[Senate Hearing 108-641]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-641

                     STRENGTHENING SOCIAL SECURITY:
    WHAT CAN PERSONAL RETIREMENT ACCOUNTS DO FOR LOW-INCOME WORKERS?

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

                                HEARING

                               before the

                       SPECIAL COMMITTEE ON AGING
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             WASHINGTON, DC

                               __________

                             JUNE 15, 2004

                               __________

                           Serial No. 108-37

         Printed for the use of the Special Committee on Aging


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                       SPECIAL COMMITTEE ON AGING

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

                                  (ii)




                            C O N T E N T S

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

                                Panel I

Hon. David M. Walker, Comptroller General, General Accounting 
  Office, Washington, DC.........................................     2

                                Panel II

Peter Ferrara, Institute for Policy Innovation and the Club for 
  Growth, Washington, DC.........................................    43
Jeff Brown, Ph.D., University of Illinois at Urbana-Champaign, 
  Champaign, IL..................................................    58
Jeff Lemieux, Centrists.org, Washington, DC......................    70
Christian Weller, Ph.D., Center for American Progress, 
  Washington, DC.................................................    86

                                 (iii)

  

 
STRENGTHENING SOCIAL SECURITY: WHAT CAN PERSONAL RETIREMENT ACCOUNTS DO 
                        FOR LOW-INCOME WORKERS?

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



                         TUESDAY, JUNE 15, 2004

                                       U.S. Senate,
                                Special Committee on Aging,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:32 a.m., in 
room SD-628, Dirksen Senate Office Building, Hon. Larry E. 
Craig (chairman of the committee) presiding.
    Present: Senators Craig and Kohl.

           STATEMENT OF SENATOR LARRY CRAIG, CHAIRMAN

    The Chairman. Good morning, everyone. The U.S. Senate 
Special Committee on Aging will convene.
    Thank you all very much for being with us this morning and 
allowing us to adjust schedules a little bit for the joint 
session earlier this morning.
    Last year, my good friend and Ranking Member of the 
Committee John Breaux and I asked the GAO to use its analytical 
expertise to evaluate how the Social Security status quo or do-
nothing plan would redistribute benefits for workers. We also 
asked how well personal retirement account models and other 
proposals might affect redistribution of Social Security 
benefits for our children and grandchildren. I was especially 
interested in this report as on objective and nonpartisan 
analysis. It is important for us to understand how reform would 
impact those in most need, the low-income workers.
    Today's GAO on study on Social Security redistribution 
builds on previous reports requested by myself and Senator 
Breaux and represented before this Committee by the Comptroller 
General. This Committee has been very active on issues of 
income security in retirement. The GAO continues to strongly 
support the research interests of this Committee, and we thank 
you, Mr. Walker, and all of your staff for the high of the 
quality of the work products that you present.
    As the United States considers personal retirement accounts 
as one potential option for strengthening Social Security, it 
is important that we understand how different proposals impact 
low-, middle-, and high-income workers. I want to emphasize 
that the topic of this hearing is really about America's youth. 
Those currently on Social Security and about to retire will not 
be affected by any reforms discussed here today.
    Finally, I would also like to comment on the Congressional 
Budget Office study released yesterday with different 
projections on the issue of solvency compared to Social 
Security's Office of Actuary. Those who advocate we do nothing 
suggests the CBO supports their position because insolvency is 
pushed forward by another decade. On the contrary, the problem 
of insolvency is still there, though we have a little more 
breathing room on the front, but the cash-flow deficit is still 
projected to occur prior to 2020.
    As many of us know, insolvency isn't the only reason reform 
is necessary. We must also be concerned about long-run 
sustainability of the system and adequacy of benefits and a 
fair return for middle- and high-income workers. It appears the 
CBO projects that many low- and middle-income retirees will 
receive lower benefits than the actuaries were projects. As a 
result and contrary to the do-nothing crowd's response to the 
CBO study, today's hearing on benefits levels takes on an even 
greater importance in light of the CBO's findings.
    With that, I am pleased to welcome our distinguished 
witnesses to the Aging Committee. On panel one, we have a 
single witness, one who is very familiar to this committee, 
David Walker, the Comptroller General of the General Accounting 
Office.
    On our second panel, we will hear from Peter Ferrara of the 
Institute for Policy Innovation and the Club for Growth; Dr. 
Jeff Brown, professor of Finance for the University of Illinois 
at Urbana Champaign Campus; Jeff Lemieux, executive director 
for the Centrist.Org of Washington DC., a think tank; along 
with Dr. Christian Weller, a senior economist mist from the 
Center for American Progress here in Washington.
    So I look forward to all of their testimony, and, David, 
let us begin this morning with you, and again, thank you for 
allowing us to be a little flexible in our schedule.

STATEMENT OF HON. DAVID M. WALKER, COMPTROLLER GENERAL, GENERAL 
               ACCOUNTING OFFICE, WASHINGTON, DC

    Mr. Walker. Thank you, Mr. Chairman. I also appreciate your 
understanding in recognizing that I need to try to get out of 
here by eleven because I have a hearing on the House side.
    The Chairman. We will keep you on schedule.
    Mr. Walker. Thank you, Mr. Chairman.
    I appreciate you inviting me here today to continue our 
dialog on a range of issues of mutual interests concerning the 
Social Security system and potential reform proposals. As I 
have stated before on numerous occasions, without substantive 
reforms, both of Social Security and the Medicare programs are 
unsustainable in their present form, and their long term impact 
on the Federal budget and the economy will be dramatic.
    Today, we are issuing a report at your request and the 
Ranking Minority Member, dealing with the issue of distribution 
of benefits and taxes relative to earnings levels. We believe 
this is an important contribution to the continuing discussion 
and debate about various Social Security reform proposals, and 
before I summarize the results of that report, I think it is 
important to make a few overview comments.
    First, Social Security reform is a part of a broader fiscal 
and economic challenge. In fact, it is a subset of a major 
fiscal imbalance that we face. The biggest part of it is 
Medicare. Second, focusing on trust fund solvency alone, as you 
noted in your opening comments, is not sufficient. We need to 
put the program on a path toward sustainable solvency and to 
consider cash-flow, to consider its percentage of the federal 
budget, its percentage of the economy, etc. Third, solving 
Social Security's long-term financing problem is more than 
important and complex and simply making the numbers add up. It 
is not just about sustainable solvency. It also involves 
adequacy, equity, and administrative feasibility 
considerations. Last, but certainly not least, acting sooner 
rather than later would help to ease the transition difficulty 
and help facilitate the need for us to move on to much more 
difficult complex and controversial reforms, namely health care 
reform in general, and Medicare, in particular.
    As you know, Mr. Chairman, under Social Security, retired 
workers can receive benefits at age 65 that equal about 50 
percent of their pre-retirement earnings for an illustrative 
worker with relatively low earnings, but only about 30 percent 
for individuals with relatively higher earnings. To ensure that 
beneficiaries have adequate incomes, Social Security's current 
benefit formula is designed to be progressive, that is to 
provide disproportionately larger Social Security benefits as a 
percentage of pre-retirement earnings to lower earners than to 
higher earners.
    However, the benefit formula is just one of several program 
features that influence the way benefits are distributed. One 
such program feature includes provisions for disabled workers, 
spouses, children, and survivors. Changes in the program over 
time will affect the distribution of benefits across 
generations. So the distribution of Social Security benefits 
can vary by eligibility, household type, and birth year, as 
well as by earnings level.
    As you know, over the last several years, we have been 
developing increased capacity to use micro-simulation models 
and other types of tools to help quantify the effects of 
possible Social Security reform proposals, and in doing that, I 
would like to move on to the requested study. There are two 
distinct perspectives, in our view, relating to Social 
Security's goals that suggest different approaches to measuring 
progressivity. Both perspectives provide valuable insights, in 
our opinion. First, an adequacy perspective focuses on benefit 
levels and how well they help to ensure a minimal subsistence 
or maintain pre-retirement-level living standards. Second, an 
equity perspective focuses on rates of return and other 
measures relating to lifetime benefits and relative individual 
contributions. This perspective also gauges whether the system 
gives people a, quote-unquote, fair deal for their 
contributions. These measures themselves describe the adequacy 
and equity, but the distribution with respect to earnings level 
describes progressivity.
    It is important to note that equity measures cannot 
accurately assess the distributional effects of reform 
proposals that rely upon general revenue transfers, because 
they don't specify who is going to end up paying for those 
general revenue transfers, namely what the relative tax burden 
is going to be with regard to those general revenue transfers. 
In our view, estimating future effects on Social Security 
benefits should reflect the fact that the program faces a long-
term actuarial deficit and benefit reductions and/or revenue 
increases will be necessary in order to restore program 
solvency.
    Social Security's current distributional effects reflect 
program features and demographic patterns among its various 
recipients. The retired worker benefit formula favors low 
earners by design. In addition, the disability benefit formula 
also favors low earners since disability recipients are 
disproportionately low earners. Alternatively, individual 
Social Security reform proposals would have different 
distributional effects, reflecting various provisions that make 
up the proposed reform proposal.
    In particular, for example, Model 2 of the President's 
Commission to Strengthen Social Security proposes a new system 
of voluntary individual accounts along with a combination of 
certain benefit reductions for all beneficiaries and selected 
benefit enhancements for selected low earners and survivors. 
One of its provisions would reduce Social Security defined 
benefits proportionately for all workers by modifying the 
current benefit formula. At the same point in time, benefits 
would be enhanced for certain lower earners and surviving 
spouses, and 4 percentage points of an individual's payroll 
taxes up to a thousand dollar annual limit could be diverted an 
individual investment accounts.
    To illustrate the distributional effects of this proposal, 
we used our micro-simulation model to estimate the benefits 
under it and under our various benchmark scenarios. We did not 
examine the distributional effect of the equity measures 
because it presumes significant general revenue transfers and 
it is difficult to ascertain who will bear the burden of those 
general revenue transfers. Since the account participation is 
voluntary--by that, I mean the individual account 
participation--we use two simulations to show the bounds, one 
simulation that assumed that there is one hundred percent 
participation in individual accounts and another one that 
assumed there would be zero. From a practical standpoint, we 
know it is going to be somewhat in between.
    We also assumed that account participants would have the 
same asset allocation, that they would invest in the same type 
of portfolios, if have you will, divided between equities, 
fixed income, investments etc.
    Based on our simulations, the distribution effects under 
Model 2 of the President's Commission could favor lower earners 
more than the distribution of benefits under either the 
currently promised or currently funded benefits/services. 
Stated differently, the distribution of benefits or the 
progressivity under Model 2 would be better than under the 
current Social Security program. It is important, however, to 
note that while the simulation suggests that the distribution 
of benefits under Model 2 is more progressive than the 
benchmarks under the current program, that does not mean that 
benefit levels are always higher.
    Progressivity is about how the pie is divided up. It is not 
about how big the pie is, and, therefore, something can be more 
progressive, but the benefit may not be more adequate. 
According to our simulation, median household lifetime benefits 
for the bottom fifth of the population under Model 2-0, would 
be 3 percent higher than under the funded benefits scenario, 
but 21 percent lower than under the promised benefits scenario. 
Medium household lifetime benefits for the bottom fifth under 
Model 2-100 percent would be 26 percent higher than under the 
funded benefits scenario, but 4 percent lower than under the 
promised benefits scenario.
    I think it is important, last, to note that we used 
individuals born in 1985 as a basis to do our simulation 
because you were concerned about the longer-term effects on our 
children and grandchildren, appropriately so. Importantly, the 
results could differ depending upon the age of the individual 
and nature of the reform proposals going forward.
    So in conclusion, Mr. Chairman, we are happy to provide 
this study. We believe it represents an additional contribution 
to the very important ongoing discussion and debate about the 
need for Social Security reform. My personal opinion, having 
been a former trustee of Social Security and Medicare, having 
consulted in the private sector for many years in the pension 
and health areas, is that we have an opportunity to reform 
Social Security in a way that will exceed the expectations of 
every generation of Americans if we put our mind to it. The 
sooner we act, the better. We look forward to working with this 
Committee and other interested parties in the Congress to try 
to achieve this desirable outcome.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Walker follows:]

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    The Chairman. David, thank you very much for that 
presentation and, more importantly, the study that you have 
just completed. I think this goes along with where we are going 
in this Committee, and that is to build a solid base of 
information, analytical information, as Congress moves 
ultimately toward reform of the Social Security system.
    Before I do questions, David, we have been joined by 
Senator Kohl.
    Herb, do you wish to make any comment beforehand?
    Senator Kohl. No.
    The Chairman. Then let me start with questions, and you 
might have questions yourself, Herb.
    Mr. Walker, after doing all this research on redistribution 
issues for Social Security and personal retirement accounts, 
what are probably the most important things we should walk away 
with looking at this study?
    Mr. Walker. Well, first, there is a difference between 
progressivity and adequacy. I think that is an important point. 
Second, when you are looking at progressivity, you need to 
consider it not just from the benefit-level standpoint, but 
also tax burdens; and, third, that individual account plans 
can, depending upon what their design is, improve 
progressivity, but you also need to consider the effect from 
the other dimensions; and last, I would say, there can be 
differences between individuals and households.
    The Chairman. Yes. That was going to be my next question. 
Elaborate on that just a little bit if you would, the analysis 
and the redistribution effects.
    Mr. Walker. Progressivity tends to be a little bit less 
from a household standpoint than on an individual basis, and 
the reason being is because of family patterns. You can have 
low-income individuals join a household that has higher-income 
workers, and therefore it tends to moderate the distributional 
effects. Marriage is probably the best example of how that can 
have an effect, and having been married 33 years, I understand 
how this can happen.
    The Chairman. That is exactly the effect that happens as a 
result of that, OK.
    If the funds used to transition to a personal retirement 
account proposal such as in Model 2 are temporary, would it be 
reasonable to consider the funds as an investment in a 
sustainable system? How do we look at that?
    Mr. Walker. I would not look at it as an investment. I do 
think it is, however, appropriate to look at the discounted 
present value cost of various reform proposals. One of the 
challenges that we have in the United States is the way we keep 
score. The way we currently keep score provides a misleading 
view of really where we stand and what the real economic cost 
is of various reform proposals. So I think that you need to 
look not only as to the budgetary commitment, but what is the 
discounted present value cost of various reform proposals in 
current dollar terms.
    For example, right now, assuming that you want to end up 
delivering on all the benefits that have been promised under 
Social Security today, and I am not saying that is true, but if 
that is true, it is going to take an additional $4.9 trillion 
to be able to deliver on that for the next 75 years. Now, that 
number is gross, not net of the bonds in the trust fund. Each 
of those other reform proposals will require different amounts 
of money as well, and so I think we need to think about the 
discounted present value cost, which is typically how 
economists would look at it and typically also how you would 
look at it from an accounting standpoint.
    The Chairman. Yes. That is a point well made.
    Your report briefly discusses general revenue transfers and 
the problem of assigning distributional effects. Can you 
elaborate on the general distribution effect if income taxes 
are used to finance the transfers?
    Mr. Walker. Well, in general, as you know, Mr. Chairman, 
income taxes tend to be more progressive in nature. Payroll 
taxes tend to be very regressive in nature, and so you would 
have to say that in general terms, if you are going to use an 
incomes tax versus a payroll tax, the income tax would be a 
more progressive approach. I think it is, however, important to 
note that based upon GAO's long-range budget simulations, we 
face a large and growing structural deficit, and we are going 
to have to address how we are going to close the gap whether 
through spending cuts, whether through the tax side, and, if 
so, whether or not it is going to be income taxes, payroll 
taxes, consumption taxes. The Congress will ultimately have to 
decide.
    The Chairman. OK. GAO talks about the twin goals of 
adequacy as equity as important considerations in any reform to 
strengthen Social Security. There are some who suggest that we 
shouldn't ask one system to achieve both goals. What is your 
thinking on that issue?
    Mr. Walker. I think it is important to look at four 
dimensions: Sustainable solvency, adequacy, equity, and 
administrative feasibility. Yes, there are challenges and 
tradeoffs between looking at those, but I think it is important 
to look at all four dimensions.
    The Chairman. What you are saying is, as we reform, we have 
got to look through all four of those lenses, if you will, to 
get the right one.
    Mr. Walker. I agree, Mr. Chairman. I think we have to look 
at all four. I think others will evaluate your proposals either 
for the positive or the negative, looking at all four, and 
failure to look at all four, I think exposes any potential 
reform to potential criticism and could slow needed reforms.
    The Chairman. OK. Thank you very much.
    Let me turn to Senator Kohl. Any questions?
    Senator Kohl. Thank you very much, Mr. Chairman.
    Mr. Walker, did you put a number of transition costs?
    Mr. Walker. Yes, sir, we did, based upon our assumptions. 
Right now, if you look at, for example, the three proposals, 
under the Model 2 of the President's Commission, it is my 
understanding that the discounted present value cost for the 
transition obligation over the next 75 years would be $2.3 
trillion. Now, that is gross. That is not considering the bonds 
that are in the trust fund, but it is also important to note 
that the other two proposals we looked at would also require 
some general revenue funding. The most would be the Ferrara 
approach. We estimated that it would take about $6.9 trillion 
in discounted present dollar terms.
    Senator Kohl. So we are talking about, no matter how you 
want to apportion it out, it is a tremendous amount of money to 
get to where it is we would like to go. This is not cost-free 
in any way.
    Mr. Walker. You are exactly right, Senator, but I also 
think it is important to know that right now, we have about a 
$4.9 trillion shortfall. Now, that is gross. Net of the bonds 
in the trust fund, it is 3.7 trillion, but as you both know, 
the bonds in the trust fund are going to require additional 
revenues. We have already spent the money.
    Senator Kohl. No question.
    Mr. Walker. So we are going to have to somehow come up with 
the revenues to deal with it.
    Senator Kohl. No question about it. When you look at the 
present formulas that are used with respect to Social Security, 
while I am not advocating it, I heard people talk about the fix 
that we could attach to Social Security by raising the 
threshold. Are you familiar with how much we could help Social 
Security in terms of its solvency by raising the threshold from 
where it is, which I think is about 86 or 87 thousand dollars?
    Mr. Walker. You mean the taxable wage base? I don't have 
the numbers in front of me, Senator Kohl. I would be happy to 
provide that for the record, what we have.
    Senator Kohl. Yes. I am assuming, perhaps incorrectly, that 
you have done some examination of what would happen if we 
decided to bite the bullet and raise the threshold, let us say, 
from 87 to 150.
    Mr. Walker. There is work that has been done on that by us 
and by others, and I would be happy to provide something for 
the record. I mean, there are various reform proposals, whether 
it is raising the retirement age, whether it is increasing the 
taxable wage base, whether it is modifying the benefit formula 
that can help to show you how far you get under the different 
proposals, and I do think it is important to keep in mind that 
from a funding standpoint and from a degree of imbalance, 
Social Security is a much easier problem to deal with than some 
of the other ones you are going to have to deal with, 
especially Medicare.
    Senator Kohl. I agree.
    Mr. Walker. For example, if you look at the discounted 
present value underfunded liability for Social Security, it is 
about $3.7 trillion, net of the bonds in the trust fund. If you 
look at Medicare, it is about $27.8 trillion, net of the bonds 
in the trust fund. So I think one of the things that we need to 
consider is not just what needs to be done to assure solvency 
and sustainability of Social Security for current and future 
generations, but to the extent that you do things for Social 
Security, for example on the revenue side, then how is that 
going to affect what you are going to be able to do for 
Medicare? The gap is much greater in Medicare.
    I do believe and I think it is important to look at some 
other dimensions, such as the normal retirement age, such as 
the replacement rates, such as the indexing. Having been a 
trustee of Social Security and Medicare before, I spent a fair 
amount of time looking at reform proposals, and the good news 
is I really do believe you can reform this Social Security and 
exceed the expectations of every generation. I really do 
believe that.
    Senator Kohl. I think that is a good point, and I think it 
is a point well worth making and repeating, because the public 
is not aware that the Social Security problems are not nearly 
as serious as the Medicare problems in terms of funding. I 
think if you took a survey out there, most people would think 
Social Security problems are the biggest problems we face 
looking forward. Medicare problems are by far much bigger.
    Mr. Walker. Medicare is seven times greater on relative 
terms, based on the numbers that I gave you.
    Senator Kohl. Thank you, Mr. Chairman.
    The Chairman. Herb, thank you for those questions.
    David, you are obviously not the first to tell us of the 
reality of the problems, and that is obviously why we continue 
to hold these hearings and build this informational base, 
because you are right. When you are dealing with a dynamic 
environment versus a relatively static or fixed environment 
where you can lock in numbers and they work in relation to 
Social Security versus Medicare, the world changes 
significantly, and we are sitting here as we attempt to tackle 
health care; we are also dealing with a phenomenally moving 
target that is dynamic in its character, and we can make 
projections, but we all know that one new discovery out there, 
one new application significantly changes costs, positive or 
negative, as we deal with health care.
    Mr. Walker. It is a lot easier to get a handle on the 
estimated cost of Social Security than it is for health care 
for the reasons that you mention and others. I agree.
    The Chairman. But I am pleased with your optimism about the 
reality of reform in Social Security, because I am very 
frustrated and have been for some years that we are going to 
tell our grandchildren that if we don't reform it, it is really 
going to be a significantly bad investment for them as it 
relates to the amount of money coming in versus the reality of 
money that would come out to them. I am saying that in a 
comparative way to my parents that are in their eighties and 
still alive where Social Security was just a phenomenal 
investment for them, and somehow Herb and I are going to try to 
fix that.
    Mr. Walker. One of the reasons I say that is because 
myself, having two children and two grandchildren and also 
having done an extensive amount of outreach on this issue 
outside of Washington, I find that the people that are most 
fearful about Social Security reform are current retirees and 
people that are approaching retirement. From a practical 
standpoint, they are really not going to be affected by the 
reform.
    The Chairman. That is right.
    Mr. Walker. It is really going to be the children and the 
grandchildren, our children and grandchildren and future 
generations, and for them, they are discounting Social Security 
to a greater extent than they should. Therefore, that means 
there is an opportunity to structure reforms, with or without 
individual accounts, in a way that everybody gets more than 
they think they are going to get. I would call that a win and a 
desirable outcome, and the sooner, the better.
    The Chairman. I think you are right.
    Well, thank you very much for your time, your 
participation, and the work that has been done. I think that 
this report, again, builds on that base of knowledge that we 
need to have as we move forward on Social Security reform.
    Mr. Walker. Thank you, Mr. Chairman and Senator Kohl. It 
was a pleasure to be with you.
    The Chairman. Now let me call our second panel forward, 
please.
    Again, for the record and the listener, we have on our 
second panel Peter Ferrara of the Institute for Policy 
Innovation and the Club for Growth; Dr. Jeffrey Brown, 
professor of Finance from the University of Illinois at Urbana-
Champaign; Jeff Lemieux, executive director for Centrists.Org, 
Washington DC, think tank; and Dr. Christian Weller, senior 
economist for the Center for American Progress here in 
Washington, DC.
    Gentlemen, thank you all for being with us this morning. 
Peter, let us start with you.

STATEMENT OF PETER FERRARA, INSTITUTE FOR POLICY INNOVATION AND 
              THE CLUB FOR GROWTH, WASHINGTON, DC

    Mr. Ferrara. Thank you very much, Senator, for inviting me 
this morning.
    I am here to discuss a proposal, a progressive proposal 
providing a progressive option for personal retirement accounts 
as a choice as compared to Social Security. The option provides 
for a large personal retirement account, and the option is 
designed to be progressive, which means that lower-income 
workers can contribute a higher percentage of their taxes to 
the account than higher-income workers. So the option provides 
specifically that out of the 12.4 percent current Social 
Security payroll tax, workers could take 10 percentage points 
of that 12.4 on the first $10,000 of their wage income each 
year and 5 percentage points on their taxable wage income after 
that. That comes out to an average of 6.4 percentage points of 
the 12.4 that would go into the personal accounts, a much 
larger account than has been proposed before, with lower-income 
workers contributing a higher percentage above that and higher-
income workers being able to transfer a lower percentage.
    The proposal makes no change in disability and survivors 
benefits at all, and there is no change in Social Security 
benefits otherwise for anybody at any point now or in the 
future. Because the advantages of a large personal account are 
so great, no other changes are necessary. I discuss in detail 
in my written testimony how this structure mirrors the 
progressivity of social security. It preserves within the 
personal account the progressivity of Social Security so that 
workers across the board would gain roughly the same percentage 
depending on their investment portfolio, and I will go into 
that in more detail.
    There are five ways I think in which this proposal in 
addition enhances progressivity for low- and moderate-income 
workers. First of all, it sharply increases future retirement 
benefits for low- and moderate-income workers. Large accounts 
do that much more than any other alternative. Because of the 
bigger accounts, they are able to take more advantage of the 
better return in the private sector, and so they provide very 
sharp increases. Again, I detail that in my written testimony, 
but for a worker where they invest over a lifetime half and 
half in stocks and bonds at standard market investment returns, 
I calculate that they would gain a benefit increase of two-
thirds compared to currently promised Social Security benefits. 
In other words, at standard market investment returns, 
investing half in stock and half in bonds, workers across the 
board, and low- and moderate-income workers in particular, 
would gain a benefit increase of two-thirds as compared to what 
Social Security promises, let alone what it can pay. If they 
invested two-thirds in stocks and one-third in bonds, the 
benefits they would gain would double what Social Security 
promises but cannot pay.
    So you see potentially very large increases and a large, 
large margin for error. So then in addition to that, in terms 
of rates of return analysis, you would get far higher rates of 
return through the large personal accounts than you would 
through the current Social Security system. Again, based on a 
number of studies that I have done in the past and others, I 
estimate for most workers today, the real rate of return 
promised by Social Security, let alone what it could pay, is 
one to 1.5 percent; the long-term return on corporate bonds, 
real return, three to three and a half percent; on stocks, I 
think the record will bear out seven to seven and a half 
percent.
    So much higher returns, and you see what we have done here 
is a vast improvement both on the basis of adequacy and of 
equity, because the returns are much higher and the future 
benefits are much higher. Also under the reform plan, low-and 
moderate-income workers would gain much greater accumulations 
of personal wealth than under Social Security. The chief 
actuary of Social Security has already officially scored this 
plan. He estimates that by 15 years after the reform plan is 
adopted, working people would have gained $7 trillion in 
today's dollars in their own personal accounts. Again, that is 
the chief actuary's number. You see, this is the greatest 
advantage and break for working people that we could possibly 
adopt today, $7 trillion accumulated in just the first 15 years 
in the personal accounts of working people.
    I detail in the written testimony of some of the gains you 
could expect: average workers, 300 to $400,000; lower income 
workers, 270,000 to 350,000, depending on what portfolios they 
invest in, how much in stocks, how much in bonds. So again, it 
is more progressive because it lets workers accumulate much 
more money. It is more progressive because it lets worker get 
better benefits. It is more progressive because it lets low- 
and moderate-income workers get higher returns .
    Also, these much larger accumulations of personal wealth by 
low- and moderate-income workers would greatly broaden wealth 
ownership in our nation and sharply reduce the concentration of 
wealth. That $7 trillion is relatively equally distributed 
across the board, especially as compared to our current 
distribution of wealth. If you add wealth to the current 
wealth, it greatly reduces the concentration of wealth, again, 
one of the most progressive reforms that we could possibly have 
on that score. Nothing else in prospect would so greatly reduce 
the concentration of wealth.
    In addition, the reform plan addresses another problem that 
harms low-income workers, which is lower life expectancies. If 
they die before they reach retirement or just after, they lose 
everything, but with the personal accounts, they would have 
that money and they would accumulate.
    Finally, I would submit that on these five measures, the 
large personal accounts do much more, are much more 
progressive, than either the Diamond-Orszag plan, which 
achieves virtually none of these, or the smaller accounts 
proposed in Commission Option 2. Because the accounts are 
smaller, the net gains in these areas are not nearly as large.
    Thank you very much.
    [The prepared statement of Mr. Ferrara follows:]

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    The Chairman. Peter, thank you.
    Now let me turn to Dr. Brown.

   STATEMENT OF JEFF BROWN, Ph.D., UNIVERSITY OF ILLINOIS AT 
                URBANA-CHAMPAIGN, CHAMPAIGN, IL

    Mr. Brown. Chairman Craig, Members of the Committee, I 
thank you for the opportunity to appear before you today.
    I would like to begin by summarizing quickly the three main 
points of my testimony. First, as we heard from Comptroller 
General Walker this morning, Social Security's poor long-term 
fiscal health virtually requires that the system be reformed in 
some manner. Virtually any proposal to restore fiscal 
sustainability is going to have an effect on the distribution 
of costs and benefits across the population.
    Second, any reform, whether it includes personal accounts 
or whether it relies solely on tax increases or changes to 
benefits can be structured to be less progressive, equally 
progressive, or more progressive than the current system. An 
important implication of this is that it is possible to design 
a system that includes personal accounts which is actually more 
progressive than the system we have today.
    Third, Model 2 of the President's Commission to Strengthen 
Social Security is a specific example of a plan that can 
restore fiscal sustainability and still provide a strong safety 
net for low-income individuals and families.
    As we heard earlier today, ever since Social Security's 
inception, policymakers have had to balance sometimes competing 
goals. Two of these goals which are quite relevant for today 
are, first, the desire to reduce poverty among low-income 
elderly, and second, is the desire to make Social Security fair 
for all participants. Social Security is not and was never 
designed to be a welfare program. It was designed to provide 
all participants with benefits that increase as their lifetime 
contributions increase.
    Meeting multiple objectives with a single program is always 
difficult and it is made all the more so when the resources 
available to finance the system are insufficient. Indeed, it is 
actually somewhat meaningless to talk about progressivity 
without first discussing how the system will be brought back 
into long-term fiscal balance. Given the well-known fact that 
Social Security faces these long-run deficits, it is both 
economically and mathematically obvious that something must 
change. Either we need more resources flowing into the system 
or we must decrease expenditures from it. The GAO testimony 
this morning underscores a very important point, which is that 
it is possible to design both a sustainable and a 
redistributive Social Security system that includes personal 
accounts.
    Indeed, the President's Commission made a very conscious 
effort to do this. There were several features of that plan 
that I believe are worth highlighting. The first is that the 
personal accounts in Model 2 are themselves progressive. Low 
income workers could expect to benefit the most because they 
were able to contribute a higher fraction of their earnings. 
Also, within the defined benefit portion of the reformed plan, 
benefits for low-wage workers were actually increased in order 
to provide a specific anti-poverty protection. It is also the 
case that Model 2 was designed to increase the benefit that was 
paid to widows and widowers upon the death of a spouse, and in 
addition, those widows or widowers would be able to receive an 
inheritance from the account upon the death of their spouse. 
Both of these features have an important redistributive effect.
    The net result, as we saw from the GAO report released 
today, is that Model 2 actually compares quite favorably to 
current law in terms of overall progressivity. Yet it does this 
while achieving fiscal sustainability without relying on a 
permanent increase in payroll taxes or a permanent infusion of 
general revenue. There are other reform plans out there that 
take a very different approach, relying on permanent increases 
in the tax burden to support a larger program. I simply want to 
point out that in many of the more expensive reform plans, the 
incremental dollars are being used to increase the generosity 
of the program for everyone, not just for low-income workers. 
So this certainly serves to make the program and more 
expensive, but it doesn't necessarily do anything to increase 
progressivity.
    In short, just because a reform plan is more expensive does 
not necessarily mean it is more progressive. Indeed, if 
Congress wishes to reform Social Security in a way that 
protects the poor, it still has a choice of whether to do this 
with a very large expensive system that requires higher tax 
burdens in the future or whether to do so within a system that 
actually lives within the existing payroll tax while still 
providing a strong safety net for low-income individuals. I 
believe that Model 2 of the President's Commission provides a 
very useful blueprint on how to do just that, how to design a 
system that allows Social Security to live within its means 
over the long term, to be sustainable, and yet still serve the 
redistributive purpose for which the program was intended.
    Thank you.
    [The prepared statement of Mr. Brown follows:]

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    The Chairman. Jeff, thank you very much.
    Now let us turn to Jeff Lemieux of Centrists.Org. Welcome 
to the committee.

    STATEMENT OF JEFF LEMIEUX, CENTRISTS.ORG, WASHINGTON, DC

    Mr. Lemieux. Thank you, senator. Thank you, Senator Kohl as 
well.
    We view our role in this particular debate as providing 
data to help evaluate the various different types of proposals 
rather than pitching any one particular proposal or explaining 
its merits. We also have tried to foster some bipartisanship on 
this issue, which has been very hard. There is one particularly 
good example of bipartisanship in the House. Representatives 
Kolbe and Stenholm have a new bipartisan bill that we have 
analyzed, and we also had an event recently where 
Representative Harold Ford discussed with Senator Lindsey 
Graham some approaches and some possible areas for common 
ground. I thought that was very helpful. In addition, as has 
already been mentioned, the economists Peter Orszag and Peter 
Diamond have put forward a proposal that is very responsible in 
its financing.
    Unfortunately, these constructive approaches and efforts 
seem to be the exception rather than the rule. Most of the 
political discussion on Social Security is very shrill and 
simplistic, and as a result, the most popular proposal is 
probably the do-nothing option. At the other extreme are these 
very large account proposals which have been characterized as 
free-lunch plans. If we pour lots of money into Social Security 
accounts, they will, in fact, provide a lot of money for 
people, but financing them is very difficult. I am particularly 
concerned that legislators might not have a clear picture of 
either the budgetary or the distributional consequences of some 
of these more extreme proposals.
    I have a chart packet that was included with the testimony. 
All of the charts in the testimony are also in the written 
statement, but if you have this packet, I will go through a 
couple of the charts as examples. The first chart is called 
``Four Big Entitlements'', and as you can see at the bottom is 
Social Security, which doesn't look bad by comparison with 
Medicare and with another entitlement that is often not 
mentioned in the debate, which is interest on the National 
debt. If we continue to accumulate deficits and debt and 
interest rates go back up, then after 2030 we will have to pay 
even more in interest, conceivably, than Medicare or Social 
Security.
    The second chart, Figure 2, just goes through Social 
Security costs and revenues. The blue line shows that we expect 
Social Security benefit costs to grow from about 4.2 or 4.3 
percent of GDP up to about 6.3 percent of GDP and then remain 
flat thereafter once the baby-boomers have retired, while 
dedicated tax revenues are about 5 percent of GDP and roughly 
flat. This is the nature of the Social Security financing 
problem.
    Figure three shows the difference between those two lines, 
revenues and costs. We are currently in a position of surplus 
where the Social Security revenues raise more than we pay in 
benefits, but that will switch over to a deficit in about 10 or 
15 years and then become a long-term deficit ranging between 
one and 2 percent of GDP, which is a substantial amount.
    The next figure shows roughly how the Kolbe-Stenholm 
approach would attempt to solve that deficit problem. It would 
bring the surplus down to zero immediately, spending money to 
build private accounts, but reducing the deficit to a much 
lower rate in the long run.
    Chart 4 shows Senator Graham's proposal, which is similar 
to Kolbe-Stenholm in its effect, and the Ferrara proposal, 
considering the cost of Social Security where the baseline goes 
up from a little over 4 percent to over 6 percent. The Graham 
proposal would increase Social Security costs for the time 
being and then reduce them in the long run. The Ferrara 
proposal would increase them by a considerably larger amount, 
but then also reduce them in the long run. To be fair to 
Senator Graham, the final version of his proposal is opening a 
wide variety of financing mechanisms that would help reduce 
that increase in Social Security costs in the short run.
    The Diamond-Orszag plan essentially is the best performing 
proposal on the metric of how much it costs to implement. Dr. 
Walker talked about the long-term present value of these plans 
and how the current law is between four and five trillion. The 
Ferrara plan is over seven trillion. Some of the other account 
proposals, like the Graham and the Kolbe-Stenholm plans are in 
the neighborhood of two to three trillion. The Diamond-Orszag 
plan is under one trillion. In that sense, it is the best 
performer. The down side of the Diamond-Orszag plan is that it 
incorporates a permanent increase in taxation.
    Finally, I would like to mention the new Social Security 
numbers that came out yesterday. These are in Figures 7 and 8 
and came out from the Congressional Budget Office. They differ 
slightly from the numbers that I have been using, which come 
from the Social Security trustees. CBO sees slightly lower 
outlays, especially between about 2020 and 2060 and slightly 
higher revenues after about 2040. They also have some differing 
economic assumptions; for example they assume higher interest 
rates on the debt that Social Security--the Treasury debt that 
Social Security holds and the Government pays Social Security 
interest on which has the effect of extending the life span of 
the Social Security fund, but I think most economists discount 
that measure.
    The final chart shows the graphic of the deficit. CBO 
assumes that it is between one and 1.5 percent of GDP. The 
trustees are a little higher between 1.5 and 2 percent of GDP.
    Finally, Mr. Chairman, just in response to an earlier 
question, the final figures from Dr. Walker will probably be 
more authoritative, but raising the tax cap to about 140 or 
$150,000 a year probably saves between .2 and .3 percent of 
GDP. In other words, it would raise Social Security financing 
by .2 or .3 percent of GDP, depending on whether or not you 
allow those extra taxes to accrue benefits when people 
eventually become retirees. So that would help close the gap a 
little bit, but it wouldn't close the gap completely or 
anything even close to that.
    Thank you.
    [The prepared statement of Mr. Lemieux follows:]

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    The Chairman. Jeff, thank you very much.
    Now let us turn to Christian Weller, Center for American 
Progress. Christian, welcome.

   STATEMENT OF CHRISTIAN WELLER, Ph.D., CENTER FOR AMERICAN 
                    PROGRESS, WASHINGTON, DC

    Dr. Weller. Thank you very much, Chairman Craig. Thank you 
very much, Senator Kohl, for inviting me here today to talk 
about individual accounts and Social Security.
    I would like to make the following three points on my 
testimony today: Social Security is a necessary and 
increasingly important component to providing retirement income 
adequacy; second, any expected shortfalls under Social Security 
can be addressed without radically changing the system; and 
third, privatization as an alternative to fixing Social 
Security within the parameters of the system is too risky and 
too costly, especially for low-income families.
    Usually, 80 percent of pre-retirement income is considered 
adequate for a decent standard of living. A substantial 
minority of households, typically one-third, fall short of the 
standard. The shortfalls are especially large for minorities, 
single women, workers with less education, and lower-wage 
workers. To make ends meet in retirement, these households will 
have to curtail their consumption, often severely, and rely on 
public assistance in retirement. Retirement income adequacy has 
also worsened for the typical household over the past 2 years.
    Underlying this trend are three factors: first, pension 
coverage has remained low and declined in recent years; second, 
retirement wealth has become increasing unequally distributed; 
and third, with the proliferation of defined contribution 
plans, such as 401(K) plans, risk has shifted onto workers. 
Against this backdrop, Social Security gains in relative 
importance. Its coverage is almost universal. Its benefits 
favor low lifetime earners and has guaranteed lifetime 
inflation-adjusted benefits.
    Part of Social Security's importance also results, as was 
mentioned before, from its other benefits, in particular 
disability and survivorship benefits. These benefits are often 
at stake when Social Security benefits are reduced to pay for 
privatization, but we have got to keep in mind that Social 
Security benefits are bare bones. The average replacement ratio 
in the U.S. is about half of that in Germany or Italy, and the 
average monthly benefit was about $850 in 2002, yet Social 
Security benefits were 80 percent of income for households--
retirement income for households in the bottom 40 percent of 
the income distribution in 2000, meaning that the private 
sector is still not doing its job to help low-income workers. 
Yet, Social Security trustees predict a financial shortfall in 
the long run. It is anticipated that by 2042, Social Security 
will have exhausted its trust funds and the tax revenue will 
cover only more than two-thirds of promised benefits. An 
immediate and permanent increase of the payroll tax by 1.9 
percent would allow Social Security to cover all its shortfall.
    Social Security expenditures, however, are expected to 
stabilize around 6.5 percent of GDP in the long run, but 
payroll taxes will grow as the tax base of the system shrinks 
at the same time; thus, I would submit, that Social Security's 
expected shortfalls can be addressed within the parameters of 
the system. One example would be the Diamond-Orszag plan, and 
other examples come from the 1994 and 1996 Advisory Council on 
Social Security.
    Privatization, however, as an alternative is too risky and 
too costly, and it would require a large transfer from general 
revenue and large benefit cuts to pay for benefits that workers 
have already earned. With privatization, insurance is replaced 
with savings accounts. That is, the risks are privatized. These 
risks include the risk of misjudging the market and investing 
and losing assets. Another risk is the possibly of financial 
markets staying low for long periods of time. Moreover, workers 
face also the risk that they will exhaust their savings during 
the retirement and, finally, a risk that we haven't paid enough 
attention to, in my view, workers face the risk that they are 
out of work or have low earnings when asset prices are low, so 
they cannot take full advantage of dollar cost averaging.
    Along with the risks, the costs also rise. For one, 
administrative costs rise particularly for low income workers 
in small plans. Most estimates put these administrative costs 
well above 1 percentage point of assets per year. Other costs 
arise from the loss of security. For instance, workers could 
purchase lifetime annuities to minimize longevity risks, and 
they could purchase invest guarantees to reduce market risk. 
However, the cost of lifetime annuities average about 5 percent 
of accumulated savings with higher costs for smaller accounts. 
That means that their benefits are reduced by 15 to 20 percent 
compared to no costs, and the cost of guaranteed minimum 
benefits amounts to about 16.1 percent of annual contributions 
during a 40-year period with a balanced portfolio, according to 
estimates of Professor Mitchell from the University of 
Pennsylvania.
    Some workers are more likely than others to experience 
unemployment and low wages during an economic downturn, thus 
they cannot take full advantage of dollar cost averaging. In 
recent research that I have done with Professor Wenger from the 
University of Georgia, we find that this adds costs similar to 
those associated with annuitization for women and minorities. 
All of these costs will not be offset with substantially higher 
rates of return. In particular, Social Security expected 
shortfalls are based on low growth assumptions, but stock 
market returns follow economic growth over the long run; hence 
if the trustees are correct in their assumptions, the real 
rates of return on the stock market should also fall below 
historical averages.
    Privatization also increases the cost to the Government. We 
already heard a lot about that. Let me just say that in 
addition to greater transfers from general revenue into Social 
Security, privatization would also reduce promised benefits.
    I will end my remarks here, seeing that the light is on. 
Thank you very much.
    [The prepared statement of Mr. Weller follows:]

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    The Chairman. Christian, thank you for very much for those 
comments.
    Let me ask some general questions of all of you and then 
some specific ones. You have all heard Mr. Walker talk about 
the GAO study. What, in your opinion, is the most interesting 
or profound finding in that study?
    Peter.
    Mr. Ferrara. Well, I think it is actually a very 
fascinating study because the conclusions I draw from that is 
that if their projected scenario is correct, it reduces the 
transition costs to large personal accounts because the gap 
that has to be covered is smaller. It also means that personal 
accounts are more urgent because the implication of their 
analysis is that the rates of return are lower under Social 
Security than we have expected so far. So it is an even worse 
deal now today for current workers than we had expected, and so 
it increases the urgency of large accounts, and it also shows 
that because the long-term deficit is smaller, what I have been 
saying all along is that with large accounts, you don't need 
any other reductions in Social Security benefits. You don't 
need price indexing, which is a very large reduction in the 
future promised benefits, and because the large accounts shift 
so much of the burden to the accounts and away from Social 
Security, they eliminate the long-term deficit by itself. That 
is what the chief actuary's score showed.
    Now, the CBO analysis bears me out in this, that you do not 
need price indexing if you go to the larger accounts. You don't 
need any reductions in future Social Security benefits to close 
the gap, because if you go to the large accounts, it eliminates 
the gap by itself, because again, so much of the burden of 
paying for retirement benefits is shifted to the account. When 
you go to larger accounts, they take more of the burden.
    The Chairman. You were speaking mostly of the CBO.
    Mr. Ferrara. Right, the CBO.
    The Chairman. What about the GAO?
    Mr. Ferrara. Oh, I am sorry. I mean, I think the GAO 
analysis doesn't really deal that much with my proposal. I 
think that they are accurate in what they say in laying out the 
parameters, that they show that, for example, adequacy and 
equity are two goals, but I think what is interesting there and 
the most interesting implication I draw out of that is with a 
large account proposal, those two goals are not in conflict. 
Those two goals are both increasingly satisfied, improved with 
the larger account. Benefit adequacy is improved. The current 
system does not provide benefit adequacy. The benefits are 
inadequate in the current system.
    So if you go to the large accounts, you have much bigger 
increases in future benefits, and you have--so it scores on the 
adequacy side, and you have much bigger increases in future 
returns because you can take more advantage of the higher 
returns in the private market. In this analysis, we have got to 
take into account the degree to which different proposals 
enhance future economic growth and productivity. What is 
missing in a lot of the analysis is that when you have large 
accounts or you have so much savings and investment being 
produced into those accounts, those contribute greatly to 
future economic growth. Again, this is based on decades of 
research from Professor Martin Feldstein at Harvard and others 
who have written about it, the CATO Institute, Heritage 
Foundation and others, and so to use words like a ``free 
lunch'', you are ignoring people who use those. You are 
ignoring the economic growth impacts of such a productive 
increase in savings and investment, and all of that becomes 
bigger, much bigger, when you go to the much bigger accounts.
    So they point out these two goals sometimes are in 
conflict. Here, they are both served by the larger accounts, 
both adequacy and equity.
    The Chairman. Jeff.
    Mr. Brown. Well, I would first begin by actually commending 
the GAO on what I think is, methodologically a very well done 
report. The study shows that, as we have learned in the 
academic literature over the last several years, that an 
accurate measure of progressivity requires that one take into 
account the complex household and family interactions. I think 
the most important finding, and one of the points I made in my 
testimony, is that in any reform, whether it includes personal 
accounts or not, it is possible through careful construction of 
the policy to make the system as progressive or as regressive 
as one wants.
    It is sometimes assumed incorrectly that by moving to 
personal accounts, that one necessarily is going to do 
something to hurt the poor, and I think the GAO proves this 
assertion to be false. In fact, it is quite possible to design 
a personal account system that is very good for low-income 
families.
    The Chairman. Thank you.
    Jeff.
    Mr. Lemieux. Thank you. I have a similar reaction. Both 
CBO's work and GAO's work are leading toward a higher level of 
analysis for all of these proposals. For example, until now, we 
haven't really seen from official Congressional or 
Administration sources lots of publications on the 
progressivity of the different plans. I included in our packet 
some tables that show, for example, that the Graham plan does 
seem to increase progressivity fairly substantially, but these 
are based on data that I have cobbled together from a variety 
of sources, some of them unpublished. With the CBO and GAO 
reports, I think we will have more authoritative work on how 
account proposals of varying sizes would affect the 
progressivity.
    The Chairman. Right.
    Christian.
    Dr. Weller. I agree. I have the utmost respect for my 
colleagues at GAO. I think this is a study that moves at least 
some of the issues in the right direction, but I think a lot of 
the debate that we are having is actually not analyzed, and I 
hope that this is the first step in the right direction. In 
particular, the study only looks at progressivity and makes a 
lot of qualifying remarks and in particular on the average 
level of benefits, but also on the financing of the transition 
costs to approach the individual account system. I would also 
submit that I think the study is discounting somewhat the risks 
associated with the individual accounts just by using 
hypothetical examples rather than the full heterogeneity of the 
real word, and I hope that this study is going in the right 
direction in terms of analyzing the complexity of all these 
reform proposals and the costs associated with these reform 
proposals.
    The Chairman. Yes. Thank you.
    Before I go to you all individually, Jeff, you had 
mentioned in your analysis in the different plans the need for 
bipartisanship on this issue and the lack, at least to date, in 
the debate that has gone on. Let me only suggest that this is 
called warm-up rhetoric, that in the end, any reform of the 
Social Security system by its very character will be 
bipartisan. I just believe that firmly and I say that because 
of the character of this institution and the inability to move 
anything that isn't. We just have laid to rest a President who 
recognized the need to become very partisan on the issue of 
Social Security reform back in the early eighties. I happened 
to be there and watched he and another Irishman duke it out 
until they realized they weren't going to get anywhere and they 
need to reform system until they work collectively together, 
and they ultimately did, and I think that that refrain 
certainly stays with me, and I think it stays with most who 
recognize that what we are trying to do is build a base of 
information from which all of us can look, hopefully, with 
limited partisan or philosophical bias, look objectively at a 
system that is critically necessary for the American people in 
the long term and do it right so that we can all benefit.
    Mr. Lemieux. I hope we can achieve that level of 
bipartisanship before we come to a crisis like we did in the 
1980's.
    The Chairman. My guess is there will be a few dust-ups 
before we get there.
    Peter, let me go back to you with a question. How do you 
respond to the critics of personal retirement account proposals 
who argue that they promise reasonably higher returns and 
realistic revenue feedback?
    Mr. Ferrara. Well, the returns that we used are the 
historical, standard historical, market returns. They are 
returns going back a hundred years. They are very similar to 
what the chief actuary uses in his estimates, and most analysts 
use the same returns. I mean, the most authoritative source is 
Ibbotson Associates, where they combine stocks and bonds and 
Federal debt and inflation and report the returns going back 
dozens of years, debt going back several decades, and you can 
use other data and go back 200 years if you want. The returns 
are basically the same.
    Well grounded in the economic literature, I think an 
important fact that people overlook is revealed in the work of 
Martin Feldstein, because the important number here is not 
really the bond returns and not really the stock returns, but 
the before tax real rate of return to capital. If you are 
shifting from a pay-as-you-go system like we have today with 
Social Security, which is just redistribution and not 
investment, and you shift to a system that is real savings and 
investment, the net gain from that is not the corporate bond 
return and it is not the stock market return. It is the before 
tax real rate of return to capital, and that is just overlooked 
by too many people.
    Now, that is where you get the corporate revenue feedback, 
because you see when the accounts buy these stocks and bonds, 
what happens to the money they use to buy them? That goes to 
the corporation selling the stocks and bonds. Corporations use 
that money to make investments, build new plant equipment, 
start new businesses, hire more workers, and they earn money 
back on that. That money that is earned at the corporate level 
is taxed, and that provides the revenue feedback.
    Now, you know, Martin Feldstein, Chairman of the National 
Bureau of Economic Research, is one of the chief progenitors of 
this idea going back to the 1970's, where I learned about it 
when I was a student of his at Harvard, and it is well grounded 
in the economic literature. Moreover, the literature shows 
that, you know, extensive writings over the years, that this 
shift to a large personal account system is going to have a 
very substantial economic growth effects, not just on terms of 
the corporate revenue feedback, but you have got increased 
savings and investment. You have got a more efficient labor 
market. You have got reduced taxes. So the total economic 
growth effects are going to be much larger than was taken into 
account in the chief actuary's score when he included the 
corporate revenue feedback. So that is only a small part.
    If you did a comprehensive analysis of the full economic 
growth effects and the rate of revenue feedback that would 
result, the revenue feedback would be much greater than you had 
there, and you can't take--when you go to the larger accounts, 
you are taking basically 20 percent of the Federal budget and 
now that is going into a savings and investment system. That is 
a big change, and you can't discount the economic effects of 
that, because the economic effects are going to be huge.
    So these are, in fact, very moderate assumptions that are 
used in here. The true reality is going to be, in fact, much 
greater.
    The Chairman. Well, I happen to agree with you in general.
    Mr. Ferrara. Thank you.
    The Chairman. I think that is a very exciting prospect long 
term for our country if we can move in that direction.
    Jeff Brown, in your view, when the President's Commission 
considered funding the transition to a system of personal 
retirement accounts, were they talking about new transition 
costs required by reform or costs that already exist?
    Mr. Brown. That is very good question, because I think the 
transition cost concept is often misunderstood. These are not 
really new costs in a present value sense. What we are really 
talking about here is a re-timing of costs. The transition 
costs will rise because of the fact that we have made benefit 
promises to current workers and retirees, and if we fulfill 
those promises and simultaneously want to fund the accounts, 
that certainly requires that we put more money aside today in 
order to do that.
    Another name for putting more money aside today in order to 
reduce the burden on future generations is saving. What these 
transition costs, if you want to call them that, are simply way 
for us to increase our national saving. So I actually do think 
it is appropriate to refer to these as an investment, because 
while it does require that we as a Nation reduce our 
consumption today, it has the benefit of either reducing tax 
burdens in the future or allowing a higher level of benefits 
and consumption in the future.
    The Chairman. One of the issues raised by critics of 
personal retirement accounts is that of market risk. What 
dimensions should we consider when we think of risk in that, 
Jeff?
    Mr. Brown. Sure. Well, I am a finance professor, and so I 
certainly recognize that the ability to access higher expected 
returns in equity markets does entail an increase in financial 
market risk. However, there are a couple of additional points 
that are worth noting. First, people who make that argument 
often assume that there is no risk to the current defined 
benefit system, and I think that is incorrect when we are 
facing a significantly underfunded system. There is political 
risk to the current system, that benefits and taxes can be 
changed going forward, and having a mixed system like was 
proposed in Model 2 actually allows allowing some 
diversification of political and financial market risk.
    Second that in Model 2 of the Commission, the accounts were 
voluntary, and even if you chose the account, there was no 
requirement that you invest in equities. You could actually 
come out ahead with a very conservative investment portfolio if 
you wanted to. So there are mechanisms in place for managing 
that risk which does exist.
    Mr. Ferrara. May I make a couple of points in answer to 
that question?
    The Chairman. Let me proceed, and then I will let you all 
do a wrap-up response to any other comments that individuals, 
that you as panelists, have made, because we will run out of 
time, Peter, if we don't move through.
    I want to get to you, Jeff Lemieux. Your testimony is 
supportive of personal accounts; however, you do have concerns 
with plans that promise, quote, a free lunch. Could you 
elaborate on the features most associated with what you call a 
free lunch?
    Mr. Lemieux. Yes. I think that it boils down to whether or 
not you are going to make an attempt to pay for the transition 
costs of moving to accounts, whether they are medium-sized 
accounts, small accounts, or large accounts. As Jeff was 
talking about just a second ago, it is really a matter of 
timing and a matter of saving. If we sacrifice now, then we 
will have a better funded system, but implicit in sacrifice is 
paying for the accounts, perhaps, with revenue increases or 
spending cuts or other things. If we don't pay for at least a 
significant share of the transition costs, then we won't really 
be increasing national savings. It will be neutral. We will be 
putting money in people's accounts, but we would be taking away 
from the public account. I think the financial markets would 
view that as roughly neutral, and if that were the case, then 
you wouldn't have any of these potentials for the sorts of 
economic improvements that Peter has talked about. So my main 
worry about the free lunch is that we haven't figured out how 
to pay for at least a substantial share of the transition costs 
in any accounts.
    The Chairman. I think that puts that in context from how 
you see it.
    As a former CBO analyst, you are probably familiar with 
CBO's new projections for Social Security or the Social 
Security system. Are there any real changes in CBO's 
projections compared to the actuaries?
    Mr. Lemieux. I don't think we have had a chance to really 
analyze it deeply, but I did a superficial graphic here in the 
testimony that shows the trends in costs and revenues, and they 
look to me to be substantially similar, certainly within the 
bounds of any sort of reasonable difference of opinion on a 
wide variety of issues. I don't think it changes the story at 
all. We have a demographic and political problem ahead of us 
with Social Security. It is substantial. It is not as big as 
Medicare or perhaps interest, on the national debt but is 
substantial and we should address it.
    The Chairman. OK. Thank you.
    Christian, your testimony is critical of personal 
retirement accounts, yet doesn't really talk about an 
alternative. Do you have any specific ideas of how to address 
the challenge that is obvious with the Social Security system?
    Dr. Weller. I would submit that there is a number of 
proposals out there. We don't have, the Center for American 
Progress doesn't have its own plan. I personally don't have an 
individual plan, but I think there are enough options out 
there. I think one idea that is worth debating is the Orszag-
Diamond plan. The alternative is to go back to the 94-96 
Advisory Council on Social Security, and there are a number of 
options that we could address within the system.
    I would lean probably in the direction away from cutting 
benefits, because I think that the overall benefit structure is 
a bare bones system.
    The Chairman. Yes. Well, in the Diamond-Orszag plan, their 
plan raises taxes on workers and cuts benefits for them in 
their retirement. It is this approach. What redistribution 
features of their plan do you find most attractive or least 
attractive?
    Dr. Weller. I find least attractive the idea of indexing 
benefits, benefits cuts to longevity. I think that we will 
ultimately see an erosion of retirement income adequacy for 
low-income workers. I think the literature is very clear on 
that, that we won't see an adequate commensurate increase in 
private saving to compensate for that. I think the idea of 
raising taxes beyond the taxable limit at this point is an 
attractive feature.
    The Chairman. OK. Now let me turn to all of you, and I will 
start back with you, Peter. You can choose in this last round 
to critique or debate what one other of your panelists have 
said or make a point that you don't feel has been made for the 
record.
    Mr. Ferrara. Well, let me address two issues. One is the 
risk issue. I want to emphasize that in the plan that I have 
put forth, there is Federal guarantee that all workers with 
personal accounts would get at least the benefits promised 
under current law. So in that sense, the risk issue is 
enormously mitigated, if not eliminated completely, for workers 
across the board. This is a flat-out Federal guarantee.
    Now, a second critical part of this risk issue and the 
reason that guarantee works is because the gulf between market 
investment returns and the returns Social Security promises is 
so large, and that is just overlooked in the risk analysis. 
There is virtually no probability that over an entire lifetime, 
the returns in the markets are going to fall below what Social 
Security promises today. In order for that to happen, the 
returns in the stock market over the last 75 years would have 
to fall by 80 percent and stay that low for the next 75 years, 
and that would just give you the return promised by Social 
Security. If that happens, America is going to be a very 
different and far, far less prosperous country than it is 
today. It would be a Third World nation rather than the 
prosperous nation we know. So with that very large gulf, first 
of all, that mitigates the risk enormously. Second, it means 
that you can offer a guarantee like that, and the chief actuary 
in his score scored the cost of the guarantee using the 
standard Federal Government's methodologies for guarantees, and 
the cost was very small because that gulf is so large.
    Now, on the second issue, the transition issue, the free-
lunch issue, people who make this point want to count only tax 
increases or cuts in future Social Security benefits as 
counting in financing the transition, and that is just too 
narrow. I think that what my plan shows and what the chief 
actuary's score shows is you don't need tax increases and you 
don't need cuts in future benefits if you go to large accounts. 
One of the huge implications of large accounts which is not 
fully appreciated, and what I was trying to show through the 
chief actuary score, is how quickly they shift benefits and how 
massively they shift benefits to those personal accounts.
    So why argue about what Social Security benefits are going 
to be in 2050 and argue that we should be cutting them when if 
you go to a large account, people will be actually getting 
better benefits than Social Security even promises from the 
personal accounts. So it is a meaningless argument to argue 
about we need to cut benefits in 2050 when, in fact, if you go 
to the large accounts, that is not even an issue.
    The plan I proposed provides for full and complete 
financing of the transition through reduced personal 
consumption in two ways. One is the reduction in growth of 
Federal spending, which reduces present consumption, and the 
second is devoting part of the increased growth to savings 
rather than consumption. In conclusion----
    The Chairman. My time is going to have to ask you to stop 
at that point.
    Mr. Ferrara. That is fine.
    The Chairman. Thank you very much. I find your ideas very 
exciting, because I look at the opportunity spread across a 
long period of time, and I can't imagine--and yet I know we are 
going to be faced with the reality if we take the current model 
and simply tinker with it, we are going to try to have to look 
out into the future and project benefits in 2050, and I find 
that a rather impossible task for this mind to come up with.
    Jeff.
    Mr. Brown. I would just like to respond to two points, one 
made by each end of the table. The first is that financial 
economists and actuaries actually think very differently about 
the true economic cost of guarantees. As a financial economists 
I would agree that guaranteeing benefits equal to current law 
scheduled benefits is actually extremely expensive, much more 
so than the actuaries analysis would suggest.
    The second point I would make is about plans which would 
not make any benefit reductions whatsoever, such as the type 
that Mr. Weller was referring to. It is really important that 
one not just look at adequacy of benefits without thinking 
about the lifetime tax burden that such a plan is going to 
impose on families. It is a simple mathematical fact that the 
only way that we could guarantee to pay current law scheduled 
benefits without personal accounts is through fairly enormous 
payroll taxes or other tax increases on current and future 
generations, and I think that that has a strong redistributive 
effect as well.
    The final point I would like to reiterate once again is 
that it is actually quite possible to design a personal 
accounts reform that over the long run allows the system to be 
sustainable, but with careful design provide some very strong 
protections for low-income individuals.
    The Chairman. Jeff.
    Mr. Lemieux. I would just like to emphasize the four 
criteria for evaluating reform plans: first, the impact on the 
budget; second, the degree of progressivity. Ultimately, we 
would like Government to be small and progressive, and Social 
Security is no different; third, the opportunities for wealth 
creation and the use of Social Security as a lever to help low-
income people save and accumulate assets; and then, fourth, the 
presence or absence of gimmicks. I think it would be sort of a 
false promise if we tell the next generation, Look, we are 
going to provide you with an attractive new account, and, Oh, 
by the way, we are also going to provide you with an awful lot 
more of the National debt which you ultimately have to pay off 
in one way or another.
    Then the final comment is this hyper-politicalization of 
Social Security has become a problem. Even the most bland or 
technical analysis can sometimes be used for partisan political 
propaganda or other, you know, ways if it is not spelled out 
very clearly what the analysis means, and I am really 
encouraged by the GAO work and the CBO work and always the 
great professional work by the Social Security actuaries to 
just try and spell it out very clearly so that your data isn't 
used in the wrong way and it eventually helps the debate.
    The Chairman. Christian.
    Dr. Weller. I would like to come back to the point that 
individual accounts carry risks with them. I think that some 
risks are understudied, in particular the labor market risks 
that I mentioned here. I think that we need to pay more 
attention to that. In that same vein, I was struck a little bit 
by what Jeff Brown said earlier, and I think we can probably 
find some common ground here. If we care and are concerned 
about savings, National savings, which I am as a macro 
economist, but also personal savings, I think we should have a 
debate over what is progressive savings and what are 
progressive savings policies, but I think that debate should 
happen outside of the parameters of Social Security.
    Social Security is an insurance mechanism, not a savings 
mechanism. Let us leave it at that. Let us talk about 
progressive savings initiatives instead.
    The Chairman. OK. Let me conclude with this brief comment: 
I have been fascinated in the debate over Social Security since 
I came to Congress 24 years ago, and I watched the politics of 
it then and I have watched the politics of it now. I guess the 
analysis that I can use, because I held a lot of hearings out 
in my State and around the country, talking about Social 
Security, talking about all aspects of it, is to watch the 
generational differences at work out there now. They are very, 
very significant, and I don't think we can overlook those, 
Jeff, as your concern relates to the partisans or the politics 
of Social Security.
    Having gone through the debates of the eighties on Social 
Security reform, I would call that the old politics. I think 
somebody not long ago mentioned the old Europe versus the new 
Europe. I would suggest that with the tools we have today and 
the understanding we have today and the youth and their 
frustration about putting such large sums of money into 
something that will return so little or comparatively speaking, 
that the new politics of today, making a single assumption that 
is critical is that those who are currently on or about to go 
on are held relatively whole or whole is going to be a much 
different debate than we have ever had before on Social 
Security and that the political transition this country is 
going through as it relates to these kinds of analysis and 
understanding are going to be considerably different.
    There is a sense of independence out there because of just 
the character of the work force today and the tools that are 
available to it for investment and analyzing its own economic 
concerns that I find at least I am much more excited about the 
idea of a constructive debate on a system that is allowed to 
alter itself into a new form, if you will, over a generation of 
time as being something that really is going to be an exciting 
thing to put this country through, because I have a feeling 
that the country will engage in it very aggressively, at least 
I hope they will.
    That is part of why we are here and part of why we are 
laying this informational base, so that as we move the Congress 
toward this issue in the next few years, we will have well 
established some of the parameters, I hope, for the debate and 
the realities of where we might be able to get with the kind of 
reform that is going to have to be anticipated.
    Gentlemen, thank you all very much for your time before the 
Committee and your effort. I appreciate it.
    The Committee will stand adjourned.
    [Whereupon, at 11:50 a.m., the Committee was adjourned.]

                                 
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