[Senate Hearing 108-425]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 108-425
 
          RETIREMENT PLANNING: DO WE HAVE A CRISIS IN AMERICA?

=======================================================================

                                HEARING

                               before the

                       SPECIAL COMMITTEE ON AGING
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             WASHINGTON, DC

                               __________

                            JANUARY 27, 2004

                               __________

                           Serial No. 108-27

         Printed for the use of the Special Committee on Aging




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                       SPECIAL COMMITTEE ON AGING

                      LARRY CRAIG, Idaho, Chairman
RICHARD SHELBY, Alabama              JOHN B. BREAUX, Louisiana, Ranking 
SUSAN COLLINS, Maine                     Member
MIKE ENZI, Wyoming                   HARRY REID, Nevada
GORDON SMITH, Oregon                 HERB KOHL, Wisconsin
JAMES M. TALENT, Missouri            JAMES M. JEFFORDS, Vermont
PETER G. FITZGERALD, Illinois        RUSSELL D. FEINGOLD, Wisconsin
ORRIN G. HATCH, Utah                 RON WYDEN, Oregon
ELIZABETH DOLE, North Carolina       BLANCHE L. LINCOLN, Arkansas
TED STEVENS, Alaska                  EVAN BAYH, Indiana
RICK SANTORUM, Pennsylvania          THOMAS R. CARPER, Delaware
                                     DEBBIE STABENOW, Michigan
                      Lupe Wissel, Staff Director
             Michelle Easton, Ranking Member Staff Director

                                  (ii)





                            C O N T E N T S

                              ----------                              
                                                                   Page
Opening Statement of Senator Larry E. Craig......................     1

                           Panel of Witnesses

Prepared Statement of Dr. Goodman, President, National Center for 
  Policy Analysis................................................     3
Jack L. VanDerhei, Ph.D., CEBS, Professor, The Fox School of 
  Business and Management, Temple University, Philadelphia, PA...    23
Jagadeesh Gokhale, Ph.D., Senior Fellow, Cato Institute, 
  Washington, DC.................................................    41

                                APPENDIX

Prepared Statement of Senator John Breaux........................    75
Prepared Statement of Senator Gordon Smith.......................    75

                                 (iii)





          RETIREMENT PLANNING: DO WE HAVE A CRISIS IN AMERICA?

                              ------------



                      TUESDAY, JANUARY 27, 2004

                                       U.S. Senate,
                                Special Committee on Aging,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
SD-628, Dirksen Senate Office Building, Hon. Larry Craig 
(chairman of the committee) presiding.
    Present: Senators Craig and Carper.

       OPENING STATEMENT OF SENATOR LARRY CRAIG, CHAIRMAN

    The Chairman. Well, good morning, everyone. The U.S. Senate 
Special Committee on Aging will be convened. I appreciate all 
of you for braving the weather of today. Our hearing is on 
retirement planning, do we have a crisis in America as it 
relates to that?
    I am pleased to reconvene the Special Committee on Aging 
for the Second Session of the 108th Congress. Today's hearing 
is on a topic of strong interest to me and my colleague, John 
Breaux. Senator Breaux had planned to be here this morning. I 
think, you know, Southerners just do not cope well with this 
kind of weather. We Westerners oftentimes find this a slight 
inconvenience but somehow are able to kind of push through. I 
will never live that down. John will be all over me on that 
one.[Laughter.]
    But having said that, both of us have shown a keen interest 
in the issue of retirement security for our senior Americans. 
Just 2 years ago, Senator Breaux and I served as delegates to 
the Savers Summit. At that time, I remarked that the summit was 
the beginning, not the end, of our commitment to help Americans 
plan for their retirement. This hearing is a continuation of 
that effort.
    America has come a long way in building a stronger 
retirement system compared to the early part of the 20th 
Century. We should not lose sight of those accomplishments; 
however, we have seen a dramatic increase in longevity and a 
trend toward healthy aging. Americans are living longer and 
healthier than ever before. This means they must plan to save 
more to keep them from outliving their retirement nest eggs. I 
know in talking with our elderly today, oftentimes, that is a 
growing concern that they express.
    A recent report from the Department of Commerce shows that 
the personal savings rate has actually declined from 7.7 
percent in 1992 to 2.3 percent in 2002. At a time when savings 
should be going up, we see a dramatic decline. Today's hearing 
should help us understand the impact of this dramatic decline 
in personal savings and the leading ideas for addressing the 
decline.
    With that, let me say how pleased I am to welcome two of 
our three experts today. One of those is snowbound in Texas, or 
at least, his planes were not flying, and he apologizes for not 
being here. But we are very proud that the two gentlemen who 
are here before us this morning were able to weather the 
elements: Dr. Jack VanDerhei of Temple University and the 
Employment Benefit Research Institute; we appreciate you for 
being here.
    The gentleman who is not with us, but we trust we will be 
able to get his testimony to put in the record, John Goodman, 
president of the National Center for Policy Analysis in Dallas.
    [The prepared statement of Dr. Goodman follows:]
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    The Chairman. We also have Dr. Gokhale--I am struggling 
with your first name--who is a senior fellow at the Cato 
Institute, who will offer his observations and analysis today 
before the committee.
    So we look forward to your testimony on what we believe is 
an ever-important issue for our country and for the seniors of 
our country and those who are obviously beginning to think and 
plan toward their retirement.
    With that, Doctor, we will turn to you first to start the 
testimony.

STATEMENT OF JACK L. VANDERHEI, PH.D., CEBS, PROFESSOR, THE FOX 
     SCHOOL OF BUSINESS AND MANAGEMENT, TEMPLE UNIVERSITY, 
                        PHILADELPHIA, PA

    Dr. VanDerhei. Thank you. Senator Craig, I am Jack 
VanDerhei from Temple University and research director of the 
EBRI Fellows Program. It is my pleasure to appear before you 
today to discuss the extremely important topic of whether we do 
have a retirement crisis in America.
    As you will note from my written testimony, I believe the 
answer is yes for some groups and no for others. However, 
another question of equal public policy concern is how severe 
is this crisis, and is it feasible to expect the vulnerable 
groups to be able to deal with those projected problems through 
increased savings?
    As you know, the ability of future retirees to have broadly 
defined levels of retirement security has been the focus of 
several Congressional hearings as well as countless public 
policy analyses in the past. However, in recent years, there 
have been several reasons to revisit earlier studies and 
conclusions. Most significant among these is the evolution from 
defined benefit plans to defined contribution plans in the 
private sector in the last two decades.
    In addition, there have been advances in research and 
analysis in recent years. While several studies have attempted 
to project retirement income and wealth, there have been few 
attempts to reconcile their results with the uncertain amount 
and duration of retiree expenditures. A new computer model I 
have developed with my co-author Craig Copeland of the Employee 
Benefit Research Institute allows a quantification of the gap 
between basic future retirement needs and assets under various 
comfort levels, if you will.
    The Employee Benefit Research Institute and the MilBank 
Memorial Fund, working with the Governor of Oregon, set out to 
see if the necessary retirement security analysis could be 
undertaken on a State-specific basis and undertook an initial 
study on the future retirees of Oregon. The results, released 
in 2001, made it clear that there is a significant shortfall 
and that major decisions lie ahead if the State's population is 
to have adequate resources in retirement.
    Subsequent to the release of the Oregon study, it was 
decided that the approach could be carried to other States as 
well. Kansas and Massachusetts were chosen as the second and 
third States for analysis, and we completed their results in 
2002. The model was recently expanded so it could be national 
in scope, and initial estimates were published in the November 
2003 EBRI Issue Brief and were discussed at a day-long EBRI 
policy forum held December 4, 2003.
    While I would be happy to answer any questions regarding 
the components of this model, I think it is important to note 
that the primary objective of this analysis is to combine 
simulated retirement income and wealth with simulated retiree 
expenditures to determine how much each family would need to 
save today as a percentage of their current wages to maintain 
some prespecified comfort level that they will be able to 
afford simulated expenses for the remainder of their lifetime 
once they retire.
    We report these savings rates by age cohort, by family 
status, and by gender in figures A and B of the written 
testimony that I have submitted. It is important to note that 
these percentages represent savings that need to be generated 
in addition to what retirement income and or wealth is 
simulated by the model. Therefore, if the family unit is 
already generating savings for retirement that is not included 
in defined benefit plans or defined contribution plans or IRAs 
or Social Security or net housing equity, that value needs to 
be deducted from the estimated percentages.
    Figure A, which is on page 13 of my written testimony, 
shows the median percentage of compensation that must be saved 
each year until retirement for individuals to have adequate 
retirement income in three out of four of their simulated 
outcomes. This represents our baseline assumptions that current 
statutory Social Security benefits are paid and that housing 
equity is never liquidated, although we do run alternative 
scenarios in the model.
    The results show that for the median individual in birth 
cohorts on the verge of retirement, there is little possibility 
of them saving enough to supplement the simulated retirement 
wealth to provide adequate retirement income to meet basic 
needs. However, younger birth cohorts would benefit from the 
increased years of contributions and would have savings targets 
that are feasible for most groups.
    However, there are some notable exceptions: single females 
in the lowest income quartile are predicted to need in excess 
of 25 percent of compensation per year to have sufficient 
retirement wealth regardless of the birth cohort. Figure B, 
which is on page 14 of the written testimony shows the median 
additional savings required to provide retirement adequacy if 
one wanted a 90 percent confidence level, in essence, to have 
nine out of 10 of their simulated life paths sufficient.
    We have purposely structured many of our assumptions to 
provide conservative estimates of the amounts that would be 
needed to be saved while employees are working to alleviate any 
deficits. For example, we have assumed in this version of the 
model that all employees continue to work until Social Security 
normal retirement age, even though there has been a long-term 
trend toward early retirement, albeit one that seems to be 
reversing in recent years.
    But even with these conservative biases built in, the 
numbers appear troubling for some age cohorts and almost 
fatalistic for others. The good news is that if many of the 
younger cohorts begin saving a reasonable amount to supplement 
their Social Security and qualified retirement plans now, they 
have a good chance of providing themselves with reasonable 
assurance that they will at least be able to cover basic 
retirement expenditures.
    However, changes in public policy and additional resources 
from families and charities would be required to provide 
adequate retirement income for retirees with greater longevity 
who suffer serious and persistent chronic disease.
    To wrap up, both for individuals and public policymakers, 
being able to quantify the extent of the impending shortfall in 
basic retirement income adequacy has obvious implications. For 
those lucky enough to be young and disciplined at saving, 
getting started now is likely to assure them a comfortable 
retirement. Since there are many who are older, nearing 
retirement age, and in the lower income brackets, public 
resources are likely to be called upon either directly or 
indirectly to deal with their inability to finance their old 
age.
    Knowing the extent of the future problem will at least 
allow policymakers at both the State and Federal levels to try 
to prepare to deal with these issues when they arrive.
    Thank you very much and I look forward to your questions.
    [The prepared statement of Dr. VanDerhei follows:]
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    The Chairman. Doctor, thank you very much.
    Now, let me turn to our second panelist this morning, Dr. 
Gokhale, senior fellow at our Cato Institute. Welcome.

  STATEMENT OF JAGADEESH GOKHALE, PH.D., SENIOR FELLOW, CATO 
                   INSTITUTE, WASHINGTON, DC

    Dr. Gokhale. Thank you very much. I am quite honored to 
have this opportunity to testify about retirement planning in 
the United States.
    The answer to that question about whether there is a 
retirement crisis is simply yes. There is a significant crisis 
that we face. The crisis should be attributed more to the 
public policies that we have adopted over the last several 
decades rather than to private saving behavior that generates 
inadequate saving in a benign policy environment. As I go 
along, I think it will become clearer as to why I say that.
    With regard to whether we have a crisis, well, we know that 
the baby boom generations are going to exit the work force over 
the next couple of decades, and that means two things: Their 
exit from the labor force means that labor force growth rates 
will fall, dragging down with it output growth rates. Second, 
the share of the population that is retired will increase 
considerably, and therefore, retiree consumption as a share of 
total consumption must also increase significantly. Those two 
things are quite clear in the projections that we see today.
    Therefore, we need to transfer more resources toward 
retirees. Even if we were to maintain overall retiree living 
standards at the same real level as today's retiree standards, 
it implies that the share of retiree consumption in total 
consumption would have to increase from 20 percent today to 
about 35 percent. If we have to provide a higher living 
standard to future retirees consistent with the growth in the 
trend of retiree living standards from the past, that share 
would have to increase to about 43 percent, as I have 
documented in my testimony.
    So, we need to transfer more resources toward retirees, but 
this transfer essentially means a transfer of resources from 
younger generations to older generations. That transfer will 
downward pressure on national saving. The reason for that is 
younger generations, because they have a longer life span ahead 
of them, generally spend less per dollar of resources than 
retirees.
    So, if resources are transferred from low spenders to high 
spenders, total consumption in the economy will rise and 
savings rates will decline. That is one observation. In the 
past, we have accomplished the same kind of transfer from 
younger to older generations through expansions of Social 
Security and Medicare benefits. But that expansion was feasible 
because national output growth remained high.
    In turn, high output growth occurred because we had this 
big, productive cohort of baby boomers in their working years. 
National output was high and continued to grow, despite a 
decline in productivity in the mid-1970s. That, labor force 
growth however, is going to be slower from now on. We have the 
following vexing dilemma facing us as a result: we know that 
the exit of the baby boomers from the work force is going to 
reduce labor force growth. That has a dampening effect on 
output growth. We need the high output growth in order to be 
able to transfer these resources to retirees for consumption. 
But the very act of transferring these resources by way of 
entitlement programs itself puts a dampening effect on saving 
because we are transferring resources from low spenders to high 
spenders.
    As a result, we are caught in this dilemma: we need output 
growth to be fast in order to be able to transfer these 
resources, but in implementing this transfer, we are going to 
dampen output growth itself. That is kind of a vicious logic 
that we are faced with, and the only thing we can do about it 
is really to encourage more saving on the part of the 
population.
    We cannot do anything about the demographic trends except 
by additional immigration of young, skilled workers, but that 
only postpones the problem, because when more immigrants come 
into the country, they will work and contribute payroll taxes, 
which will help us transfer more resources to the elderly, but 
then, they, in turn will qualify for benefits in the future, 
and the problem does not necessarily go away; it just gets 
postponed.
    We could try and affect saving behavior in the U.S., but 
admittedly, doing so is quite difficult. We have in place 
several types of tax incentives for encouraging additional 
saving on the part of workers, but the evidence shows that 
those incentives result at most in 25 to 30 percent of new 
saving in the economy. The reason is that the rules of our tax 
incentive saving programs are quite complicated, and therefore, 
may discourage employers from offering those plans--I am 
talking about traditional 401(k) and traditional IRA plans.
    An additional complication arises because the rules of 
those plans, interact in significant ways with the rest of the 
tax code to dilute the tax incentives such plans provide for 
additional saving. We need to properly design these saving 
incentives to maximize the tax incentive. The rules should be 
less uncomplicated, as uncomplicated as possible, and the 
structure of the programs should be frontloaded so that the 
plans follow the Roth type design. That means plan 
contributions are made on an after-tax basis, but withdrawals 
are not subject to income taxes.
    Now, doing it in this manner implies very few interactions 
with the rest of the tax code and therefore a higher tax saving 
incentive. However, in providing such saving incentives, we 
know that the Government would lose revenue. It is also 
important to consider what other tax or spending policy 
adjustments should be put in place to deal with that lost 
revenue. If we raise other taxes to make up the lost revenue 
from the initial incentive, then, we may end up with very 
little net incentive to save. If we finance for a short-term 
basis the lost revenue through higher deficits, well, higher 
deficits will soak up some of the saving, and therefore, again, 
we do not have an overall increase in saving.
    It appears that to maximize the tax incentive, we should 
deal with the lost revenue through lower spending. That would 
be the better way to provide a tax saving incentive. But again, 
what is ultimately done to make up the lost revenue is a very 
difficult question to answer, because lots of changes occur 
simultaneously in taxes and spending.
    So with that, let me close my spoken remarks. I would like 
my written remarks to be submitted into the record, and I 
welcome any questions.
    Thank you.
    [The prepared statement of Mr. Gokhale follows:]
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    The Chairman. Thank you very much, Dr. Gokhale.
    All of your testimony and your charts and everything will 
become a part of our record.
    In part, both of you may have answered this, but let me ask 
the question, because I think it is at the core of what we are 
not doing versus what we are doing that is affecting the 
savings rate. There have been several national educational 
efforts designed to increase savings over the past decade. Yet, 
the savings rate continues to decline. How are we to view these 
educational efforts in light of a declining personal savings 
rate, and I ask that of both of you as a general question?
    Dr. VanDerhei. Well, not to change the question, but I 
really think what one wants to focus on as an output metric is 
not necessarily personal savings rates. There are many 
components that have long been debated as perhaps not being 
totally effective in determining what you are trying to 
accomplish in those educational campaigns.
    I think what one might want to look at in more specificity 
is what is happening to certain targeted groups of those 
educational campaigns; for example, with 401(k) participants, 
there was a lot of conventional wisdom recently that with the 
recent 3-year bear market, 401(k) participants would have given 
up and started to reduce their contributions or get out of the 
401(k) plans altogether.
    A recent study I have done on approximately 10 million 
individual 401(k) participants with Sarah Holden from the 
Investment Company Institute shows there has only been a very, 
very minor decrease. One of the reasons for that is the 
educational campaigns that the employers and the service 
providers have been able to transmit to the 401(k) 
participants. I think if you look at particular groups of 
individuals that are likely recipients of those educational 
campaigns, you can get a better feel than if you look at some 
aggregate overall statistic.
    So overall, I would say that the employer-provided 
educational campaigns have been quite effective, not only in 
increasing the employee contributions going into 401(k) plans 
but also keeping them at a substantial rate, even over one of 
the worst bear markets we have seen in the last recent history.
    The Chairman. Dr. Gokhale.
    Dr. Gokhale. Well, as far as education campaigns, my answer 
is going to be somewhat general, but I will speak to the issue 
of whether encouraging more participation in 401(k)s, 
especially on the part of lower-income individuals, is really 
desirable and how effective that is really as a savings 
incentive.
    Well, increased education can improve a person's perception 
of the alternatives available. But if those alternatives are 
all bad, then, it is not going to result in a higher saving 
rate necessarily. So, my view is these programs are probably 
misguided, and you should not spend as much time and effort 
into these educational programs, because the policy environment 
within which people operate today has built into it 
disincentives to save.
    I have studied the decline that we have had over the last 
several decades in the national saving rate. I came up with 
three reasons for why that decline has occurred. First, we have 
transferred resources from low spenders to high spenders, 
essentially through the expansion of Social Security and 
Medicare. Well, that means the elderly who consume a higher 
fraction of every dollar of their resources are getting 
resources to consume, and that is reducing national output, 
whereas, younger individuals who consume less per dollar of 
their resources are losing resources.
    Second, the provision of greater Social Security and 
Medicare benefits in annuitized form, meaning that they are 
paid as annual income rather than as a lump sum at retirement, 
provides longevity insurance, meaning they insure individuals 
from the uncertainty about how long they are going to live.
    But as a result of providing that insurance, people who 
receive these annuitized benefits are able to consume at a 
faster rate out of their Social Security wealth, and therefore, 
again, consumption goes up, and national saving goes down.
    Finally, because of higher health care costs, the retirees 
over the last several decades have increased their rate of 
consumption out of every dollar of resources. We have 
transferred resources towards retirees, and their rate of 
consumption out of resources has been rising over time. That is 
the third reason for the decline in national saving.
    One may try to encourage younger generations to save more, 
but imagine the situation these generations face. They have 
high necessary expenditures in bringing up their children, 
providing for childrens' expenses paying mortgages on their 
homes, and on top of that, paying 15.3 percent as payroll 
taxes. If they did not have to pay those taxes they would, 
presumably, have more to save. They might expect, incorrectly, 
that the Government is doing the saving for them, taking this 
15.3 percent of earning and promising them these Social 
Security and Medicare benefits when they retire.
    But we know there is a funding shortfall in these programs; 
that it is not clear how fully people appreciate that funding 
shortfall. So the public policy stance here is to provide 
retirees with the ability and incentive to consume at a faster 
rate, because we are giving them additional resources. We 
provide younger individuals with diluted tax incentives to 
save. As I mentioned the 401(k) plans, even though they save 
taxes on the accrual of interest and capital gains on the 
account balances, once these balances are withdrawn, they are 
subject to tax.
    Depending on how well the plan does in the accumulation 
phase the individual might end up in a higher income tax 
bracket upon retiring because of high withdrawals from the 
plans and, therefore may pay more in taxes on a lifetime basis. 
In addition, you might have more of your Social Security 
benefits subject to tax because of these high withdrawals. In 
the withdrawal phase, you would have, if you downshift your tax 
bracket, you would lose on your exemptions, the value of your 
exemptions and deductions.
    So younger individuals, even though they receive tax-saving 
incentives, those incentives are really very dilute. The 
401(k)-type tax incentive is not as efficient as one might 
believe, especially for low earners, some of whom might lose on 
a lifetime basis. They would be able to afford less consumption 
over their lifetime and pay more taxes as a result of 
participating in these plans.
    Within this public policy environment, where the elderly 
are receiving resources and are encouraged to consume more, and 
the young are in a situation where they have huge necessary 
expenses and inefficient tax incentives to save, educational 
efforts to get them to save more are not going to work.
    Thank you.
    The Chairman. Thank you.
    Dr. VanDerhei, your testimony presented 5 percent as an 
additional increase in savings needed to reduce the income 
expenses gap for future retirees. Have you calculated what 
total percentage of savings would be necessary to meet 
retirement expenses and, if so, what would that be?
    Dr. VanDerhei. Actually, I believe you are referring to 
figure C in the written testimony.
    The Chairman. Yes.
    Dr. VanDerhei. One of the things that we did, which I did 
not have time to mention in the oral testimony, is an addition 
to compute what savings rates individuals would need to make to 
have a particular comfort level that they will be able to meet 
their retirement expenditures. We wanted to try to find out if 
there was some relatively feasible goal, savings goal, target 
savings that individuals could all do and see how that was 
going to impact the overall probability of having sufficient 
retirement income.
    The 5 percent was more or less an ad hoc number that seemed 
relatively reasonable. Most groups could probably afford that. 
And if you take a look at--actually, Craig, could you--we have 
a chart over here, chart C.
    I apologize, Senator. Can you see that from there?
    The Chairman. I can, and I have it in your testimony. I 
will refer to that. Go ahead.
    Dr. VanDerhei. OK; basically, as you look out, as a 
function of age, the younger birth cohorts, obviously, since 
they would have the longer period of time to be able to put in 
that 5 percent have a much higher probability regardless of 
income quartile and regardless of family status and gender to 
be able to have sufficient income. But the 5 percent only gets 
you over a 90 percent probability if you are in the very 
youngest birth cohort and one of the highest two income 
quartiles. That is what the red circle represents.
    After we put together the written testimony, actually Money 
magazine is running a special article in their March issue 
based on similar types of things, and they asked much the same 
question: that is fine for the youngest cohort, but what about 
people that are currently in their fifties--or born in the 
1950's, excuse me, which would be the next two younger cohorts?
    I went back and ran the same type of analysis, and it would 
indeed take a 10 percent additional savings rate to be able to 
get the upper two income quartiles for people born in the 
fifties up to the 90 percent level. But even at that 10 percent 
level, the lower two income quartiles do not even come close to 
that. So again, I think you need some caution when you come up 
with, quote, the savings rate; it is going to largely depend 
on, unfortunately, their family status, their gender and their 
income quartile as far as how much they have generated already 
within the defined benefit, the defined contribution, and the 
IRA environment.
    But I would say for the third and fourth quartile, people 
born in the 1950's or later, 10 percent would seem to be 
adequate.
    The Chairman. OK; your testimony included a reference to 
scenarios where you assume retirees use their home equity to 
finance their expenses in retirement. Could you elaborate on 
the findings and the message seniors should take away from 
those results?
    Dr. VanDerhei. I would be glad to. Again, something I did 
not have a chance to talk about in the oral testimony is that 
we knew that there was anything but a general consensus in what 
retirees should do, much less what they actually do do, with 
their net housing equity when it comes to financing retirement.
    Some individuals suggest that you should just keep it and 
never liquidate it; not use it for retirement. Other say that 
as soon as you retire you should sell the house, take the net 
equity, perhaps annuitize it in something known as a reverse 
annuity mortgage. Others would say just hold on to it as long 
as you can, but when you need it, whether it is for a 
catastrophic medical cost or something else, that is the time 
to sell it, and instead of annuitizing it, to basically keep it 
as a lump sum.
    So we ran all three scenarios. What I presented earlier 
today was a baseline, where you assume there was never any 
liquidation, but we find that in the third scenario, where you 
hang onto the house after you retire, as long as you can until 
you need it for some financial reason, perhaps catastrophic 
health care costs, that basically, the aggregate deficits for 
all people in a particular year decrease by as much as 23 
percent.
    So certainly, from all of the scenarios we ran, it seems to 
make sense when possible to hold on to that as long as you can 
as another part of your nest egg that you are going to easily 
be able to liquidate to use for other purposes later.
    The Chairman. Can you explain why percentages for some 
groups differ so widely? You have done that in part, but 
figures A and figures B, you have got a wide spread there.
    Dr. VanDerhei. Sure; just to quickly flip to figure A--and 
this is all in the written testimony if you are interested--one 
of the problems we have with the types of retirement planning 
devices which are widely available is they do a very good job 
of simplifying the assumptions so that they are easily used, 
but oftentimes, they use averages: what is your average life 
expectancy? What is the average rate of return you expect? The 
problem is that if you do not deal with uncertainty, you are 
basically going to end up planning for how much money do I need 
to be able to survive through retirement 50 percent of the 
time?
    I think if you ask most individuals ``is having enough 
money just 50 percent of the possible times in retirement 
sufficient?'' they are going to say no. So what we did in 
figure A was to run the scenario so that you are going to have 
enough money three out of four times; hence, the 75 percent 
confidence level. Just to focus on a particular group to give 
you an example, the circled number there is for the single 
females in the next to lowest income quartile, born between 
1951 and 1955. The median individual in that cohort, we assume, 
if you want enough money to have enough retirement income three 
out of four times, would have to save an additional 11 percent.
    But if you flip that to figure B, the exact same cohort, if 
they want enough money to have sufficient retirement income 
nine out of 10 times in retirement, obviously is going to have 
to save more. For this particular group, you see that 11 
percent on the previous chart now escalates all the way up to 
18 percent. So you are going to need to have a bigger buffer 
against some of these consequences if indeed you want to have 
more certainty that you are going to be able to meet, for 
example, the longevity risks that were just mentioned 
previously.
    The Chairman. Let me ask you this last question before I 
turn to Dr. Gokhale: what is the best way to interpret your 
results in figure C, given the current public policy debates 
that are underway?
    Dr. VanDerhei. The good news about figure C is that 
overall, the numbers seem to get better as you go further and 
further to the right. What that is saying is that those 
individuals that start saving and start saving early are 
obviously going to have a much, much higher probability of 
having sufficient income overall. So that would be the overall 
message, I think, from a public policy standpoint is to start 
saving and to start saving early.
    When you go back, and you compare not just the retirement 
wealth, but whether retirement wealth will be sufficient to 
meet retirement expenditures, you find a much higher 
probability overall.
    The Chairman. Thank you very much.
    Dr. Gokhale, you said in your statement something that 
really caught my attention, because not long ago we had 
Chairman Greenspan before the committee to talk about the 
demographics of aging and cultures and economies and the impact 
that those aging demographics have on given public policy and 
economies. He used Japan as an example. But he also said 
something that I want to clarify in what you said. He said 
because we have a dynamic immigration policy in this country, 
we will not hit the same indices, if you will, that Japan did, 
where as we grow older, and the baby boomers leave the work 
force, we will not have anyone to replace them in the work 
force.
    Now you mentioned, and I believe these were your words, 
labor force growth rates will fall as the baby boomers exit. In 
reality, if we have a dynamic immigration policy, will that be 
the case? I understand, and I think most who look at this 
clearly understand, that if we have a declining labor force 
committed to pay for the public commitment that we have toward 
our baby boomers, we are in real trouble. We are in real 
trouble anyway.
    But having said that, if we have--and the reason I find 
that important is because we are right in the midst of a fairly 
aggressive debate on immigration policy in this country and how 
we deal with immigrants and undocumented workers and all of 
that. Expand on that, if you will.
    Dr. Gokhale. Well, I think a friendlier immigration policy 
that encourages immigrants to enter the United States and work 
and contribute and pay taxes will definitely alleviate the 
problem we are facing with a growing commitment toward 
financing consumption for retirees. Having said that, current 
immigration levels do not, I think, even approach the level of 
immigration that would be needed to completely overcome the 
problem we are facing.
    I think today--I may be off a little in the numbers I am 
citing, but I think roughly about a million immigrants, a 
little under a million immigrants enter the United States every 
year.
    The Chairman. That is about right.
    Dr. Gokhale. I have documented that by 2030, the retiree 
population will essentially double. Now, if you are going to 
keep everything in the same proportions, then, the working 
proportion should also double in order to have sufficient 
resources through tax revenues coming in to pay the retirees 
the consumption resources they will need.
    Doubling the worker population is going to require a huge 
increase in immigration, which I do not believe is going to be 
possible or even contemplated. I think that the immigrants who 
are in this country and who wish to come into the United States 
and work would be welcome, but I think immigration as a 
solution to the retirement crisis we are taking is probably not 
on the cards.
    The Chairman. Well, that puts your statement in context, 
then, of the kind that helps me understand what you are saying 
and why you are saying it.
    In your testimony, you have suggested that short-term 
budget concepts like deficits are inappropriate. How would the 
longer-term measures that you recommend help us solve 
entitlement finances?
    Dr. Gokhale. Well, we know that Social Security and 
Medicare involve very long-term commitments. The budget 
concepts that are regularly published by the official budget 
reporting agencies such as the Congressional Budget Office and 
the Office of Management and Budget, essentially look five or 
10 years ahead into the future. That implies that these short-
term budget measures do not capture the longer term 
implications of current policies, because most of the budget 
crunch, the shortfall or revenues to cover the promised 
benefits, will occur beyond that projection horizon.
    The budget measures that I am recommending would be much 
longer-term in their focus. They would essentially help us in 
two ways. We know that there is a budget shortfall. We need to 
quantify how big that shortfall is. Those budget measures 
essentially tell us how much additional resources the 
Government has to raise or have on hand in order to make those 
policies sustainable. That is one message that my recommended 
budget measures would help us to understand.
    The other way in which those budget measures would help us 
is choosing between alternatives policies that we could use to 
fix the problem. We have a choice between many different ways 
of implementing those policies in order to close the funding 
gaps for these programs.
    Of course, depending on what type of policies are 
implemented, different groups in the population, including 
future populations, are going to be affected differently. We 
need to understand how those different effects will occur under 
different policies in order to be able to make informed choices 
about the most desirable ways to address the funding shortfalls 
of Social Security and Medicare.
    The Chairman. You mentioned that economists believe that 
only 25 or 30 percent of the total savings benefiting from tax-
favored savings accounts would be new savings. In light of 
this, can you elaborate on the benefits of expanding Roth IRA-
like savings accounts?
    Dr. Gokhale. Well, if you save more, then, obviously, you 
acquire a claim on real, productive assets. Greater saving has 
significant beneficial effects--completely the opposite of when 
there is inadequate saving in the economy. That sounds 
tautological, but let me elaborate a little bit.
    If people save more, they acquire a claim on real, 
productive assets. The counterpart to there claims in the real 
economy would be more capital per work, making workers more 
productive.
    When the high savers retire, we need to transfer 
consumption resources towards them. But they would then have 
the claims that are needed to effect that transfer. So, the 
financial mechanism that we need to transfer these additional 
resources from younger to older generations, for the retirees 
to be able to draw on resources--they would already have the 
financial claims on resources. So, the transfer would be easily 
effected.
    Both the real and the financial economies would work in a 
complementary fashion to effect the required transfer toward 
the retiree populations.
    The Chairman. You seem to favor the after-tax type Roth 
account, after-tax dollars going in but tax-free dollars coming 
out.
    Dr. Gokhale. Right.
    The Chairman. We obviously found early on that tax-free 
dollars going in up to a certain amount was a phenomenal 
incentive. After-tax dollars are less incentivized, and not 
until you are much older do you recognize the value of tax 
dollars coming out being untaxed.
    You still hold that it is preferable that it be after-tax 
dollars going into a Roth-style IRA?
    Dr. Gokhale. That is correct. There are several reasons why 
the saving incentives, such that before-tax dollars go in, but 
the withdrawals are taxed, provide a very diluted savings 
incentive on a lifetime basis to those who participate. I 
mentioned three reasons earlier. Essentially the reasons are 
the withdrawals can put you in a higher tax bracket. The higher 
withdrawals, if they are sufficiently high, can subject more of 
the retiree's Social Security benefits to taxation and 
therefore increase total tax liability over the lifetime.
    In the contributions phase, if a person downshifts across 
tax brackets, then, the value of exemptions and deductions and 
mortgage interest and all of those things that you take 
deductions for, the value of those deductions would reduce.
    An additional reason is that if plan withdrawals are taxed, 
capital gains accruals in the accounts, which would ordinarily 
be taxed at a lower rate, would now be subject to an income 
tax, and that tax would perhaps be at a 30 percent rate. If you 
could keep these resources outside the tax incentivized saving 
vehicle, those would be subject to a capital gains tax rate, 
which would be much lower.
    So these tax interactions dilute the saving incentives of 
the traditional IRA type savings plans.
    The Chairman. Thank you. Is Tom coming back? Do you know? 
Oh, he is on the phone.
    Well, then, I will ask one more question, and then, we have 
been joined by our colleague, Tom Carper, Senator Carper. See 
if he has any opening comments or questions.
    Dr. Gokhale, you elaborated on your view of the two 
approaches to solving the Social Security's financial problems, 
i.e., maintaining the existing systems with benefit cuts and 
tax increases or moving to personal retirement accounts.
    Elaborate on that, if you could, for the record. That is a 
debate that we are moving toward; no question about it, and we 
have to. I think collectively, in a bipartisan way, most of us 
recognize that Social Security, especially for younger ones 
coming into it, needs to produce a greater return as it relates 
to dollars in, dollars out. At the same time, being able to 
sustain a secure system for those who are moving quickly toward 
it. If you would expand on those approaches.
    Dr. Gokhale. I recently did a study about the funding 
shortfalls for Social Security and Medicare in the entire 
Federal Government. It has been published in a book by the 
American Enterprise Institute. In that, I show that Social 
Security's shortfall over the entire future is about $7 
trillion, and that of Medicare is even larger, at about $36 
trillion. These numbers are as of the fiscal year 2002. These 
are huge shortfalls.
    It essentially means that going forward under current 
policy, not enough tax dollars will come in to pay the 
scheduled benefits of these programs. Now, at some point in the 
future, either the scheduled benefits will have to be cut in 
order to bring them in line with the amount of resources, the 
revenues that we have under current tax laws, or the tax rates, 
the payroll tax rates, would have to be increased. We could do 
that, just a simple fix to Social Security and Medicare's 
financing problem; either cut the benefits in the future or 
raise taxes but keep the financing mechanism the same. That is 
one alternative. I call it the status quo alternative.
    Now, the problem with this alternative is that when we 
either cut benefits--future benefits of workers and future 
generations--or raise their taxes in order to close the funding 
shortfall, we would delink benefits from taxes, which means, on 
net, we would increase the taxes of these individuals. On net, 
whether we cut benefits, or whether we raise taxes, the net 
effect is to increase the take from them in terms of net tax 
dollars.
    Higher net tax rates distort individual behavior and 
essentially impose an economic loss in addition to the amount 
of tax revenue raised by that measure. So, if we raise taxes, 
let us say, to cover the $7 trillion shortfall in Social 
Security, it is not only the $7 trillion that will be a cost to 
future workers, but in addition, their behavior will change. 
They will work less, perhaps, because their tax rates are high.
    That distortion will create an additional economic loss. My 
simple calculation suggests that that loss will be about a 30 
percent additional cost on top of the amount of funding gap 
that exists in Social Security today. So, the alternative to 
that is to not make the additional transfers required for 
future retirees now that the baby boomers are going to retire. 
We will need to expand these transfers; at the margin, not do 
that expansion through the existing Social Security system but 
do it through reforming the system such that we get people to 
save in these type of tax-incentivized saving vehicles through 
a personal or individual account reform of the Social Security 
system.
    The benefit of an individual account reform would be to 
reduce the additional distortions from tax or spending measures 
that are taken to close the funding gap. The distortion would 
be minimized, because now, the individual account is owned and 
controlled by the individual. That has some benefit, some 
value, to individuals. Hence, the distortionary impact of these 
tax law changes would be lowered. They can own the account; 
they can invest it in their preferred investment directions, 
subject to some regulations, of course, but the investments 
would be matched to their personal risk preferences.
    In addition, once they pass away, they can bequeath those 
account balances to their loved ones, which means those 
additional features, because they add value to the benefits, 
will minimize the distortions arising from the necessary tax 
and benefit changes that have to occur in the future.
    The Chairman. In those studies, did you go on to discuss 
the type of personal account and how it got managed as relates 
to the individual? Or did you compare it to a Federal--the 
current system that we have for Federal employees to invest in 
an IRA-like account, if you will?
    Dr. Gokhale. The Cato Institute has just released an 
outline of an individual accounts reform plan for Social 
Security. In that, we have a fairly elaborate mechanism whereby 
these account balances would be set up. There would be a three-
tier regulation of the investments allowed. Initially, when 
workers contribute into these accounts, until their accounts 
reach a certain size such that they could purchase, let us say, 
an annuity that would allow them a living standard about 120 
percent of the poverty level, they would have to restrict their 
investments in reasonably safe and conservative investments.
    But once they have accumulated sufficient amounts in these 
accounts, they could broaden their investment choice. We are 
working on estimating how, exactly, the finances would work, 
but the Cato Institute just released an outline of such a plan, 
and we are working on designing its details.
    The Chairman. Do you also propose in that a phase-in period 
for those who are currently participating in this system, if 
they choose, or new work force coming in--
    Dr. Gokhale. Right.
    The Chairman [continuing.] Percentages of a total amount 
going in, move toward a personal account?
    I have looked at a variety of models, and of course, the 
frustration for those of us who believe that we ought to move 
toward personalized accounts, is how do you continue to fund, 
over a period of time, the existing commitment, i.e., 
liability, to Social Security from the current work force while 
allowing them to move toward personalized accounts?
    Dr. Gokhale. Right, the existing liability is there. The 
only problem is that it is not reported in official budget 
reports.
    The Chairman. Right.
    Dr. Gokhale. That does not make it--
    The Chairman. No.
    Dr. Gokhale. It does not make it disappear. It is there. It 
is just not as visible as it would otherwise be.
    So, sure, when you take a part of today's payroll tax 
payments and invest them in individually owned and controlled 
accounts, then, we have a problem in financing current benefits 
to current retirees.
    For a period of time, that may have to be done through 
borrowing more from the markets. That implies higher debt 
levels, but that simple transaction is just replacing an 
implicit debt that exists--off the books, but it still exists--
an implicit debt for an explicit debt.
    The Chairman. I see.
    Dr. Gokhale. That is a transition mechanism that we are 
working on designing.
    The Chairman. That is a clear way of stating it. I had not 
thought of it in that total context.
    Do you want to check and see if Senator Carper has any 
comments he wants to make? I do not have any further questions 
of these gentlemen.
    Well, I want to thank both of you for being here this 
morning. This is obviously a dialog for the record of an 
oversight committee like this one that I think is increasingly 
valuable as we look at a variety of instruments. Our President 
has proposed a variety within the Medicare prescription drug 
package. We established something that I have worked on for a 
good number of years, as have others; the health savings 
account concept, which I think hopefully will begin to showcase 
the value of these kinds of tools out there that citizens can 
go toward to advance their own needs, whether it be health care 
or retirement. I think that is extremely valuable.
    Senator Carper, we are pleased you have joined us this 
morning. I have concluded my questioning, and if you have any 
comments to make of these gentlemen or questions, please 
proceed.
    Senator Carper. Mr. Chairman, I was just talking with a 
retiree, a fellow who is 86 years old, and he lives in the 
Riverdale section of Brooklyn. His last name is Biaggi, Biaggi. 
Does that name ring a bell with you?
    The Chairman. Biaggi.
    Senator Carper. Used to be a captain in the New York Police 
Department.
    The Chairman. I will be darned.
    Senator Carper. Later a Congressman.
    The Chairman. Oh, of course, Mario.
    Senator Carper. Mario.
    The Chairman. I will be darned.
    Senator Carper. Eighty-six years old. I just try to keep 
tabs on him.
    The Chairman. Very colorful gentleman.
    Senator Carper. He is a great guy.
    The Chairman. Yes, he is.
    Senator Carper. He is a great guy; 86, he is a widower now, 
and he just returned my call, and I felt my cell phone 
vibrating, and I slipped in back to take it. So I have missed 
what was said here, but he asked to be remembered, and I know 
you and I served with him--
    The Chairman. Absolutely.
    Senator Carper [continuing.] In the House.
    Gentlemen, thank you for joining us this morning. I am glad 
you did not get stuck in Dallas with the storm or bad weather.
    I was looking at a chart that came with the materials for 
today's hearing, and I do not know that--I think you might be 
able to tell it. It starts over here on the left hand side in 
1981, and we are measuring the personal savings rates from 1981 
over here to 2003. You do not need very good eyesight, I think, 
to see that the trend is going in the wrong direction. When I 
look at this number, it says in 2003, our savings rate was down 
to almost 2 percent. Let me just start off, if we could, by 
just asking you to tell me what do we count when we talk about 
the personal savings rate?
    Dr. Gokhale. Well I generally tend to--
    Senator Carper. Maybe what do we not include that we ought 
to think about?
    Dr. Gokhale. Well I have--I mean, the personal savings rate 
is calculated as personal disposable income minus household 
outlays. The remaining part is the amount not consumed, 
essentially, and that is how I prefer to calculate the saving 
rate--as the rate of the amount not consumed divided by the 
income base over which the saving rate is defined.
    I prefer doing it that way rather than adding up different 
saving components; that gets to be pretty difficult.
    Senator Carper. Go ahead, Mr. VanDerhei. Would you want to 
add to that or take away?
    Dr. VanDerhei. Well, I would agree with that. I think there 
have been some long-acknowledged deficiencies with it. I 
remember back in the days when retirement plans were primarily 
defined benefit plans, that the primary difference that we had 
was if you are looking at employer contributions going into the 
plans as the component of savings rates as opposed to what the 
actual benefit accruals of the employees were that when you had 
artificial restrictions, as were imposed in 1987 with the so-
called full funding limit, that you had these time series out 
of whack for awhile.
    Obviously, as defined benefit plans have diminished in 
overall importance, that becomes less and less of a problem. 
But actually, Senator Craig had asked a very similar question 
earlier, and I guess my response to him was I think if you are 
really wanting to concentrate on what this problem with the 
savings rate is for future retirement income, that perhaps the 
aggregate number is not what you want to focus on; that you 
want to focus on what pockets of the population are vulnerable 
and, basically, what types of savings rates they would have to 
have prospectively.
    We realize there is a problem historically, but 
prospectively, what would they need to have to get to some 
adequate retirement income by the time they hit, say, Social 
Security normal retirement age? Unfortunately, those types of 
vulnerabilities get masked in those aggregate numbers.
    So I guess breaking them out into individual components, I 
think, is the important point.
    Senator Carper. Well, when I was Governor of Delaware, our 
administration spent a fair amount of time encouraging 
homeownership. We ended up with a homeownership rate that 
approaches 75 percent in my little State, which is pretty good. 
I continue to focus on that as a United States Senator, with a 
real focus on my home State.
    I am wondering if--we have seen a lot of refinancing of 
home mortgages; in some cases, people taking the equity out of 
their homes in order to pay for other debt and to pay off other 
debt, maybe more expensive debt, and to end up with a lower 
mortgage payment. Does that explain some of the reduction in 
the savings rate? Do we count here the equity in people's 
homes? Is that reflected here in this personal savings rate?
    Dr. Gokhale. I think the personal savings rate does not 
reflect the capital gains accruing on homes. Essentially, it is 
an income--it is a measure of how much income is not spent on 
consumption. But the income measure does not include capital 
gains accruing on homes. So even though capital gains affect 
the amount we consume, the gains themselves are not part of the 
income definition. So even though it affects the saving rate, 
the measure does not directly address the fact that you are 
also receiving value through appreciation in your home.
    Senator Carper. Some other countries that have a 
historically high rate of savings--Japan comes to mind--I used 
to kid the guy who was the Prime Minister of Japan; I remember 
meeting with him a number of years ago, and I said, ``you know, 
your country is so different from ours.'' I was giving him a 
little bit of encourage to stimulate his economy, and I said, 
``in our economy, if you cut taxes by, a dollar, people will go 
out and spend $2.''
    In Japan, if you cut taxes by, like 1 yen, people will go 
out and save 2 yen. But Japan and other countries where they do 
not invest as much of their money in housing, they have a 
pretty high savings rate. I wondered if maybe our capital 
accumulation, is a little bit better than is reflected in these 
numbers, because we do inordinately invest in our homes.
    I like to think that probably for the majority of people in 
our country, probably, that the biggest source of capital 
accumulation for a lot of folks is the equity in their home. We 
use that equity to, in some cases, reverse mortgages to help 
pay for our lives at the end of our lives, and to sustain it, 
some people use the equity in their homes to start a small 
business, you know, to send their kids to school, that kind of 
thing.
    But could one of the reasons why--let me make up an 
example. Let us say a person makes $50,000 a year, and they put 
$500, let us say $1,000 a year in savings of some kind, stocks, 
whatever, a 401(k). But they also pay a mortgage every month, 
and part of the principal for that mortgage might, we will say, 
adds up to over the course of a year to, say, $5,000 just for 
principal, and they have seen accumulation of equity and the 
capital gains in their home.
    Do I understand it that this personal savings rate reflects 
the $1,000 that they might put in their 401(k), but it does not 
reflect the $5,000 in principal payments that they have made in 
their home or the increase in capital accumulation on their 
home, increase of value in their home? If that is true, does 
that make sense? Either one of you, feel free. I do not want to 
pick on you, Doctor.
    The Chairman. Let me add this, because this is an excellent 
question. Is not the indices or the numbers that we calculate 
personal savings rate in this country include IRAs, 401(k)s, 
defined benefit pensions and personal retirement accounts, all 
other forms of accumulation are not a factor in these figures? 
Is that an accurate thought? Is that accurate?
    Dr. Gokhale. My understanding is that all saving is 
included in the personal saving rate. The way I calculate it, 
if you do not consume something, you are saving it out of the 
income definition we use.
    The Chairman. So your definition would include--
    Dr. Gokhale. My definition would include the budget--
    The Chairman. The buildup of--
    Dr. Gokhale. The buildup of--no, would include the buildup 
of equity through paying the mortgage, because essentially, by 
paying a mortgage, you are buying part of a durable good, the 
home. If you appropriately adjust the personal savings rate to 
take into account the fact that you are purchasing a durable 
good, it would be included.
    Usually, however, in the definition of outlays includes 
purchases of durable goods. So there are some subtleties--
alternative ways of calculating the personal savings rate to 
adjust for purchases of durable goods.
    What is not included is the appreciation of that $5,000, 
because home values go up. So you might be paying off $5,000 in 
principal, but at the end of the year, that $5,000 appreciates 
and becomes $6,000, because the home's value has increased. 
That additional $1,000 of home appreciation will not be 
included.
    The Chairman. Intriguing.
    Senator Carper. OK; let me just ask each of you: just give 
me some really basic responses in terms--and you have already, 
I am sure, gone over this in your testimony and with the 
Chairman. But if our interest is in encouraging greater savings 
in this country for capital formation, for investments to make 
us more productive, it is kind of interesting: we continue to 
be more and more productive as a nation, our work force is, 
while our savings rate is going to pot.
    I do not know if there is an easy explanation for that or 
not. But just a couple of basic things that we ought to be 
doing, particularly with us in the Congress, to encourage 
greater savings.
    Dr. Gokhale. Well, my recommendation is to essentially 
design saving incentives in the style of Roth IRAs rather than 
traditional IRAs and 401(k)s, simply because Roth IRA rules 
minimize the interactions of contributions and withdrawals with 
the rest of the income tax code and that dilutes the saving 
incentives.
    The Roth design does not involve such interactions with the 
rest of the income tax code, and therefore, the tax incentive 
remains strong. But an important additional qualification is 
that when we provide either a Roth or a traditional type of 
saving incentive, the government loses revenues. Which type of 
other tax and spending policies are used to recoup lost 
revenues is also important.
    If we raise other taxes to make up for lost revenues, we 
may not, on net, be providing significant saving incentives. If 
we finance the lost revenues through incurring larger deficits, 
then, we would have to raise future taxes by even more, not 
only to recoup lost revenues but to pay interest on the debt 
accumulated along the way. That would dilute the savings 
incentive even more. But if we cut spending in response to lost 
revenues, then, we would preserve the saving incentive. So we 
need to couple such saving incentives with control over federal 
spending.
    Senator Carper. OK.
    Dr. VanDerhei. I would say fundamentally, you want to look 
at what is doing the best job of producing retirement savings 
at this point in time. I think if you look at the private 
retirement system, you would want to look at both what you can 
do for employers that currently do not sponsor plans to give 
them the incentives to start doing it, because that will, by 
definition, increase the participation in retirement plans for 
their employees and then also look at the employees.
    One of the problems on the employee side is not necessarily 
that employees are not responding to employer incentives, 
because when a 401(k) plan is offered with a match, a large, 
large percentage even of the lower income employees will 
respond to that. The problem is, however, that currently, it 
is, in many people's opinion too easy for that money to slip 
out of the retirement system at job change.
    Currently, there are tax incentives to keep it in the 
system, but those incentives, obviously, are not sufficient, 
especially when the employees are young. Instead of rolling 
over those account balances from the old employer to the new 
employer or into an IRA, many times, even with the 20 percent 
withholding and even with the 10 percent premature tax, young 
employees will think, well, I will work with the next employer 
long enough to have sufficient retirement income.
    Iteration by iteration, they cash out those early 
accumulations. The problem is, oftentimes, they end up with 
just the last employer or the last two employers' account 
balances for their overall retirement savings. Finding ways of 
encouraging them to retain those, I think, would go a long way 
to increasing overall retirement account balances, especially 
as we become more and more dependent on defined contributions 
going forward.
    Senator Carper. OK; let us just talk for a moment about 
middle-income and lower middle-income workers. You know, when 
you offer somebody who makes over $100,000 an IRA the ability 
to defer--whether it is a Roth IRA or a traditional IRA--but 
the ability to delay, in some cases, for a long time, your tax 
obligation, I can see where there is a real incentive for 
upper-income families to participate. They have more disposable 
income anyway.
    When I was State treasurer of Delaware, we started a 
deferred compensation program for our State employees, and the 
participation was pretty good among higher paid State 
employees. It was not very good among lower-paid State 
employees. When I was Governor, we changed the program up a 
little bit so that the State would match, literally for 
everybody, a relatively small match for what people deferred 
and put into the plan.
    For people whose income was low, it was really rather 
significant. For people whose income was high, it was a little 
incentive, but comparatively speaking, not much. Just talk to 
me a little bit about how we get more lower-income folks to 
save for their retirement, because my sense--and I think I 
heard the Chairman saying this, and I believe I heard Mr. 
Gokhale--did I get that right, Dr. Gokhale?
    Dr. Gokhale. Gokhale, that is fine.
    Senator Carper. OK; Gokhale; all right. Has anyone ever 
mispronounced your name? [Laughter.]
    Dr. Gokhale. Nobody but you right now. [Laughter.]
    Senator Carper. I am the first; I do not believe that. 
[Laughter.]
    I guess my question is, what would we be doing more to 
encourage not just people whose income is $100,000 and above to 
save; I think they will anyway, but the people whose income is, 
say, under $40,000 or under $30,000, who are not saving much at 
all, but they are just trying to get through the day? There are 
a lot of them, as you know.
    Dr. Gokhale. Well, low-income individuals have huge amounts 
of necessary expenditures. I mean, they have to pay for 
bringing up their kids, pay for kid's college expenses. Even 
sending them to a community college at that income level, is a 
significant expense. On top of that, they have to pay, payroll 
taxes, which is a huge burden. Ultimately, in some sense, it is 
saving for them. Government is doing that saving for them. It 
takes the 15 percent in payroll taxes and promises some 
retirement benefits.
    Unfortunately, those benefits cannot be paid as promised. 
So that saving essentially provides a very low rate of return. 
If, instead, we could somehow redirect that 15 percent payroll 
tax into an individual account, that would earn a higher rate 
of return. Of course, I recognize that somehow we have to 
finance the benefits of existing retirees.
    Senator Carper. That is the $64,000 question, is it not?
    Dr. Gokhale. That is right, but that debt is on the books. 
The question is should we make it explicit, and allow low-
income individuals to access higher returns in the market or 
whether we should continue under the current system and make 
future changes as they become necessary, which has not just 
costs in terms of higher taxes but also costs in terms of 
distorting labor market behavior on the part of low income 
individuals. So I think we observe low saving rates because low 
earners have tremendous responsibilities and necessary 
expenditures that they need to make.
    Senator Carper. Dr. VanDerhei.
    Dr. VanDerhei. Senator, I think you touched on what is 
absolutely the most important way of accomplishing this, and 
that is by the employers offering a match. Craig Copeland and I 
have an article in the North American Actuarial Journal that 
shows, because we actually went back and took from millions of 
different participants and looked at their match rates, that 
when you control for age, and you control for wage, and you 
control for gender, that the larger the match and not only 
that, the larger you go out with the match--
    Senator Carper. When you say the larger you go out, what do 
you mean?
    Dr. VanDerhei. Three percent of compensation versus 6 
percent of compensation; the higher the participation and the 
higher the contribution percentage from those employees.
    So, without a doubt, we found that statistically, that is 
the single most significant thing. With respect to what else 
could happen, I truly think that although it is difficult, 
there is a role that the Government could play as far as 
educating individuals, again not solely with respect to the 
message that you need to save now to have bigger accumulations, 
because accumulations really do not mean that much, certainly 
to young individuals.
    But if you are able to show them how the likelihood of them 
having sufficient money for their retirement expenses to match 
up retirement income versus retirement expenses and show what 
you are doing as far as likelihood of being able to have a 
significant retirement income is going to be able to help most 
individuals. This is something I have been teaching, now, for 
my undergraduates for 25 years, and while it is tough to get a 
20-year-old to think about retirement, we oftentimes use their 
parents as guinea pigs as far as what types of educational 
devices would indeed get them to start contributing more to 
their retirement plans, to their IRAs, whatever.
    If you move away from the exclusive focus on retirement 
wealth to one that looks at the expenses they are going to have 
to cope with also, you find much better response upon those 
people in their forties and fifties.
    Senator Carper. Thank you both, Dr. VanDerhei, Dr. Gokhale.
    Dr. Gokhale. Gokhale.
    The Chairman. Gokhale.
    Senator Carper. Gokhale; all right, we will get it.
    Thank you both for being here and for your testimony.
    I would just say in closing--I will go back to sort of the 
issue that I raised initially, Mr. Chairman, and that is the 
notion that for a lot of families in this country, the biggest 
form of savings for them is the equity in their homes and just 
to close by saying again how important it is that we make the 
idea of homeownership a reality for a lot of families, and not 
just those income is fairly high but particularly for those 
whose income is low but for whom owning their own home would 
just be a very good thing for their current life but also for 
their later years.
    Thank you, and thanks for being so generous with that time.
    The Chairman. Both you and I totally agree on that. It is 
extremely valuable, and it is one of the tools that we promoted 
in this country, and obviously, we have incentivized it through 
the tax code and found it very valuable and not only for 
savings but I think for community stability and all of the 
other kinds of social benefits that are gained from it.
    Gentlemen, thank you very much for your testimony, your 
involvement in these issues. They grow increasingly important 
for those of us who are going to have to make some tough 
decisions in the future. A few of us spend time looking at 
those projections in those out years and $7 trillion 
liabilities and $36 trillion liabilities and recognize that 
those are very ominous figures against any economy, let alone 
ours, being the largest in the world. But one that we want to 
try to keep there and all of the factors that play into that, 
recognizing that that economy pays for the social commitment 
this Government has made long-term to its citizens.
    So those are important issues. Thank you very much for 
weathering the weather to be with us today.
    Dr. VanDerhei. Thank you.
    Dr. Gokhale. Thank you.
    The Chairman. The committee will stand adjourned.
    [Whereupon, at 11:19 a.m., the Committee adjourned.]
                            A P P E N D I X

                              ----------                              


               Prepared Statement of Senator John Breaux

    I would first like to thank Chairman Craig for holding this 
vital hearing on retirement savings. I would also like to take 
this opportunity to thank all of the witnesses who have come 
before us to testify today. Your testimony will be of great 
value as the Committee works to address some of the critical 
challenges that exist in ensuring financial security for both 
today's and tomorrow's retirees.
    The need for retirement income security for our nation's 
retirees is great. This need will only grow, as 77 million baby 
boomers stand on the doorstep of retirement. We, as a nation, 
can no longer wait to address issues of retirement security nor 
turn a blind eye to them. In recent years, several competing 
theories have come to the fore. Before we as legislators can 
attempt to implement any of these theories, we must first 
understand the implications of each. That is why this hearing 
is so important. I look forward to hearing what our witnesses 
have to say and to working with my them along with my 
colleagues here in the Senate on this crucial issue.
                                ------                                


             Prepared Statement of Senator Gordon H. Smith

    Today's hearing on retirement planning is of vital interest 
to all Americans. With America's changing demographics and the 
increased mobility of our citizens, it is essential that every 
American be able to adequately prepare for their own 
retirement. Our retirement system must face the realities of 
our time. Unlike in the past, employees do not have the same 
jobs for life; increasingly, they switch both employers and 
professions. Families have become increasing separated by 
distance, and retirees must be able to financially provide for 
their own care as they get older. In addition, Americans 
longevity rate in increasing--we as a nation are living longer, 
healthier lives.
    With these trends taken together, it is imperative that the 
federal government promote a retirement system that encourages 
all American's to prepare for their financial future. At a time 
when Americans should be saving more, they are not. American's 
personal savings rate has been on the decline. We must have a 
strong retirement system that encourages private savings. The 
federal government and future generations cannot be made to 
bore the cost of an every increasing size of retirees who are 
living longer than there predecessors.
    Since the early 20th Century, America has made important 
headway in building a stronger retirement system by encouraging 
innovate ways of saving for retirement. We have made 
significant improvements, however, much needs to be done to 
ensure the income security for Americans during their 
retirement.
    Therefore, I join the Chairman, and look forward to 
learning more about creating innovative policies to encourage 
American's to increase their personal savings in an effort to 
provide for their future.

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