[Senate Hearing 108-577]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-577

  STRENGTHENING SOCIAL SECURITY: WHAT CAN WE LEARN FROM OTHER NATIONS?

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

                                HEARING

                               before the

                       SPECIAL COMMITTEE ON AGING
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             WASHINGTON, DC

                               __________

                              MAY 18, 2004

                               __________

                           Serial No. 108-35

         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
Statement of Senator Evan Bayh...................................    39

                                Panel I

James B. Lockhart III, Deputy Commissioner, Social Security 
  Administration, Washington, DC.................................     2
Yoshinori Ohno, member of Japanese House, and chairman, Research 
  Commission on the Annuities System, Liberal Democratic Party of 
  Japan, Kagawa, Japan...........................................    15

                                Panel II

Vincent J. Truglia, managing director, Sovereign Risk Unit, 
  Moody's Investors Service, New York, NY........................    46
Axel Boersch-Supan, director, The Institute for Economic 
  Research, University of Mannheim, Mannheim, Germany............    58
David O. Harris, senior consultant, Watson Wyatt Worldwide, 
  London, England................................................    64
L. Jacobo Rodriguez, final services analyst, The Cato Institute, 
  Washington, DC.................................................    81

                                APPENDIX

Testimony submitted by Richard Jackson, director and senior 
  fellow, CSIS Global Aging Initiative...........................   121

                                 (iii)

  

 
  STRENGTHENING SOCIAL SECURITY: WHAT CAN WE LEARN FROM OTHER NATIONS?

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



                         TUESDAY, MAY 18, 2004

                                       U.S. Senate,
                                Special Committee on Aging,
                                                    Washington, DC.
    The committee convened, 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, Bayh, and Carper.

       OPENING STATEMENT OF SENATOR LARRY CRAIG, CHAIRMAN

    The Chairman. Please excuse me. I have been stalling for a 
few moments. We have some of our folks who will testify today 
stuck in traffic, but I assume that we are about ready to go so 
let me convene the Senate Special Committee on Aging. I want to 
say good morning to all of you. We are here today to learn how 
other nations are working to strengthen their Social Security 
systems.
    The world is aging. Birth rates are declining. People are 
living longer. The worker-to-retiree ratio is declining across 
the globe. The result is that public pension systems around the 
world are increasingly under pressure. Over the next decades, 
the world will see a growing share of economic resources 
transferred from the young to the old. Much of this transfer 
will occur through public pension systems. The challenge for 
industrialized nations is how to provide a decent standard of 
living for the old without overburdening the young.
    Japan and Europe are on the leading edge of aging 
populations compared to the United States. Many nations have 
undertaken or are in the middle of enacting reform to secure 
the retirement income of retirees. The pace and approach to 
reform differs by nation. Many of the largest industrialized 
economies have generally opted to increase taxes and cut 
benefits. About 30 nations have chosen, in whole or in part, to 
increase the rate of return on assets by enacting prefunded 
personal retirement accounts.
    As the United States considers personal retirement accounts 
to strengthen Social Security, it is important that we learn 
what other nations are doing. So we are here this morning to 
improve our understanding and to build a record so we in 
Congress can move forward with the best available information.
    With that, I am very pleased to welcome our witnesses to 
the Aging Committee today. We have on our first panel two 
distinguished government officials from the United States and 
Japan to help us better understand what is being done to 
strengthen Social Security around the world.
    Our first panel is made up of Jim Lockhart, Deputy 
Commissioner from the U.S. Social Security Administration; and 
Mr. Yoshinori Ohno, a member of the Japanese House and chairman 
of the Liberal Democrat Party Research Commission on the 
Annuities System.
    Joining us on our second panel will be Vince Truglia, 
managing director of the Sovereign Risk Unit at Moody's 
Investment Services; Axel Boersch-Supan, director, Institute 
for Economic Research, University of Mannheim in Germany; David 
Harris, director, Watson Wyatt Worldwide in London; and Jacobo 
Rodriguez, financial services analyst at the Cato Institute.
    I want to thank all of our witnesses for being with us 
today and now let me turn to Commissioner Lockhart to begin 
this morning's testimony. Thank you.

   STATEMENT OF JAMES B. LOCKHART, III, DEPUTY COMMISSIONER, 
         SOCIAL SECURITY ADMINISTRATION, WASHINGTON, DC

    Mr. Lockhart. Thank you, Mr. Chairman, for inviting me 
today to testify about strengthening Social Security and also 
the very important lessons we can learn from experiences in 
other nations.
    I also want to thank you, Mr. Chairman, for hosting a 
series of events last month in Idaho during which we discussed 
Social Security's future. I think they were very useful and 
very successful and I thank you for your support.
    Achieving sustainable solvency is one of the Social 
Security Administration's four strategic goals. Although Social 
Security trust funds exceed $1.5 trillion today, Social 
Security does face serious long-range financing issues.
    In 2018, the trust funds are projected to begin paying out 
more in benefits than is collected in payroll taxes, which will 
begin to put significant pressure on government finances. By 
2042, just prior to the retirement of my two children, the 
Social Security trust fund assets are projected to be 
exhausted. Absent any changes, any reforms to strengthen Social 
Security, their scheduled benefits will be cut by 27 percent.
    The reason Social Security is unsustainable under current 
law is very simple. As you said, it is the aging of America. 
People are living longer and the birth rate is low. It is 
projected by 2030 the ratio of workers to all beneficiaries--
and this ratio includes not only retirees but the disabled and 
the survivors that are covered by the Social Security system--
which is currently 3.3-to-one will fall to 2.2-to-one and 
continue to fall thereafter.
    This next chart, or the chart I have up here, as you can 
see on the easel and is attached to the testimony, excludes the 
disabled and survivors and tries to show the ratio of workers 
to retirees throughout some of the developed countries in the 
world. As you can see, in 1995, the ratio is well over two-to-
one in many of these developed countries. In fact, in some like 
the U.S. and Canada, it was over three-to-one. By 2050, it is 
projected to fall dramatically to unsustainable levels in most 
of these countries. Actually, in Italy, it will sink to below 
one-to-one, meaning there will be more people receiving 
retirement benefits than paying taxes.
    Fortunately, the United States is somewhat cushioned by 
higher birth rates and higher immigration levels than some of 
the other developed countries.
    As a result of this global aging, many countries have been 
actively reforming their Social Security programs. In addition 
to the traditional reforms of raising taxes, which we have 
actually done 19 times in the history of Social Security in the 
United States, or reducing benefits, many have decided to 
prefund a portion of future retirement payments by investing 
funds in stocks and bonds to increase returns. Some countries, 
such as Canada, have chosen to increase returns by direct trust 
fund investments, while many others, approximately 30, have 
done so indirectly through personal accounts.
    By looking at the experience of other countries, we can 
make better choices about how to strengthen Social Security.
    One of the first lessons we can learn is that Social 
Security reforms will happen. They will have to happen. As 
President Kennedy said back in 1961, ``The Social Security 
program cannot remain static. Changes in our population, in our 
working habits, and in our standard of living require constant 
revision.''
    A second lesson is the importance of acting sooner rather 
than later. The trustees have said this in their annual report 
for many years in a row. We need to act sooner rather than 
later. Delay may cause the need for more significant tax 
increases and benefit reductions, as it is doing now for some 
continental European countries and Japan. If we act sooner to 
strengthen our Social Security system, we will be able to 
select from a broader array of options and phase in changes 
gradually.
    A third lesson, and really it is a whole series of lessons 
we can learn from these countries, is that they can teach us 
things about the impacts of increasing taxes, reducing 
benefits, and also, very importantly, increasing rates of 
return. In fact, just yesterday, Social Security sponsored with 
our Retirement Research Consortium a conference on global aging 
to learn more about the impacts of these changes.
    Finally, I think it is very important to continue our 
efforts to improve financial literacy in the United States and 
to help people understand the need for reform, as we were doing 
out in Idaho. Once the need is understood, the experience of 
many of these countries showed that a bipartisan consensus is 
achievable to strengthen Social Security.
    In conclusion, we share the challenge of the global aging 
with many countries around the world. It is important to learn 
as much as we can from their experiences.
    Mr. Chairman, I again commend you for holding this hearing 
and especially for your very strong leadership in the 
bipartisan effort to strengthen Social Security. I will be 
happy to answer any questions. Thank you.
    The Chairman. Jim, thank you very much.
    [The prepared statement of Mr. Lockhart follows:]

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    The Chairman. Now let me turn to Mr. Ohno, who, as I said 
earlier, is a member of the Japanese House and Chairman of the 
LDP's Research Commission on the Annuities System. Mr. Ohno, it 
is a great pleasure to have you travel the distance you have to 
be with us today.

  STATEMENT OF YOSHINORI OHNO, MEMBER OF JAPANESE HOUSE, AND 
CHAIRMAN, RESEARCH COMMISSION ON THE ANNUITIES SYSTEM, LIBERAL 
            DEMOCRATIC PARTY OF JAPAN, KAGAWA, JAPAN

    Mr. Ohno. Thank you, Mr. Chairman. I am extremely honored 
to be here to testify before the Senate Special Committee on 
Aging regarding the Japanese pension reform now under 
deliberation in the Diet. In Japan, the pension reform is badly 
needed because our society is dramatically aging with fewer 
children.
    The Japanese people are living longer. This is one of the 
greatest achievements of our society. Page six of my written 
testimony shows how dramatically the Japanese society is aging. 
This also shows that the discrepancy of life expectancy between 
men and women is getting wider and wider. Why? That is another 
story. Living longer is a great pleasure and we should not turn 
this pleasure into anxiety.
    A more serious problem than living long is extremely low 
birth rates. Currently, the birth rate is 1.32 per woman. It 
was 2.14 in 1965. Thus, the Japanese population would halve by 
the end of the 21st century.
    As you see at page eight, the average age of first marriage 
is going up now. At their 20's, unmarried women occupy two-
thirds of the total.
    Thus, the age dependency ratio is, as you see at page nine, 
worsening. Under such circumstances, it is necessary to raise 
contributions and lower benefits every 5 years when the pension 
system is to be reviewed and people are losing trust on their 
pension system. The most important task, therefore, is to 
restore confidence in the pension system and make it 
sustainable for at least 100 years to come. This is, in my 
analysis, the fundamental purpose of the current reform, 
because the DNA of the Japanese people is security.
    The gist of our pension reform plan is as follows. First, 
sustainability. In order to make the Japanese pension system 
sustainable for the coming 100 years, we decided to restructure 
the level of benefits and contributions, as you see at page 
ten. On the point of the level of benefits, we decided that the 
minimum level of pension benefits should be about 50 percent of 
the average income of working people. It is now almost 60 
percent.
    The level of contributions of the employees' pension, 
currently 13.58 percent, will be gradually raised to 18.3 
percent over 14 years, each year by 0.354 percent. We also 
decided to raise the tax-financed part of the basic pension 
from one-third to one-half within 5 years.
    In addition to the above, for example, the government 
proposed that in case of a working husband and non-working 
wife, working husband's income-related benefits be divided half 
and half when both of the couple reach the age of 65. But we 
thought that dividing half and half of the husband's income-
related benefits might be a stimulus to divorce of the loved 
couple, so we made the system in which the benefits will be 
half only when they are divorced.
    The opposition party, the Democratic Party of Japan, 
proposed its draft law against ours. The main points of the 
proposal are the integration of the three categories of pension 
system, that is to say, the national pension, the employees' 
pension, and the mutual aid pension, as you see at page three.
    Final agreement was reached between government parties and 
the opposition party that we will discuss the matter of 
integration later on. The draft law of the pension reform 
passed the House of Representatives, but now the political 
climate of Japan is rather chaotic because it is revealed that 
some leading politicians did not pay into the pension program. 
We will do our best, we try our best so that the law may pass 
the House of Counselors by the end of this Diet session.
    It is said in Japan that the pension is a gift from young 
generation to parents and grandparents. However, because of the 
rapidly aging society with fewer children, the Japanese pension 
system is becoming unfair between generations. People of my age 
are to receive benefits eight times of the paid contributions 
in case of employees' pension, but people born in 1985 and 
after will receive benefits only 2.3 times of the paid 
contributions. However, in the framework of the pension system 
we see not only the remittance of money, but also we see a gift 
of warm heart, which is most important in our human society.
    Yet, the most important is to produce more babies. If we 
are successful in making the Japanese society more favorable 
for the youngsters to produce more babies, it is not necessary 
at all to discuss the level of contributions and benefits and 
all the serious problems will immediately be solved. I am sure 
that producing more babies is the most fundamental reform of 
the pension system in Japan.
    Thank you very much, Mr. Chairman.
    The Chairman. Mr. Chairman, thank you very much.
    [The prepared statement of Mr. Ohno follows:]

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    The Chairman. Let me ask both of you some questions that 
will help bring out several of the points involved. 
Commissioner Lockhart, you provided some lessons to be learned 
from the foreign experience. What do you believe, based on what 
you know now, would be the most important lesson to date?
    Mr. Lockhart. I think we can learn an awful lot from the 
foreign experiences, but I think the most important lesson 
really is to act sooner rather than later. If we act sooner, we 
will have more of a range of opportunities, more choices to 
make. Any changes will be less drastic, less abrupt to the 
people.
    As you remember, in the 1983 reforms, they increased the 
retirement age from 65 to 67, and just 2 years ago, it started 
to actually move up. If we can make those kinds of gradual 
changes, that will allow people to compensate.
    It will also allow us to look at more options, not just the 
traditional increase taxes or decrease or slow down the growth 
of benefits. We can start looking at some of those related to 
increasing investment returns and prefunding.
    We can learn also from the experience of those countries--
how they reformed their programs and some of the lessons they 
learned, if they didn't do it as well as they should have, if 
they made them too expensive, and some other things. So there 
are a lot of lessons out there that we can learn.
    The Chairman. What activities is the Social Security 
Administration currently undertaking that would begin to 
explore all of these kinds of options that could be presented 
to Congress?
    Mr. Lockhart. First of all, we have been very active 
internationally. We belong to three international Social 
Security groups. We actively meet with them. We have various 
working committees on things related to policy, in particular.
    Social Security itself has been really strengthening our 
ability to respond to Congress and the administration on 
reforms. We have developed a whole series of models, papers, 
that really look at all aspects of reform, and on top of that, 
our actuarial shop led by Steve Goss has been very active at 
looking at plans, helping members to structure them, and 
helping to score them. There has been a lot of activity there. 
I mean, that is the good news, that he has been very active in 
looking at plans, not just Republican plans but also Democratic 
plans.
    So what we have tried to do is put in place all the 
infrastructure to help Congress and the administration make 
reforms.
    The Chairman. You mentioned your presence in Idaho last 
month, and I greatly appreciate that presentation. It got good 
play in our State. It was the rolling out of a communications 
effort and an information effort on the part of the Social 
Security Administration.
    You and I visited earlier before the hearing today about 
the difficulty of getting public attention at this moment on 
this issue because of all the other issues that are out there 
and a Presidential political year probably on top of all of 
that. But having said that, I think that both you and Mr. Ohno 
have spoken to the value of information and the value of public 
knowledge about what is reality and their willingness to adjust 
and change based on that reality.
    Would you visit with us for a few moments about that 
particular information piece that you offered in Idaho, the 
work that has been done on it, and what your plans are to use 
it effectively over the next couple of years?
    Mr. Lockhart. Yes. As I said early in my testimony, one of 
the four strategic goals of Social Security is achieving 
sustainable solvency, and that means not just solvency for the 
75-year period but for the very long term. I think a key aspect 
of that is to help educate the American people about the future 
of Social Security. Social Security has been one of the most 
successful, if not the most successful program. Certainly 
President Bush has said that several times. But he and many 
others have said we need to strengthen Social Security for 
future generations. He has actually asked the Social Security 
Administration to work with members and interested parties in a 
bipartisan educational effort, and that is really what we have 
been trying to do.
    As you know, those events in Idaho were designed, first of 
all, to lay out the issue to the people and then look at the 
various alternatives for strengthening Social Security. We 
tried to do it very much in a very level, evenhanded manner. We 
looked at reforms, various reforms related to increasing taxes, 
various reforms related to slowing the growth in benefits, and 
then looked at the increased investment return alternatives. 
Again, we looked at three different kinds of alternatives 
there. As you know, we also had a simulator that we had 
launched in Idaho which allowed people to actually make choices 
and see what would happen to the system, but also more 
importantly to their benefits and to their taxes.
    We are hoping that this tool and these series of events, 
which we hope to get more sponsors for, could be a very useful 
component in helping the American people understand the issue 
here, because it is an extremely serious long-term issue for 
American people, for the American economy, and the sooner we 
start moving on it, the better off we will be.
    The Chairman. We thank you very much for being here this 
morning, and I do believe that presentation was extremely 
valuable and I would agree with you. The simulator is really a 
hands-on opportunity for the average recipient or beneficiary. 
I think once those kinds of pieces of knowledge are out there 
and they can actually see how it would impact them 
individually, that change is doable. It is very sellable to the 
American people if the educational process goes forward.
    What I don't want to create is the very experience I had 
and that every member of this Congress has had that has served 
here for any length of time, and that is the flood of mail that 
continually comes because somebody got notched, the old notch 
act, as we know. The problem is people don't understand that 
the notch was one of those adjustments in the system out there 
that was made and then later was allowed to be effectively 
misrepresented, in part because there was not an informational 
base out there. You and I had nothing to do with it, but we 
have wrestled with it over the years.
    Mr. Lockhart. I think it is an important point, and 
President Bush makes it many times, that any reforms will not 
touch today's retirees and near-retirees.
    The Chairman. Yes.
    Mr. Lockhart. Their benefits are safe and secure. As we saw 
out there in Idaho in these events, once you talk to the 
elderly about that, they really start to understand that these 
are really reforms for their children and grandchildren and 
they actually get into thinking about how best to do it and I 
think that is extremely important.
    The Chairman. Thank you very much, and speaking of reforms 
for children and grandchildren is a great sequel to you, Mr. 
Ohno, and again, we are very pleased that you are with us this 
morning.
    My first question to you would be, you have clearly given a 
lot of thought on how to reform your public pension system. You 
mentioned sustainability as the first goal of the proposed 
reforms. How well do the proposed reforms achieve their 
intended goal of sustainability in that 100-year window that 
you speak of?
    Mr. Ohno. Thank you very much, Mr. Chairman. As I told you 
in my first statement, every 5 years, the Japanese pension 
program is to be reviewed, and every 5 years when we review the 
Japanese pension program, we have to change the structure of 
the pension program. That is to say, we have to raise the level 
of contributions and we have to lower the level of benefits. 
That is the reason why the Japanese people at large are losing 
the confidence, as I told you, in the Japanese pension program.
    So in order to make the pension system sustainable for the 
100 years to come, the actuarial calculation of the current 
pension reform is based on the following figures. First, birth 
rates. There is in 2050 1.39. It is now 1.32. Life expectancy 
in 2050, men 80.95, women 89.22. Rising consumer price, 1.0 
percent per year. Rising wage, 2.1 percent every year. Interest 
rate, 3.2 percent, et cetera. This is the actuarial calculation 
basis.
    If the birth rates in 2050 is 1.1, very, very low level, or 
as I told you, 1.32 or 1.39 is the actuarial calculation basis, 
but if the birth rate goes down to 1.1, the pension system will 
be, I am terribly sorry to say this, but insolvent--insolvent, 
exhausted in 2066.
    Well, if we do not strengthen our pension program, the 
employees' pension will be insolvent within 17 years--within 17 
years--and the national pension will be insolvent in 13 years. 
If we maintain the current level of benefits, we must raise the 
contributions of the employees' pension to almost 26 percent. 
Well, on the contrary, if we maintain the current level of 
contributions, we must lower the level of benefits by 40 
percent.
    Anyway, we have right now 150 trillion yen for the 
accumulated fund from the contributions and that will be used 
after around 2050 and we can see this, if, as I told you 
before, every actuarial calculation basis keeps as it is. It 
continues for around 100 years to come. Thank you.
    The Chairman. Mr. Ohno, you have spoken, of course, in your 
testimony to the importance of the increase in Japan of the 
birth rate as a matter of good pension policy. Not only is 
birth rate an issue in your country, it is becoming an issue in 
our country as it relates to the long-term actuarial soundness 
of the pension fund, but also the dynamics of the economy 
itself, a strong vibrant economy, people at work, contribution 
into the system.
    Would you speak to me or speak to the committee for a few 
moments about policies that you have considered that would 
actually promote an increase in birth rate, how you would make 
it more desirable for the Japanese family to have more 
children, and your present look at the economy long term and 
changes that you might produce there to keep it vibrant.
    Mr. Ohno. Mr. Chairman, before I speak about the policy 
problem, how to increase the birth rates, let me make an 
analysis why the Japanese women are not producing more babies. 
First of all, well, about 40 years ago, there was a pressure on 
Japanese girls to get married before the age of 25. If they 
were not married before the age of 25, they were called 
``leftover Christmas cakes'' or something like that---- 
[Laughter.]
    Mr. Ohno [continuing]. They look, of course, beautiful, 
still edible, but no one would buy them.
    Senator Bayh. What did they call the boys, Mr. Ohno? 
[Laughter.]
    Mr. Ohno. I don't know. [Laughter.]
    So then there is no pressure like that in Japan of today. 
Girls work and stay with their parents, relying everything, 
including meals and room and everything on their parents. They 
enjoy their lives, relying everything on parents, well, say 
earn money and enjoy their lives, going abroad for sightseeing, 
et cetera. In Japan, they are called ``parasite singles,'' if 
you call that in the United States or not, I am not quite sure, 
but this may be the Japanese inventive English.
    The Chairman. It is very descriptive, I will say that. 
[Laughter.]
    Mr. Ohno. So as I told you before, the average age of first 
marriage of the Japanese girls, women, is rising, and so, how 
to educate them, how to let them know about the human contact, 
warmness of human relations. This is very important for the 
Japanese society. This is the first one.
    As I told you, the average age of first marriage is getting 
up. It is right now 27. About 30, 40 years ago it is 24 years, 
and right now, 27 years old. So this is the average of the 
first marriage for Japanese women.
    Maybe in the second place, I have to say long working hours 
for the Japanese workers, including women. So maybe we have 
to--and, of course, Japanese women occupy almost 40 percent of 
the total workforce, so we have to ask the business circle to 
establish some sort of new working habit or practice. This is 
one of the points.
    Third, in Japan, a man does not share the housekeeping 
business. Japanese husbands share only 5 percent of the total 
working household keeping business, while in Norway, for 
example, as I understand it, husbands' share of housekeeping is 
40 percent, as I understand it. Well, I don't know how much 
percentage in America.
    Fourth, then very high cost of education in Japan--very 
high cost of education in Japan. Children go to cram school in 
order to pass the entrance examination at the university, et 
cetera. So education cost is very, very expensive. That is the 
reason why they do not like to produce more babies.
    One more thing, if I may say so, the average size of 
Japanese houses is very, very small, so they have to give up 
the hope of having one more baby. This is the reality.
    Then on the point of the policy, while there are some 
policy measures we have established and are following, name 
some, for example, improvement of work environment, for 
example, extension of the period of child rearing leave, 
promotion of shorter working hours and securing various types 
of employment, fulfillment of child allowance, et cetera.
    But the most important point I have to say, have to point 
out here, is that government expenditure for the aged people, 
if it is ten, level ten, then the government expenditures for 
children is only two or something like that. As I understand 
it, in Scandinavian countries, if the ten expenditures, 
government expenditures for the aged is the same level for the 
children, or more than that. So from now on, we have to 
consider the increase of the expenditure so that we survive 
this low birth rate world. Thank you.
    The Chairman. Thank you very much. What you say is 
phenomenally important when we look long-term at programs like 
a Social Security or pension program, and that is the cultural 
changes that go on in a country, social adjustments and changes 
that may not be predictable in the long term as trends develop 
that are substantially different from when these programs were 
initially created.
    Let me turn to one of our colleagues that has joined us, 
Senator Evan Bayh of Indiana. Senator, welcome.

                 STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman. I apologize for 
being a little bit late. As you understand and our witnesses 
may or may not, traffic delays are an occupational risk here in 
Washington, so I am sorry to have missed the testimony, but I 
want to thank you for your appearance, and Mr. Chairman, I want 
to thank you for holding this hearing. It is not often that 
Congress tries to get out in front of the curve and anticipate 
the solution to problems before they have reached the critical 
point. I think the more we can focus our nation's attention 
upon this looming problem, the better off we will be.
    I was looking at some briefing materials. In the year 2018, 
14 years from now, I think--is that right, Mr. Lockhart--the 
system tips over and we begin to pay out more in benefits than 
we take in in revenues. My guess is it is at that moment when 
the crowding-out effect will begin and other programs will 
begin to receive less funding because of the needs to meet our 
entitlement obligations, that this will come in stark relief. 
But if we wait that long, then obviously the potential 
solutions are much more difficult to implement. These actuarial 
problems tend to take on a momentum all of their own.
    So in any event, thank you, gentlemen. Mr. Chairman, thank 
you for calling the hearing. Are we in the question time now, 
Mr. Chairman?
    The Chairman. Please. Go right ahead.
    Senator Bayh. Just a couple things, and Mr. Ohno, please 
don't think I am ignoring you, but I would like to at least 
direct my first couple questions to Mr. Lockhart.
    Is my understanding correct that the magnitude of the 
challenge in Social Security is significant, but Medicare is in 
all likelihood going to be a more sizable problem? Is that 
correct? If we did nothing and just sort of let the situation 
run, we would still have in the out years about 73 percent of 
the money coming in to fund Social Security, so we are looking 
at a 27 percent problem or thereabouts, is that correct?
    Mr. Lockhart. Both are very, very serious problems to the 
American people and both long term. The numbers on Medicare are 
larger, but the numbers on Social Security are still very, very 
large. If you look, for instance, at the shortfall over the 
next 75 years and say, we need that money today, to invest it 
today to cover the benefits that are scheduled for today and 
without increasing taxes, that is $3.7 trillion. That is equal 
to the U.S. debt to the public today.
    Senator Bayh. So it is a $3.7 trillion problem?
    Mr. Lockhart. Over the 75-year period, and as Chairman 
Greenspan says, after the 75-year period, which is an arbitrary 
number, you just fall off the cliff and you keep falling and 
the number grows to the----
    Senator Bayh. Three-point-seven--that is in today's 
dollars?
    Mr. Lockhart. Today's dollars, earning interest, you need 
it.
    Senator Bayh. That is about 27, 25 percent?
    Mr. Lockhart. Well, another way to look at it is----
    Senator Bayh. In other words, if we did nothing, we would 
still have enough money coming in to cover about three-quarters 
of our obligations?
    Mr. Lockhart. That is correct. For instance, if we did 
nothing, no tax increases, no change in benefits, no change in 
investment policy, in 2042 when the trust fund is exhausted, 
the benefits would be cut 27 percent, and then every year 
thereafter, they continue to fall.
    Senator Bayh. Just to make it clear on the record, I am in 
the camp of hoping that we don't do nothing, but I am just 
trying to identify the size of the problem.
    I am also interested, Mr. Chairman, in our use--and we all 
do it, we refer to the trust fund. But am I right in saying, 
Mr. Lockhart, just for the record, there really is no pot of 
money. These are just obligations against the ongoing revenues 
of the government, correct, and so it is money we are taking 
out of either education or health care or other things that we 
would like to do as a society. There is no bank account with 
assets sitting in it.
    Mr. Lockhart. The trust fund consists of special issue 
Treasury bonds that have been issued to Social Security over 
the years in every year in which there has been an excess of 
taxes over benefits paid. In addition, every year, we get new 
Treasury bonds for the interest owed on the trust fund. So, for 
instance, last year, the increase was about $138 billion, but 
over half of that was actually interest. It wasn't even excess 
taxes.
    Senator Bayh. I guess my point is, in 2018 when we tip over 
and we start paying out more in benefits than we take in tax 
revenues, these are not actually--the money is going to have to 
come from somewhere, correct, and there is not some magical 
trust fund sitting there we can just take the money out of and 
say, ``Well, we will plug the gap by doing that.'' We are 
either going to have to raise taxes or cut other parts of the 
budget----
    Mr. Lockhart. That is very correct, Senator. At that point, 
Social Security comes knocking on the door of the Treasury and 
Treasury will have to start paying the interest in cash and/or 
redeeming the bonds. Obviously, where that money comes from is 
increasing taxes, cutting government spending somewhere else, 
or borrowing it somewhere else.
    But it even happens before 2018. Pressure really starts 
about 2008, 2009 when us baby boomers start to retire and----
    Senator Bayh. Believe me, it is going to come as a 
revelation, I think, Mr. Chairman, to folks up here on Capitol 
Hill whenever the date arrives when they say, ``What do you 
mean, we have to appropriate money for Social Security?'' This 
has never happened. We thought there was a trust fund. It is 
going to come as--you mean we have to have less for the other 
things we want? It is going to, I think, be a real eye opener 
for people who haven't followed this problem, probably a shock 
to the system.
    Just a couple of other questions. Our country has 
experienced a renaissance in productivity growth over the last 
few years and it seemed to hang in there pretty well even 
during the most recent economic downturn. I would like to ask 
you, if we are fortunate enough to see--I imagine it will taper 
off, but hopefully will taper off at a higher plateau than was 
the case over the last couple of decades--if we are fortunate 
enough to experience higher productivity growth, can that play 
some role in helping to close this gap or not?
    Mr. Lockhart. Certainly, higher productivity will help. We 
are projecting reasonably high productivity in our 75-year 
numbers. But if it goes beyond that, it will certainly help, 
but it can't solve the problem.
    Senator Bayh. Forgive my ignorance. What are you 
forecasting over the----
    Mr. Lockhart. About 1.6 percent.
    Senator Bayh. You are a brave man to try and forecast 
anything over 75 years.
    Mr. Lockhart. Well, it is not me. It is our independent 
actuaries at Social Security. But the trustees get very 
involved in those discussions. In fact, there have been some 
very significant discussions over the years about productivity 
numbers.
    But if you do sensitivity analysis over productivity, it 
still won't grow your way out of the problem, and the real 
issue goes back to what Chairman Ohno was saying, is that there 
is just not enough population growth. If you have very few 
workers, even if you have relatively high productivity, you are 
not going to be able to pay for all of today's retirees or 
tomorrow's retirees.
    Senator Bayh. So you have factored in some of--forgive me, 
I was thinking you said--what is your average estimate of 
productivity growth?
    Mr. Lockhart. About 1.6 percent, but, I mean, it has been 
higher and it has historically been lower, and we can send you 
some numbers around what that will do to the numbers, but if 
you increased it, you would almost have to get to about a 3-
percent productivity level continually for the 75-year period 
to actually solve this issue and that would be pretty unheard 
of.
    Under the intermediate assumptions of the 2004 Trustees 
Report, the annual change in productivity is assumed to 
decrease from 3.4 percent for 2003 to the ultimate assumed 
level of 1.6 percent by 2012.
    If the assumed ultimate level of annual productivity were 
increased from 1.6 percent to 2.1 percent (an extra 0.5 percent 
increase in the ultimate annual productivity assumption) and 
all other assumptions were equal to those under the 
intermediate assumptions, this would lead to an improvement in 
the financial status of the Social Security program. The 
maximum improvement on the 75-year actuarial deficit is about 
0.5 percent of taxable payroll). The word maximum is used 
because it is assumed that all the extra increase in 
productivity falls through to average real earnings. That is, 
the assumptions for the other linkages to average real earnings 
(hours worked per week, compensation to GDP, etc.) remain as 
assumed under the intermediate assumptions.
    Senator Bayh. Can I just, in knocking this around just in 
my own mind, I didn't anticipate that this would solve the 
problem, but if we are a little on the upside on productivity, 
that can make a contribution to helping hopefully close the 
gap.
    Mr. Lockhart. Yes, I think that is right. Economic growth 
will help us, too. Anything we can do to stimulate economic 
growth will be helpful, as well. Yes, that will close the gap 
somewhat. But the key issue, as you were saying earlier, is if 
we can make these changes earlier, we have a lot of time and we 
can make them smaller and we have a lot of time to have them 
have an impact. Frankly, some of these changes might actually 
increase productivity, I mean, might increase growth of the 
economy, so you would have a dual benefit.
    Senator Bayh. Well, the good news, if there is any, over a 
75-year period, these things go up and down. Mr. Chairman, I 
never cease to be amazed. We try and estimate, as you know, Mr. 
Lockhart, and Mr. Ohno, you may be aware, too, our budget is on 
a 10-year basis. When I was Governor of my State, we had 
biennial budgets. The estimates were never right for 2-year 
periods, let alone 10 or 75 years. So again, I tip my hat to 
you and the actuaries for attempting this.
    But the good news, if there is any, may be, Mr. Chairman, 
it seems to be that the pace of innovation, if anything, is 
accelerating. If you look at our economies--and it ebbs and 
flows over long periods of time, but if you try and anticipate 
what our economy's long-term comparative advantage is going to 
be, it is probably going to be structuring our activities more 
around high innovation, value-added parts of the economy. So 
perhaps if that is true and we can make the most of those 
opportunities, maybe we can bump up that productivity number a 
little bit, not solve the problem, but at least make a modest 
contribution, which leads me to my next question.
    I don't want to hog the microphone here, Mr. Chairman. I 
had a couple of other questions.
    The Chairman. You can proceed.
    Senator Bayh. The GDP price deflator, did you discuss that 
in your testimony?
    Mr. Lockhart. No, I didn't. I think we are assuming a 2.8 
percent inflation rate over the 75-year period.
    Senator Bayh. The annual cost-of-living adjustment, that is 
what I wanted to get to. I gather that on a technical basis, 
some experts feel that that overstates the true rate of 
inflation. If that were to be adjusted to what the technical 
analysts feel is a more accurate number, what kind of 
contribution would that make to solving the problem?
    Mr. Lockhart. Well, I am not an expert on various CPIs with 
all the little letters after them, but it is my understanding 
that it would have, again, a marginally beneficial impact to 
the system. Obviously, there are issues, and as I said to the 
chairman, President Bush has made it clear that he wants to 
protect the benefits of today's retirees and near-retirees.
    Senator Bayh. That is just one item that some people, I 
remember former Senator Moynihan and others had put out there 
to say----
    Mr. Lockhart. Right, and Chairman Greenspan recently----
    Senator Bayh [continuing]. Absolutely nobody wants to 
tinker around, or nobody wants to--it is just a technical 
matter. I mean, is this, the current way it is being 
calculated, is that an accurate expression or----
    Mr. Lockhart. I think there are experts on both sides and I 
am really not an expert, so I will not comment on it.
    Senator Bayh. That never stops people in our positions from 
commenting, but I thank you for your reticence.
    Two more quick questions. It seems to me that the real 
challenge we are trying to arrive at here is how do we--and I 
want to get to the rate of return issue. Is there a way we can 
harvest greater rates of return while still maintaining the 
safety net mechanism? There are different ways to go about 
that.
    Have you looked at all at the experience of some State 
pension funds, where they invest in stocks and other higher 
rate of return instruments, but they do it by, rather than the 
individual accounts--and I am not expressing an opinion one way 
or the other, but they pool their resources, invest them and 
generate a higher rate of return over longer periods of time 
and yet maintain the safety net by guaranteeing a certain 
pension. Have you looked at that option and do you have an 
opinion about that?
    Mr. Lockhart. Certainly, I know that world very well. I 
spent probably a 30-year career in the world of pensions, 
meaning the corporate side and international side, for that 
matter. So I am very familiar with all forms of pensions. 
Certainly, the State systems have some pluses and minuses to 
them.
    I think actually you can--and some of the proposals out 
there are creating a safety net within Social Security but also 
allowing personal accounts to individuals. That way, the 
individual has a little more choice and control of their assets 
and it does give them a nest egg.
    Senator Bayh. Let me follow up on that. How would you go 
about guaranteeing a minimum rate of return, in other words, 
the safety net, within the individual account approach?
    Mr. Lockhart. There are a whole series of different kinds 
of personal account approaches. There are all sorts of bills 
that have been introduced. There was the President's 
commission. I think the key issue is to keep a defined benefit 
portion in any type of reform to have that safety net under 
there that is a defined guarantee, a defined benefit plan, and 
then layer on top of that the personal account--as is done in 
some of the reforms we are looking at. So you have, like many 
corporations do today, a defined benefit plan with a personal 
account, in that case a 401(k) on top of it.
    Senator Bayh. The advantage of that over the State pension 
model in your mind would be----
    Mr. Lockhart. Well, what we are talking about here is much 
more money than any State pension plan has. We are talking 
trillions of dollars, and I think that could lead to some real 
political issues if a government agency owned a major portion 
of many American companies. The CBO, I think probably last June 
or thereabouts, wrote a paper on this and really started to 
talk about some of these issues. What happens if a factory is 
being shut down in someone's district? Wouldn't there be 
pressure on the Social Security trustees to put pressure on 
that company not to do it?
    Senator Bayh. Has that been the experience with State 
pension funds?
    Mr. Lockhart. That is a good question and I really don't 
want to make many comments about State pension plans, but there 
have been some things about social investing and other issues 
in State pension plans. There has been, you know, certainly 
some pressure from time to time. Most of them don't succumb to 
it, but there has certainly been pressure.
    Senator Bayh. My final question has to do with the 
transition costs to a private account system. Have we been able 
to estimate what the transition costs would be?
    Mr. Lockhart. I like to call it a transition investment 
because that is what it really is. It is actually reducing the 
long-term cost by putting some money up a little sooner rather 
than later.
    Various plans have transition investments in the range of, 
again, in today's dollars, present value, what you would need 
today, of $1 to $2 trillion versus that $3.7 trillion I talked 
about earlier. Really, because some of these plans actually 
produce sustainable solvency which means the program is fixed 
forever, if you will, you can compare it to that $10 trillion 
number. So at a cost----
    Senator Bayh. I am sorry, what was the $10 trillion number?
    Mr. Lockhart. The $10 trillion----
    Senator Bayh. That is to fix it forever?
    Mr. Lockhart. Yes, basically----
    Senator Bayh. The $3.7 trillion is for what, 75 years?
    Mr. Lockhart. A 75-year period, but then the 76th year it 
just falls off the cliff again. It is a new number we 
introduced in the Trustees' Report last year and it is really 
trying to look at the very long-term issue. Obviously, those 
numbers, there is variability around them, but it is an 
indication of the potential we might need to fill. If you look 
at the transition investment of $1.5 trillion, that can be very 
small compared to the long-term costs if we don't fix the 
system.
    Senator Bayh. In a private account approach, as I 
understand it, the Social Security recipients of most modest 
means are actually subsidized somewhat, is that correct?
    Mr. Lockhart. Well----
    Senator Bayh. They actually receive more in benefits than 
they paid in? Could you still maintain that----
    Mr. Lockhart. Most of the private account proposals I have 
seen have actually increased the safety net for the lower-
income workers. In fact, they consciously have done that.
    Senator Bayh. So there would still be a subsidy----
    Mr. Lockhart. Well, I wouldn't call it a subsidy because 
everybody contributes to this program. I mean, that is one of 
the great things about Social Security.
    Senator Bayh. But the people at the higher end would be, in 
fact, having some of the money they pay in, as is currently the 
case, go to help people at the lower end.
    Mr. Lockhart. Yes. The people at the lower end get a higher 
replacement rate, get a higher return on their investment.
    Senator Bayh. That is currently the case, isn't it?
    Mr. Lockhart. Yes, and some of the proposals are even 
raising that safety net higher than that, just again to protect 
the longer-working, lower-wage workers.
    Senator Bayh. Good. I am interested in exploring all these 
options and am merely in favor of what works.
    Mr. Chairman, again, I want to thank you. It is refreshing 
for us to take a look at a problem that, gee, 75 years, that is 
not too often we look that far over the horizon. Our children 
and grandchildren will thank us if we do that, and I thank you 
for holding the hearing today, and thank you, gentlemen, for 
your time.
    The Chairman. Senator, thank you for being here and asking 
those questions this morning. It is important that we begin 
this dialog and that the Congress of the United States become 
increasingly aware of the urgency of it in relation to long-
term stability. You and I both know with our experience here 
that we usually tend to wait until the last minute. This is an 
issue in which we cannot wait until the last minute to make 
those changes. Oh, we could, but you and I might not survive 
them politically. It is to our political advantage and to our 
economic advantage and to the advantage of our children and 
grandchildren that we make them long-term and that we get out 
in front of this issue. I think that is good business and good 
politics and that is what we are trying to accomplish.
    Chairman Ohno, thank you very much for coming and sharing 
with us this morning the challenges, and I view them as 
challenges, you have in your country. In many respects, there 
are challenges similar to ours, different countries, different 
cultures, but there are some similarities. As we look across 
the world to other countries that are making these adjustments, 
yours will be one that we will watch very closely. So we thank 
you for being with us this morning.
    Mr. Ohno. Mr. Chairman.
    The Chairman. Yes?
    Mr. Ohno. Could I say something?
    The Chairman. Please.
    Mr. Ohno. In my opinion, the pension reform should be 
considered not only from the viewpoint of the level of 
contributions and benefits, but also from a viewpoint of macro 
economy, corporate profitability, fiscal stability, working and 
lifestyle. Everything should be taken into account when we 
consider the pension reform. Thank you very much.
    The Chairman. Thank you very much. Commissioner, thank you 
for being with us this morning.
    Mr. Lockhart. Thank you, Mr. Chairman.
    The Chairman. We will ask you to step down and we will 
introduce our next and last panel.
    While they are coming, I was visiting with the Commissioner 
earlier this morning and I will never forget, oh, a year ago, I 
guess, we had Alan Greenspan before us and we were questioning 
him then, you and I, and others were contemplating how we 
adjust Medicare, get prescription drugs into it, and I asked 
the question, in measurements of difficulty, how much more 
difficult is it, one over the other, to make the reform.
    I think the Chairman was very clear in saying, oh, Social 
Security just takes political will. It is relatively easy to 
fix because you are dealing with predictable numbers that you 
can control and manage, whereas with Medicare or health care, 
you are dealing with a very dynamic economy. He said, one major 
change in health care delivery and/or a breakthrough in science 
could throw all of your actuarials or all of your variables off 
by a considerable amount simply by cost factors.
    I had not thought of it in that context. I looked at them 
as trust funds and social programs and benefit relationships, 
but not with the idea of how they apply to the dynamics of a 
set number versus a non-set number.
    Senator Bayh. All of that is true. If history is any guide, 
my guess is it would throw them off on the up side, not on the 
down side.
    The Chairman. Oh, very much so. Very much so.
    Let me introduce our next panel. We have with us this 
morning Vincent Truglia, managing director of the Sovereign 
Risk Unit at Moody's Investor Services. We also have with us 
Axel Boersch-Supan, director, Institute of Economic Research, 
University of Mannheim in Germany; David Harris, director of 
Watson Wyatt Worldwide in London; and Jacobo Rodriguez, 
financial services analyst at the Cato Institute.
    Mr. Truglia, we will turn to you first for your testimony.

 STATEMENT OF VINCENT J. TRUGLIA, MANAGING DIRECTOR, SOVEREIGN 
       RISK UNIT, MOODY'S INVESTORS SERVICE, NEW YORK, NY

    Mr. Truglia. Thank you very much, Mr. Chairman. Let me 
first start by pointing out that my perspective in this is 
looking at pensions and health care benefits truly from a 
credit risk point of view. There are obviously many other 
different perspectives you could have, but it does produce a 
somewhat different view than other perspectives.
    Given that, it is our expectation that every industrialized 
nation will, ``default'' on its pension and health care claims, 
and what do I mean by that? A default simply means that you 
don't meet the terms of the original contract, and in this 
case, if a government did that on a bond obligation, that would 
simply be considered a financial default. But simply changing 
the rules on pension and health care reforms also represents 
the equivalent of a default.
    The only reason society seems to care less about a default 
on a pension or health care claim is that it is a societal 
convention. We just happen to place greater importance on a 
contract if it happens to be a truly financial obligation.
    If we take a look around the world, and we have looked at 
lots of different countries and we have taken a look at endless 
estimates of their net present value of their pension 
obligations, it becomes pretty clear that, as I mentioned, 
every country will have to change its pension and health care 
claims. When we start looking at the individual analysis, what 
you have to start with as a credit analyst is the amount of 
debt outstanding.
    I have on this table here, and it just is trying to look at 
the major industrialized countries and put them into small 
groups, you have the U.S. and France and Germany and the U.K. 
approximately at the same area. The mean for AAA and AA rated 
countries of debt to GDP is about 58 percent and the median 56 
percent. The U.S. has a slightly higher debt-to-GDP ratio than 
others and so we are probably in the middle range. But every 
country on this list cannot afford to suddenly add the 
equivalent of $3.5 trillion or $5 trillion worth of debt to the 
overall total.
    Now, this is one measure of what countries look like, and 
you can see, given the earlier presentation, that there are two 
outliers. One is Italy, but the other one is really Japan and 
Japan is really in a class all by itself, starting out with a 
ratio of 170 percent of government debt to GDP at this time.
    There is another ratio, however, that probably gives you a 
better idea of how much governments can actually afford given 
their existing levels of debt and that is to take a look at the 
general government debt-to-revenue ratio. Here, you can see the 
U.S. is significantly worse than certainly the mean or the 
median and especially for most continental European countries, 
and the reason for that is that we have a smaller government. 
We take less revenue in, in general. You can see Italy doesn't 
look that much worse than the U.S. simply because the Italian 
government is so large and takes so much revenue relative to 
GDP.
    Once again, though, the outlier is here Japan, and this is 
unprecedented for an industrialized country. Their existing 
debt is already over five times their total revenue. Now, what 
you see here is that the Japanese, because of their economic 
situation for the last 10 years, have not been able to raise 
revenues, and that is why it is going to be fascinating to see 
what actually happens when they start to increase these pension 
contributions, which as you know is the same as a tax, what 
happens to the economy when you do that. They have been very 
reluctant to do that and they have been financing all their 
deficits, very large deficits, through debt creation.
    Now, the question is, how much can you do of that? What is 
the upper limit? Well, if you look historically, when 
governments in the pre-World War II period, where we actually 
had defaults, when they reached about 170 to 180 percent of 
national income, that put great stress on financial systems.
    The problem we have today, even though Japan is already 
there, is that when you make a comparison with those earlier 
periods, you also had countries functioning under a gold 
standard and we think that that actually has created greater 
limitations because you had balance of payments considerations 
and constraints much sooner then than you would have today. So 
we think that countries can probably absorb more debt than they 
did under that old system.
    But when looking at the individual pension and especially 
the health care estimates, we obviously have to use net present 
values and I think the Senator alluded to some of the problems 
regarding actuarial calculations for pensions in general. But 
when you look at these net present value estimates, they are 
through the roof in most instances.
    But I remember in the 1990's when the Italians reforming 
their pension system under the Dini reforms, all of a sudden, 
the Italian net present value of their pension reform, which 
was rather modest--in the long run, it wasn't important, but 
over the next few decades it was very modest--and suddenly the 
net present value declined by 200 percent of GDP. Well, the 
lesson we learned there is ignore these numbers. They are just 
too susceptible to dramatic shifts in the final outcome.
    When looking at what will happen to governments, and again 
rating governments, what we are very careful about is the what 
we consider intergenerational resource allocation, and we think 
that sometimes people misuse that concept. From our point of 
view, there can never be an intergenerational resource transfer 
from the present, or from the future to the present or the 
present to the future. All you ever have is an 
intergenerational transfer in the present. All fiscal problems 
are always in the present. So we are actually optimistic in 
that as long as you expect industrialized democracies to act 
reasonably at every point in time, then you don't get a default 
on the government debt.
    Now, does that mean that we don't have a problem? No, it 
doesn't, because fundamentally, the problem is not fiscal. 
Fundamentally, the problem is standards of living in the future 
and all you have to then do is what is going to create the 
highest standard of living going forward. So any pension reform 
that has a negative effect on increasing standards of living 
over time are probably a negative.
    What do we think is going to happen over the next 50 years? 
One is I guarantee you that the forecast for the birth rate 
decline will not happen because the incentives as population 
shrinks to have children in all likelihood will rise.
    Two, one of the biggest changes we have seen in the last 50 
years is the decline in working by older people. Again, an 
extreme example is the Italians after World War II. About 50 
percent were still in the workforce above 65 years old. Today, 
it is down to 4.5 percent. For the industrialized world, we 
were at, at that time, slightly under one-fourth of all people 
over 65 were still working. Today, we are down to 9 percent.
    So I think what is going to happen, and we are already 
seeing the beginnings of it, is the normal economic incentives 
are going to occur for people to work a longer period of time. 
There will be a change in the nature of their occupation, 
perhaps. But that is what is probably going to occur.
    Then the final thing that is going to probably happen is 
that we are going to have and have to maintain more 
immigration, but that is temporary because as you know so well 
and have seen all the studies, the whole world is aging. So 
Mexico will have the same age distribution we have today and 
China, in fact, will be older than we are today. So what they 
are going to have to do is the same thing we are going to have 
to do, is figure out how do we produce more income in the 
future so when you are fighting over resource allocation in the 
future and income distribution in the future, that the 
discussions will be more civil than they otherwise would be.
    Thank you, Mr. Chairman.
    The Chairman. Thank you for that overview. I think all of 
that fascinates us as we move down this road.
    [The prepared statement of Mr. Truglia follows:]

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    The Chairman. Let me turn to you, director Boersch-Supan. 
Please proceed.

  STATEMENT OF AXEL BOERSCH-SUPAN, THE INSTITUTE FOR ECONOMIC 
      RESEARCH, UNIVERSITY OF MANNHEIM, MANNHEIM, GERMANY

    Mr. Boersch-Supan. Thank you, Mr. Chairman, for having me 
here. Just picking up on what you said before, it is actually 
already the last minute to do reforms, essentially because 
reforms----
    The Chairman. Thank you for saying that. I think it is, 
too.
    Mr. Boersch-Supan. Reforms take a while, and you have got a 
problem in 2018. In any case, in the grand scheme of things, 
Germany and the United States have very similar pension 
systems, so there are a lot of lessons which can be drawn on 
either side.
    Social Security is still the most dominant income source 
for most of the elderly. It is financed pay-as-you-go. It is 
earnings related. The big differences are, and that is a little 
bit strange if you think of European programs, the German 
system redistributes less than the American system. The other 
thing is the German system is very generous, much more generous 
on average. Replacement rates are 70 percent rather than about 
50 percent.
    The reform pressures also in Germany are much higher, and 
that is mainly due to a lower birth rate in Germany and to a 
somewhat higher life expectancy than the United States. 
Actually, we had a picture here which shows that the ratio of 
workers to retirees in Germany right now is what the United 
States will have in 2050. So look at Germany now and you will 
see what the United States will look like in 50 years, 45 
years.
    Because of the reform pressure, we had a string of recent 
reforms in Germany. The main reform process started in 2001, 4 
years ago, 3 years ago, and that was a two-pronged approach. 
One was to scale down pay-as-you-go benefits. That is what you 
call default. The second was to increase occupational and 
personal pensions.
    That reform more or less failed for two reasons, because 
the benefit cuts were not transparent and they were very 
unpopular, but nobody understood how they actually worked. The 
second and third pillar pensions, occupational and private 
pensions, are highly overregulated. So there was little 
acceptance. These were voluntary pensions and nobody took them 
up.
    That required another reform fairly soon after. In 2004, 
actually, it just went through the Bundestag in March, it 
deregulated the second and third pillar pensions so the uptake, 
it will be hoped, will be higher. But the crucial step, and 
that is a real important step, was to index benefits to the 
financial basis of the system. So the benefits are now indexed 
to what we call the system dependency ratio. That is the number 
of workers per the number of beneficiaries. This automatically 
creates solvency in the system by reducing, according to the 
financial basis, the benefits. It is a brutal way, but it works 
for sure just because you index to what you can pay.
    So Germany essentially converted the current defined 
benefit system in a notional defined contribution system. It is 
the contributions which define what can be paid to the 
pensioners.
    This will lead to a reduction in the replacement rate from 
about 70 percent now to 60 percent in 25 years, in 2030. So it 
is about a 15 percent benefit cut. That is not as hard as----
    The Chairman. Fifteen percent?
    Mr. Boersch-Supan. Fifteen, yes. So it is not the 27 
percent you were talking earlier, but still is substantial.
    The system is self-stabilizing by this very construction. 
That is, if there is higher than expected fertility, for 
example, or labor force participation, then these benefit cuts 
will be milder than currently expected. On the other hand, if 
life expectancy increases even faster than we used, to think 
then benefits will automatically go down by that proportion.
    So I think there are four main lessons which we have 
learned, which one can learn from the German reforms. First, 
indexation to the system dependency ratio is politically 
feasible. It went, although with a lot of talking, through the 
Bundestag.
    Second, the mechanics of what we call the sustainability 
factor, that is this indexing mechanism, is relatively easy to 
communicate to the public, and that was one reason why this 
reform actually went through.
    Third, the sustainability factor provides an automatic 
budget stabilization feature. I think that is really important 
for having solvency in the long run.
    The fourth one is the resulting pension gap, this 15 
percent, which is not little, but it can actually be filled by 
personal pension accounts and that is what the government is 
now pushing by using tax privileges.
    Thank you, Mr. Chairman.
    The Chairman. Thank you very much and we appreciate that 
testimony.
    [The prepared statement of Mr. Boersch-Supan follows:]

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    The Chairman. Now let me turn to David Harris, director of 
Watson Wyatt Worldwide in London. David, welcome to the 
committee.

 STATEMENT OF DAVID O. HARRIS, SENIOR CONSULTANT, WATSON WYATT 
                   WORLDWIDE, LONDON, ENGLAND

    Mr. Harris. Mr. Chairman, thank you and committee members. 
I am pleased to appear before the Senate Aging Committee to 
discuss Social Security reform experiences in Australia and the 
United Kingdom. Equally, as a former resident of this good 
country, I am also a member of Social Security, so I have got a 
personal vested interest, if you like.
    The Chairman. I am glad for that disclosure. Thank you. 
[Laughter.]
    Mr. Harris. All right.
    The Chairman. Now we will understand all your bias. Please 
proceed.
    Mr. Harris. For many countries, the need for Social 
Security reform is becoming more pressing as populations 
rapidly age. Moreover, through generous promises linked with 
Social Security programs in many developed nations, chronic 
economic and social reforms will likely have to be implemented 
against the backdrop of either cutting benefits or increasing 
associated contributions, and indeed, difficult political 
situation to confront.
    The ongoing relative success of Australia and the United 
Kingdom's retirement model is a clear proof that successful 
pension reforms can be achieved in developed nations that 
benefit the entire nation as a whole. I think it is important 
to point here that women, minority groups, and blue-collar 
workers have been seeing significant benefits flow to them in 
having the ability now to efficiently craft out their own 
retirement savings.
    It is important also to note, simply put, that the 
countries like Australia and the United Kingdom have moved 
toward encouraging individuals, especially lower-income groups 
and women, to save on an individual retirement basis, so 
offsetting the economic impacts of rapid aging.
    I will just move to some of the important points or 
features of both systems. The old age pension in Australia is 
seen by many as providing both a foundation or a bedrock of our 
retirement system. It is non-contributory and largely is drawn 
out of taxation. The view by most Australians is if you work 
for 40 or so years, you are entitled to an old-age pension, and 
that was shared by my mother and my late father.
    But the important point here to note is that Australia in 
the 1980's recognized, like the United States, that through 
aging populations and fiscal constraints, new ways or new 
measures needed to be executed, if you like, to ensure that 
retirement savings were stimulated.
    It is important to note in 1983 that only 40 percent of the 
workforce was covered by some form of second pillar pension and 
that in total asset terms, Australia had roughly 32 billion 
Australian dollars. Today, Australia has 88 percent of its 
workforce covered by a mandatory second pillar retirement 
system with 568 billion Australian dollars in assets. It is 
interesting to note that 80 percent of our assets in second 
pillar are invested abroad, largely in the United States, which 
is an important point.
    How did Australia move toward individual funding in the 
second pillar? There was a general recognition that something 
had to be done certainly in the first pillar with regard to its 
fiscal constraints. The Australian old-age pension only 
provides 26 percent of male total average weekly earnings as a 
benefit.
    In 1992 to 1993, the then-Labor government, supported by 
trade unions--and that is an important point--supported the 
notion of individual retirement accounts, a stark contrast to 
this country. What happened thus far is that Australia has 
implemented a retirement system that is predicated on the basis 
of 9 percent of every employee's salary being committed to an 
individual retirement account.
    It is important to note, Mr. Chairman, that on average 
also, Australians contribute up to 3 percent on a voluntary 
basis to individual retirement accounts in the second pillar.
    So today, Australia has moved from, if you like, reliant on 
a pay-as-you-go non-earmarked first pillar system to an 
enriched compulsory environment where it argues that 
individuals should pay significant amounts into their 
retirement future.
    It is important also to note, and I would leave you with 
this thought, if we are talking about taxation of pensions, was 
to tell you that taxation of superannuation in Australia can be 
described as TTT. In Australia, we tax the contributions. We 
tax the income coming out of the fund. We tax the fund flows 
coming from the fund itself, TTT, quite a significant amount, 
and for a politician, an interesting trick if you can perform 
that and then you can get elected with a successful majority 
the next year, which was cleverly done.
    Moving now toward our former colonial masters, if you like, 
the United Kingdom, where I am proudly a resident now of, the 
United Kingdom has underlying a first pillar pension predicated 
on the basis of a very major first pillar pension, that is, 20 
percent of average male total work earnings or male full-time 
working earnings equals the first pillar pension.
    To put it in real terms, the first pillar pension in the 
United States equates to 79.60 pounds per week. A round fare, I 
can assure you, return to Edinburgh is 84 pounds a week. So it 
is very, very, very meager in terms of amount in the first 
pillar. This has been uplifted or increased by pension credits 
or improvements to this first pillar.
    But what is important to note with regard to the United 
Kingdom is in the 1980's and 1990's, there was very much a 
fundamental shift, partly sponsored by the then-Thatcher 
government and later Major government, to ensure that 
individuals move toward more fully funded or more, if you look, 
took great responsibility in their retirement savings.
    This notion of the individual taking or crafting out their 
own retirement savings is being picked up, if you like, by the 
mantra of the Blair government, and in April 2001, they moved 
toward what was called stakeholder pension, where individuals 
who are now entitled to a low-cost, very efficient, if you 
like, pension product largely driven on an individual basis. 
This product, called the stakeholder pension product, has only 
a maximum price cap of one percent. No further charges above 
that can be levied. Importantly now, the Blair government is 
enacting more significant reforms to their broader-based 
pension saving.
    It will be interesting to note, and just finally 
concluding, which is most startling is that the pension reform 
approach now being adopted by the Blair government is 
predicated on the U.S. experience. Like the PBGC in the U.S., 
which the current United Kingdom government believes is a 
success, a pension protection fund will now be enacted in the 
United Kingdom to cover shortfalls in existing defined benefit 
schemes.
    Importantly, critics like Mike Crick and Chris Mapp of the 
Investment and Life Insurance Pension Committee suggested 
regulatory complexity still dogs the United Kingdom pension 
system. So overall, where the United Kingdom's retirement model 
is moving, Mr. Chairman, to one of sustainability and with the 
individual taking greater control in regard to their 
retirement.
    Just finally, I would leave you with my conclusions. In the 
United States, the challenge of Social Security reform might 
seem immense, if not impossible, from initial observations. Yet 
what countries like Australia and the United Kingdom 
demonstrate is the ability for a nation to give its people a 
greater ability to craft out a sufficient and appropriate level 
of retirement wealth to meet expected future needs and demands.
    Certainly no one country's experiences with regard to 
Social Security reform can be easily translated to another. Yet 
what countries like Australia and the U.K. can demonstrate to 
public policy planners in the United States is the strong 
propensity that the individual is ideally placed to determine 
his or her own retirement needs and assess market risk, which 
is a very important point to make.
    Give people certainty with regard to retirement or Social 
Security is an important basis to the two models I have 
described. This harnessing of the individual's need to maintain 
retirement security in retirement will increasingly become a 
major political and social issue, not only in the United States 
but equally continue on in Australia and the U.K.
    Ideally, Social Security reform should encompass all 
perspectives of a country's society. Failure to act or to 
simply adopt a myopic position by lawmakers is no answer in the 
long term for the citizens in a nation like the United States. 
Thank you.
    The Chairman. David, thank you very much.
    [The prepared statement of Mr. Harris follows:]

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    The Chairman. Now to our last panelist, Mr. Rodriguez, 
service analyst for the Cato Institute. We are pleased to have 
you with us this morning. Please proceed.

 STATEMENT OF L. JACOBO RODRIGUEZ, FINANCIAL SERVICES ANALYST, 
               THE CATO INSTITUTE, WASHINGTON, DC

    Mr. Rodriguez. I am pleased to be here. Thank you, Mr. 
Chairman, for your invitation to appear before this committee. 
In my remarks today, I will focus on the pioneering effort of 
Chile because that effort remains still to this day the 
standard against which other pension reforms in Latin America 
are and should be measured.
    Indeed, if there is a main lesson to be drawn from the 
collective experiences of Latin American countries, it is that 
not all reforms are created equal. Some Latin American 
countries have introduced important flaws in the design of 
their private pension systems that have limited the success and 
popularity of those systems.
    In 1981, Chile replaced its bankrupt Social Security system 
with a fully funded system of individual retirement accounts 
managed by the private sector. That revolutionary reform 
defused the fiscal time bomb that is ticking in other countries 
with pay-as-you-go systems under which fewer and fewer workers 
have to support the retirement benefits of more and more 
retirees. More important, Chile created a system that, by 
giving workers clearly defined property rights in their 
contributions, offers proper work and investment incentives, 
and acts as an engine of, not an impediment to, economic 
growth.
    Since the Chilean system was implemented, labor force 
participation, pension fund assets, and benefits have all 
grown. Today, more than 95 percent of Chilean workers have 
joined the system. The pension funds have accumulated over $50 
billion in assets, an amount that is equivalent to about 67 
percent of Chilean gross domestic product. The average real 
rate of return has been over 10 percent per year.
    The system's popularity with workers has turned it into the 
third rail of Chilean politics, one that politicians by and 
large have not dared touch. Of course, there have been 
regulatory improvements and updates, but those have been 
carried out by a highly technical and independent agency that 
regulates and supervises the system and its participants.
    Abroad, if imitation is the sincerest form of flattery, the 
Chilean system should be blushing from the accolades it has 
received. Since 1993, ten other Latin American nations have 
implemented pension reforms modeled after Chile's. In short, 
the Chilean system has clearly become the point of reference 
for countries interested in finding an enduring solution to the 
problem of paying for their retirement benefits of aging 
populations.
    The basic story is well known, but it is worth recapping 
briefly. Every month, workers deposit 10 percent of their 
income in their own individual pension savings accounts, which 
are managed by the specialized pension fund administration 
company of their choice. These companies invest workers' 
savings in a portfolio of bonds and stocks, subject to 
government regulations on the specific type of investments and 
the overall mix of the portfolio.
    Contrary to a common misperception, there is no obligation 
to buy government securities, a requirement that would not be 
consistent with the notion of privatization, and the pension 
funds can invest up to 30 percent of the portfolio overseas, a 
measure that allows workers to hedge against currency and 
country risk.
    Workers who want to retire early or with a higher pension 
can contribute up to an additional 10 percent of their wages. 
The pension fund companies are required to take out life and 
disability insurance on behalf of their clients and to provide 
them with statements of account at least every 4 months.
    At retirement, workers can use the funds accumulated in 
their accounts to purchase annuities from an insurance company, 
or alternatively, they can make programmed withdrawals from 
their accounts. The amount of those withdrawals depends on the 
worker's life expectancy and those of his dependents.
    The government provides a safety net for those workers who 
at retirement do not have enough funds accumulated in their 
accounts to obtain a minimum pension. But because the new 
system is much more efficient than the old one and because 
under the new system, a worker must have at least 20 years of 
contributions to qualify for the minimum pension, the cost to 
the taxpayer of providing the minimum pension has been so far 
negligible.
    Through their pension accounts, Chilean workers have become 
the owners of the means of production in Chile and they have 
grown much more attached to the market economy and to a free 
society. This has had the effect of reducing class conflicts, 
which in turn has promoted political stability and helped 
depoliticize the Chilean economy, which is an important factor 
to consider in the context of Latin American societies.
    Pensions today do not depend on the government's ability to 
tax future generations of workers nor are they a source of 
election-time demagoguery. To the contrary, pensions depend on 
the workers' own efforts and, thereby, afford workers 
satisfaction and dignity.
    The Chilean system, of course, is not perfect and has some 
shortcomings. Critics often point to high administrative costs, 
the lack of portfolio choice, and the high number of transfers 
from one fund to another as evidence that the system is 
inherently flawed and inappropriate for the United States.
    Chilean authorities have taken some important steps to 
improve an already good system. The most important structural 
reform of the last three or four years is the introduction of 
multiple investment funds. After the year 2000, the pension 
fund administration companies could only manage one fund. In 
early 2002, the regulatory agency that supervised the system 
instituted a rule that mandated the pension fund administration 
companies to offer five different funds, funds that range from 
very low risk to high risk.
    This adjustment allows workers to make prudent changes to 
the risk profile of their portfolios as they get older. For 
instance, they could invest all the mandatory savings in a low-
risk fund and any voluntary savings in a riskier fund, or they 
could invest in a higher-risk fund in their early working years 
and then transfer their savings to a more conservative fund as 
they approach retirement.
    This reform has been an important step and there are 
indications that consumers are behaving as one would expect; 
that is, by diversifying their investments across the menu of 
funds. There are other steps which are described in my written 
testimony that Chilean regulators have taken or should take to 
ensure the continued success of the private pension system. 
These adjustments should be consistent with the spirit of the 
reform, which has been to adopt a more liberalized regulatory 
structure as the system has matured and as the fund managers 
have gained experience.
    But all the ingredients for the system's success--
individual choice, clearly defined property rights and 
contribution, private administration of accounts, and a strong 
and independent supervisor--have been present since 1981. Some 
shortcomings remain, to be sure, but the Chilean model still 
provides an excellent example to those countries, 
industrialized and developing alike, that are thinking about 
their retirement systems.
    I thank you, Mr. Chairman, for the opportunity you have 
given me today and I look forward to your questions.
    The Chairman. Thank you all very much.
    [The prepared statement of Mr. Rodriguez follows:]

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    The Chairman. No matter which country it is, the challenge 
is one of substantial magnitude, and for those of us who are 
the shapers of public policy, I will also say it has a 
political challenge to it. But there appears to be a common 
theme as adjustments and changes in these pension or Social 
Security systems go forward. Is it fair to say that common 
theme is a growing increase--or let me put it this way--a 
growing belief that individuals ought to be more responsible 
for their retirement than they were in the past? That would be 
a question to all of you. Therefore, government incentifies 
that responsibility?
    Mr. Truglia. Around the world, we have found that there has 
been less willingness on the part of societies to socialize 
risk, so yes, it is almost across the world that we are calling 
upon people to be more responsible than they were in the past.
    Mr. Boersch-Supan. Well, I think the most important insight 
is that there are no miraculous solutions. Babies are nice. 
They stabilize the system in the long run. But they are 
definitely no substitute for pension reform in the short run. 
In the short run, I mean the next 30 years. Actually, in the 
short run, the next 30 years, it would make things more 
expensive.
    Productivity, as your colleague Senator says, is also no 
solution, because as long as you pay, like in the United 
States, pensions in proportion to wages, pensions go up just as 
much as wages go. So productivity cannot finance pensions.
    Fully prefunding, so fully making everybody responsible for 
himself, is not an option anymore. That had been an option in 
the 1980's, but the baby boom generation actually retires in 15 
to 20 years. So a full transition is just not feasible anymore.
    Given all these constraints, the only logical solution is 
to cut Social Security, the public pension pillar, somewhat, as 
much as you can afford politically, and offset that by 
prefunded pensions. You will see this solution necessarily in 
all the countries across the world, and I am sure we will also 
see it in the United States.
    Mr. Harris. Mr. Chairman, I agree with the thoughts here. I 
think taking control for the individual of guiding or crafting 
out their own retirement savings and future is very much 
ingrained, very much in the Australian and the U.K. model. I 
think it is important to also stress an underlying premise, is 
that of political risk. Both countries, both Australia and the 
United Kingdom, have witnessed a significant shift or movement 
away from the underlying predication of the regional Social 
Security models, i.e., it was basically if you worked in 
Australia for 40 years, you would get an old-age pension. Now, 
there is a very stringent income and assets test. Equally, in 
the United Kingdom, the old-age pension in the first pillar 
used to be indexed to average wages rather than prices.
    So I think, importantly, what you are seeing in both 
countries, and certainly they have certainly less generous 
first pillar pension arrangements than, say, Germany, is that 
the individual is being provided with the tools to craft out 
their own retirement needs more effectively, and this links 
very much into the principle or concept of market-based risk 
and allowing the individuals to be empowered to, if you like, 
determine their own retirement destiny.
    The Chairman. Mr. Rodriguez.
    Mr. Rodriguez. I think I would answer your question in the 
affirmative. I think that there has been a trend toward greater 
reliance on individuals and on their ability to manage risk, 
and I think that when given the proper incentives, individuals 
have shown that they are quite adept at managing their own risk 
and making wise and informed decisions about how to allocate 
their own resources between present and future consumption.
    The Chairman. When the Chilean model is looked at and 
juxtaposed against our system, one of the criticisms is the 
transitional costs to get us from where we are today 
progressively toward a personal retirement account. Would you 
discuss with us those costs and how they affected Chile or the 
Chilean programs as you transitioned out of and into where you 
are today?
    Mr. Rodriguez. Let me give you a little bit of background 
before I answer that question directly. When Chile was 
considering this reform, the ratio of workers to retiree had 
decreased to 2.2. In the United States, I think it is about 
three today, or a little bit over three. The implicit debt of 
the system was estimated about 80 percent of GDP.
    My colleague, Jagadeesh Gokhale, who testified before this 
committee earlier this year, has estimated that the implicit 
debt of the United States system is about $7 trillion. So that 
figure would be a little bit less as a percentage of GDP than 
what it was in Chile.
    There were three rules for the transition that were set up. 
The first rule was respect your promises. That is, to those 
people who were already retired, their pension benefits as 
promised were guaranteed.
    The second rule was to those workers who are already in the 
labor force, they were given the choice of moving to the new 
system or staying in the old system under the rules of the game 
that had been established when the new system was implemented.
    The third rule of the transition was to new workers, they 
had to go. Because the old pay-as-you-go system, wasn't 
sustainable, they had to go to the fully funded private system.
    The Chilean government used five different methods to 
finance the transition. The first method was to recognize part 
of the implicit debt, to recognize it explicitly by issuing 
recognition bonds. One thing that I did not mention was that 
those workers who decided to move from the old system to the 
new system were given a recognition bond that recognized the 
contributions that they had made into the old system. That way, 
they did not have to start under the new system with a zero 
balance in their accounts. So the Chilean government recognized 
part of the implicit debt, about half of it, by issuing 
recognition bonds. That was the first method.
    The second method was there was a difference between what 
they had to contribute under the new system and what they had 
to contribute in payroll taxes under the old system. Under the 
old system, it was about 20 percent of wages. Under the new 
system, it was 10 percent plus the administration cost and the 
life and disability insurance premiums. So the total 
contribution under the new system was about 13 percent of 
wages. Under the old system, it was 20 percent of wages.
    The Chairman. The new system is what?
    Mr. Rodriguez. Thirteen percent.
    The Chairman. Thirteen?
    Mr. Rodriguez. Ten percent that went into the account, and 
then initially, the administration costs were about 3 percent 
of wages, and that included the life and disability insurance. 
Today, those costs have come down to about 2.3 percent of 
wages.
    So there was a difference there of 7 percentage points. 
What the Chilean government did was to maintain that difference 
as a temporary tax on the transition. That tax has decreased 
gradually over the years, and today, that tax is zero so that 
the payroll tax in Chile is zero. That was the second method.
    The third method was to privatize state-owned enterprises 
and other state-owned resources and use the proceeds from those 
privatizations to fund the transition.
    The fourth method was to cut government spending at all 
levels, and this was a sustained effort that had to be 
maintained over a number of years. It is still being 
maintained.
    Finally, the reform, plus other reforms, have improved the 
functioning of the economy, which has led to an increase in the 
rate of economic growth and the increase in the rate of 
economic growth has led to an increase in general tax revenues, 
especially those coming from the value-added tax.
    So those are the five different methods that the Chilean 
authorities used, and their situation that I think was more 
drastic than the situation the United States faces today, yet 
they were able to accomplish the transition to a fully funded 
system.
    The Chairman. I thank you for that, because I knew that it 
was a significant change and I know that it wasn't just the 
system itself that was changed. It was literally government 
reform somewhat across the board. That, of course, is 
significant. What are the participation rates today?
    Mr. Rodriguez. When we talk about participation rates, we 
have to be careful about what we are talking. If you take the 
number of Chilean workers who have a private pension account, 
that is over 100 percent of the labor force because there are 
workers who may have been in the labor force before, especially 
young workers and women, who have come out of the labor force. 
Of course, these workers still have a pension account and 
whatever balance is in their accounts is theirs and that money 
is still earning interest.
    If we talk about the people who contribute on a regular 
basis, the number is lower. It is about 60 percent of the 
people who have a pension account.
    Then if we are talking about as a percentage of the total 
number of account holders, the number is still a little bit 
lower because there are people who come in and out of the labor 
force or of the formal sector of the economy and there are 
people who may become salaried workers at one point in their 
lives and then become independent workers. This reform was only 
mandatory, as the old system was only mandatory, for salaried 
workers, not for independent workers or members of the 
military.
    But the participation rates are similar to participation 
rates under the old system overall. Of course, to the extent 
that participation rates are low, they have more to do with the 
structure of the labor market that may encourage some workers 
to leave the formal sector of the economy and go into the 
informal sector of the economy and not so much with the 
structure of the system, which I think provides the right 
incentives to save.
    Let me add that participation rates in Chile are higher 
than in other Latin American countries, and the size of the 
informal sector in Chile, because it has a better functioning 
economy, is much smaller than in other Latin American 
countries.
    The Chairman. Thank you. Axel, the main innovation of the 
reforms that you were talking about in part was the 
introduction of a tax-favored individual account similar to our 
IRAs. Why do you think the take-up on the IRAs has not been as 
high in Germany over the past few years as it was in the United 
States, let us say in the 1980's?
    Mr. Boersch-Supan. Well, two, actually three points. Also 
in the United States, as much as I remember, it took quite a 
while until IRAs were really sort of a broad financing 
instrument----
    The Chairman. Then it became so popular we had to reduce 
it.
    Mr. Boersch-Supan. Right. But that took about six, 7 years. 
Now, we introduced in Germany these accounts in 2001, so it is 
not even half the time.
    The Chairman. Well, then that wouldn't be a fair 
comparison.
    Mr. Boersch-Supan. So one may want to be patient here. The 
other thing is----
    The Chairman. What is your reaction to the current----
    Mr. Boersch-Supan [continuing]. They are highly regulated, 
and I think that is the big problem, and they are regulated 
both on the buyer's side, so everything has to be annuitized. 
The payouts have to be paid out as an annuity, so they are not 
bequeathable, for example, or they cannot be used to pay down a 
house, for example. That restricts the popularity quite a bit.
    On the seller's side, there are quite a few restrictions. 
For example, the commission if you sell a policy of this sort 
was heavily backloaded, and that is obviously what the sellers 
don't like. They want frontloaded schemes.
    The Chairman. Sure.
    Mr. Boersch-Supan. So these were two restrictions. So the 
buyers didn't really like the product and the sellers didn't 
like the product, either.
    I think the third point, and that comes back to what you 
said earlier about information, people pick up, I think, the 
second and the third pillar if they realize that the first 
pillar is going to be decreased.
    The Chairman. Yes.
    Mr. Boersch-Supan. In the case of Germany, the first pillar 
would shrink to about two-thirds of its current size. That is a 
large amount of shrinkage and that has to be communicated to 
the public and that is a real hard job. We do this in a little 
bit similar to the way you do it in the United States. Social 
Security sends out these little sort of statements. But these 
statements do not really communicate what will happen in 30 
years. They don't give the signal, well: ``You get much less 
than the current generation does.'' Very often, the numbers are 
actually expressed in nominal dollars or Euros. Well, people 
can't handle these numbers.
    So it has got to be a quite clear message: ``You won't get 
what your parents currently do.'' That is something no Social 
Security administration likes, neither in Germany nor in the 
United States.
    One of my toughest jobs as the Chairman of the German 
Reform Commission was to communicate these things and try to 
push those changes through, because it is obvious that if you 
force people to realize that Social Security won't be as it 
was, that does not go well with your constituency. But you have 
to do it anyway because otherwise the uptake of the second and 
third pillar won't work. So you are caught between two hard 
places here.
    Mr. Truglia. Might I make----
    The Chairman. Yes.
    Mr. Truglia [continuing]. One observation about the various 
reforms that were discussed here, and I think it is important 
looking at them as to how they occurred.
    The Chairman. In answering this question, would you also 
put it in this context, not only what you plan to say, but you 
were here and listened to the representative of the Japanese 
Diet and the reforms they are making. Bring that into it, if 
you would, because I am a bit frustrated by the reforms they 
are talking about as it relates to where that country goes in 
debt structure and the other point that you made earlier about 
its very large debt and its ability to sustain.
    Mr. Truglia. In the case of Chile, which I think has unique 
circumstances, one has to remind ourselves of 1981 and the 
nature of the government at the time. So it didn't really need 
public support to institute a radically changed system.
    In the industrialized countries, when you take a look at 
when Australia made its changes and the U.K. made its changes 
and some of the Scandinavian countries made their changes, they 
were occurring at a period that was following a fiscal and/or 
balance of payments crisis. So there was a sense of crisis in 
the country. If you go to the Italian reforms of the mid-
1990's, it was a crisis that they had to deal with.
    Now you are seeing the West German, the Germans, the 
Italians, the French today. It has become a crisis because of 
Mastricht criteria. So all of a sudden, what were once modest 
deficits are now unacceptable deficits. So it is no longer a 
30-year problem, which is always there. It has now become, we 
have to get our deficits down to meet the criteria over the 
next one to 2 years. What do you do there? So when you are 
fixing that, you have got the longer-term problem to fix.
    In the case of the Japanese, the Japanese people do not 
believe--they fully understand their system cannot support them 
in terms of the present pension promises. So the real challenge 
for the Japanese government is that since no one trusts the 
system as it is, Japanese people are saving more. So the 
problem has been to get consumers once again believing that the 
future is going to be brighter. So all the growth we are seeing 
in Japan recently has been due to higher export earnings and 
higher capital spending related to the export sector.
    The consumers have been very reluctant because they 
understand the problem very well. So having now the Japanese 
Prime Minister even admitting that he didn't pay for many years 
into the system just sort of feeds into their distrust of the 
whole system. However, at the same time, what it does provide 
is that there is an ongoing fiscal crisis in Japan, is that 
they are probably freer to do what they want to do with the 
system.
    The difficulty is that they are in such an economic bind 
that anything they do risks putting the economy back into a 
potential deflationary spiral, and I would be really surprised 
if they wind up actually carrying out the present pension 
reform and not push it back a little when they suddenly realize 
that higher payroll taxes is not maybe what they want so soon.
    The Chairman. We are up against a time crunch here. We have 
just been joined by my colleague, Tom Carper, who may wish to 
ask a question, and Tom, I will let you do that and then we 
will allow you to adjourn the committee and I will go off to 
vote.
    I will say by your last observation, if you ask the average 
young worker in this country today if they should rely on a 
Social Security system in their retirement, most will say no. 
That is a growing attitude in our country today, that Social 
Security will not be there to sustain them as a retirement 
system and they have got to look at other methods and 
approaches.
    I think that it appears to be a growing dominant belief in 
our country today, so that is something we will have to wrestle 
with also as it relates to the willingness to participate in a 
future reform that will reward the recipient enough to want 
them to participate without it being such a negative mandatory. 
I think that will be a part of what we struggle with as we get 
into reform of Social Security.
    Now let me turn to my colleague, Senator Carper, and I 
will, Tom, allow you to rap the gavel when you are through. 
Thank you.
    Senator Carper [presiding]. Mr. Chairman, it has been a 
while since I got to rap the gavel and I look forward to doing 
that, maybe several times. [Laughter.]
    Mr. Truglia, you mentioned the Japanese Prime Minister. I 
remember a conversation I had on a trade mission I led as 
Governor to Japan and at the time, they were struggling with 
their economy and were talking about what they might do to 
stimulate it. I was kidding with him and I said, ``In our 
country, we can cut taxes by one dollar and we will go out and 
spend two. In your country, if you cut taxes by one yen, your 
people go out and save two yen. That is part of their strength 
and part of their problem.
    In the information provided us by our staff in anticipation 
of the hearing, one doctor in here says that some 30 nations, 
including the U.K. and Australia, Sweden, Mexico, and Chile, 
have chosen in whole or in part to increase the rate of return 
on assets by enacting prefunded personal retirement accounts. I 
don't know if you can share with us today whether there are 
some countries that we might look to as a model who have gone 
from the kind of Social Security system that we have to one 
that also includes prefunded personal retirement accounts and 
how they have made that transition in a way that enables them 
to fully meet the commitment to those who are retiring under 
the old system.
    Part of the problem, as you know, here is that if those 
people in my generation or my children stop paying into the 
fund the full amount, my mother and her generation aren't going 
to have enough money for the benefits that were promised to 
them.
    Among those 30 nations, there is probably somebody who has 
figured out a reasonable way to do this that is fiscally 
responsible. If there is a model out there for us, just share 
it with us, please.
    Mr. Boersch-Supan. I think the approach should actually 
start at the first pillar, at Social Security as it is right 
now, because that is the dominant income source for most 
people. So the art is to slowly decrease the benefits, and here 
is where actually productivity comes in.
    Aging is slow but steady. It does take away----
    Senator Carper. I have noticed that. [Laughter.]
    Mr. Boersch-Supan. It leaves enough room, as a matter of 
fact, even in the European countries to have still in nominal 
terms increasing pensions, and I think that is very important 
in communicating. Pensions will still increase, but they will 
increase somewhat slower than wages. Decoupling pensions from 
wages, I think is the important step which gives you the 
ability to sell the entire thing politically. Then 
automatically, people will pick up second and third pillar 
pensions, occupational pensions, 401(k)s, IRAs.
    But the trick is to sell the benefit cuts, and that is the 
difficulty. That is quite difficult as a relative decline, not 
an absolute decline. If it were an absolute decline, it would 
be a disaster because that really means poverty for some of the 
people. But it is only a relative decline.
    So in terms of numbers, if I may come back to my country, 
which ages faster than the United States, we take away out of, 
1.5 percent wage growth for the next 30 years, we take away 
two-tenths of a percentage point. So pensions will grow 1.3 
percent, wages will grow 1.5 percent. That little gap 
accumulates over the next 30 years and allows financing Social 
Security on a solvent basis without doing too much damage.
    Senator Carper. Thanks very much. What is your country?
    Mr. Boersch-Supan. It is Germany.
    Senator Carper. OK. Let me just ask for the record, we have 
a 15-minute vote that started 12 minutes ago and I need to get 
over and vote. Otherwise, I miss my opportunity. Anybody else, 
just real quickly? My question was, as you may recall, is there 
a country out there that can serve as an example, and it may be 
Germany, it may be another one. But if you have a thought 
quickly. If not, just maybe submit something for the record.
    Mr. Harris. Just a quick comment, Senator. I think there is 
no one particular country that identifies a magic bullet or a 
complete answer. It is a blend, if you like, a blending. I 
think countries like Switzerland, how Switzerland has achieved 
122 percent of their GDP in pension assets, they moved to 
fundamentally a compulsory system and that is what it largely 
comes down to. Do you have an incentive-based tax system or do 
you move toward compulsion, as in my country in Australia, or 
the country I now reside in, in the U.K., where they are still 
grappling with the issue of incentives, a tough issue.
    The fundamental tenet I would leave you with the Generation 
X, which I am part of and a little bit behind, is that 
education and communication is critical. It can be sold and 
politicians can be reelected on the basis of pension reform.
    Senator Carper. All right. Going, going, gone. Now I get to 
take this gavel. Just think of all the legislation I could 
bring up for votes and for enactment and everything in the 
absence of the chairman of the committee, but I won't do that. 
Otherwise, he will never let me have this gavel again.
    Let me conclude by thanking you all for joining us today 
and helping us to address what I think we will all agree is a 
ticklish and challenging issue. Thank you very much.
    [Whereupon, at 11:52 a.m., the committee was adjourned.]


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