possible
to simulate the impact of Social Security reform on American
households with a high degree of realism, surpassing the ``flat
unisex earnings'' assumptions of the Social Security
Administration. Finally, SSASIM has the great virtue of
requiring you to say exactly how the cost of benefits will be
paid: no creative accounting tricks are possible. I think
you'll find that the results of a rigorous analysis of Social
Security reforms are eye-opening.
[GRAPHIC] [TIFF OMITTED] T7507.021
The study is divided into two parts (along with appendixes
examining some of the important issues raised). The first part
illustrates the basic choices for Social Security reform in
their effect upon the average benefits and rates of return for
couples representing four different birth-years (1955, 1975,
1990 and 2025). Those born in 1955 are the middle of the Baby
Boom; those born in 1975 are the smallest cohort in
``Generation X''; those born in 1990 are the largest cohort in
the ``Echo of the Baby Boom''; and those born in 2025 represent
the longer-term effects of various kinds of Social Security
reform. The second part of the study looks at winners and
losers among households within each of those birth-years or
``cohorts''--unmarried or married; two-earner or one-earner
couples; those with average, above-average or below-average
earnings; and also selected African-American households.
There are essentially two possible approaches to Social
Security reform: either balance the current pay-as-you-go
retirement program, or else replace it with a system of
individual retirement accounts. Every reform plan does one or
the other, or else some combination. The current study examines
the whole range of options, by comparing results under three
different plans to reform the current OASI (Old Age and
Survivors Insurance) program.
The first plan would completely ``privatize'' Social
Security, by replacing it over the course of one lifetime with
a system of individual accounts. Initial benefits for new
retirees would be phased out evenly over 45 years, which means
that the payroll tax would disappear after about 80 years. At
first, the total contribution rate would be increased by 2
percentage points, though it would later fall back to equal the
current payroll tax rate.
The couple born in 1955, whom I call John and Debra, would
therefore live under a partially privatized system--putting
about 3 percentage points into individual accounts and about 9
percentage points into Social Security. Their Social Security
retirement benefits would be just under two-thirds of current
law. This approximates the various plans to ``carve'' out part
of workers' contributions for individual accounts to supplement
reduced Social Security benefits.
The couple born in 1975, Carl and Amy, would live under a
mostly privatized retirement system. By the time they retired,
the payroll tax would have fallen, and account contributions
risen, by about 3 percentage points. Social Security retirement
benefits would be reduced by about four-fifths. Plans like the
Personal Security Accounts (PSAs) favored by some of the Social
Security Advisory Council members, or the more recent Feldstein
plan (which would combine investment in individual retirement
accounts with Social Security benefits reduced from current law
by 75 percent), would fall somewhere between the experience of
John and Debra and the one for Carl and Amy.
The couples born in 1990 (Patrick and Hilary) and 2025
(Abraham and Dorothy) would receive benefits that depended
entirely on their individual accounts--similar to plans favored
by the Cato Institute. The main difference is that the Patrick
and Hilary, born in 1990, would still have paid substantial
payroll taxes to fund benefits to earlier retirees, but payroll
tax rates would almost have disappeared by the time the Abraham
and Dorothy retired nine decades from now.
The other two plans are ``traditional'' reforms to balance
the current pay-as-you-go Social Security system. One
``traditional'' plan would raise the Normal Retirement Age
faster and higher than under current law: this was recommended
by a majority of the 1994-96 Social Security Advisory Council.
The OASI payroll tax would be maintained at the current rate of
10.6% until the trust fund fell to one year's reserve; then the
payroll tax would be adjusted as necessary to keep the system
in balance.
The other ``traditional'' plan has two features. First, the
system would be restored to a pure pay-as-you-go basis by
cutting the payroll tax rate 20% (just over 2 percentage
points) immediately; at the same time, benefit formulas for new
retirees would be scaled back over 45 years until they reached
80% of current law. Inflation-adjusted Social Security
retirement benefits would therefore rise, but not as fast as
under current law. If the trust fund reserve ever fell to the
minimum one-year reserve, payroll tax rates would be adjusted
to keep income and outgo in balance.
Of course, any actual reform plan would be more
complicated; these were chosen to illustrate the major issues.
The study examines four different sets of assumptions, from
the most extreme to the most realistic. The most important
conclusion from the first part of the study is this: for
everyone now alive, it doesn't greatly matter what assumptions
you use about the stock and bond markets. (See Graph 4.) For
the Baby Boom, Generation X and the children of the Baby Boom,
not even unrealistically high stock and bond market returns can
offset the ``transition tax.'' For everyone now alive, both
average benefits and rates of return are much higher under even
a scaled-back Social Security system than could be had from a
partly or fully privatized retirement system.
The assumptions do make a difference for people who are not
born yet. The couple born in 2025 would come out ahead under a
``privatized'' retirement system, if you assumed that the stock
market's price/earnings ratio will in fact surpass 1,000 years
worth of earnings. But with reasonable financial asset returns,
the average couple born in 2025 would be better off with even a
scaled-back pay-as-you-go Social Security system than with a
system of individual retirement accounts.
The second part of the study goes into much deeper detail
about the impact of the various plans upon a wide variety of
American households. A sample population of 32 individuals was
created for each of the four birth-years, using Census data
about earnings and employment by age, sex, marital status, and
education level. The individuals are chosen to reflect
differences in marital status (unmarried individuals or married
couples); labor market behavior (two-earner couples with wives
working full-time or part-time, as well as one-earner couples),
and education levels (average education [some college], high-
school graduates and college graduates). Individuals with
below-average education and earnings are assumed to have
higher-than-average mortality (that is, they don't live as
long), and vice versa.
[GRAPHIC] [TIFF OMITTED] T7507.022
Three of the 16 pairs of men and women in each birth-year
are intended to represent selected African-American households
which may differ from the general population: one unmarried man
and woman each, and a two-earner married couple (all with
average education and earnings for African-American men and
women); as well as a couple intended to represent the most
economically and socially disadvantaged African-Americans: a
single mother with children and her separated partner, both of
whom are high-school dropouts. All the African-American
individuals are assumed to have significantly higher mortality
(shorter lives) than the general population with the same
education and earnings. There are no separate examples for
college-educated African-Americans, on the assumption that such
households have socioeconomic characteristics very similar to
those for other college graduates.
The results of the second part of the study are richly
detailed, and bear examining in some detail. However, in
summarizing the results, I will concentrate on a few overriding
themes, and focus on the most realistic set of assumptions.
(See Graph 5.)
The first important finding is that the largest group of
losers from ``privatizing'' Social Security would be women.
This is true for women in all birth-years, all kinds of marital
status, all kinds of labor-market behavior, and all income
levels. The main reason is that Social Security was
specifically designed to protect women in three ways, all of
which would be eliminated by ``privatization.'' First, Social
Security benefits are progressive, and at all education levels,
women have lower average earnings than men. Second, Social
Security provides the same annual benefits to men and women
with equal earnings, but women live longer and so collect more
benefits. Third, Social Security provides benefits for spouses
of retired workers, as well as survivors benefits, which are
far more advantageous to women than the private market can
provide. The study shows that even unmarried women with high
earnings, and women with high incomes in two-earner families,
lose from privatization. However, the losses are even greater
for women who work part-time, intermittently or not at all in
the labor market.
[GRAPHIC] [TIFF OMITTED] T7507.023
The second important finding is that, to the degree Social
Security is ``privatized,'' the current progressivity of
benefits would be eliminated. The actual progressivity of
Social Security is rather mild: this is because the
progressivity of combined taxes and benefits is partly offset
by the fact that individuals with less education and lower
earnings tend to have shorter lifespans, so they collect
benefits for fewer years. Individuals with more education and
higher earnings tend to live longer and so collect benefits for
more years. However, Social Security is still progressive, and
this feature would be eliminated by ``privatization.'' The
study finds that individuals with lower education and earnings
will tend to lose more, and individuals with higher education
and earnings will tend to lose less, from privatization.
The third important finding is related to the first and
second; it concerns the relative treatment of unmarried
individuals and married couples. (Of course, we need to bear in
mind that fewer than 5% of those who reach retirement age have
never been married, and perhaps 10% have never had children.)
``Privatizers'' have claimed that Social Security is biased
against unmarried individuals. But the study shows that this
claim is the result of the faulty ``unisex wage'' assumption.
The facts are more complicated, and much more interesting.
Unmarried women actually receive a higher rate of return from
Social Security than most married couples. Unmarried men
receive a significantly lower rate of return than unmarried
women, because the men have higher average earnings and don't
live as long. If we considered husbands and wives separately,
we would find that married men receive a lower rate of return
than unmarried men, because unmarried men spend less time in
the labor market, and so have lower average earnings and
benefit more from Social Security's progressivity. Viewed as
individuals, the highest rates of return are received by
married women--the lower the earnings, the higher the rate of
return.
The final important finding concerns how African-American
families would fare if Social Security were ``privatized.'' A
recent study sponsored by the Heritage Foundation gained
notoriety by claiming, against earlier research, that African-
Americans are big losers under Social Security and would gain
tremendously if Social Security were replaced by individual
retirement accounts. However, the Heritage Study contained all
the errors of method outlined earlier--inconsistent
projections, unrealistic earnings, entirely ignoring the
``transition tax,'' and a few more besides. The current study
squarely contradicts the Heritage findings. Of African-
Americans now alive, the average household would lose about
half the value of its retirement savings if Social Security
were ``privatized.'' (See Graph 6.) For African-Americans who
are not born yet, the pattern is like that for the general
population. The only African-Americans born in 2025 who would
not lose under ``privatization'' would be unmarried men without
children: they would receive approximately the same rate of
return from Social Security or a private retirement account.
However, under realistic assumptions all other future African-
American households studied would lose from ``privatization''--
including typical two-earner married couples, unmarried women,
and those with substantially below-average education and
earnings.
[GRAPHIC] [TIFF OMITTED] T7507.024
What does the study imply for the future of Social Security
reform?
In the first place, the study is a wake-up call to policy
analysts. Policymakers and the public require much better
information than they are now getting--about the financial
markets, about earnings of American households, and about the
funding of Social Security reform. That information is
available--but so far, it has not been used.
Second, the study strongly indicates that policymakers
should be focusing on fixing the Social Security system,
instead of getting rid of it. The ``transition tax'' under
privatization dwarfs any possible cost of balancing Social
Security. The low future returns predicted for Social Security
are not due to its pay-as-you-go nature, but simply to the
projections about the future economy. If the United States is
in fact about to enter an Economic Ice Age, then the rates of
return on everything--Social Security, stocks and bonds alike--
are going to be substantially lower than in the past. It must
be said that in the past few years the economy has not been
behaving that way. So far, inflation, unemployment and interest
rates have all been signficantly lower than the intermediate
projections. The economy has so far most closely resembled the
Social Security Actuaries' ``Low-Cost'' economic assumptions.
It would not be surprising if, in the next annual report, the
Actuaries' intermediate assumptions were modified. However, the
projections in the current study are based on the 1998
intermediate projections.
But this raises an important issue for policymakers. How is
it possible to set retirement policy when the future is so
uncertain? As we have seen, even in the long run, the case for
``privatizing'' Social Security depends entirely on being right
about a long string of highly specific--and in part, highly
unlikely--forecasts.
Most ``traditional'' reform plans have the great advantage
of not depending on a particular forecast. Unlike
``privatization,'' they are reversible. If the economy performs
better than expected, the announced changes in future benefits
might never have to be enacted; or else, under the ``Low-Cost''
assumptions, payroll tax rates might actually have to be
reduced below current law (Graph 7). But if the economy does
perform as poorly as projected, a ``traditional'' reform plan
would provide a reasonable way to balance the current system.
American families would be prepared long in advance, and any
surprises would be positive ones.
Over the years, Social Security has in fact been adjusted
several times to allow for changing circumstances. Precisely
because it has been able to cope with such uncertainties,
Social Security has proven itself to be a ``plan for all
seasons.''
[GRAPHIC] [TIFF OMITTED] T7507.025
Chairman Shaw. Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman.
Mr. Mueller, just for historical background, you started
off saying that you supported individual accounts before you
actually embarked upon this study. Is that a correct statement?
Because I want to make sure that, at least on the record, that
in terms of a bias or an interest that you might have, this is
one in which there is no question.
Mr. Mueller. No. That is quite correct, Mr. Matsui. By way
of background, I worked for Jack Kemp for 10 years, from 1979
through 1988; from 1981 through 1987, I was the economic
counsel for the House Republican Conference and in that
capacity I was asked to look at the privatization proposals,
which were bubbling up on the Republican side in the 1988
election cycle. I began, like many Reagan Republican
conservatives, by considering it self-*evident that Social
Security should be privatized. And I was quite surprised and
chagrined when the facts contradicted that position.
I came, regretfully, to the conclusion that the case for
privatization had not been well founded, that it is a mixture
of one part ignorance of the financial markets, one part
ignorance of the labor markets, and one part wishful thinking.
And I don't mean that metaphorically. I mean that literally in
the three areas that I have pointed out today: first, the
economic and financial-market assumptions that are not
consistent; second, labor-market assumptions that do not
conform to reality; and third, the attempts to ignore the
transition tax.
So, you are correct. I began making precisely the same
arguments you have heard from the earlier panel today. I would
hope, a little bit better, perhaps. But I just had to conclude
that I was wrong. And my particular conversion doesn't mean
anything, but I'd like it to point to the facts involved here.
Mr. Matsui. If I may, and I know the graph over there is a
little far, and I wouldn't want you to go over there, but the
blue part of the graph is the current----
Mr. Mueller. That is, the blue part--perhaps I should set
up, what all the parts mean.
Mr. Matsui. Maybe you can explain it briefly.
Mr. Mueller. That is a bar graph, which shows average
annual retirement benefits for four couples, each representing
the average couple born in each of four different years. The
first group of bars on the left represent John and Deborah, who
are born in 1955. They are 44 years old this year. The second
group of bars is for Carl and Amy. They were born in 1975. They
are 24 years old this year and not married yet. The third group
of bars is for Patrick and Hillary. They were born in 1990 and
are all of 9 years old now, and thinking about Social Security
is probably not on their agenda. The fourth group of bars is
for Abraham and Dorothy. They will be born in 2025 and will be
eligible for retirement at the earliest in the year 2087.
Now, what the four colors represent are four different
possibilities for Social Security reform. The first two sets of
bars, those are the blue and the red, represent what the
different experience would be for each one of those four
couples under two sets of assumptions, if Social Security were
privatized within one lifetime, and by that I mean, the initial
retirement benefit would be phased out evenly over 45 years,
permitting the payroll tax to disappear after 80 or 90 years.
John and Deborah, who are 17 years away from retirement, would
still live under a partially privatized system. They would be
putting in about 3 percentage points of taxable earnings into
an individual account. The remaining 9 percentage points would
be paying the Social Security benefits to existing retirees.
Their own Social Security benefits would be reduced by 38
percent from current law.
Carl and Amy would live under a substantially privatized
system, receiving Social Security benefits which had been
reduced, instead of by a little over one-third, by about 80
percent. So they would be much more reliant on private
retirement accounts.
Patrick and Hillary would have to rely entirely on their
individual accounts, but still would be paying substantial
payroll taxes. Abraham and Dorothy have pretty much passed the
transition tax.
Now the first two bars show what happens under two
different sets of assumptions for the privatized system. The
blue bar is what you would get under the most optimistic
projections for the financial markets. Those include the
thousand-years'-worth-of-earnings scenario for the stock
market. The red bar is what you could get under what I found to
be realistic assumptions. The green bar is what you could get
under currently promised Social Security benefits. And the
yellow bar is what would happen under a scaled back Social
Security system, which was balanced by adopting some of the
proposals which were mentioned earlier today.
What the chart shows is that for the first three cohorts or
birth years, that is, those who are now alive, it doesn't
matter what you assume for the stock market. The cost of giving
up Social Security benefits is too great to be made up by any
stock market assumptions. So everyone now alive would lose.
It's only a question for the people born in 2025.
If you assume that in fact the stock market will be worth
1,063 years' worth of earnings in the year 2087, they come out
ahead. If you assume that P/E, price-earning, ratios are
roughly flat between now and then, they would receive lower
benefits than you would receive from even a pared back Social
Security system.
Mr. Matsui. My time has run out. If I may just ask one
further question, and then I will yield back, with the
Chairman's permission.
In terms of the concept of the transition cost, you
basically have three provisions, the transition cost, the
modeling of that average person or average family, and then the
third is the disparity between investment patterns of the
Social Security system. In other words, investing in the bond
market, and second investing in the equity markets, and how one
is, as you suggested, backward and the other one is forward in
terms of its thinking.
Those are the three areas, is that correct?
Mr. Mueller. That's right.
Mr. Matsui. What is the most significant aspect of all
this? Is it the transition cost, or is it the latter, disparity
between bond market and equity market and the assumptions
behind it?
Mr. Mueller. For everyone now alive, it is the transition
cost, which is the problem that the earlier panel was wrestling
with. I'm grateful that Mr. Goldberg pointed to the importance
of the assumptions because that is, in fact, the whole point of
the study, that the assumptions are important. And I think the
squawks of outrage are due to the fact that the gimmick in this
study is that there are no gimmicks. What I have done is make
explicit for each individual what the cost of that transition
would be. And the cost of ending Social Security is just--the
cost would be much greater than any possible cost of balancing
the system.
Mr. Matsui. I wanted to ask this one last question. In
terms of the yellow bar, which is using assumptions that are a
scaledback Social Security plan, which I suppose if you cut
benefits you would have. Did you figure it to be 80 percent of
current benefit level?
Mr. Mueller. Yes. It ultimately reached 80 percent. For the
baby boomers it would be 92 percent. It would be 84 percent for
Carl and Amy, and for the last two couples, it would level off
to 80 percent of currently promised benefits.
Mr. Matsui. OK. Now compare that with what the privatized
system. That is what bar? That's the----
Mr. Mueller. The privatized system under realistic
assumptions is the red bar.
Mr. Matsui. Right.
Mr. Mueller. And you are comparing that with the pared back
Social Security system is the yellow bar.
As you can see, the biggest burden of the transition cost
actually falls on those born in 1975 and 1990, not on the baby
boom or those born in the future. And for those two cohorts,
the possible benefits from a partly or completely privatized
system are less than half of what you would receive from a
pared back, pay-as-you-go system. It would be a little bit
higher than that if you adopted the more optimistic financial
market assumptions, but still substantially lower than the
pared back, pay-as-you-go plan.
Mr. Matsui. Thank you very much. Thank you, sir.
Mr. Mueller. Thank you.
Chairman Shaw. Mr. Mueller, a couple of questions.
What has been the performance of the equity markets, the
stock markets, over the last 20 years in terms of real dollars?
Mr. Mueller. The last 20 years, it's about 12 percent.
Chairman Shaw. And, what is your assumption for the next 20
years?
Mr. Mueller. For the next 20 years? It's going to be quite
low. According to SSASIM, the average real equity return in the
future will be 4.7 percent, but historically, after a period of
20 years in which you outperform the average by nearly 100
percent, you have periods where you underperform by an equal
amount.
From 1901 to 1921, from 1929 to 1949, and from 1962 to
1982, in all those 20-year periods, the real return on equities
in this country, before taxes, was approximately zero.
Chairman Shaw. So, your assumption is that in the next 20
years the growth is only going to be a little over one-fourth
of what it has been in the last 20 years?
Mr. Mueller. Perhaps one-third.
Chairman Shaw. Yes. One-third. OK. In the benefits. What
benefits do you cut?
Mr. Mueller. I modeled two different possibilities because
they have been discussed. One was raising the normal retirement
age according to what is known as the Gramlich Plan, which
would index the retirement age in the future to rises in
longevity. The other is----
Chairman Shaw. How high would you raise it?
Mr. Mueller. It ultimately goes to age 70. And this is not
my plan. I modeled it merely for the----
Chairman Shaw. That's your assumption?
Mr. Mueller. Right.
Chairman Shaw. That's what the yellow line tells us?
Mr. Mueller. I'm sorry?
Chairman Shaw. That's what the yellow line tells us?
Mr. Mueller. No. The yellow line is what is called an
across-the-board plan. That would leave current benefits
essentially as they are today, except all would be scaled back
to 80 percent of currently promised benefits over 45 years.
Chairman Shaw. Well, you are raising--is that the green
line? Or is that even on there?
Mr. Mueller. The yellow line.
Chairman Shaw. Oh, it is yellow. OK. And what other
benefits would you cut?
Mr. Mueller. None. It is across-the-board reform.
Chairman Shaw. OK. You raised the age to 70?
Mr. Mueller. No. That is a separate reform. Currently,
under the current system, the normal retirement age is
scheduled to rise from 65 to 67 in steps. That would remain the
same, and the only other benefit changes would be across-the-
board benefit changes.
Chairman Shaw. And what would they be?
Mr. Mueller. They would be a scaling back over 45 years of
initial retirement benefits in even percentage amounts until
initial benefits beginning in the 45th year would be 80 percent
of what is currently promised under Social Security.
Chairman Shaw. I think the politics of that are dismal.
Mr. Mueller. If so, then the politics of the individual
accounts would be even worse because that promises less than
half the benefits----
Chairman Shaw. It's your assumption that the stock market
is only going to perform at one-third of the level that it has
for the last 20 years at historical levels, then obviously
that----
Mr. Mueller. Well, sir. It is not my assumption. It is the
assumption of SSASIM. That is one thing that I did not make up.
Chairman Shaw. Well, somebody did because it hasn't
happened yet. So someone had to come up with these figures and
these theories. Obviously.
Mr. Mueller. The underlying research comes from an economic
textbook by John Campbell, Andrew Lo, and Craig MacKinlay
called ``The Econometrics of Financial Markets,'' Princeton
University Press, 1997. That is the underlying basis for the
forecast in SSASIM.
Chairman Shaw. I see. And I would assume that you have read
forecasts that would be far rosier than that?
Mr. Mueller. Yes. I have read many rosier forecasts, but
they are inconsistent forecasts.
Chairman Shaw. Inconsistent with yours?
Mr. Mueller. No. Inconsistent with the Social Security
Administration's intermediate economic assumptions.
Chairman Shaw. Oh. Then let me ask you another question
then. If this is the assumption of the Social Security
Administration, what would be your thoughts with regard to the
President's plan and investment of the surplus, or portion of
the surplus, into equities? Have you assessed that plan?
Mr. Mueller. Not in this paper. If you ask for my opinion,
I don't think it would make a great deal of difference one way
or the other. We heard Mr. Summers say this morning that it
would affect only 4 percent of benefits in the middle of the
next century. I did think it was interesting though how much
time was spent, especially in your colloquy with Mr. Summers,
about the question of the accuracy of the figures.
I think the difficulty raised by this study for privatizers
is that I am merely demanding the same sort of fiscal
responsibility and accounting that you, in my view, are
correctly asking of President Clinton.
The common assumption of everyone who was at this table
before us was that in some form or another, we will be funding
Social Security through general revenues and that somehow this
would not show up in the cost of investment for the people who
were covered by Social Security.
Now, in my view, all that President Clinton has done is to
say to the privatizers, ``You say you can fund privatized
accounts out of general revenues; why can't we fund Social
Security out of general revenues? If there's no cost, what's
the problem?'' I think they are both equally off base, but of
the two, I would say President Clinton is at least less wrong.
Chairman Shaw. I'm sure he will appreciate that.
[Laughter.]
Even with your gloomy predictions of the future as far as
the stock market is concerned, do you know what the present
level of return on Treasury Bills to the Social Security
Administration is in terms of real dollars?
Mr. Mueller. Are you asking me what his rate-of-return
assumption is?
Chairman Shaw. Yes. Do you know what it is?
Mr. Mueller. I believe it is 2-point-something. That is
what Mr. Summers said.
Chairman Shaw. Yes. Well 4 percent is better than 2 points.
Maybe the President is more right or more wrong.
Mr. Mueller. Well, it would be except even the 2.8 percent
would be inconsistent with real growth of the economy equal to
1.4 percent. The reason is that it is generally agreed by
macroeconomic theorists that a situation in which the rate of
interest remains permanently above the rate of economic growth
is inherently unstable because under those conditions, the
total burden of debt, both public and private, would mushroom
indefinitely. And I don't believe that the interest-rate
assumptions----
Chairman Shaw. Let me ask you one other question. I think
it is sort of interesting here.
I guess that your prediction that the stock market is only
going to rise at the level of approximately a third of where it
has risen for the past 20 years would assume that there is
going to be some dips in the market. That it is not going to be
a constant upward spiral. Is that correct?
Mr. Mueller. I would assume so.
Chairman Shaw. Are you making any predictions as to the
performance of the market over the next 2 years?
Mr. Mueller. I do as a professional forecaster. In fact, I
predicted the 20-percent decline of the market last summer.
Chairman Shaw. And it didn't last very long, however.
Mr. Mueller. No, it didn't. But I also predicted the
recovery. [Laughter.]
Chairman Shaw. When did you predict the recovery?
Mr. Mueller. I'm sorry?
Chairman Shaw. When did you predict the recovery?
Mr. Mueller. When the market was at its bottom. I am
willing to supply the report, sir. This will be wonderful
advertising for Lehrman Bell Mueller Cannon, Inc. [Laughter.]
Chairman Shaw. Could I ask you what is your prediction for
the next year?
Mr. Mueller. I think we are going to have another
correction in the market, and then it will recover again.
Chairman Shaw. After it hits the bottom, it will go back up
again?
Mr. Mueller. Yes.
Chairman Shaw. OK. Mr. Doggett.
Mr. Doggett. Thank you very much. I think that your study
is very important. I appreciate the work that you have done on
it. I think you were in the room when Mr. Goldberg, as I
understood it, suggested you might be a member of the Flat
Earth Society on these transition and administrative costs.
I guess the first specific I would want to turn to, as I
understood his criticism, he said you assumed total
privatization. That is in error, is it not? You considered two
options.
Mr. Mueller. Well, I considered actually all degrees of
privatization. You could see, again from the earlier panel,
what my difficulty was. If I took a single plan which was only
a partially privatized plan, Michael Tanner would say, Oh, but
our plan at Cato is complete privatization.
Mr. Doggett. Right.
Mr. Mueller. If you model complete privatization, then Mr.
Goldberg says oh, but you didn't model partial privatization.
So what I did was to take a plan that privatized the Social
Security Program over one lifetime, and looked at what the
experience of people born in different years was, because at
any moment, you could stop the system and say this is our
partially privatized system.
If you stopped where the 1955 couple is, you would have
roughly a one-third privatized system. If you stopped where the
couple born in 1975 is, you would have roughly a three-quarters
privatized system. For the other two, it is completely
privatized, only with two different degrees of paying the
transition tax.
So I try to cover all the bases by using three plans,
experienced by four different generations, with four different
sets of assumptions.
Mr. Doggett. There was also the suggestion that over time,
all these administrative costs will work themselves out. Does
the experience in other countries suggest that we will ever see
administrative costs of a fully privatized or partially
privatized system down at levels that are anywhere near the
current administrative costs of the Social Security system?
Mr. Mueller. No. The current annual administrative costs
for Social Security are equivalent to four basis points or four
one-hundredths of a percentage point. Mr. Goldberg, in his
defense, said that he thought we could get costs down to 50
basis points with private accounts. The difference between his
assumption and the assumptions in this study is only 50 basis
points. Right now, the average equity fund costs the average
shareholder 1\1/2\ percentage points per year. I rather
charitably assumed that over time, there would be in fact
efficiency gains and that the annual cost would fall to 100
basis points. I doubt it would ever go much below that.
Mr. Doggett. I understand basically the bottom line of your
analysis is that if you use realistic assumptions, that there
is no one in this room today or alive on this planet today that
will come out better under the partial or complete
privatization plan under either one, than they would under
Social Security?
Mr. Mueller. It is certainly true for everyone in this room
today. I think the planet may go a little far since much of it
is not covered by the Social Security system.
Mr. Doggett. Well, we have got people on Social Security I
guess scattered around the world, literally in this system.
Mr. Mueller. That's true. But I did find no group now alive
that would benefit from privatization. In fact, no group that
could avoid substantial losses from either partial or full
privatization.
Mr. Doggett. And it will be those people born, is it after
2025 or beginning in 2025, a small portion as I understand your
study, of those that are at the very top of the pyramid of the
economic scale who are Anglo males who might have some benefit
if the system were fully or partially privatized after the year
2025?
Mr. Mueller. That is correct, if you add the qualifier
``with the realistic assumptions.'' As the last set of bars
shows, under the unrealistic assumptions the average person
born in 2025 could come out ahead. But by those unrealistic
assumptions, I mean the stock market selling for more than one
millennium worth of earnings.
Mr. Doggett. Well, I just hope that the research that you
have done, and Ms. McSteen, I am really appreciative of the
role the National Committee has played in getting this research
to us, that it will form the basis of what should be a truly
bipartisan effort, but it has to be a bipartisan effort that
accepts certain principles, one of which, it seems to me, has
to be that the system which we have had has been one of the
best the world has ever known. Before we junk it and experiment
on the American people, we ought to take into consideration
this simulation, recognize its value, and try to strengthen and
preserve the system rather than to weaken and destroy it. Thank
you.
Mr. Mueller. Thank you.
Mr. Matsui. The Chair was gracious to give me another
question. Mr. Mueller, I just wanted clarification or perhaps
you can even expand on this. For the economic assumptions you
are using for both the current system minus 20-percent or an
80-percent benefit level and a privatized system, you are using
the same inflation rate, the same economic growth rate, the
same projections. What you are doing is using a different
assumption in terms of what the economic benefits to the stock
market would be based upon projections over the long period of
time that you have done your study, right? Am I understanding
that correctly?
Mr. Mueller. That is correct. I was going to say to Mr.
Shaw in response to his last question that in fact, I do not
agree with those assumptions, but they happen to be the ground
rules for the debate. The intermediate economic assumptions of
the Social Security Administration amount to saying that we are
about to enter an economic ice age, one key feature of which is
that we are going to reach zero population growth because the
birth rate will fall below the replacement rate. That will be
roughly made up by immigration. But there will be no growth in
the population beyond mid-century. The only growth in the
economy would come from a 1-percent annual increase in labor
productivity.
You asked me for my opinion. I think that is probably too
pessimistic. In fact, so far the economy has been behaving more
like the low cost assumptions. I wouldn't be surprised in the
least if the actuaries raised their intermediate assumptions in
the next annual report. All I was insisting on is that if you
are going to adopt the economic ice age forecast, you can not
at the same time assume that the stock market is going to be
flourishing like a hothouse plant.
Mr. Matsui. What you are saying is that assuming even a
higher growth rate, the numbers in your graph would be similar
in terms of who benefits and who doesn't benefit?
Mr. Mueller. The shape would be the same. What would happen
is that for each percentage point of higher economic growth,
you would get a 1 percentage point higher return both in the
stock market and from Social Security.
Mr. Matsui. Right. I would just conclude by saying that I
think you have responded consistently with your testimony, that
you are using the same basic economic assumptions for the
equity market, and also the bond market in terms of Social
Security, and other components Social Security is involved in.
In other words, you are not saying one has a different growth
rate than the other.
Mr. Mueller. That is correct. Right.
Mr. Matsui. Thank you.
Chairman Shaw. Just one more question, if you could clear
up a confusion I have got in my head. You are projecting the
growth in the stock market of 4 percent, real dollars. We have
a system now that is making 2.5 percent in real dollars. How
can you say that 4 percent is not as good as 2.5 percent?
Mr. Mueller. It is because you don't get the 4 percent. If
you take the 4 percent, you have to subtract first the
transaction costs, which are a little over 100 basis points a
year. In addition, you have to subtract the cost of the lost
benefits. If you are going to give up all the Social Security
benefits over a period of 45 years, you have to subtract
another 2.2 percent from your rate of return. That puts you in
the hole compared with Social Security.
Chairman Shaw. How do you figure that?
Mr. Mueller. It is because if you are giving up Social
Security benefits--this is the ``clawback'' that the earlier
panel was talking about--that comes out of your rate of return.
That is a negative. I mean you are starting in the hole. It is
so large because in each case we are talking about a benefit
loss of about 38 percent for the first couple, 82 percent for
the second couple, and 100 percent for the other two couples.
Chairman Shaw. Do these examples take into effect that both
the President's plan and some on the Senate side, as far as
Republicans are concerned, assume up to an infusion of 62
percent of the surplus going into the retirement accounts or
into the Social Security system?
Mr. Mueller. No, sir. It assumes what the Social Security
Administration assumes, which is essentially current law. My
point about the transition tax is that----
Chairman Shaw. I think all of the witnesses, and I think
anybody who has studied this at all knows that if we do get
into some type of personal accounts, that there is going to be
a transition cost. That transition cost is going to require
some of the surplus. I think that is a given. We can't go from
one system to another system without having some type of cost
to bridge the transition.
If we do nothing, the system is going to take a huge
infusion of cash. Once you get into two or three generations
from now, if you do nothing, our grandchildren will suffer
greatly.
Mr. Mueller. I am certainly not proposing to do nothing.
The whole reason I modeled two different plans for balancing
pay-as-you-go Social Security was to show that even a pared
back, balanced Social Security system would give you a higher
rate of return than you could get from a partially or fully
privatized system.
Chairman Shaw. OK. But now your system assumes a greater
working population and it assumes a smaller than historical
stock market escalation. Is that not correct?
Mr. Mueller. It assumes that economic growth will be slower
and that equity returns will become lower commensurate with
that lower growth, yes.
Chairman Shaw. What is your forecast on corporate bonds?
Mr. Mueller. Corporate bond yields are assumed to equal the
growth rate of the economy. The Social Security Administration
assumes that long-term growth of the economy would settle down
at 4.7 percent. So that is the corporate bond rate assumption.
Chairman Shaw. So it is about the same as the stock market,
in your opinion?
Mr. Mueller. No. I'm sorry, 4.7 percent would be in nominal
terms. After inflation, it would be 1-point something, less
than 2 percent.
Chairman Shaw. Oh. Corporate bond return is going to be
lower than the Treasury bills?
Mr. Mueller. No.
Chairman Shaw. Treasury bills are at 2.5 percent in terms
of real dollars.
Mr. Mueller. Well, they are if you have an inconsistent
forecast for the bond market as well as for the stock market.
You can not have the burden of debt, public or private,
compounding at a rate, a real rate of 2.7 percent, while the
economy is only growing at 1.4 percent. You run into the same
sort of problem that you do with the price/earnings ratio; in
this case, the burden of all debt, public and private, would
mushroom. Under those assumptions, you would have nonfinancial
corporate debt, which is now at a record 210 percent of GDP,
going to 16 times GDP. You would have all of the economy being
eaten up by interest costs, with nothing left over for anything
else.
This is precisely the point I am making. These projections
are not consistent.
Chairman Shaw. I think if we have proved anything by this
segment of the hearing, it is why CPAs do not understand
economists. [Laughter.]
In any event, we thank you for your input. We do have your
study and we are analyzing it at this time. I wish we had had
an opportunity to fully digest it before this hearing.
[A response from Mr. Mueller to Mr. Matsui follows. The
attachment is being retained in the Committee files.]
Lehrman Bell Mueller Cannon, Inc.
Arlington, VA 22201
11 March 1999
Honorable Clay Shaw
Chairman, Social Security Subcommittee
House Ways and Means Committee
Raybum HOB
Washington, D.C. 20515
Dear Congressman Shaw,
At the March 3rd Social Security Subcommittee hearing, Congressman
Matsui asked me to submit a written response to Fred T. Goldberg's
remarks about my study, ``Winners and Losers from `Privatizing' Social
Security.'' I request that this response be made part of the published
written record of the hearing.
Mr. Goldberg's opening comments on geography were somewhat
enigmatic, but I took him to mean that anyone who disagrees with Mr.
Goldberg must believe that the earth is flat. As it happens, my casual
observations of the horizon from commercial aircraft, combined with
some basic knowledge of geometry, incline me to endorse Mr. Goldberg's
general views about the shape of our planet. However, regarding the
subject of the hearing, Social Security reform, I can agree with Mr.
Goldberg about only one thing: the critical importance of assumptions.
The main point of my testimony was that ``privatizers'' necessarily
require erroneous assumptions to support their case. Mr. Goldberg
proved me correct on all three points I raised:
1. a fundamental inconsistency between the ``privatizer'' projected
returns for Social Security and those for financial assets;
2. unrealistic assumptions by the ``privatizers'' about earnings of
American households; and
3. ``privatizers'' attempts to ignore or conceal the ``transition
tax'' inherent in any move away from pay-as-you-go Social Security
toward a partly or fully privatized system.
1. (In)consistency of financial-market and economic assumptions.
a. Mr. Goldberg generally objected to my new study's
projections, including those concerning equity returns, but
under questioning from the chairman he could not offer any
projections of his own. If Mr. Goldberg would be kind enough to
supply the committee with specific 75-year projections for
average real equity returns and real GDP growth, it should be
possible to calculate the implied price/earnings ratio, as I
did for the projections of the 1994-96 Social Security Advisory
Council. As I showed, those projections implied price/earnings
ratios surpassing 500 or even 1000 years by the time some of
the people in the study retired.
In response to a question from Chairman Shaw, I cited the
source for these calculations and for the stock market
projections used in my study. The equity projections are those
calculated by the SSASIM model to be consistent with the 1998
Intermediate economic assumptions of the Social Security
Trustees (which project 1.4% average real GDP growth over the
next 75 years), upon which projections of returns on Social
Security are based. As I noted, the SSASIM model is not my own
creation. SSASIM was developed by Policy Simulation Group,
initially under contract with the Social Security
Administration, and most intensively in partnership with the
Employee Benefit Research Institute (EBRI). SSASIM is being
used by several Federal agencies (SSA, 0MB, Treasury and GAO)
to analyze Social Security reform. SSASIM calculates that,
given the SSA projections for economic (and thus long-term
corporate earnings) growth, the real rate of return on equities
would have to fall from about 7% in the past 75 years to about
4.7% in the next 75 years. I also cited the survey of stock
market research on which this feature of the model is based.\1\
In short, there is a glaring contrast between the
``privatizers'' projections for the equity market and for the
economy, the result of a fundamental and indefensible logical
inconsistency.
---------------------------------------------------------------------------
\1\ Holmer, Martin, ``New SSASIM Equity Return Stochastic
Process,'' September 28,1998, Policy Simulation Group, Washington, D.C.
Holmer cites John Y. Campbell, Andrew W. Lo and A. Craig MacKinlay, The
Econometrics of Financial Markets, Princeton University Press, 1997.
---------------------------------------------------------------------------
b. Mr. Goldberg argued that the average transactions costs
for investments in private accounts would be lower than my
study assumed. At the hearing, Mr. Goldberg cited a figure of
50 basis points a year for management fees, and his submission
suggested a range of 30-50 basis points; the assumption for
annual management fees I used was 100 basis points. (The
comparable figure for Social Security is about 4 basis points.)
Now, the average total shareholder cost ratio for equity funds
in 1997 was 149 basis points, according to the Investment
Company Institute.\2\ Therefore, my estimate already assumes a
further one-third reduction in the average expense ratio. A
recent study of administrative expenses by the Employee Benefit
Research Institute (EBRI) cited evidence ``401(k) plan fees
varied by as much as 300% and can comprise of up to 3-5 percent
of 401(k) balances per year.'' \3\
---------------------------------------------------------------------------
\2\ John D. Rea and Brian K. Reid, ``Trends in the Ownership Cost
of Equity Mutual Funds,'' Investment Company Institute Perspective Vol.
4 No. 3, November 1998, page 2.
\3\ Kelly A. Olsen and Dallas L. Salisbury, ``Individual Social
Security Accounts: Issues in Assessing Administrative Feasibility and
Costs,'' EBRI Special Report and Issue Brief #203, November 1988, 32.
---------------------------------------------------------------------------
My study also assumed a 5% ``load'' on the purchase of
private annuities, which is far below the going rate. But to
this Mr. Goldberg does not appear to object. In his own
submission, he writes: ``Because the administrative costs of
individual annuities may be as much as 5 to 10 percent of the
purchase price (even without premiums for adverse selection),
we believe that it is appropriate for retirees who choose to
purchase such annuities to bear these costs themselves.'' \4\
Thus he thinks my estimate may be right, or may be understated
by as much as 50%.
---------------------------------------------------------------------------
\4\ Fred T. Goldberg Jr. and Michael J. Graetz, ``Reforming Social
Security: A Practical and Workable System of Personal Retirement
Accounts,'' NBER Working Paper 6970, February 1999, 27.
---------------------------------------------------------------------------
These are the only transactions costs assumed in the study.
I suggest that it is Mr. Goldberg's estimate that is
unreasonable. And if ``privatization'' really stands or falls
on a 50 basis-point difference over management fees, I think it
reinforces my point: the ``privatizers'' case depends upon a
highly specific (and in large part highly unlikely) set of
assumptions.
2. Unrealistic labor market assumptions.
Mr. Goldberg touched on this point only indirectly, when he
claimed that those who would be helped most by ``privatizing''
Social Security would be low-income households, blue-collar
workers and African-Americans. However, he did not cite any
source for this claim. My study showed that a recent Heritage
Foundation study making an assertion similar to Mr. Goldberg's
was based entirely on several errors, including the three
discussed here (Appendix K, ``A Syllabus of Errors: The Recent
Heritage Foundation Study''). Whatever the source, Mr.
Goldberg's assertion necessarily implies unrealistic earnings
assumptions on his part. My study found that households with
lower earnings would be hurt more than those with higher
earnings, in part because (for example) high-school dropouts
are not employed enough of the time to generate the savings
claimed by using the faulty ``unisex flat earnings''
assumption. But of course, Mr. Goldberg's claim may also partly
have to do with unrealistic assumptions for returns on
financial assets, already discussed.
3. Ignoring the ``transition tax.''
a. This is the most important practical question in the
debate about Social Security reform, because the ``transition
tax'' dwarfs any possible cost of balancing pay-as-you-go
Social Security. In general, I believe Mr. Goldberg is confused
about the transition tax, but he is not alone.
Every penny of current benefits is paid out of someone's
current income. This means that for a whole generation, what
matters is the total amount of retirement benefits, not how
they are financed. The net ``transition tax'' on a generation
may be defined as the difference between the Social Security
benefits it pays to earlier retirees while in the labor force,
and the (smaller) Social Security benefits it receives during
its own retirement. This is the point of Graph 3 in my
testimony, which shows the difference between current OASI
benefits and benefits received 25 years later (both measured as
a share of taxable payroll). The graph shows that under
``privatization in one lifetime,'' the ``transition tax'' rises
to at least 7% of taxable payroll each year by the year 2030,
before beginning to decline. The chart stops at 2050 because
SSA projections only go as far as 2075, but this tax would
continue for at least 75 years. For an individual or household,
the calculation is the same, except for secondary differences
due to any unequal distribution of the burden among workers
within the generation. (The whole burden is paid by workers:
see below.)
Mr. Goldberg asserted that my study arbitrarily assumes
that the transition cost would fall entirely on lower-income
households. This is simply incorrect. The burden falls on
whomsoever loses the Social Security benefits without any
compensation (or pays extra contributions without extra
benefits). A relatively larger burden is indeed imposed on
lower-income families. This is not due to any assumptions on my
part, but simply to the fact that full or partial
``privatization'' aims precisely to strip out those components
of Social Security which favor lower-income families most
(progressivity of benefits, spousal and survivors benefits).
Mr. Goldberg strongly implied that the burden of the
transition cost might be significantly different if it were
funded out of general revenues. This objection is presumably
based on the argument that the burden of the payroll tax
differs from the burden of the income tax. However, the
argument contains several fatal flaws.
First, neither Mr. Goldberg nor any other ``privatizer''
has produced any figures to support his contention. Rather, all
``privatizers'' have made the ridiculous assumption that the
income tax--or borrowing against the income tax--has zero cost
to anyone. All rates of return calculations in studies
advocating privatization of Social Security use this absurd
convention. This is precisely the ``creative accounting''
against which I warned, which enjoys no support from any theory
or evidence. Based on the ``privatizers'' preposterous logic--
which ignores any cost but the payroll tax in calculating rates
of return--funding Social Security completely through general
revenues would provide everyone an infinite rate of return.
Social Security is now financed (in fact, overfinanced)
through payroll taxes; but using some other means (such as
current income taxes or current borrowing against future income
taxes) would not significantly affect the calculation. If
benefits were instead funded, say, partly through payroll taxes
and partly through income taxes, then for each individual we
must subtract part of the payroll tax and add back that
individual's share of the income tax levy that replaces it. In
any case, before measuring rates of return for individual
workers or households, the first requirement is that the whole
cost must be attributed to someone. This the ``privatizers''
fail to do.
Second, if Mr. Goldberg troubled to do the calculations, he
would learn that his objection is not merely of secondary, but
of tertiary significance. Most of the transition ``tax'' under
partial or full privatization consists of the loss of Social
Security retirement benefits without a corresponding reduction
in payroll contributions. (In some proposals, the loss of
benefits is coupled with an increase in mandatory
contributions.) It is primarily this loss of benefits--not any
explicit increase in either payroll or income tax rates--which
turns part or all of the existing payroll contribution into a
pure tax. Mr. Goldberg himseif argued that such changes must be
part of any Social Security reform package. An explicit
increase in tax rates would only come into play when the
``privatizers'' seek to make those workers whole again out of
general revenues. Yet they do not attribute any of that cost to
anyone, thereby invalidating their calculations. This flaw is
contained in every single study on privatization of which I am
aware, for example, from the Cato Institute or the Heritage
Foundation.
The third problem with Mr. Goldberg's argument is that the
whole burden of retirement benefits must be financed out of
labor compensation--no matter how it is formally financed. In
the jargon of economists, the ``incidence'' of a tax differs
from its ``burden.'' For example, half the payroll tax is paid
by employers: its ``incidence'' is on businesses; yet
economists generally agree that the ``burden'' of the payroll
tax actually falls on labor compensation, not on corporate
profits: it is paid out of income that would otherwise go to
workers.
Let us suppose that the payroll tax were completely
replaced by income tax funding of retirement benefits. By Mr.
Goldberg's argument at least part of the cost of Social
Security benefits would be paid out of property compensation
(interest, dividends, etc.) rather than labor compensation,
because the income tax falls on labor and property
compensation, while the payroll tax falls only on labor
compensation. However, this is not in fact possible. The theory
of the distribution of income suggests that any shifting of the
payroll tax burden to owners of property would be offset by an
approximately equal loss of pretax income by workers. And the
evidence supports this. I have done extensive analysis of the
distribution of U.S. national income--both labor compensation
and property compensation, before and after all Federal, state
and local taxes and transfer payments--going back to 1929, and
can show that the theory of income distribution is supported by
the evidence.
Mr. Goldberg's real objection, I contend, was to the fact
that my study allocated the transition cost at all--not to the
way in which that cost was accounted for. This is exactly the
sort of ``creative accounting'' by privatizers against which I
warned in my testimony. It also reveals the great virtue of
using SSASIM as I did: the user must allocate the transition
cost to someone. I invite Mr. Goldberg to allocate the
transition tax in any way he chooses--as long as he allocates
the whole cost to somebody. He will find that doing so would
not affect the qualitative results of the study in the least.
The ``transition tax'' is simply too large to be affected by
any estimates about its distribution.
b. Mr. Goldberg objected that my study only modeled a bill
for complete privatization of Social Security, whereas he,
personally, was against going beyond partial privatization. Yet
there was a great deal of disagreement on this point among the
members of the first panel, ranging from those who are against
or skeptical of private accounts (Mr. Summers and Mr.
Reischauer), to those favoring various degrees of partial
privatization (Ms. Weaver and Mr. Goldberg) to those favoring
complete privatization (Mr. Tanner).
Precisely because there is no agreement among
``privatizers,'' my study was constructed to survey the whole
range of possible options, from balancing the pay-as-you-go
system without private accounts, to various degrees of partial
privatization, to full privatization. I did this by comparing a
plan to privatize Social Security over one lifetime (roughly 80
to 90 years) with two plans to balance the pay-as-you-go
system. As I pointed out in my testimony, and in response to
one of Congressman Matsui's questions, the experience of those
born in 1955 involves partial privatization; of those born in
1975 substantial privatization; and of those born in 1990 and
2025 complete privatization (the 1990 cohort facing the
heaviest burden and the 2025 cohort the lightest). Thus no one
can complain that his or her favorite approach was neglected in
my study.
I believe the foregoing thoroughly refutes Mr. Goldberg's
objections. But before closing I would like to remark on
another important issue raised by the morning panel March 3rd.
In his testimony, Professor Lawrence J. White outlined what he
aptly named the ``canned goods'' theory of investment, his
lucid metaphor for the ``neoclassical'' economic theory devised
in the late 19th century. I urge members of the committee to
compare this explanation with a newer and better grounded
opposing view, summarized in a paper which I am enclosing
(``The Economics of Pay-as-you-go Social Security and the
Economic Cost of Ending It''). Despite their disagreements on
several points, all members of the moming panel were partisans
of the ``canned goods'' theory, which argues that the only
investment that matters to the economy is investment in
things--so-called ``nonhuman capital.'' All the panelists
agreed that the funding of Social Security depends on the
growth of labor compensation--and yet all ignored the past 40
years of research showing that labor compensation is the return
on investment in so-called ``human capital'' the size and
earning ability of the labor force. A large body of research
shows that investment in ``human capital'' is between two and
three times as important to economic growth as investment in
``nonhuman capital.'' The ``transition tax'' is levied
precisely on the return on such investment, and must tend to
discourage it. None of the ``privatizers'' take this negative
impact into account.
I am grateful to the subcommittee for the opportunity to
testify on this important question.
Sincerely yours,
John Mueller
Chairman Shaw. I thank you both for being with us. The
hearing is now adjourned.
[Whereupon, at 2:50 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of Emma Y. Zink, Chairperson, Teachers' Retirement Board,
California State Teachers' Retirement System, Sacramento, California
CalSTRS and Other State and Local Government Retirement Systems Have
Met Their Fiduciary Responsibilities to Provide Pre-Funded Retirement
Benefits for Millions Of State and Local Government Employees
In the course of the recent debate over the President's
proposal for direct investment of a portion of the Social
Security trust fund in equities, there has been the suggestion
that public pension plans, including State and local retirement
systems, have underperformed in their investments because of
political interference. While we do not intend to inject
ourselves into the debate over Social Security privatization,
as one of the largest State retirement systems in the country
we feel compelled to respond to the suggestion that State and
local plans and their governing bodies have failed to fulfill
their fiduciary responsibilities.
In testimony before the Senate Budget Committee on January
28, 1999, Federal Reserve Board Chairman Alan Greenspan, in
discussing the President's proposal for direct investment of
Social Security trust fund assets in equities, asserted: ``Even
with Herculean efforts, I doubt if it would be feasible to
insulate, over the long run, the trust funds from political
pressures--direct and indirect--to allocate capital to less
than its most productive use. The experience of public pension
funds seems to bear this out.'' Chairman Greenspan argued that
the returns on State and local pension funds are lower than
private sector counterparts, while conceding that much of this
disparity would be eliminated were these returns adjusted for
risk in light of the fact that State and local pension funds
often are invested more conservatively than private plans. The
remainder of the disparity, Chairman Greenspan suggested, may
be ascribed to political interference in the management of the
State or local pension fund.
The California State Teachers' Retirement System (CalSTRS)
covers more than 600,000 active and retired elementary,
secondary, and community college teachers in California.
Established in 1913, CalSTRS has successfully provided benefits
to generations of retired teachers in California. The CalSTRS
retirement system has assets with a total market value of
$93.456 billion as of December 31, 1998. Last year, as of June
30, 1998, CalSTRS collected $1.005 billion in contributions
from the State, and its investments returned $12.949 billion in
earnings and asset growth. CalSTRS is essentially fully funded
(to meet its actuarial accrued liability). Last year, CalSTRS
paid, on a pre-funded basis, over $3 billion in benefits to
150,000 retirees and families.
A twelve-member Teachers' Retirement Board governs CalSTRS.
The Governor appoints eight members representing active and
retired teachers, business people from the insurance field and
commerce banking, or savings and loan field, and a public
representative to serve four-year terms. Four Board members
serve in an ex-officio capacity and actively participate in
Board matters; the State Superintendent of Public Instruction,
the State Controller, the State Treasurer, and the State
Director of Finance.
The Teachers' Retirement Board vigorously discharges its
fiduciary obligations in the management of the retirement plan
for the exclusive benefit of its active and retired members.
Providing retirement security is the driving force of the
investment policy. To meet this goal of retirement security,
CalSTRS is dedicated to obtaining the highest possible return
on its investments of the mandatory employer and employee
contributions and other fund income, given an acceptable level
of risk. The CalSTRS Investment Management Plan incorporates
strategies that implement the Board's investment direction. The
Board has established safety, diversification, liquidity, and
structure as the appropriate standards for a complete and
profitable investment portfolio. Reducing the System's funding
costs within prudent levels of risk, diversification, and
reduction of costs associated with managing the System assets
are measures that have contributed to a solid investment
portfolio. The Board establishes and regularly reviews the
asset allocation policy that is designed to meet the investment
objectives with an acceptable minimum risk.
We do not wish to become involved in the debate over the
President's proposal for direct investment of Social Security
trust fund assets in the stock market. However, we cannot let
rest any implication from Chairman Greenspan's testimony or
elsewhere that the Teachers' Retirement Board of the State of
California or the governing bodies of other State and local
government retirement systems are failing to live up to their
fiduciary responsibilities. The members of the California State
Teachers' Retirement Board take our fiduciary responsibilities
very seriously, vigorously exercise those responsibilities and
have fully discharged them.
Statement of Century Foundation, New York, New York
Social Security Reform Proposals: How They Stack Up Against Principles
for Prudent Change
Members of Congress, private organizations, academics, and
others have put forward widely differing plans for reforming
Social Security. Many of the details of those proposals are
complicated and the extent to which they address the primary
problem confronting the program--a projected shortfall
beginning in the year 2032--vary considerably.
To help those who care about the future of Social Security
understand the most prominent proposals under consideration,
the Century Foundation is publishing a series of Social
Security Reform Checklists. Each summarizes the main provisions
of a particular plan and then assesses whether it adheres to
seven principles for prudent reform that were developed by a
panel of leading Social Security experts.
The Seven Social Security Reform Principles
1. Social Security should continue to provide a guaranteed
lifetime benefit that is related to past earnings and kept up-
to-date as the general standard of living increases.
2. American workers who have the same earnings history and
marital status, and who retire at the same time, should receive
the same retirement benefit from Social Security.
3. Social Security benefits should continue to be fully
protected against inflation, and beneficiaries should continue
to rest assured that they will not outlive their monthly Social
Security checks.
4. Retirees who earned higher wages during their careers
should continue to receive a larger check from Social Security
than those with lower incomes; but the system should also
continue to replace a larger share of the past earnings of low-
income workers.
5. Social Security's insurance protections for American
families, including disability insurance, should be fully
sustained.
6. Social Security's long-term financing problem should not
be aggravated by diverting the program's revenues to private
accounts and benefits should not be reduced to make room for
private accounts; any such accounts should be supplementary to
Social Security, entirely as an add-on.
7. In addition to securing Social Security as the
foundation of income support for retirees, their dependents,
the disabled, and survivors, more needs to be done to encourage
private savings and pensions.
Social Security Reform Check List #1
The Robert M. Ball Plan
Overview
Robert M. Ball, a former commissioner of Social Security,
advocates a plan that retains Social Security's current
structure while making a series of adjustments to assure the
system's long-term financial integrity and giving wage earners
a way to save additional money for retirement. His plan is
similar to a proposal endorsed in January 1997 by six out of
thirteen members of the 1994-96 Advisory Council on Social
Security. The Ball plan requires only limited benefit cuts and
tax increases. It would invest a portion of the Social Security
trust funds, now exclusively comprising U.S. Treasury
securities, in private equities. All disability and life
insurance benefits would be maintained at present levels.
Benefits to retirees would continue to be guaranteed for life
and indexed for inflation. Those who paid more in payroll taxes
would continue to receive larger benefit checks, while the
program would also continue to replace a greater portion of
wages for low earners than for higher earners. In addition,
beginning in 2000, wage earners would have the option of
contributing up to 2 percent of their wages to voluntary
private savings accounts.
Summary of Key Features
Benefit Changes. The Ball plan would avoid major benefit
cuts. Like most other reform proposals, however, it does
include minor changes in the cost-of-living adjustments to
reflect corrections to the consumer price index recommended by
the Bureau of Labor Statistics. Those changes, most of which
are already scheduled to take effect, should reduce annual
cost-of-living adjustments by about 0.25 percentage points a
year. The Ball plan would also increase the number of working
years counted to determine benefit levels from today's 35 to
38. Adding more years would reduce average benefits by about 3
percent because the average past salaries that benefits are
based on would include more years when workers were young and
earning less--or nothing at all. Those with long absences from
the workforce--women more commonly that men--would end up with
the largest reductions.
Tax Changes. The plan does not include major tax changes;
but it would raise the ceiling on earnings subject to Social
Security taxes (currently $68,400 per worker) at a rate faster
than current law allows. The plan would seek to raise the
portion of taxable wages from 85 percent of the national
payroll to 90 percent--the traditional level of the program.
Structural Changes. The Ball plan would invest part of the
Social Security trust funds, which now hold exclusively U.S.
government securities, in stocks beginning in 2000. By 2015, 50
percent of the trust funds' assets would be invested in a broad
index of equities. A Federal Reserve-type board would oversee
these investments.
The plan would also move toward making Social Security
universal by including all newly hired state and local
government employees, some of whom are now covered under
separate retirement systems. (Federal employees hired since
1974 are already covered under Social Security.) In addition,
the Ball plan would allow workers to invest up to an additional
2 percent of their pay in voluntary supplementary retirement
accounts administered through Social Security.
Evaluating the Plan
To assess the impact of various proposals to change Social
Security, The Century Foundation organized a group of experts
to develop principles for prudent reform. Here's how Robert
Ball's plan stacks up against those principles:
Principle 1. Social Security should continue to provide a
guaranteed lifetime benefit that is related to past earnings
and kept up to date as the general standard of living
increases.
Analysis: The Ball plan leaves intact nearly all basic
features of the current system, including lifetime benefits
based on past earnings (with adjustment to account for past
changes in the cost-of-living).
Principle 2. American workers who have the same earnings
history and marital status, and who retire at the same time,
should receive the same retirement benefit from Social
Security.
Analysis: None of Ball's changes would alter this basic
feature of the current system. However, workers who chose to
make use of voluntary supplementary retirement accounts usually
could expect to receive higher overall benefits than those who
did not.
Principle 3. Social Security benefits should continue to be
fully protected against inflation, and beneficiaries should
continue to rest assured that they will not outlive their
monthly Social Security checks.
Analysis: By endorsing modifications to the cost-of-living
adjustment recommended by the Bureau of Labor Statistics to
correct for current overstatements of inflation, the Ball plan
would slightly reduce the amount by which Social Security
checks are increased each year. Still, this proposal would
retain the current system's protections against inflation.
Principle 4. Retirees who earned higher wages during their
careers should continue to receive a larger check from Social
Security than those with lower incomes; but the system should
also continue to replace a larger share of the past earnings of
low-income workers.
Analysis: Again, the Ball plan maintains the current
benefit structure of Social Security. Higher earners would
continue to receive larger benefit checks than lower earners,
but low-income retirees would receive checks that replaced a
larger share of their average earnings.
Principle 5. Social Security's insurance protections for
American families, including disability insurance, should be
fully sustained.
Analysis: The Ball plan maintains all of Social Security's
insurance protections and current benefit levels for the
disabled and for family members of workers who die.
Principle 6. Social Security's long-term financing problem
should not be aggravated by diverting the program's revenues to
private accounts and benefits should not be reduced to make
room for private accounts; any such accounts should be
supplementary to Social Security, entirely as an add-on.
Analysis: The Ball plan would not divert any of Social
Security's payroll tax revenue into private accounts. However,
it does feature voluntary add-on accounts that would be
administered by Social Security and that workers could use to
build greater retirement savings. The Ball plan would also
invest a portion of the Social Security trust funds in private
equities, which historically have increased in value more
rapidly than the Treasury securities the system now holds. This
change would potentially help alleviate the long-term financing
challenge facing the system. But because stocks can lose value
during particular periods of time, the assets in the trust
funds might decline during a bear market.
Principle 7. In addition to securing Social Security as the
foundation of income support for retirees, their dependents,
the disabled, and survivors, more needs to be done to encourage
private savings and pensions.
Analysis: By creating add-on accounts supplementary to
Social Security, the Ball plan would institute a new mechanism
for workers to accumulate savings for retirement. This
provision would be especially beneficial to Americans who have
no private pensions or other retirement savings options. On the
other hand, a variety of tax incentives currently in place to
promote savings, such as tax breaks for individual retirement
accounts and 401(k) plans, have not been sufficient to induce
low- and moderate-income households to increase their anemic
savings rates. It is unclear whether a voluntary program like
Ball's would create significant new savings.
Social Security Reform Check List #2
Two Percent Personal Retirement Accounts
Overview
Harvard economist Martin Feldstein, a former chairman of
the Council of Economic Advisors, has proposed reforming Social
Security by creating ``two percent personal retirement
accounts.'' Feldstein's proposal, unlike most other plans,
seems painless. It imposes no reductions in Social Security
benefits or increases in taxes. In fact, its most distinctive
feature is the creation of a new benefit: a fully refundable
income tax credit, equal to 2 percent of each worker's earnings
subject to the Social Security payroll tax that would finance
new personal retirement accounts. (This tax credit is fully
refundable because workers with no income tax liability and
those who owe less than 2 percent of their earnings would still
receive the full 2 percent contribution to their account.)
Under the plan, workers would have flexibility to choose
from a group of regulated stock and bond mutual funds that
would be administered by private managers. After retirement,
however, every dollar a retiree withdraws from his or her
personal account would reduce that retiree's guaranteed Social
Security benefit by 75 cents. In cases where workers invested
so badly or the market performed so poorly that little money
was left in the accounts, they would continue to receive the
benefits promised under today's system. Social Security's
projected shortfall in the year 2032 would be deferred because
the system would presumably owe less money to beneficiaries
thanks to the accumulations in the investment accounts.
The Price-tag
According to the Congressional Budget Office, which
recently released a critique of the Feldstein plan, the
proposed tax credits would cost the government about $800
billion over the next ten years. Rather than raise taxes or
reduce government spending over that period, Feldstein proposes
allocating anticipated federal budget surpluses to pay for the
tax credit. Whenever federal surpluses become insufficient,
then Congress would determine how to raise the money. But for
the near future, Feldstein argues, his proposal could be
implemented without imposing either benefit reductions or
revenue increases that other plans for strengthening Social
Security include.
Since Social Security faces a projected shortfall in 2032,
can the system really be strengthened painlessly? The Feldstein
plan appears to do so by financing the new accounts with the
surplus in general revenues, as opposed to the payroll tax that
is dedicated to Social Security benefits, thereby tapping a new
well of resources for mandatory retirement savings. But because
current federal budget surpluses reduce the debt, creating a
new tax credit and diverting the surpluses to private accounts
would increase the government's long-term obligations and
interest costs. Therefore, as the report stated, ``The policy
would implicitly increase the tax burden on future workers if
no further adjustments were made on the spending side of the
budget.''
Evaluating the Plan
To assess the impact of various proposals to change Social
Security, The Century Foundation organized a group of experts
to develop principles for prudent reform. Here's how the
Feldstein proposal for 2 percent personal retirement accounts
stacks up against those principles:
Principle 1. Social Security should continue to provide a
guaranteed lifetime benefit that is related to past earnings
and kept up-to-date as the general standard of living
increases.
Analysis: Under the Feldstein plan, guaranteed Social
Security benefits under the current formula, which is based on
past earnings and takes into account cost-of-living changes,
would become the minimum that workers receive. The actual
payments that workers would collect, however, would depend to a
significant extent on how the investments in their personal
retirement accounts fared. Because the personal retirement
accounts would be financed through a flat-rate income tax
credit of 2 percent, the dollar amount of the contributions to
the accounts would be higher for workers with larger incomes
and would rise over time as a worker's earnings grew.
Therefore, a retiree's total benefits would continue to be
related to past earnings, although less so than under current
law because of variations in the investment performance of his
or her account.
Principle 2. American workers who have the same earnings
history and marital status, and who retire at the same time,
should receive the same retirement benefit from Social
Security.
Analysis: The Feldstein 2 percent plan would produce new
disparities in benefits earned by retirees with the same
earnings history and marital status because some workers could
be expected to make better investments than others. Variations
in investment performance would be somewhat limited, however,
because every extra dollar that workers accumulate in their
personal retirement accounts would increase the benefits they
receive by just 25 cents under the plan's formula.
Distributions would be further reduced by the cost of
administering the accounts, paying investment management fees,
and integrating them with the rest of the Social Security
system. Economist Peter Diamond has shown that the
administrative costs in countries that have set up individual
accounts (Britain, Chile, Argentina, Mexico) reduce benefits by
20 to 30 percent compared to what the U.S. Social Security
system would pay given the same resources.
Principle 3. Social Security benefits should continue to be
fully protected against inflation, and beneficiaries should
continue to rest assured that they will not outlive their
monthly Social Security checks.
Analysis: Because the baseline benefit would remain intact,
beneficiaries would continue to receive some lifetime benefit.
To date, however, the Feldstein 2 percent personal account plan
does not specify whether and how the amounts accumulated in
personal accounts would be converted into monthly payouts. Even
if beneficiaries were required to annuitize their accounts
(that is, convert the lump sums into smaller periodic payments
based on life expectancy levels), the value of those payments
would be eroded by inflation unless they were indexed to
increases in the cost of living, as are today's Social Security
benefits. The Feldstein plan does not indicate that the
payments would be adjusted for inflation, however. If retirees
were allowed to withdraw the money in a lump sum, as they can
with individual retirement accounts, for example, they might
spend all that money before they die.
Principle 4. Retirees who earned higher wages during their
careers should continue to receive a larger check from Social
Security than those with lower incomes; but the system should
also continue to replace a larger share of the past earnings of
low-income workers.
Analysis: When the payouts from personal retirement
accounts are included, the overall effect of the plan would be
that higher earners would receive disproportionately greater
increases in their total benefit package than lower earners.
Brookings Institution economists Henry J. Aaron and Robert D.
Reischauer show that a worker with a high income would see
their combined Social Security and private account payment
increase by more than twice that of a low-income worker.\1\
That would happen mainly because 1) contributions to the
accounts would be made at the same 2 percent rate regardless of
income, but 2) guaranteed benefits, which would be reduced at
the same rate for all retirees, replace a larger share of the
past earnings of low-income workers. These calculations don't
factor in the probability that high income workers would invest
more aggressively and successfully. The bottom line is that
lower-income workers would benefit less from the proposed
formula than upper-income workers. (Feldstein has said that
this problem could be addressed by imposing a modest
redistributive tax on the investments of higher earners).
---------------------------------------------------------------------------
\1\ In the table below, Social Security benefits correspond
approximately to the average replacement rates of low and maximum
earners--56 percent and 25 percent, respectively. Each worker
contributed proportionately to earnings. When Social Security benefits
are reduced by three-quarters of the pension based on the individual
account, the low earner's pension goes up 12 percent, and the high
earner's by 21 percent.
----------------------------------------------------------------------------------------------------------------
Social Individual Total Change in
Average Earnings Security Account Pension Pension
----------------------------------------------------------------------------------------------------------------
Low earner--1,000........................................... 560 240 620 +11%
High earner--5,600.......................................... 1,375 1,340 1,720 +25%
----------------------------------------------------------------------------------------------------------------
Principle 5. Social Security's insurance protections for
American families, including disability insurance, should be
fully sustained.
Analysis: The Feldstein 2 percent account plan is not
explicit about what changes, if any, would be made to the
survivor's and disability features of Social Security. By
skirting this issue, the plan leaves important questions
unanswered. For example, if a worker died prematurely and left
dependents, what formula would be used for paying out the
proceeds of his or her personal retirement account and
integrating these funds with Social Security survivor's
benefits? If workers became disabled, would they be entitled to
gain access to the investments accrued in their accounts?
Principle 6. Social Security's long-term financing problem
should not be aggravated by diverting the program's revenues to
private accounts, and benefits should not be reduced to make
room for private accounts; any such accounts should be
supplementary to Social Security, entirely as an add-on.
Analysis: By creating a new refundable income tax credit to
finance personal accounts, the Feldstein plan avoids, for now,
diverting payroll tax revenues earmarked for current benefits
and the Social Security trust funds. But because the tax credit
would create a new long-term government obligation, future
Congresses would need to find a way to pay for the personal
accounts when and if surpluses run out. One inviting target at
that point would be the Social Security trust funds themselves,
which are projected to have accumulated over $2 trillion by
early in the next century to finance guaranteed payments to the
baby boomers. Any shifting of assets from the trust funds to
private accounts would reduce the money available to pay for
guaranteed benefits in the future. Another ``fix'' would be for
Congress to allow the national debt to grow to keep the program
whole.
Principle 7. In addition to securing Social Security as the
foundation of income support for retirees, their dependents,
the disabled, and survivors, more needs to be done to encourage
private savings and pensions.
Analysis: Initially, the Feldstein plan would neither
increase nor decrease America's low levels of national savings,
which many economists believe should be raised to promote
investment and long-term economic growth. Every federal surplus
dollar shifted to investment in a personal account would remain
a dollar saved. To gauge the effect of the plan on national
savings when and if surpluses run out, one would need to
predict what actions Congress would take in the absence of the
plan--which obviously are unknown. Professor Feldstein assumes
that, without his plan, Congress would spend any anticipated
surpluses. Under that assumption, his plan would increase
savings and, consequently, economic growth. But the
Congressional Budget Office argues, at least as plausibly, that
the new accounts would lead to higher government budget
deficits and lower national savings because they constitute a
new, costly, and unlimited commitment of federal resources.
Moreover, if the government guarantees prevailing Social
Security benefits as a baseline regardless of how well each
worker's personal account performs, it risks encouraging
workers to take greater, perhaps imprudent risks with their
investments than they otherwise might. Under that scenario,
akin to the savings and loan debacle of the 1980s, the
government's future obligations would be even greater.
Social Security Reform Check List #3
The National Commission on Retirement Policy Plan
Overview
The National Commission on Retirement Policy (NCRP), a
bipartisan group convened by the Center for Strategic and
International Studies, has endorsed a proposal that would
fundamentally restructure Social Security. The plan channels
two percentage points of the current payroll tax (12.4 percent
of wages, divided equally between workers and their employers,
with a cap at $68,400 in yearly income) into mandatory
individual savings accounts. To compensate for the reduction in
tax revenue and eliminate the projected shortfall in Social
Security beginning in the year 2032, the NCRP plan cuts
benefits substantially--in part by increasing the retirement
age to seventy.
Summary of Key Features
Benefit Changes. According to the Congressional Research
Service, the NCRP plan would reduce guaranteed benefit levels
set under current law by 33 percent for an average-wage-earning
worker retiring at the age of sixty-five in the year 2025. By
2070, after the plan is fully phased in, benefits for the
average worker (who retires at sixty-seven) would be 48 percent
lower than under present law. The specific changes leading to
those reductions include:
Raising the normal retirement age from sixty-seven in 2029
(an increase that is already scheduled to be phased in under
current law) to seventy. The plan would also increase the age
of eligibility for reduced benefits from sixty-two to sixty-
five by 2017. Raising the retirement age amounts to cutting
benefits, since workers will receive lower lifetime benefits.
Reducing benefits for middle-income and high-income
retirees. The portion of pre-retirement earnings that Social
Security pays middle-income beneficiaries would decrease from
32 percent to 21.36 percent by 2020. For higher-income
beneficiaries, the reduction would be from 15 percent to 10.01
percent by 2020.
Increasing the number of working years counted to determine
benefit levels from today's thirty-five to forty by 2010.
Adding more years would reduce benefit levels because the
average past salaries that benefits would be based on would
include more years when workers were young and earning less--or
nothing at all. Those with long absences from the workforce--
women more commonly than men--would end up with the largest
reductions.
Reducing benefits to dependent spouses from 50 percent of
their spouses' benefits to 33 percent.
Tax Changes. The plan would not increase payroll taxes,
raise the cap on taxable earnings, or increase the taxation of
benefits to help close the existing financing gap. But it would
divert two percentage points of the current payroll tax into
individual savings accounts.
Structural Changes. The NCRP proposal's structural changes
to the Social Security program include:
Introducing individual savings accounts modeled on the
Federal Thrift Savings Plan, which allows workers to invest in
several broad-based funds. At retirement, workers would be
required to annuitize the majority of funds in their accounts--
that is, convert them from lump sums into monthly payments that
are made for the duration of their lives.
Expanding Social Security coverage to include all newly
hired state and local government employees.
Creating a new minimum benefit equal to 100 percent of the
poverty line for those who have spent forty years or more
working and 60 percent of the poverty line for those with
twenty to thirty-nine years in the workforce.
Evaluating the Plan
To assess the impact of various proposals to change Social
Security, The Century Foundation organized a group of experts
to develop principles for prudent reform. Here's how the
National Commission on Retirement Policy plan stacks up against
those principles:
Principle 1. Social Security should continue to provide a
guaranteed lifetime benefit that is related to past earnings
and kept up to date as the general standard of living
increases.
Analysis: Although the plan retains a guaranteed benefit
based on a worker's past earnings, the size of that benefit
would be cut by 33 percent for the average worker retiring at
65 in 2025. Those reductions would be offset somewhat by
provisions for new individual savings accounts and minimum
benefits of 100 percent of the poverty line for those who spent
forty years or more working and 60 percent of the poverty line
for those with twenty to thirty-nine years in the workforce.
But, in the process, benefit levels would become less closely
tied to past earnings and more dependent on the performance of
the investments in each worker's individual savings account.
Principle 2. American workers who have the same earnings
history and marital status, and who retire at the same time,
should receive the same retirement benefit from Social
Security.
Analysis: While workers with similar earnings histories and
marital status would receive the same, reduced baseline benefit
from Social Security, the introduction of individual savings
accounts would produce significant variations in overall
benefits. Those who enjoyed better luck with their individual
accounts, who invested more aggressively, and retired when
their investments were at a peak would receive higher payments
than workers who invested less wisely, opted for more
conservative investments, or retired when their investments
were down.
Principle 3. Social Security benefits should continue to be
fully protected against inflation, and beneficiaries should
continue to rest assured that they will not outlive their
monthly Social Security checks.
Analysis: Although guaranteed benefits are cut
substantially under the NCRP plan, they would still be indexed
for inflation and continue until death. However, payments from
individual accounts would not be protected against inflation.
The NCRP plan would require retirees to convert most of their
individual savings accounts investments into annuities upon
retirement, but it does not mandate that these annuities make
payments that are indexed for inflation. Unless workers chose
to convert the accumulations in their accounts into annuities
that are indexed for inflation, the value of each payment would
decline over time as inflation reduced the value of the dollar.
Today, inflation-adjusted annuities are very expensive and not
widely available in the private market.
Principle 4. Retirees who earned higher wages during their
careers should continue to receive a larger check from Social
Security than those with lower incomes; but the system should
also continue to replace a larger share of the past earnings of
low-income workers.
Analysis: The NCRP changes in the benefit formula would
result in middle-income and higher-income retirees receiving a
lower percentage of their past earnings than is currently the
case. This would represent a substantial cut in their benefits.
Still, workers who earned more would continue to receive
somewhat higher benefits than individuals who had lower
incomes. And the new guarantee of benefits equal to 100 percent
of the poverty level for workers who spent at least forty years
in the workforce and 60 percent for those who worked twenty to
thirty-nine years would offer protection for some low-income
retirees--though less than the current system does in most
cases.
Principle 5. Social Security's insurance protections for
American families, including disability insurance, should be
fully sustained.
Analysis: Although the NCRP plan would retain insurance
coverage for the disabled and for surviving spouses, the
reductions in guaranteed retirement benefits would dramatically
reduce protections for workers whose earned income plummets for
an extended period because of disability. The combination of
delaying the retirement age, extending the number of working
years counted in determining baseline benefits, and changing
the formula for calculating those benefits would especially
imperil those, like the disabled, who leave the workforce for
years at a time.
Principle 6. Social Security's long-term financing problem
should not be aggravated by diverting the program's revenues to
private accounts and benefits should not be reduced to make
room for private accounts; any such accounts should be
supplementary to Social Security, entirely as an add-on.
Analysis: The NCRP plan imposes significant benefit cuts to
allow two percentage points of payroll tax revenue to be
diverted to individual savings accounts. The reduction in
guaranteed benefits is far greater than the cuts that would be
needed to assure that the system will be adequately financed
throughout the next century.
Principle 7. In addition to securing Social Security as the
foundation of income support for retirees, their dependents,
the disabled, and survivors, more needs to be done to encourage
private savings and pensions.
Analysis: The NCRP plan shifts assets accumulating in the
Social Security trust funds to individual savings accounts, a
process that would neither increase nor decrease national
savings (the combined savings of the government, companies, and
households), or personal savings levels. Many economists argue
that increasing the nation's low savings level would help to
promote long-term economic growth by supplying more capital for
long-term investment.
Social Security Reform Check List #4
The Moynihan-Kerrey Plan
Overview
Senators Daniel Patrick Moynihan (D-N.Y.) and Robert Kerrey
(D-Neb.) have introduced legislation that would make
significant changes in Social Security. Their plan would
establish voluntary private retirement accounts while
instituting major reductions in guaranteed benefits, a large,
temporary payroll tax cut, and some tax increases. Most
notably, the plan would reduce the payroll tax that finances
Social Security from 12.4 percent (divided equally between
workers and their employers) to 10.4 percent, giving
individuals the option of either contributing the two point
difference to a savings account or keeping one percentage point
to use as they see fit.
The guaranteed benefits received by today's retirees,
currently adjusted for inflation as the consumer price index
rises, would increase at a slower rate because in calculating
benefits a percentage point would be subtracted from the rate
of increase in the Consumer Price Index each year. By the end
of the average retirement period of twenty years, that change
alone would leave beneficiaries with monthly checks about 25
percent below what they would be under current law. Economist
Alicia H. Munnell of Boston College calculates that by the year
2070, when all the plan's changes would be fully phased in, the
cut in guaranteed benefits for a worker with an average
earnings history who retires at age sixty-five would amount to
31 percent. That's substantially more than the 25 percent
across-the-board cut in guaranteed benefits that the government
estimates will be required in the year 2032 if no changes
whatsoever are made to Social Security in the interim.
Summary of Key Features
Benefit Changes. In addition to subtracting a full
percentage point from the rate of increase in the consumer
price index each year when adjusting retirement benefits for
inflation, the Moynihan-Kerrey plan reduces benefits in the
following ways.
It would increase the age at which full retirement benefits
could be collected by two months per year from 2000 to 2017,
and by one month for every two years between 2018 and 2065.
This means that workers who reach sixty-two in 2017 will not be
eligible for full retirement benefits until age sixty-eight and
workers reaching sixty-two in 2065 will only become eligible at
seventy. Under current law, workers reaching sixty-two in 2022
will be eligible for full retirement benefits at age sixty-
seven.
Benefit levels would be based on how much a worker earned
over the course of thirty-eight years rather than over thirty-
five years, which is the period currently used. On average, the
change would reduce a worker's retirement benefits by about 3
percent because it includes in the average the earlier years in
workers' careers when they likely earned less--or nothing at
all. Because women are more likely than men to withdraw from
the workforce for years at a time to raise children, this
change would affect them disproportionately.
Tax Changes. The Moynihan-Kerrey plan's payroll tax cut
would begin in 1999 and last through 2024. After that, the
payroll tax would increase according to the following schedule:
from 2025 to 2029, it would rise from 10.4 percent to 11.4
percent;
from 2030 to 2044, it would return to the current level of 12.4
percent;
from 2045 to 2054, it would be 12.7 percent;
from 2055 to 2059, it would rise to 13.0 percent,
in 2060 and thereafter, it would be 13.4 percent.
Other tax increases would be imposed sooner, however:
The cap on yearly earnings subject to the Social Security
payroll tax would increase from $68,400 in 1998 to $97,500 in
2003, and thereafter would be indexed to wage inflation.
Social Security benefits would become taxable to the extent
that a retiree's benefits exceed his or her tax contributions
to the system. This change would result in more extensive
taxation of benefits than under current law, which taxes only
half of benefits received by retirees with total yearly incomes
in excess of $25,000 ($32,000 for married couples).
Structural Changes. The largest structural change is the
incorporation of voluntary private retirement accounts. This
new component of Social Security would give an individual
earning $30,000 a year--who now pays $1,860 in Social Security
payroll taxes--the option of investing $600 in a savings
account or keeping an extra $300 in take-home pay. The
individual could put the $600 either in investment funds that
the government now offers to federal employees or in privately
run accounts. Other structural changes include:
Newly hired state and local government workers would be
required to participate in Social Security. They are the last
group of workers now excluded from Social Security.
The earnings test, which may reduce current benefits for
individuals who continue to work after electing to receive
their Social Security benefits, would be eliminated beginning
in the year 2003 for all beneficiaries aged sixty-two and over.
Evaluating the Plan
To assess the impact of various proposals to change Social
Security, The Century Foundation organized a group of experts
to develop principles for prudent reform. Here's how the
Moynihan-Kerrey plan stacks up against those principles:
Principle 1. Social Security should continue to provide a
guaranteed lifetime benefit that is related to past earnings
and kept up to date as the general standard of living
increases.
Analysis: Under the Moynihan-Kerrey plan, guaranteed
retirement benefits would continue to be based on past
earnings, adjusted for changes in the cost of living. But those
benefits would be significantly lower than under reform
proposals such as those put forward by former Social Security
commissioner Robert M. Ball or Brookings Institution economists
Henry J. Aaron and Robert D. Reischauer. That's mainly because
of the annual one-percentage-point reduction in the cost-of-
living adjustment and the increase in the retirement age.
Principle 2. American workers who have the same earnings
history and marital status, and who retire at the same time,
should receive the same retirement benefit from Social
Security.
Analysis: While workers with the same earnings history and
marital status would receive the same guaranteed benefits from
Social Security, the introduction of personal retirement
accounts would produce significant variations in overall
benefits among workers with the same earnings history. Because
these accounts are voluntary, some workers would choose not to
participate. (Only 3 percent of Americans earning $30,000 or
less, for example, have elected to open Individual Retirement
Accounts despite considerable tax advantages in doing so).
Moreover, investment returns on the accounts are certain to
vary widely. Investors with greater financial acumen and better
luck, and those who retire when investment markets are strong,
would receive higher payments than workers who invested less
skillfully or retired during a bear market. As a result, under
the Moynihan-Kerrey plan, Social Security would more closely
resemble an investment program than retirement insurance.
Principle 3. Social Security benefits should continue to be
fully protected against inflation, and beneficiaries should
continue to rest assured that they will not outlive their
monthly Social Security checks.
Analysis: Under the Moynihan-Kerrey plan, Social Security
would continue to pay guaranteed lifetime benefits indexed for
inflation. However, by reducing the benefit adjustment tied to
the consumer price index by one percentage point each year, the
plan would hurt many low-income elderly who are already
struggling with rising medical costs (which rise more rapidly
than the consumer price index). These costs have come to
consume an ever-growing share of elderly Americans' personal
expenses--20 percent of such expenses on average and an even
higher share for poor seniors. Over the past fifteen years,
adjustments in Social Security benefits have failed to take
account of this rising burden. As for the assets accumulated in
private retirement accounts, their value could be significantly
reduced by a period of high inflation.
Principle 4. Retirees who earned higher wages during their
careers should continue to receive a larger check from Social
Security than those with lower incomes; but the system should
also continue to replace a larger share of the past earnings of
low-income workers.
Analysis: The Moynihan-Kerrey plan would retain this
feature of the current program for determining guaranteed
benefits.
Principle 5. Social Security's insurance protections for
American families, including disability insurance, should be
fully sustained.
Analysis: The Moynihan-Kerrey plan retains all of the
disability and survivor's insurance features of the current
Social Security program.
Principle 6. Social Security's long-term financing problem
should not be aggravated by diverting the program's revenues to
private accounts and benefits should not be reduced to make
room for private accounts; any such accounts should be
supplementary to Social Security, entirely as an add-on.
Analysis: By reducing the payroll tax in order to introduce
personal retirement accounts, the Moynihan-Kerrey plan would
deplete the asset buildup in the Social Security trust funds.
This would shift a much greater share of the burden of
financing Social Security to future workers after the
retirement of the baby boomers. The benefit cuts will reduce
those obligations to some extent but cutting revenues to the
system now will add to, rather than lessen, the challenge of
keeping Social Security sound in the next century.
Principle 7. In addition to securing Social Security as the
foundation of income support for retirees, their dependents,
the disabled, and survivors, more needs to be done to encourage
private savings and pensions.
Analysis: The Moynihan-Kerrey plan includes no measures
that would encourage private savings and pensions. Indeed,
reducing payroll taxes (which by definition reduces the federal
surplus or increases the deficit) without requiring households
to save the money threatens to reduce further the nation's
already low level of national savings.
Social Security Reform Check List #5
The Gramm Plan
Overview
Senator Phil Gramm (R-Tex) is sponsoring a plan to
transform Social Security by diverting nearly one-fourth of the
payroll taxes that finance today's retirement insurance system
into individual investment accounts. Under his proposal,
workers would have the option of either retaining their current
Social Security coverage and benefits or electing to shift
three percentage points of their 12.4 percent Social Security
payroll tax (split equally between workers and their employers)
into their own investment account. Workers would not be allowed
to opt out of the system altogether or transfer a different
share of their payroll tax into the accounts. Those who opted
for the investment accounts would be allowed to invest that
money in a selection of privately managed mutual funds that
would be certified and regulated by a new government oversight
board. Initially, the accounts would be restricted so that no
more than 60 percent of an investment portfolio could be in
stocks, which can decline precipitously in value.
Upon retirement, workers with investment accounts would be
required to convert the accumulated assets into an annuity
that, like today's Social Security, would provide a lifetime
monthly payment that increases as inflation rises. After the
system was fully phased in, retirees who opted for the personal
accounts would be guaranteed a total monthly benefit equal to
the guaranteed payment promised under today's system, plus 20
percent. If the assets accumulated in a retiree's personal
account proved to be insufficient to pay the full 20 percent
bonus, the government would make up the difference. Retirees
who invested more successfully would be entitled to cash out
any accumulations in excess of the 20 percent bonus as a lump
sum if they wanted to.
Senator Gramm claims that his plan would end prospects that
Social Security will face a shortfall in the year 2032, when
payroll taxes combined with system's trust fund assets are
expected to become insufficient to pay guaranteed benefits in
full. The main reason is that the assets accumulated in the
private accounts would significantly reduce the benefits that
the system would have to pay out from the remaining 9.4 percent
payroll tax and the assets in the Social Security trust funds.
The Price-tag
Diverting three percentage points of the Social Security
payroll tax into private accounts for every worker who makes
that choice would significantly reduce the anticipated growth
in the Social Security trust funds, which currently are
expected to tide the system over from 2013 to 2032--a period
when promised benefits are expected to exceed payroll tax
revenues. Because current retirees will have no private
accounts to draw on and older workers will have little time to
accumulate much in their private accounts, maintaining today's
guaranteed benefits for them while payroll tax revenues decline
by up to 24 percent (depending on how many workers opt for the
new system) poses an expensive transition challenge.
Stephen C. Goss, deputy chief actuary of the Social
Security Administration, calculates that if all workers opted
for the private accounts, the cost to the federal budget and
the Social Security trust funds would be an average of $140
billion a year from 2000 to 2009. Senator Gramm has said that
those transition costs could be paid out of projected federal
budget surpluses. Drawing on surpluses poses problems, however.
First, surpluses are projected to be adequate to pay for only
$81 billion of the $140 billion that would be needed. Second,
if the projected surpluses were to be used to finance the
transition to the new retirement system, actual surpluses would
be substantially lower each successive year because the surplus
from the previous year would not have been used to reduce the
federal debt and thereby reduce interest obligations. Third,
the projected federal budget surpluses through 2007 are almost
entirely attributable to the surpluses in the Social Security
trust funds. So paying for the transition with budget surpluses
essentially means depleting 72 percent of the Social Security
trust funds, which would raise the level of government debt.
Senator Gramm projects that it would take 32 years before
his plan would become financially self-sustaining and 50 years
before the assets accumulated in individual investment accounts
would be sufficient to generate a benefit equal to 20 percent
above the level promised by the existing system. If the
investments in the private accounts don't increase in value as
rapidly as Senator Gramm predicts--5.5 percent annually over
and above the inflation rate--the system's long-term financial
burdens could increase rather than decrease. Senator Gramm also
claims that the government would gain additional revenues from
higher corporate tax collections attributable to increased
corporate profits that would arise from more money flowing into
capital markets through the private accounts. There is little
historical evidence, however, that higher levels of market
capitalization generate increased corporate profits.
Evaluating the Plan
To assess the impact of various proposals to change Social
Security, the Century Foundation organized a group of experts
to develop principles for prudent reform. Here's how Senator
Gramm's proposal stacks up against those principles:
Principle 1. Social Security should continue to provide a
guaranteed lifetime benefit that is related to past earnings
and kept up-to-date as the general standard of living
increases.
Analysis: Guaranteed Social Security benefits under the
current formula, which are based on past earnings after taking
into account cost-of-living changes, would remain the minimum
that workers would receive if they decided against opening
their own accounts. If they opted for the accounts, they would
be guaranteed a 20 percent bonus on top of a benefit that would
still be based on past earnings. And because the personal
retirement accounts would be financed through a 3 percent flat-
rate contribution, the dollar amounts flowing into the accounts
would be higher for workers with larger incomes and would rise
over time as a worker's earnings grew. Workers who invested so
successfully that they could collect even more than the 20
percent bonus would receive benefits less proportionate to past
earnings, however.
Principle 2. American workers who have the same earnings
history and marital status, and who retire at the same time,
should receive the same retirement benefit from Social
Security.
Analysis: Workers who elect to open private accounts gain a
guaranteed 20 percent benefit bonus above the amount that those
who declined the option would receive. So the same past
earnings history and marital status would not lead to identical
benefits for workers who 1) made different decisions about
whether to open an account and 2) had different degrees of
investment success. Those who earned more than the 20 percent
bonus in their accounts would be able to collect the difference
as a lump sum.
Principle 3. Social Security benefits should continue to be
fully protected against inflation, and beneficiaries should
continue to rest assured that they will not outlive their
monthly Social Security checks.
Analysis: The Gramm plan stipulates that the accumulations
in the personal investment accounts would be required to be
converted to lifetime, inflation-adjusted annuities akin to
current benefits, and that those payments would be a minimum of
20 percent higher than the benefits currently promised.
Although many questions could be raised about whether the plan
adequately accounts for the cost of financing those benefits,
the proposal adheres to this particular principle. An important
ambiguity about the plan remains, however: it is unclear what
benefits surviving spouses would receive. Under current law,
survivors receive 100 percent of the benefit that their late
spouse collected (presuming that benefit was higher then the
payment the survivor was previously entitled to). The Gramm
plan, as summarized to date, does not specify what happens upon
the death of a beneficiary.
Principle 4. Retirees who earned higher wages during their
careers should continue to receive a larger check from Social
Security than those with lower incomes; but the system should
also continue to replace a larger share of the past earnings of
low-income workers.
Analysis: Workers whose private accounts grow enough to
provide more than the 20 percent guaranteed bonus would receive
larger payments relative to their past earnings than those who
invested less successfully. In all probability, the most
prosperous investors will be clustered at high income levels
because 1) they have much greater experience and familiarity
with investing, 2) they would have more money in their accounts
to build on (since the contributions are a flat 3 percent
rate), and 3) low-income workers with no investment experience
may be more reluctant to open accounts in the first place.
Principle 5. Social Security's insurance protections for
American families, including disability insurance, should be
fully sustained.
Analysis: The Gramm plan stipulates that the survivor's and
disability insurance features of the current system would be
preserved in full. But Social Security actuary Stephen Goss
points out that the proposal allocates only 1.5 percentage
points of the 12.4 payroll tax toward maintaining those
protections, even though that insurance now costs the system
about twice as much--3 percentage points. Because the plan does
not provide an explanation of how current disability and
survivor's insurance could be maintained on half the funding it
now receives, that aspect of the proposal deserves further
scrutiny.
Principle 6. Social Security's long-term financing problem
should not be aggravated by diverting the program's revenues to
private accounts and benefits should not be reduced to make
room for private accounts; any such accounts should be
supplementary to Social Security, entirely as an add-on.
Analysis: By diverting 3 percentage points of the payroll
tax financing the current system into private accounts, for
those who choose them, the Gramm plan compounds the challenge
of alleviating the long-term financial pressures on Social
Security. Because current retirees and those now near
retirement age must continue to receive promised benefits from
payroll taxes in the years ahead, the cost of creating the new
accounts will, in essence, deplete the Social Security trust
funds and the federal budget surplus while increasing the
national debt and government interest costs. Although the
accumulations in the investment accounts after several decades
might indeed be sufficient to finance the more generous
benefits proposed, that eventuality depends on a variety of
uncertainties about the number of workers who opt for the
accounts, the performance of the economy, and investment
growth. In any case, no one disputes that the cost of making a
transition to Senator Gramm's system would add to federal
budgetary pressures.
Principle 7. In addition to securing Social Security as the
foundation of income support for retirees, their dependents,
the disabled, and survivors, more needs to be done to encourage
private savings and pensions.
Analysis: At first blush, the Gramm plan would seem to
neither increase nor decrease national savings because payroll
taxes would be moved from one category of savings--the Social
Security trust funds--to private savings in the form of the
personal accounts. But because of the need to finance the
transition to the new system, the government will either have
to borrow more, reduce promised Social Security benefits, or
increase taxes. Increased federal borrowing by definition is
the same as reduced government savings. And either reducing
Social Security benefits or increasing taxes would cut the
amount of money available to households to save.
The government guarantee of a 20 percent bonus above
today's benefits for those with investment accounts--even those
that perform poorly--risks encouraging workers to take greater,
perhaps imprudent risks with their investments than they
otherwise might. Under that scenario, akin to the savings and
loan debacle of the 1980s, the government's future obligations
could skyrocket since the bonus would be guaranteed whether the
money was there or not.
Issue Brief #8
Investing the Social Security Trust Funds in Stocks
The Social Security program is running surpluses that, by
law, must be invested exclusively in U.S. Treasury securities.
The assets accumulating in the system's trust funds, currently
in excess of $900 billion and projected to peak at around $3.8
trillion in the year 2020, are intended to enable Social
Security to continue paying full benefits well after payroll
tax receipts are no longer sufficient to pay benefits to
retirees. One reason why those receipts are expected to fall
below the system's obligations is the impending retirement of
the baby boom generation--the enormous cohort of citizens born
between 1946 and 1964. By 2031, the ratio of Social Security
beneficiaries to workers is expected to increase from today's
30 per 100 workers to 50 per 100 workers. In addition, longer
lifespans largely attributable to improvements in health care
will increase the financial pressures on the system.
One proposal for easing those pressures is to diversify the
holdings in the trust funds from safe but low-yielding Treasury
securities into stocks, which historically have generated much
higher investment returns. Indeed, trust fund diversification
is an important element of President Clinton's Social Security
reform plan. The rationale is that the change would enable the
trust funds to grow more rapidly and pay out benefits further
into the future. (Under current projections, the trust funds
will be depleted in the year 2032. Thereafter, revenues would
be sufficient to pay 75 percent of promised benefits).
Depending on assumptions about the rate of growth in the stock
market, the overall size of the trust funds, and the portion of
them that would be invested in stocks, diversification could
add anywhere from two to 20 years to the lifespan of the trust
funds.
It should be noted that neither President Clinton's
proposal nor anyone else's relies exclusively on trust fund
diversification to strengthen the finances of Social Security.
The centerpiece of the President's plan is an infusion of $2.8
trillion over the next 15 years--or about 62 percent of the
projected federal budget surplus over that period--into the
trust funds from the general fund of the Treasury. About $600
billion of this amount would be invested in stocks, while the
remainder would be used to retire publicly held debt. The
administration estimates that shifting additional money to the
trust funds would delay the date when they would become
depleted from 2032 to 2049. The investment in the stock market,
which under the president's plan would increase incrementally
and would never exceed 15 percent of the value of the trust
funds, would add five more years.
Allowing the Social Security trust funds to invest in
equities has significant consequences for the U.S. economy, the
federal budget, and the Social Security system.
How much would diversification strengthen Social Security?
The projected annual rate of return on U.S Treasury
securities held in the Social Security trust funds is 2.7
percent, after inflation. In contrast, stocks generated an
annual return of about 7 percent above the inflation rate from
1900 to 1995. If past serves as prologue and stocks continue to
significantly outperform Treasuries in the future,
diversification would bolster the trust funds.
Several variables will affect the extent to which
diversification ultimately strengthens Social Security:
Actual rates of return. Century Foundation Research Fellow
Dean Baker, in a paper titled ``Saving Social Security with
Stocks,'' points out that stocks may not grow as rapidly in the
future as they have in the past if consensus forecasts for
slower future economic growth turn out to be accurate. Social
Security's trustees project that the U.S. economy will expand
at an annual rate of less than 1.5 percent a year over the next
75 years, far below historical levels. The main reason for this
decline is that the workforce is expected to grow much less
rapidly than in the past. Since slower economic growth implies
that corporate profits will increase more slowly, stocks may
not be able to maintain 7 percent real returns in the future.
The share of the trust funds to be invested in stocks. The
Clinton administration has proposed limiting the portion of the
Social Security portfolio that could be invested in stocks to
15 percent. Many state and local pension funds, in contrast,
allocate as much as half their assets to stocks. More extensive
investment in stocks would create the possibility of higher
returns for the portfolio as a whole, but it would also expose
the trust funds to greater risk. During a bear market, a
portfolio half-invested in stocks would be more likely to
decline in value than one with only 10 percent in equities.
Time frames. During particular periods when stocks perform
poorly, diversification may leave the Social Security trust
funds with less than they would have if they had remained fully
invested in Treasury securities. From 1968 to 1978, for
example, the market fell 44.9 percent in real terms. During the
twentieth century, average stock prices have failed to
appreciate over three different 20-year stretches. But over
longer time frames, stocks have consistently outperformed other
investments. Because current projections indicate that the
trust funds will not face a shortfall until 2032, market ups
and downs over such a lengthy period would be more likely to
leave a diversified trust fund with more reserves than one
solely invested in Treasuries.
Would government ownership of stocks lead to unwelcome political
interference in the investment markets?
Federal Reserve Board Chairman Alan Greenspan and others
object to diversifying the Social Security trust funds because
they believe politics will inevitably intrude on decisions
about how the money is invested. Greenspan argues that instead
of seeking the highest returns, the managers of the funds will
be constrained from investing in companies that arouse
political controversy--say, tobacco companies or firms accused
of discrimination or union busting. Because the trust funds
have the potential to become the largest single shareholder in
the entire stock market, the ultimate fear is that the
government could significantly affect whether shares of
different companies rise or fall--undermining the idea of
freely operating markets.
Treasury Secretary Robert Rubin and others respond that the
scenario Greenspan fears can be avoided by erecting barriers
between Congress and the management of the trust funds. Those
barriers would include creating an independent board, much like
the Federal Reserve itself, to oversee the trust funds. Its
members would be appointed by the president and confirmed by
the Senate, serving staggered 14-year terms and shielded from
dismissal from office for political reasons. In addition, the
power of the board could be limited to selecting fund managers
who would be required to make only passive investments in
securities that represent broad market averages--so-called
``index mutual funds.'' Moreover, Congress could require the
board to waive its voting rights on shares in the trust funds'
portfolio to prevent any efforts to influence the management of
any company. Perhaps the strongest evidence that Social
Security could keep politics out of the process of investing in
stocks is the experience of the Federal Thrift Savings plan of
the Federal Employees Retirement System, which covers 2.3
million government workers. Since 1984, the plan has invested
in three different index funds, including a stock fund, without
taking any action that has reflected a political consideration.
Francis Cavanaugh, who was executive director of the agency
responsible for administering the Federal Thrift Savings plan
from 1986 to 1994, has said that though many individuals and
groups have attempted to influence the investment decisions of
the fund, the barriers against such forces have proven
sufficient. Of course, Social Security's assets are many times
larger than the $66 billion in the Federal Thrift Savings plan,
making it a far more conspicuous target for political
activists.
Some state and local government retirement funds, most
notably CALPers in California, play active roles in corporate
governance. But many other government pension plans are
required to behave as completely passive investors. And even
CALPers's energy is usually focused on maximizing shareholder
value rather than imposing political-based demands on
companies. If Congress decides that the Social Security trust
funds should be diversified, examples like the Federal Thrift
Savings plan and other passive government retirement plans
would be the most suitable models.
Would the trust funds' purchase of stocks cause the market to become
overvalued, running the risk of a disastrous crash in the next century
as the assets are liquidated?
As large as the Social Security trust funds are expected to
become, they would still be a relatively small fraction of the
value of the entire stock market. Based on the assumptions of
the 1997 report of the Advisory Council on Social Security,
gradually investing up to 40 percent of the Social Security
trust funds would produce a stock portfolio of an estimated $1
trillion (in 1996 dollars) in 2020. Today the capitalization of
the U.S. stock market is about $12 trillion, and it will grow
to something like $40 trillion by 2014 according to the
advisory council forecasts. Under President Clinton's plan,
which would limit the trust funds' stock holdings to 15 percent
of assets, Social Security's share of the market would be
between 3 percent and 4 percent, according to actuary Stephen
C. Goss of the Social Security Administration. In contrast,
state and local pension funds held about 9.5 percent of
corporate equities in 1996. Keep in mind, as well, that Social
Security's investment in the stock market would occur
gradually--no more than 0.3 percent of overall stock market
capitalization in any year. Social Security would not suddenly
come to Wall Street with a trillion dollar stake to place on
the table. Similarly, the liquidation of shares in the next
century to pay benefits to retired baby boomers would be
gradual.
Would transaction and administrative costs reduce the benefits of
diversification?
The administrative and transaction costs of individual
investment accounts like 401(k)s, IRAs, and other plans where
each investor has a specified amount of money invested in his
or her name can add up to about 20 percent. Tracking the value
of each account, switching funds from investment to investment
upon request, sending updates to investors, and so forth is
expensive. In contrast, a large pension fund serving many
members who are not directly in control of a specified amount
incurs negligible costs. In the case of the Federal Thrift
Savings plan--the best existing equivalent of a diversified
Social Security trust fund--administrative costs amount to a
scant \1/10\th of 1 percent of assets.
What would be the impact on the federal budget of diversifying the
trust funds into stocks?
Investing trust fund assets in equities would have the
immediate effect of decreasing the federal budget surplus (or
increasing a deficit if there is one in that year). That's
because current accounting rules consider stock purchases to be
a federal outlay, just like spending on roads or tanks. In
contrast, the current practice of investing excess payroll
taxes in Treasury securities adds to the federal surplus (or
reduces deficits). Under President Clinton's plan, the
contributions to the Social Security trust funds from general
revenues would be counted as government expenditures even when
they were not used to buy stocks. The rationale for this rule
is that those contributions would be earmarked to retire
publicly held federal debt, substituting government-owned debt
held by the trust funds in its place.
The administration claims that its plan would reduce the
share of publicly owned government debt from about 45 percent
of the economy to just 7 percent by 2014--a level last reached
in 1917. Reducing the government's debt to the public, the
administration and many economists argue, would promote
investment and economic growth by 1) injecting capital into the
economy through the purchase of government securities and 2)
reducing competition that private bond-issuers face in raising
funds, lowering their borrowing costs and interest rates
generally. The additional Treasury securities in the trust
funds would insure that, in the future, the government would
have to meet its obligations to Social Security before
appropriations were made to other priorities. These changes, in
combination with others that Clinton has proposed, would soak
up the entire projected surplus.
What would be the impact on the economy of diversifying the trust funds
into stocks?
There is no reason why shifting a share of the trust fund
reserves from Treasury securities into stocks would either
increase or decrease economic growth. The change would not
directly affect national saving, investment, capital stock, or
production. It is possible that government borrowing rates
might have to rise slightly to induce private investors to buy
the securities that the trust funds would be eschewing for
stocks. And private savers might earn slightly lower returns
because their portfolios would contain fewer common stocks and
more government bonds--those that the trust funds no longer
purchased. Still, most analysts believe that these effects
would be almost undetectable.
Statement of Credit Union National Association
The Credit Union National Association (CUNA) is pleased to
submit a statement on the topic of investing Social Security in
the private market for the Committee's March 3, 1999 hearing.
CUNA applauds the Committee for tackling the difficult
issue of the investment of Social Security's trust funds. One
of the options under consideration is to allow individuals to
invest a portion of their Social Security funds in ``private
retirement accounts'' or PRAs. Another option would be for the
Social Security Administration to invest directly in equity
markets. CUNA does not have a position on the second of these
options, but would like to point out that the two options need
not be mutually exclusive. A Social Security reform package
could include both some investment by the Social Security
Administration in equities, and the introduction of private
retirement accounts.
If PRAs are a feature of final Social Security reform, and
CUNA believes the idea has considerable merit, CUNA strongly
recommends that account holders be offered a wide range of
investment options, including investments in depository
institutions, such as credit unions. Investors should not be
restricted only to financial securities, such as stocks, bonds
and mutual funds. Many households are comfortable and familiar
with investments in certificates of deposit in credit unions
and other depositories. They are completely safe if held under
$100,000, and offer a variety of return options, many of which
are fixed and known. We believe this would be good public
policy for a number of reasons.
First, different households have very different levels of
risk tolerance. Not all households will want to be fully
invested in direct securities all the time. In fact, for some
house-holds, the lack of a safe harbor among investment options
would be extremely troubling. More generally, the opportunity
to structure a diversified portfolio of stocks, bonds and
certificates of deposit in depository institutions would
provide the correct level of choice where it properly belongs,
with the individual investor.
Second, some concern has been raised about the ability of
individual investors to manage the risks inherent in
investments in the stock market. Offering households a safe-
haven option such as shares and deposits in credit unions
reduces the risk of poor management.
Third, investors' needs change over their life cycles. We
certainly do not believe that someone saving for retirement
should hold all assets all the time in lower-risk, lower-
yielding investments, such as those available from depository
institutions. However, the closer one gets to retirement, the
more a portfolio should be weighted to more liquid, safer
investments. Allowing investment in depository institutions
would ensure such investments were available to PRA holders.
Finally, peace of mind is important to investors. This is
particularly true as one approaches retirement and accumulated
balances grow relatively large. Consumers trust credit unions.
Credit union members are as likely to believe that credit
unions have skilled professional management as banks, and they
are much more likely (by 54 percent to 31 percent) to believe
that credit unions provide reliable money-management
information than banks. (Credit Union Magazine's ``1998
National Member Survey,'' page 20.)
Instituting PRAs would make individual investors out of
many people who had never previously faced the daunting task of
directing their own investment portfolios. Offering such
households access to institutions they trust, such as a credit
union, will make the transition that much smoother.
Statement of Richard Freeman and Marianna Wertz, Executive Intelligence
Review News Service
The debate that is taking place here today, and around the
nation this year, on the pros and cons of government- or
individually-directed Social Security fund flows into the stock
market, is itself completely wrong in its assumptions, as well
as its recommendations.
Firstly, the stock market is, in effect, a bubble of wildly
inflated values and expectations, and like other bubbles of the
worldwide speculative financial system of recent years which
have popped (Russian GKOs, Brazilian debts, Asian ``emerging''
markets, etc.), it too cannot last. Proposing or condoning
throwing more money into the frenzy of stock speculation, is
the last thing that lawmakers should be doing.
The most intense argumentation for Social Security flows
into the stock market comes from Merrill Lynch, State Street
Bank of Boston, the Cato Institute, and other advocates of
keeping the bubble going at all costs.
The real issue before us in 1999, as more of the worldwide
``casino economy'' blows out, is: how do we intervene to
protect and restore the functioning of national economies
serving the public interests, and end the parasitical effects
of global speculation? In response to this strategic crisis,
since fall, 1998, over 150,000 people internationally, have
signed a petition-appeal to President Clinton, to take the step
of appointing economist Lyndon LaRouche, EIR's founder and
contributing editor, as economic adviser to the Administration.
EIR News Service, since its founding over 25 years ago, has
documented in detail, the growing disparity between the
increase in money flows into speculative activity, and the
decline in productive investment flows into infrastructure,
agriculture, industry, etc., to the point where today, we are
seeing worldwide financial disintegration, and physical-
economic breakdown. We will gladly make this documentation
available.
For the purposes of the specific hearing topic today,
however, we here provide the following references for the
Committee, that bear on the point that channeling Social
Security money into the stock market should NOT be done:
1. The idea that there is a federal budget surplus is a
hoax.
2. The idea that Social Security is not ``solvent'' is a
hoax.
Debating the pros and cons of how to put Social Security
money into the stock market, only serves as an opening for
extremist privatization schemes, subversive to the national
interest. On Jan. 19, National Economic Council director Gene
Sperling demurred that, under the Administration's new, limited
proposal, the Social Security Trust fund would never have more
than 15% of its assets in the stock market. [In fact, were $600
billion to go into the markets over a 15-year period--the State
of the Union address plan--that would represent one-fifth of
what the projected asset level of the Social Security trust
fund is projected to be in fiscal year 2014.] The very next
day, Rep. Mark Sanford (R-S.C.), the proponent of one of the
most radical Mont Pelerinite Social Security privatization
plans, said that the presentation of the Administration plan
helps clear the way for others in Congress, like himself, to
now bring forward their plans of how to invest Social Security
funds into the stock market. The following facts and figures
show how insane would be this course of action.
Currently, the Federal budget of the United States has a
deficit of more than $100 billion, and it will continue to be
significantly in deficit for the next several years. But, it is
widely proclaimed in the press and on Capitol Hill that the
fiscal year 1999 Federal budget (which runs from Oct. 1, 1998
through Sept. 30, 1999) will run a surplus of $60-70 billion!
What this refers to, however, is not the actual budget of the
United States, but a phony construct called the ``unified
budget.'' This concoction was developed about 15 years ago to
hide the actual size of the deficits that the U.S. budget is
running. It figures prominently in the hoax that the United
States will have a $4.2 trillion budget surplus current over
the next 15 years.
Let us first determine what the actual U.S. budget deficit
is, and then see how the ``unified budget'' has been used to
distort it. There are two ways to determine the actual budget
deficit.
The actual Federal revenue budget of the United States is
the ``general revenue budget,'' sometimes called the ``on-
budget budget.'' It provides for most of the functions of
government: education, building infrastructure and public
works, running the various departments of the Executive branch,
the military, and so on. Its revenues come from a variety of
sources: primarily, personal, corporate, excise, and estate
taxes.
The Office of Management and Budget (OMB), which reports
the official budget expenditures, revenues, and deficit, and
makes future projections, reported its projections of future
deficits of the ``on-budget budget'' in the official Budget of
the United States Government, Fiscal Year 1999. This was
reported in the ``Historical Tables'' appendix to the budget,
on page 20. The data are presented in Table 1. The OMB
projected that the ``on-budget'' U.S. budget deficit would be
$94.7 billion in FY1999, and that the United States would still
have a deficit of $62.7 billion in FY2003. It does not project
beyond the year 2003. The size of the deficit may be revised
downward, after correcting for increased tax revenues, but
according to the government's own official figures, there is no
surplus.
Table 1.--Projected budget deficit of ``on-budget'' U.S. budget
(billions $)
------------------------------------------------------------------------
------------------------------------------------------------------------
1999....................................................... $95.7
2000....................................................... 104.9
2001....................................................... 94.1
2002....................................................... 44.6
2003....................................................... 62.8
------------------------------------------------------------------------
AAAAA (Source: OMB)
However, the official ``on-budget budget'' incorporates
some accounting tricks whose effect are be to still understate
the actual deficit. To correct that, a budget expert at the
Congressional Budget Office (CBO) stated that the real budget
deficit can be derived best by measuring the yearly increase in
the ``Federal debt outstanding.'' This is the cumulative
outstanding debt of the United States. It is only increased
each year for one purpose: because the U.S. Treasury has
floated new debt obligations to cover that year's budget
deficit. That is, when expenditures exceed revenues, that
results in a budget deficit, and the manner by which the
government covers the gap is by issuing new Treasury debt. That
increases the Federal debt outstanding for the year. Table 2
shows the result of using this more accurate method. (In this
case, the data for this table are taken from the CBO estimate
of the Federal debt outstanding, because it is more up-to-date
than the OMB's data.) One can see that the actual U.S. general
revenue budget deficit for FY1999 will be $119 billion. Though
this figure may be revised a little downward if tax revenues
increase, it will exceed $100 billion.
Table 2.--Projected budget deficit of actual U.S. budget
(billions $)
------------------------------------------------------------------------
------------------------------------------------------------------------
1999....................................................... $119
2000....................................................... 127
2001....................................................... 124
2002....................................................... 82
2003....................................................... 94
2004....................................................... 81
2005....................................................... 72
2006....................................................... 31
2007....................................................... 18
------------------------------------------------------------------------
AAAAA (Source: CBO, FY 1999 Mid-Session Review)
How, then, can one transmute an actual U.S. budget deficit
of $119 billion for FY1999, into a surplus of $60-70 billion,
as the media, the Congress, and the White House allege? This is
done by the legerdemain of the ``unified budget,'' whose
function is to mask the actual budget deficit. What the unified
budget does is to find various funds that are in surplus, and
mix them in, quite improperly and illegally, with the actual
budget deficit, to produce an apparent surplus. This practice
was started in a major way during the Reagan administration,
because the administration was wracking up large actual
deficits.
The favorite target to mix in with the actual budget
deficit is the OASDI trust fund, because, since the Social
Security reforms of the 1980s, this fund has been running
growing annual surpluses (see below). (OASDI refers to the
formal name for the Social Security trust fund, which is the
Federal Old Age and Survivors and Disability Insurance Trust
Fund, or OASDI.)
But this is quite illegal. The Social Security trust fund
has its own dedicated tax, which produces a revenue stream
earmarked only for the Social Security trust fund's purpose.
This special tax, by law, cannot be used to fund or to be mixed
into the revenue stream of the general revenue or ``on-budget
budget.'' Therefore, the ruse of the ``unified'' budget, which
says that the actual budget is not in deficit, because we have
now mixed in the surplus of the OASDI trust fund, is a complete
fraud. Everyone who works on the budget knows that.
Let us show how this fraud works in FY1999. As stated above
(Table 2), the FY1999 actual budget will have a deficit of $119
billion. Let us assume that tax revenues are higher than
originally projected, so the deficit is only $100 billion. Now,
in the current fiscal year, the OASDI trust fund will have a
surplus of $81 billion. Mixing the two together, one has
reduced the deficit to only $19 billion. The government also
adds in, quite illegally, surpluses from other trust funds
(such as the Highway Trust Fund), and employs other gimmicks.
Voila! It produces a surplus of $60-70 billion.
But there is an additional key element in the government's
work to produce an alleged $4.2 trillion budget surplus over
the next 15 years: The OMB has incorporated into its budget
calculations, that U.S. tax revenues will continue to grow at
an accelerating rate, because of the impact of the U.S. stock
market bubble in swelling capital gains and other tax revenue.
Thus, the OMB and all other agencies are counting on the
continuance of the stock market bubble for revenues, a stinging
commentary on the state of affairs of the U.S. economy.
The OMB does not take account of the deepening worldwide
financial and economic disintegration, which will blow out tax
revenues, whether generated from the stock market or the real
economy, and send the budget deficit through the ceiling.
Thus, the government's estimate of a $4.2 trillion surplus
is based on fraud combined with fantasy.
Myth that Social Security Is Insolvent
The rationale for diverting Social Security funds to the
stock market, is that it would generate a higher yield on
investment, which is alleged to be critical to add some years
of solvency to the Social Security trust fund (which is
formally known as the Federal Old Age and Survivors and
Disability Insurance Trust Fund, or OASDI). However, the OASDI
trust fund is not in any imminent danger, and investing a
portion of it in the stock market is not a way to make it
sound.
Table 3 shows the CBO's projected Social Security annual
surpluses. By fiscal year 2008, it is estimated at $186
billion. During fiscal years 1999 to 2008, the OASDI trust fund
is expected to build up a cumulative surplus of $1.516
trillion. The CBO and OMB have not yet publicly released
figures of what they project the Social Security surplus will
be for the five fiscal years 2009 through 2013, but were the
rate of growth assumed for 1999-2008 to continue, the sum for
those five years would be approximately $1 trillion. Hence, for
1999-2013, the OASDI projected surplus is $2.516 trillion, or
three-fifths of the total $4.2 trillion ``budget surplus'' that
the government is projecting for next 15 years.
Table 3.--Projected Social Security annual surplus
[billions $]
------------------------------------------------------------------------
------------------------------------------------------------------------
1999....................................................... $117
2000....................................................... 125
2001....................................................... 130
2002....................................................... 142
2003....................................................... 146
2004....................................................... 155
2005....................................................... 165
2006....................................................... 173
2007....................................................... 181
2008....................................................... 186
------------------------------------------------------------------------
Cumulative total, 1999-2008: $1.516 trillion
(Source: CBO, FY 1999 Mid-Session Review)
Therefore, when the government says that it will
distribute, out of its imaginary $4.2 trillion surplus, $2.7
trillion to the Social Security fund over the next 15 years,
all that it is doing is giving back to the Social Security
trust fund money that already belongs to the Social Security
trust fund, i.e., the $2.516 trillion surplus that the Social
Security trust fund would be building over the next 15 years.
This act consists of finding the OASDI's surplus, taking it,
and then giving it back. This is an elaborate ruse, but if the
government did not use it, it could not so easily pretend that
it had a $4.2 trillion budget surplus.
What Social Security needs
The main rationale given for investing a portion of the
Social Security trust fund into the stock market is that this
will make the Social Security fund ``solvent.'' Otherwise, it
is claimed, the trust fund would go broke. This story is not
true, on several levels.
First, as a result of reforms of the Social Security System
in the 1980s, the OASDI trust fund was mandated to build up a
surplus over succeeding years to plan for contingencies.
According to the mandate, the OASDI trust fund will go through
three phases. First, by the year 2012, the revenue that the
fund gets from a special dedicated Social Security payroll tax,
will not be enough to cover payouts to retirees. At that point,
the trust fund will also have to rely on the interest income it
earns from the Treasury bonds it holds. In the second phase, by
the year 2019, the combined tax income and interest income will
not be enough to meet payouts to retirees, and the trust fund
will then have to start drawing down the surplus it has built
up. In the third phase, by the year 2032, all the trust fund
surplus will be gone, and the rate of payout to retirees will
exceed the income from the social security tax and interest. At
that point, according to the story, the OASDI trust fund is
broke.
Keep in mind that this last phase will not be reached until
one-third of a century from now. The story that the collapse of
the trust fund is imminent, is hokum. That is a lot of time to
do something to reverse post-industrial society policies.
Second, the trust fund, by law (unless it is changed), is
required to invest all of its money in U.S. Treasury
securities. They are far sounder than stocks.
Third, the real issue is economic policymaking. The
assumption that the OASDI trust fund will go broke by the year
2032 is premised on the assumption that U.S. GDP will grow by a
real rate of about 1.9% per year between now and 2032. Were
real transformation of the physical economy to occur--i.e.,
especially if President Clinton were to appoint Lyndon LaRouche
as an economic adviser--the growth of the economy would take
off like a shot.
The other problem is that there are fewer younger workers,
as a percentage of the total population, entering the
workforce. It is the tax contributions of the younger workers
which helps provide the money needed for retired workers. The
demographic collapse is simply a part of the economic collapse.
Were economic growth and optimism to return to the United
States, families would have more children--not as a result of
being told to, but as a result of the enjoyment and confidence
in the future that an advancing economy instills in a family.
Fourth, despite the official claim, that the purpose of
putting the money into the stock market is to ``make solvent''
the Social Security system, in reality, it would bail out the
stock market bubble. The Wall Street financier sharks want to
have that new money in the stock market to prevent the its
decline and to churn the market higher. They have been pushing
for the trust fund's money to go into the stock market for
years. The speculative U.S. stock market bubble is wildly out
of control. It will pop, and will lose perhaps 50 to 75% of its
value. The OASDI trust fund is now invested in Treasury
securities, which, following upon the proper changes in broader
economic policymaking, are a reliable investment.
Statement of David Oliveri, MFS Investment Management, Boston,
Massachusetts
The Future of Retirement: Beyond Social Security
Social Security has long been described as the ``third
rail'' of American politics: Touch it and you're dead. Today,
however, doing nothing has far more dangerous consequences.
When the first wave of baby boomers begins retiring in the next
15 years, the world's largest governmental program will
approach bankruptcy, according to the Social Security
Administration. To restore the public's trust in the federal
government--and ensure the economic viability of its citizens--
politicians are being forced to toss out conventional political
wisdom and find a solution.
Traditionally, Americans have accumulated retirement income
through a combination of sources including government,
employers, and individual savings. However, the potential
insolvency of Social Security and the massive reduction in the
number of defined benefit plans offered by employers have
reduced the role of both sources, leaving individual investors
with virtually the sole responsibility of planning for their
own retirements. Americans are gearing up for the challenge
ahead. Indeed, seven of 10 Americans (69%) agree that the trend
toward individuals taking more responsibility for their
retirements than in the past is ``more of a good thing than a
bad thing,'' according to Roper Starch Worldwide, Inc. (Roper
Starch).
Not surprisingly, opinion research revealed that retirement
planning weighs heavily on the minds of most Americans.
Unfortunately, however, most individuals are woefully
unprepared to fulfill this obligation. The national savings
rate, for example, has fallen to its lowest level since the
Great Depression, according to the National Center for Policy
Analysis.
To encourage personal investing, the federal government has
enacted legislation providing tax incentives for those who
invest for their retirements. As a result, financial services
companies have pioneered a vast array of retirement products,
such as 401(k) plans; Individual Retirement Accounts (IRAs),
which are funded through annuities and mutual funds; and other
investment products. These products were originally designed to
provide investors with supplementary sources of retirement
income; today, however, they have become the foundations of
many Americans' retirement portfolios.
But despite the growing popularity of these retirement
vehicles, the government has an obligation to preserve the
legacy of the Social Security system by providing a safety net
for all Americans, particularly for lower-income citizens. With
the projected date of its bankruptcy drawing near, the issue of
how to fix Social Security has been taken off the back burner.
To date, the debate has been shaped by two radically different
philosophies. One school of thought is to maintain the current
Social Security system through a mix of benefit cuts and tax
increases. The second view is to entirely overhaul the system
by introducing the concept of mandatory savings, which allows
participants to invest, own, and manage some or all of their
contributions through private investment accounts.
Proponents of the private investment account concept
contend that unfunded liabilities under the current system will
have a devastating impact on the American economy during the
next century. Furthermore, they argue, citizens would achieve
far better returns on their investments based on the historical
performance of the stock market. Of course, past performance is
no guarantee of future results. Opponents counter that
introducing risks to Social Security could devastate benefits
in the event of a stock market downturn. They also suggest that
benefits under a privatized system would be unfairly skewed
toward higher-income citizens.
In either scenario, there is little question that the next
few years will see many hands touching the ominous ``third
rail'' of American politics. Leadership is needed to energize
Americans to plan for their retirements and enact reforms that
deliver retirement security for all citizens in the 21st
century.
The state of Social Security
The U.S. Social Security system was created in 1935 under
The Social Security Act to provide economic relief for retired
citizens in the aftermath of the Great Depression. Two years
later, the first Federal Insurance Contributions Act (FICA)
taxes were collected. The program was extended in 1939 to
provide survivors' benefits to the spouses and children of
workers. In 1956, it was expanded further to provide disability
insurance called Old-Age and Survivors Disability Insurance
(OASDI).
In the years since Social Security was enacted, the program
has played an integral part in improving the lives of our
nation's senior citizens. During the early part of this
century, most elderly Americans received financial support from
their extended families. Those who had no families were poor.
As a result of governmental assistance, the elderly poverty
rate has dropped sharply. In 1959, the poverty rate was more
than 35% for retirees. In 1979, it declined to 15.2%, and by
1996, the poverty rate was down to 11%, according to the Social
Security Administration.
True to its goal of providing a safety net, Social Security
reported that it had lifted 11.7 million elderly people out of
poverty in 1996 alone. In addition, the program elevated 3.5
million nonelderly adults and 800,000 children out of poverty.
The world's largest government program, Social Security spends
more than $350 billion each year.
Unfortunately, however, too many Americans began to rely on
Social Security for a level of financial support that extended
beyond its original scope. Indeed, economic theorists have
suggested that these entitlements are directly tied to the
declining savings rate in the United States. The National
Summit on Retirement Savings in 1998 reported that this benefit
has become the single most important source of retirement
income for 80% of senior citizens. For 18%, it is the only
source of income.
The Social Security system was designed as a ``pay-as-you-
go'' system, which means that each generation of workers makes
contributions to the Social Security Administration, which in
turn pays the benefits for current retirees. This system,
dubbed ``an intergenerational transfer of wealth,'' worked well
in 1940 when America had 159 workers per beneficiary, but
declining birth rates have caused that ratio to decline
significantly. Today, there are only 3.3 workers per
beneficiary, and, by 2060, it is projected that there will be
1.8 workers per beneficiary. (See Figure 1.) Thus, as most
Americans have grown to depend on Social Security as a vital
source of retirement income, the program is approaching
bankruptcy.
The resulting fiscal imbalance is largely a function of
dramatic shifts in the demographics of the American population,
particularly a vast increase in birth rates between 1946 and
1964. There are currently over 44 million people who receive
Social Security benefits, which accounts for approximately 12%
of the population. When baby boomers begin to retire, that
figure will move up to about 20%, according to the Heritage
Foundation. In other words, there will be virtually double the
number of retired citizens as there are today.
Furthermore, life expectancies have risen substantially
since the system was established in 1935. The original
retirement age for Social Security, 65, was agreed upon when
life expectancy at birth was 63. Social Security was not
intended to fund the lengthy retirements of American citizens
but to support the elderly who lived longer than expected and
could no longer work. Today, life expectancy is 76 and is
projected to rise to 81 over the next 75 years. This means that
Social Security will have to pay benefits to individuals for 18
more years than it had originally planned. The normal
retirement age today remains 65 and is scheduled for only a
slight increase, to 67, under current law.
To deal with the rising number of retirees, the government
has increased FICA taxes on workers and employers 36 times
since 1970. These rates have grown steadily, from 2% in 1940 to
12.4% today, with most increases being enacted in the past two
decades. (See Figure 2.)
In 1983, the National Commission on Social Security Reform
was created to restore Social Security to solvency. The
commission called for an increase in the self-employment tax,
partial taxation of benefits to upper-income employees,
expansion of coverage to include federal civilian and nonprofit
organization employees; and an increase in the retirement age
from 65 to 67, to be enacted gradually beginning in 2000. As a
result of these reforms, Social Security was declared
actuarially sound.
Today, few legislators support the notion that Social
Security can be saved with these types of minor changes.
According to the 1998 Social Security Trustees report, the
annual expenditures of the system will begin to exceed the
amount of money it will collect in 2013 as the first wave of
the 77 million baby boomers begins retiring. As a result, the
Social Security Administration will begin to draw down the
surplus it has generated since 1984, until 2032, when there
will be insufficient funds to pay out benefits to citizens.
If the Social Security program is allowed to continue
unfettered, it will begin to cause a considerable strain on the
fiscal stability of the federal government. Pundits fear that
Social Security and other entitlements will swallow up federal
revenues, leaving Congress with little discretionary spending.
Currently, entitlements account for 64% of spending capability.
Under the Balanced Budget Act of 1995, they would rise to 72%
of spending by 2002.
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Social Security, alone, accounts for approximately 34% of
entitlement spending. The trust fund is currently running a
surplus and as a result of contributions from baby boomers will
continue to do so in the near term. The annual surplus is
estimated to be nearly $100 billion by 2000, but it is dwarfed
by an estimated $3 trillion in unfunded liability over the next
75 years. Moreover, once baby boomers begin leaving the work
force, the trust fund will be virtually gone by 2029, when
Americans who are now between the ages of 30 and 50 expect to
receive their benefits.
It is important, however, to note that this surplus should
not be viewed as money that has been tucked away for future
retirees. The trust is a myth; it contains no money. Instead,
it consists of nonmarketable IOUs issued by the federal
government to repay the fund, with interest.
Budget rules have allowed the government to invest all
surplus dollars coming into the trust fund in nonmarketable
special government debt. In other words, the government simply
collects the trust fund's surplus revenue, replaces it with
nonmarketable government debt in the same amount, and then uses
the money from the surplus for other government spending. For
example, in fiscal year 1997, Social Security's cash surplus of
$40 billion was used to reduce the $62 billion deficit in the
rest of the unified budget.
The projected shortfall will become reality not in the
distant future, but in the next several decades. If substantial
changes are not made, by the time baby boomers begin to retire
revenue will not be adequate to cover costs, and the government
will have to go deeper into debt, raise taxes, or reduce
benefits.
In any event, future generations will be much worse off
than those that have preceded them. According to Michael
Tanner, director of health and welfare studies at the Cato
Institute, today's retirees will generally get back all they
paid into Social Security plus a modest return on their
investment. But when today's young workers retire, they will
receive a negative rate of return--they will get less than they
paid in.
The Individual's Increased Responsibility for Retirement Planning
Traditionally, an individual's financial security in
retirement has been called a ``three-legged stool'' of Social
Security benefits, employer-provided benefits, and personal
savings. However, the uncertainty surrounding Social Security
has put a tremendous amount of strain on the retirement
strategies of the American public.
Moreover, changes in American corporations including
corporate downsizing have required large companies to restrict
employee benefits, mainly by replacing the traditional pension
plans of employees with defined contribution plans. These plans
remove a considerable financial burden from institutions, many
of which are more focused on profitability than at any time in
the past.
The Pension Benefit Guarantee Corporation (PBGC) estimates
that the number of current workers participating in pension
plans has dropped from 29 million in 1985 to fewer than 25
million in 1994. If this trend continues, PBGC projects that by
the year 2005 most participants in defined benefit plans will
be retired. Indeed, the number of plans insured by PBGC has
decreased from 114,000 in 1985 to only 45,000 today.
The diminishing responsibility of the federal government
and employers has placed the burden of retirement planning on
individuals. For example, a recent survey by Roper Starch
Worldwide, Inc. found that most Americans (72%) agree that
``individuals themselves'' are responsible for their own
retirements. The survey also showed that many individuals
continue to expect help from sources such as employers (53%),
financial advisers (42%), the government (36%), insurance
companies (33%), mutual fund companies (32%), and banks (27%).
In fact, economic data suggest that individuals are not
shouldering the burden to the extent necessary to provide for a
comfortable retirement. For example, the national savings rate
has declined dramatically in the past 15 years. So far this
decade, net national saving (excluding depreciation) has
averaged less than 2% of gross domestic product, down from 5%
during the 1980s and from about 8% in previous decades. (See
Figure 3.) Taken at face value, the figures suggest that
Americans are saving less than at any time since the Great
Depression.
Interestingly, most American workers are concerned about
maintaining their current lifestyles after they retire. Only
39% of Americans who are not yet retired say they expect to
have enough income to live comfortably during retirement,
according to Roper Starch. This proportion is down from 45% in
1980 and from 51% in 1974. Meanwhile, 36% of respondents are
uncertain whether they will have enough funds to retire, up
from 27% in 1980. (See Figure 4.)
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All told, the nation is becoming increasingly skeptical
about the availability of funds for retirement living. Since
1974, Roper Starch has asked nonretired Americans whether they
feel they can count on various sources of income in retirement.
(See Figure 5.) The results reveal a significant decline in the
proportion of the public saying it feels it can count on
specific sources of income. The most dramatic declines have
come for Social Security and pensions from employers. Today,
just 49% of non-retired Americans say they can count on Social
Security during retirement, according to Roper Starch. That's
down by 13 points since 1991 and a staggering 39 points since
1974. It should be noted, however, that Social Security remains
the source the public feels it can count on most. Just 39%
think they will be able to depend on a pension plan provided by
their employer, down 6 points since 1991 and down 15 points
since 1974.
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Interestingly, while Roper Starch reported declines in
confidence in sources of retirement income, the only product
group to show gains were IRAs, 401(k)s, and Keogh plans, up 9
points since 1991. This finding, according to Roper Starch,
reflects a much larger trend taking place among Americans: the
trend of self-reliance. As Americans feel increasingly
disillusioned by the elite in government and business, they
increasingly feel they must depend on themselves.
Filling the Gap: The Proliferation of Retirement Products
With the assistance of legislation designed to encourage
retirement saving, the private sector has continually developed
new products that enable individuals to invest in their own
retirements. Originally designed as supplemental investment
vehicles, defined contribution plans, IRAs and annuities have
become, for many individuals, primary sources of retirement
income.
Defined contribution plans
The federal government passed the Employee Retirement and
Income Security Act (ERISA) in 1974 to empower individuals to
take more responsibility for their financial well-being during
their retirement--and to provide regulation to protect their
assets.
401(k) plans, the most popular type of defined contribution
plan, were not included in the original ERISA legislation but
were added in 1981 as a variation on profit-sharing plans. It
was not anticipated that these plans would play a major role in
the retirement security of millions of workers.
However, the reductions in defined benefit plans since the
early 1980s have elevated 401(k)s into the fastest-growing
segment of pension plans. What's more, these plans allow for
more flexibility than defined benefit plans because they are
available to all participants, regardless of the worker's
length of employment. Most employees become eligible to join
their company's 401(k) plan within six months to one year of
employment.
Roper Starch reported that 52% of those surveyed agree that
employers are responsible for helping individuals prepare for
retirement. This, with Americans' common belief in personal
responsibility, would suggest that a 401(k) or similar program
is what Americans have in mind when they think of the ideal
retirement plan.
These plans have quickly become the primary vehicles
through which individuals contribute to their retirement nest
eggs. In 1975, for example, the U.S. Department of Labor
reported that there were 38 million total participants (active
workers and retirees with vested benefits) in about 310,000
retirement plans. Of these, 103,000 were defined benefit plans,
and 207,000 were defined contribution plans. By 1994, there
were 85 million total participants in approximately 700,000
retirement plans, of which only 75,000 were defined benefit
plans and 625,000 were defined contribution plans. Today,
private retirement plans hold about $3.5 trillion in assets,
according to the Investment Company Institute (ICI), the mutual
fund trade organization.
Mutual funds have become an increasingly popular investment
vehicle for these plans, representing approximately 16% of all
total retirement assets in 1997, up from only 6% in 1990,
according to the ICI. Of the mutual fund industry's $5 trillion
in total assets, 35% are held in retirement accounts.
But despite the growth of 401(k) plans as a means of
planning for retirement, there is much work to be done to
ensure that the benefits of tax-deferred investing are
available to all Americans. As opposed to defined benefit
plans, these investments are not funded by an employer but
primarily by the discretionary savings of participants
(although many employers match contributions). This means that
participation in such plans is far from universal. For example,
the Employee Benefits Research Institute (EBRI) reported that
approximately two-thirds of those offered plans actually
participate, and that retirement benefits are frequently less
generous than those offered by traditional defined benefit
plans, depending on the level of employer contributions. An
EBRI study reveals that the average amount of assets in 401(k)
accounts is only $29,000 and that half of all accounts have
less than $10,000. individual retirement accounts (IRAs)
Individual Retirement Accounts (IRAs)
Under the ERISA legislation of 1974, individuals were
afforded the opportunity to invest up to $2,000 on a tax-
deferred basis as a supplementary vehicle for retirement
planning. IRAs have been further expanded to include the Roth
IRA, which instead of providing for tax-deductible
contributions allows for tax-free withdrawals, and the
Education IRA, which allows parents to invest for their
children's college educations.
Total assets held in IRAs and Keogh plans (retirement plans
for the self-employed) reached $1.4 trillion as of year-end
1996. Between 1985 and 1996, total assets held in IRAs and
Keogh plans increased 524%, according to the ICI. During 1996
alone, IRA and Keogh assets rose 15.7%, compared with a growth
rate of 24.7% between 1994 and 1995, 9% between 1993 and 1994,
and an average annual growth rate of 18.2% between 1985 and
1996. The ICI reported that most of the recent growth, however,
was due to rollovers from qualified retirement plans, not from
new contributions to the accounts.
Fixed and variable annuities
Annuities were first introduced in the late 1930s as part
of Franklin D. Roosevelt's New Deal Program to encourage
individuals to save for their own retirements. The first fixed
annuities had guarantees of principal and set rates of return
offered by the issuing insurance company. In 1952, the first
variable annuity was created to provide policyholders with more
control over how their money was invested. Variable annuity
owners could choose what type of accounts they wanted to invest
in and often received modest guarantees that their annuity
value would never fall below what they originally put in the
account. This guarantee, which is known as a death benefit and
is not available until the death of the annuitant or the owner,
depending on the contract, is backed by the claims-paying
ability of the insurer.
Sales of variable annuities have exploded in the past
decade from $9.3 billion in 1987 to more than $87 billion in
1997, according to the National Association for Variable
Annuities. These products are generally geared toward a more
affluent market including individuals who have already
contributed the maximum amount to both their defined
contribution plan and IRA.
Social Security Reform: Proposed Measures
To date, federal government attempts to assure the future
financial solvency of Social Security have relied on a
combination of proposed tax increases and minimal benefits
cuts. To illustrate the impact of such measures, the following
is an examination of what would occur if either of these
traditional options were to be adopted.
Tax increase. Actuarial estimates in the 1998 report of
Social Security's Board of Trustees project that the program
faces a $3 trillion shortfall in funding over the 75-year
estimating period. If the shortfall were to be met only by
raising taxes, FICA taxes would immediately have to increase by
20%, from 12.4% to 14.6%. This tax hike could rise to more than
50% in the event that it is delayed for another decade, warned
the Board of Trustees. Likewise, future additional taxes would
be required to assure the program's solvency beyond the 75-year
time frame.
Benefits reduction. If this situation were met by cutting
benefits across the board, there would have to be a 28%
reduction in 2032 and even larger reductions in later years
(ultimately reaching 33% in 2070). These reductions would
affect both those becoming entitled to Social Security benefits
in 2032 and later and those already receiving benefits at that
time, according to the Board of Trustees.
In either case, economists have warned about the negative
effect these options would have on the domestic economy. A
significant tax increase, they believe, would not only serve to
slow economic growth, it would further reduce the national
savings rate. They also suggest that benefit cuts could mean
that, in 2032 and later years, the percentage of elderly people
living in poverty would rise and that there would be greater
reliance on welfare programs, diminishing the original intent
of Social Security.
Furthermore, there is little support for maintaining a
``business as usual'' approach with regard to Social Security.
According to Roper Starch, only one in four Americans would
prefer to leave the system as is and simply supplement the
Social Security system with additional taxes as needed.
In his January 1999 State of the Union address, President
Clinton called for action to save Social Security by reserving
the government's surplus until all of the necessary measures
have been taken to strengthen the Social Security system for
the 21st century. This surplus is projected by the Federal
Budget Office to total $679 billion over the next 11 years.
Some members of Congress have rallied behind the
president's plea. Rep. Charles Rangel (D-N.Y.) has introduced
legislation to create a Social Security reserve fund for any
federal budget surpluses. Similarly, Sen. Ernest Hollings (D-
S.C.) has called for Congress to bar any tax cuts or make any
new investments with other funds until legislation is enacted
to make Social Security sound.
But as the presidential election approaches and the fight
for the government surplus intensifies, cutting taxes is
believed to be more likely to take precedence over Social
Security reform. The budget surplus notwithstanding, more than
two dozen Social Security reform plans have been designed by
legislators, private think tanks, and special interest groups.
Although the goal of all of these proposals is to ensure
some level of income for retired persons, it is clear that
individuals will be required to take on much more
responsibility for their retirements than in the past.
Government subsidies are being scaled back to bring Social
Security more in line with its original intent of providing a
safety net to citizens who have no other form of support. What
follows are summaries of several key initiatives that have
framed the Social Security debate as it stands today.
Report of the 1994-1996 advisory council on social security
In 1994, Donna Shalala, Secretary of Health and Human
Services, appointed the Advisory Council on Social Security to
examine ways in which Social Security could achieve financial
stability over the next 75 years. The 13-member panel, however,
could not agree on an approach and ultimately submitted three
separate proposals to Congressional leaders.
Six of the 13 members agreed to maintain the present Social
Security system, recommending a blend of cost-cutting and
revenue-producing measures. Most notably, they suggested that
the government itself should invest up to 40% of the surplus in
the Social Security trust fund in stocks. The remaining seven
members favored mandatory private savings through individual
accounts, but they vehemently disagreed over whether workers
should have limited or complete control over these accounts.
The following is a brief summary of the three proposals of
the Advisory Council on Social Security. Although these
measures were never adopted, their findings provide the basis
of many of the latest proposed bills on Social Security reform.
Option I: maintenance of benefits. This option
would maintain the present Social Security system as a defined
benefit plan. To ensure the system's solvency, it includes
several revenue-producing measures, such as reducing benefits
and/or increasing worker contributions and requiring newly
hired state and local government employees to contribute to the
system. The plan also favors additional taxes on Social
Security benefits, among others. Furthermore, it suggested that
the federal government help bring the program into balance and
improve the benefits of future generations by investing a
significant portion of the trust fund's assets in the equity
market.
Option II: publicly held individual accounts. The
second option, endorsed by five members of the council,
involves significant reductions in the growth of Social
Security benefits. Specifically, it would reduce the growth of
benefits to workers at all earnings levels by increasing the
retirement age and by reducing benefits for middle- and high-
wage workers.
In addition, this plan would introduce the use of
individual accounts, or IA plans, as a means of raising overall
national retirement saving. It would require all workers to
contribute an additional 1.6% of their annual salaries, which
would be held by the government in defined contribution
individual accounts. Individuals would have limited investment
choices, ranging from a portfolio consisting entirely of bond
index funds to equity index funds. Upon retirement, the
government would convert the money that has accumulated in a
worker's individual account to a single or joint guaranteed
indexed annuity, which would supplement his or her Social
Security benefits.
Option III: two-tiered system with privately-held
individual accounts. The remaining council members favored
reforming Social Security by making a substantial portion of
the new system fully funded. Ultimately, a two-tiered system
would take the place of the present Social Security system. The
first tier would provide a flat retirement benefit for workers,
and the second tier would provide individually owned, defined
contribution retirement accounts, referred to as personal
security accounts (PSAs).
In contrast to the IA plan, the funds in these accounts
would not be held or managed by the federal government, the
investment options would be less restricted, and workers would
not be required to annuitize their accumulations at retirement.
In addition, the PSAs would be funded with 5% of current FICA
taxes. Survivors and disability insurance benefits would be
modified but continue to be financed by the OASDI trust funds
and administered through the Social Security Administration.
To bring the current system back into financial balance,
provisions in the first tier would increase the retirement age
and extend coverage to newly hired state and local workers. The
7.4% portion of payroll tax that was not used to fund PSAs
would finance retirement benefits, spousal benefits, and
survivors and disability insurance. The cost of transition to
the new system would call for a 1.52% payroll tax, supplemented
by added federal borrowing.
Investment account payroll deduction plan--Sen. Daniel Moynihan
(D.-N.Y.), Sen. Robert Kerrey (D.-Neb.).
The Investment Account Payroll Deduction Plan involves a
two-tier system that would allow workers to contribute 2% of
their annual pay into a private account. The worker would pay
1% of the contribution, with an equal amount paid by the
employer. These deposits would be placed in an IRA or sent to a
newly created ``Voluntary Investment Fund'' to be managed like
the Thrift Savings Plan available to federal government
employees. Participation in the private option would be
voluntary.
To restore the fiscal strength of the current Social
Security system, all Social Security benefits in excess of the
dollar amount of each employee's contributions would be
taxable, which is similar to the tax treatment of defined
benefit pension plans. Likewise, cost-of-living increases would
be based on the Consumer Price Index minus 1%. The program
would call for minor benefits reductions; however, the existing
OASDI program would be retained in full. Other adjustments to
the current Social Security system would include raising the
normal retirement age to 68 by 2017, with a gradual increase
thereafter until it reaches 70.
Under this plan, FICA taxes would decline to 5.2% for
employees and 6.2% for employers until 2001, when the employer
tax would fall to 5.2%. By 2025 to 2029, FICA taxes would rise
to 5.7% for both employees and employers, with further tax
increases slated for the future. The authors of this plan
suggest that in 2004 all transitional costs would be recouped.
The social security solvency act of 1997--Rep. Nick Smith (R.-
Mich.).
Similarly, the Social Security Solvency Act establishes a
two-tiered system that uses the current benefit structure as a
safety net. However, this plan gives workers the option to
invest a substantially larger part of their 12.4% of payroll
taxes.
The plan involves mandatory retirement savings with a
Personal Retirement Savings Account (PRSA), through which
investors can choose from a range of options. The amount of
payroll contributions that can be put in a PRSA increases over
time, starting at 2.5% of wages and growing to 10.2%.
Under this plan, benefits are gradually reduced for
individuals making over $50,000 who have received everything
they and their employer have contributed to Social Security,
plus interest. It also involves other small reductions in
benefits; however, existing OASDI benefits would be retained.
In addition, the normal retirement age would gradually increase
to 69 between 2003 and 2018. The plan would then index the
retirement age to reflect increases in life expectancy and
working careers. Workers would be able to access their PRSAs at
age 60.
To finance the transition, the plan would make
methodological adjustments to the Consumer Price Index, fixing
the index at 0.15 percentage points below assumptions in the
1997 Social Security Trustees Report.
The individual social security retirement accounts plan--Rep.
John Porter (R-Ill.).
The Individual Social Security Retirement Accounts (ISSRA)
Plan is another two-tiered system that allows workers to divert
10% of their pay to a private plan. Participation in this plan
is voluntary. Social Security benefits would not change for
workers who decided to remain in the current system.
For those who chose the private plan, the worker would pay
5% of the contribution and the same amount would be paid by the
employer. Voluntary additional employee contributions up to 20%
of taxable pay would then be permitted. Investment options
would include government-approved private investment companies.
Those participating in the plan would also pay 2.4% of their
salaries annually (split evenly between employer and employee)
during the first 10 years after election. Retirement age for
full retirement benefits in either plan would ultimately
increase to age 70.
For participants age 30 and older electing private savings
plans, recognition bonds would be issued to ISSRAs, redeemable
upon retirement for monthly benefits earned by Social Security
tax payments under the current system. If, at age 62, a
participant's ISSRA were not sufficient, the government would
supplement it with a minimum annuity payment from the general
funds of the U.S. Treasury. The ISSRA would purchase private
disability and life insurance for the account holder equal to
at least the same coverage under Social Security.
Transition financing would involve, among other things,
$500 billion (in 1996 dollars) of government bonds issued over
the first 12 years. Unspecified reductions in other government
spending of $875 billion would be required.
The personal retirement accounts plan--Rep. Mark Sanford (R.-
S.C.)
The Personal Retirement Accounts (PRA) Plan involves the
full replacement of the current Social Security system with 8%
of pay diverted to a private plan, split evenly between
employers and employees. It would be mandatory for all workers
entering the work force in 2000 or later. Those employed before
then could decide whether to remain in the current Social
Security system or participate in PRAs. For those participating
in the new plan, investment options would include low- to
moderate-risk index funds. The Securities and Exchange
Commission (SEC), with expanded authority, would regulate these
funds.
Workers would continue to pay 5.8% in FICA taxes, split
evenly between employers and employees, to fund the existing
OASDI system. The existing disability insurance system would be
retained, however. PRA trustees would be required to provide
insurance for any survivors and dependents. Retirement age
would increase to age 70 by 2029.
Of note, this plan advocates the dissolution of the Social
Security trust fund and would pay benefits with general
revenue. Transition financing has not been determined. The plan
would establish a Social Security Transition Commission to
recommend spending cuts, asset sales, debt issuance, or
increased revenue to fund the transition.
The committee for economic development proposal
This proposal would require participants to invest 3% of
their pay into a mandatory private savings plan called a
Personal Retirement Account (PRA), split between employer and
employee. The PRA plan would offer broad-based funds managed by
private companies.
The 12.4% FICA tax would continue to fund the existing
Social Security system, which would offer reduced benefits.
Specifically, replacement rates (the ratio of retirement
benefits to the last year of earnings before retirement) would
be reduced by 0.5% per year in the first 14 years and by 1.5%
in the subsequent 19 years. Furthermore, 85% of all Social
Security benefits would be taxable. The retirement age would
also increase to 70.
Because the present Social Security system would remain
intact, there would be no transitional costs.
In addition to these and other massive reform plans, there
are a number of incremental reform proposals being introduced.
For example, legislation introduced by Rep. Thomas E. Petri (R-
Wisc.) would establish a retirement account of $1,000 for each
newborn American. The start-up funds would be derived from the
sale of government assets and would be invested in the same
retirement investment funds that are currently available to
federal employees through the federal Thrift Savings Plan.
Account holders could voluntarily add up to $2,000 per year,
tax free, to their retirement accounts.
The Case of Chile's Pension Savings Account
The United States is not the first or the only country to
deal with a fiscal crisis in its social security program. In
the late 1970s, the government-run pension plan in Chile was on
the verge of bankruptcy. For reasons similar to those plaguing
the U.S. Social Security system, Chile had no funded reserves,
and it had already begun paying more benefits than it was
collecting in revenue. As this situation worsened, higher taxes
were the only solution, which stunted job creation. This led
the Chilean government to scrap its social security system
altogether and replace it with mandatory private savings.
Chile's Pension Savings Account (PSA) system was born on
May 1, 1981. In a radical change from convention, Chile shifted
the entire responsibility for funding a worker's pension from
the government to the individual. Indeed, the amount of a
pension was solely determined by the sum an individual worker
accumulated during his or her working years. Under this system,
the government required each worker automatically to put 10% of
his or her wages into an individual PSA. A worker could
contribute an additional 10% of his wages each month, also
deductible from taxable income, as a form of voluntary savings.
This pension is available to all citizens, including those
who are self-employed. It is completely portable, meaning that
it is independent of the company with which a worker is
employed.
These savings accounts are funded through a combination of
more than 20 mutual funds of each worker's choice. These funds
are managed by private companies called Adminatratoras de
Fondos de Pensiones (AFPs). These companies can engage in no
other activities and are subject to government regulation to
safeguard against fraud and to guarantee a diversified and low-
risk portfolio. Government regulation sets maximum percentage
limits both for specific types of instruments and for the
overall mix of the portfolio. Underscoring Chile's desire to
remove the government from the pension business, there is no
obligation to invest in government or any other type of bonds.
Workers are free to change from one AFP to another. For
this reason, there is competition among the companies to
provide a higher return on investment, better customer service,
and a lower commission, according to Jose Pinera, Chile's
former minister of labor and social security and president of
the International Center for Pension Reform.
Participants are given a passbook and receive a quarterly
statement. They can monitor the performance of their
investments and can change the level of their contributions
based on the amount of income they would like to receive and
the year in which they plan to retire. Contributions are tax
deductible, and the return on pension savings is tax free.
Similar to the rules governing defined contribution plans and
other tax-deferred investments in the United States, taxes are
paid according to an individual's income tax bracket upon
retirement.
The only government subsidy involves providing a minimum
pension to low-paid workers. Those who have contributed for at
least 20 years but whose pension funds, upon their reaching
retirement age, are below the legally defined minimum will
receive government-sponsored pensions from the state once their
PSAs are depleted. The minimum pension for an average-wage
worker is 40% of preretirement income. The PSA system also
includes insurance against premature death and disability,
which costs 2.9% of a worker's annual salary and is contracted
from the AFP to a private insurer.
Upon retirement, there are two payout options. Under the
first payout option, a retiree may use the capital in his PSA
to purchase an annuity from any private life insurance company.
The annuity guarantees a constant monthly income for life,
indexed to inflation, plus survivorship benefits. If these
payments exceed 70% of preretirement income, the worker is
allowed to take out the excess in the form of a lump sum. The
second option allows a retiree to leave his funds in the PSA
and make withdrawals, subject to limits based on the life
expectancy of the retiree and his dependents.
During the transition to the new PSA system, all workers
were given the choice of staying in the government-sponsored
program. Those who chose the new system were given a
``recognition bond,'' which was deposited in their new pension
savings accounts. These bonds were indexed and carried a 4%
interest rate. Recognition bonds, which are payable when the
worker reaches the legal retirement age, are also traded on the
secondary markets so as to allow them to be used for early
retirement. The choice of whether or not to participate in the
PSA system was given only to current workers. All new entrants
into the labor force were required to use the new system.
As an added incentive to participating in the system,
workers' gross wages were increased to include most of their
employers' contributions to the old pension system. As a
result, salaries for those who moved to the new system
increased by 5%. Employers continued to pay the difference in
order to help finance the transition. However, that tax has
since been phased out.
More than 40% of the transitional costs were financed
through the issuance of government bonds at market rates of
interest. These bonds were primarily purchased by the AFPs to
fund their investment portfolios. The Chilean government
projects that this ``bridge debt'' should be completely
redeemed once it no longer has to fund the pensions of the
participants in the old government-sponsored system.
The impact of Chile's pension savings accounts has been
phenomenal. In the 14 years of its operation, benefits are
already between 40% and 50% higher than under the government's
plan. In 1997, PSAs have accumulated an investment fund of $30
billion, an exceptionally large amount of money for a
developing country of 14 million people and a GDP of $70
billion.
Today, more than 93% of Chileans are in the new system. The
Chilean government estimates that these workers will be able to
retire with an average of 70% of pre-retirement income, more
than three times the amount promised under the old system. The
average rate of return on investment has been 12% per year,
which was more than three times higher than the anticipated
yield of 4%. (Note: This period included the longest bull
market on record for equities.) Furthermore, the savings rate
in Chile has increased from 10% in 1986 to 29% in 1996. All
told, savings for the average Chilean is equal to four times
his or her annual income, which is quadruple the average in the
United States, according to Pinera.
Pension privatization, which has reduced the cost of labor,
has been credited for pushing the growth rate of the economy
from a historical 3% per year to 7% on average for the past 12
years. Chile ranks among the world's fastest-growing economies
and has the highest credit rating of any Latin American
country.
Privatization: The $10 Trillion Debate
The fundamental question in the debate over the
privatization of Social Security is whether individuals would
be better off directing all or a portion of their FICA taxes to
private pension accounts of their own. The American public is
divided on this subject. Roper Starch reported that most favor
some individual control of Social Security contributions, with
60% supporting the idea that individuals be allowed to invest a
portion of their Social Security contributions as they see fit.
However, there is strong opposition to the government's playing
the market to any degree. Only 26% support changes that would
allow the government to invest a portion of Social Security in
the stock market, and less than 13% support the government's
investing all of Social Security in the market.
Proponents of the privatization of Social Security contend
that the average individual would obtain far higher returns
than he or she would under the current system. For example, a
study from The Cato Institute's Project on Social Security
Privatization revealed that low-income workers born in 1950 can
expect to receive approximately $631 per month from Social
Security. But had those investors invested the same amount of
money in a stock mutual fund, they would have earned upwards of
$2,419 per month. Moreover, individuals would own their own
accounts, which would alleviate the federal government of a
massive liability.
In contrast, opponents of privatization contend that Social
Security is not simply an investment vehicle or a pension
program--and never has been. By design, it's a complex social
program that involves massive subsidies from the next
generation of retirees. Privatization would introduce a level
of risk that could ultimately prove to be harmful to the
investor. Furthermore, it would allow higher-income individuals
to make larger contributions over their working lives, thus
widening the chasm between the rich and the poor.
However, while past performance is no guarantee of future
results, based on the historical returns of the stock market,
returns from privately invested retirement accounts would be
significantly greater for all wage earners than the benefits
received from Social Security. For example, a recent article in
Barron's estimated that a median-wage worker who was born in
1976 and will retire in 2043 would receive almost three times
more money through a privatized plan that invested in a
traditional stock fund than with Social Security based on the
performance of the S&P 500 Index during that time period. (See
Figure 6.) For low-income workers, the returns generated from
stock funds would be 230% higher than those attained from
Social Security. While there are inherent risks involved in the
stock market, proponents of reform suggest that based on the
historical performance of the S&P 500 Index, the higher rate of
return from stocks would balance the risk of short-term
fluctuations for long-term investors.
[GRAPHIC] [TIFF OMITTED] T7507.018
One of the foremost proponents of privatization, Martin
Feldstein, professor of economics at Harvard University and
president of the National Bureau of Economics Research,
estimated that Social Security privatization would raise the
well-being of future generations by an amount equal to 5% of
America's gross domestic product (GDP). Although the transition
to a fully funded system would involve a significant investment
of capital, he projected that the value of the gain would be as
much as $10 trillion to $20 trillion.
Critics of Social Security reform have countered that
Social Security benefits should not be compared with private
investment vehicles because the goals are very different. For
example, insurance aspects of Social Security help skew the
returns downward. About one-fifth of payouts under Social
Security go to wives and children of workers who are disabled
or die before they have been able to contribute to the system
over a full 40-year career.
Furthermore, the 68-year-old program has had the backing of
the federal government and has to date fulfilled its promise to
the American public. Opponents of privatization have said that
the government could fix Social Security through a mix of
benefit and tax reductions. What's more, there is concern that
investors who retire during an extended bear market will
achieve significantly less-than-average returns. For example,
from 1968 to 1978, the stock market as measured by the S&P 500
Stock Index fell by 44.9% in real terms. People who retired in
the late 1970s and financed retirement from stock sales had a
return well below the historical market average. This scenario
would have a devastating impact on the retirement income of
lower earners. Opponents argued that the lower one's earnings
over a lifetime, the more Social Security pensions matter to
one's retirement security.
Investor education is another key determinant to the
success or failure of American workers participating in a
privatized system. Clearly, investors need sophisticated
knowledge to invest successfully. Opponents worry that Social
Security participants lack such knowledge. England's experience
with social security reform offers a sobering example of the
consequences of uninformed people investing money in the stock
market. In 1988, the United Kingdom allowed individuals to opt
out of its national public pension system and into private
accounts. Sales agents often gave investors wrong and biased
advice. These abusive sales practices, coupled with inadequate
regulation, led to billions of dollars in losses for investors,
according to SEC Chairman Arthur Levitt in a recent speech on
Social Security reform at the John F. Kennedy School of
Government Forum at Harvard University.
But reform proponents have said that a properly designed
market-based system would build on the structures already
developed for defined benefit and defined contribution plans.
These plans do not require their participants to be highly
sophisticated investors. For decades, workers of all income
groups in defined benefit plans have entrusted their pension
benefits to sophisticated investors, who, for the most part,
have done very well in fulfilling their fiduciary
responsibilities. In defined contribution plans where
individuals have more of the investment responsibility,
evidence suggests that they are more comfortable if given
proper investment guidance.
Opponents have expressed concern that the transitional
costs associated with privatizing Social Security could be
burdensome on working Americans. For example, the National
Committee to Preserve Social Security and Medicare has observed
that either payroll taxes would have to be increased
significantly or substantial government debt would have to be
incurred. The organization estimates that a proposal to divert
5% of earnings from Social Security to private pensions would
cost about $2 trillion and require a payroll tax increase of
1.5%, combined with $1.2 trillion in new government debt.
Reform proponents contend that the benefits of a privatized
system would offset any transitional costs. According to a
study by The Cato Institute, the tax revenues generated from
the net increase in investment alone would be about $150
billion in the 10th year from the start of the transition, and
they would continue to grow as private investments accumulated
each year. The study estimates that this effect, combined with
modest spending cuts of about $60 billion per year and modest
increases in borrowing of about $50 billion per year, would
yield a positive cash flow for current retirees who depend on
Social Security. There would be no further spending cuts or
borrowing by the 15th year after privatization.
Conclusion
The debate over whether or not to privatize Social Security
will involve considerable compromise from those on both sides
of the issue. Without clear and effective leadership, the
ensuing retirement crisis will have a detrimental impact on the
nation's economy and the quality of the lives of its citizens.
Whatever the outcome, individuals will be required to assume
more responsibility for their retirements than the generations
before them. To encourage saving, regulators, financial
services companies, and financial advisers must not only
provide more access to investment products, they must educate
individuals and provide strategies to help them maintain a
comfortable lifestyle in retirement. Indeed, for the sake of
the nation's economy and the quality of the lives of its
citizens, the debate over Social Security reform and how to
encourage better retirement planning must take center stage as
the 21st century approaches.
February 27, 1999
The Honorable E. Clay Shaw, Jr.
Chairman, Subcommittee on Social Security
House Committee on Ways and Means
United States House of Representatives
Washington, D.C. 20515
Dear Representative Shaw:
We understand the House Ways and Means Subcommittee on Social
Security will be holding a hearing on the direct investment component
of the President's Social Security reform proposal. We have also been
advised that state and local government pension plans may be
characterized in this hearing as allowing ``political interference'' in
their investment decisions.
We have no position on the President's proposal. However, we
strongly disagree with the current comments implying we earn a lower
rate of return due to alleged politicization of investment decisions
and policies that focus on social factors other than the best interests
of the plan participants. We strongly believe that public pension plan
assets are invested in a prudent manner that ensures that plan
participants receive the benefits to which they are entitled and also
in a manner that reduces the costs for taxpayer support of the plans.
Should the Subcommittee find it necessary to raise the issue of the
investment performance of state and local government pension plans, we
respectfully request the Subcommittee invite independent experts to
testify on the rates of return obtained by public pension plans as
compared to their private sector counterparts over the past several
years. Such testimony will show that the rates of return achieved by
public and private plans over these periods are quite similar.
Furthermore, it will provide the Subcommittee with information based on
current data.
Data the Ways and Means Committee has received to date, and relied
upon by Federal Reserve Board Chairman Alan Greenspan, was based on
information from the 1960s through the 1980s and showed the rates of
return for public sector plans trailing by two to three percentage
points the return rates of private sector plans. Chairman Greenspan
suggested that some of the disparity might be ascribed to political
interference in the management of the state or local pension plans.
This is incorrect. Even the Chairman conceded that much of this
disparity would be eliminated were these returns adjusted for risk in
light of the fact that State and local pension funds are often invested
more conservatively than private plans.
We believe virtually all of this lag is attributable to the
investment restrictions imposed on public funds but not on corporate
plans. As these restrictions have gradually been lifted, public funds'
performances have grown to become comparable with private pension
funds. Current data shows that public retirement funds are efficiently
managed financial institutions with well diversified portfolios that
have achieved impressive rates of return.
If the Subcommittee does wish to pursue the issue of state and
local government pension investment practices, we would appeal for a
full, fair and complete hearing record. We respectfully request that
the Committee invite independent experts to testify on the rates of
return obtained by public pension plans as compared to their private
sector counterparts over the past several years.
We would suggest that you call Laurette Bryan and/or John Gruber,
Senior Vice Presidents of State Street Bank. Their testimony will be
factually rooted in the actual rates of return experienced and provided
by scores of the nation's public and private pension plans to their
institution as well as Chase Manhattan Bank, Citibank, Mellon Bank,
Northern Trust Company, U.S. Trust, Bank of New York, NationsBank and
11 other banks. These banks support the Trust Universe Comparison
Service (TUCS) which produces rates of return and other data that are
used as the industry standard by which pensions measure their
performance. (We have attached a summary of these independent findings
for your review).
We appreciate your consideration. If you have any questions or
would like additional information you may contact our legislative
representatives:
Gerri Madrid/Sheri Steisel,
National Conference of State
Legislators
Neil Bomberg,
National Association of
Counties
Doug Peterson,
National League of Cities
Larry Jones,
United States Conference of
Mayors
Tom Owens,
Government Finance Officers
Association
Jeannine Markoe Raymond,
National Association of
State Retirement
Administrators
Cindie Moore,
National Council on Teacher
Retirement
Ed Braman,
National Conference on
Public Employee
Retirement Systems
Attachment
[The attachment is being retained in the Committee files.]
Statement of Peter J. Sepp, Vice President, Communications, National
Taxpayers Union, Alexandria, Virginia
Mr. Chairman and distinguished members of the Committee, I
am grateful for the opportunity to present the views of the
300,000 members of National Taxpayers Union (NTU) as you
consider proposals that would allow the federal government to
direct and control the investment of Social Security funds in
private financial markets. As you may know, the vast majority
of NTU's members are either retirees or middle-class employees
and business owners working towards retirement. Therefore, the
issue before the Committee today is of great concern to them,
and I commend you and your colleagues for recognizing the
impact of this proposal.
Introduction
No one can deny the central role that individual investing
has played in lifting the fortunes of millions of middle-class
families. Nor can one deny increased public anxiety over the
solvency of federal retirement programs, and the government's
inability to address the problem.
These economic and political trends seem to have eluded
President Clinton and many of his allies in the White House and
Congress. Under the President's budget proposal, nearly 62
percent of projected budget surpluses ($2.7 trillion over 15
years) would be funneled into the porous ``Trust Fund.'' Of
this, Clinton proposed ``investing a small portion in the
private sector just as any private or state government pension
would do.'' This proposal, if enacted, would present the
greatest threat to the finances of taxpayers and consumers
since the Administration's attempt to nationalize \1/5\ of the
nation's economy under the guise of ``health care reform.''
There is ample evidence from a range of disciplines to support
this dire prediction.
American Investors Are Confident in Themselves, But Not in the
Government
Perhaps no other economic factor is more responsible for
the continued prosperity of Americans than the growth of
individual investments in stock and bond markets. From 1989 to
1995, the percentage of all families having direct or indirect
holdings in the stock market rose by one-third, to 40.3
percent. From 1990 to 1997, mutual fund holdings have increased
an incredible 500 percent, to more than $3 trillion. But these
investments have not been fueled by short-term speculation.
Indeed, most are directed towards long-term gains. Despite
continued acts of Congress that have narrowed their
availability and appeal, Individual Retirement Accounts
contained $1.35 trillion in 1996, double their worth just five
years before.
This recent explosion in individual investment has
financially empowered the middle class more than any other
income level. Today, half of all families in the $25,000-
$50,000 bracket have holdings in the stock market. For the
$50,000-$100,000 bracket, the level soars to more than two-
thirds. It is therefore no wonder that this boom in investing
has been accompanied by an explosion in financial counseling
services, investment publications, and Internet sites all
designed to provide consumers with the information they need to
make rational choices in the stock and bond markets. Americans
are unquestionably savvier about finance today than at any
other period in history.
Yet, the rise in individual investor confidence has
corresponded with a steady drop in taxpayer confidence in the
federal government's retirement programs. As early as 1990,
scientific opinion research by National Taxpayers Union
Foundation revealed that less than one-fourth of workers under
age 35 were confident that Social Security would pay the full
level of benefits promised to them once they retired.
By 1995, significant pluralities of Americans had warmed to
the idea of allowing individuals to plan more for their own
retirements. A Grassroots Research Survey taken in November of
that year found that 48% of Americans aged 30 to 39 would
voluntarily withdraw from Social Security, even if they
received nothing in return for the taxes they had already paid.
Today, public opinion not only favors individually-directed
retirement investments, it also opposes government-directed
schemes. A CNN/USA/Gallup poll conducted in December of last
year indicated a 64%-33% approval margin for ``individuals
investing a portion of their savings'' in the stock market as a
Social Security reform option. An equally lopsided margin--65%-
33%--disapproved of the ``Federal Government investing a
portion'' of Social Security in the stock market.
State and Local Investments Have a Tarnished History
President Clinton unwittingly made the worst historical
case for a federally-directed investment scheme when he
referred to the experiences of state and local pension funds.
The dismal political and financial track record of these funds
is Exhibit Number One in the case against expansion.
In 1990, Connecticut Treasurer Francisco Borges
directed the State Pension Fund to invest $25 million into the
ailing Colt Firearms Division of Colt Industries, insisting
that the money was ``not a bailout, not a handout, and not a
subsidy ... it is a bona fide financially prudent investment.''
At the time Borges didn't mention that the state brokered a
deal with the company's striking union workers for a 13% pay
raise and $13 million in back wages. Borges later found himself
in the curious position of supporting a ban on ``assault
rifles'' while investing in the very company accused by gun
control advocates of manufacturing the weapons. Colt later
filed Chapter 11 bankruptcy.
The Kansas Public Employee Retirement Systems
(KPERS) has lost between $138 million and $236 million due to
its Economically Targeted Investments (ETIs). Among the
System's ``bad picks'' were a seized savings and loan once run
by the head of KPERS and a now-abandoned steel plant.
Pennsylvania school teachers and state employees
have watched helplessly as $70 million of their pension funds
have been sunk into a new Volkswagen plant, an investment that
has since lost half its value.
Rick Dahl, the Chief Investment Officer for Missouri's
State Employee Retirement System, summed up this sad history
when he observed, ``Anytime you get a big chunk of money in
front of politicians, you run the risk of investments made not
in the best interests of the beneficiaries.''
Those who consider such a statement to be too harsh should
examine hard data. In 1998, John Nofsiger found that ETIs and
other ``socially responsible'' investing practices depressed
the average annual returns of public retirement funds by 1.5
percent. Ironically, former Clinton Treasury official Alicia
Munnell conducted a similar study 15 years earlier that showed
a 2 percent annual reduction.
Federal Financial Management Is Likewise Tarnished
Beneath President Clinton's proposal is a thinly veiled
contempt for the intelligence of the average American. It is
based on the claim that the government, but not America's
taxpayers, can invest budget surpluses wisely.
Given the plethora of policies that document the federal
government's penchant for poor financial management, it is
incredible that the Chief Executive would even imply such a
thing. While the scope of these hearings do not permit a
wholesale examination of the government's track record, the
Administration's analogy forces us to remind the Committee of a
few examples:
In 1997, the average default rate on private bank
loans to homebuyers was 2.8 percent. That same year, defaults
on government home loans reached 8.1 percent.
The total national debt owed by the federal
government is $5.6 Trillion. The total debt owed by consumers
is $1.235 Trillion.
Between 1950-97, the average annual return of
money invested by citizens in the stock market has been 8.7
percent. The average annual return of the Social Security
``Trust Fund'' since inception has been 2 percent.
In 1996, nearly \1/3\ of all citizens audited by
the IRS were later cleared or were actually given refunds. Yet,
the IRS has only cleared 1 out of 7 ``audits'' of its own
books, as conducted by the General Accounting Office.
Citizens are bombarded virtually every evening with
newscasts exposing $445,000 outhouses in national parks, $1
million angora goat subsidies, and other instances of wasted
tax dollars. But the facts above go beyond the sensational to
the very fundamental reason why Americans do not--and will
not--trust the federal government to invest wisely for the
national interest.
The Bottom Line: $350 Billion in Lost Returns and a Less Accountable
Political System
In order to quantify the amount at stake for future
retirees if President Clinton's proposal is enacted, NTU's
research staff compared the average rate of return of large
company stocks over the past 70 years (as estimated by the Bank
of Boston) to the average loss of return due to the political
influence on retirement funds (as estimated by Nofsinger and
Munnell). We then applied those rates to the estimated 15-year
investment pattern of Social Security Funds provided by the
White House and the Congressional Budget Office.
NTU determined that the average loss to Americans' retirement
funds under the President's plan would be $354.53 billion over
15 years.
However, the financial ``ripple'' would not end at that
point. Hundreds of billions of government dollars flowing into
private companies could give Washington direct control over a
majority of shares in hundreds of companies. As past experience
has shown, shareholders with even a 2 or 3 percent bloc of
shares can significantly influence the policies of publicly
traded companies. Thus, even investors who are buying shares
out of their own pockets will see their influence over
corporate governance diluted. In addition, the sheer volume of
federal trading would affect returns on private portfolios,
even those weighted to broader indices. After all, any major
shareholder who pulls out of a company can depress dividends
and capital gains for smaller investors.
Such linkages would likewise prevail abroad. Although the
government could improve its returns by diversifying into
foreign stocks and bonds, all sorts of political questions
would present themselves. If Washington invests in countries
whose leaders later become corrupt or violent towards U.S.
military personnel, should the government sell its shares and
worsen the risk of destabilizing those nations further, or
should it stand pat and risk bankrolling the regimes?
Yet, perhaps the most troubling political question lies
between our own shores. How would massive government investment
in private companies affect the relationship between elected
officials and special interests? Based on past experience, the
impact would be decidedly negative. Corporate Political Action
Committees could have an increased incentive to contribute to
government shareholding officials, or those closest to them.
For their part, federal officials would almost certainly have
knowledge of impending public policy decisions that could
affect the health of the companies in which the government owns
shares. Those concerned with ``campaign finance reform'' and
``insider trading'' should be alarmed over President Clinton's
proposal.
Conclusion--Let Individuals, Not Government, Control the Surplus
The American people were intelligent and diligent enough to
produce a booming economy and a burgeoning Treasury in the
first place. They are likewise intelligent and diligent enough
to manage their own retirement finances.
Economic tides will always leave some individuals
unprepared to retire in financial security. For this reason,
many citizens support some kind of modest, targeted government
program to keep the elderly out of poverty. However, Congress
should not read this public mood--or knee-jerk polls that
seemingly support the nebulous ``Save Social Security''
mantra--as an endorsement for further government meddling in
the development of a sustainable middle-class retirement
system. To adapt the words of entitlement expert Pete Peterson,
Washington must grow up before today's workers grow old--and
give hard-working Americans they credit they deserve to invest
budget surpluses individually.
Once again, I thank you, Mr. Chairman, and the Committee
for your thoughtful deliberation of this policy matter.
Statement of Chris Tobe, Plan Sponsor, Greenwich, Connecticut
Lessons from Public Pension Plans--Pure Indexing is only choice for
Social Security Stock Investing
President Clinton outlined a proposal to invest part of the
Social Security Surplus in stocks. In 1998 summer I co-wrote
with Dr. Ken Miller for Kentucky Auditor Ed Hatchett a review
of Kentucky's large public pension plans. As part of that
review, we surveyed 41 of the largest public pension plans in
the Country representing $950 billion in assets. These multi-
billion dollar plans are the closest parallels you can find to
what a stock investment by Social Security would be like.
This proposal raises many issues. It is not a simple issue
of privatization. However, I think it can work if we use the
best examples of what our Public Pensions are doing today. They
show that adding stocks to investment portfolios give us not
only the historical higher returns of equities, but also more
volatility and sticky governance issues that require our
attention.
I am analyzing the President's plan of investing 10%-15% of
Social Security assets directly in the stock market. This in my
opinion is a very separate issue than the other IRA type
retirement vehicles being proposed. Under this government
direction scenario, you primarily need to decide who manages
the stocks (private or public) and how those managers invest
the proceeds.
Choose Index Funds
Based on our findings in public pension plans my suggestion
of how we invest Social Security proceeds is to invest in index
funds. If you chose this option it matters much less who
manages the money, only who can do it most efficiently. Public
Pension plans have used indexing at an increasing rate because
of its good performance and low cost. More importantly
indexing, if strictly enforced, rids us of the sticky
governance issues.
Active management leads to governance problems whether
private firms or the government is managing the money. Most of
us are familiar with the argument being made by political
conservatives that if the government is the manager, it could
have undo influence over corporations and be a step toward
socialism. The conservative nightmare is that a Social Security
stock selection committee will be made up of Jesse Jackson,
Ralph Nader, and labor unions making demands on corporate
management.
The California Public Employees Pension Plan and others
have shown that they can hold at bay many of the social
concerns, while maximizing returns for retirees. However, I
think the resistance is much stronger for index funds than for
the actively managed portfolios. We have seen this in New York
and Florida, which divested Tobacco in their active portfolios
while keeping them in their index funds.
Management by private firms is apt to be no better. It's
susceptible to conflict of interest problems. Let us say an
Investment firm has the government stock portfolio, but they
also manage the pension plan of ACME auto. Do you think they
would dump the stock of ACME auto, causing it to plummet and
risk losing their business? In addition, the huge size of a
Social Security portfolio could cause all kinds of potential
for market manipulations when buying or selling stocks to
benefit other portfolios or individuals. For example, the
secretary overheard the portfolio manager say he was going to
sell GM in the Social Security account. This information would
be worth billions and is just too tempting.
An index fund, if adhered to, strictly prevents the
majority of problems from government interference. It would
also lower conflicts of interest if private firms were hired.
Whether run by a neutral Federal Agency like the Federal
Reserve, or bid out to a private vendor with oversight from a
Federal Reserve type body, there would be little difference in
the outcome with an index fund.
How to Effectively Run the Index
While indexing is straightforward, it requires crucial strategic
decisions
First, you have to choose an index. With this much
invested, you need to try to have as little effect on the
market as possible. The index should be a market capitalization
weighted index like the S&P 500 or Wilshire 5000. This means
that the fund might hold 100 times more of Microsoft than Apple
because of their proportionate weight in the stock market. This
would ensure that the market impact on each individual stock
would be more or less spread equally across the portfolio of
500 to 5000 stocks.
I have argued that the S&P 500 is preferable because it is
more widely used and is more liquid due to an active futures
and options market. The Wilshire 5000 however is more
indicative of the entire stock market in the United States and
causes less disruption when issues are added or removed.
Lessons From Public Plans--Low Fees
Our public retirement review included a detailed review of
the operation of a $3 billion and $1 billion S&P 500 index fund
by two public funds, and a more general review of public
pension plans nationally from our survey results of 41 large
public plans.
A major finding was that index funds charged very low costs
and had excellent performance for the 1, 3 and 5-year periods
ending July 1997. Our reports concluded that both internal and
external management of S&P 500 index funds could be very
inexpensive.
Indeed, outside management fees could actually be negative
for a large S&P 500 index fund, or at least cost-free. One of
the reasons for this is securities lending in which the
underlying stocks are loaned to other investors. While it is
unclear how and if the Social Security Surplus could be subject
to securities lending, it could prove very beneficial. It is
conceivable that private firms would actually pay the
government to have the Social Security assets and make their
money off the security lending. This entire issue would need to
be studied intensely to measure its market impact.
The cost advantages of indexing, however, go down if you
deviate from pure indexing. A Wilshire study of the average
total turnover of the AMA tobacco free indices is greater than
the turnover for pure indices. This results in increased
trading costs for the funds. Wilshire predicted higher trading
costs of $130,000 a year for a $1 billion, S&P 500-index fund.
The higher turnover is a result of the constant realignment of
the tobacco free funds due to the over weighting of industries
resulting from a zero weighting in the tobacco industry.
Public officials, therefore, need to understand the
investment cost they are paying to achieve any moral gain.
Investment restrictions will reduce opportunities for
outperformance for active managers, increase risk for passive
managers, generate one-time excess transactions costs, and
cause measurement problems associated with imperfect
benchmarks.
We have analyzed costs for each of these effects.
Divestment = Tracking Error
Divestment of any kind causes tracking error. For our
report we defined ``Tracking Error'' as the percentage
difference in total return between an index fund and index it
is designed to replicate. Our definition, based on Nobel
Laureate Bill Sharpe's work, holds that even if you beat the
index you still have tracking error. The objective is to
exactly match the market, not to attempt to beat it. Exactly
matching the index lowers the risk of underperforming your
benchmark.
Public Funds have a mixed record in this regard. We found
in our study of Kentucky's two plans that they deviated from a
pure S&P 500 index portfolio. Kentucky Teachers and New York
Teachers sold tobacco stocks in both their active and index
funds. This seemed to be the exception, as New York, Florida
and Minnesota public employees decided on tobacco divestiture
only in their active funds, not in their index funds. Even the
American Medical Association did not sell tobacco stocks from
its index fund.
The Kentucky Retirement system dumped stocks in the S&P 500
that had international headquarters--like Royal Dutch and
Northern Telecom--and for other reasons. Kentucky Retirement
suffered significant tracking error to the index. Kentucky
Teachers, however, despite the divestiture effectively
minimized their tracking error through constant rebalancing,
though they suffered minor error on a daily basis.
We recommend in our report that both Kentucky funds
reinvest in the under-weighted securities represented in the
S&P 500 Index fund to reflect the correct weightings. Our
reasoning was that the index fund needs to function according
to its established investment policy. Our recommendation
concerned the efficiency of running an S&P 500-index fund--not
any social concerns. A pure index fund both reduces fees and
eliminates the risk of underperforming your index.
There have been anecdotal reports of good performance by
socially responsible funds. These reports depend mostly on what
time period you use. Two studies show tobacco divestiture to
have a negative effect on returns. One by Wilshire shows lower
returns over long periods. A study from the Journal of
Investing concludes: ``The current arguments about whether to
limit or prohibit pension fund investments in tobacco stocks,
in contrast to earlier debates about `sin-free' investing,
focus on investment considerations rather than morality. But
tobacco divestiture doesn't stand up as an investment decision.
It doesn't reduce risk in the typical pension fund context, nor
does it constitute a clever active strategy issued from the
legislature. We should see tobacco divestiture for what it is:
a moral decision.''
On balance, the argument for social investing as a long
term positive to performance does not seem to hold up under
careful scrutiny.
Pure Indexing--Social Security Stock Investings Best Chance
The best example from Public Pensions is the pure index
approach. For Social Security stock investing to be accepted,
it needs to go into index funds with no exceptions, no matter
the pressure. If states like New York and California and even
the AMA resist tobacco divestiture in their index funds, so can
Social Security if and only if it is in an index fund.
Our large Public plans have led the way in showing how it
is possible to invest billions in stocks within a Government
framework. Social Security reform should use the best of these
examples when formulating how to invest in the stock market by
using index funds.
Stock investing by Social Security can work with a pure
index approach.
An edited version of this article will appear in the April 1999
edition of Plan Sponsor magazine.
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