[House Hearing, 106 Congress]
[From the U.S. Government Printing 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\
---------------------------------------------------------------------------
    \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.]