[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
A LEGACY TO OUR CHILDREN: UNDERSTANDING INTERGENERATIONAL ECONOMIC
ISSUES
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
HEARING HELD IN WASHINGTON, DC, JULY 27, 2000
__________
Serial No. 106-12
Printed for the use of the Committee on the Budget
----------
U.S. GOVERNMENT PRINTING OFFICE
66-012cc WASHINGTON : 2000
COMMITTEE ON THE BUDGET
JOHN R. KASICH, Ohio, Chairman
SAXBY CHAMBLISS, Georgia, JOHN M. SPRATT, Jr., South
Speaker's Designee Carolina,
CHRISTOPHER SHAYS, Connecticut Ranking Minority Member
WALLY HERGER, California JIM McDERMOTT, Washington,
BOB FRANKS, New Jersey Leadership Designee
NICK SMITH, Michigan LYNN N. RIVERS, Michigan
JIM NUSSLE, Iowa BENNIE G. THOMPSON, Mississippi
PETER HOEKSTRA, Michigan DAVID MINGE, Minnesota
GEORGE P. RADANOVICH, California KEN BENTSEN, Texas
CHARLES F. BASS, New Hampshire JIM DAVIS, Florida
GIL GUTKNECHT, Minnesota ROBERT A. WEYGAND, Rhode Island
VAN HILLEARY, Tennessee EVA M. CLAYTON, North Carolina
JOHN E. SUNUNU, New Hampshire DAVID E. PRICE, North Carolina
JOSEPH PITTS, Pennsylvania EDWARD J. MARKEY, Massachusetts
JOE KNOLLENBERG, Michigan GERALD D. KLECZKA, Wisconsin
MAC THORNBERRY, Texas BOB CLEMENT, Tennessee
JIM RYUN, Kansas JAMES P. MORAN, Virginia
MAC COLLINS, Georgia DARLENE HOOLEY, Oregon
ZACH WAMP, Tennessee KEN LUCAS, Kentucky
MARK GREEN, Wisconsin RUSH D. HOLT, New Jersey
ERNIE FLETCHER, Kentucky JOSEPH M. HOEFFEL III,
GARY MILLER, California Pennsylvania
PAUL RYAN, Wisconsin TAMMY BALDWIN, Wisconsin
PAT TOOMEY, Pennsylvania
Professional Staff
Wayne T. Struble, Staff Director
Thomas S. Kahn, Minority Staff Director and Chief Counsel
C O N T E N T S
Page
Hearing held in Washington, DC, July 27, 2000.................... 1
Statement of:
Dan L. Crippen, Director, Congressional Budget Office........ 2
Hon. Pete du Pont, former Governor, State of Delaware........ 22
Hon. Tim Penny, former Minnesota Member, U.S. House of
Representatives............................................ 26
Henry J. Aaron, Senior Fellow, the Brookings Institution..... 33
Hon. J. Robert Kerrey, a United States Senator from the State
of Nebraska................................................ 59
Alicia H. Munnell, Professor of Management Studies, Boston
College.................................................... 80
Laurence J. Kotlikoff, Professor of Economics, Boston
University................................................. 89
Prepared statement of:
Mr. Crippen.................................................. 8
Governor du Pont............................................. 24
Mr. Penny.................................................... 30
Mr. Aaron.................................................... 37
Senator Kerrey............................................... 66
Ms. Munnell.................................................. 83
Mr. Kotlikoff................................................ 91
A Legacy to Our Children: Understanding Intergenerational Economic
Issues
----------
THURSDAY, JULY 27, 2000
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to notice, at 10:02 a.m., in
room 210, Cannon House Office Building, Hon. John R. Kasich
(chairman of the committee) presiding.
Members present: Representatives Kasich, Chambliss, Smith
of Michigan, Hoekstra, Gutknecht, Sununu, Knollenberg,
Fletcher, Price, Moran, Lucas, Holt, and Baldwin.
Chairman Kasich. Let us go ahead and get started. The
purpose of this hearing is to focus on how the Federal
Government distributes resources among the generations.
Understanding our current situation is the first step in
setting priorities for the future, Mr. Crippen.
Two of the biggest programs affecting both the current and
future generations, obviously, are Social Security and
Medicare.
The programs have, without question, dramatically improved
the lives of our Nation's seniors, providing real retirement
security for nearly 40 million Americans and helping to lift
seniors out of poverty. But, of course, it has come at a very
high cost. Today, the Federal Government spends $7 on seniors
for every $1 on children. It is a very interesting statistic.
In other words, for every dollar we spend on kids today, we
spend $7 on senior citizens.
Over the next 75 years, benefits paid out will exceed
payroll taxes and premiums coming into these programs by
dramatic amounts. And the numbers are really almost too hard to
appreciate. Social Security will be in the hole by $133
trillion. Medicare A and Medicare Part B will be in the hole by
about $204 trillion. That adds up to a $337-trillion shortfall.
These costs will impose a huge burden on future generations,
and eliminating these cash shortfalls would require increasing
payroll taxes by two-thirds over the next 30 years. Why is it
happening? Part of the reason, demographics. The baby boomers
will start retiring in about 10 years, and the ratio of workers
to beneficiaries will fall.
In 1960, there were five workers paying for each Social
Security beneficiary. Today, the ratio is 3.4 to 1, and in 30
years it will be 2 to 1. In addition, spending per beneficiary
in these programs is growing faster than the rate of inflation.
There are, obviously, proposals to address this issue. I have
one. Congressmen Kolbe and Stenholm, Kerrey, Breaux-Thomas for
Medicare, all of these folks have weighed into this issue. But
all of the proposals require that we act sooner, rather than
later. The latest figure shows a $4.6-trillion budget surplus
over the next 10 years, and it is an historic opportunity. The
question is can we leverage these surpluses to develop the
kinds of reforms that will make these programs stronger and
better for the future?
I suppose when you take a look at these kinds of numbers,
$337 trillion worth of shortfall, it is pretty hard for anybody
to even begin to consider them. I think it is important we
begin to look at this. Because if we don't get started sooner,
the problems get even more devastating later, and it gives us
an opportunity to get started on them.
So, Dan, we have a vote on the floor. I am thinking maybe,
we have got so many committees marking up today, but I don't
really want to have you--I want to make sure we vote, and come
right back and hear from you, whatever members we can get back
here. And why don't we just take a break right now because I
want to hear all of the testimony. And I also would, on the
record, like to extend my deepest sympathies to you and to your
family over the loss of your wife. But we are glad you are back
on the Hill. I just want to tell you that publicly. Thanks for
being back, Dan.
We will just recess, and vote and return.
[Recess.]
Chairman Kasich. OK. Let us get started.
STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET
OFFICE
Mr. Crippen. Thank you, Mr. Chairman, Mr. Spratt, members
of the committee.
Let me begin by recognizing the difficult schedule we have
today and the more limited time of some of your panelists. I am
available all day, so please feel free to interrupt me if it
proves convenient for the committee or for other witnesses.
Mr. Chairman, I take as one of CBO's roles assisting in
getting the questions right. That is not to say that CBO is
always right or even that it always has an answer. But I
suggest, Mr. Chairman, it would be rare to obtain the right
answer when positing the wrong question.
I believe there is a growing consensus among economists on
the appropriate questions concerning programs that span
generations, specifically Federal programs that support
retirees. But before I present what I believe to be the right
questions, I want to state what I believe to be the wrong
question, namely, the status or solvency of trust funds. This
hearing was billed as considering the sustainability of
Government entitlement programs. Mr. Chairman, balances in
trust funds by themselves have nothing to do with
sustainability. We mislead and confuse ourselves and others
when we cite improvements in solvency as improvements in our
collective ability to pay obligations in the future.
Unfortunately, the confusion is widespread. This poster is
representative of----
Chairman Kasich. Mr. Crippen, would you say that in
English. I understood what you meant, but there isn't anybody
else in the room, except for Kotlikoff back there that
understood what you just said. Say it in plain terms, would
you?
Mr. Crippen. Well, I'll be as plain as I can be. Trust
funds don't matter for the issue of sustainability. They are an
accounting mechanism, and I will cite others who believe that
and say other words that may make it clearer than I can. But
the balance in the trust funds has little to do with our
ability to pay future obligations.
Chairman Kasich. I think that was pretty clear there.
Mr. Crippen. As I said, this poster just shows you the
reporting after the last Trustees report. The reporters equated
solvency, or increased trust fund balances, with a rosier
future. It may turn out to be true, but not for any of the
reasons cited in these articles, save one, and I will get to
that in a minute.
Let me give one example of the potential danger in our
accounting, and then, by contrast, pose what I believe to be
the more relevant questions. Sometime in the not-too-distant
future, around 2015, Social Security expenditures will exceed
payroll taxes. At that point, general funds, in the form of
interest credited to the trust funds, will be drawn down to pay
benefits. Later on, U.S. Government debt credited to the Social
Security trust funds will be redeemed for cash to cover any
shortfall.
But all of that raises the question, how does the cash get
generated to cover benefits in excess of payroll taxes? It must
come from the rest of Government and taxpayers by cutting other
programs, increasing borrowing or raising taxes--the same
result as if there were no bonds credited to the funds or,
indeed, if there were no trust funds at all.
I repeat, the economic and budgetary result is the same
with or without trust funds. As the President said in his
fiscal year 2000 budget: ``* * * the trust fund balances are
claims on the Treasury that, when redeemed, will have to be
financed by raising taxes, borrowing from the public, or
reducing benefits. The existence of large trust fund balances,
therefore, does not by itself have any impact on the
Government's ability to pay benefits.'' That point, Mr.
Chairman, is not well-understood.
So if the trust funds are inappropriate for answering
questions about sustainability, what is appropriate? I would
argue, as have others I will cite this morning, that the size
of the economy and the amount of those resources consumed by
the elderly are most relevant to the issue of sustainability.
Clearly, there are other very legitimate questions,
particularly about distribution of the benefits, that this
analysis does not address; rather, this approach analyzes the
overall funding. As such, it would apply to virtually any
distribution of the benefits you choose.
In the end, Mr. Chairman, it is the economy that acts as
our intergenerational trust fund, not just for Social Security,
but for all other transfer payments to retirees. It is largely
the resources produced after we retire that we will be
consuming in Federal benefits--mostly resources produced by our
children and transferred to us to satisfy our claims.
Before the committee supposes that I have jumped off an
ideological cliff, let me assure you that this is not a fringe
notion, nor does it favor one kind of reform over another. It
simply states that the size of the economy defines and
constrains our ability to pay beneficiaries.
Dr. Alice Rivlin, in a speech last year on this topic said,
and I quote, ``I believe, however, that focusing too narrowly
on the Social Security funding question, in isolation from the
more fundamental economic challenge of an aging population,
risks muddling the problem and perhaps picking a wrong
answer.''
``In any given future year,'' she went on to say, ``say,
2050, a larger proportion of older people will be competing
with the workforce and the rest of the population for shares of
GDP in that year. Whatever is produced in 2050 will have to
suffice for all claimants. Societies cannot consume more than
they produce for long, nor can consumer goods feasibly be
stockpiled.''
Dr. Rivlin went on to say that the most important and
urgent question--I would argue, Mr. Chairman, the right
question--is, and I again quote, ``What can we do now to
increase future GDP so that there are more goods and services
to be distributed among the claimants in future years?''
She went on to say, ``Some solutions contribute to higher
growth and some do not. It is important to choose a pro-growth
solution and choose it soon.''
Similarly, Alan Blinder and Frank Newman, in an op-ed
article in the Wall Street Journal earlier this year said,
``Unlike pension funds, Social Security does not own
independent assets that can be sold. Rather, retired Americans
can consume more of our gross domestic product only if other
segments of society, including working people and children,
consume less. And the harsh reality is that the workforce of
the future will have to support a larger number of retirees.
Just how heavy that burden will be depends on several factors,
including the level of retirement benefits and the rate of
population growth. But one factor stands out particularly
important, the rate of productivity growth.''
Again, that was Alan Blinder and Frank Newman earlier this
year in the Wall Street Journal.
Thankfully, there is, I believe, one calculation that takes
those factors into account: the percent of the economy devoted
to Federal spending for the elderly. The numerator is obviously
obligations to retirees, as defined by existing law, and the
denominator is the size of the economy, the result of both the
size of the workforce and its productivity.
These next two charts, one the record for the last 30 years
and one our projections for the next 30, plot the portion of
the economy dedicated to Federal spending on the elderly. We
have also added to both charts the actual and projected amounts
of total Federal revenues as a percent of GDP.
Chairman Kasich. I just want everybody in the room to know,
particularly my colleagues on the Democratic side, I didn't
want to have this hearing today for any purpose that was
related to politics. I just want everybody to take a look at
these numbers, and we are going to have other people that are
probably going to have other points of view. But the purpose of
this is really, I think my party, in a large way is as unable
to deal with these as the other party. And in some respects, I
feel like I am back in 1989 again saying we need to balance the
budget. Now I don't think I would say that, but I want to warn
about this--frankly, this problem is as serious or more than
what we faced 10 years ago. So I just would like everybody to
be able to kind of see these charts.
Go ahead, Dan. I am sorry.
Mr. Crippen. The next two charts show the record of the
past 30 years and our projections for the next 30 years. As I
said, we have added the revenue projections as a percent of GDP
as well, just to be illustrative.
For the past 30 years, this measure has been creeping up,
largely because of increased costs of Medicare and because of
growing numbers of retirees. Thus, because the ratio grew,
costs were shifted from the elderly to the working population--
the burden on the workforce increased.
Over the next 30 years, the portion of the economy
dedicated to Federal programs for the elderly will virtually
double from 7 percent to 14 percent. A substantial part of the
increase is due, Mr. Chairman, as you already said, to the
increase in the retired population--the baby boomers--with
little growth in the underlying workforce.
A large portion of the increase is also due to ever-
increasing Medicare costs for each retiree. The result is that
the burden on the workforce and future generations will rise
dramatically. Put another way, as we have talked before, to
eliminate the shift of burdens to the future, my generation,
essentially, needs to pay twice--once for our parents and once
for ourselves.
We are currently contributing more than our parents
require--hence, the Social Security surpluses.
In order for that surplus to contribute to future funding
of these programs, it must, I repeat, must add to national
savings. Simply running a surplus in the Social Security trust
funds or otherwise adding to the trust fund balances does
nothing to aid future financing, does nothing to grow the
economy. That is why trust fund accounting, by itself, has
nothing to do with the ability to meet future obligations. But
saving Social Security surpluses by running total budget
surpluses of the same amount or more should enhance economic
growth and make future benefits more affordable.
The calculation of spending on the elderly as a percent of
GDP illustrates the policy dilemma.
There are only two moving parts--the level of benefits and
the size of the economy. If you want to change this outlook,
say, to lower future burdens, the economy needs to grow faster
or benefits need to grow more slowly, neither of which is
directly related to solvency or trust fund balances.
But assume, for a moment, that these charts are about
right; what are the implications of our projections for
spending on the elderly? With revenues at a constant 20-plus
percent of GDP, programs for the elderly will eventually
consume much of the Federal budget, leaving little room for
anything else. I should note Federal revenues have averaged
under 18 percent of GDP for the last 55 years, and the current
level is near the historic high of 20.9 percent, reached in
1944.
How can we reduce future burdens? We need to increase
productivity, and one way to do it is to save more as a Nation.
As our grandparents and parents told us, forgoing consumption
today and saving instead will make us better off in the future
by enhancing productivity. There may be other policies that
enhance productivity. We could also expand our workforce by
changing immigration policy. In short, Mr. Chairman, we need to
exhibit behavior and pursue Government policies that will grow
the economy.
Can we grow our way out of this problem? Not within the
construct of current programs. Social Security is pegged to
replacing a portion of real wages, so as the economy grows, so
will future Social Security obligations, although there is a
significant lag that would improve this picture. Likewise,
Medicare, as currently structured, will likely increase even
more rapidly than the economy. But make no mistake, a growing
economy will make it easier for our kids to support us in
retirement, as Blinder and Newman observed.
If we can't grow all the way out of the problem, we--
meaning my generation--would have to accept some reduction in
our benefits to ease the burden on future generations. For
example, as you have proposed, Mr. Chairman, if in calculating
an individual's Social Security benefits, the current
indexation for real wages were changed to indexation for
consumer prices, the growth in average benefits would be less
than the growth in the economy. That would restrain the growth
of the ratio on the second chart considerably. Obviously, the
policy implication of such a change is the conversion of some
notion of wage replacement to one of preservation of purchasing
power--retirees would be guaranteed some level of consumption.
Mr. Chairman, let me quickly summarize what I've tried to
present here today:
First, I want to note that it is my generation, my kids,
and my grandkids, not my parents, who would be affected by
anything I have discussed today.
Second, the existence of trust funds, and whatever balances
might be in them, are largely irrelevant to the country's
ability to pay future obligations. That is not to say the
financing of the program, the current excess of taxes over
expenditures, is irrelevant, but those surpluses are a result
of the operation of the program and the operation of the rest
of the Government, not a result of the existence of trust
funds. Rather, the most important factor is economic growth--
the future size of the economy. Unless we begin to recognize
this, as Dr. Rivlin said, we are likely to take actions that
will make the outlook worse, not better.
Mr. Chairman, if we don't have the right question, we are
unlikely to get the right answer.
Thank you.
[The prepared statement of Dan Crippen follows:]
Prepared Statement of Dan L. Crippen, Director, Congressional Budget
Office
Mr. Chairman, Congressman Spratt, and members of the committee, I
appreciate this opportunity to appear before you today to discuss the
budgetary implications of an aging population.
My testimony focuses on several major themes:
Financing the nation's current promises to the elderly
will require a major reallocation of society's resources once the baby-
boom generation has retired.
A strong and growing economy will make fulfilling pledges
to Social Security and Medicare recipients easier, but it is not the
entire solution.
Although government trust funds arguably have some value
as an accounting mechanism, their projected solvency does not by itself
ensure that economic resources are available to cover program costs.
the current outlook
Earlier this month, the Congressional Budget Office (CBO) projected
that under current policies, the Federal Government would accumulate
total surpluses of about $4.6 trillion to $5.8 trillion over the next
10 years (see Table 1). The off-budget surpluses, which are basically
the Social Security surpluses, total $2.4 trillion over the decade; the
on-budget surpluses amount to $2.2 trillion to $3.4 trillion, depending
on the assumptions about discretionary spending. Two important caveats
apply to those projections:
Demographic and economic forces already in place are
expected to erode the surpluses, renewing the Federal Government's
fiscal imbalance of previous years. According to CBO's long-term budget
projections published in December 1999, Federal deficits will return in
about three decades under current policies and eventually cause the
Federal debt and its corresponding interest costs to escalate as a
percentage of national income.
Deficits will reappear earlier if the government spends
more or taxes less than CBO projects under current policies.
Significant pressures are already building to cut taxes, increase
Medicare spending, and boost discretionary spending.
TABLE 1.--THE BUDGET OUTLOOK UNDER CURRENT POLICIES
[By fiscal year, in billions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Actual Total, Total,
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001-2005 2001-2010
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Discretionary Spending Grows at the Rate of Inflation After 2000 \1\
On-Budget Surplus............................................. 1 84 102 126 143 154 169 222 260 288 332 377 695 2,173
Off-Budget Surplus............................................ 124 149 165 186 202 215 232 247 263 278 293 307 1,001 2,388
---------------------------------------------------------------------------------------------------------------------------------
Total Surplus............................................. 124 232 268 312 345 369 402 469 523 565 625 685 1,696 4,561
Total Surplus as a Percentage of GDP.......................... 1.4 2.4 2.6 2.9 3.0 3.1 3.2 3.6 3.9 4.0 4.2 4.4 n.a. n.a.
Discretionary Spending Is Frozen at the Level Enacted for 2000 \1\
On-Budget Surplus............................................. 1 84 116 157 195 231 270 346 410 466 541 618 969 3,349
Off-Budget Surplus............................................ 124 149 166 187 202 216 233 248 263 279 294 309 1,003 2,395
---------------------------------------------------------------------------------------------------------------------------------
Total Surplus............................................. 124 232 281 344 397 447 503 594 673 745 834 927 1,971 5,744
Total Surplus as a Percentage of GDP.......................... 1.4 2.4 2.7 3.2 3.5 3.8 4.1 4.6 5.0 5.3 5.6 6.0 n.a. n.a.
Discretionary Spending Equals CBO's Estimates of the Statutory Caps Through 2002 and Grows at the Rate of Inflation Thereafter
On-Budget Surplus............................................. 1 84 163 219 245 263 290 348 393 433 488 545 1,179 3,387
Off-Budget Surplus............................................ 124 149 165 186 202 215 232 247 263 278 293 307 1,001 2,388
---------------------------------------------------------------------------------------------------------------------------------
Total Surplus............................................. 124 232 329 405 446 478 522 595 655 711 781 853 2,180 5,774
Total Surplus as a Percentage of GDP...................... 1.4 2.4 3.2 3.7 3.9 4.0 4.2 4.6 4.8 5.0 5.3 5.5 n.a. n.a.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
SOURCE: Congressional Budget Office.
NOTE: n.a. = not applicable.
\1\ After adjustment for advance appropriations.
The projected long-range fiscal shortfall is associated with three
phenomena: the aging and eventual retirement of the baby-boom
generation; increased life expectancy, which will lengthen the time
people spend in retirement; and escalating per capita medical costs.
Under the intermediate assumptions of the Social Security trustees,
from 2000 to 2030 the number of elderly people in the United States
will nearly double while the number of people ages 20 to 64 will grow
by about 16 percent.
With demographic trends such as those, Federal programs for the
elderly will consume sharply increasing shares of national income and
the Federal budget. According to the Social Security and Medicare
trustees, spending for Social Security and Medicare as a percentage of
gross domestic product (GDP) will rise from about 6.5 percent in 2000
to almost 11 percent in 2030. Using similar projections, CBO expects
that in 2030, those programs will constitute more than half of total
Federal spending excluding interest, compared with 39 percent in 1999.
In addition, the Medicaid program will experience severe budgetary
pressures in meeting the needs that low-income elderly people will have
for long-term care.
But those projections, as unfavorable as they may seem, may be too
optimistic for at least two reasons. First, the Medicare trustees'
projections assume that the growth rate of Medicare costs per enrollee
will gradually slow to equal the growth of average wages. No policy
currently in place would accomplish that end, and little historical
evidence would suggest that the slowdown could occur on its own. When
CBO updates its long-range projections, the middle-cost assumption will
be that costs per enrollee will continue to climb more quickly than
wages. Moreover, pressures are growing to increase Medicare spending
through a new prescription drug benefit, increased payment rates for
providers, or both. For example (as shown in Table 2), in the Mid-
Session Review, the President has proposed specific initiatives in
those areas, which CBO estimates would cost $427 billion in direct
spending over the next 10 years, with Medicare alone accounting for
three-quarters of that. (The President also has proposed to move
Medicare's Hospital Insurance Trust Fund off-budget, which I will
address later in this statement.)
Second, the intermediate assumptions about demographic and economic
trends could prove to be too favorable. Under the high-cost assumptions
of the Medicare trustees and the assumption that Supplementary Medical
Insurance spending equals the same proportion of Hospital Insurance
outlays as projected under the intermediate assumptions, Social
Security and Medicare outlays would exceed 15 percent of GDP in 2030.
TABLE 2.--ESTIMATED EFFECT ON DIRECT SPENDING OF CHANGES IN THE
PRESIDENT'S HEALTH INSURANCE PROPOSALS
[Billions of dollars]
------------------------------------------------------------------------
10-year cost
------------------------------------------------------------------------
Medicare
CBO's Estimate of February Proposals \1\............ $67.3
Changes in Mid-Session Review:
Expand prescription drug benefit \2\............ 167.6
Drop policies to reduce payment rates........... 34.9
Add policies to increase payment rates.......... 40.5
CBO's Estimate of Mid-Session Review Proposals...... 310.4
Medicaid and SCHIP
CBO's Estimate of February Proposals \1\............ 98.2
Changes in Mid-Session Review:
Expand prescription drug benefit \2\............ 14.6
Other changes and interactions \3\.............. 3.6
CBO's Estimate of Mid-Session Review Proposals...... 116.4
Total (Medicare, Medicaid, and SCHIP)
CBO's Estimate of February Proposals \1\............ 165.6
Changes in Mid-Session Review:
Expand prescription drug benefit \2\............ 182.2
All other changes............................... 79.0
CBO's Estimate of Mid-Session Review Proposals...... 426.8
------------------------------------------------------------------------
SOURCE: Congressional Budget Office.
NOTE: SCHIP = State Children's Health Insurance Program.
\1\ CBO's estimate of the February budget proposals reflects the
estimate of the Medicare prescription drug benefit as revised in
testimony presented before the Subcommittee on Health of the House
Committee on Ways and Means on May 11, 2000.
\2\ Consistent with the estimates in the Administration's Mid-Session
Review, this estimate assumes that subsidies for low-income
beneficiaries will cover all of their costs each year in excess of the
initial coverage limit but less than the annual out-of-pocket cap. If
the President's proposal does not include coverage of those costs, CBO
estimates that the change in direct-spending outlays from expanding
the prescription drug benefit would be $163.3 billion over 10 years
for Medicare, $1.5 billion for Medicaid, and $164.8 billion in total.
CBO has made minor technical changes to its estimating methods since
preparing estimates of the February budget proposals. Those changes
account for a very small portion of the estimated cost of expanding
the prescription drug benefit.
\3\ Includes the effects of dropping the school lunch initiative
(because it was enacted), freezing allotments for disproportionate
share hospitals, and interactions with Medicare provisions and with a
proposal to change rules regarding the treatment of income for
veterans in nursing homes.
Some analysts have argued that focusing on the resources directed
toward the elderly ignores an important offsetting factor--the drop in
children's share of the population. That is, while the elderly
population is projected to climb from 12.4 percent of the total
population to 19.7 percent over the next 30 years, the portion
represented by children will fall from 28.6 percent to 24.7 percent.
The combined share for the two groups will change only from 41 percent
to 44 percent. But for the outlook for the Federal budget, the combined
share is misleading because Federal spending for an elderly person is
roughly seven to eight and one-half times that for a child. Although
state and local governments spend much more on children than on the
elderly, that support is at a much lower level than Federal spending
for the elderly (see Tables 3, 4, and 5).
Today's children are the taxpayers of the future, so they will be
the ones called upon to pay for the increasing portion of the Federal
budget that will be devoted to programs for the elderly. However,
significant wage growth is assumed in most projections, so today's
children will be more affluent and may be able and willing to share an
increasing portion of their income with the generations that preceded
them.
preparing for the future
The resources required to finance the government's obligations are
drawn from the overall economy when the obligations are liquidated.
That is, in 2030, as in any year, pledges to the elderly as well as
other Federal priorities--such as national defense, assistance to State
and local education agencies, public health services, and
transportation projects--will require the government to draw on
economic resources available at that time. Whether a program receives
earmarked revenues and is accounted for through a government trust fund
or relies upon annual appropriations does not alter that fact. Whatever
the Federal Government is required to spend, it must acquire those
resources through taxes, borrowing, sales of assets, or some
combination of those.
TABLE 3.--ESTIMATED FEDERAL SPENDING FOR THE ELDERLY UNDER SELECTED PROGRAMS, 1971-2010
[By fiscal year, in billions of dollars]
----------------------------------------------------------------------------------------------------------------
Projected
1971 1980 1990 2000 2010
----------------------------------------------------------------------------------------------------------------
Mandatory Programs
Social Security \1\.............................................. 29 85 196 307 471
Federal Civilian Retirement...................................... 2 8 21 33 50
Military Retirement.............................................. 1 2 7 14 21
Annuitants' Health Benefits...................................... (\3\) 1 2 4 9
Special Benefits for Coal Miners and Black Lung.................. (\3\) 1 1 1 1
Supplemental Security Income..................................... 1 2 4 6 10
Veterans' Compensation and Pensions.............................. 1 4 7 9 14
Medicare......................................................... 8 29 96 189 377
Medicaid......................................................... 2 5 14 33 73
Food Stamps \2\.................................................. (\3\) 1 1 1 1
----------------------------------------------
Total...................................................... 44 137 349 597 1,026
Discretionary Programs
Housing.......................................................... (\3\) 2 4 7 10
Veterans' Medical Care........................................... 1 3 6 9 13
Administration on Aging Programs................................. (\3\) 1 1 1 1
Low Income Home Energy Assistance Program........................ n.a. (\3\) (\3\) (\3\) 1
----------------------------------------------
Total...................................................... 1 6 11 18 24
Total
All Federal Spending on People 65 and Over....................... 46 144 360 615 1,050
Memorandum:
Federal Spending on People 65 and Over
As a percentage of the budget................................ 21.7 24.3 28.7 34.8 42.8
As a percentage of gross domestic product.................... 4.2 5.3 6.3 6.4 7.1
Per elderly person (In 2000 dollars)......................... 8,896 11,839 15,192 17,688 21,122
----------------------------------------------------------------------------------------------------------------
SOURCE: Congressional Budget Office.
\1\ Includes Tier 1 of Railroad Retirement.
\2\ Includes the Federal share of states' administrative costs and nutrition assistance to Puerto Rico.
\3\ Less than $500 million; n.a. = not applicable.
One way to prepare for the budgetary pressures expected in the 21st
century would be to save more as a nation. By implementing policies
that promote capital accumulation, the nation could boost both its
productive capacity and its wealth and essentially help prefund future
consumption. But adding to the supply of capital requires less current
consumption in exchange for more national saving and investment. One
approach to increasing national saving is for the Federal Government to
run annual budget surpluses, so long as the policies creating the
surpluses do not come at the expense of private saving. Strategies to
encourage private saving might also help pay for future consumption.
Economic growth would expand the capacity to fund future Social
Security benefits and other Federal commitments, and a larger economy
could ease the transfer of additional resources to retirees. Strong
growth swells revenues, which, if used for debt reduction, would reduce
interest costs and improve the overall outlook for government budgets.
Yet despite those benefits, growth will not eliminate the imbalances of
the current Social Security program. The reason is that economic growth
generally increases real (adjusted for inflation) wages, and under the
current benefit formula, higher wages subsequently translate into
higher Social Security benefits, although with a substantial lag.
Therefore, although the nation might be wealthier, it would still face
a sharp increase in the budgetary resources necessary to pay for the
Social Security and health care costs of the baby-boom generation
during retirement.
The sharp rise in the share of national income directed toward
programs for the elderly could be mitigated directly by curtailing
promised benefits. If the benefits provided to the elderly are to be
reduced relative to those promised under current law, it is desirable
that such changes be announced well in advance so that people who will
be affected can change their plans accordingly.
government trust fund accounting
Some analysts suggest that government trust fund programs offer a
mechanism for accumulating public savings. They point to the Social
Security trust funds as an example. However, government trust fund
accounting often can be misleading. Simply because surpluses are
recorded in a particular government account does not necessarily mean
that the government is actually contributing to national savings. The
overall budget deficit or surplus better indicates the Federal
Government's potential contribution to savings.
TABLE 4.--FEDERAL SPENDING FOR CHILDREN UNDER SELECTED PROGRAMS IN 2000
AND 2010
[By fiscal year, in billions of dollars]
------------------------------------------------------------------------
Estimated Projected
2000 2010
------------------------------------------------------------------------
Mandatory Programs
Medicaid...................................... 23 52
Family Support \1\............................ 16 21
Earned Income Tax Credit (Outlay portion only) 14 17
Social Security and Railroad Retirement....... 13 20
Child Nutrition............................... 9 14
Food Stamps................................... 9 13
Foster Care and Adoption Assistance........... 5 10
Supplemental Security Income.................. 5 10
State Children's Health Insurance Program..... 2 5
Social Services Block Grant................... 1 1
Child Tax Credit (Outlay portion only)........ 1 (\2\)
Medicare...................................... (\2\) (\2\)
Total................................... 99 163
Discretionary Programs
Elementary and Secondary Education............ 20 27
Housing Assistance \3\........................ 10 14
Other Health and Human Development Programs 9 12
\4\..........................................
Nutrition Programs \5\........................ 4 5
Community Services, Development, and Other 2 3
Block Grants.................................
Youth Employment and Training \6\............. 2 3
Low Income Home Energy Assistance Program..... 1 1
Department of the Interior (Indian Affairs) 1 1
\7\..........................................
Juvenile Justice.............................. (\2\) 1
Refugee and Entrant Assistance................ (\2\) (\2\)
Other......................................... (\2\) (\2\)
Total................................... 50 66
Total
All Federal Spending on Children.............. 148 229
Memorandum:
Federal Spending on Children
As a percentage of the budget............. 8.4 9.4
As a percentage of the gross domestic 1.5 1.5
product..................................
Per child (In 2000 dollars)............... 2,106 2,541
------------------------------------------------------------------------
SOURCE: Congressional Budget Office.
\1\ Family support programs include Temporary Assistance for Needy
Families, Family Support, Emergency Assistance, Child Care
Entitlements to States, Children's Research and Technical Assistance,
and Child Support Enforcement.
\2\ Less than $500 million. These numbers do not include payments to
adults, even when adults receive the payments because of the presence
of children.
\3\ Includes Federal assisted-housing dollars based on data from the
American Housing Survey. Housing assistance includes low-rent public
and Indian housing, Section 8 low-income housing aid, Section 236
interest-reduction payments, Section 101 rent supplements, and Section
235 homeownership assistance.
\4\ Includes services provided to children by community and migrant
health centers; some programs of the Centers for Disease Control and
Prevention and the Substance Abuse and Mental Health Services
Administration, such as immunization programs and programs for
children with serious emotional disturbances; spending on the National
Institute on Child Development; services for children through the
Indian Health Service, and various programs and aid administered
through the Department of Health and Human Services, including Healthy
Start, perinatal facilities, pediatric emergency medical service, Ryan
White Title IIIB and IV programs, family planning, child welfare and
child abuse programs, programs for runaway and homeless youth,
programs involving children with developmental disabilities, and Head
Start.
\5\ Includes the Special Supplemental Nutrition Program for Women,
Infants, and Children; the Commodity Supplemental Food Program; food
aid provided by the Federal Emergency Management Agency; and the
Emergency Food Assistance Program.
\6\ Includes Job Training Partnership Act programs such as youth
training grants, youth opportunity grants, and Job Corps.
\7\ Includes services to Indian children, the elderly, and families;
Indian housing assistance; Indian Affairs schools; and other
educational services funded through the Department of the Interior for
the Bureau of Indian Affairs.
TABLE 5.--FEDERAL SPENDING ON CHILDREN AND THEIR PARENTS UNDER SELECTED
PROGRAMS IN 2000 AND 2010
[By fiscal year, in billions of dollars]
------------------------------------------------------------------------
Estimated Projected
2000 2010
------------------------------------------------------------------------
Mandatory Programs
Medicaid...................................... 31 69
Family Support \1\............................ 23 29
Earned Income Tax Credit (Outlay portion only) 25 30
Social Security and Railroad Retirement....... 15 22
Child Nutrition............................... 9 14
Food Stamps................................... 9 13
Foster Care and Adoption Assistance........... 5 10
Supplemental Security Income.................. 5 10
State Children's Health Insurance Program..... 2 5
Social Services Block Grant................... 1 1
Child Tax Credit (Outlay portion only)........ 1 (\2\)
Medicare...................................... (\2\) (\2\)
Total................................... 126 203
Discretionary Programs
Elementary and Secondary Education............ 20 27
Housing Assistance \3\........................ 10 14
Other Health and Human Development Programs 9 12
\4\..........................................
Nutrition Programs \5\........................ 4 5
Community Services, Development, and Other 2 3
Block Grants.................................
Youth Employment and Training \6\............. 2 3
Low Income Home Energy Assistance Program..... 1 1
Department of the Interior (Indian Affairs) 1 1
\7\..........................................
Juvenile Justice.............................. (\2\) 1
Refugee and Entrant Assistance................ (\2\) (\2\)
Other......................................... (\2\) (\2\)
Total................................... 50 66
Total
All Federal Spending on Children and Their 175 269
Parents......................................
Memorandum:
Federal Spending on Children and Their
Parents:
As a percentage of the budget................. 9.9 11.0
As a percentage of the gross domestic product. 1.8 1.8
Per child (In 2000 dollars)................... 2,491 2,986
------------------------------------------------------------------------
SOURCE: Congressional Budget Office.
\1\ Family support programs include Temporary Assistance for Needy
Families, Family Support, Emergency Assistance, Child Care
Entitlements to States, Children's Research and Technical Assistance,
and Child Support Enforcement.
\2\ Less than $0.5 billion. These numbers include payments to adults
when adults receive the payments because of the presence of children.
\3\ Includes Federal assisted-housing dollars based on data from the
American Housing Survey. Housing assistance includes low-rent public
and Indian housing, Section 8 low-income housing aid, Section 236
interest-reduction payments, Section 101 rent supplements, and Section
235 homeownership assistance.
\4\ Includes services provided to children by community and migrant
health centers; some programs of the Centers for Disease Control and
Prevention and the Substance Abuse and Mental Health Services
Administration, such as immunization programs and programs for
children with serious emotional disturbances; spending on the National
Institute on Child Development; services for children through the
Indian Health Service; and various programs and aid administered
through the Department of Health and Human Services, including Healthy
Start, perinatal facilities, pediatric emergency medical service, Ryan
White Title IIIB and IV programs, family planning, child welfare and
child abuse programs, programs for runaway and homeless youth,
programs involving children with developmental disabilities, and Head
Start.
\5\ Includes the Special Supplemental Nutrition Program for Women,
Infants, and Children; the Commodity Supplemental Food Program; food
aid provided by the Federal Emergency Management Agency; and the
Emergency Food Assistance Program.
\6\ Includes Job Training Partnership Act programs such as youth
training grants, youth opportunity grants, and Job Corps.
\7\ Includes services to children, the elderly, and families; Indian
Housing assistance; Indian Affairs schools; and other educational
services funded through the Department of the Interior for the Bureau
of Indian Affairs.
The Federal budget contains more than 150 trust funds. They vary
widely in size and purpose, but the best known ones fall into two
categories: major benefit programs (such as Social Security, Medicare,
unemployment insurance, and retirement programs for Federal employees)
and infrastructure programs (notably, the Highway and the Airport and
Airway Trust Funds). The Federal Government's trust funds, including
those for Social Security, are not trust funds in the same sense as
private trust funds but rather are accounting mechanisms. They record
the income from earmarked taxes and transfers from the general fund;
spending for benefit payments, purchases, grants, and administrative
expenses; and the interest that accrues on the difference. Private
trust funds such as pension plans, by contrast, preserve assets for
future use. Government trust funds do not necessarily do that because
surpluses in a trust fund may be offset by higher spending or lower
taxes elsewhere in the budget. Moreover, even the nature of the
government's trust funds is different since the Federal Government can
unilaterally establish the terms for benefits and contributions.
Simply stated, the government has a deficit when it spends more
money than it takes in and a surplus when the reverse is true. Any
change that affects outlays or revenues, regardless of whether it
concerns trust fund or Federal fund activities, alters the measured
deficit or surplus and therefore the potential contribution to national
savings. Nevertheless, people often attempt to portray the true deficit
or surplus as excluding trust funds. Such attempts ignore the fact that
trust fund revenues and outlays are an integral part of the Federal
Government's tax and spending policy and the fact that decisions
affecting trust funds generally are not made in isolation. They also
overlook the extent to which trust fund surpluses reflect the effects
of transfers within the budget rather than genuine surpluses of
earmarked taxes over spending.
From 1983 to 1997, the government's accounts--including trust
funds--added $1.4 trillion in holdings of government securities, while
the debt held by the public grew by $2.6 trillion as total Federal
revenues lagged well behind spending. Currently, the government's trust
funds are credited with $1.9 trillion in government securities, but the
publicly held debt stands at $3.6 trillion. Thus, even though surpluses
generated by Social Security and other government trust funds may have
helped reduce overall borrowing from the public, the government remains
a net borrower.
Ultimately, the government's ability to pay future commitments,
whether they are Social Security benefits or some other payments,
depends on the total financial resources of the economy--not on the
balances attributed to the trust funds. As the President has stated,
``[T]he existence of large trust fund balances * * * does not, by
itself, have any impact on the government's ability to pay any
benefits.'' Trust fund balances indicate that the government may
provide funding in the future for certain programs, but they do not
have direct economic significance. The government can prefund future
obligations--that is, make it easier to meet them--by taking actions
that enhance economic growth. Reducing debt held by the public is one
of the most effective means of increasing saving and investment. Thus,
the economy is the true ``trust fund'' because it forms the pool from
which future consumption--public and private will come.
proposed accounting changes and intrabudgetary transactions
Notwithstanding the limitations of government trust funds,
proposals abound that would use trust fund accounting to achieve
various policies. For example, the President's Mid-Session Review
contains two proposals for the budgetary treatment of Medicare's
Hospital Insurance trust fund. One would transfer additional funds from
the general fund of the Treasury to the trust fund; the other would
place the receipts and outlays of that fund off-budget.
transferring additional funds to the hospital insurance trust fund
The Administration proposes to assign an extra $115 billion to the
Hospital Insurance trust fund over the next 10 years: $31 billion in
2001, $14 billion in 2002, and $70 billion between 2008 and 2010, over
and above the income the fund would ordinarily receive. Those transfers
are described in the Mid-Session Review as ``interest savings resulting
from devoting the Medicare surplus to debt reduction''--although, under
current law, the trust fund is already credited with interest earnings
on the surplus it generates.
Since the transferred amounts would not be needed immediately to
pay benefits, they would add to the trust fund and make it appear more
``solvent.'' But, as illustrated earlier, the solvency of a trust fund
is not a meaningful measure of the government's ability to meet its
future obligations because the fund's balances are really just claims
against future tax collections. Under current policies, as the
population ages, payroll tax collections will become inadequate to
finance Medicare, which will have to be funded through general revenues
and, perhaps, through proceeds from borrowing. That will be true
whether or not trust fund balances exist on paper.
By themselves, changes in trust fund balances through legislated
transfers would affect neither the size of the economy nor the
resources available to the government in the future. There is some
risk, however, that larger trust fund balances could obscure the long-
term fiscal threat posed by the aging of the population and deter
needed reforms by giving lawmakers and the public a false sense of
security.
taking the hospital insurance trust fund off-budget
The Administration also proposes to change the budget
categorization of the Hospital Insurance trust fund so that its
receipts and outlays would be off-budget, like those of the Social
Security trust funds. That change is intended to ensure that the
Hospital Insurance trust fund's surpluses over the next 10 years ``are
not used for other purposes and therefore will be used to reduce the
debt,'' according to the Mid-Session Review. That proposed accounting
change would have no direct effect on the economy or the overall
budget. It would reduce on-budget surpluses while correspondingly
increasing off-budget surpluses, but it would not, by itself, reduce
the debt or change the government's financial position.
However, if the Congress and the President agreed to avoid on-
budget deficits in future years, that accounting change might make the
surpluses generated by the Hospital Insurance program (and any
additional transfers from the general fund) less vulnerable to
proposals to increase spending or reduce taxes. But even if the
accounting change made expanding on-budget programs and cutting taxes
more difficult, the President's proposed transfers to the trust fund
might still lessen the public debt reduction that would have taken
place otherwise. The reason is that the enhanced fund balances might
make it easier to liberalize Medicare benefits and deter programmatic
reforms.
conclusion
The current strong economy and growing budget surpluses encourage
optimism about the nation's future, but they should not breed
complacency about maintaining budgetary discipline. The aging of the
population will bring about major structural shifts in the amount of
resources directed toward the elderly. By increasing national savings
and capital accumulation that will contribute to growth, the budget
surpluses offer one course of action that may make it easier for
workers of the future to bear that heightened burden.
It is critically important to consider the impact that legislative
action may have on economic growth and on the burden that future
taxpayers will have to bear. The challenge before the nation is to find
the appropriate balance between benefit levels that are both affordable
and adequate to meet the needs of the elderly and an overall fiscal
policy that will help create an economy strong enough to sustain those
benefits.
Chairman Kasich. Well, obviously, you say the economy would
have to grow faster, but yet we--let me ask you this question:
Do you think that the economic growth we have been seeing, with
the higher productivity, which is brought about by higher
productivity, do you think it can be sustained, in your
judgment? Have we actually seen a break-through in terms of
productivity based on the development of all of the new
technology?
Mr. Crippen. There seems to be an increase that is closer
to historic rates of productivity increases. So, in that sense,
it is comforting to say this might go on. It is still not
clear. A number of weeks ago, we hosted a conference, at the
request of your counterparts in the Senate, on the new economy
and where the productivity is coming from. And there is no
consensus, exactly, on what is happening.
One point of view, Dr. Gordon's, is that we are getting
most of the productivity increases out of making computing
equipment--not in using it, but in making it. If he were right,
for example, then there might not be as pervasive a
productivity increase as would appear to be the case now.
Chairman Kasich. And now the Napster has gone down.
Mr. Crippen. I know.
Chairman Kasich. We are really in trouble.
Mr. Crippen. That means you got off-line, I assume, last
night.
Chairman Kasich. I ain't telling. [Laughter.]
Mr. Crippen. I noticed that. It would be wrong.
So we have adopted in our forecasts some increase in
productivity over the last 12 to 18 months, as we have changed
our economic estimates as well. But our long-term forecasts are
still below what we are currently experiencing. So we are not
complete converts yet, in our forecasting, to showing a new
economy at permanently higher productivity levels. But we have
upped our forecast of productivity growth by about 0.6
percentage points over the next 10 years.
So we are hopeful that some of this increase is permanent
and obviously have put that in our projections.
Chairman Kasich. It just kind of occurs to me, a lighter
moment here is it would be interesting to see, on the next vice
presidential questionnaire, when exactly did you stop
downloading Napster. Anyway----
Mr. Crippen. It will get there eventually.
Chairman Kasich. The answers to the Social Security problem
really aren't that difficult, are they, if you have--they are
really not that difficult, are they, if you can figure out a
way to generate a significant boost in return on the Social
Security taxes plus, over time, you slow the growth in the
benefits to keep pace with inflation rather than higher than
inflation; is that correct?
Mr. Crippen. Well, just increasing the rate of return on
Social Security contributions won't do you a lot of good in and
of itself. Again, those increased returns have to be due to
increased national savings. If we are simply swapping one
dollar for another, debt for equity, it doesn't matter how you
view it, just increasing the rate of return to the trust funds
makes the trust funds look better, but it doesn't grow the
economy. And, again, that is why I am arguing that we should
not focus or at least diminish our focus on the trust funds
and, rather, look at what I think is the more relevant
question--are the actions we are taking growing the economy?
Whether or not the trust funds have improved or worsened is
irrelevant. The point is, is the economy made better by the
proposal of reform that you are positing?
Chairman Kasich. But if the problem with Social Security is
being driven by demographics, number one, the fact that more
retired, fewer working, and the problem that the benefits
themselves are being funded at a level that is higher than
replacement level, higher than the rate of inflation, then even
if this economy were to grow, I don't know if it could grow
much--I mean, it depends who the Fed chairman is--but let us
assume it grew a little bit faster, you still are going to have
a rising percentage of the economy being eaten up by Social
Security, for example. In other words, the point I want to make
is, if you do nothing about the benefits, then you can't fix
this.
Mr. Crippen. That is why I was saying, I think, Mr.
Chairman--trying to say, at least, in my opening statement--
that if you define the problem as an ever-growing share of the
economy going to the elderly, and therefore probably squeezing
all other things, and if your policy goal is to lower the 14-
plus percent to something less, growing the economy will help
because there is a considerable lag in the benefits as we grow
the economy, but it can't solve the entire problem because you
are chasing your own tail.
So, in order to lower that number significantly, you will
have to do something with benefits.
Chairman Kasich. Let us move on to Mr. Smith. But I wanted
to just make the point to you that I think it is possible, with
very modest projections, to not only create the private
accounts, which would generate a higher rate of return and
maybe the debate gets to be who invests this money--I hope that
is where it ends up because that means you won a fundamental
debate about the need to allow people to put some money in the
private economy. But you don't have to slash the benefits,
really. You just have to slow the growth in those benefits, and
the people would benefit more. I mean, their total amount of
take from Social Security would be greater than the current
system, even though the current system can't meet this
obligation.
I think the problem with Medicare is a lot more severe, and
the Medicare problem is more severe, isn't it?
Mr. Crippen. Yes.
Chairman Kasich. Do you want to just do 30 seconds on that?
Mr. Crippen. Well, about half of the increase you see here
is accounted for by Social Security and the other half,
Medicare, and even then most of these long-term projections are
based on assumptions about Medicare that are probably way too
low. For example, the Medicare actuaries, which most of us use
for our projections, assume that at some point in the not-too-
distant future--I think it is around 2010--the cost of
Medicare, the increases in Medicare, will only mirror those in
the economy--Medicare can only grow as fast as the economy. But
that has not been the case almost since it was instituted. So
that assumption is probably very low, and spending on the
elderly, which our figure portrays as 14.6 percent of GDP in
2030, will be higher because Medicare spending is going to be
higher than we currently project.
Chairman Kasich. So it is likely that for every dollar we
spend on children which, in a sense--and I hate to get into
this debate, but I think maybe Democrats have some, or the
economists that argue that investing in, you know, for example,
higher education, I happen to think they are probably right on
this, although the higher education programs are so screwed up
from the standpoint of out-of-control costs, but certainly
investments in higher education, which gives you greater
skills, is going to contribute to higher productivity.
But if, in fact, that ratio of 7 to 1 grows to 8 to 1 or 9
to 1 or 10 to 1, then you are feeding consumption, while you
are not encouraging investment. Would that be correct?
Mr. Crippen. Yes.
Chairman Kasich. Mr. Smith. Go ahead, Nick.
Mr. Smith of Michigan. Mr. Chairman, thank you very much.
Just a tremendously important hearing, disappointed that
there aren't more members. Maybe it represents the fact that it
is still somewhat a third rail. There is a reluctance, when we
talk about the huge challenge that faces us with both Social
Security and Medicare, to deal with that problem. It is easier
to put it off, and that is what we have been doing.
Dan, what is included when you talk about senior spending?
Is there anything in addition to Social Security, Medicare and
Medicaid?
Mr. Crippen. No. Although we have compiled some estimates
of other things that you might put into that category, of
programs for veterans, for example.
Mr. Smith of Michigan. Veterans' programs, extra tax
benefits, that isn't included.
Mr. Crippen. Those are not included.
Mr. Smith of Michigan. How about GDP, what is included in
GDP? Is the inflated--I use that word uneconomically--is the
inflated value of equities, especially the tech stocks and
Nasdaq included as part of GDP?
Mr. Crippen. The effects that rising equity values have had
on the economy are included in the base, which we then grow by
our assumption over time. So I think the answer is yes.
Mr. Smith of Michigan. So, in my mind, you would have an
inflated evaluation of GDP then if you are including the
increased value of those stocks, rather than real production in
this country.
Mr. Crippen. There are arguments, let me say, on both
sides; that, yes, the equity values may be too high, and
therefore if they decreased precipitously, it would hurt
economic growth. As we were talking with the chairman, we may
have our productivity numbers too low as well.* But what----
---------------------------------------------------------------------------
*While the effects of rising equity values are incorporated in
CBO's projections, the actual measurement of GDP does not include a
valuation of the equities market.
---------------------------------------------------------------------------
Mr. Smith of Michigan. Do you support Alan Greenspan's
contention that we should be providing the Bureau of Economic
Analysis over in the Department of Commerce, more funding to
deal with these more complicated problems of developing GDP?
Mr. Crippen. Data are certainly a continuing problem.
A number of the past administrations have recognized that
and tried to increase funding without success. We rely
exclusively on other folks to generate data. We don't collect
data.
Mr. Smith of Michigan. So is that a yes?
Mr. Crippen. Yes.
Mr. Smith of Michigan. And, Mr. Chairman, as you know, I
introduced my first Social Security 7 years ago when I first
came to Congress, introduced the first bill 5 years ago that
was scored by the Social Security actuaries to keep Social
Security solvent, so they scored that, and then each session I
have introduced a new bill. And, Mr. Chairman, most of those
plans that are proposed set aside 2 percent of taxable payroll
in terms of investment, and I call for 2.5 percent. It
eventually grows to 8 percent. But in terms of solving the
problem without reducing benefits for senior citizens or
increasing taxes, it would take closer to 7 percent, rather
than 2 percent of payroll, with a kind of investment that is
going to return someplace around 8 percent in real terms to
still solve the program. And if you go that high, then the
transition costs are almost unsolvable. And so it is a huge
challenge.
And the good news is that we are more conscious of this
than we have ever been. We have got two presidential candidates
that are at least approaching some of the solutions, and yet we
have still got a Congress that is looking at this new-found
wealth of extra surplus revenues as justification to increased
spending. And so, politically, the decision continues to be
extremely difficult, it seems to me.
In your evaluations of the benefits to seniors, did you
include or project prescription drugs as part of that
projection?
Mr. Crippen. No. This is our current baseline, if you will,
which does not have prescription drug benefits reflected in it.
Mr. Smith of Michigan. In terms of the economic
consequences of putting this kind of burden on future workers,
if we were to solve the problem like we have in '77 and again
in '83 by increasing taxes and decreasing benefits, the
consequences on the economy, if we simply rely on increased
payroll taxes that we project are going to approach 40 percent
by the year 2040, 40-percent payroll taxes to solve the problem
of senior benefits, what kind of effect is that going to have
on the economy?
Mr. Crippen. Well, those kinds of payroll taxes would
presumably seriously deter work effort and hurt economic
growth--if not in the generation on which you imposed them,
certainly on succeeding generations. So such taxes would
continue to push the burden onto the workforce and into the
future.
Mr. Smith of Michigan. And when you suggest chasing our
tail by an expanding economy--in the short run, bringing more
Social Security funding in, but in the long run resulting in
higher benefits because of what the chairman suggested, in
terms of our benefits being indexed to wage inflation rather
than straight inflation, what is the lag time? Do you have an
idea of the lag time?
Mr. Crippen. Well, it occurs over cohorts, if you will, or
generations. The lag, however, produces a benefit equal to
about 1 percent of payroll for a 1 percentage point increase in
real wages. So the lag is a fairly significant part of the
benefit increases in these out years--maybe 30 or 40 years from
now. So it is significant.
Mr. Smith of Michigan. But still, it eventually catches up
with us.
Mr. Crippen. Yes.*
---------------------------------------------------------------------------
*After about 30 years, the beneficial effects of the more rapid
wage growth levels out. It still improves the outlook for Social
Security, but the improvement no longer increases after several years.
---------------------------------------------------------------------------
Mr. Smith of Michigan. And, Mr. Chairman, what we are also
I don't think building into a very serious situation is the
futurist projections of longevity. With our new technology and
the gene technology now evolving, our futurists in our Social
Security Task Force were guessing that within the next 20 years
anybody that wanted to live to be 100 years old would be able
to do that, and they would be able to live to be 120 years old
within the next 40 years. And we are not even considering that
kind of medical technology that is going to really add to the
longevity of people.
So savings and investment and getting a real investment
return of the money and some of the surpluses is just critical
if we are going to solve the problem.
Chairman Kasich. Mr. Sununu.
Mr. Sununu. Thank you.
One of the things that strikes me in the chart on the
right, and in the chart we have and some of the notes prepared
for this hearing is the degree to which benefit payments, in
particular I believe this is a graph of Social Security
payments, which is the largest transfer of benefits to the
elderly, grow at a rate much higher than the rate of inflation.
And I think that the general perception of Members of Congress
and the public, for that matter, is that the cost of living
adjustment is intended to keep pace with inflation, so that
benefits grow, and you don't have an erosion of purchasing
power for those who are dependent on Social Security.
Could you describe why Social Security benefits or the
total payments through the Social Security system are projected
to grow dramatically higher than inflation.
Chairman Kasich. John, let me--there is a motion to
instruct on the floor that has to do with military retirees,
which I think you will want to----
Mr. Sununu. How much time do we have left?
Chairman Kasich. We have about 6 minutes, I think.
Mr. Sununu. I will try to finish my questioning in just 3
or 4 minutes, and then we can let Mr. Crippen----
Chairman Kasich. That is fine. We can run over.
Mr. Crippen. I will think about it.
Mr. Sununu. I will try and finish in 2 minutes, so you can
answer, and we can free you from your bonds here.
Why is it the benefits grow so much higher than the rate of
inflation?
Mr. Crippen. Well, there are two reasons, but largely, in
this chart, the reason you see the benefits growing is because
of the baby-boom generation's retirement. We are going to
double the number of retirees, roughly double, from between
2000 and 2030. So even if the per capita benefits weren't
growing any more than inflation, clearly, you would have an
increasing amount going to the elderly.
Mr. Sununu. But do the per capita benefits grow at a rate
higher than CPI as well?
Mr. Crippen. No, not after the initial benefit calculation.
The initial benefit is currently based on wages, adjusted for
wage inflation. So it is a wage-replacement concept. After that
initial benefit calculation, benefits are then indexed to CPI
or to price increases. So the initial benefit uses----
Mr. Sununu. That would mean that an individual's benefit
would grow at inflation, but the system's per-capita benefit
would grow at a higher rate than inflation, correct?
Mr. Crippen. Right.
Mr. Sununu. Terrific. Second, a brief question about cash
balances. There are projections now for surpluses on budget and
off budget, very significant. CBO just increased its estimates.
It seems to me that the surpluses will exceed the amount of
outstanding debt coming due and force the Government to start
accumulating very significant cash balances. What will the
Federal Government do with the excess cash as it is
accumulated?
Mr. Crippen. We don't know, and we don't make an assumption
about what it is invested in. But we do make an assumption that
it will earn some rate of return.
Mr. Sununu. Are there any statutory limits right now to
what the Treasury can do with the cash balances?
Mr. Crippen. Not that I am aware of.
Mr. Sununu. Could they purchase equities in the public
markets?
Mr. Crippen. I don't know the answer to that.
Mr. Sununu. What is the projection for cash balances right
now at the end of this fiscal year, fiscal year 2000?
Mr. Crippen. At the end of this fiscal year, over the last
couple of years, about $40 billion. That is partially a cash
and debt management----
Chairman Kasich. We are about out of time, John. We
better--we can come back and finish this. We will just take a
few minutes, and then we will have Pete du Pont and the next
group get up. We will be right back.
Mr. Sununu. I am happy to follow-up in writing, unless you
have additional questions, so that Mr. Crippen doesn't have to
stay, and we don't have to detain him.
Chairman Kasich. That would be fine.
Mr. Sununu. Thank you, Mr. Chairman.
[Recess.]
Chairman Kasich. OK. This has just been the most bizarre. I
swear to you, you have a hearing like this, and the committee
will come to order, and we are going to have my long-time
friend, I think this is the first time Tim has ever testified
before this committee. He is a great, great buddy of mine. And,
of course, Pete du Pont, who is in really a class of his own.
He is a terrific man, and I have admired him for many years.
We have got so many things going on, all of these votes on
the floor, committee meetings, but I would like to get started
and get this stuff on the record. And, Pete, you know, I think
that sometimes you have got this iceberg out there, and you
have got to start talking about it before the ship hits it. So
this stuff will get on the record. Some members will come, and
let us just go through this stuff.
So I think the first person we want to have testify is Mr.
du Pont; is that right? Let us let Mr. du Pont go first. You
are on, sir.
STATEMENTS OF HON. PETE DU PONT, FORMER GOVERNOR, STATE OF
DELAWARE; HON. TIM PENNY, FORMER MINNESOTA MEMBER, U.S. HOUSE
OF REPRESENTATIVES; HENRY J. AARON, SENIOR FELLOW, THE
BROOKINGS INSTITUTION
STATEMENT OF PETE DU PONT
Mr. du Pont. Thank you, Mr. Chairman. And it is good to be
with former Congressman Penny and Henry Aaron. Henry and I have
debated this issue many times over the last 5 years. And I was
just saying to him that I think we can take credit for the fact
that when we started talking about it, nobody much cared, and
now it is the central issue in a presidential campaign, and I
think Henry and I have done well in elevating the debate that
far.
Mr. Chairman and committee members, thank you for the
opportunity to say a few words this morning about how we might
meet the demographic challenges of the U.S. Social Security
system.
I think maybe the place to start is the Organization for
Economic Cooperation and Development, OECD. Their website has a
map that shows the fertility rate of the world's nations,
nation-by-nation. A fertility rate of 2.1 children per woman is
required to maintain a constant population in the long run. And
of all of the OECD countries, only Ireland, Mexico and Turkey
meet or exceed 2.1. In other words, the population increase is
starting to decline. In the United States, the fertility rate
last year was 2.06 children per woman.
At the same time, people are living longer in every
developed country. U.S. life expectancy in 1940 was 61 years
for a male and 66 years for a female. Last year, it was 74 for
a male and 80 years for a female. There are going to be fewer
and fewer of us, and we are going to live longer and longer,
and this demographic trap is the problem that Social Security
is facing.
There is going to be major trouble for developed nations,
with pay-as-you-go Social Security systems, of which the United
States is one, as they face these demographic challenges. Fewer
babies are being born. They grow up to be workers paying
payroll taxes, and at the same time people are living and
drawing retirement accounts longer and longer.
There is no question that the pay-as-you-go Social Security
system is unsustainable in the long run. Fourteen years ago, in
1986, one poll found that 46 percent of Americans doubted that
Social Security would be there and that 68 percent were not
confident about the future of the Social Security system. So
even then it was clear that things could not go on as they are
for a long while.
I recount these events of 14 years ago to emphasize the
conditions that make Social Security reform imperative have not
gone away, and we cannot put off for another 14 years what we
should have been working on 14 years ago because the cash flow
in the Social Security system turns negative in about 2015.
In 1986, I actually proposed a solution to the problem of
demographics in the retirement system in our country called a
financial security program, and it involved giving Americans
the options of contributing part of their payroll taxes to
private retirement accounts. That fell pretty much on deaf ears
then, but it's certainly very much in the news today.
In short, the problems inherent in the Social Security
system and their solutions are nothing new. The problems have
been there for a long while, the solutions have been on the
table for a long while. The only things that have changed is
that the American people now seem interested in hearing about
alternative solutions to meet the challenge.
Some very respected economists have helped raise this
awareness. Eugene Steuerle of the Urban Institute wrote in
1994, and I quote, ``The next few years should be viewed as a
crucial period of opportunity during which the Nation should be
readying itself for the demands of the future. We should not be
lulled into inaction by the relative retiree-to-worker ratios
in the near time, while a potent demographic challenge looms
right around the corner.''
Federal Reserve Chairman Alan Greenspan said in 1996, ``It
is becoming conventional wisdom that the Social Security
system, as currently constructed, will not be fully viable
after the baby boom generation starts to retire in about 15
years.'' And I was looking over Professor Kotlikoff's
testimony, which he is going to give later on, and he is going
to present you some data in very stark terms about those
numbers.
The plight of Social Security is not a partisan matter.
Senator Bob Kerrey of Nebraska said, ``Each day we let go by
means tougher tax increases or benefit cuts for future workers
and retirees.''
Senator Moynihan, ``Social Security, as now constituted, is
a social insurance program that will disappear before our eyes
if we do not reform it now.''
So my message to this committee this morning is that the
moment to act is now. The time to act has come. The American
people are interested, as they have not been interested before,
and the proposals on the table give us a number of alternatives
for meeting the challenge.
It seems to me that letting workers put a percentage of
their Social Security payroll tax into personal retirement
accounts to be invested in real assets, continues to be the
best approach. Indeed, 5 of the 13 members of President
Clinton's 1994 Advisory Council on Social Security favored that
approach.
A number of approaches have been suggested by Members of
Congress of both parties. You are familiar with them. The idea
of personal retirement accounts is both current and bipartisan.
Senator Robb has such a bill, Senator John Breaux has such a
bill. And he said, and I think this is an interesting point
with which I agree, he said, ``I believe we have moved the
debate past the argument of whether there should be private
investment to how private investment should be done.''
Now, Mr. Chairman, some witnesses may tell you today that
the problem is a small one, requiring a minor adjustment to the
benefits paid here or the taxes levied there. They are
mistaken. The demographic destiny of our current retirement
system presents a massive challenge to our economy, to our
families and to the Congress. You cannot save Social Security
with some makeshift fixes in an effort to get beyond the baby
boom retirements. You must make a choice, and you must make it
soon. Either we can make it possible for people to fund their
retirement income during their working years, or we can
anticipate a ruinous intergenerational conflict that will
balkanize America and limit opportunity for everyone.
Thank you, Mr. Chairman.
[The prepared statement of Pete du Pont follows:]
Prepared Statement of Hon. Pete du Pont, Former Governor of Delaware
and Policy Chairman of the National Center for Policy Analysis
Mr. Chairman, members of the committee, thank you for the
opportunity to testify this morning on how we might meet the
demographic challenges of the U.S. Social Security System.
The Organization for Economic Cooperation and Development's Web
site has a map that shows--in color--the fertility rates nation by
nation. A fertility rate of 2.1 children per woman is required to
maintain a constant population in the long run. Blue indicates nations
with fertility rates below 2.1--and a sea of blue spreads across the
map, from the United States and Canada through Europe and Asia and on
to Japan and down to Australia. Of all the OECD countries, only
Ireland, Mexico, and Turkey meet or exceed 2.1. The U.S. fertility rate
of 2.06 last year was one of the highest among developed nations.
At the same time, people are living longer in every developed
country. The U.S. life expectancy at birth in 1940 was 61.4 years for a
male and 65.7 years for a female. Last year it was 73.7 years for a
male and 79.5 years for a female.
What these demographic statistics add up to is impending major
trouble for developed nations with pay-as-you-go Social Security
systems, of which the U.S. is one. Fewer babies are being born to grow
up to be workers paying payroll taxes; at the same time people are
living and drawing retirement benefits longer and longer. As the
population ages, it becomes increasingly difficult to pay the benefits
of the many who are retired out of payroll taxes collected from fewer
current workers.
It is no secret that our pay-as-you-go Social Security system is
unsustainable in the long run. Nor is that something only recently
discovered. Fourteen years ago, in 1986, one poll found that 46 percent
of Americans doubted that Social Security would be around when they
retired, and another found that 68 percent were not confident about the
future of Social Security. Even then it was evident that taxing today's
workers to pay benefits to today's retirees could not continue
indefinitely when the ratio of workers to retirees was shrinking.
I recount these events of 14 years ago to emphasize that the
conditions that make Social Security reform imperative have not gone
away, and that we can put it off another 14 years only at our peril.
Indeed, cash flow in the system turns negative in another dozen years,
about 2015. Today, a majority of young people doubt that Social
Security will be around when they retire. The ratio of workers to
retirees, which thanks to the baby boomers has remained steady over the
past two decades, is about to begin a sharp decline. The Social
Security system has piled up 14 more years of unfunded liabilities
since 1986--unfunded liabilities that threaten to destroy our
retirement system, our tax system, and our economy.
In 1986, I proposed a solution to the problem, what I called the
Financial Security Program, which would protect Social Security by
giving Americans the options of contributing part of their payroll
taxes to private retirement accounts. These accounts would be invested
in the market and would finance part of a person's retirement benefit,
thus reducing the burden borne by the Social Security system. I pointed
out that the cost of transition from a pay-as-you-go system to a funded
system to save Social Security would be costly then, and more costly
later, but would spare future generations from having to choose between
much higher payroll tax rates or deep cuts in Social Security benefits.
I also suggested extending the full faith and credit of the U.S.
government to Social Security benefits to protect retirees.
In short, the problems inherent in the Social Security system, and
their solutions, are nothing new. The only thing that has changed is
the American people are more aware of the problem and more amenable to
a long-term approach that actually saves Social Security instead of
delaying the inevitable wreck for unborn generations to deal with.
Some respected economists have helped raise this awareness. For
example, Eugene Steuerle of the Urban Institute wrote in 1994 regarding
Social Security, ``The next few years should be viewed as a crucial
period of opportunity during which the nation should be readying itself
for the demands of the future. We should not be lulled into inaction by
the relative retiree-to-worker ratios in the near term, while a potent
demographic challenge looms right around the corner.'' And Federal
Reserve Chairman Alan Greenspan said in a 1996 speech, ``It is becoming
conventional wisdom that the Social Security system, as currently
constructed, will not be fully viable after the so-called baby boom
generation starts to retire in about 15 years.''
The plight of Social Security is not a partisan matter, and Members
of Congress from both sides of the aisle have also helped increase
public awareness. For example, in introducing the Senate Bipartisan
Social Security Relief Act of 1999, Senator Bob Kerrey, a Democrat,
said, ``Each day we let go by means tougher tax increases or benefit
cuts for future workers and retirees.'' And Senator Daniel Patrick
Moynihan, also a Democrat, recently said that Social Security as now
constituted ``is a social insurance program that will disappear before
our eyes if we do not reform it now.''
So this is the moment to act, to make the changes needed to save
and preserve our retirement system.
Letting workers put a percentage of their Social Security payroll
tax into personal retirement accounts to be invested in real assets
continues to be, in my opinion, the best approach. Five of the 13
members of President Clinton's 1994-1996 Advisory Council on Social
Security also favored letting individuals invest part of their Social
Security taxes directly in the financial markets. As these accounts
grow, and the magic of compounding increases them still further, the
payroll tax revenues needed to fund benefits will decrease. Several
proposals based on this approach have been made by Members of Congress
of both parties, and some have already offered bills that address not
only the mechanism for setting up the personal retirement accounts but
also the transition costs involved in meeting current commitments to
retirees and future retirees.
Nor is the idea of personal retirement accounts a partisan matter.
For example, here is what Senator Charles Robb, Democrat of Virginia,
said about the bipartisan reform bill mentioned earlier. ``Creating
individual retirement savings accounts ensures today's Social Security
surplus is set aside for today's workers who will become tomorrow's
retirees.''
Another Democratic sponsor, Senator John Breaux of Louisiana, said,
``I believe we have moved the debate past the argument of whether there
should be private investment to how private investment should be done.
There is a growing consensus that we can strengthen the safety net
provided by Social Security, while at the same time providing Americans
with more investment opportunities and retirement choices.''
Mr. Chairman, some witnesses may tell you today that the problem is
but a small one, requiring a minor adjustment to the benefits paid
here, on the taxes levied there. But they are mistaken: the demographic
destiny of our current retirement system presents a massive challenge
to our economy, our families, and to the Congress.
We cannot save Social Security with some makeshift fixes in an
effort to get us beyond the baby boom retirements. The United Nations
Population Division projects that by 2050, 22 percent of the world's
population, 33 percent of the population of developed nations, and 28
percent of the U.S. population will be over age 60. Further, the
Population Division projects that the world's population may be
decreasing by the end of the 21st century.
The significance of this demographic information about the world
and the United States, it seems to me, is that we must make a choice
and make it soon. Either we can make it possible for people to fund
their retirement income during their working years, or we can
anticipate a ruinous intergenerational conflict that will balkanize
America and limit opportunity for everyone.
Thank you.
Chairman Kasich. Thank you very much, Governor.
Mr. Penny, welcome.
STATEMENT OF TIM PENNY
Mr. Penny. Thank you. It is good to be here. I testify
today in my role as co-chairman of the Committee for
Responsible Federal Budget. This is an organization that has
now been around for 19 years. It is a bipartisan, nonprofit
educational organization. My co-chairman is a fellow
Minnesotan, Bill Frenzel, who served our State for 2 decades
here in the U.S. Congress, and was at one time the ranking
Republican on this committee.
Over the years, our board membership has included every
former House and Senate Budget Committee chairman, every former
House and Senate ranking committee member, every former CBO
director and most of the former OMB directors. So it is sort of
a haven for us budget wonks when we leave elective office.
My testimony today is going to be based on two initiatives
that our group has been involved with over the last few years.
The first is The Graying of America Project. I think most
members of this committee have received copies of this in your
office. We concluded this project in January of this year. It
is an exhaustive research project sort of analyzing some of the
various statistics that Mr. du Pont just shared with you, and I
have several charts from the study that will be displayed at
the front of the room, and I will discuss the information in
those charts briefly.
The second aspect of my testimony today will be to discuss
with you an exercise that we conducted in eight localities
around the United States, where we pulled together groups--on
the Federal budget, on Federal tax policy, on demographic
trends, and asked them to make some hard choices and to help us
sort through policy options that Congress would soon face
regarding these various budget decisions.
These exercises were co-sponsored by American Express
Financial Advisors. We had participation from Democratic and
Republican House members at virtually every stop along the way
and had somewhere between, I believe we had somewhere between
60 and 120 participants, and in one case a couple hundred
participants in these sessions. We broke them into roundtable
discussions and made sure that there was a diversity at each
table; in other words, to sort of force the kind of compromise
and consensus that would be required here in Congress in order
to sort through the options and come up with policy
recommendations.
So I will conclude with an aggregate number of respondents
from these groups and what sorts of recommendations they would
make relating to the demographic pressures that are facing our
retirement programs in the years ahead.
I want to start with the chart that is on display. It shows
from 1940 through 2050, both actual and projected workforce
participation rates. This gives you some sense of the segment
of the population--the under-20 crowd represented in green, the
over-65 cohort represented in yellow, and how that relates to
the center, those between 20 and 64, who are of working-age
population and essentially paying the bulk of the taxes,
virtually all of the taxes to support those on either side of
the spectrum.
As you can see, the size of the working population, as
compared to the, for lack of a better term, dependent
population, has been increasing and will continue to increase
significantly as we move into the new century.
The second chart that I would like you to review has to do
with the amount of time that the average American worker stays
in the workforce. This chart, as well, gives you, in the
center, the number of years that men and women are likely to be
working. And then at the far right, from my perspective, it
demonstrates the average number of years that they will be in
retirement phase. And as you can see, the number of working
years is declining. This is comparing 1940 to 1995 actual
statistics; whereas, the length of those retirement years has
dramatically increased. It is a good news/bad news scenario. It
is great that we are now living much longer and enjoying
another phase in our lives. But it is also a phase in our lives
where we are drawing on public resources, to a great extent,
through both the Social Security and Medicare programs. And
that longevity issue will continue to plague these retirement
programs in the years ahead.
The third chart that I want to share with you has to do
with the worker-to-retiree ratio. Flowing from the earlier
charts, it should be no surprise that today we have about 3.5
workers per each retiree. But by the year 2030, we will be down
to two workers for every retiree. Hard to sustain a pay-as-you-
go system, which our Social Security system is when we have
that sort of a declining worker-to-retiree ratio.
It suggests that we would need to do a variety of things in
order to make these programs sustainable in the longer term.
Obviously, we could look for ways to increase the workforce.
Expanding immigration is a possibility, although there are
limits in that regard. We could, of course, reduce the number
of beneficiaries by extending the retirement age. We could
reduce benefit payments, so that the amount paid into the
system would not need to be increased or payroll taxes would
not need to be increased. However, another option would be to
simply increase payroll taxes or to borrow money or we could
cut other programs in the Government to provide the
differential. But none of these are attractive or easy options.
All of these options, however, were options that we shared
with the focus groups in our exercise with hard choices, and I
will get to the response of those groups at the end of my
testimony.
The fourth chart has to do with the median age of the U.S.
population. And as you would expect, flowing from the
statistics in the earlier charts, here as well we are seeing an
aging population according to this chart.
A parallel trend is that our workforce is becoming more
diverse. And that is depicted in the next chart that Wayne will
place on the board. This one might be a little harder to read.
In fact, I can't even read it from here. But it exhibits that
as years go by, a larger share of the workforce is projected to
be nonwhite and Hispanic and that as we approach the year 2030
and beyond, we will have essentially a retirement population
that is white, and a much, much larger segment of the working
population that is nonwhite or Hispanic.
I think it raises some interesting policy implications as
we continue to tax, through the payroll tax system, virtually
every dollar earned by working Americans in order to support a
largely white and less diverse retired population. And I think
the implications of that could play out politically and
complicate the policy debate in years ahead.
And the final chart that I want to share with you simply
indicates where we are going in terms of retirement population
in America. We now have about 14 percent of Americans who are
retired. That will grow to over 20 percent by the year 2030. In
a sense, we will be a Nation of Floridas within 3 decades.
So with this as background information, we challenged these
groups of average citizens in eight locales around the United
States to share with us their recommendations, their policy
prescription. It was interesting to me to see the responses
because it didn't track with what you often see in opinion
polls. And I think it bears out that, given adequate
information, that Americans are capable of coming to different
judgments than they might by simply being asked: Would you cut
Medicare? Would you raise taxes? Those answers are relatively
simple--less simple when you have the policy briefing as a
background.
Our response to size of Government found that 60 percent of
our exercise groups were determined to hold the size of
Government at about 19 percent of GDP. This conforms with
trends that you can see over the past several decades in which
we have risen above 19 percent of GDP as the size of Government
only to see, in ensuing years, the size of Government retract
once again. It indicates that American voters over time are
resistant to tax levels that take more than 19 percent of GDP
out of their pocketbooks, and that was reaffirmed by the focus
groups that we met with around the Nation.
Seventy-three percent of our participant groups voted for
unified budget surpluses, followed by balanced budgets as the
norm for fiscal policy decision making. So there was a sense of
fiscal restraint exhibited by these groups.
Seventy-six percent of the roundtable groups that we met
with supported some form of individual account as part of
Social Security reform. These audiences were well-informed and
did understand the tension between political risk and financial
risk if partial privatization were adopted. They understood
that the entire amount of payroll tax withholding is also,
including the employer's share, is also part of employee
compensation. They discussed and understood the financial risk
associated with individual investments, and they understood the
political risk that future Congresses and future presidents
could modify promised benefits or raise taxes to fund current
benefit promises.
Knowing all of that, most groups, again, chose to balance
political and economic risk and did support some degree of
individual accounts as part of a Social Security reform plan.
There was no clear consensus on Medicare reform. However,
interestingly, 44 percent of our exercise groups voted for
incremental reforms, which is to say they favored constraining
provided benefits, increasing eligibility age and encouraging
more beneficiaries to enroll in managed care. Thirty-six
percent voted for some kind of defined benefit contribution
program or voucher program. There were no other options
discussed by these groups that commanded more than 12-percent
support.
The bottom line is I think the American people are
perfectly capable of understanding the crunch that Government
faces as our population ages and becomes more diverse. They do
not want Government to grow hugely to meet those challenges.
They do want to be able to meet the needs of our children and
others in the population, while at the same time meeting the
legitimate needs of our elderly. There seemed to be a strong
sense of fiscal responsibility in these groups and that debt
reduction, in their view, ought to be a near-term priority.
They seemed to understand the relationship between debt
reduction, overall national saving rates, and the way that
would play out in terms of our economic performance.
Today's surpluses, Mr. Chairman, cannot be used to pay
benefits in the year 2010, when Medicare will likely spend more
than its dedicated receipts or in 2015 when Social Security is
projected to go negative on a cash-flow basis. The taxes
Government collects in future years must be augmented by future
borrowing or benefit promises must be revised or future leaders
must eliminate other functions of the Government to make money
available for these retirement programs. These are demographic
challenges that will only grow more serious as time goes by,
and delay will make solving the problem much more difficult.
Frankly, in this election cycle, it may not be a bad thing
to delay any far-reaching prescriptions for solutions in these
programs and to allow this to be played out in the presidential
and congressional debate during this election cycle. In the
meantime, as we wait for this election, it might be best to do
no harm and to allow current surpluses to be used for debt
reduction.
We do, at our committee, applaud your committee for holding
these hearings. There is not anything wrong with too much
education on an issue like this. And so we do applaud you for
trying to keep this issue on the front burner and out there in
the public domain because it is an issue that must be better
understood by the American public. And our sense, after holding
these eight sessions around the country, is that armed with the
information that they need, Americans are willing to make
rather far-reaching and significant changes in these programs
so as to avoid unnecessary burdens on future taxpayers.
Thank you for your time and for your efforts to advance the
education of the public on these issues.
[The prepared statement of Tim Penny follows:]
Prepared Statement of Hon. Tim Penny, Former Member of Congress and
Cochairman, Committee for a Responsible Federal Budget
Mr. Chairman, Mr. Spratt, members of the committee, I am very
pleased to be here--some might say back home--to talk with you about
the impact that intergenerational issues will have on public policy in
the years ahead.
I am here today as cochairman of the Committee for a Responsible
Federal Budget. I cochair the Committee with Bill Frenzel who was the
Ranking Republican on your Committee until he retired from Congress in
January 1991. Our group believes that the baby boom generation's
retirement--and intergenerational issues driven by changing
demographics--will dominate the public policy debates for decades to
come, unless the United States finds itself embroiled in major foreign
conflict(s).
For 5 years, the Committee for a Federal Budget focused our time
and resources on two projects designed to examine the intergenerational
issues that are the focus of this hearing:
Building a Better Future--The Graying of America produced a two-
part report and Chart Book. We provided copies of those materials to
your staff. The Graying project began out of concern that political
leaders tend to consider individual programs and policies as if each
existed in a vacuum. But various aspects of spending and tax policy
must fit together like a jigsaw puzzle. Policy-makers must take into
account trade-offs between and among individual programs and the impact
of spending decisions on tax policies. Changes at the Federal level
affect other levels of government and the private sector. Current
policy choices affect future economic and social conditions. Unless
policy makers keep all these separate pieces in view, choices they make
in one area may foreclose desirable options in others. Changing
demographics make the problems we face much more urgent than they
otherwise would be. Medicare, Social Security and the tax system
generally are viewed as sources of the long-term problem and they must
contribute to the solution. Ignoring the interrelationships among these
issues and their collective impact of the Federal budget and the
overall economy is folly.
Much of the information, and many of the opinions, I shall share
with you today developed out of the Graying of America project.
Building a Better Future: An Exercise in Hard Choices was a joint
venture between the Committee for a Responsible Federal Budget and
American Express Financial Advisors. That project produced eight
programs. Each included briefings on the issues by well-known experts
followed by the Exercise in Hard Choices. To complete the Exercise,
audience participants are divided into groups of eight to ten. We
assign people to groups to ensure diversity within each, i.e.,
different ages, political party affiliations, political leaning
(conservative, liberal, moderate) professional and educational
backgrounds, etc. Each group goes through a book, not unlike your
budget mark-up books. Each group makes decisions collectively. They
decide on the appropriate size of government relative to GDP; adopt a
fiscal discipline (i.e., maintain budget balance, ``save'' by using
surpluses to retire debt until the baby boomers retire, or stabilize
the ratio of debt to GDP); then they consider alternative approaches to
reform retirement income policies and programs, Medicare policies and
programs, and all other programs; next they consider tax options;
lastly, they decide how short-term budget surpluses best should be
used. At the end of the day, groups share their results with one
another.
We have provided your staff copies of the Exercise, Background
Materials and Final Report from the Exercise project. It is interesting
to note that the eight meetings occurred in seven states and the
District of Columbia. Democratic and Republican Members of Congress
participated (frequently in the same meeting). The Exercises were held
in urban, rural and suburban areas, the populations of which were all
over the political spectrum.
The Board of Directors of the Committee for a Responsible Federal
Budget believes that these two projects produced information not to be
found elsewhere. (Our board includes three former Chairmen of your
Committee and Bill Gradison who also served as Ranking Member. Over
time, every former Budget Committee Chairman and Ranking Member--all
former CBO Directors and almost all former OMB Directors have served on
our Board.)
Pollsters may think they know how Americans feel about future
retirement policy, health care policy, tax policy, etc. But public
opinion polls can't produce a meaningful feedback on such complex
issues. I don't care how many phone calls the pollsters make, people
need more information and more time than they are likely to get in any
telephone canvass in order to provide meaningful information.
Similarly, focus group results may not prove dispositive because they
tend to tell you that 75 percent of individuals support option ``a'',
20 percent support option ``b'' and 5 percent are undecided. By
contrast, the Exercise does not report individual preferences. We
report consensus preferences of diverse groups mirroring congressional
constituencies. This kind of feedback is likely to reflect the kinds of
compromises that can pass Congress and command consensus support in the
court of public opinion.
So what have we learned from these two projects?
First, American voters understand the demographic changes that
already are underway in our society.
They know that the labor force rapidly is shrinking relative to the
retired population. Faced with facts, they can understand very easily
the impact such change will have on tax burdens for workers and
entitlement benefits for the elderly. When shown how small changes now
can make huge impacts to ease the crunch a few years hence, citizens
have hard time understanding why Washington has not acted to address
the problems. Having completed an Exercise, however, voters begin to
understand the difficulty facing their elected representatives--to find
compromises that can command support among competing constituencies
with different values and different priorities.
lessons learned--the graying of america project
Dependency ratios add the number of young people and the
number of retirees and compare to the number of workers. In this
calculation, ratio or workers continues to shrink well into the 21st
century. This suggests that the burden to support a burgeoning elderly
population could impact on society's ability to meet children's needs--
even more than is the case today.
Labor Force participation. Women entering the workforce
enabled much of the economic and productivity growth in the last
quarter century. But there probably is not much room further to expand
the numbers of women in the workforce beyond current levels. One
possible approach to increase future economic growth and productivity
would be to increase immigration--but that could create other political
problems.
Longer life Expectancies--Shorter Working Lives. People
are going to work later in life, retiring earlier and living longer.
One way to ease the crunch would be to encourage people to remain in
the workforce longer.
The Number of Workers per Beneficiary of Federal
entitlement programs drops precipitously and by 2030 falls to about
2:1. If we cannot increase the workforce, we must either reduce the
number of beneficiaries or the per capita payments to beneficiaries
must decline--else the tax burden on workers must rise very
substantially.
The median age of the population is increasing. 1940-1980,
the median age of the U.S. population was 28-30. In 2020-2050, the
median age will be 38-39 years old. People in their late thirties are
more likely to have college age children than those in their late
twenties or early thirties. College is increasingly expensive. This
serves to underscore the importance of dependency ratios. Future
workers could feel squeezed between the demands of their parents and
grandparents and the desire to provide their children with increasingly
important post-secondary and tertiary educational opportunities.
Changing racial and ethnic trends. There are two parallel
changes occurring in the U.S. population. We are getting older and we
are becoming more diverse. As diversity occurs first among the young.
By 2040, a majority of the U.S. labor force could be non-White or
Hispanic. At the same time, the vast majority of retirees will be
White.
On average, non-Whites and Hispanics are much less well off than
Whites in the U.S. population. Whites have higher average incomes and
education; they enjoy better health care and live longer; they live in
better housing and in almost every other measurable way do better than
their non-White and Hispanic counterparts.
Unless we act now to improve the condition of non-Whites and
Hispanics, is it reasonable to expect that they will be happy to
shoulder increased burdens in the future to support a largely White
retired population who (in general) have enjoyed better lives than the
majority of workers?
Americans over 65 will increase from 11 percent in 1980,
and 13 percent today, to 17 percent in 2020 and 20 percent by 2030.
That will require dramatic increases in productivity so that a smaller
percent of the population can produce sufficient goods and services to
meet the needs of a huge retired population, and satisfy the needs of
workers and their children at the same time.
Alice Rivlin reminds us that dollar bills don't taste very good.
That is short hand for the fact that the dollar value of tax financed
retirement and elderly health care benefits is not nearly as important
as purchasing power and the availability of goods and services to
satisfy demand.
This is why savings, investment and productivity growth are the key
to solving the demographically driven problems we will face in future
years. Growth will not solve all problems but without growth the
country cannot expect to meet the demands we know lie ahead.
Government cannot pass a law to grow the economy or increase
productivity. Economists disagree about many policies to promote
growth. But economists virtually universally agree that increased
saving is needed to fuel increased growth. The US is a very low saving
country. The Federal Government has gone from record deficits to record
surpluses--and applied the majority of current surpluses to debt
reduction. That change in fiscal policy has done more to increase net
saving available for productive private investment than any other
alternative policy could have done. It should surprise no one that the
economy and productivity have grown very rapidly coincident with that
change in fiscal policy.
Going forward, government policies must continue to foster and
encourage savings investment and growth else nothing else you do likely
will effectively address the challenges we face as the baby boom
generation ages.
feedback--the exercise in hard choices
60 percent of Exercise groups chose to hold government
expenditure to about 19 percent of GDP. Put another way, the majority
of our audiences would solve the challenges we face without raising
taxes.
73 percent of participant groups voted for unified budget
or temporary surpluses followed by balanced budgets as the norm for
fiscal policy decision-making.
43 percent would run budget surpluses more or less equal to Social
Security surpluses then maintain unified budget balance after Social
Security goes negative on a cash flow basis.
35 percent would balance the unified budget permanently.
76 percent favor some form of individual account as part
of Social Security Reform. Our audiences understood the tension between
political risk and financial risk. They understood that the entire
amount of payroll tax withholding (including the ``employer share'') is
part of employee compensation. Groups discussed and understood the
financial risk associated with individual investments. They understood
the political risk that future Congresses and future Presidents could
modify promised benefits--or raise taxes to fund current benefit
promises. Most chose to balance political and economic risk.
The largest percentage of groups would scale back tax financed
benefits to achieve solvency in the traditional system and increase
payroll taxes to fund personal accounts. The Gramlich Commission option
that represented this choice in the Exercise would have a federally
appointed board manage investments in individual accounts. Our
audiences were less enthusiastic about that aspect of the proposal than
they were about the mix of sustainable tax-financed guaranteed benefits
and earnings from individual accounts.
There was no consensus on Medicare Reform. 44 percent of
Exercise groups voted for ``Incremental Reforms'' (constraining
provided payments, increasing the eligibility age, and encouraging more
beneficiaries to enroll in managed care). 36 percent voted for a
Defined Contribution (voucher) program. No other option commanded more
than 12 percent support.
Many if not most audiences would have been happier had
there been a separate, explicit option to cut benefits more for middle
and upper income--and protect low-income retirees--in both Social
Security and Medicare reform.
To meet fiscal policy goals 52 percent of Exercise
audiences voted to cut Medicaid by 10 percent; 48 percent voted to cut
nondefense discretionary spending 10 percent; 43 percent would cut
``other entitlements'' 10 percent; 39 percent voted to cut defense.
89 percent of all exercise groups voted to save the
surpluses and reduce debt. 4 percent would cut taxes; 2 percent would
cut taxes and increase spending; none would use surpluses just to
increase spending.
Of course, this was before surplus projections grew into the
trillions.
conclusions
The American people are perfectly capable of understanding the
crunch government faces as the population ages and becomes more
diverse. They do not want to grow government hugely to meet those
challenges. They do want to be able to meet the needs of children and
others in the population--and meet the legitimate claims of the
elderly.
Americans understand the need to save and invest for the future.
They do not understand nearly as well that saving is consumption
delayed. And government programs to increase saving for education, home
purchase, retirement, etc., may simply shift saving from other accounts
or purposes. The single most effective ``program'' government can adopt
to increase savings is the one we have adopted almost de facto in
recent years--run surpluses and reduce debt held by the public.
Debt reduction has the added benefit that it reduces claims on
future Federal budgets for interest costs. However, debt reduction
alone cannot solve the problems we face. And extending the actuarial
solvency of trust funds does nothing to address the challenges we face,
unless we also reduce future benefit claims or increase future taxes.
Today's surpluses cannot be used to pay benefits in 2010, when
Medicare likely will spend more than dedicated receipts--or in 2015
when Social Security is projected to go negative on a cash flow basis.
The taxes government collects in future years must be augmented by
future borrowing or benefit promises must be revised or future leaders
must eliminate whole functions from the Federal Government.
The demographic challenges we face are so great that those are the
only options. Delay makes the problem harder to solve. But delay may be
inevitable. It seems inconceivable that this Congress and the incumbent
President could pass legislation to address these challenges in the few
legislative days you have left. And delay until after the election may
not be a bad thing. That would give the electorate an opportunity to be
heard on the two major party's and the Presidential candidates' very
different views of the future and recommended policy directions. In the
meantime, we hope that your first priority will be to do no harm.
We applaud your committee for holding these hearings. There is no
such thing as too much education on these issues. Congress and the
American people will need all the information and wisdom we can gather
when our political leaders do turn to issues such as Social Security
reform, Medicare reform and tax reform. Thank you for taking time today
to help forward that education process.
Chairman Kasich. Mr. Aaron.
STATEMENT OF HENRY J. AARON
Mr. Aaron. Thank you very much, Mr. Chairman, for inviting
me to appear here today, and I am honored to appear with
Governor du Pont and former Congressman Penny.
Governor du Pont referred to a comment made by Gene
Steuerle in 1994 regarding the importance of moving
expeditiously to deal with the obligations we are going to be
facing in the future. He suggested, I believe, that we had not
done much since 1994 in that direction. I think that is not
true.
In 1994, as you know better probably than anybody else in
this room, official projections of the Congressional Budget
Office, foresaw ever growing deficits stretching out into the
indefinite future. The 1995 projection was for a deficit of
$450 billion by 2005. In July of the year 2000, the CBO's
projection for the budget in the year 2005 is plus $550
billion. That is a swing of $1 trillion in 1 year of additional
national saving. Credit for that achievement goes to you, and
other members of this Congress and to the White House. There is
enough credit here to share on a bipartisan basis.
The idea that we have not done anything in the last few
years to prepare ourselves for the obligations we are going to
face in the future is not correct. We are doing the right thing
by building national saving, which can increase our productive
capacity and enable us to meet whatever we decide are our
obligations to the elderly in the future.
Now, my testimony is divided into four parts. I am going to
refer briefly to one part, and at somewhat greater length to a
second part and omit the other two parts altogether. I will
just name them.
The first section deals with the projections of the
financial condition of Social Security and Medicare. In the
service of those remarks, I would draw your attention to Table
1 of my testimony. The purpose of this chart is to illustrate
the rather considerable variability over time in the
projections that we make. I am going to focus on Medicare.
Ten years ago we foresaw a long-term Medicare deficit,
measured as a percent of payroll, of over 3 percentage points.
Three years ago, in 1997, we foresaw a deficit of over 4
percentage points of payroll. As a result of the strong economy
and legislation enacted in 1997, the Balanced Budget Act of
1997, we currently project the long-run deficit in Medicare of
1.2 percent, less than one-third as large as what we projected
just 3 years ago. The point of this is that a combination of
significant, but not really radical, legislation and a stronger
economy than we anticipated just 3 years ago, compounded out
for 75 years, has completely transformed the character of the
financial problem that we see in Medicare. Rather than having
an enormous hill to climb, there remains a problem, but one
that I think successive Congresses will be able to deal with.
The simple fact is, when one goes out into very long-term
projections, the likelihood that the numbers we are currently
projecting will actually be realized diminishes sharply. We do
not know how to make accurate forecasts over very long time
periods. Just with respect to the budget, there is a trillion-
dollar error over the last 5 years. And I might add that error
is purged of all effects of policy change. The trillion-dollar
error results exclusively from changed forecasting methods and
economic assumptions.
If we can make mistakes of that magnitude looking just a
few years ahead, we should, I think, understand that the
projections we make in the very distant future are highly
uncertain. It doesn't mean they are wrong, and it doesn't mean
they are biased, and it doesn't mean we should ignore them. But
I think it does mean we should be careful about undertaking
radical action that will have immediate effects on today's
population based on projections of the quite distant future.
I think we can all agree Social Security and Medicare
currently are running large cash flow surpluses. We could all
agree that they face significant projected long-term deficits,
and I think we can all agree that current action to deal with
those long-term deficits is in order. We probably won't agree
on what the character of those actions should be.
The second section of my testimony deals with the
arithmetic of transferring payroll taxes from Social Security
to individual accounts along the lines that Governor Bush has
proposed. I am not going to spend any time on that. I ask that
it be part of my printed testimony.
The next section presents what I think is a persuasive
argument for why it does, indeed, make sense to transfer
general revenues, both to Social Security and to Medicare. And,
indeed, the testimony has implications for what the size of
those general revenue transfers should be. But I would like to
spend the rest of my time on a question that I gather was
raised by Mr. Crippen and I know has been of concern to many
Members of Congress. That question is whether the Social
Security trust fund is real or somehow imaginary.
Many analysts have claimed that Social Security and
Medicare reserves are just accounting mechanisms, that the
trust funds hold only paper assets. They sometimes claim that
the accumulation of large trust fund balances does not do
anything to improve Government's ability to meet future
benefits. This view, I believe, is simply and flatly wrong, and
I would like to explain why.
One has to start, I think, by acknowledging that Government
accounting conventions contain many arbitrary rules, and that
if different conventions had been adopted, budget accounts
would look rather different from the way they do right now.
Professor Larry Kotlikoff, from whom you are going to hear
presently, has contributed greatly to our understanding of
these anomalies by pointing out these problems in a series of
articles that have appeared in economics journals, and you may
hear more about that today.
But the issue here is not whether Government accounts are
logically consistent constructs. The issue, rather, is whether
a policy of collecting more in taxes earmarked for Social
Security than is paid in Social Security benefits today
contributes to the Nation's and the Government's capacity to
meet future benefit obligations. The answer to both of those
questions, I believe, is yes, and the issue isn't even close.
The first step is to recognize that the direct effects on
private investment of adding $1 billion to Social Security
reserves or to individual accounts are identical, as shown in
Table 6 in my testimony. Given Government spending and revenues
outside Social Security, a $1 billion cash flow surplus in
Social Security and a $1 billion addition to private saving
directly add to funds available for private investment in
exactly the same way and in exactly the same amount. In each
case, the return to the Nation is $1 billion multiplied by the
private marginal productivity of capital.
That table demonstrates that the answer to the first
question I posed--does the accumulation of Social Security
reserves increase the Nation's capacity to pay pensions in the
future, the Nation's capacity?--is a clear and unambiguous yes.
The accumulation of reserves also shifts the asset position of
the Federal Government. The accumulation of a billion dollars
in Social Security reserves means that future taxpayers will be
spared $1 billion in taxes to pay for any given future level of
benefits. Pay more taxes today, and we have to pay fewer taxes
in the future.
To be sure, some form of financial transaction is going to
be necessary----
Chairman Kasich. Mr. Aaron, can I ask you just a question
on that point?
Mr. Aaron. Yes, please.
Chairman Kasich. Does that presume that it is not then
spent?
Mr. Aaron. I am taking the rest of Government operations as
given. So that what we are doing is we are adding----
Chairman Kasich. In other words, if we are running a
surplus in Social Security, you are presuming that money is
being used to retire debt.
Mr. Aaron. Correct.
Chairman Kasich. Not being used to spend.
Mr. Aaron. That is correct. In effect, what I am saying is
that I think the position----
Chairman Kasich. Whether you save here or save there, it is
savings.
Mr. Aaron. I am taking the position, I think, that members
in both parties in Congress and both presidential candidates
have embraced, which is you should treat Social Security
reserves, in effect, as a locked box. Balance the rest of the
budget, do what one thinks is wise there.
Chairman Kasich. You are not betting any money on that, are
you, that that is going to happen?
Mr. Aaron. I think the chances are not bad. I trust you,
Mr. Kasich, and I trust----
Chairman Kasich. Well, Henry, I have got to, you know, just
like having a name like Henry Aaron, I have just got to say,
you know, if you ask me, ``Say it ain't so,'' I couldn't tell
you that. We will spend a big chunk of it. But go ahead. We
already have. But go ahead.
Mr. Aaron. I think what has been happening is that you have
been spending a chunk of the projected surpluses in the non-
Social Security budget. Whether we are going to dip into the
Social Security reserves to use those to justify tax cuts or
spending increases, I think there would be a very hard case
that a Member of Congress would have to make to get that
through Congress today.
Let me turn to the paper assets point. The statement that
Social Security reserves are only paper assets is true at an
insignificant level and is false in substance. Neither Social
Security nor private financial savers, including individuals
and pension funds, hold real assets in their accounts. Both
hold IOUs, paper promises of some private or public entity to
pay interest or dividends. In each case, the assets are only as
good as the willingness of someone to redeem the assets or to
buy them before maturity. In each case, any future need to cash
in reserves to meet current obligations would reduce national
saving. The only difference between the reserves of Social
Security and those of private savers is that Social Security
reserves consist entirely of gilt-edged Federal securities
guaranteed as to principal and interest by the Federal
Government because Federal law restricts Social Security
trustees to invest only in those assets.
Private savers, in contrast, can invest in assets that
carry higher yields because the companies issuing them face
some risk of bankruptcy. Social Security reserves are as real
as the reserves of any private pension fund, personal brokerage
account or corporate reserves.
The view that the trust fund assets are not real confuses
two distinct questions: whether trust fund accumulation adds to
national saving, investment, and the capacity to pay future
pension benefits and whether Government budget operations on
accounts other than Social Security add to national saving,
investment, and capacity to pay future benefits.
As noted, the additions to Social Security reserves add to
national saving and the capacity of the Government to meet
future pension obligations in precisely the same sense that
additions to private savings accounts add to national saving
and the capacity of savers to meet their debts.
The concluding section of my testimony deals with some
comments on the proposed repeal of 1993 legislation, which
subjected an increased portion of Social Security benefits to
personal income tax. It argues that the repeal of that
legislation at this time would be unwise.
Thank you very much, Mr. Chairman.
[The prepared statement of Henry J. Aaron follows:]
Prepared Statement of Henry J. Aaron, Bruce and Virginia MacLaury
Senior Fellow, the Brookings Institution
Mr. Chairman, thank you for the invitation to testify today on
entitlement reform. This topic raises so many issues that the limits of
time demand that one be selective.
I should like to start with some observations with which I think
everyone on this committee and all those sitting before you agree.
First, current long-run projections indicate that neither
Social Security nor Medicare will have enough revenue under current law
to pay for all the benefits promised under current law. Each faces a
long-term financing problem, and the sooner Congress acts to deal with
those problems the better.
Second, the long-run projections of both programs have
improved in recent years--dramatically in the case of Medicare and
significantly, but less dramatically in the case of Social Security.
Third, both programs are now running sizeable cash flow
surpluses and these surpluses are currently projected to continue
throughout the forthcoming decade and beyond. Social Security has
sufficient revenues to pay all currently promised benefits for the next
thirty-seven years, Medicare for about the next twenty-five. These
facts mean that talk of ``crisis'' is hyperbolic nonsense. But they do
not contradict the existence of a projected, long-run financing problem
or excuse Congress and the next president from moving expeditiously to
solve it.
Fourth, whether one favors or opposes the diversion of
part of the current payroll tax to underwrite the creation of
individual savings accounts, reducing revenues flowing to Social
Security will increase the size of the cuts in Social Security benefits
necessary to restore balance in that program. This is a matter of
simple arithmetic. We may disagree on the likelihood that balances
accumulated in such individual accounts will compensate workers for the
cuts in Social Security benefits. That is an issue to which I shall
return presently.
I should also like to comment on two other matters. The first is
the claim that Social Security and Medicare reserves are just
accounting mechanisms, that all it holds are ``paper'' assets, and that
the existence of large trust fund balances does not have any impact on
the Government's ability to pay benefits. This view is simply wrong,
and I shall explain why. The final issue that I shall address in my
testimony is the legislative proposal, now under discussion, to repeal
the 1993 legislation mandating couples with taxable incomes above
$44,000 and single persons with incomes above $34,000 to include 85
percent of their Social Security benefits in taxable incomes, revenues
from which are now deposited in the Medicare Trust Fund. I shall
explain why repeal of this tax has no analytic justification.
the financial condition of social security and medicare
The long-run financial projections for both Social Security and
Medicare indicate that the programs face sizeable projected long-term
deficits. This fact is well-known. What is less well known is that
these projections have been quite volatile and that further sizeable
adjustments can be expected. Table 1 illustrates both the existence of
financial problems and the volatility of projections. The projected
long-run deficit in Medicare is now 72 percent smaller than it was just
3 years ago. The Balanced Budget Act of 1997 explains most of the
change, but the projected Medicare deficit today would be more than
twice as large as it is, were it not for other changes. The improvement
in the financial status of Social Security is less dramatic, but still
significant--the projected long-term deficit is 15 percent smaller than
it was 3 years ago.
Even more striking has been the inaccuracy in projections of
balance in the fund in specific years. I have picked the year 2000 to
illustrate the problem. Just 3 years ago, Medicare was projected to run
a $32 billion deficit in 2000. It fact, it will run a $28 billion
surplus, a $60 billion swing in just 3 years. The Social Security
surplus is also about $60 billion larger than projected just 3 years
ago, and without significant legislative change. These errors
illustrate that even very skilled professionals fail to make accurate
projections, even in the near term balance of these two programs. These
projections also illustrate that both programs are now collecting much
more than they are spending and that results are better than
anticipated just a few years ago. To label this situation a crisis
makes little sense.
As one looks into the more distant future, the uncertainty of
projections increases. The reason is that long-term projections depend
on extrapolations of assumed growth rates. Small errors in assumptions
regarding compound growth rates cumulate into massive errors after
periods as long as the seventy-five year projection periods used for
Social Security and Medicare. If real wages were to grow half a percent
a year faster than assumed by the actuaries--a rate that is below the
actual record of the last 3 years--real earnings seventy-five years
hence would be 45 percent higher than the current projections assume
and the projected deficits in Social Security and Medicare would be 27
percent and 14 percent smaller, respectively, than current official
projections indicate. On the other hand, sharper decreases in mortality
rates than now assumed could result in significantly larger deficits
than current projections indicate. The simple fact is that we do not
know how to make accurate forecasts, over very long periods, of any of
the variables on which Social Security and Medicare projections
depend--birth rates, death rates, productivity growth, disability
rates, immigration rates, real interest rates, the rate and character
of advance in medical science, or the evolution of institutions to hold
down medical costs. If you doubt me, I invite you to examine previous
projections of each of these variables contained in past Trustees
Reports. Current projections may be too optimistic. They may be too
pessimistic. But they will assuredly be wrong--despite the best efforts
of some of the most competent and dedicated professionals working in
the pension and health insurance fields.
This fact does not mean that they are biased or that we should
ignore long-term projections. They are based on reasonable, if
unreliable, assumptions regarding key variables that lie well within
the rather wide range of estimates of responsible analysts. The
projections are signals that problems may well lie in the future. Given
the length of pension promises and the need for gradualism in modifying
those promises, we should gradually introduce changes when long-run
projections indicate that problems probably lie ahead. It would be
imprudent in the extreme to make abrupt changes based on long-term
financial projections, particularly when--as now--financial balances
are currently favorable and expected to remain that way. But it would
also be imprudent to ignore the warning signals and do nothing now. We
should act promptly to phase in changes to close projected long-term
deficits. And we should recognize that as more information becomes
available, we may undo those changes or we may do more.
the simple arithmetic of diverting payroll taxes to individual accounts
Many people favor the creation of individual accounts as a partial
or complete substitute for Social Security. Some propose to fund these
accounts out of general revenues. When some part of the pensions based
on these individual accounts is used to reduce Social Security
benefits, this approach can indirectly reduce the projected long-term
deficit in Social Security. This is the approach used, for example, in
the Archer/Shaw bill.
Other so-called ``carve-out'' plans, such as those of Senator Kerry
and Governor Bush, would divert part of the current payroll tax from
the Social Security system. Their plans would carve out part of the
payroll tax, which would then be directed to individual accounts. They
would cut Social Security benefits enough to restore projected long-
term balance.
The first point to recognize is that by subtracting
revenues from the Social Security system, these plans force larger cuts
than would otherwise be necessary to restore financial balance in that
system. On the other hand, pensioners would have the balances in their
individual accounts with which they could (or, in some plans, would
have to) buy annuities.
This trade raises several practical questions:
Will the individual-account-based pensions fully
compensate pensioners for the Social Security cuts?
Will the individual-account-based pensions be inflation
protected?
Will individual account holders be required to convert
their accounts into annuities? If not, what happens to those who are
imprudent or unlucky, exhaust their accounts, and find themselves
dependent on much-reduced Social Security benefits.
the bush plan as illustration
As far as Governor Bush's proposal is concerned, I have no idea
about how he would answer the second and third questions because his
statements so far have been confined to broad principles and do not
address many of the difficult technical questions with which, to their
credit Senator Kerry and Representatives Archer and Shaw have grappled.
But some simple arithmetic suffices to answer the first of these
questions ``What will be the effect of the proposal on retirement
income?'' Tables 2, 3, and 4, from a report \1\ by Alan Blinder, Alicia
Munnell, Peter Orszag and me, provide the answer.
---------------------------------------------------------------------------
\1\ Governor Bush's Individual Account Proposal: Implications for
Retirement Benefits, Issue Brief No. 11, The Century Foundation,
www.tcf.org or www.socsec.org.
---------------------------------------------------------------------------
average benefit cuts
If one were to use benefit cuts to close the gap,
proportional cuts relative to current law in Social Security benefits
of 41 percent for all workers would restore long-term financial balance
(Table 2).
We derived this conclusion from the following basic arithmetic. The
cost of the benefits that Governor Bush does not promise to leave
unchanged is 9.2 percent of taxable payroll. The current deficit is
1.89 percent of payroll. If one diverts to individual accounts 2
percentage points of the payroll tax starting in 2002, the size of the
deficit rises to 3.8 percent of payroll--3.8/9.2 = 0.41.
phased benefit cuts
The foregoing estimate assumes that benefits are cut abruptly and
equally for all workers who are covered, even briefly, under the new
individual account system. Such a policy would be unfair, however.
Older workers would have little time to build up individual account
balances and would suffer major reductions in their pensions. Younger
workers would fare better because their individual accounts would have
more years to build up.
Accordingly, we calculated a phased-in reduction in Social Security
cuts, so that the change in the combined Social Security benefit and
individual-account-based-pensions would be the same for workers of all
ages. Table 3 shows the cuts in Social Security benefits for the
average earner.
Under this more realistic schedule, Social Security
benefits would have to be cut 25 percent for 55-year-old workers and 54
percent for workers age 30 or younger.
overall effect
Table 4 shows the combined effect of the Social Security benefit
cut and the partly offsetting pension that could be financed by the
individual account.
Total benefits are cut 20 percent relative to current law
for the average single earner who earns the average rate on individual
accounts assumed by the Bush advisers.
risk
Average earners who happened to experience the lowest rate of
return actually observed over a thirty-five year historical period
(1947-1981) would have earned less in their individual accounts and
would experience an overall reduction of 38 percent relative to current
law. Average earners who received the highest rate of return actually
observed over a thirty-five year historical period (1965-1999) would
have earned more on their individual accounts and would have no cut in
benefits relative to current law.
high and low earners
All of the foregoing statements apply only to average single
earners. Table 5 shows the effects of the partial shift to individual
accounts on married earners and on workers who have above- or below-
average earnings. Married workers experience larger cuts in their
combined benefits because their Social Security benefits--and hence
their benefit cuts--are larger absolutely than those of single workers,
yet their individual accounts will be the same. Low earners experience
larger cuts in their combined benefits because the Social Security
benefit formula favors low earners while individual accounts do not.
Under the Bush plan, cuts in combined Social Security and individual
account benefits for married, low-earners who receive lower-than-
average returns on their individual accounts could approach 50 percent.
can the disabled, current retirees, and older workers be protected?
Despite claims in the Bush plan that the disabled, current
retirees, and those near retirement would be spared all benefit cuts,
it is difficult to believe that Congress--or, indeed, Mr. Bush on
fuller consideration--would decide to cut retirement benefits for
younger workers by 50 percent or even more and leave the disabled,
older workers, and current retirees wholly insulated from benefit
reductions. I believe that few elected officials would think it fair to
subject some Americans to large benefits cuts yet spare others from any
cuts at all.
can general revenues soften the blow?
Benefit cuts would be smaller than I have indicated if a plan
transfers general revenues to the Social Security fund. Based on
revenue and expenditure projections based on current law, official
projections indicate that there will be sufficient general fund
revenues to support sizeable transfers--$2.2 trillion over the next
decade alone, according to the most recent CBO projections.
However, these projections misstate the budget situation for
several reasons. First, as this committee knows well, this projection
assumes that growth of discretionary spending will not exceed
inflation. Neither party has shown a willingness to live within such
tight constraints. Neither Republicans nor Democrats, as groups, have
recently shown a willingness to hold discretionary spending growth as
low as the rate of inflation.
Second, both parties have agreed that cash flow surpluses in Social
Security should not be used to justify spending increases or tax cuts.
The logic is that these reserves (and more) will be needed to pay for
future benefits. Yet the same logic applies to Medicare reserves and to
balances accumulating in the Civil Service Retirement System, both of
which are now counted toward the projected budget surpluses. Both
should be removed. Doing so would reduce the projected surpluses by
approximately $500 billion over the next decade, reducing the projected
surpluses to $1.7 trillion. Adjusting the AMT for inflation and various
other tax extenders will reduce revenues by about $150 billion over the
next decade, leaving a projected surplus of about $1.55 trillion. As it
happens $1.55 trillion exactly matches the cost of the tax cut that
Governor George W. Bush has proposed, as estimated by the Joint
Committee on Taxation, plus added interest costs that would be
generated by the tax cut.
In short, if the candidate for president who supports
individual accounts is elected, his other policies are adopted, and one
uses plausible budget projections, there would be no funds to transfer
to Social Security, unless the deficit financing pays for the
transfers.
Martin Feldstein has argued that establishing individual accounts
would boost national saving and that the corporate profits taxes
generated by a larger capital stock could be transferred to Social
Security to reduce the size of benefit cuts that would otherwise be
necessary. The claim that individual accounts would boost national
saving is without foundation, however. As indicated, the general
revenue transfers would have to be financed by borrowing from the
public; and each dollar of payroll taxes transferred to individual
accounts would force the government either to borrow $1 more or pay
down the Federal debt $1 less for each dollar deposited in individual
accounts, a wash transaction that would not tend to boost saving at
all.
If, on the other hand, large tax cuts are not enacted, the general
fund is likely to generate some surpluses--although not as large as
current CBO or OMB projections would lead one to think--and resources
would be available to support general revenue transfers to Social
Security.
why general revenue transfers make sense
General revenue transfers to Social Security do make sense. The
program's unfunded liability is more properly viewed as an obligation
of the American people as a whole than of future workers based on their
earnings.
Early Social Security beneficiaries received benefits worth far
more than the payroll taxes they and their employers paid. Money to pay
these extra benefits came from the payroll tax collections of still-
active workers. The period when cumulative benefits to new retirees
will be worth more than the payroll taxes paid by them and their
employers is coming to an end. Current retirees and those who will
retire in the future will, on the average, receive benefits worth no
more than the taxes they have paid, cumulated at a modest real rate of
return. Thus, Social Security will not be generating new unfunded
liabilities for future retirees.
Whether or not one thinks that the payment of comparatively
generous benefits to early Social Security retirees was a good or a bad
idea, that action cannot now be undone. The reserves not accumulated to
support benefits of future retirees is an obligation that we must meet,
one way or another. The question is: who should meet it? Under current
law, the cost of paying for this unfunded liability falls on workers,
in proportion to their earnings. The rationale for this policy is
difficult to comprehend. They will be receiving in benefits no more
than they and their employers will be paying in taxes. The unfunded
liability, like the national debt, should be recognized as a general
obligation of the American people. To be sure, workers are a large part
of the American people and their earnings are a large part of the
overall tax base. But I know no one who would suggest financing the
pay-down of the national debt or interest payments on that debt
exclusively from the payroll tax, and there is no good reason for
distinguishing Social Security's unfunded liability from general
obligations of the Federal Government.
social security trust fund--phony or real?
Some analysts have claimed that Social Security and Medicare
reserves are just accounting mechanisms, that the Trust Funds only hold
``paper'' assets. They sometimes claim that the accumulation of large
trust fund balances does nothing to improve the Government's ability to
pay future benefits. This view is simply wrong.
One should begin by acknowledging that government accounting
provisions contain many arbitrary conventions and that if different
conventions had been adopted, budget accounts would look different from
the way they do now. Professor Laurence Kotlikoff, among others, has
contributed greatly to our understanding of these anomalies by pointing
out these problems in a series of articles in economics journals. But
the issue here is not whether government accounts are logically
consistent constructs. The issue is whether a policy of collecting more
in taxes earmarked for Social Security than is paid in Social Security
benefits contributes to the nation's and the government's capacity to
meet future benefit obligations. The answer to both questions is
``yes,'' and the issue is not even close.
The first step is to recognize that the direct effects on private
investment of adding $1 billion to Social Security reserves or to
individual accounts are identical, as shown in Table 6. Given
government spending and revenues outside Social Security, a $1 billion
cash flow surplus in Social Security and $1 billion of private saving
directly add to funds available for private investment in exactly the
same way and in the same amount. In each case, the return to the nation
is $1 billion multiplied by the private, marginal productivity of
capital. Table 6 demonstrates that the answer to the first question I
posed--does the accumulation of Social Security reserves increase the
nation's capacity to pay pensions in the future--is a clear and
unambiguous ``yes.''
The accumulation of reserves also shifts the asset position of the
Federal Government. The accumulation of $1 billion in Social Security
reserves means that future taxpayers will be spared $1 billion in taxes
to pay for any given level of future benefits. By paying more in taxes
today, we shall have to pay less taxes in the future. To be sure, some
form of financial transaction will be necessary to pay for those future
benefits, but that is true everywhere and always when savers cash in
assets to pay for something they want to buy. Private savers must
reduce future saving or increase borrowing when they cash in assets
they have accumulated. The Social Security Administration will have to
do the same.
The statement that Social Security reserves are only ``paper
assets'' is true at an insignificant level that has no significance,
and is false in substance. Neither Social Security nor private
financial savers, including individuals and pension funds, hold
``real'' assets in their accounts. Both hold IOUs--paper promises of
some private or public entity to pay interest or dividends. In each
case, the assets are only as good as the willingness of someone to
redeem the assets or buy them before maturity. In each case, any future
need to cash in reserves to meet current obligations would reduce
national saving. The only difference between reserves of Social
Security and those of private savers is that Social Security's reserves
consist entirely of ``gild-edged'' Federal securities, because Federal
law restricts Social Security trustees to invest only in securities
guaranteed as to principal and interest by the Federal Government,
while private savers can invest in assets in private securities, which
carry higher yields because the companies issuing them face some risk
of bankruptcy. Social Security reserves are as real as the reserves of
any private pension fund, personal brokerage account, or corporate
reserves.
This view that Trust fund assets are not real confuses two distinct
questions: whether trust fund accumulation adds to national saving,
investment, and the capacity to pay future pension benefits; and
whether government budget operations on accounts other than Social
Security add to national saving, investment, and the capacity to pay
future benefits. As noted, additions to Social Security reserves add to
national saving and the capacity of the government to meet future
pension obligations in precisely the same sense that additions to
private savings accounts add to national saving and the capacity of
savers to meet their debts.
On the other hand, simultaneous deficits in the non-Social Security
budget can subtract from national saving. From fiscal year 1983 through
fiscal year 1999, Social Security ran surpluses--thereby adding to
national saving--but deficits in the rest of government operations
subtracted from national saving. From 1983 through 1997, the deficits
on non-Social Security accounts exceeded Social Security surpluses so
that the Federal Government as a whole ran deficits, thereby reducing
national saving. In 1998 the Social Security surpluses exceeded the
deficit on the rest of government operations. And starting in 1999 the
Federal Government began to run surpluses both in Social Security and
in the rest of government operations. In no case, however, does the
fact that non-Social Security operations of government are in deficit
contradict the fact that additions to Social Security reserves add to
national saving, productive capacity, and the government's balance
sheet, thereby increasing the capacity of Federal Government and of the
nation to meet future pension obligations.
taxation of social security benefits
In 1983, President Reagan signed into law a bill under which only
half of Social Security benefits would be included in income subject to
tax and only to the extent that couples' incomes exceeded $32,000 and
single persons' income exceeded $25,000. The revenues were to be
transferred to the OASDI trust funds. In 1993, President Clinton signed
into law a provision that 85 percent of Social Security benefits would
be included in income subject to tax, but only to the extent that
couples' incomes exceeded $44,000 and single filers' incomes exceeded
$34,000. The revenues were to be transferred to the Medicare trust
fund. There would be no income thresholds below which Social Security
income would be exempt.
The rules applied to taxing Social Security are patterned on, but
are more lenient than, those applied to taxation of contributory
private pensions. Pensioners are required to include private pensions
in income subject to tax pensions only to the extent that they
represent the repayment of contributions out of previously taxed
income. If the same rules were applied to Social Security, workers
would be required to include in income subject to tax all Social
Security benefits in excess of a portion equal to their own payroll tax
payments, but the rest of benefits would be subject to tax.
In 1979, I chaired the Advisory Council on Social Security which
reported that if that rule were applied to workers retiring at that
time, less than 15 percent of benefits would be excluded from income
subject to tax for any worker and the percentage would be lower for
most workers. That meant that 85 percent or more of Social Security
benefits should be included in income subject to tax if they were to be
treated in the same way as contributory private pensions.
Even after the 1993 legislation, Social Security benefits are
treated more favorably than are contributory private pensions. On
grounds of tax policy, there is no basis for repealing the tax enacted
in 1993. It is needed for the proper definition of an income tax base.
To be sure, there is no particular reason for allocating revenue from
the taxation of Social Security benefits to either the Social Security
or the Medicare trust fund any more than there is justification for
transferring revenues from taxing private pensions to private pension
funds. But, as I have noted, there is a good case for general revenue
transfers to Social Security; and the same logic applies to Medicare.
Since both programs face projected long-term deficits and since the
current tax treatment of Social Security is still more favorable than
that of contributory private pensions, I believe that there is no
analytical justification for reducing this tax at this time.
TABLE 1
----------------------------------------------------------------------------------------------------------------
Social Security Medicare
-------------------------------------------------------------------------------
Projection year 75 Year balance Balance in 2000 75 Year balance Balance in 2000
(percent of (billions of (percent of (billions of
payroll) dollars) payroll) dollars)
----------------------------------------------------------------------------------------------------------------
1990............................ -0.91 +150 (est.) -3.26 -23.9
1995............................ -2.17 +95.7 -3.62 -16.9
1997............................ -2.23 +91.7 -4.32 -37.9
2000............................ -1.89 +153.8 -1.21 -22.3
----------------------------------------------------------------------------------------------------------------
Source: Trustees Reports, selected years.
TABLE 2.--THE SIMPLE ARITHMETIC OF THE BUSH PLAN
------------------------------------------------------------------------
Percent of taxable
payroll
------------------------------------------------------------------------
Current law 75-year cost of Social Security.... 15.4
Less ``protected benefits''................ -6.2
= Unprotected benefits (available for cuts) 9.2
Projected long-term imbalance.................. 1.89
------------------------------------------------------------------------
Source: Social Security Trustees Reports and calculations of Henry
Aaron, Alan Blinder, Alicia Munnell, and Peter Orszag.
TABLE 3.--SOCIAL SECURITY BENEFIT REDUCTIONS
[Phased-in to reflect time to accumulate accounts]
------------------------------------------------------------------------
Reduction relative to current
Age in 2002 law
------------------------------------------------------------------------
55...................................... -25%
50...................................... -29%
45...................................... -33%
40...................................... -39%
35...................................... -46%
30...................................... -54%
25...................................... -54%
------------------------------------------------------------------------
Source: Social Security Trustees Reports and calculations of Henry
Aaron, Alan Blinder, Alicia Munnell, and Peter Orszag.
TABLE 4.--COMBINED RETIREMENT BENEFIT
[Including individual account]
------------------------------------------------------------------------
30-year-old single average earner
($31,685 in 2000)
------------------------------------------------------------------------
Current-law benefit................ $15,877
Minus: 54% reduction............... -$8,510
Plus: Average individual account... +$5,305
Total........................ $12,672
Change relative to current law..... -$3,205 (-20%)
------------------------------------------------------------------------
Source: Social Security Trustees Reports and calculations of Henry
Aaron, Alan Blinder, Alicia Munnell, and Peter Orszag.
TABLE 5.--COMBINED RETIREMENT BENEFIT
[Including individual account for workers age 30 or younger]
------------------------------------------------------------------------
Single Married
------------------------------------------------------------------------
Low earner.................................... -29% -38%
Average earner................................ -20% -33%
High earner................................... -3% -22%
------------------------------------------------------------------------
Source: Social Security Trustees Reports and calculations of Henry
Aaron, Alan Blinder, Alicia Munnell, and Peter Orszag.
TABLE 6.--WHAT HAPPENS WHEN WE SAVE $1 BILLION?
------------------------------------------------------------------------
Addition to
Private saving Social Security
reserves
------------------------------------------------------------------------
Private savers save.......... +$1 billion Social Security +$1 billion
reserves rise.
Social Security +$1 billion
trustees buy
additional
government
bonds.
Government +$1 billion
sells fewer
bonds to
private sector.
Private saving available for +$1 billion Private saving +$1 billion
private investment. available for
private
investment
rises.
U.S.-owned capital stock +$1 billion U.S.-owned +$1 billion
grows. capital stock
grows.
------------------------------------------------------------------------
In either case the return equals $1 billion times private rate of
return.
Chairman Kasich. Mr. Aaron, I am going to have Pete du Pont
respond to you, but I would agree with you that if we took
Social Security surplus and we use it to pay down debt, in
fact, part of the argument now is we should not only take the
off-budget surplus and use it to pay down debt, but to take as
much of the on-budget surplus as we can, these dramatically-
improved forecasts, and use it to pay down debt because it gets
us ahead of the game.
The problem is though that if you have a $4.6-trillion
surplus over the next 10 years, and your projections are for a
$337-trillion shortfall in both Social Security and Medicare
combined, then the $4.6 trillion compared to the $337 trillion
obviously gets dramatically overwhelmed, correct?
Mr. Aaron. Actually, no, it isn't correct. And the reason
it is not correct is that you are referring to periods of
radically different duration to some of those numbers.
Chairman Kasich. No, that is correct.
Mr. Aaron. In fact, were you to transfer instantly, this
afternoon, $2.9 trillion of general revenues to the Social
Security trust fund, the system would be in actuarial balance
over the next 75 years.
Chairman Kasich. Right. But the actuarial balance is based
on the notion that somehow we are going to honor these IOUs.
Mr. Aaron. I could not imagine the United States Government
reneging on its debt, and I hope you can't either.
Chairman Kasich. Let me ask you this question: How do you
think that is going to happen?
Mr. Aaron. How do I think what is going to happen?
Chairman Kasich. How are you going to honor those IOUs?
Where are you going to get the money from?
Mr. Aaron. The same way we have always honored them. The
Government has never reneged on its public debt once.
Chairman Kasich. We have never had the demographic
challenge that we have now. I mean, how would we do it? Tell me
how you would do it.
Mr. Aaron. The public debt, even if you use the gross debt,
not the debt in the hands of the public, has been declining in
recent years as a share of our GDP. And debt in the hands of
the public is now lower than it has been in probably 2 or 3
decades. The projections are that debt in the hands of the
public will continue to diminish. What that means is that by
paying down the debt today and even conceivably building up
positive assets, publicly-held assets, we are preparing
ourselves to meet the very costs that you describe in the
future.
Pensions are transfers from the active population to the
inactive population. From the 40 years from 2000 until 2040,
the number of people that each active worker will have to feed
goes up 6 percent, not the huge numbers that you hear thrown
around. In fact, as the elderly increase as a share of the
population, children as a percent of the population go down,
and labor force participation is projected to increase. So the
actual burden that workers are going to be carrying to support
the inactive population goes up, but it goes up relatively
modestly. And if we save now and increase productive capacity,
we can meet those obligations.
Chairman Kasich. Well, but Mr. Penny just testified that
Medicare will not be collecting enough revenues to meet the
demands in 10 years. Social Security will not be collecting
enough revenue in 14 years to meet the demands.
Mr. Aaron. Actually, Medicare can pay all its bills for 25
years, Social Security for 37 years. Even cash flow surpluses
remain positive a little longer than Mr. Penny indicated. And
in both cases there are reserves which could be used to support
benefits. Medicare now has a larger window of financial
solvency than it has had at any time since it was enacted.
Chairman Kasich. Well, that is the issue of solvency.
Mr. Aaron. Yes.
Chairman Kasich. Solvency isn't the issue. The issue is
when the bills come due, how do you pay them? Do you pay them
by raising taxes? Do you pay them by raiding other programs?
How do you pay your bills when they come due? You won't have
enough money to pay them, so where do you get the money from?
Mr. Aaron. As with the purchase of a house or sending our
children to college----
Chairman Kasich. Go in debt.
Mr. Aaron. Planning, prudent planning is to start saving
early.
Chairman Kasich. Right.
Mr. Aaron. Then when the expense comes, you have the income
from those assets to help you meet those costs.
Chairman Kasich. This is only 10 years away for Medicare
and only 15/14 years away for Social Security.
Mr. Aaron. Oh, it is actually sooner than that. The baby
boomers start retiring in 2008.
Chairman Kasich. Right. So we won't have enough money. So
what is all of this prudent planning? You are going to have, I
mean, it would be like my barber, who is trying to set some
money aside to pay for his daughter's education, and then she
announces she is going to a school that costs $35,000 a year.
He can't pay for it. I mean, in other words, what is coming
over the wall is so big that the kind of action we would have
to take today wouldn't be enough to keep the waves from coming
over the wall. I mean, we are putting up two sandbags, and we
have got the ``Perfect Storm'' coming our way.
Let me ask Mr. du Pont to make a comment on this and Mr.
Penny.
Mr. du Pont. Well, Mr. Chairman, I can't disagree with Mr.
Aaron's comment that a dollar is a dollar, and a dollar surplus
in Social Security helps you just as a dollar of saving in the
private sector helps you. That is certainly true. But as a I
said in my testimony, this is not a small problem. When the
baby boom generation retires, we are going to double the number
of people who get Social Security benefits. We are going to
double from where we are today. I don't see how $2.9 billion
transferred this afternoon----
Mr. Aaron. Trillion.
Mr. du Pont. Trillion dollars, transferred this afternoon
can solve a doubling of the retirement population. I mean, the
arithmetic isn't there. If you cut off how far you go out in
time, you can always make it look a little bit better. I mean,
you can say if you cut it off at 10 years, well, we are fine;
if you cut it off at 20 years, well, we are not in much
trouble. But if you look at the number of people who are
working, who are entitled to benefits, and as that number is
going to double over time, there is a problem, and I don't
think $2.9 trillion will simply wash that away.
Mr. Aaron. This isn't a matter of opinion. This number
comes courtesy of Stephen Goss, who is the deputy chief
actuary. They have a continuing calculation that is done as
part of the long-term projections. It is the direct analog of
all of the projections that we commonly use.
Chairman Kasich. This is all about actuarial soundness.
That is a presumption that somehow my two young girls are going
to be chained to a machine about 22 hours a day to have to pay
those bonds. That is the problem with your actuarial soundness.
Mr. Aaron. No, it isn't. With due respect, sir, that is not
correct.
Chairman Kasich. Sure, it is correct.
Mr. Aaron. It isn't. I don't believe so.
Chairman Kasich. You have fewer workers, you have
dramatically fewer workers, dramatically more beneficiaries,
you have the benefits growing by faster than the rate of
inflation. I mean, the numbers are pretty simple. I don't know
who this guy is, but I know that----
Mr. Aaron. He is the guy that produces the projections we
all rely on.
Chairman Kasich. Well, he makes the projections to say that
somehow this program is actuarially sound. That is based on the
presumption you are going to take--that these IOUs are
ultimately going to count for something.
Mr. Penny, do you want to make a comment?
Mr. Penny. Well, I thought you were going to respond.
Mr. Aaron. No, go ahead.
Mr. Penny. The point that you keep stressing, Mr. Chairman,
is to remind us that this is a pay-as-you-go proposition. And
payroll tax collections will be insufficient to meet annual
benefits in the Medicare program by 2010, in the Social
Security program by 2015. Once you reach a point where we have
to begin relying on reserves, you have to come up with the
cash. And Mr. Aaron continues to insist that somehow because
these are assets that have the full faith of the Federal
Government behind them that they are not any different than any
other sort of investment, and therefore we can count on it,
ignores the fact that in order to honor these IOUs in the trust
fund we have to make some other adjustment in the budget at
that time. It is not money in the bank that we can simply grab
hold of.
There is something to be said about paying down debt in the
near term, which will ease our interest payments on an annual
basis, and you could then have those interest savings in the
budget in year 2011, 2012, 2013, to honor some of our trust
fund obligations, but it won't be enough. Even if you pay off
the debt, those interest savings are not enough, in an ongoing
basis, to pay all of the promised benefits in this system. So
something else will have to give.
And with the declining worker-to-retiree ratio, there are
only three options available to us: One is to borrow once again
and begin increasing our debt, having spent a decade or more
paying down our debt; the other is to cut dramatically the
other programs of Government so as to make money available for
a general fund transfer into the Social Security and Medicare
systems; or the third is to burden future taxpayers with higher
payroll taxes. These are explicit choices that will need to be
made unless some miracle happens, whether it is higher
immigration rates that expand dramatically our workforce,
whether it is some other growth in our economy that just
continues unabated for the next 2 decades, but that is betting
on the come, and I don't think that is prudent public policy.
Chairman Kasich. Just one other question for Mr. Aaron.
When you talk about Mr. Goss, you are talking about actuary
soundness; is that correct? That is his argument----
Mr. Aaron. He is an actuary, yes.
Chairman Kasich. That the bonds actually will be honored.
Mr. Aaron. I am, indeed----
Chairman Kasich. That is the basis.
Mr. Aaron. But I have never heard any elected official
suggest otherwise.
Chairman Kasich. Well, you are going to hear one here. I am
not convinced of it. I am not convinced that--the reason they
will not be able to be honored is because you are going to have
a generational war if you don't deal with this problem up
front, which is the purpose of this hearing. We are not going
to boost people's payroll taxes by 30 or 40 percent, and we are
not going to slash--you are going to have a problem, going to
end up having to slash benefits if we don't deal with it, and
create private accounts and figure out how to generate more
revenue.
The fact is this problem is the most vexing problem facing
this country, but there is even one more problem, and that is
the rest of the world is facing the same problem. And then it
is going to be great difficulty being able to come up with the
capital to even borrow the money to finance not only this, but
also the operation of our economy.
I can tell you that in the transportation trust fund, we,
in fact, did write off bonds that were deposited. We did not
honor them in the agreement we did on the transportation bill.
We, in fact, cancelled out IOUs to the Government. And we want
to avoid that. We don't want to get into that position. But,
Mr. Aaron, if the argument is because there is an IOU in there,
everything is going to be hunky-dory, I have been around
politics 25 years. This is a sunami coming our way. But I think
some of what you say I agree with, in terms of saving here
means you get ahead of the program.
Mr. Aaron. May I ask you a question, Mr. Chairman?
Chairman Kasich. Sure.
Mr. Aaron. Bond obligations to the Social Security trust
fund are obligations of the Treasury Department in the same
sense as are the bond obligations of the Treasury Department
held, say, by Chase Manhattan Bank. Are you telling me that you
think that the Government would renege on bonds that underwrite
promises to $45 million beneficiaries before they would renege
on bonds to the Chase Manhattan Bank?
Chairman Kasich. I know that New York City went bankrupt
and that the Government had to bail them out. I know there have
been a lot of times when--I know about the S&L crisis, where
people lost much, much, much money. The point is, Mr. Aaron, I
don't think we can allow ourselves to get to that position. But
the notion that everything is great----
Mr. Aaron. I am not suggesting that.
Mr. Penny. If I could ask, Dr. Aaron, a related question.
Accepting your premise that these bonds are as secure as any
instrument, more so because the faith of the Federal Government
stands behind them, and we have never reneged on any debt in
the past, would you also grant that in order to make good on
our promise, we have basically only three options: to transfer
out of the general fund monies into the Social Security system,
which may then require us to dramatically reduce spending in
the general fund for other purposes; to raise payroll taxes on
future workers to replenish, to make sure that the fund has
enough money to honor obligations; or to borrow money in the
future to make the system whole?
Mr. Aaron. Currently, these bonds can be sold only to the
Treasury Department. Under those circumstances, the three
options you describe are the only ones available.
However, if the Social Security fund held bonds that could
be marketed to the public, then there would be no need for
Treasury borrowing, higher payroll taxes or cuts in other
spending.
Chairman Kasich. You mean if you borrow more money.
Look, I think that the question here is we don't know what
is going to happen. Hopefully, and I think we will, at some
point we will deal with this, but I never know what the
Government is ultimately going to do or what elected officials
are ultimately going to do when the crisis comes. You remember
the Pepper Commission, they did a variety of things. It was
involved in cutting benefits. I don't think that the debate is
really ultimately going to be what do we do with these bonds?
Do we honor them? There will be some way to get through that
period if we let this thing roll. And I think Mr. Penny is on
to it. There are only two or three things that can happen. And
my only point of the hearing is let us be aware of this, and
let us begin to deal with this thing sooner, rather than later.
Because I believe that if we deal with it sooner, Mr. Aaron,
what we need to do is a lot simpler than if we deal with it
later.
Mr. Aaron. Amen.
Chairman Kasich. And that is my point.
Mr. Aaron. Amen.
Chairman Kasich. The only thing I get concerned about with
some of the testimony is everything is fine. I get that sense
from the two sides. One side says everything is trouble, the
sky is falling, and then there is the other side of this which
is, well, you know, we can grow out of this. Everything will
kind of work itself out. I think that both sides need to say,
look, the sky isn't going to fall, and the other side needs to
say we have got a problem, we ought to get about it as soon as
we possibly can.
Mr. Aaron. What you have said almost exactly echoes the
first bullet in my testimony, which says we have got a long-run
problem, and the sooner we deal with it the better.
Chairman Kasich. Thank you, Mr. Aaron.
Mr. Smith is recognized.
Mr. Smith of Michigan. Bearing out, Mr. Chairman, what you
suggested, we really don't renege on the debt. But what
happened in 1977, what happened again in 1983, when push came
to shove on available money, we reduced benefits and we
increased taxes. And so you don't say we are not going to pay
our debt, and that is the danger that we are facing if we
continue to put off this problem in the future. And I am
disappointed, Mr. Aaron, at your suggestion or at least the
implication that the problem isn't that big. And your
suggestion of putting $2.5 trillion into the trust fund now is
not consistent with the figures that we have received from the
actuaries at the Social Security Administration or Chairman
Alan Greenspan, who has suggested, at one time, $9 trillion
unfunded liability and at one time $10 trillion unfunded
liability. And if you add to that approximately $3.2 trillion
unfunded liability for Medicare and Medicaid for seniors, then
I think the problem is significant.
The words ``unfunded liability'' and ``$9 trillion for
Social Security,'' means, to me, that if you took that money
now and put it in a savings account, then the problem would be
solved. If you pay out the money that is needed over the next
75 years for Social Security, the shortfall, what revenue is
coming in from the Social Security taxes are going to be short
of the benefits that are now promised, then it is $120 trillion
over the next 75 years. The problem, I think, is significant.
And then there was sort of the suggestion that, look,
everybody has agreed we are now taking the extra surplus from
Social Security and paying down part of the debt, the debt held
by the public. That is not what has been happening.
Mr. Aaron. It is what has been happening. Furthermore, Mr.
Smith, our output over the next 75 years will be approximately
$7 quadrillion. So an obligation of $120 trillion, although a
large number, is less than 2 percent of the total.
Mr. Smith of Michigan. For the last 40 years--pardon?
Mr. Aaron. It is what has been happening.
Mr. Smith of Michigan. No, sir. No, sir. For the last 40
years, we have used that Social Security surplus for other
spending. Where we came close for the first time in the last 40
years, 30-some years--close to 40--was last year at $700
million, .7 billion dollars. But if you put the cost of the
overexpenditure of the Postal Service, then we still spent part
of the Social Security surplus last year. This is going to be
the first year that we are putting the Social Security surplus
in a lock box. And if we go ahead with this Railroad Retirement
bill that is going to cost $21 billion, if we continue with
even half of the increased spending that the President has
suggested in his budget that he sent to us for next year, we
are going to spend part of that Social Security surplus again
this year.
So I am very nervous about the suggestion that we simply
might somehow be disciplined in spending, and I agree with the
chairman that the tendency is to spend it.
Let me ask the three of you a question in terms of getting
some real investments from some of these surplus monies. And,
let us see, two-thirds of you were in Congress. Mr. Aaron, you
didn't serve in this chamber.
Mr. Aaron. Regrettably, no.
Mr. Smith of Michigan. Well, you have looked at the thrift
savings account. The thrift savings account is essentially a
Government-type board making decisions on investments. Is it
possible to set a private investment account that would
ultimately be in the name of the worker, so that he or she
would have some entitlement to that money--in case they died
before they were 62, it would go into their estate?
Is it possible to set the kind of parameters of limiting to
some kind of safe investments--indexed funds or whatever--that
we could have the kind of safe parameters for those investments
or even having a Government board, like the thrift savings
account, invest it, but having that money in the name of the
individual worker, so that they would have the entitlement to
those funds, like we do in the thrift savings account?
Let me maybe get your reactions, starting with you,
Governor, on this balance that Republicans and Democrats seem
to be arguing about, where Republicans say, look, it has got to
be privately-owned personal investments; a lot of the Democrats
are saying, well, look Government should do the investing. But
it seems to me that a reasonable compromise there is maybe
there could even be a Government board investing it, but it
would be in the name of that individual worker, so that the
Supreme Court on two decisions now that says there is no
entitlement for Social Security can at least start to be
countered by having part of that money and part of that
investment in the name of individuals.
Pete and then----
Mr. du Pont. Well, certainly, you could structure it that
way. The real solution to this enormous unfunded liability that
is facing us in the Social Security system is a market account
that allows people to get a better return on their Social
Security contributions, which ultimately will take the pressure
off the existing trust fund. Yes, you could design an
investment account in which the individual had unrestricted
investment choices, and I don't know anybody who is in favor of
that, in terms of letting you invest in the latest dot com or
art or speculative securities. You could then move to the next
step and say, well, we will have an account that simply can go
into one of ten or fifteen Government-approved investment
vehicles, and that has been tried in many countries around the
world and worked extremely well. Or you could take the next
step, which you just suggested, Congressman, of letting a
Government board make the investment in your name.
Mr. Smith of Michigan. Well, I really, to make the record
clear, I am not suggesting that. I am just throwing that out.
Mr. du Pont. Exactly.
Mr. Smith of Michigan. I am very nervous about Government
having that much control over that much investment.
Mr. du Pont. Certainly, it could be done. The risk, of
course, of having Government oversee investments is that the
investments aren't made on a market basis. There tends to be a
little political investing done, and that is not often good for
the beneficiaries of the investment. But, technically, it could
easily be done. Any one of those alternatives could be
accomplished very simply.
Mr. Smith of Michigan. Tim.
Chairman Kasich. Pete du Pont has to get on a plane in
about--he has to leave here to get a plane in about 10 minutes.
Could we just direct a few questions to Mr. du Pont, and then
we can come back.
Mr. Moran is recognized. You have a question for Mr. du
Pont.
Mr. Moran. Thank you, Mr. Chairman.
Let me bring up another alternative that is invariably part
of this context, of course. And that is the fact that as we see
this change in demographics, we also have to recognize that
there is a change in the health, the longevity of the
population. We have a much healthier population. And I think it
is almost criminal that so many people are retiring so early,
so healthy, and not contributing to this economy and society,
and we are having to go overseas to bring in workers, which is
fine with me, and I think it is essential. But, gosh, we are
losing a whole lot of human resources because people are
retiring too damn early because we are making it too damn easy.
Now, I think we ought to raise the retirement age
significantly, but incrementally. The big problem, though, in
doing that is that that is unfair to people who work all of
their lives in functions that require brawn, that require the
use of your back, and your arms, and the human body just can't
sustain that kind of work. Now, we are making a transition,
where far more people are relying upon their brains, and
automation and computer technology. So that is helping.
But could we not devise a system where people could retire
from those back-breaking jobs earlier, using some combination
of disability insurance and retirement insurance, so that we
could relieve the burden on the trust fund and act in a
rational manner with regard to the vast majority of people who
can certainly afford a much higher retirement age? The work
that has been done on that seems to me pretty sketchy. And yet
I don't know why that it is not possible to figure something
out that would enable us to use a whole lot more of the
resources that you find down in Florida on the golf courses
instead of contributing to our economy in productive ways.
Now, Pete can answer that, and I would be more than happy
to have some response from the rest of the panel, as well.
Mr. du Pont. My answer will be brief. I am not familiar
with any research, Congressman, that has been done on that
either. One way, of course, to keep the talents of the people,
in your language, who are in Florida, keeping those talents in
the economy, is to remove the earnings limitation, which----
Mr. Moran. Well, we are doing that.
Mr. du Pont [continuing]. Which is being done. I am not
sure what your suggestion is regarding people who do physical
work, as opposed to mental work. But I would think that the
Congress should be cautious in creating two classes of
beneficiaries, if that is what you are suggesting. That begins
to raise a lot of equity issues that I think would prove very
difficult.
Mr. Moran. Let me just respond. See, I think that you can
show some physical inability to continue doing the work that
you have traditionally performed. It takes a more flexible
disability insurance policy. But that may be a way to be fair
and also rational and fiscally responsible. I just don't know
what work has been done, and it just seems to me it is not that
outlandish an idea. Because we have got to raise the retirement
age, but we are going to be stuck with--we are going to be hit
with all of these anecdotal examples, which are absolutely
true, that there is a whole lot of people out there where you
just can't expect them to working, you know, loading things on
trucks and so on or even working in a lot of heavy industrial
manufacturing jobs much beyond 65.
Now, Henry, I think has----
Mr. Aaron. The key age really is 62. I agree with you, and
I would frame it just the way you did. But the key age in
Social Security is not 65, it is 62. That is when you become
eligible first for benefits.
There is research on the effect of reducing benefits on
people's willingness to work. And let us be clear, raising the
age of full benefits is a benefit cut. That is all it is, and
strictly speaking has nothing to do with ``the retirement
age.''
Available research indicates that cutting benefits has a
very small effect on labor supply. Raising the age of initial
entitlement would have a much larger effect on labor supply,
and that is precisely where the problem you are raising comes
into play. The people who are retiring at age 62 include, to a
disproportionate degree, those people who have been doing heavy
labor and just can't get out fast enough.
Mr. Moran. And need Social Security all the more than the
average.
Mr. Aaron. But I must say I share Governor du Pont's
concern about designing this. I have thought about exactly this
question for a long time. I know a number of other people have.
We can't come up with a good answer. How you would produce an
administratable program that would provide some kind of soft
condition for disability benefits, really. And, unfortunately,
the more you get into the disability program and look at the
way it works, the less confident you are. I won't even say that
they can administer it the way it is, and this kind of
additional complexity would be troublesome. I wish we could. I
wish I had a more upbeat answer.
Chairman Kasich. Gil, any questions for Pete du Pont?
Mr. Gutknecht. Yes, just real briefly.
First of all, I want to say that I attach myself largely to
the comments of my colleague from Virginia. It just strikes me
that, you know, we are living longer, we are healthier, and at
some point we have to address the idea. And I think I speak, as
a baby boomer--I was born in 1951--which, coincidently, I am
told there were more kids born in 1951 than any other year.
This is a generational fairness issue. My parents are both
alive. I don't want to pull the rug out from under them. But on
the other hand, I don't want to saddle my kids with a burden
that they won't be able to pay.
I don't expect to retire when I am 65. I really don't
expect to retire when I am 67. I am not going to ask any
personal question about your particular ages, but whether you
expect to retire at 67. I think many of my generation does not
expect to retire, as we know it today, at some magic age.
I do want to raise a quote, and I am going to go to
Governor du Pont. Winston Churchill observed once that
Americans always do the right thing, once we have exhausted
every other alternative. It does seem that we have to be forced
by some crisis to take action, and that is, indeed,
unfortunate. I am interested in this issue, in fact, fascinated
by it, for a variety of reasons--as I mentioned, because I was
born in 1951. But, also, when I was in the State legislature,
and I am not sure if former Congressman Penny served on the
Legislative Commission on Pensions and Retirement in the State
legislature or not. I know that our colleague Colin Peterson
did and I did.
I am curious, and the reason I get to this, Governor du
Pont, when you were governor of Delaware, you clearly had to
deal with pension issues in the State. How did you depoliticize
those? And I guess what we had in Minnesota I think was very
effective. We had a commission. It was bipartisan. It was five
members of the House, five members of the Senate, and we
literally worked out some of these retirement issues, which
sometimes could be very thorny, but those were worked out. We
had our own set of actuaries. All of these things were done.
And as a result, starting in 1978, when we had a pension fund
problem in the State of Minnesota which was we had unfunded
liabilities all around, and they began to lay out a plan, and
they stayed with the plan. And the Pension Commission I think
was very effective.
And I have really felt for a long time--I am getting to a
question, I guess--but I felt for a long time what happens with
this big issue, and this is a huge issue, and we thank you,
even though we may have slight differences in terms of where we
should go and how big the problem is, it clearly is a big
problem, and it is something that the Congress needs to
concentrate on. But the problem is we have the Budget Committee
who once in a while takes a bite at this, and we have the Ways
and Means Committee that once in a while takes a bite at this,
we have the Government Reform Committee which sometimes takes a
bite at it. It seems to me we need to have more of a permanent
congressional commission.
And I am just curious, Governor, did you have something
like that in the State of Delaware? And do you think there
might be a way we could set up some kind of a permanent
commission that would begin to chart a course and would somehow
hold the Congress accountable for staying on that course?
Mr. du Pont. A twofold answer, Congressman. First, from my
years not as governor, but my years in this body--I was an
inmate here for some time--the idea of making one committee
responsible for dealing with this, rather than the six or seven
or eight that are responsible is a good idea, to get more
focus. Because as I testified, this is a massive problem. This
is not a problem to be nibbled at around the edges of eight
committees.
As for Delaware's experience, there was good news and bad
news. The good news was that we did not have a pension crisis
in my 8 years in office. The bad news was we had so many other
crises, that if we had had a pension crisis, that would have
made it absolutely intolerable. We had so many fiscal problems
dealing from near bankruptcy of the State to sagging revenues
to ballooning expenditures, I mean we had the whole 9 yards.
But the answer has to be to find a way to take some
pressure off of the Social Security trust fund by increasing
the amount of resources that go to beneficiaries outside that,
and that is why the market-based accounts offer such a good
opportunity.
Mr. Gutknecht. Well, I happen to agree with you. And I
think whether we are talking about retirement age, whatever we
are talking about, you know, the system that was created in the
thirties fit the times back in the thirties. But the workforce
has changed, a lot of things have changed. Life expectancy has
changed, and I think it really is time for us to modernize and
update the retirement system.
Mr. du Pont. There was nothing wrong with Social Security
in 1935. It has served millions of people extremely well in the
years since. But the demographics have dramatically changed
since 1935, and that is what needs to be addressed by the
Congress.
Mr. Chairman, I apologize for having to leave. But I trust
my two colleagues will provide you enough ammunition to keep
you going for sometime. And I thank you for allowing me to
testify.
Chairman Kasich. Thank you, Mr. du Pont. Other questions
for the panel?
Mr. Aaron. May I respond to the question about
jurisdiction?
Chairman Kasich. You sure can.
Mr. Aaron. I think it is an important issue, and it is
devilishly difficult, as you well know. No committee wants to
give up jurisdiction, and that is one of the sources of the
problem.
In the case of tax policy, one solution that has been
adopted is to have a staff that is shared jointly by the House
and the Senate to do tax analytic work. I wonder whether, and I
may be foolish to suggest something without thinking through
its full implications, but I wonder whether something analogous
to that in the field of social insurance might serve the
Congress well.
Mr. Gutknecht. Well, that is exactly what we had in
Minnesota. We had this commission, and it was a joint
commission between the House and the Senate. They had
professional staff. They had their own set of actuaries. And
many of the problems that we had relative to particular pension
questions were worked out, ironed out in that commission, and
pretty much accepted by the rest of the body.
The problem here, of course, is we have got everybody--if
everybody is in charge, nobody is in charge. And because of the
political nature sometimes of these issues, and they are easily
misunderstood, easily misconstrued, and easily demagogued
politically, it makes it almost impossible for us to take any
kind of action. And, clearly, it is time.
And I did appreciate your comments, Tim, that if you give
the American people the facts, they can sort this out much
better than we sometimes think they can. And I think if we have
a rational discussion about where we are and where we need to
go, I think the American people will go with us. I think
sometimes we worry far too much about this, in terms of
politics, but it does seem to me that we need some commission
or committee that helps to work these things out and begins to
chart a course.
I don't share the chairman's view that we are all headed--I
don't see this as a sunami. I do see this as a serious problem,
but I do think it is solvable if we make modest changes now. I
hope we don't wait until that wall is upon us.
I yield back my time, Mr. Chairman.
Chairman Kasich. Mr. Moran.
Mr. Moran. The other question I wanted to ask, in addition
to trying to find some differential in benefit structure so
that we can raise the retirement age, and it will work from a
policy and a political standpoint, is means testing.
We have a bill that is coming up on the floor this
afternoon, and basically it is a means testing bill--at least
the Democratic substitute is, that says that a couple can earn
up to $100,000 and not have to pay any more than--tax on 50
percent of their income. Over $100,000, you would pay on 85
percent of your income, and it is $80,000 for single, up from
35 and 45 respectively, roughly. But that is going to fail, and
we are going to go back to the 50 percent that we had, and of
course repeal one of the elements of that 1997 Balanced Budget
Act that both of you were strong proponents of and, in fact,
Henry has alluded to.
What is your point of view on the legislation before us
today?
Mr. Aaron. I would oppose repeal. This is a question of
income tax policy. In the case of contributory private
pensions, the pensioner is entitled to receive back in pension,
without tax, all contributions that came out of taxed income.
All of the rest of the pension is subject to tax.
In 1979, I chaired the Advisory Council on Social Security
that recommended partial taxation of benefits. And in order to
do that, staff estimated the lowest fraction of benefits--that
should be included in taxable income under this principle, so
that everybody, except for the last person, would get a better
deal out of the recommendation that we advanced than under the
rules applied to contributory private pensions. It was to
include 85 percent of Social Security benefits without a floor
and without a 50-percent range in the tax base. It may come as
no great surprise that that recommendation was not received
with great enthusiasm by the Congress. But it is the correct
policy if you are going to have consistent taxation of pension
income.
There is a question of whether one wants to cut tax
revenues now, and I realize there is a partisan divide on that
issue. But if we wish to cut taxes, I think the way to do so is
by cutting rates for everybody, not by adopting a rule that
makes even more overly generous than the current rule the
definition of income for one class of beneficiaries. Be clear
that the current rule treats Social Security under the income
tax more favorably than it would be treated if it were taxed as
other contributory pensions are taxed.
Mr. Penny. I could quickly answer this by saying, since I
voted for the 1983 Social Security reforms and the 1993
increase in the threshold of taxation, that I would be hard-
pressed now to say roll those back. And I think the arguments
that Dr. Aaron has laid out are valid arguments. I would also
draw to your attention two other documents that would, I think,
provide some perspective on this question. One is a fax alert
that was sent out by another organization which I am involved
with, the Concord Coalition--I am on the board of directors--
and a recent fax alert, dated July 20th of this year, speaks to
this very issue and suggests that reduction in this tax would
be inequitable, as this is a tax that essentially applies only
to seniors who are relatively well off. The higher rate, the
85-percent threshold, only applies to those earning $34,000 or
more, as an individual, and $44,000 or more as a couple. And
some degree of taxation of that income I think is warranted in
those income categories.
There is another report by CBO that looks at the relative
tax burden of young and old, and the relative benefit programs
for the young and the old. And I think that also suggests that
especially among the better-off seniors, there is some reason
to think that they ought to put more back into Government
coffers in reflection of the fact that our Government programs
are now tilted heavily in favor of the retirement population.
So, again, those better off clearly could be expected to return
some portion of their income to the Government to help finance
these senior programs.
Mr. Moran. Thanks.
Chairman Kasich. Dave.
Mr. Price. Thank you, Mr. Chairman. Tim, we want to welcome
you back. It is good to see you here today and Dr. Aaron as
well. We appreciate your testimony.
Let me start, Tim, with the answer you just gave
Representative Moran, and I apologize for being in and out of
this hearing today. We have just come from a memorial service,
which made me unable to hear all of your testimony. So I hope I
am not repeating questions others have asked.
If you move to the analysis you just gave of the proposal
before us today to a political or public opinion assessment,
much like you testified, I wonder what you would say about
that. Because, as you know, we were faced last year with a
trillion-dollar tax cut all in one piece, and public opinion
was not particularly receptive to that, given the uncertainty
of surplus projections, and given the trade-off in terms of
debt reduction and other national priorities.
Now, as you know, the majority party in the House has
adopted a very different strategy, which is to split that
trillion-dollar tax cut into smaller morsels and to try to pass
them one at a time. The total amount of the tax cuts we have
had before us thus far are well over $700 billion over the
decade, and future tax cuts are proposed, and of course there
are interest losses and so forth. So I gather you are not
terribly sympathetic with that strategy, whether you do it in
the aggregate or in pieces.
I want to ask you, though, specifically about public
opinion because I think the shift in strategy is dictated by an
assumption that the public opinion battle is tougher when you
are dealing with these more focused tax breaks.
What do you find in your own discussions around the
country; have they raised this issue? You talked a great deal
about how the public is willing to make those budget trade-offs
and those budget sacrifices. You have some pretty impressive
evidence about how seriously people take our country's fiscal
situation. Do you have any evidence about where the public
comes down when the issue is posed, though, as the current
strategy of the majority would pose it?
Mr. Penny. The workshops that we conducted around the
country predated this legislative session, and so they are a
bit dated in that respect.
What I can tell you is that, in the eight sessions we
conducted with anywhere between 60 and a couple hundred people
in attendance, we broke them into the tables for discussion,
made sure that there was diversity at each table in terms of
age, and ethnicity, and political persuasion, and profession,
so that, very much like Congress, people of differing views
were forced to come to terms with one another.
And so, in that sense, what we felt we got out of these
sessions was sort of an informed poll. And what we heard from
the vast majority of the participants was a strong desire for
fiscal responsibility, a strong inclination to use current or
near-term surpluses to pay down debt. And as I recall, when the
question of tax cuts for any future projected surplus was
brought into the discussion, we had I think fewer than 4
percent of our respondents that thought that tax cuts ought to
be a priority item for Congresses in the near term.
So, again, I can only tell you what came out of these
roundtable discussions that we sponsored in eight locations
around the Nation. But there clearly was a disinclination to
buy into any sort of a tax-cut scenario, and I think that was
based on their understanding that while we may have some near-
term good news, in terms of the economy and surplus revenues in
the Federal coffers, that we still have these daunting
challenges right out there on the horizon that require a
certain caution in the near term, and that applies to the tax-
cut agenda.
Mr. Price. Of course, as you stress, this is an informed
poll, and it assumes that people do have good information about
the trade-offs they, in fact, face. And that, of course, places
a burden on Members of Congress and others who understand these
issues and who have to deal with them to make certain that
public interpretation is made.
Mr. Penny. That is right. And obviously the exercise we
went through, which involved half a day of presentations to
give people a context for their ultimate decisions, is not
necessarily the way this will play out in a campaign
environment.
Mr. Price. Let me quickly, Dr. Aaron, ask you a question. I
know we have limited time here, and again forgive me if you
have already dealt with this. Maybe this amounts to a request
to slice your testimony a somewhat different way because I am
sure you did touch on these subjects.
I know you come to this hearing and the subjects you have
testified on today with a great concern to increase national
savings, to help older Americans in future years avoid total
dependence on the regular Social Security program for their
retirement income, to shore up other sources of retirement
income, but you end up with an unfavorable comparison, I
gather, between privatization or partial privatization of
Social Security versus the design of a supplemental retirement
savings program, perhaps much like the President has proposed--
this kind of private savings plan inside or supplementary to
Social Security.
I wonder if you could, in shorthand, tell us how you
compare those two options. What are the relative advantages or
disadvantages of approaching the agreed-upon need in those two
ways?
Mr. Aaron. Let us start with Social Security. This is not,
in fact, a very generous system. A full-time average wage
worker retiring at age 62 will receive a pension slightly above
the U.S. poverty threshold. The function of social insurance is
to provide assured basic income, income that isn't going to
vary, that will be there till you die.
It strikes me that a system of approximately the size of
the one we now have, that provides benefits roughly of this
order of magnitude, perhaps starting at a later age, is one we
want to keep because it does provide assured basic income, and
the simple fact is that no private account system can provide
an equal degree of insurance--assurance. They are subject to
financial market risk during the accumulation phase, and unless
they are converted into indexed annuities at pension phase,
they are subject to inflation risk, and if you will, the danger
you might live too long and outlive your assets.
So I think the starting point is that, of course, we have a
projected long-term deficit, and I fully agree with the
chairman and others that we should move expeditiously to try
and close that deficit through a combination of instruments
that would leave the system in a condition similar to the
current system.
Having said that, there are large numbers of Americans, all
too many, who don't save at all in other forms. They may own
their own homes, they have their Social Security and that is
just about it, and I think that is regrettable. It is important
to encourage saving for people who now don't find it the
fashionable thing to do, who are bombarded by advertisements to
consume now, and do, and even go into debt. It is important to
make saving chic. It will help them meet lifetime objectives,
sending children to college, buying houses, meeting illnesses,
being ready for unemployment, being able to take care of a
serious illness, that now will lay them low financially or that
they will find simply impossible to do.
And for that reason I think using the tax system to
encourage additional private saving, along the lines of
accounts that would be tilted toward those who now don't save
enough, which mean low- and lower middle-income households. It
would serve a very important public objective, and I would hope
that Congress would view such savings devices sympathetically.
I would add that I think it would be a bad mistake to
condition those savings--to make those savings available only
for retirement income. The motivations I have described are
that if you are a low-income household, the true fact is Social
Security does provide what financial advisers would
characterize as an adequate replacement rate, ratio of benefits
to earnings. But these folks don't have the cash on hand to
deal with lifetime wants and crises before retirement. So the
direction I think should be to promote saving. If people want
to keep it till retirement, fine, if they want to withdraw
funds under the kinds of rules under which we now allow
withdrawals from 401(k) plans, IRAs, SEPs, the whole
alphabetical zoo of saving instruments we now have, those rules
ought to carry over to this plan as well, and I think it would
be a great step ahead.
Mr. Price. How do you think this kind of savings for the
households that you are wanting to target could best be
incentivized? And, of course, in your answer I would appreciate
your taking account of what you think, at this point, we could
afford.
Mr. Aaron. Well, I agree with the chairman that the true
fact is that, confronted with on-budget surpluses of the
magnitudes we now confront, whether this year or next year or
the year after, we are going to see some increases in spending,
and we are going to see some tax cuts.
What form should they take? It seems to me that one form
that the use of some tax reductions could take would be as
incentives to individuals who set up savings accounts and make
some contribution on their own, a kind structurally similar to
401(k) plan. I call it a tax cut with a benign string attached.
The benign string attached is this: we are giving you a tax
cut, but you can't consume it right now. You are going to have
to build it up for a while, and you will have it available when
the need strikes later in your life. That seems to me to be a
tax cut that would merit very serious consideration.
Mr. Price. Thank you. Thank you, Mr. Chairman.
Chairman Kasich. I want to thank both of you for being
here.
Henry, one question. Would you be for lowering or
eliminating the tax on long-term held capital gains?
Mr. Aaron. No, I would not. I have gone through the
evidence on this question pretty carefully. The evidence that
it would boost national savings isn't there. On the contrary,
it is more likely to lower saving, given other tax rates. And
it is, in fact, a tax cut that is very heavily skewed toward a
very small percentage of the wealthiest people in the United
States--a feature, I might add gratuitously, that it shares
with repeal of the estate tax.
Chairman Kasich. I understand.
I want to thank you guys for being here, both of you, very,
very much. Senator Kerrey has arrived, and we want to make sure
he gets up and delivers his testimony. He is a very important
man. [Laughter.]
He is now on the short list, they tell me. I sure hope you
are not breathing heavy over that.
Mr. Penny. Mr. Chairman, if I might, before we call forward
the illustrious Senator from Nebraska, in response to
Congressman Smith's question, though he is no longer in the
room, I would simply refer the committee to Pages 9 and 10 of
my testimony, my written testimony, where I speak to the issue
of individual accounts, and I would ask that someone bring that
segment of my testimony to Mr. Smith's attention, so that he
can get a response to the question he posed.
Chairman Kasich. Terrific. Thank you. Thank you, gentlemen.
Well, I want to welcome the Senator from Nebraska. I had an
opportunity to take a look at a little of his testimony, and we
will let him run through it. I can see him. There we go.
Senator Kerrey, has had a long distinguished career, a
successful businessman, a Senator and now moving on to be
president of a university, if he is truly going to retire from
politics.
So, Bob, it is all yours.
STATEMENT OF HON. J. ROBERT KERREY, A UNITED STATES SENATOR
FROM THE STATE OF NEBRASKA
Senator Kerrey. Thank you, Mr. Chairman and members of the
committee.
I appreciate the opportunity to testify. I have written
this testimony, and I may not get through all of it, but I will
begin as if I am, and if not, if I feel like ad libbing, I will
ask later to be made a part of the record.
I do think this hearing provides us with an opportunity,
certainly it has provided me with an opportunity, to reflect
about how we should set our priorities for the future and what
kind of legacy we want to leave to our children. We are lucky,
in many ways, to be having this discussion about spending
priorities and intergenerational equity during a time of large
projected surpluses.
These surpluses provide legislators with a great deal more
flexibility in choosing among priorities and in determining our
legacy to future generations. Until recently, we were not so
lucky. For more than 30 years, the budget projection reports in
the Congressional Budget Office and the Office of Management
and Budget were a source of growing despair to the American
people. As each year went by, CBO and OMB would present worse
news--larger deficits, larger national debt levels, larger net
interest payments. And as the Government's appetite for debt
expanded, fewer and fewer dollars were available for private
investment.
In the beginning, Mr. Chairman, as you may recall, experts
were saying that the deficits were good for us because they
were stimulating economic growth and were creating jobs. But
over time, the voices of experts opposed to large deficits grew
louder. They argued that deficits caused inflation, increased
the cost of private capital, mortgaged away our future just at
the time when we needed to be preparing for the retirement of
the large baby boom generation. As the opinions of the experts
shifted, so did public opinion.
During the 1980s and 1990s, the Federal deficit became
public enemy number one. Great efforts were made to understand
it, to propose solutions to reduce it, to explain how much
better life would be without it. During election season, the
airways were filled with promises and plans to get rid of the
deficit and pay off the national debt. Editorial page writers
reached deep into their creative reservoir to coin new phrases
and create new metaphors to describe the problem. Books were
published, nonprofit organizations were created, constitutional
amendments were called for. There was even a new political
party created simply on account of the deficit.
In the 1990's, at great political risk, we finally started
action to control the size of the deficits and control the
national debt. We voted and passed three budget acts in 1990,
1993, 1997. Unfortunately, we didn't pass Penny-Kasich, Kerrey-
Brown, which would have made it even better. These three acts
have radically altered the fiscal condition of the Federal
Government, and now the debate in Congress is about how the
public's hard-earned tax dollars should be spent.
The enactment of these three budget acts--particularly the
1993 and 1997 budget acts--coupled with impressive gains in
private-sector productivity and economic growth, led to a
remarkable reversal of our deficit and debt trends. We
celebrated our first unified budget surplus of $70 billion in
1998. And over the next 10 years, if we maintain current
spending and revenue policies, CBO projects an eye-popping
unified budget surplus of $4.5 trillion. I am proud that we are
able to celebrate the fruits of our fiscal restraint.
But today, Mr. Chairman and members of the committee, I
would like to call your attention to what I would call one of
the unintended consequences of our fiscal responsibility. Not
only have we allowed total Federal spending to dip below 20
percent of GDP--levels that we have not seen since the 1970's--
but very seldom has it been commented upon that we are also on
course to have spending levels drop to 15.6 percent of GDP by
2010--spending levels we haven't seen since the 1950's. At the
same time as total spending is declining as a percent of GDP,
Mr. Chairman, the makeup of our Federal spending is continuing
to shift in very significant and, in my view, troubling ways.
An increasingly larger proportion of our spending, even after
net interest is reduced, is being used for mandatory spending
programs compared to discretionary spending programs. These
numbers have very important implications for the measurement of
intergenerational equity.
And now that we have constrained spending and eliminated
our budget deficits, the budget debate has shifted to questions
about how to spend the surplus on debt reduction, tax cuts, new
discretionary spending programs, fixing Social Security,
creating a new Medicare prescription drug benefit. I favor all
of these things, to varying degrees, and enjoy participating in
this debate, as I suspect most of you do as well.
Mr. Chairman and members of the committee, the trick is to
find the right balance among these initiatives. And in finding
the right balance, I believe one of the most important
criterion in determining how to use these surpluses should be
measuring intergenerational equity. Not only do we need to
assess the amount of money we invest on our seniors versus our
children, but we also need to assess the trends of mandatory
versus discretionary spending.
Let me start my own assessment of Federal spending on
children and seniors. Today, the Federal Government spends
substantially more on seniors over the age of 65 than it does
on children under the age of 18. In 2000, the Federal
Government spent roughly $17,000 per person on programs for the
elderly, compared with $2,500 per person on programs for
children. This means, at the Federal level, we are spending
seven times as much on people over the age of 65 as on children
under the age of 18.
Mr. Chairman, even when we consider that States are the
primary funders of primary and secondary education, the
combined level of State and Federal spending still shows a
dramatic and growing contrast in spending on the old versus the
young. At the State and Federal level, we are still spending
2.5 times the amount of money on people over the age of 65 as
on children under the age of 18.
Given these discomforting facts, it might seem logical that
most of our current proposals for spending surplus dollars
would be for investments in our children. But instead, the
Congress--and especially the Senate--has been proposing, and
working and voting as well to spend a major portion of the
surplus on the most politically organized voting bloc in the
Nation--Americans over the age of 65.
In the Senate, Mr. Chairman, we have either acted on or are
expected to act on the following proposals, which directly
benefit seniors only. We eliminated the earnings test on Social
Security, which has a price tag over the next 10 years of $23
billion. There is an offset after that, but over the next 10
years, we will take $23 billion out of the payroll taxes of
Americans to pay for that new law.
We voted to allow military retirees who do not like
Medicare to opt out of Medicare and into TriCare or the Federal
Employee Health Benefit Program. That has a 10-year price tag
of $90 billion.
We are proposing to create a new universal Medicare
prescription drug benefit, which has a price tag of about $300
billion over 10.
We are discussing Medicare give-backs, which has a 10-year
price tag of about $40 billion.
And we voted once, and we will probably vote again after we
get back, to increase the Federal income tax exemption provided
to Social Security beneficiaries, which has a 10-year price tag
of $125 billion.
Mr. Chairman, if Congress acts on all of these popular
provisions, we will be spending for seniors over the next 10
years, we will have an increase in spending of $578 billion, an
amount that is equivalent to this year's entire discretionary
spending budget.
At the same time as we are proposing these things, voting
in favor of and enacting legislation to improve benefits and
tax cuts for seniors, we will be lucky to get legislation
passed that spends an additional $10 billion on children under
the age of 18.
The principal reason, Mr. Chairman, as you know very well,
is not simply because seniors are better organized voters and
children are not. We also have to look at how most programs for
seniors are funded versus programs for children. As the members
of this committee are well aware, most programs for seniors are
funded through mandatory entitlement spending. Whereas,
spending increases in these programs are not subject to the
annual appropriations process and are protected by automatic
cost of living COLAs each year, spending programs that
primarily benefit our children are discretionary. And that
means, as you know well, they are subject to the annual
appropriations process. There are no automatic spending
increases for these programs, and instead, most programs for
children are held victim to politics and spending caps.
As a result, the proportion of Federal Government spending
on mandatory versus discretionary spending has undergone a
dramatic and relevant shift of this debate. Back in 1965, when
I graduated from the University of Nebraska, the Federal
Government spent the equivalent of 6 percent of GDP on
mandatory entitlement programs, like Social Security, and 12
percent of GDP on discretionary funding items, like national
defense, education and public infrastructure.
Put another way, Mr. Chairman, 35 years ago, one-third of
our budget funded entitlement programs and two-thirds of our
budget funded discretionary programs. But today, the situation
has completely reversed. Today, we spend about two-thirds of
our budget on entitlement programs and net interest payments
and only one-third of our program on discretionary spending
programs.
I am particularly troubled, Mr. Chairman, by the decline in
spending on discretionary initiatives. Although our tight
discretionary spending caps were a useful tool in the past for
eliminating deficits and lowering debt, they are not so useful
today in helping us assess the discretionary budget needs of
the Nation. And, today, appropriated spending is contained
through spending caps, in my view, that are too tight for
today's economic reality.
Mr. Chairman, downward pressure on discretionary spending
will become worse during the retirement of the baby boom
generation, when the needs of programs on the mandatory
spending side will increase dramatically. Mr. Chairman, the
coming demographic shift of workers per retirees is not a ``pig
in a python'' problem, as described by some commentators whose
economics are usually better than their metaphors. The ratio of
workers needed to support each beneficiary does not increase
after the baby boomers have become eligible for benefits. It
remains the same.
And, Mr. Chairman, here are the hard numbers. You cannot
run away from these numbers. This is what we are going to face
starting in 10 years. The number of seniors drawing on Medicare
and Social Security will double from 39 million to 77 million,
and the number of workers is projected to grow only slightly
from 137 million to 145 million. Worse, if we continue to
underinvest in the education and training of our youth, we will
have no choice, but to continue what I consider to be a
terrible process. I voted for it before, and I probably will
again, of using H-1B visas to solve the problem of shortage of
skilled labor.
One of the least-understood concepts regarding Social
Security and Medicare, Mr. Chairman, is that neither of these
programs is a contributory system with dedicated accounts for
each individual. Both are intergenerational contracts, and we
are saying again they are intergenerational contracts. The
generations in the workforce agree to be taxed on behalf of
eligible beneficiaries in exchange for the understanding they
will receive the same benefit when eligible. Both programs are
forms of social insurance. They are not welfare, but both are
also transfer payment programs. We tax one group of individual
people and transfer that money to another group.
The proportion of spending on seniors and the proportion of
mandatory spending will most surely increase as the baby
boomers become more eligible for transfer payments. Unless we
want to raise taxes substantially or accrue massive amounts of
debt, much of the squeeze will be felt by our discretionary
spending program. The spiral of underinvestment in our children
and in the workforce will continue. Our Government will become
more and more like an ATM machine.
So what should we do about this problem? Well, Mr. Chairman
and members of the committee, I recommend a two-step approach.
Step one is to honestly assess whether we can cut our way out
of this problem. Do you think public opinion will permit future
Congresses to vote for reductions in the growth of Medicare or
Social Security or the long-term care portion of Medicare? At
the moment, my answer is a resounding no. Indeed, as I said
earlier, we are currently heading in the opposite direction.
There is no indication, Mr. Chairman, that the political will
is there to do anything other than to spend more, not less,
than we are currently forecast to spend.
Thus, I reached a conclusion that Step 2 is to consider
whether it is time for us to rewrite the entire social
contract, and to do that you have to answer the question do the
economic and social changes that have occurred since 1935 and
1965 justify a different kind of safety net? Mr. Chairman and
members of the committee, I believe they do. I believe we need
to rewrite and modernize the contract between Americans and the
Federal Government in regards to retirement income and to
health care. We should begin by transforming the Social
Security program, so that annual contributions lead all
American workers, regardless of their income, to accumulate
wealth by participating in the growth of the American economy.
Whether the investments are made in low-risk instruments such
as Government bonds or higher-risk stock funds, it is a
mathematical certainty, Mr. Chairman, that 50 years from now a
new generation of American workers could be heading toward
retirement with the security that comes with the ownership of
wealth if we rewrite now the contract to allow them to do so.
Not only should we reform Social Security to allow workers
to personally invest a portion of their payroll taxes, but we
should also make sure those account contributions are
progressive so that low- and moderate-income workers can save
even more for their retirements. At the same time, it is
important to make the traditional Social Security benefit
formula even more progressive so that protections against
poverty are stronger for our low-income seniors.
Finally, it is important to change the laws so that we can
keep the promise to all 270 million current and future
beneficiaries. And that will mean reforming the program to
restore its solvency over the long term.
Mr. Chairman, in addition to reforming Social Security, we
should end the idea of being uninsured in this Nation by
rewriting the Federal law so that eligibility for health
insurance occurs simply as a result of being a citizen or a
legal resident. Currently, under Federal law, you are eligible
for subsidies if you can prove that you are 65 and you paid in
for 40 quarters. You are eligible for a subsidy if you prove
that you are poor enough and promise to stay poor under the
Medicaid program.
If, like me, you get lucky to get blown up in a war, you
are eligible for a subsidy as a consequence of being service-
connected disabled through the Veterans' Administration. If you
work for the Government at the local level, at the State level,
at the Federal level, you are also eligible for subsidies. What
that means is that all of us who under law are eligible have a
claim on the income of all other Americans. And, unfortunately,
that claim also reaches out to about 40 million Americans, 20
million of whom, I would guess, simply cannot afford to buy
health insurance, though their taxes are being collected to
subsidize everybody else who is eligible. I left one out, Mr.
Chairman, the Federal income tax deduction, which is an odd
formula that says that the higher your income the greater the
subsidy we are going to provide you.
Mr. Chairman, I think we should end all of those programs,
have a single system of eligibility--if you are an American, if
you are a legal resident. And we should provide subsidies for
the purchase of health insurance only for those who need
assistance.
Mr. Chairman, in 1969, I needed assistance, and thank God I
live in a great country like this that would have a law written
so that I had my health care needs taken care of. But today it
embarrasses me that there are Americans out there with incomes
far lower than mine subsidizing me, while they have no claim on
my income to provide them assistance. They are law-abiding,
they are in the workforce, they are struggling to raise their
families. I have been with them, Mr. Chairman. I have met with
mothers and fathers who have children who, as a result of an
accident or because of a birth defect, had their legs or arms
amputated. They come to me for some assistance because I am in
a similar condition, and we have to seek charity to provide
them with assistance because they are uninsured.
It is, in my view, it makes no economic sense, nor does it
make moral sense for the richest Nation on Earth to have this
differentiated and fractionized system of eligibility.
Now, to be clear, Mr. Chairman and members of the
committee, enacting a Federal law that guarantees health
insurance does not mean we have to have socialized medicine. It
worked for me in 1969 when I was in the Philadelphia Naval
Hospital. I would not argue for it for all Americans. There
will be times when only the Government can deliver. But, in
general, in my view, it is better for the market to be making
these decisions. You can still have 80 percent of it controlled
by the marketplace.
And, Mr. Chairman, I don't believe we will face the problem
of growing mandatory spending until we create on the Social
Security side that says that every single American is going to
have the opportunity to accumulate a sufficient amount of
wealth, so they don't need to be subsidized in other areas. If
you look at the long-term costs, especially of the health care
program that we have, and you just scratch your head of whether
it is acute care or long-term care, which is in many ways
worse, and you say, how are we going to be able to finance
that? And if you finance it only with taxes, Mr. Chairman, we
are going to find, sooner rather than later, that our budget is
entirely an ATM machine.
Mr. Chairman, one last suggestion. With budget projections
showing that Federal spending will fall to 16.6 percent of GDP
by 2010, given our willingness to vote additional monies for
people over the age of 65, I would urge my colleagues to
consider whether or not we should set a goal of putting aside a
portion of the surpluses, perhaps an amount equivalent to one-
half or 1 percent of GDP--it isn't that large--by 2010 for
additional discretionary investments, investments that will
improve the lives of our children, both in the near and long
term--investments in education, in research and development, in
science and technology, all of the things that my parents did
when we had a Nation that was investing in its future rather
than merely worrying about how to entitle the present.
Mr. Chairman, again, and members of the committee, I want
to thank you for this opportunity to testify. I want to, in
particular, Mr. Chairman, thank you for your leadership over
the years. You have been a truth teller on the budget, a real
leader on the budget. If Penny-Kasich had passed over here and
Kerrey-Brown had passed over in the Senate, we might have
eliminated the deficit an awful lot earlier. Now, that is the
good news. You probably wouldn't be chairman if that would have
happened. I am not sure that the election of the 1994 would
have had the same outcome. But I appreciate very much your
leadership, and I have enjoyed our friendship.
[The prepared statement of Senator Kerrey follows:]
Prepared Statement of Hon. J. Robert Kerrey, a United States Senator
From the State of Nebraska
I want to thank the distinguished chairman and ranking member for
providing this opportunity to come before the committee to talk about
inter-generational issues related to Federal budget spending. I
appreciate your ongoing interest in inter-generational equity issues
related to entitlement and discretionary spending. This hearing
provides an important opportunity to talk about the spending priorities
we should be setting for the future and the legacy we want to leave to
our children.
We are lucky to be having this discussion about spending priorities
and inter-generational equity during a time of large projected
surpluses. These large projected surpluses provide legislators with a
great deal more flexibility in choosing among priorities and in
determining our legacy to future generations.
Until recently, we were not so lucky. For more than thirty years,
the budget projection reports from the Congressional Budget Office
(CBO) and the Office of Management and Budget (OMB) were a source of
growing despair for the American people. As each year went by, CBO and
OMB would present worse news: larger deficits, larger national debt
levels, and larger net interest payments. As the government's appetite
for debt expanded, fewer and fewer dollars were available for private
investment.
In the beginning, experts explained that deficits were a good thing
because they stimulated economic growth and created jobs. Over time,
however, the voices of experts opposed to large deficits grew louder;
they argued that deficits caused inflation, increased the cost of
private capital, mortgaged away our future--just at the time when we
needed to be preparing for the retirement of the large Baby Boom
generation. As the opinions of the experts shifted, so did public
opinion.
During the 1980's and 1990's, the Federal deficit became public
enemy number one. Great efforts were made to understand it, to propose
solutions to reduce it, and to explain how much better life would be
without it. During election season, the air-waves were filled with
promises and plans to get rid of the deficit and pay off the national
debt. Editorial page writers reached deep into their creative reservoir
to coin new phrases and create new metaphors to describe the problem.
Books were published. Non-profit organizations were created.
Constitutional amendments were called for. There was even a new
political party created on account of the deficit.
In the 1990's--and at great political risk--we finally started
taking action to control the size of the deficits and the growth of the
national debt. I am proud to have participated in and voted for three
budget acts--in 1990, 1993, and 1997--which have radically altered the
fiscal condition of the Federal Government and the debate about how the
public's hard-earned tax dollars should be spent.
The enactment of these three budget acts--particularly the 1993 and
1997 budget acts--coupled with impressive gains in private sector
productivity and economic growth led to a remarkable reversal of our
deficit and debt trends. Deficits started shrinking in 1994. We
celebrated our first unified budget surplus of $70 billion in 1998.
Over the next 10 years, if we maintain current spending and revenue
policies, CBO projects an eye-popping unified budget surplus of $4.5
trillion. I am proud that we are able to celebrate the fruits of our
fiscal restraint because we had the sheer will and political courage to
put ourselves on a spending diet.
Today, however, I want to call your attention to what could be
called the ``unintended consequences'' of our fiscal responsibility.
Not only have we allowed total Federal spending to dip below 20 percent
of GDP (levels not seen since the mid-1970's), but we are also on
course to let spending drop to 15.6 percent of GDP by 2010. We have not
seen spending levels this low since the 1950's. At the same time as
total spending is declining as a percentage of GDP, the make up of our
Federal spending is continuing to shift in significant ways. An
increasingly larger proportion of our spending is used for mandatory
spending programs compared to discretionary spending programs. These
numbers have important implications for the measurement of inter-
generational equity.
Now that we have constrained spending and eliminated our budget
deficits, the budget debate has shifted to questions about how to spend
the surplus: on debt reduction, on tax cuts, on new discretionary
spending programs, on fixing Social Security, or on creating a new
Medicare prescription drug benefit?
I favor all of these things to varying degrees, as I suspect most
of you do. The trick is to find the right balance among these
initiatives. In finding the right balance, I believe one of the most
important criterion in determining how to use these surpluses should be
measuring inter-generational equity. Not only do we need to assess the
amount of money we invest on our seniors versus our children, but we
also need to assess the trends of mandatory versus discretionary
spending.
Let me start with my own assessment of Federal spending on children
and seniors. Today, the Federal Government spends substantially more on
seniors over the age of 65 than it does on children under the age of
18. For example, in 2000, the Federal Government spent roughly $17,000
per person on programs for the elderly, compared with only $2,500 per
person on programs for children. This means that at the Federal level,
we are spending seven times as much on people over the age of 65 as on
children under the age of 18.
Even when we consider that states are the primary funders of
primary and secondary education, the combined level of State and
Federal spending still shows a dramatic contrast in spending on the old
versus the young. At the state and Federal level, we are still spending
2.5 times the amount of money on people over the age of 65 as on
children under the age of 18.
Given these discomforting facts, it might seem logical that most of
the current proposals for spending surplus dollars would be for
investments in our children. Instead, this Congress has been proposing
and voting to spend a major portion of the surpluses on the most
politically organized voting bloc in the nation--those over the age of
65.
In the Senate alone, we have either acted on, or are expected to
act on, the following proposals which directly benefit seniors only:
Eliminating the Social Security earnings test for workers
over the age of 65 (10-year price tag: $23 billion)
Allowing military retirees to opt out of Medicare and into
TriCare or FEHBP (10-year price tag: $90 billion)
Creating a new universal Medicare prescription drug
benefit for seniors (10-year price tag: $300 billion)
Medicare provider ``give-backs'' package (10-year price
tag: $40 billion)
Increasing the Federal income tax exemption provided to
Social Security beneficiaries (10-year price tag: $125 billion)
If Congress actually enacted all of these popular provisions into
law, spending for seniors over the next 10 years would increase by $578
billion--an amount equivalent to this year's entire discretionary
spending budget.
At the same time as we are proposing, voting in favor of, and
enacting legislation to improve benefits and tax cuts for seniors, we
will be lucky to get legislation passed that will spend only an
additional $10 billion on children under the age of 18.
Why? The answer is not simply because seniors are politically
organized voters and children are not. We also have to look at how most
programs for seniors are funded versus programs for children. As the
members of this Committee are well aware, most programs for seniors are
funded through mandatory/entitlement spending. Spending increases in
these programs are not subject to the annual appropriations process and
are protected by automatic cost-of-living-adjustments (COLA) each year.
The spending programs that primarily benefit our children, on the
other hand, are discretionary, which means they are subject to the
annual appropriations process. There are no automatic spending
increases when it comes to programs for our kids. Instead, most
programs for kids are held victim to politics and spending caps.
As a result, the proportion of Federal Government spending on
mandatory versus discretionary spending has undergone a dramatic shift.
Back in 1965, the Federal Government spent the equivalent of 6 percent
of GDP on mandatory entitlement programs like Social Security and 12
percent of GDP on discretionary funding items like national defense,
education, and public infrastructure. Put another way: 35 years ago,
one-third of our budget funded entitlement programs and two-thirds of
our budget funded discretionary spending programs.
The situation has now reversed. Today, we spend about two-thirds of
our budget on entitlement programs and net interest payments and only
one-third of our budget on discretionary spending programs.
I am particularly troubled by the decline in spending on
discretionary spending initiatives. Although our tight discretionary
spending budget caps were a useful tool in the past for eliminating
deficits and lowering debt, they are not useful today in helping us
assess the discretionary budget needs of the nation. Today,
appropriated spending is contained through spending caps that are too
tight for today's economic reality. We are left with a discretionary
budget that bears little relationship to the needs of the nation and
that leaves us little flexibility to solve some of the big problems
that still need to be addressed: health care access for the uninsured,
education, and research and development in the areas of science and
technology.
The downward pressure on discretionary spending will become worse
during the retirement of the Baby Boom generation--when the needs of
programs on the mandatory spending side will increase dramatically. The
coming demographic shift toward more retirees and fewer workers is NOT
a ``pig in a python'' problem as described by some commentators whose
economics are usually better than their metaphors. The ratio of workers
needed to support each beneficiary does not increase after the baby
boomers have become eligible for benefits. It remains the same.
In 10 years, the unprecedented demographic shift toward more
retirees will begin. The number of seniors drawing on Medicare and
Social Security will nearly double from 39 million to 77 million. The
number of workers will grow only slightly from 137 to 145 million.
Worse, if we continue to under-invest in the education and training of
our youth, we will have no choice but to continue the terrible process
of using H-1B visas to solve the problem of a shortage of skilled
labor.
One of the least understood concepts regarding Social Security and
Medicare is that neither is a contributory system with dedicated
accounts for each individual. Both are inter-generational contracts.
The generations in the work force agree to be taxed on behalf of
eligible beneficiaries in exchange for the understanding that they will
receive the same benefit when eligible. Both programs are forms of
social insurance--not welfare--but both are also transfer payment
programs. We tax one group of people and transfer the money to another.
The proportion of spending on seniors--and the proportion of
mandatory spending--will most surely increase as the baby boomers
become eligible for transfer payments. Unless we want to raise taxes
substantially or accrue massive amounts of debt, much of the squeeze
will be felt by our discretionary spending programs. The spiral of
under-investment in our children and in the future work force will
continue. Our government will become more and more like an ATM machine.
What should we do about this situation?
I recommend a two step approach. Step one is to honestly assess
whether we can ``cut our way out of this problem.'' Do you think public
opinion will permit future Congresses to vote for reduction in the
growth of Medicare, Social Security, and the long-term care portion of
Medicaid? At the moment my answer is a resounding ``no.'' Indeed, as I
said earlier, we are currently heading in the opposite direction.
Step number two is to consider whether it is time for us to rewrite
the social contract. The central question is this: Do the economic and
social changes that have occurred since 1965 justify a different kind
of safety net? I believe they do. I believe we need to rewrite and
modernize the contract between Americans and the Federal Government in
regards to retirement income and health care.
We should transform the Social Security program so that annual
contributions lead all American workers--regardless of income--to
accumulate wealth by participating in the growth of the American
economy. Whether the investments are made in low risk instruments such
as government bonds or in higher risk stock funds, it is a mathematical
certainty that fifty years from now a generation of American workers
could be heading toward retirement with the security that comes with
the ownership of wealth--if we rewrite the contract to allow them to do
so.
Not only should we reform Social Security to allow workers to
personally invest a portion of their payroll taxes, but we should also
make sure those account contributions are progressive so that low and
moderate income workers can save even more for their retirements. At
the same time, it is important to make the traditional Social Security
benefit formula even more progressive so that protections against
poverty are even stronger for our low income seniors. Finally, it is
important to change the law so that we can keep the promise to all 270
million current and future beneficiaries--and that will mean reforming
the program to restore its solvency over the long-term.
In addition to reforming Social Security, we should end the idea of
being uninsured in this nation by rewriting our Federal laws so that
eligibility for health insurance occurs simply as a result of being a
citizen or a legal resident. We should fold existing programs--
Medicare, Medicaid, VA benefits, FEHBP, and the income tax deduction--
into a single system. And we should subsidize the purchase of health
insurance only for those who need assistance. Enacting a Federal law
that guarantees health insurance does not mean we should have
socialized medicine. Personally, I favor using the private markets as
much as possible--although there will be situations in which only the
government can provide health care efficiently.
One final suggestion. With budget projections showing that total
Federal spending will fall to 15.6 percent of GDP by 2010, I urge my
colleagues to consider setting a goal of putting aside a portion of the
surpluses--perhaps an amount equivalent to one-half to 1 percent of
GDP--for additional discretionary investments. Investments that will
improve the lives of our children both in the near future and over the
long term--investments in education, research and development, and
science and technology.
Mr. Chairman, Congressman Spratt and other members of the
committee: I again thank you for the opportunity to testify on the very
important issue of inter-generational equity. Given the length of my
response I suspect this may be the last such invitation I receive.
Chairman Kasich. Thanks, Bob. It is amazing testimony. It
is on the record. And I think part of the problem is that
people don't really want to look at these things right now.
They think it is so far away. And the tragedy of it, as I know
you are aware, if you don't get on it soon, the power of things
like compound interest is minimized. I am convinced that we
need to create not only private accounts for Social Security,
but I think we need to create private accounts for Medicare as
well, where the Government would ensure against catastrophic
illness, but that the private accounts could accumulate money
that could be used for other kinds of medical care and perhaps
an ability to have a seamless transition into long-term care.
But, Bob, when do you think that we could actually get
about doing some of these things?
Senator Kerrey. I don't know. I mean, as to the question
you are raising with your suggestion to have private accounts
both for Social Security and for Medicare, one of the problems,
Mr. Chairman, is oftentimes what happens is the private
accounts get debated all by themselves, as if that is all I am
proposing or all that you are proposing.
There is a purpose in both proposals, and the purpose is to
enable somebody, whether you are making $5 an hour or $500 an
hour, to accumulate wealth and become wealthy. And one of the
interesting things there is it may take that moment when people
who write and report on this thing to understand that there is
a huge difference between income and wealth. I can have
$500,000 worth of income every single year. If I spend it all,
I don't have any wealth to show for it. At the same time, I can
make $5 or $6 an hour, if I save a little bit, and my poster
child over the years who is Oseola McCarty from Hattiesberg,
Mississippi, who was a washer woman for almost 60 years, and
when she finally quit working, she called Southern Mississippi
University up to offer them a gift. They thought it was a doily
or a coffee can she had decorated or something, it turned out
to be a couple of hundred thousand dollars cash. When they
asked her how she accumulated $200,000 cash on income that was
under $10,000 a year, she said it was simple. I just used the
power of compounding interest rates. Well, on that basis, I
would have voted for her to be chairman of the Federal Reserve.
Chairman Kasich. It is like the book, ``The Millionaire Who
Lives Next Door.''
Senator Kerrey. The goal here is to say, I don't care how
much money you make, you have value. You are worth something.
The market may say you are only worth $6 an hour or $7 or $8 or
whatever, but we can change the law to enable you to accumulate
wealth.
Mr. Chairman, it may take us going, and rather than
allowing the press to do it or our opponents to do it, it may
take us going to people who are over the age of 65 and asking
them, so the country can hear, especially those who have only
Social Security income, and say to them, you are 70 years old
now, let me describe this program. And they will say, my gosh,
I wish that had been in law when I was young and working
because they know what makes them secure is wealth. They don't
feel secure as a result of getting $600 a month from Social
Security.
So it may take a real muscular public education effort
because right now, boy, I think the jaws of consent are closed.
There is just too much misunderstanding and too much
disinformation that is put out. In our line of work, Mr.
Chairman, and you have seen as well an awful lot of money spent
that is essentially lying to the American people about what
Social Security is. So if you have that on top of sort of a
tendency not to want to know the truth to begin with, why it is
not accidental that people don't understand it.
Finally, I say I do think that we have a tendency to
underestimate the willingness of people over 65 to participate
in this. This is the greatest generation ever. You give them
the truth, in my view, they will take the truth, they care
about their kids, they care about their grandkids, they want
them to have a better future. If you BS them, that is a
different thing. But if you tell them the truth, in my view,
and if you call out greatness in them, I think they will take
the challenge.
Chairman Kasich. Bob, in an era where it seems as though
people are isolating themselves more every day, in a time when
we have great economic prosperity, but it seems as though the
gated community and the high walls are the direction that we
are going--you know, I want to take care of me--how do we begin
to, and maybe you have touched on it. Maybe the greatest
generation one more time needs to contribute to the country,
but how do we get people to look beyond the self-interests in
this country, particularly in light of everybody yelling, and
screaming, and shouting, and politicizing everything because
that is always all about me. It is about reelection, it is
about whatever is good for me, how do we even begin to start
this kind of a dialogue? How do we get this where people can
think in a broader way? I mean, you are a poet. I wouldn't ask
this question to most people, but you are a poetic man.
Senator Kerrey. I think you have got to start just quietly
talking straight to a person and say, look, you and I both know
that our worst instinct is when all we care about is ourself.
And I get in the most trouble when I am selfish. If all I am
worried about is me, I am unhappy. That is not how happiness is
found. Happiness is found when you fall in love with someone,
when you care about somebody more than you do yourself, when
you have children, when you do something for somebody else. And
if you want to be remembered, if you want to have somebody
stand on your grave, as they most assuredly will, because
nobody gets of this deal alive, if you want to have somebody
stand on your grave and weep because you are a hero, you have
got to act like it.
We celebrate D-Day and we celebrate those men landing on
the beaches of Normandy, well, those were not selfish kids. And
by the way, they didn't ask for Veterans benefits when they
went over. They didn't say, wait a minute, I am not going to go
over there unless you let me have a VA hospital. I mean, we
gave that to them because we saw them as heroes, and I think
you have just got to, you just quietly, and if that doesn't
work, you have got to come and try to shame people into
understanding this Nation didn't become great as a consequence
of starting out with selfish human beings.
Chairman Kasich. Well, here you have a situation, curious
situation, where both our friend, Tim Penny, went face-to-face
with a race for the United States Senate, a race I personally
believe he would have won; Bob Kerrey comes face-to-face with
whether he runs for reelection, and he says, no, I don't think
I need to do that. And yet we, all of us, look at this problem,
and we know that it needs real leadership. Maybe I could ask
you to reflect on your decision. Did you have a sense that you
could do more to move these issues out of here? How did you
reach the conclusion not to continue to fight on these kinds of
issues?
I know that Mr. Penny made the decision really based on
family considerations, yet he is here today, and going about
this in another way. What was your decision process?
Senator Kerrey. Well, first, Mr. Chairman, God bless them,
Nebraskans gave me permission to work on these issues. I
campaigned on it in 1994. I asked their permission and told
them much of what I have said today, except I have learned a
lot more since then about the problem.
And, secondly, I believe in going back to private life. You
can see things, hear things, feel things that you just can't
here, not because we are--just because, in any job, you get
focused on what you are doing, and it is hard to get away from
it.
And, thirdly, I got an opportunity to do something else
that I am excited about--to work directly with kids in
education, so I said yes to it.
And I don't think, lastly, that I can be as influential. I
mean, there is nothing quite like being in the arena, having
the platform to talk. I would love to, and intend to try to
find something. Maybe when we are down in Texas together at
George Bush's library, we can talk about doing something
together because I would love to try to create a public space,
where the public could understand the issue better.
I thought the President was going to be doing that with
Social Security, and unfortunately he didn't. I will never
forget out at Georgetown he was introduced out there by a young
woman who understood the program. It was his first Town Hall
meeting that he had in this year-long discussion on Social
Security. And she said, I got my first paycheck, and I went
home, and I said to my mother, who is this FICA person and why
are they taking so much money away from me? And then she went
on to explain what FICA was. She understood it. And then she
made a mistake, and she said I have been contributing to that,
and I don't get a very good return on my investment. And the
President didn't correct her, and should have.
What he should have said is, no, we are taxing you now at
levels higher than ever before. I have talked to many people
who say, well, I am paying--I paid in all of my life and I am
just getting it--young people are taxed today at levels that we
have never taxed them before on the payroll tax side to pay for
benefits that we have raised over time, and boy do I know this
one. My benefits from military retirement started in 1969, and
I watched on in absolute sort of a combination of horror and
delight as Congress in 1970, 1971, and 1972 voted 20-percent
increases, and then had to put a COLA through in law, 1973. I
thought, oh, my gosh, I dropped back down to 4 percent. And
then guess what? Inflation took care of that. In 1978, 1979,
1980, 1981, it was 17/18, it was a huge increase.
So we need some way to have a public debate, so that people
like Congressman Sununu, who are still here, have permission to
talk about this and do the right thing. Because otherwise right
now, it seems to me, that, as I said, the jaws of consent are
closed. We need to pry them open somehow so that political
representatives who are still in the game have permission to at
least honestly assess what they want to do. Let the left and
right have a debate at that point, and it will be a healthy
debate, but it will not be healthy as long as it is dominated
by the political fear that currently dominates it.
Chairman Kasich. Well, the 7-to-1 statistic is just
staggering to me; that for every dollar we spend on children we
spend $7 on our seniors. You know, Bob, maybe most things in
life are really about experience. I have two little twin
daughters 6 months old now----
Senator Kerrey. Congratulations.
Chairman Kasich. And they are very healthy, and we have
been very blessed.
Senator Kerrey. I knew you when you didn't, and you are a
better man.
Chairman Kasich. You are right. I am. I am. But here is the
interesting thing. I had an opportunity. I kind of sometimes
think maybe the good Lord sent me to this place, but my little
girl had a virus early in her life, RSV. It was sweeping Ohio
and a lot of the Midwest, and she ended up in the Children's
Hospital for a couple of days. And I went down there, and I
looked, slept on the floor one night, and after you are
sleeping there long enough, they really don't care who you are.
They just, you know, could you just get out of my way. And I
watched the nurses. And I listened to the nurses talk about, it
wasn't about being overworked, it was about the fear of the
fact that they could not properly attend to children.
Our program of reimbursing physicians is based on Medicare
recipients. You get graduate medical education based on how
many Medicare recipients you have in the hospital. There are no
senior citizens in the stand-alone Children's Hospitals. So
what a lot of the Children's Hospitals have done is to
associate with the adult hospitals, which means, again, that
the tail begins to wag the dog. There is a network of hospitals
that stand alone and serve only children. We need $285 million
to make sure that these hospitals can be reimbursed for the
training of physicians.
And you know, Bob, this has been a near impossibility. Out
of a $100 billion HHS budget, they somehow have difficulty
finding $285 million for children. I don't know how--maybe your
suggestion of setting aside a certain amount of dollars. We
have seen fit to dramatically increase the budget of the
Pentagon by $25/$30 billion in 1 year, yet it seems to be so
hard, in this society, to carve out some things for our
children.
Senator Kerrey. I think if you did it in a real thoughtful
fashion, I think you could come up with a package that the
Republicans and the Democrats both would support. But I think
unless you do, the problem is, John, it won't get done. Because
we will vote--the mandatory stuff is easy to vote for.
Chairman Kasich. Yes.
Senator Kerrey. And you vote for it once----
Chairman Kasich. Or you don't vote for it, and then it is
automatic. I think we are going to get the money for the
Children's Hospitals, and I hope you will help. But it is an
interesting, but it is in subtle ways that are difficult to----
Senator Kerrey. No, you are right.
Chairman Kasich. To determine, to assess.
Senator Kerrey. And by the way, I have been leading the
effort on the Senate side on that very issue, Children's
Hospital. So I hope we can succeed and get something done this
year.
Chairman Kasich. The 7 to 1 is interesting because when you
look at all of the charts, we realize that it is the children
who build this economy over time. And if they are shortchanged,
then this economy is hurt and hurt dramatically.
Senator Kerrey. I have no idea how you voted on that H-1B
issue, but I have seen you talk very eloquently about what it
means to be middle class in America today. That is a vote that,
I mean, I will vote for it. But I heard Chairman Goodling,
before the Web-Based Education Commission, say exactly--he
described exactly how I feel. He said, it was the worst vote I
ever cast. He said, I know I am going to have to do it again,
but it is essentially a vote that says we failed--we failed.
Chairman Kasich. Maybe we will start our own party, huh?
Let me recognize the gentleman from New Hampshire, Mr. Sununu.
Mr. Sununu. Thank you, Mr. Chairman. Thank you for being
here, Mr. Kerrey.
You talked a little bit about your disappointment, that it
is not the best environment to talk about these issues, or
sometimes we feel it is not the best environment, the most
receptive environment. But I happen to be a bit more of an
optimist, and I sense that people, as you described the
greatest generation, they are willing to take up their burden,
they are willing to take on a tough issue, and people really
are further out in front of this issue than we give them credit
for. And I think that is largely due to the ground-breaking
work that you have done, and my own Senator Gregg, and Pat
Moynihan, and others in the Senate, and Jim Kolbe, and Charlie
Stenholm here in the House, and Chairman Kasich. So I think the
public is ready. We are more ready than we give them credit
for.
I guess I have a two-pronged question here: One, if you
don't feel that the debate is as advanced as it ought to be,
what else can or should we do, as legislators, other than just
talk honestly and substantively about these issues to better
prepare the public for legislation on this issue?
And question two would be, well, why not just move? Why not
just move a legislative vehicle? Why not just take up the
legislation and use that as a focal point for engaging both
policy makers and the public in debate?
Senator Kerrey. Well, first of all, I share your optimism
about the American people's view, which leads me to say I would
love to do a markup. Senator Gregg, your distinguished Senator,
and I have worked together on this. And what we have tried to
do is we have tried to resolve our own relatively small
conflicts to produce a single piece of legislation. And I would
love to see a markup on it because I think, in fact, it would
pass the Senate. I think we could enact it on the Senate floor
if we were able to get it done.
As to the second part of your statement and question having
to do with what can we do, I do think that there is just an
awful lot of work that needs to be done to help people
understand both what Social Security is and what it isn't, and
to help them understand what it could become, and to do
something, and I was taught--I was in the Navy, but I went to a
number of Army schools and one of them was called Army Ranger
School. And I led a mission one night under instruction, and
the instructor said, you know, you did a good job, except you
were missing one thing. And I said, what is that? And he said
you are missing a sense of urgency, and your men know it. They
know that you lack the sense of urgency, and so they are all
sort of slacking and taking it easy, and you are not as
successful as you--and I think we have to create that sense of
urgency that says if you do it today, here are the good things
that happen. And the longer you wait, the harder this thing
gets. And guess who pays the price for it? Guess who pays the
biggest price? It is lower wage, lower income people that are
going to pay the biggest price of all.
So part of what we need to do is simultaneously educate and
create a real positive urgency. This isn't about eating
spinach. This is about helping people accumulate wealth that
right now don't think they have any chance of it.
Chairman Kasich. Bob, don't you also think, though, that,
you know, we talk about the Penny-Kasich bill--by the way, I
want you to know I named my dog after Tim Penny. My dog now is
named Penny Kasich. [Laughter.]
But, Bob, isn't it interesting, I would say that that was
the first successful shot fired in the war. I mean, you have to
be able to go to the floor and get your brains beat out and be
willing to a bunch of times before people really start to
notice. I mean, in ``1776,'' I don't remember the movie all
that well, but they used to say, ``Would you sit down, John.
Will you shut up.'' And isn't that what really we need? We need
votes, we need people raising cane, and right now----
Senator Kerrey. I think you do. But, John, you need a lot
of sort of calm education simultaneously with getting people
turned onto the idea that this could change their lives in a
positive way, in a very positive way. I mean, it can be quite
exciting to think about we have 3.8 million babies will be born
in the United States of America in the year 2000. Think about
helping them accumulate wealth. What happens if all of them hit
50 years of age and say to Henry Aaron, you are wrong about the
estate tax. I want to get rid of it because I have got an
estate over $650,000, which we could do.
Chairman Kasich. There is no way you are getting picked,
Bob. [Laughter.]
Mr. Sununu. There are brief questions about particular
issues that have been raised in this debate that I have some
concerns about. And I just wanted to get your reaction, as
someone who has probably thought more than I about these
points.
One is the thought raised that among the reforms or changes
to Social Security that might strengthen the system would be to
bring those currently not covered under Social Security into
the system--a lot of State and local employees, public safety
employees, that aren't part of the Social Security system. And
people say, well, let us bring them into the system because it
would be good for them and good for Social Security. I have got
real questions about the ``good for them part'' because I
haven't seen a lot of the letters written by these employees to
their State, local or Federal officials saying please allow me
to pay 12.5 percent per year and participate in Social
Security.
And I have questions about the ``good for Social Security
part'' because what that seems to mean to me would be, well, it
is a way to bring more revenues into this system that is
insolvent.
I want to bias your answer. Somehow I don't think I have.
But what is your thought about that option for reform?
Senator Kerrey. Well, I have been squarely on both sides of
that issue, so that you know. Moynihan and I had it in our
first proposal, and I agreed to it because we needed the money,
not because I thought it was necessarily----
Mr. Sununu. I was unaware of that.
Senator Kerrey. And we did not put it in our second
proposal, in part, because of the mix of people who were then
looking to get on the bill included people whose States didn't
require it. If I am able to step back from the thing, it is a
little difficult to make the case that I should force somebody
to buy into a system that I think is so badly flawed that needs
to be, you know, give them a chance to pay 12.4 percent to buy
into a system that I am not particularly crazy about.
Mr. Sununu. In my limited discussions with public safety
employees or State employees, it is my experience that most of
them are covered by private or public--quasi-public pension
systems that are solvent and well managed. Again, I am not
aware of any that have looked at what they have in the way of
private pensions and said, we would like to participate.
Do you know of any that----
Senator Kerrey. No. That is also a good measure. You are
exactly right. That is another good measure. Believe me, if the
State employees of California wanted to get into the Social
Security system, I believe they could find a way to get it
done. The last time I checked it is a pretty good congressional
delegation in the House. So my guess is if they really wanted
to get into that system, they could somehow manage to get it
done.
Mr. Sununu. One final question about modeling. In the
discussion about personal retirement accounts and an evaluation
of the opportunities created by such accounts, inevitably you
need to try to model those accounts. You make assumptions about
the mix in your portfolio, you make an assumption about how
much you are contributing, you make an assumption about rate of
return and all kinds of other things.
There are a number of plans that have been put out there,
and I assume yours is one, which have been structured in such a
way as to use these accounts to strengthen the system. But one
of the other witnesses today has put together a model that
looks at these accounts and suggests that they are doomed to
fail.
It would seem to me that it is a little bit dangerous to
try to put together these kinds of portfolio models that try to
empirically prove the success or failure of the personal
accounts----
Senator Kerrey. That is true.
Mr. Sununu [continuing]. Before we even get into the
crafting of legislation. Could you talk a little bit more about
a point you made about wealth and income? It seems to me that a
good portion of the value of a personal account isn't
necessarily found in a quantitative analysis, but more in a
personal or moral analysis of empowerment of the individual and
wealth creation at the individual level.
Senator Kerrey. You have touched on a number of things in
your question, so let me know if I don't answer them, whichever
ones are your priorities.
But I believe strongly all of the administrative stuff,
those are usually objections raised by people that if you could
solve the problem that they have got, they are still going to
oppose the plan. They are basically ankle biters, you know,
looking for some reason to inflict a little bit of pain on a
proposal knowing that they are going to be against it no matter
what.
The administrative problems are easy to solve. I mean, for
gosh sakes, the payroll tax is a very complicated system to
administer. For anybody that has been in business out there and
has tried to figure out how to get the forms filled out and
that--I figure that is why God allowed us to invent software.
That is an easy problem to solve.
Arthur Levitt once gave a speech when this thing got hot a
couple of years ago, the head of the SEC, people are not
educated enough, and they are not going to be able to figure it
out. And I wrote him a letter back saying, look, if you can't
regulate it, let us put it on the banking system. We will just
take it away from the stock market and see what your clients
think about that.
And as far as being educated enough, the kid that bags my
groceries at HiV has got a 401(k) account, and every time I go
through there, he is talking to me about stocks and bonds. He
knows more about it than Arthur Levitt does. So the American
people are educated enough to be able to figure this thing out,
in my view.
I think it is terribly important to just almost brush aside
those administrative folks, and maybe just say, look, go talk
to somebody that runs annuities. We can keep the administrative
costs low, we can keep the risk at an acceptable level, we can
do all of that sort of stuff. But if we can solve that problem,
will you join us in trying to help create wealth for everyone?
And in that regard, I say to you, Congressman, I do think it is
important to recognize that people with lower incomes, if you
put 2 percent on them, they are simply not going to be able to
generate enough. I am not a mathematician so I don't know why.
But for some reason, you need to get somewhere north of $700 or
$800 a year annual contributions in order to accumulate wealth
impressively.
Well, the way I figure it, whoever vacuumed this rug last
night is worth as much as I am, even though the market may say
I am worth $130,000 and he or she is worth $20-. But 2 percent
of that $20- only generates $400 a year. So I think you have
got to figure out a way, and we call ours the Breaux kicker,
the one that John Breaux, and I and Judd Gregg have introduced,
that enables everybody to get up to that $7- or $800 level--
makes it relatively easy. And we are talking to people who have
some ideological problem. The Heritage has been working with us
trying to get it better.
And we also open accounts early. Because the variable that
is most important is the number of years you contribute. You
can jog, you can eat Grape Nuts, you can do high colonics, you
can do whatever you want to get healthy, but you don't get
those years back. And if you are 55, you cannot make this thing
work. And even if you are 45, it is tough to make it work. If
you are 35, you have got to contribute a lot more than you do
at 25. And the best way to do it so to get them opened at
birth. And, again, we have been working at Heritage. I know
there are some ideological problems with that.
I think you can make it an earned entitlement, so that it
is not giving money away. But you have got to get those
accounts opened early, and you have got to just force the
debate into helping people accumulate wealth and just say, do
you think it would be good for somebody making $7 an hour to
hit age 60 and have real wealth in their hands? And if they
answer the question yes, you say, join me in figuring out how
to get it done. Because it is absolutely mathematically certain
that it can be done.
Mr. Sununu. Thank you.
Thank you, Mr. Chairman.
Mr. Hoekstra. The Senator is also----
Senator Kerrey. We have got to go take a nap. We have had
three votes this week. [Laughter.]
Mr. Hoekstra. The Senator is also awfully good on this
issue. I only had a chance to catch the tail end of your
testimony and then the questioning by Congressman Sununu. I
would just like to say it is refreshing, and I hope that you
guys reach out to the House and work in putting together some
partnerships.
Senator Kerrey. We will try.
Mr. Hoekstra. Because I think you are providing some very
fresh thinking to the issue. On these kinds of issues, that is
exactly where you need to be. You need to step back, think
about it in a fresh way. We might be surprised with the kinds
of coalitions that we could put together to actually get some
things done. You have piqued my interest into what you are
doing on the Senate side.
Senator Kerrey. Thank you.
Mr. Hoekstra. Thank you very much.
And, John, thanks for calling over and saying, ``Hey, Pete,
you have got to get over here. There is some stuff over here
you can learn.''
Mr. Chambliss. I don't have a question. I just want to make
a comment, and that is, Senator Kerrey, I am sorry I had to be
away and didn't have a chance to listen to you. But I have
followed you on this issue, as well as many other issues, over
the 6 years that I have been here, and I have great admiration
for you. And I am just sorry really, in one way, that guys like
you and John Kasich are leaving our institution because you
bring fresh ideas and not just common sense, but just plain
good sense to some complicated issues, and this being one of
them.
And it is unfortunate, from my perspective, that we don't
have strong leadership coming out of the administration on this
issue. I think it was a perfect opportunity over the last
couple of years to have something laid on the table when guys
like you, and John and others were willing to pick up the ball
and run with it, and I think the Congress was in the mood to
maybe get something done. It is going to take a long period of
time to really accomplish a good positive end result. But I
just want to commend you for your boldness, your thoughtfulness
on this idea, and I hope that folks like you, as well as John,
will continue on the outside to keep beating up on us here on
the inside until we get something done because I have got a
couple of grandchildren that I sure want to see fall into that
category that you are talking about, whether they are making $7
an hour or $700 an hour, I mean, it is just critical for them
60 years from now that we do something now.
Thank you for your service.
Senator Kerrey. Thank you.
Chairman Kasich. Bob, I make a prediction. I think the
Social Security solution is relatively simple. Because if you
create the accounts and get it done quickly, most people are
winners. Almost everybody wins. And the younger you are, the
bigger the winner you are.
You are going to have to do something with benefits, but I
think you can actually write them in such a way that they keep
up with inflation and not more. And that is why the 7-to-1
statistic is so important because people are going to say you
are going to hurt these people as they become seniors. And with
a 7-to-1 advantage, seniors over children, maybe it helps to
put some perspective on this.
I think that the Medicare problem and the long-term care
problem is very--is so much tougher. Because with Social
Security, there is a win. You can sell this as a winner. Like
you say, there is a great wealth there. Health care is going to
be trickier because the nature of our tax code, the nature of
the way in which the benefits, the health benefits are arrived,
and we all I think know that health care has to become more
market-oriented, while protecting people against catastrophic.
To me, that is going to be the great challenge. But I kind of
look at Social Security as a very short putt. Most people know
what the problem is, and maybe we can get it done in a
relatively short period of time.
Senator Kerrey. And I see it as two sides of the same coin.
I suggested in my testimony, if you start off by saying you are
going to change Social Security so it becomes a source of
wealth, and by the way I say to my Democratic friends, many of
whom have spent a long time and are great passionate and
articulate defenders and helpers of people who are poor, that
you don't make somebody not poor by increasing the minimum wage
or expanding the EITC or some other device like that. That
doesn't make them nonpoor. That gives them a little more
income, but it is not the same thing. And if you really do care
about the rich getting richer and the poor getting poorer, you
are not going to solve that problem by having an estate tax or
by putting other barriers in between people and wealth.
You are going to solve that problem by helping everybody
accumulate wealth. And if they accumulate wealth, John, I think
the second problem gets fixed. But you have got to be willing
to come in and tear up that contract and say, well, what we had
in 1965 for health care was a system that was based upon the
economic reality at the time, which was you worked for 45 years
in the same job--I graduated from high school in 1961, and
three-fourths of my class went right in the workforce, and they
were making more money than I did for quite a while. And they
did a little time in the service, they came back. The job
supported a family.
Today, it is 6 or 7 years, and you are on to something
else. So what we needed then was something to take care of you
when you hit 65 because that was the economic reality then. It
is not the economic reality now. And if you are going to have
the right trade, technology and immigration policies, in my
view, you have got to have a safety net that starts off by
saying you get health care by being an American or legal
resident, and then fold Medicare, Medicaid, the VA, the income
tax deduction, all of it, into a single system of eligibility
and say, Bob Kerrey, if you need it in 1969 right after you got
blown up in the war, God bless you. We are going to provide it
for you. If something else happens to you, and your genes say
that you are going to have cancer or something else, which
happens--I mean, I don't control 90 percent of the things that
happen to me--so if something bad happens to me, we'll provide
a subsidy.
But if your income goes up, Bob, and you have the capacity
to take care of yourself, we are not going to ask somebody with
a lower income to pay higher taxes to take care of you. That is
why I think Social Security fixes the second one. But the
second one you are exactly right, it is a much, much longer
putt. It is more like a hole in one. I am not even sure you are
on the putting surface.
Chairman Kasich. I think that is exactly right. But maybe
it all kind of, in a funny sort of way, dovetails with what I
think is the greatest challenge of the future, and that is
whether we can get people to tear down the walls and realize
that life is not just about me. And maybe it all kind of fits
together.
I want to thank you for your testimony.
Senator Kerrey. Thank you. Thanks for your service.
Chairman Kasich. I look forward to spending time with you.
Senator Kerrey. And you are a better man now that you have
got those babies.
Chairman Kasich. You have got it. All right, Bob.
Senator Kerrey. I know your committee knows that.
Chairman Kasich. All right. I am going to bring Larry
Kotlikoff, the father of generational accounting, and Alicia
Munnell, who has had a long and distinguished career in
academia and with the Clinton administration. I want to welcome
you both and have you, see if we can get through the first part
of your testimony.
At 2:30, I have to defend a Kosovo provision in a
Conference Committee. I will go to that. But Saxby will be here
to hear you. I have to do that. I have no choice on that.
So if you want to go ahead and testify. What does the
committee want to do? Do you want to start the testimony? Why
don't we go ahead, and if you can--I hate that we have to do
this--but go ahead and summarize where you are.
STATEMENTS OF ALICIA H. MUNNELL, PROFESSOR OF MANAGEMENT
STUDIES, BOSTON COLLEGE, AND LAURENCE J. KOTLIKOFF, PROFESSOR
OF ECONOMICS, BOSTON UNIVERSITY
STATEMENT OF ALICIA MUNNELL
Ms. Munnell. Mr. Chairman and members of the committee, I
am delighted to have the opportunity to appear before you today
to discuss the question of intergenerational economics. These
issues are crucial to framing the debate over Social Security
and Medicare. If you say there is a huge problem out there and
that the numbers are just staggering, then that forces you to
find a very dramatic solution. If you say the problems out
there are manageable, then you can solve the problems with
moderate changes. What I would like to argue is that the
problems are manageable and that dramatic restructuring of
either Social Security or Medicare is both unnecessary and
undesirable.
I would like to make four points: First, the projected
increase in Social Security spending due to the aging of the
population is neither enormous nor unprecedented. The cost of
the program is going to go up by 2.6 percent of GDP between now
and the year 2074, 2.6 percent over the 75-year period. We have
seen budget changes of that magnitude before. Defense spending
went up by 5 percent of GDP when the Cold War began, and it has
gone down by 2.6 percent of GDP in the last 10 years.
Social Security financing is not in crisis. Rather, the
current projections show a manageable long-run financing gap.
If you look over the whole 75 years, revenues are equal to 84
percent of projected benefits. We have enough money to pay full
benefits until the year 2037. After that, the trust funds are
exhausted, but that doesn't mean the program ends. There is
still enough money in place to pay 70 percent of benefits.
Of course, Social Security is not the whole story. You also
have spending on Medicare, and that is projected to grow. But
incomes are also projected to grow. And if you look at the
growth of income and the projected growth in Social Security
and Medicare, the increase in cost for these two programs is
going to take up only 20 percent of the increase in well-being
and the standard of living that we are going to experience in
the future. Thus, moderate economic growth should enable future
workers both to enjoy rising standards of living and to pay the
added costs necessary to sustain current benefits.
So my first point is that we are not facing a crisis and
that future costs are manageable. I am not saying there is not
a problem. There is a problem in Social Security. There is a
problem in Medicare. Both problems should be fixed, and fixing
them sooner is much better than fixing them later.
My second point is that the old arguments that Social
Security and Medicare spending will crowd out other Government
programs have lost their force now that both parties are
committed to moving away from the unified budget. The real
threat to on-budget programs is massive tax cuts, not Social
Security and Medicare. Under the new budget arrangements, the
Social Security financing will be completely separate; that is,
they will be kept in a lock box.
With Social Security off-budget, Congress will be focusing
on the financing of the non-Social Security expenditures and
the money to finance those programs. In the next 20 years or
so, these programs are threatened far more by the prospect of
massive tax cuts than by Social Security. Thus, the answer to
future budget pressures is to limit the size of tax cuts, not
to dramatically restructure well-functioning programs.
My third point reiterates the thrust of the testimony by
Dan Crippen and everyone else who has testified today. The most
important economic decision is the level of national saving
because everyone in the future--the elderly and workers--will
have to be supported out of future GDP. As a practical matter,
we cannot stockpile food and clothing today for retirees in
2040. Their food and their clothing will come out of output
produced in 2040. Therefore, the key factor determining the
welfare of future workers is the size of GDP in 2040. And the
key determinant of future GDP is saving and investment today,
both in physical capital and in workers.
One argument used by those who support restructuring of
Social Security is the desire to increase national saving. This
desire happens to be one that I share wholeheartedly. However,
increased saving can be accomplished equally well in the
existing Social Security trust funds or in personal accounts.
The new budget arrangements will make it clear that Social
Security surpluses add to national saving. These surplus funds
will be used to reduce Federal debt held by the public, freeing
up additional resources for private investment.
Since saving can occur either through Government or through
personal accounts, restructuring the Social Security system by
itself would do nothing to increase the size of the future
economy. Under a system of personal accounts, future retirees
would have increased private claims on economic output, but
these claims would simply be offset by reduced public claims.
Therefore, the desire to increase national saving is not a
plausible reason to restructure Social Security.
So my first three points argue that there is no need to
dramatically restructure Social Security. First, the program is
not facing a financial crisis and people can afford future
costs; second, the old arguments about programs for the aged
crowding out other Government programs is much less relevant in
the new budget environment; third, we can increase national
saving as easily through Social Security as through personal
accounts.
My last point is that replacing all or part of Social
Security's current defined benefit package----
Mr. Chambliss [presiding]. Ms. Munnell, I hate to interrupt
you, but we have got 4 minutes, and we need to run over and
vote. If you all can be patient with us, let us vote, we will
be back because we really want to hear you.
Ms. Munnell. OK. Go.
Mr. Chambliss. You have already raised some interesting
questions.
[Recess.]
Mr. Chambliss. Thank you all for your patience and for
letting us interrupt your lunch there.
Ms. Munnell. Sorry. All finished.
Mr. Chambliss. No, that is quite all right. You take your
time. Other members may be coming back, but we will proceed on.
Ms. Munnell. Can I just summarize where I was and finish up
my last point?
Mr. Chambliss. Sure. Absolutely.
Ms. Munnell. I think this whole issue of intergenerational
economics is very important because it determines how you frame
the issues of Social Security and Medicare. And basically, if
you characterize the problems as enormous, then when you are
looking for solutions, you need a dramatic change. If you
characterize the problems as manageable, then when you are
looking for solutions, you can get moderate changes.
And the first three arguments I tried to make is that the
problems are not enormous, they are manageable. People can
afford the future costs. And second, a lot of these arguments
have been around about the programs for the elderly squeezing
out other programs I think have less force now that Social
Security is outside the budget. The third point was that people
say, well, we really need to restructure Social Security
because we need individual accounts so that we can increase
national saving. I agree increasing national savings is
extremely important. It will determine what the size of GDP in
the year 2040 is. But I argue that you can do that under this
new budget arrangement equally well through either the trust
funds or through individual accounts.
And so that brings me to my last point, and that is that,
in my view, replacing all or part of Social Security's current
defined benefit plan with personal retirement accounts is
risky, it is costly, and most important it is going to hurt the
vulnerable in the long run. The whole point of having a Social
Security system is to provide workers with a predictable
retirement benefit. As people have said, Social Security
benefits are quite modest. They are about $800 a month. And all
of these proposals for personal accounts involve first cutting
back on Social Security benefits. So it involves reducing that
$800 to $600 or $500 or $400, and then substituting an
individual account that you hope makes up for the additional
lost benefit.
And so when Senator Kerrey was talking about building
wealth, I think building wealth is fine, but I think it is fine
on top of Social Security, on top of that $800, not making part
of that $800 unpredictable. In addition to making that $800
unpredictable, personal accounts are costly. But I agree that
is a secondary issue. A very important issue, though, is that
they expose participants to the temptations of early
withdrawal. I am convinced if people think those are their
accounts, they are going to have very legitimate needs to
wanting to get access before retirement. They are going to have
an illness or want to buy a home. And to the extent that they
get access before retirement, there will not be enough money
available in retirement.
It also brings up this whole issue of the risks associated
with annuitization. What do you do with these piles of money
once people get to retirement?
More fundamentally, personal accounts are likely to set in
motion a process that will end up separating income support
from social insurance. And in the U.S. I think separating these
two functions will almost certainly produce less
redistribution, which will harm future generations of low-wage
workers.
So my conclusion is that while intergenerational economic
issues are important, they do not suggest that we need to
dramatically alter our major social insurance programs. Under
the new budget structure, the main threat to other programs is
not Social Security, but tax cuts. Moreover, while increasing
national savings is important, this can be done just as easily
through the trust funds as through personal accounts. In short,
there is no compelling reason to replace part of Social
Security with personal accounts, and doing so will make
tomorrow's elderly worse off, not better off.
Thank you.
[The prepared statement of Alicia Munnell follows:]
Prepared Statement of Alicia H. Munnell, Peter F. Drucker Professor of
Management Sciences, Boston College Carroll School of Management
Mr. Chairman and members of the committee, I am delighted to have
the opportunity to appear before you today to discuss intergenerational
economic issues. These issues are crucial to framing the debate over
the future of Medicare and Social Security. Critics of these programs
claim that entitlements are unsustainable and will push the economy to
the breaking point. They are wrong. They claim that transfers to the
elderly undermine saving, investment, and economic growth. They are
wrong. They claim that intergenerational accounts are out of balance
and unfair. They are wrong. The critics of these programs exaggerate
the size of the problem in order to justify dramatic solutions.
This morning I would like to make four points to document that the
situation is not dire, and that dramatic restructuring is both
unnecessary and undesirable.
First, the projected increase in Social Security spending
due to the aging of the population is neither enormous nor
unprecedented. The cost of the program is projected to rise by 2.6
percent of GDP by 2074. Budget changes equal to 2.6 percent of GDP are
not uncommon; defense spending increased by 5 percent of GDP at the
start of the cold war and declined by 2.6 percent of GDP between 1989
and 1999. The financing shortfall is manageable and does not require
radical change in the program.
Second, under the new budget arrangements Social Security
financing will be completely separate--that is, kept in a ``lock box.''
Eventually, the same treatment may be appropriate for at least part of
Medicare. This means that other government programs are no longer in
competition with Social Security; they are in competition with tax
cuts.
Third, the most important economic decision is the level
of national saving, because everyone in the future--the elderly and
workers--will have to be supported out of GDP in the future. The new
budget arrangements make it just as easy to save through the Social
Security trust funds as in private accounts. Government saving is just
as good as private saving.
Finally, replacing all or part of Social Security's
current defined benefit plan with personal retirement accounts is
risky, costly, and will hurt the vulnerable. The whole point of having
a Social Security system is to provide workers with a predictable
retirement benefit. Social Security benefits are quite modest; the
average worker retiring at age 62 last year got $805 per month. That
modest benefit should be an amount that people can count on and to
which they can add income from private pensions and other sources. It
should not depend on investment decisions in a volatile stock market.
Let me address each of these issues in order.
i. social security is not facing a financing crisis
Social Security is not facing a financial crisis. Rather, the
current projections show a financing gap in the long run unless
remedial action is taken, as it almost certainly will be. According to
the most recent official projections, between now and 2015 the Social
Security system will bring in more tax revenues than it pays out. From
2015 to 2025, adding interest on trust fund assets to tax receipts
produces enough revenues to cover benefit payments. After 2025, annual
income will fall short of annual benefit payments, but the government
can meet the benefit commitments by drawing down trust fund assets
until the funds are exhausted in 2037. The exhaustion of the trust
funds does not mean the program ends; even if no tax or benefit changes
were made, current payroll tax rates and benefit taxation would provide
enough money to cover more than 70 percent of benefits thereafter.
Over the next 75 years, Social Security's long-run deficit is
projected to equal 1.89 percent of covered payroll earnings. That
figure means that if the payroll tax rate were raised immediately by
roughly 2 percentage points--1 percentage point each for the employee
and the employer--the government would be able to pay the current
package of benefits for everyone who reaches retirement age at least
through 2075. While such a tax increase is neither necessary nor
desirable, it provides a useful way to gauge the size of the
problem.\1\
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\1\ Social Security's long-term financing problem is somewhat more
complicated than just described. Under current law, the tax rate is
fixed while costs are rising, and this pattern produces surpluses now
and large deficits in the future. As a result of this profile, under
present law, each year the 75-year projection period moves forward,
another year with a large deficit is added to the 75-year deficit.
Assuming nothing else changes, this phenomenon would increase the 75-
year deficit slightly (.08 percent of taxable payroll with today's
deficits) each year. Many policymakers believe that the system should
not be left with a huge deficit in the 76th year.
---------------------------------------------------------------------------
A different pattern of costs emerges when Social Security outlays
are projected as a percent of gross domestic product (GDP) rather than
as a percent of taxable payrolls. The cost of the program is projected
to rise from 4.2 percent of GDP today to 6.7 percent of GDP in 2040,
and to only 6.8 percent by the end of the 75-year projection period.
The reason why costs as a percent of GDP more or less stabilize while
costs as a percent of taxable payrolls keep rising is that taxable
payrolls are projected to decline as a share of total compensation due
to a continued projected growth in fringe benefits. A 2.6-percent-of-
GDP increase in Social Security costs is significant, but hardly
qualifies as a ``demographic time bomb.''
Of course, Social Security is not the whole story when it comes to
future retirement costs. Between now and 2040, Medicare spending is
projected to rise by 2.4 percentage points of GDP. Medicaid spending,
roughly two-thirds of which provides health services to low-income
elderly and disabled persons, is also projected to increase by about
2.4 percentage points of GDP over the next four decades. The costs of
Supplemental Security Income (SSI) and food stamp benefits for the low-
income elderly and disabled may also rise. Finally, private
expenditures for long-term care will also grow.
The projected increase in the costs for Social Security in
combination with Medicare and the other programs is significant but is
not likely to overwhelm future economic growth. If real output per
capita grows 1.0 percent annually--as projected by the Social Security
Trustees--it will rise 49 percent by 2040. (Note that per capita GDP
grew at an annual rate of 2.1 percent during the 1990s.) Of this
amount, only about 20 percent would be required to deal with the
projected increases in Social Security and Medicare, even if nothing
were done to restrain benefit growth.\2\ Thus, moderate economic growth
would enable future workers both to enjoy rising standards of living
and to pay the added taxes necessary to sustain currently projected
benefit costs.
---------------------------------------------------------------------------
\2\ If per capita GDP increases by 1 percent per year between now
and 2040, it will be 48.9 percent higher in 2040. Over the same period,
OASDI, HI, and SMI outlays are projected to rise from 6.52 percent of
GDP to 11.44 percent of GDP. Applying the higher rates to the increased
per capita GDP implies that taxes in 2040 will be 17 percent of 2000
per capita GDP, or an increase of 10.5 percentage points. Taking the
ratio of the 10 percentage point increase in taxes to the 48.9
percentage point increase in per capita GDP reveals that the higher
taxes will take up only 20 percent of the project improvement in per
capita GDP.
---------------------------------------------------------------------------
ii. other government programs are no longer in competition with social
security; they are in competition with tax cuts.
Although future workers' living standards will increase by more
than enough to cover higher taxes, critics often claim that spending on
the elderly will crowd out other government programs. One projection
that they commonly use to argue for cutting back on Social Security and
Medicare is that these programs will increase from 32 percent of the
budget today to 53 percent in 2040 (CBO 1999). The implication is that
government expenditures as a percent of GDP are absolutely fixed, and
every dollar going to the elderly means one less dollar for programs in
the rest of the budget.
This argument is misleading for a number of reasons. First,
expenditures are not fixed by edict; the U.S. simply has a taste for
low government outlays. For example, government spending in the U.S. in
1996 amounted to 34 percent of GDP compared to 41 percent for the
United Kingdom, 43 percent for Canada, 46 percent in Germany, 50
percent in Belgium and the Netherlands, 52 percent for France, and 63
percent in Sweden (OECD). As the population ages, the U.S. may choose
to increase the share of resources going to government programs.
Second, even if the U.S. decides to hold government spending
relative to GDP at today's level, government debt held by the public
should be eliminated by around 2010, leading to a major drop in
projected interest expenditures. During the 1990s, net interest
accounted for 14.5 percent of Federal budget outlays. Thus, while
Social Security and Medicare expenditures are projected to go up by 21
percentage points (from 32 percent to 52 percent) of Federal Government
outlays, net interest outlays should go down roughly 15 percentage
points.
Even more important than the elimination of interest expense is the
fact that both parties now agree that Social Security financing should
be kept completely separate from the rest of the budget. Technically,
the Social Security Amendments of 1983 already reversed the reliance on
the unified budget first used by Lyndon Johnson and placed the Social
Security trust funds ``off-budget.'' The difficulty is that, while
Social Security was exempt from most enforcement procedures, budget
targets were always stated in terms of the unified budget, and the
budget numbers reported by the Administration, Congress, and the press
always included the balances in the trust funds. Thus, separating
Social Security from the rest of the budget requires changing culture
more than changing legal requirements. That is precisely the aim of
current congressional efforts to create a ``lock box'' for Social
Security. By ensuring that Congress does not use surpluses in Social
Security to cover deficits in the non-Social-Security portion of the
budget, Social Security will be completely separate and will not
compete with other domestic programs.
With Social Security truly off-budget, Congress will focus on non-
Social-Security expenditures and the financing for these programs. For
the next 20 years or so, these programs are threatened far more by the
prospect of massive tax cuts than by Social Security. Even though the
Office of Management and Budget projects that on-budget surpluses will
total nearly $1.9 trillion over the next 10 years, the amount available
for tax cuts is much smaller, according to an analysis by the Center
for Budget and Policy Priorities. Moving the surpluses in the Medicare
(HI) trust fund off-limits, as both parties are moving to do, and
assuming that Congress maintains current policies for farmers, middle-
class taxpayers, and discretionary programs cuts the $1.9 trillion
figure in half. In other words, promises of very large tax cuts
endanger current programs and any new initiatives.
In short, projections showing that Social Security and Medicare
will increase as a proportion of the Federal budget are much less
relevant than they used to be in the unified-budget regime. In all
likelihood, both Social Security and Medicare (HI) will be completely
separate from the rest of the budget and not competing for funds,
especially for the next two decades. The real and immediate threat to
the on-budget programs is the prospect of massive tax cuts. Thus, the
answer is to limit the size of tax cuts not to restructure the Social
Security system.
iii. the ``lock box'' makes it easy to save through social security
trust funds
Keeping Social Security totally separate from the rest of the
budget has major economic as well as budget implications, since it
significantly enhances the ability to save through the trust funds.
Government saving is just as good as private saving as a means of
increasing future output and enhancing the economic well-being of both
future workers and retirees.
One way or another, everyone wants retirees in the future to have
adequate retirement incomes. The argument is simply about the best way
to provide that income. Assuming that the claims of the elderly will be
the same regardless of the approach, it does not matter from an
economic perspective whether their claims on the pie in 2040 is in the
form of accrued rights under Social Security or in the form of
purchasing power gained through the sale of accumulated assets. Given
the size of the pie, the question is simply how much the working
population in 2040 will have to reduce its own consumption below that
justified by current earnings in order to allow the elderly to consume
their share. The cost to the working-age population is simply the
amount of consumption that workers will have to forego in 2040.
The size of the pie is not fixed, however, but depends to a large
extent on saving and investment decisions that are made in the interim.
The bigger the capital stock and the better educated the workforce, the
larger will be the pie. Most observers believe that we are saving too
little and many have concluded that the Social Security system is a
good mechanism for increasing national saving. From an economic
perspective, it does not matter whether that accumulation occurs in the
existing trust funds or in personal accounts.
To date, increasing saving through accumulations in the Social
Security trust funds has produced ambiguous results. Critics contend
that the existence of Social Security surpluses encourages either taxes
to be lower or non-Social-Security spending to be higher than it would
have been otherwise. Although little evidence exists to either support
or refute this contention, a unified budget and large deficits have
blurred the picture until now. But the fiscal outlook has changed; as
discussed above, Social Security will become completely separate from
the rest of the budget, and large surpluses are accumulating in the
non-Social Security portion of the budget. This configuration should
make very clear the extent to which Social Security adds to national
saving. The accumulations in the trust funds reflect the amount by
which Social Security has reduced the Federal debt held by the public.
This reduction frees up additional funds for private investment, and
the infusion of private investment boosts long-term economic growth,
thereby increasing the size of the economic pie.
Is it realistic to believe that real saving can occur through the
Social Security trust funds? Comparisons of the Federal Government with
the states are always tricky, but states have been successful in this
endeavor. They accumulate reserves to fund their pension obligations
but generally present their budgets excluding the retirement systems.
Their non-retirement budget balance has remained positive, while annual
surpluses in their retirement funds have been hovering recently around
1 percent of GDP. Thus, states are clearly adding to national saving
through the accumulation of pension reserves. With a commitment to
balance the non-Social-Security portion of the budget, the same should
be achievable at the Federal level.
Regardless of whether the increase in saving comes through the
trust funds or through personal accounts, for the effort to be
meaningful the current generation of workers will have to forego some
current consumption so that those alive in 2040 will have more. That
means that they will in effect pay twice: they already have to reduce
their consumption to cover promised benefits for the retired and those
about to retire; now they will also have to reduce consumption to build
up assets either collectively or individually. This is an inescapable
outcome of the decision to increase saving. While increasing national
saving now will impose a cost on the current generation, it means that
the pie in 2040 will be larger. One study showed that even relatively
modest advanced funding, if really saved and invested, could raise
future aggregate income--that is, increase the size of the pie--
sufficiently to offset the added Social Security costs on future
workers due to the aging of the population (Aaron, Bosworth, and
Burtless 1989).
iv. personal savings accounts are risky, costly, and hurt the
vulnerable
Despite the relative health of the Social Security system, the
ability of future generations to bear the projected increase in costs,
and the possibility of using the trust funds to increase national
saving, proposals abound to replace at least a portion of the current
Social Security program with personal accounts. The enthusiasm for
personal accounts can be traced to a confluence of events and the lure
of higher returns, but they involve enormous risks.
The basic argument against shifting to personal accounts is that it
is inconsistent with the goals of the Social Security program; it would
put people's basic retirement benefits at risk and make them
unpredictable. The whole point of having a Social Security system is to
provide workers with a predictable basic retirement income to which
they can add income from private pensions and other sources. If it is
appropriate for the government to interfere with private sector
decisions to ensure a basic level of retirement income, it does not
make sense for that basic amount to be uncertain, reflecting one's good
luck or investment skills. The late Herb Stein, Chairman of the Council
of Economic Advisers under President Nixon, summarized the argument
best.
``If there is no social interest in the income people have at
retirement, there is no justification for the Social Security tax. If
there is such an interest, there is a need for policies that will
assure that the intended amount of income is always forthcoming. It is
not sufficient to say that some people who are very smart or very lucky
in the management of their funds will have high incomes and those who
are not will have low incomes and that everything averages out.''
In addition to the fundamental philosophical argument, personal
accounts raise a host of practical problems, including potential access
before retirement, lack of automatic annuitization, and cost:
Access Before Retirement. Personal accounts create a very
real political risk that account holders would pressure Congress for
early access to these accounts, albeit for worthy purposes such as
medical expenses, education, or home purchase. Although most proposals
prohibit such withdrawals, experience with existing Individual
Retirement Accounts and employer-sponsored defined contribution plans
suggests that holding the line is unlikely. To the extent that Congress
acquiesces and allows early access--no matter how worthy the purpose--
many retirees will end up with lower, and in some cases inadequate,
retirement income.
Lack of Automatic Annuitization. Another risk is that
individuals stand a good chance of outliving their savings, unless the
money accumulated in their personal accounts is transformed into
annuities. But few people purchase private annuities and costs are high
in the private annuity market.\3\ Even if costs were not high, the
necessity of purchasing an annuity at retirement exposes individuals to
interest rate risk; if rates are high when they retire, they will
receive a large monthly amount, if rates are low, the amount will be
much smaller. Moreover, the private annuity market essentially does not
offer full inflation-adjusted benefits. In contrast, by keeping
participants together and forcing them to convert their funds into
annuities, Social Security avoids adverse selection and is in a good
position to provide inflation-adjusted benefits.
---------------------------------------------------------------------------
\3\ The reason for the high costs is adverse selection: people who
think that they will live for a long time purchase annuities, whereas
those with, say, a serious illness keep their cash. Private insurers
have to raise premiums to address the adverse selection problem, and
this makes the purchase of annuities very expensive for the average
person.
---------------------------------------------------------------------------
Cost. The 1994-96 Social Security Advisory Council
estimated that the administrative costs for an ``Individual Retirement
Account (IRA)'' approach would amount to 100 basis points per year.\4\
A 100-basis point annual charge sounds benign, but it would reduce
total accumulations by roughly 20 percent over a 40-year work life.
Moreover, while the 100-basis-point estimate includes the cost of
marketing, tracking, and maintaining the account, it does not include
brokerage fees. If the individual does not select an index fund, then
transaction costs may be twice as high. Indeed, the United Kingdom,
which has a system of personal saving accounts, has experienced
considerably higher costs (Orszag, Orszag, and Murthi 1999). Finally,
unless prohibited by regulation, these transaction costs involve a flat
charge per account that will be considerably more burdensome for low-
income participants than for those with higher incomes.
---------------------------------------------------------------------------
\4\ In addition to costs, a study by the Employee Benefit Research
Institute (Olsen and Salisbury, 1998) raised real questions about the
ability, in anything like the near term, to administer a system of
individual accounts in a satisfactory way. Unlike the current Social
Security program that deals with the reporting of wage credits, a
system of personal accounts would involve the transfer of real money.
It is only reasonable that participants would care about every dollar,
and therefore employer errors in account names and numbers that arise
under the current program would create enormous public relations
problems under a system of individual accounts.
---------------------------------------------------------------------------
Many advocates of personal accounts have now recognized the very
high administrative costs of the IRA approach and have fallen back to
recommending defined contribution plans similar to the Federal Thrift
Savings Plan (TSP), which the Federal Government provides for more than
2 million employees.\5\ In the Federal plan, the accumulated
contributions are invested in large pools, and individuals can choose
from a limited number of index funds. Costs would be substantially less
under this alternative, although it would still double the costs of the
current Social Security program. Moreover, for those concerned about
government involvement, this approach has the government picking the
appropriate equity funds and retaining control of the money. This is
not a particular problem in my view, but for those who are concerned
about government investment in private sector activities, the TSP
approach raises the same issues as investment by the central trust
funds.
---------------------------------------------------------------------------
\5\ The TSP was established by the Federal Employees' Retirement
System Act of 1986 (FERSA). It is a voluntary savings and investment
plan similar to the defined contribution plans offered under section
401(k) of the Internal Revenue Code. Individuals can direct their
contributions to a stock fund, a money market fund, or a bond fund, and
can shift their investments over time.
---------------------------------------------------------------------------
While personal accounts are merely risky and costly for the average
and above average worker, they could end up being disastrous for
vulnerable workers in the future. The whole point of shifting funds to
personal accounts is to emphasize individual equity--that is, a fair
return for the individual saver--rather than adequacy for all. Taking
part of what the high earner makes to improve the return for the low
earner would be contrary to the spirit of such a plan. To meet this
objection, many advocates of the defined contribution approach provide
either a flat benefit amount or a healthy minimum benefit for low-wage
workers. Although such provisions will protect low-income workers in
the short term, opponents of these accounts believe that maintaining
redistribution within the program is unlikely to be sustainable.
A mixed defined benefit/personal account system with a flat benefit
and a defined contribution account is likely to respond very
differently to change over time than the existing defined benefit
arrangement. For example, suppose that the overall size of Social
Security was viewed as too large as the retirement of the baby boom
neared. Benefit cuts under the existing program would likely affect all
people at all points in the income distribution proportionately; for
example, the extension of the normal retirement age from 65 to 67 in
1983 was a form of an across-the-board cut. Congress might even attempt
to protect the benefits of workers with low incomes. Cuts under a mixed
defined benefit/ personal account system are likely to be very
different. People are likely to view the defined contribution component
as individual saving and see little gain from cutting it back. The more
likely target would be the flat minimum benefit, which goes to both
those who need it and those who do not. Higher wage workers are going
to find they get very little for their payroll tax dollar from such a
residual Social Security program and will withdraw their support. As
the minimum is cut repeatedly, it will become inadequate for low-wage
workers. In response, pressure is likely to develop to replace the flat
benefit with a means-tested program.
Observers sometimes argue that the same economic outcome can be
achieved either through means-tested benefits or through social
insurance payments that are then taxed back. This conclusion ignores
psychological, social, political, and institutional factors. Means-
tested and social insurance programs in the United States grow out of
different historic traditions, have different impacts on their
recipients, and are viewed very differently by the public. Social
insurance reflects a long history of people getting together to help
themselves. This self-help approach means that individuals have an
earned right to benefits, since they receive payments based on
contributions from their past earnings. The programs involve no test of
need, and program benefits can be supplemented with income from saving
or other sources. Means-tested programs in the U.S., on the other hand,
grow out of the punitive and paternalistic poor-law tradition, which
recognizes only begrudgingly a public responsibility for providing for
the impoverished. Means-tested benefits tend to be less adequate than
those provided under social insurance programs and have a stigma, which
means that many who are eligible never claim their benefits. To the
extent that people at the low end of the income distribution are forced
to rely on means-tested benefits, they are likely to be worse off than
they would be under the existing defined benefit Social Security
system.
v. conclusion
Let me conclude. Social Security is not facing a crisis. The long-
term financial gap can be closed within the structure of the current
program, and the increased costs of Social Security and Medicare
combined will take up only 20 percent of the modest projected growth in
living standards. Moreover, the old arguments that Social Security and
Medicare spending will crowd out other government programs have lost
their force now that both political parties are committed to moving
away from the unified budget. The real threat to on-budget programs is
massive tax cuts, not Social Security and Medicare.
Despite the benign outlook for Social Security, plans abound to
dramatically restructure the system. One argument for such
restructuring is the desire to increase national saving. I share the
concern about the welfare of future workers and believe that we need to
make intelligent decisions in order to ensure them the highest standard
of living possible. We cannot stockpile food and clothing today for
retirees in 2040; their food and clothing will come from output
produced in 2040. Assuming that the personal account debate is about
the way in which the elderly secure their claims not the amount, the
key factor determining the welfare of future non-elderly is the size of
GDP in 2040. If GDP is large, future workers will have a lot after they
provide for the elderly; if GDP is small, they will have less. The key
determinant of future GDP is saving and investment today, both in
physical capital and in workers. With the separation of Social Security
from the rest of the budget, this saving can be done equally well
through the trust funds as through private accounts. Therefore, the
desire to increase national saving is not a plausible reason to
restructure the Social Security system.
The legitimate arguments for personal retirement accounts rest on
questions of individual control and better matching of portfolios to
individual risk preference. Some proponents also believe that personal
accounts would be more stable politically over the long run; others
think that they might enhance the possibility of getting more funds
into the system. The question is whether the possible gains from
personal accounts are worth the costs. The answer seems clearly ``no.''
If it is appropriate for the government to interfere with private
sector decisions to ensure a basic level of retirement income, it does
not make sense for that basic amount to be uncertain, depending on
one's investment skills. Personal accounts also are costly, and expose
participants to the temptations of early withdrawal and the risks
associated with private annuitization at retirement. More
fundamentally, separating income support from social insurance in the
U.S. will almost certainly produce less redistribution, which will harm
future generations of low-wage workers.
Mr. Chambliss. Thank you very much.
Professor Kotlikoff.
STATEMENT OF LAURENCE KOTLIKOFF
Mr. Kotlikoff. Thank you, Mr. Chairman.
Mr. Chairman and distinguished members of the House Budget
Committee, I am honored by this opportunity to discuss with you
U.S. fiscal policy, specifically the burden it is likely to
place on our children and grandchildren.
Notwithstanding the rosy fiscal scenarios being floated
today by Government agencies, there is an enormous imbalance in
the projected tax burden facing current and future generations.
Indeed, the most recent generational accounting for the United
States, which was done recently by economists at the
Congressional Budget Office and the Federal Reserve Bank of
Cleveland, but has so far not been published by either agency,
indicates that our children will face lifetime net tax rates
that are roughly 40 percent greater than those that we face.
Avoiding that outcome would, for example, require an
immediate and permanent 31-percent increase in Federal personal
and corporate income taxes. Such a policy would mean a $375
billion larger surplus this year. Stated differently, to
achieve generational balance such that our children and
grandchildren would face the same tax rates as we face, we
should be running a surplus this year that is almost three
times larger than the one we are actually running.
Now, rather than warn us about the tidal waves of
liabilities facing our children, our Government is doing its
level best to mislead the American people about our fiscal
future. I speak primarily of the Congressional Budget Office's
10-year budget forecast. But the Office of Management and
Budget, Social Security trustees, the Medicare trustees, are
all deceiving the American public about what will happen once
the 77-million strong baby boomers retire. When that happens,
we will have 100-percent more old people, but only 15-percent
more workers on whom they can lean for financial support.
Now, how can I be so grim about the Government's long-term
finances, when the Congressional Budget Office just last week
projected surpluses between now and 2010 that accumulates to
$5.7 trillion? The answer is that the CBO's surplus projection
is predicated on spending assumptions that no one in Congress
takes seriously and upon which no responsible adult would risk
his child's economic future. Consider CBO's frozen spending
projection in which Federal discretionary spending remains
fixed in nominal dollars through 2010. Under that scenario,
Federal discretionary spending falls by 35 percent as a share
of GDP between now and the end of the decade.
The CBO says that it is just doing what Congress tells it
to do in making these projections. But that is not what I and
other parents are expecting it to do. We expect the CBO and
other Government agencies to provide realistic budget
estimates, particularly if these estimates are going to be
driving the national debate that determines how we treat our
children.
How much of the CBO's $5.7-trillion surplus over the next
10 years will disappear if Federal fails magically to decline
as a share of GDP to a level not witnessed in the post-war
period? The answer is that $2.1 trillion of the $5.7 trillion
supposed surplus will disappear. Of the remaining $3.6
trillion, $2.4 trillion is off-budget and supposed to be spent
on Social Security and Medicare benefits. So what is left is
only $1.2 trillion--a nontrivial sum for sure, but a far cry
from the amount needed to cover all of the remaining Social
Security and Medicare bills, let alone those from the rest of
the Government's operation.
Mr. Chairman, this is the clear message from the
generational accounting to which I referred to at the beginning
of my remarks. That analysis, which assumes that Federal
discretionary spending stays even with the economy, takes into
account all of the future Government receipts and expenditures,
not just at the Federal level, but also at the State and local
level. Hence, it fully incorporates this $1.2-trillion surplus
that we can legitimately anticipate over the next decade. But
this short-term surplus notwithstanding, there remains a huge
imbalance in generational policy whose elimination requires not
major tax cuts or major expenditure hikes, but precisely the
opposite.
Because time is short, let me summarize the remaining part
of my testimony, and I hope I can submit the testimony to the
record.
The generational accounting suggests that we need a 31-
percent immediate and permanent increase in our income taxes.
That is one way you could solve the demographic problem. There
are, of course, other ways. I have in this testimony a Table 2
at the back, which shows alternatives. An alternative to
raising income taxes by 31 percent would be to raise all
taxes--FICA taxes, income taxes, State income taxes, State
sales taxes--by 12 percent, immediately and permanently.
You could also cut all transfer payments to unemployment,
to welfare, to Social Security, to Medicare and Medicaid by 22
percent. Or you could start from this time path of Government
discretionary spending, which stays even with the economy, and
you could cut that by one-fifth at all levels of Government,
or, if you just focus on the Federal Government, you could cut
spending by 66 percent.
Each of these alternatives would be enormously painful. But
the longer we wait, the worse the alternatives will get. So,
when Dr. Munnell says that we have a moderate problem or a
manageable problem, I couldn't disagree more. We have a
horrendous problem, and that problem is revealed by
generational accounting very clearly. And this generational
accounting is being done by the Congressional Budget Office and
the Federal Reserve Bank of Cleveland based on the latest CBO
projections.
Generational accounting does not truncate its analysis at
75 years. It looks through time at the true long-term, which
doesn't stop 75 years from now. When you stop 75 years from
now, you ignore the fact that in year 76, and year 77 and so
forth, you have absolutely gigantic deficits in the entitlement
programs and other parts of the budget. For example, in the
Social Security program, you are looking at a deficit in 2076
that is roughly $650 billion measured in today's dollars.
If you just look at Social Security and Medicare and you
ignore the whole rest of the Government, and you assume that
the trust funds for those programs that currently exist and the
surpluses that are scheduled to be accumulated are all spent on
the benefits of those programs, you still find out that those
programs are short about 40 percent of the resources they need
to pay benefits on an ongoing basis; in other words, Social
Security and Medicare are 40-percent broke.
Let me conclude by saying that the Government, through its
various fiscal agencies, is assuming away our fiscal problems,
rather than disclosing and solving them. In so doing, it badly
disserves both us and our children. Notwithstanding the rosy
fiscal projections, our country has a huge imbalance in its
generational policy. Without dramatic and immediate changes in
this policy, our children are likely to face lifetime net tax
rates that are two-fifths larger than those we face.
There are a variety of steps, all painful, that we can take
to achieve a situation of generational balance, in which our
children face the same lifetime net tax rates as we face. But
getting any of these steps publicly discussed and enacted into
law requires providing the Nation with an honest assessment of
our long-term fiscal problems.
Toward that end, Congress should establish an independent
agency to do generational accounting. This agency would
evaluate the generational accounting implications of all major
spending and tax bills and make annual reports to Congress
about the steps needed to achieve generational balance.
Thank you, Mr. Chairman.
[The prepared statement of Laurence Kotlikoff follows:]
Prepared Statement of Laurence J. Kotlikoff, Professor of Economics,
Boston University
Chairman Kasich and distinguished members of the House Budget
Committee, I am honored by this opportunity to discuss with you U.S.
fiscal policy, specifically the burden it is likely to place on our
children and grandchildren. Notwithstanding the rosy fiscal scenarios
being floated today by government agencies, there is an enormous
imbalance in the projected tax burden facing current and future
generations. Indeed, the most recent generational accounting for the
U.S., which was done by economists at the Congressional Budget Office
and the Federal Reserve Bank of Cleveland, but so-far publicized by
neither agency, indicates that our children will face lifetime net tax
rates that are roughly 40 percent greater than those we now face.\1\
Lifetime net tax rates are calculated by dividing the present value of
lifetime tax payments to federal, state, and local government, net of
transfer payments received, by the present value of lifetime labor
earnings.
---------------------------------------------------------------------------
\1\ See Gokhale and Kotlikoff (2000), which updates calculations
presented in Gokhale and Page, Potter, and Sturrock (2000).
---------------------------------------------------------------------------
Rather than warn us about the tidal wave of liabilities facing our
children, our government is doing its very best to mislead the American
people about our fiscal future. I speak primarily of the Congressional
Budget Office's 10-year budget forecast. But the Office of Management
and Budget, the Social Security Trustees, and the Medicare Trustees are
all deceiving the public about what will happen once the 77-million
baby boomers retire. When that happens, we'll have 100 percent more
elderly, but only 15 percent more workers on which they can lean for
financial support.
the cbo's $5 trillion surplus
How can I be so grim about the government's long-term finances when
the Congressional Budget Office, just last week, projected surpluses
between now and 2010 that cumulate to $5.7 trillion? The answer is that
the CBO's surplus projection is predicated on spending assumptions that
no one in Congress takes seriously and upon which no responsible adult
would risk his child's economic future. Consider CBO's frozen-spending
projection in which Federal discretionary spending remains fixed in
nominal dollars through 2010. Under that scenario, Federal
discretionary spending falls by 35 percent as a share of GDP between
now and the end of the decade! Under CBO's two other scenarios, in
which spending is a) capped through 2002 and then grows with inflation
and b) grows with inflation starting immediately, the Federal
Government is also involved in a supposed disappearing act. Under the
caps scenario, discretionary spending relative to GDP falls by 27
percent. Under the inflationary growth scenario, it falls by 16
percent.
Now the CBO is certainly up front about the assumptions underlying
its projections. But the public isn't reading its fine print, nor, for
that matter, is the press. So the CBO has succeeded in convincing the
nation that we are facing huge surpluses and that we can afford major
tax cuts, major spending hikes, or both. The counterpart of this, of
course, is that the CBO has convinced the public that there is no need
to raise taxes, trim benefits, or limit discretionary spending.
The CBO says it's just doing what Congress tells it to do. But
that's not what I and other parents are expecting it to do. We expect
the CBO and all other government agencies to provide realistic budget
estimates, particularly if these estimates are going to drive the
national debate that determines how we treat out children.
How much of the frozen scenario's $5.7 10-year unified budget
surplus disappears if Federal spending fails magically to decline as a
share of output to a level not witnessed in the postwar period? The
answer is $2.1 trillion. Of the remaining $3.6 trillion, $2.4 trillion
is ``off-budget'' and supposed to be spent on Social Security and
Medicare benefits. So what's left is only $1.2 trillion--a non trivial
sum for sure, but a far cry from the amount needed to cover all the
remaining Social Security and Medicare bills, let alone those from the
rest of the government's operations.
This is the clear message of the generational accounting to which I
referred above. That analysis, which assumes that Federal discretionary
spending stays even with the economy, takes into account all future
government receipts and expenditures. Hence, it fully incorporates the
$1.2 trillion surplus that we can legitimately anticipate over the next
decade. But this short-term surplus notwithstanding, there remains a
huge imbalance in generational policy whose elimination requires not
major tax cuts or major expenditure hikes, but precisely the opposite.
To prepare you for the size of the tax hikes or expenditure cuts
needed to achieve generational balance, let me first point out the true
dimension of the long-term funding shortfall in the Social Security and
Medicare programs. And, to make my position more difficult, let me do
so under the dubious assumption that all off-budget surpluses will be
strictly allocated to pay benefits to those programs' beneficiaries.
social security's long-term funding shortfall
Most Americans realize that Social Security and Medicare face
significant funding problems. What they don't know is that these
problems are three times more severe than the trustees of the Social
Security and Medicare programs acknowledge in their annual reports.
Consider first Social Security (the OASDI program). According to
unpublished estimates by Social Security's actuaries, paying over time
the full amount of promised benefits necessitates an immediate and
permanent 4.7 percentage point hike in the program's 12.4 percent
payroll tax rate. This 38 percent tax hike needed to shore up Social
Security's long-term finances is incredibly large particularly since it
assumes that all Social Security surpluses will be allocated to paying
Social Security benefits. It is also over twice the size of the 1.86
percentage-point OASDI tax increase the 2000 Social Security's
Trustees' Report says is needed.
The discrepancy between the two figures reflects the Trustees'
Report's truncation of its projection horizon. The Trustees' Report
looks out only 75 years, whereas the 38 percent figure considers the
entire future. While 75 years may seem like a long-enough horizon,
projected Social Security deficits in 76 years and beyond are gigantic.
Ignoring the huge deficits in years 76 and thereafter guarantees that
successive 75-year projections will look worse because they will
replace, in the prevailing 75-year window, surplus or low deficit years
with extraordinarily high deficit years. As a result, the 75-year
projection that we make, say, in the year 2020 will show a funding
shortfall and we will essentially repeat today's debates about how and
when to reform the system.
Recall that the Greenspan Commission was charged in 1983 with the
task of definitively saving Social Security. The Commission could have
and, presumably did, project that Social Security would face a
substantial 75-year financing shortfall beginning in 2000 simply
because of the inclusion of 17 additional years of very large annual
deficits that weren't included in 75-year projection as of 1983. It
turns out that about a third of today's 75-year funding shortfall could
have been anticipated back in 1983.
Unfortunately, even a 38 percent payroll tax hike would, most
likely, not suffice to address Social Security's problems. The 38
percent figure is computed using the actuaries' intermediate economic
and demographic assumptions. But the ``intermediate'' nature of these
assumptions is questioned by top economists and demographers. Indeed,
Social Security Advisory Board's 1999 Technical Panel recommended
changes in the assumed intermediate rates of longevity improvement,
real wage growth, and interest on government securities.
The most important of these changes involves projections of
lifespan extension. The Technical Panel recommended a 4-year increase
in the life expectancy being used in the actuaries' intermediate
assumptions. In demographic terms, 4 years is a huge increase. In
advocating this increase, the Technical Panel pointed out that the
actuaries were assuming it would take Americans fifty years to start
living as long as the Japanese currently live. The Social Security
Trustees paid some attention to the Technical Panel's recommendation,
but not much. They too are under political pressure to make the system
look good. Consequently, they chose to increase their life expectancy
assumption by only 1 year.
Overly optimistic OASDI forecasting is nothing new. As just
indicated, from the perspective of 1983, only about a third of the
current 75-year OASDI funding shortfall is due to the truncation of the
projection horizon. The remaining two thirds is divided roughly evenly
between overoptimistic economic and demographic assumptions and
methodological mistakes in forecasting.
Taken together, the Technical Panel's recommended assumptions raise
the OASDI tax hike needed to achieve true long-run solvency from 4.7 to
almost 6 percentage points. Given the current 12.4 percent OASDI tax
rate, this translates into close to a 50 percent tax rise! If one
assumes that the Social Security Trust Fund is available to pay
benefits, a fair assessment is that the OASDI system has only about 60
percent of the current and future resources it needs to pay benefits
through time. Stated differently, Social Security is short 40 percent
of the funds it needs if it doesn't want to cut benefits. If the Trust
Fund were not available, the system would be 50 percent, rather than 40
percent, broke.
medicare's long-term funding imbalance
The Medicare payroll tax rate for hospital insurance (the HI or
Part A program) is 2.9 percent. In contrast to the OASDI tax, the
Medicare tax is levied on all labor earnings, not simply earnings up to
the Social Security covered earnings ceiling. Medicare Part B, the
Supplemental Medical Insurance program, currently accounts for two-
fifths of total Medicare expenditure. This program is 25-percent-
financed by participant premium payments and 75-percent-financed by
general revenue.
Like the OASDI Trustees, the Medicare Trustees use a 75-year
truncated projection horizon and make the same longevity assumptions.
And like the OASDI Trustees, the Medicare Trustees report a major
funding shortfall over this period. According to their calculations,
eliminating just the HI program's 75-year deficit would require an
immediate and permanent 1.46 percentage point increase in the HI
payroll tax rate. For reasons that aren't clear, Medicare's Trustees do
not specify the income tax hike needed to eliminate the 75-year
Medicare Part B funding gap.
In a recent analysis of Medicare's long-term costs, Harvard
economist David Cutler and Federal Reserve economist Louise Sheiner
extend the Medicare Trustees' projection beyond the 75-year horizon.\2\
They also measure, as a percent of total labor income, the future costs
of paying for the 75 percent of the SMI program that would not be
covered by Medicare participant premiums. Taking these factors into
account, Cutler and Sheiner find that an immediate and permanent 4.1
percentage point increase in the Medicare tax rate is needed to achieve
true long-run fiscal solvency in both parts of Medicare. This tax
increase is 2.8 times larger than the 1.46 percent higher tax rate
advertised by the Medicare Trustees.
---------------------------------------------------------------------------
\2\ David M. Cutler and Louise Sheiner, ``Generational Aspects of
Medicare,'' The American Economic Review, May 2000.
---------------------------------------------------------------------------
medicare's newfound optimism
The Medicare trustees are dramatically more optimistic than they
were just 3 years ago. In their 1997 report, the Medicare Trustees
projected that spending in 2030, when those in the middle of the baby
boom are in the middle of their old age, would equal 7.1 percent of
GDP. In 1999, they projected 2030 spending would total only 4.9 percent
of GDP. The 2.2 percent of GDP discrepancy between these numbers is
enormous when you consider that Medicare expenditures are currently 2.6
percent of GDP. Hence, between 1997 and 1999, the Medicare trustees
assumed away an amount of 2030-spending on Medicare, which, when scaled
relative to the economy, equals 87 percent of the current program. The
trustee's newfound optimism is greater the further out in time one
looks. For 2070, the trustees assume away an amount of Medicare
spending, which, when scaled by GDP, exceeds the current program!
The fact that the Medicare trustees are making vastly different
projections about future expenditures today than they were only 3 years
ago means three things. First, the trustees are anchoring much of what
they expect Medicare to spend in future years to what it spent in the
last couple of years. Second, in extrapolating so strongly the recent
slower growth of Medicare spending to the distant future, the trustees
are paying little attention to the fact that Medicare growth has slowed
in the past, due to new cost-containment policies and other reasons,
only to speed up thereafter. Third, Medicare spending projections are
highly volatile, and there is no guarantee that the much higher future
costs projected in 1997 won't be projected again in a few years.
the social security system's long-term finances--a summary
The current Social Security plus Medicare (OASDHI) payroll tax rate
is 15.3 percent. If one adds to this the 6.0 and 4.1 percentage point
immediate and permanent tax hikes needed to secure Social Security's
and Medicare's finances, one arrives at a payroll tax rate of 25.4
percent. A total of 18.4 percentage points of this 25.4 percent tax
rate would be applied only to OASDI covered earnings; the remaining 7.0
percentage points would be applied to all earnings. While the
government's share of the additional costs of Medicare Part B could be
paid out of general revenues, this calculation illustrates the
magnitude of the fiscal burden facing today's and tomorrow's workers
from the Social Security System as currently constituted. One should
also bear in mind that this 10 percentage-point tax hike will only
suffice to correct the Social Security System's long-term imbalances if
it is implemented immediately. Any delay will necessitate an even
higher tax increase in the future if benefits are to be paid in full.
To sum up, the Social Security System, including Medicare, has only
about three fifths of the long-term revenues it needs to pay its bills.
If these programs are in trouble, can the rest of our fiscal enterprise
bail them out? Finding the answer requires comprehensive generational
accounting, to which we now turn.
u.s. generational accounts
Table 1 reports generational accounts assuming discretionary
spending grows with the economy. The accounts are constructed using a
4-percent real discount rate and assuming a 2.2 percent rate of growth
of labor productivity. This discount rate is roughly the current
prevailing rate on long-term inflation-indexed U.S. government bonds,
and the productivity growth rate is the one currently being projected
by the CBO. The accounts are for 1998, but are based on the CBO
projections available as of January 2000.
Table 1 shows, for males and females separately, the level and
composition of the accounts. Recall that the accounts are present
values discounted, in this case, to 1998. As an example, consider the
$112,300 account of 25 year-old males in 1998. This amount represents
the present value of the net tax payments that 25 year-old males will
pay, on average, over the rest of their lives. This figure is an
average. It takes into account the fact that some members of this
cohort will pay more and others will pay less in net taxes. It is also
an actuarial average in that it takes into account that some cohort
members will die earlier than others.
Note that the generational accounts for both males and females peak
at age 25 and become negative for females at age 50 and for males after
age 60. The accounts for those younger than age 25 are smaller because
they have a longer time to wait to reach their peak tax-paying years.
The accounts are also smaller for those above age 25 because they are
closer in time to receiving the bulk of their transfer payments.
the generational imbalance in u.s. fiscal policy
Given the assumed trajectory of discretionary spending and the net
taxes those now alive are slated to pay, how big is the tab being left
for future generations? The answer is 32.3 cents out of every dollar
earned. This lifetime tax rate is an average, not a marginal rate. It
is also a net rate, because it nets out transfer payments received.
For today's newborns, the lifetime net tax rate under current
policy is 22.8 percent. So future generations face a lifetime net tax
rate that is 41.6 percent higher than that facing current newborns! In
thinking about this generational imbalance, bear in mind that the
lifetime net tax rate facing future generations under current policy
assumes that all future generations pay this same rate. If, instead,
one were to assume that generations born, say, over the next decade are
treated the same as current newborns, the net tax rate for generations
born in 2010 and beyond would be higher than 32.3 percent.
policies to achieve generational balance
Table 2 considers five alternative policies to achieve generational
balance--i.e., to equalize the lifetime net tax rates of newborns and
future generations. The first involves immediately and permanently
raising Federal personal and corporate income taxes by a given
percentage. How large would the tax hike have to be? The answer is 31.3
percent!
Given the CBO's projection of $1.198 trillion in income tax revenue
for 2000, such a tax hike would mean an additional $375 billion in
revenues this year. This, in turn, would mean a $375 billion larger
surplus. Since the FY 2000 surplus is likely to run around $200
billion, achieving generational balance means running a surplus that is
2.6 times larger than we are now running. Hence, the current surplus is
far too small compared to what is needed to achieve generational
balance.
An alternative to raising just Federal income taxes is to raise all
federal, state, and local taxes. In this case, an across-the-board tax
hike of 12 percent could deliver generational balance. Cutting transfer
payments or government purchases are additional options. Cutting all
Social Security, Medicare, Medicaid, food stamps, unemployment
insurance benefits, welfare benefits, housing support, and other
transfer payments by 21.9 percent is another way to eliminate the
generational imbalance. Two final options considered in the table are
immediately and permanently cutting all government purchases by 21
percent or cutting just Federal purchases by 66.3 percent.
Cutting government purchases to achieve generational balance would
leave future generations paying in net taxes the same 22.8 percent
share of lifetime earnings as current newborns are expected (under
current policy) to pay. In contrast, either raising taxes or cutting
transfer payments would mean higher lifetime net tax rates for those
now alive. As Table 2 indicates, these alternative policies would leave
newborns and all future generations paying roughly 27 cents out of
every dollar earned in net taxes. This net tax rate is over 4 cents
more per dollar earned than newborns are now forced to pay. The payoff
from having newborns as well as everyone else who is currently alive
pay more in net taxes, is a reduction in the net tax rate facing future
generations by 5 to 6 cents per dollar earned.
will the economy save us?
One response to this dire fiscal news is that it ignores the
economy's growth potential. In particular, it ignores the possibility
that an aging society will have more capital per worker, because the
number of elderly wealth holders will rise relative to the number of
young workers. More capital per worker means higher worker
productivity, higher real wages, and the lower return to capital that
worries Wall Street. It also means a larger payroll tax base, which
would limit the rise in the payroll tax.
This sounds like the silver lining in the clouds, but is it for
real? Not necessarily. The fact that the payroll tax will, on balance,
rise means that workers will have less after-tax income out of which to
save and will arrive at retirement with less wealth than would
otherwise be the case. Thus capital deepening is not a foregone
conclusion.
My current research with Professor Kent Smetters of the University
of Pennsylvania and Dr. Jan Walliser of the International Monetary Fund
(Kotlikoff, Smetters, and Walliser, 2000) considers these two
conflicting forces. It develops a dynamic general equilibrium life-
cycle simulation model to study the demographic transition.
Unfortunately, our simulations show extremely small macroeconomic
effects over the next three decades. And because the macro feedbacks
are so small, they will do nothing to alleviate our short- and medium-
term fiscal problems. Over the longer term, the economy's general
equilibrium response will actually exacerbate our fiscal difficulties.
To be more precise, real wages per effective unit of labor are
predicted to remain virtually unchanged over the next three decades and
then decline gradually by about 9 percent. For Wall Street, this bad
news about real wages is good news about the real return on capital,
which stays fixed over the next three decades and then increases
slightly.
The absence of capital deepening between now and 2030 and the
presence of capital shallowing thereafter is driven by the model's
dramatic rise in taxes. Payroll taxes in 2030 are 85 percent higher
than in 2000. Average income tax rates are higher as well, by 15
percent higher. Together, these tax hikes raise the average total tax
on labor income tax by 50 percent.
conclusion
The government, through its various fiscal agencies, is assuming
away our fiscal problems rather than disclosing and solving them. In so
doing, it badly disserves both us and our children. Notwithstanding the
rosy fiscal projections, our country has a huge imbalance in its
generational policy. Without dramatic and immediate changes in this
policy our children are likely to face lifetime net tax rates that are
two-fifths larger than those we face. There are a variety of steps, all
painful, that we can take to achieve a situation of generational
balance in which our children face the same lifetime net tax rates as
we face. But getting any of those steps publicly discussed and enacted
into law requires providing the nation with an honest assessment of our
long-term fiscal problems. Toward that end, Congress should establish
an independent agency to do generational accounting. This agency would
evaluate the generational accounting implications of all major spending
and tax bills and make annual reports to Congress about the steps
needed to achieve generational balance.
TABLE 1.--THE COMPOSITION OF MALE GENERATIONAL ACCOUNTS
[Present values in thousands of 1998 dollars]
----------------------------------------------------------------------------------------------------------------
Tax payments Transfer receipts
----------------------------------------------------------------------------------
Age in 1998 Labor Capital
Net tax income income Payroll Excise OASDI Medicare Medicaid Welfare
payment taxes taxes taxes taxes
----------------------------------------------------------------------------------------------------------------
0............................ 249.7 128.3 61.8 107.3 93.4 45.2 24.0 58.1 13.7
5............................ 256.4 136.3 66.0 114.1 97.4 48.0 35.9 58.9 14.6
10........................... 272.3 147.1 71.8 123.1 102.1 51.7 44.2 60.2 15.8
15........................... 291.4 158.4 77.9 132.8 105.9 55.4 50.5 60.6 17.1
20........................... 318.7 171.2 85.4 143.8 107.5 59.0 51.9 59.9 18.3
25........................... 327.3 174.5 91.6 145.7 102.4 61.2 52.5 55.2 17.8
30........................... 313.7 167.8 98.2 138.1 95.9 64.6 55.2 49.9 16.5
35........................... 279.2 153.9 104.5 124.3 89.4 69.4 63.7 45.0 14.9
40........................... 241.4 137.1 110.0 108.9 83.2 76.4 67.4 40.4 13.5
45........................... 194.2 116.1 113.0 91.2 75.5 85.5 67.9 35.9 12.3
50........................... 129.7 93.0 112.4 71.8 65.6 95.6 75.4 31.0 11.1
55........................... 66.2 65.5 108.4 50.4 56.0 108.1 69.7 26.3 10.0
60........................... -5.8 38.0 100.5 29.1 46.4 123.1 66.1 21.8 9.0
65........................... -77.5 16.6 89.5 12.7 37.2 138.5 69.3 17.7 8.0
70........................... -91.0 6.8 76.3 5.1 28.4 129.7 56.2 14.8 7.0
75........................... -75.1 3.3 61.3 2.4 20.8 106.5 38.2 12.5 5.7
80........................... -56.3 1.4 46.1 1.2 14.6 85.7 20.2 9.7 4.0
85........................... -42.4 .5 33.0 .5 10.1 67.0 9.0 8.0 2.6
90........................... -25.6 .4 28.5 .4 7.9 51.7 3.1 6.0 2.0
----------------------------------------------------------------------------------------------------------------
Growth-Adjusted Net Tax Payment of Future Generations: 361.8.
Lifetime Net Tax Rate on Future Generations: 32.3 percent.
Lifetime Net Tax Rate on Newborns: 22.8 percent.
Generational Imbalance: 41.7 percent.
Note: Table assumes a 4 percent real discount rate and 2.2 percent growth rate.
TABLE 1. (continued)--THE COMPOSITION OF FEMALE GENERATIONAL ACCOUNTS
[Present values in thousands of 1998 dollars]
----------------------------------------------------------------------------------------------------------------
Tax payments Transfer receipts
----------------------------------------------------------------------------------
Age in 1998 Labor Capital
Net tax income income Payroll Excise OASDI Medicare Medicaid Welfare
payment taxes taxes taxes taxes
----------------------------------------------------------------------------------------------------------------
0............................ 109.6 67.8 21.6 64.1 89.0 42.3 24.6 44.0 22.0
5............................ 104.6 72.1 23.0 68.2 92.7 45.0 38.3 44.7 23.4
10........................... 104.6 77.9 25.1 73.7 97.0 48.7 48.8 46.1 25.6
15........................... 105.4 84.1 27.2 79.6 99.9 52.4 57.9 46.9 28.2
20........................... 113.7 91.0 29.8 86.2 100.9 56.4 61.1 46.9 29.9
25........................... 112.3 91.5 31.8 86.4 96.6 58.9 63.7 45.2 26.2
30........................... 95.6 85.1 33.9 79.9 91.2 61.9 68.0 43.2 21.3
35........................... 65.6 75.6 35.9 70.8 85.7 65.7 78.6 41.1 17.0
40........................... 37.9 66.0 37.9 62.0 79.7 71.4 83.7 39.3 13.3
45........................... 7.9 55.4 39.2 52.1 72.7 78.8 84.7 37.6 10.4
50........................... -37.7 42.2 39.6 39.6 64.4 87.7 94.1 33.5 8.2
55........................... -73.9 28.3 39.1 26.6 55.2 99.0 87.5 29.8 6.8
60........................... -115.0 15.6 37.4 14.7 46.0 112.7 84.0 26.2 5.8
65........................... -157.6 6.6 34.6 6.1 36.9 124.6 89.3 22.6 5.2
70........................... -155.9 2.5 30.8 2.2 28.7 116.8 78.7 20.0 4.6
75........................... -131.8 .9 26.3 .9 21.3 100.0 59.6 17.9 3.8
80........................... -99.2 .3 21.5 .3 15.3 82.1 36.9 14.5 3.1
85........................... -70.5 .2 16.9 .1 11.1 63.4 20.6 12.5 2.4
90........................... -44.4 .1 14.1 .1 8.3 47.3 9.0 8.9 1.8
----------------------------------------------------------------------------------------------------------------
Growth Adjusted Net Payment of Future Generations: 158.8.
Note: Table assumes a 4 percent real discount rate and 2.2 percent growth rate.
Source: Gokhale and Kotlikoff (2000)
TABLE 2.--ALTERNATIVE POLICIES TO ACHIEVE GENERATIONAL BALANCE*
------------------------------------------------------------------------
Immediate and
permanent change Equalized lifetime
Policy in policy net tax rate
instrument
------------------------------------------------------------------------
Raise all taxes................. 12.0 percent 27.5 percent
Raise Federal income taxes...... 31.3 percent 27.3 percent
Cut all transfers............... 21.9 percent 26.5 percent
Cut all government purchases.... 21.0 percent 22.8 percent
Cut Federal purchases........... 66.3 percent 22.8 percent
------------------------------------------------------------------------
*Generational imbalance is the percentage difference in lifetime net tax
rates of newborns and future generations.
Source: Gokhale and Kotlikoff (2000).
Mr. Chambliss. Thank you, sir. And I appreciate both of you
sharing your thoughts with us. We have obviously got to
continue this dialogue because we have heard a difference of
opinion with respect to where we are going to be 70 years from
now.
Professor Munnell, I hear what you are saying with respect
to tax cuts, that we have got to be careful. I don't hear you
throw in the mix that we need to be careful about how much we
increase Government spending, but that is what I am hearing, in
effect, from Professor--and I hope I am saying your name
right--Kotlikoff.
And with respect to tax cuts, with respect to trying to
increase savings, which I agree with you on, with respect to
tax cuts and keeping the economy moving to try to triple that
surplus that Professor Kotlikoff talked about that we need,
don't we need some kind of balance there with respect to tax
cuts to keep the economy moving, to keep it going the way it is
going? Don't we need tax cuts of some sort there to provide
people with more money in their pockets, so they can save, so
they can take that money, pay their bills off, put it in
savings, whatever they are going to do with it? Don't we need
those tax cuts in there? And we can argue over what is moderate
and what is too extreme with respect to tax cuts, but I have
just got to believe that tax cuts do enhance the growth of the
economy.
I just went to the University of Georgia. I didn't go to
school in Boston, but that is what they used to teach us; that
you keep the economy churning by keeping money churning in the
economy. Now, that is not the only thing. But, obviously--and I
am a little bit concerned about your honing in on the idea that
we have got a more serious problem with trying to keep tax cuts
lowered than we do with the long-term problems in Social
Security.
Ms. Munnell. I will respond quickly, since we have all been
at this for a long time today. There are two things that
separate Larry's view of the world from mine. The first is what
is the appropriate period when you are talking about long-term
planning? And all of the numbers I use and all of the numbers
that Social Security uses are the next 75 years, as a
reasonable planning horizon. Larry says that is not long
enough. You really have to look beyond 75 years. And I guess I
would just argue that Henry Aaron showed you a table of how
much the projections for these programs have changed over the
last 4 years, so I question looking beyond 75 years.
The other thing that my colleague here does is he talks in
dollar amounts. And so he talks in hundreds of billions or
trillions of dollars. And I think it is very important to
always express those numbers as a percent of GDP because we are
also going to have much bigger GDP in the future. And so if you
do those two things--if you take the 75-year planning and talk
in percents of GDP, all of the problems of both Social Security
and Medicare look much more manageable.
Just in terms of tax cuts, the economy is operating at full
capacity now. We don't really need to have any tax cuts to
stimulate it. But I would agree with you, we have surpluses and
I don't think it should all go for one thing or the other. I
would think that some of it should go for a tax cut, some of it
should go to help Social Security and Medicare and some should
go for other domestic initiatives. So I am not against tax
cuts. I think this is a time that you need to be careful that
you don't give away money that you are going to need in the
future.
Mr. Chambliss. Professor Kotlikoff, you talked about trying
to work on increasing our surplus because of, well, you said
for several different reasons there. And in looking at that, is
not the key there that rather than thinking on the flip side of
it, that in order to look where our children are going to be 50
years from now, they are going to be paying 40 percent more in
income taxes, why shouldn't we be looking at ways to decrease
Government spending?
Now, I realize in your table you show your numbers there
about what would happen with respect to Government spending.
But if we concentrate on not leveling off Government spending,
but simply slowing down Government spending--I read in the
Times this morning where, you know, when my crowd came in, in
1995, we were big on trying to reduce Government spending, and
yet we have been growing at a faster rate than previous
Congresses. And that scares me every time I see that. And if we
do put strong emphasis on trying to slow down Government
spending at the same time, would we look at our children not
paying two-fifths more in taxes than we are paying today?
Mr. Kotlikoff. Well, that depends on exactly what you mean
by Government spending. If you are talking about discretionary
spending at the Federal level, that type of expenditure as a
share of GDP is pretty much as low as it has been since 1960 in
all categories--foreign aid, defense, nondefense, nonforeign
aid, domestic discretionary spending. We have cut that quite a
bit. Now, I am not saying that can't be cut more. But to
assume, as the CBO is assuming, that it is going to be cut by
35 percent over the next 10 years is not a realistic
projection. But it has led to these enormous surplus
projections, which has led everybody to say, well, now we can
afford to cut taxes and raise spending. The reality is that if
discretionary spending doesn't fall as a share of GDP, the only
other place to cut expenditures is through the entitlement
programs.
Now, I do believe that a privatization of Social Security
could dramatically improve the situation as part of----
Mr. Chambliss. Do you think, at the same time, you could
reduce entitlement spending of Social----
Mr. Kotlikoff. Yes. Let me explain how I would do that. The
reform proposal that I have advanced, together with Jeff Sachs,
who is a professor at Harvard--a proposal that has been
endorsed by 65 academic economists, including three Nobel Prize
winners--is to take the existing OAI system, the Old Age
Insurance Program of Social Security, and pay off all of the
benefits that are obligated under that system. So you take the
current retirees, pay them all the benefits we owe them. Take
the current workers, and when they retire, you give them their
accrued benefits--the benefits they would have accrued as of
the time of the reform, which you calculate by filling zeroes
in their earnings records. So when they reach retirement, their
benefits are lower because of the fact that they have had
zeroes filled in their earnings records after the reform.
Through time Social Security retirement benefits are, under
this reform, phased out benefits. But, under our proposal, we
would leave the survivor and the disability benefits intact.
The proposal would take 8 percentage points of the the 12.4-
percent payroll tax that we now use to pay for Social Security
and put that into a private account, which would be divided 50-
50 between husband and wife. The Government would provide a
matching contribution on behalf of poor people, so there would
be a progressive element. The balances would be invested in a
single security, which is a market-weighted global indexed fund
of stocks and bonds.
At retirement age, you would have your account balances
gradually transformed into inflation-protected pensions so
there would be an annuitization process, which would be done on
a cohort-by-cohort basis and would be done collectively, so
individuals would not be having to go to individual insurance
companies and try and get a deal. And they might not get a good
deal from the insurance companies they ended up with. So it
would be done collectively at very low administrative costs.
So here you have a proposal which is phasing out the old
system, but giving everybody all of the benefits they have
accrued as of the time of the reform, putting everybody into a
new privatized retirement account, where there is
progressivity, there is protection of dependents (because
nonworking spouses would have an equal size account as working
spouses), there is diversified investment in the world
marketplace, and there is the same rate of return to all
Americans. Finally, there is collective annuitization so that
there is no problem of getting taken by the insurance companies
at the end of the day when you try to get your money out in the
form of an inflation-protected pension.
The only thing I have left out of this story is how you pay
the benefits of the old system because we are taking 8
percentage points of the payroll tax and putting that into
private accounts. Incidentally, you could call this a tax cut.
So if you want to pass a tax cut, this is the way to do it--cut
the payroll tax by 8 percentage points and put it into private
accounts.
We would pay off the existing accrued OAI benefits through
a combination of two things: one is further restraint on
discretionary spending, to the extent that is possible, the
other, which is the main source of finance, is a Federal retail
sales tax, which would mean that older people, middle-age
people and young people would collectively be paying off the
liability of the old system.
The only group that would be omitted from the obligation of
paying off the benefits of the old system would be the poor
elderly. They live off of Social Security, and because their
benefits are indexed to the price level, if you put on a retail
sales tax at the Federal level, the price level would go up,
and their benefits would be automatically increased. Hence, the
poor elderly would be perfectly insulated, and we would just be
asking the rich elderly and the middle-class elderly, as well
as everybody else in the economy, to help pay off the benefits
of the old system.
This is a plan for ending up 30 years from now with a
payroll tax for Social Security retirement benefits that is
zero, as opposed to ending up with a payroll tax for Social
Security retirement benefits, which could well be going from 8
percentage points of wages to 14 percent or so.
We need to face facts. We have a huge problem. So what I
offer is a radical plan. It is also a realistic plan. It is
also a fair plan, and it doesn't beat about the bush in terms
of being clear that somebody has to pay off the liabilities of
the old system. All of the plans that are being discussed by
the two presidential candidates, by Members of Congress, and by
most of the academics are suggesting that we can privatize
Social Security with nobody bearing any pain, any burden. We
can just let the capital markets take care of everything. That
is hogwash.
Frankly speaking, the economics are very clear. We have to
pay off the liability of the old system, and this would be the
way to do it. Alicia even agrees with that. [Laughter.]
Ms. Munnell. If I saw the problem as large as Larry did, I
would want dramatic restructuring too. But I just want to
reiterate that when you look over the 75-year period, which I
think, in my view, it is a generation, it is a perfectly
reasonable planning period, the costs of Social Security, and
this is what the trustees' report says, this is what the
actuaries say, are going to go from 4.2 percent of GDP to 6.8
percent of GDP. That is up 2.6 percent. As I said, interest is
going to go down from 3 to zero percent of GDP. Defense
spending has gone down by 2.6 percent of GDP in the 1990's. We
have seen 2.6 percent of GDP swings, and we have been able to
cope with them.
So I think we can cope with this kind of change and that
the existing system works well. I think we should fix the long-
run financing problem immediately. I think tolerating deficits
is not acceptable. I think we should get the revenues in there
or the benefit reductions or whatever we need to do to close
the gap to restore financial balance, both because it is
cheaper if you do it early and, two, people need to have
confidence in the system.
So I see a small problem, so I need a small fix. Larry sees
a big problem, he needs a big fix.
Mr. Kotlikoff. About a third of our current Social Security
problem can be traced back to 1983 and to the fact that the
Greenspan Commission, which was charged with fixing Social
Security once and for all, only looked out 75 years. Here it is
17 years later, and we have in the current 75-year projection
window 17 years of huge deficits that they did not take into
account back in 1983 because they didn't look out far enough.
The demographics are quite clear. The nature of this system
is quite clear. The fact that it is indexed and scaled to the
economy and how it works is quite clear. There is not a huge
amount of uncertainty really about the kinds of liabilities
that are going to be out there, given the demographic
realities. But we are blithely ignoring them.
Moreover, the Social Security trustees are also making what
top demographers in the country think are outlandish
assumptions about longevity. The top academic demographers
appear to think that the intermediate assumptions should have
three more years of expected life than the trustees have
assumed. I am not an expert on demography, but I know these
individuals have done a great deal of high-quality research on
the subject.
The technical panel that Social Security convened to study
this issue and other issues last year voted to advise the
trustees to increase the longevity assumption by 4 years. The
trustees increased the longevity assumption by 1 year. So if
you take that into account, you see that even over the 75-year
horizon, we have a much bigger problem than Alicia is
describing.
Mr. Chambliss. Let me just address this to both of you. In
1995, we were looking at a projection that Social Security was
going to be broke, depending on who you listened to, 2018 to
2022. The economy gets on a fast track and all of a sudden we
are looking at surpluses now both on-budget and off-budget. If
we get back into a depressed economy and if all of a sudden
these surpluses disappear, does the opinion of either one of
you change with respect to we do or we don't have a crisis in
Social Security?
Mr. Kotlikoff. Let me just say that the generational
accounting that I was referring to uses all of the latest
numbers which incorporate all of the information about the
surpluses. The only assumption that differs from the CBO
projections is that the Federal Government doesn't engage in a
disappearing act. In other words, the CBO is assuming that your
salary is going to fall by 35 percent compared to other workers
over the next 10 years. I don't see that happening. I don't see
that happening with military wages. I don't see that they are
going to fill Air Force One with 35-percent less gas. I just
don't see discretionary spending falling as a share of GDP by
35 percent over 10 years.
So if you don't make that assumption, and you instead
assume that Federal discretionary spending will stay even with
the economy, you find out that, yes, we are going to be running
some short-term surpluses, even under that assumption, but, no,
they are not anywhere near large enough to deal with the long-
term problems in Medicare, and Medicaid, and Social Security,
and other aspects of our fiscal finances. Indeed, if you leave
the whole bill to the next generation, you have them facing a
40-percent higher tax bill. That is, all of their tax rates at
not just the Federal level, but also State and local levels
would be 40-percent higher.
To make matters worse, Congress is talking about
compounding the problem by having tax cuts in the short run or
spending more on drug benefits to the elderly or other programs
for the elderly. That will make the generational accounting
situation worse. We are in a critically difficult situation
here. We have agencies in this Government that are
systematically misleading the American public about the nature
of our problems. And the situation is much more grave than has
generally been described today.
Chairman Kasich got it exactly right--this is the ``Perfect
Storm''--the perfect fiscal storm.
Mr. Chambliss. Professor Munnell, we will let you wind us
up.
Ms. Munnell. I will just answer your question about how if
we have downturn, how that would affect the outlook. Most of
the improvement in the Social Security trust fund projections
have come from events that have already occurred--the good
performance of the 1990's. The actuaries have been cautious in
incorporating optimistic economic assumptions in their
projections. For instance, they assume that productivity growth
will increase over the 75 years by 1.5 percent, even though in
the late 1990's we have been enjoying 2.5 or a little bit more.
So I don't think a downturn would have a very big affect on
the projections at this point.
Mr. Chambliss. Well, let me just say to both of you thank
you very much for your patience today and being here. And to
both of you let me say that we wish you would submit your
statement, if you haven't already. And we thank you for
enlightening us, and we look forward to a continuing dialogue
on this question. It is fascinating, it is complicated, but it
is something that is so important for literally our children
and our grandchildren. We use that phrase figuratively too
often, but this really does affect our children and our
grandchildren. So we appreciate very much your input and your
being here today. Thank you.
Ms. Munnell. Thank you, Mr. Chairman.
Mr. Kotlikoff. Thank you, Mr. Chairman.
Mr. Chambliss. We are concluded.
[Whereupon, at 3:18 p.m., the committee was adjourned.]