[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



                            SOCIAL SECURITY:
                          DEFINING THE PROBLEM

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

            HEARING HELD IN WASHINGTON, DC, FEBRUARY 9, 2005

                               __________

                            Serial No. 109-2

                               __________

           Printed for the use of the Committee on the Budget


  Available on the Internet: http://www.access.gpo.gov/congress/house/
                              house04.html


                                 ______

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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
ROB PORTMAN, Ohio,                   JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
JIM RYUN, Kansas                       Ranking Minority Member
ANDER CRENSHAW, Florida              DENNIS MOORE, Kansas
ADAM H. PUTNAM, Florida              RICHARD E. NEAL, Massachusetts
ROGER F. WICKER, Mississippi         ROSA L. DeLAURO, Connecticut
KENNY C. HULSHOF, Missouri           CHET EDWARDS, Texas
JO BONNER, Alabama                   HAROLD E. FORD, Jr., Tennessee
SCOTT GARRETT, New Jersey            LOIS CAPPS, California
J. GRESHAM BARRETT, South Carolina   BRIAN BAIRD, Washington
THADDEUS G. McCOTTER, Michigan       JIM COOPER, Tennessee
MARIO DIAZ-BALART, Florida           ARTUR DAVIS, Alabama
JEB HENSARLING, Texas                WILLIAM J. JEFFERSON, Louisiana
ILEANA ROS-LEHTINEN, Florida         THOMAS H. ALLEN, Maine
DANIEL E. LUNGREN, California        ED CASE, Hawaii
PETE SESSIONS, Texas                 CYNTHIA McKINNEY, Georgia
PAUL RYAN, Wisconsin                 HENRY CUELLAR, Texas
MICHAEL K. SIMPSON, Idaho            ALLYSON Y. SCHWARTZ, Pennsylvania
JEB BRADLEY, New Hampshire           RON KIND, Wisconsin
PATRICK T. McHENRY, North Carolina
CONNIE MACK, Florida
K. MICHAEL CONAWAY, Texas

                           Professional Staff

                     James T. Bates, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, February 9, 2005.................     1
Statement of:
    Hon. John W. Snow, Secretary, U.S. Department of the Treasury     7
    Hon. David M. Walker, Comptroller General, Government 
      Accountability Office......................................    45
    Douglas J. Holtz-Eakin, Director, Congressional Budget Office    60
    Peter R. Orszag, Ph.D., Senior Fellow, the Brookings 
      Institution................................................    89
Prepared statement of:
    Secretary Snow...............................................     9
    Mr. Walker...................................................    47
    Mr. Holtz-Eakin..............................................    63
    Mr. Orszag...................................................    91

 
                 SOCIAL SECURITY: DEFINING THE PROBLEM

                              ----------                              


                      WEDNESDAY, FEBRUARY 9, 2005

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:07 a.m., in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Portman, Crenshaw, 
Putnam, Wicker, Hulshof, Bonner, McCotter, Diaz-Balart, 
Hensarling, Lungren, Ros-Lehtinen, Bradley, McHenry, Mack, 
Conaway, Simpson, Spratt, Moore, Neal, DeLauro, Edwards, Ford, 
Capps, Baird, Cooper, Davis, Jefferson, Allen, Case, McKinney, 
Cuellar, Kind, and Schwartz.
    Chairman Nussle. Good morning, and welcome to this Budget 
Committee hearing on Social Security long-term budget 
implications. We also have the opportunity today to talk a 
little bit about the economy. We have before us on the first 
panel, the very distinguished and honorable Treasury Secretary 
John Snow who has been before our committee before. We welcome 
you back to the Budget Committee. We are pleased to have the 
opportunity today to talk about a myriad of issues and subjects 
that--you as one of the principal advisers to the President 
with regard to a number of subjects, not the least of which of 
course is the economy, is an opportunity that we take very 
seriously.
    On our second panel today we will have the U.S. Comptroller 
General David Walker and the Director of the Congressional 
Budget Office, Douglas Holtz-Eakin. They are here today to 
discuss the analysis of their respective agencies with regard 
to the challenges facing Social Security.
    On the third panel we have Peter Orszag, who is a senior 
fellow at the Brookings Institute.
    We are also pleased today to welcome a new member to the 
Budget Committee, Mike Simpson, we are welcoming you from the 
Appropriations Committee. As we all know, because this is a 
leadership committee, we accept members from a number of panels 
as a subcommittee slot, and we appreciate the sacrifice you are 
making in coming over here and in joining our humble crew from 
the Appropriations Committee. Welcome.
    We also understand, if I am not mistaken, Mr. Spratt, that 
you will be welcoming another member as well. We want to yield 
to you for that purpose so you can make that introduction.
    Mr. Spratt. Thank you, Mr. Chairman. I don't see her here, 
but Allyson Schwartz will be coming. She has just been approved 
for membership on this committee by the Democratic Caucus. Oh, 
that was good timing. Allyson Schwartz from Philadelphia, 
Pennsylvania.
    Chairman Nussle. We welcome you to the Budget Committee.
    Mr. Spratt. Is this seat here open?
    Chairman Nussle. That is the unfortunate thing, we show you 
the last seat on the panel. But welcome to our new members of 
the Budget Committee. We are pleased to have your involvement 
on our committee.
    To begin with, I want to make it clear that the purpose of 
this hearing is probably not today to write a bill. I 
understand that there is a lot of interest in coming forward 
and saying, let us skip to the last chapter of the book and 
write the plan, let us get on with it; but we have a lot of 
consideration, I think, to make before we get to that point in 
time. We are not here to try and evaluate specific reform 
proposals because there aren't many to choose from just yet. We 
have a lot of work just defining the problem--just kind of 
getting our arms around it. We know there is a challenge out 
there for Social Security. I think most reasonable people who 
look at the numbers would suggest that.
    In part by holding this hearing, we are trying to help 
prepare the debate by examining and defining the problem itself 
so we as policymakers on the Budget Committee, as well as just 
Members of Congress, can begin to discuss this issue--base any 
plans for reform on a solid understanding of what it is or what 
it is not as a challenge, and what is possible within the 
Federal budget and the parameters that we have before us.
    It is clear from some of what you might call rhetoric, that 
is flying around here lately, that today's hearing is probably 
a pretty necessary step in helping to dispel some of the 
apparent confusion and misinformation around the debate. I 
think we know pretty well that, at least from my colleagues on 
the other side, every chance they get to say the word 
``privatization,'' I think you are going to hear that word 
probably today and forever and ever. Everyone wants to use that 
word. Let us go out and use that word because it seems to poll 
well if you want to scare people about what we are going to do 
with Social Security in the future. Well, I haven't seen 
anything yet that smacks of privatization in the way most 
people I think look at that term. In fact, even the 
revolutionary thought of allowing people to control even a part 
of their own savings I think at best you could say is 
personalization rather than privatization. But I will let 
people have that rhetorical debate because that seems to be the 
interesting part.
    Even before we talk about those specific issues and 
solutions, we need to I think discuss the challenge itself--and 
I thought the President did a good job of doing that in his 
basic, as simple of terms as possible--why is it that Social 
Security is facing such a large shortfall in the future? So I 
will try in a humble way to lay it out as well as I can today.
    Back when Social Security was created, far less was 
demanded of it than it is today. People didn't live as long and 
thus drew benefits for a shorter amount of time. The benefits 
themselves were much lower. And for every one person drawing 
benefits out of the system, there were some 16 workers paying 
into the system. Today, 50 years later, things are a little 
different. Back when Social Security was created, the average 
American's life span was 62 years. Today, it is an average, 
thank goodness, of 77 years. So we are living longer, we are 
drawing benefits for a longer period of time, about 15 years 
longer than when the program was first put into place. Plus, 
the benefits themselves are scheduled to rise dramatically over 
the next number of decades. So today, instead of those 16 
workers paying in for every beneficiary, we now have about 3. 
As I understand it, that number falls to about 2 over the next 
couple of decades.
    So there is the short answer to why Social Security is 
heading for some problems, challenges, crises, depending on 
that word that--who knows how it polls well, but we know that 
there is a challenge out there, a challenge that we have to 
deal with.
    So now let us take a look at where that gets us. By 2018, 
as we are going to hear today, I think quite often, Social 
Security will be paying out more than it takes in. That is a 
shortfall in a little over a decade and unless we make some 
necessary changes, the shortfall will grow larger every year 
after that. Let me make it clear, this doesn't just start 
happening in 2018, as I understand it, the challenge begins 
today and has been going on for quite some time. If we stay on 
the current path, by 2033, the annual shortfall will be about 
$300 billion per year. By the year 2042, the entire system in 
fact by most people's definition of the word ``bankrupt'' would 
be bankrupt.
    So, in a nutshell, Social Security is threatened by a 
looming fiscal imbalance that if left unaddressed will impose 
growing burdens on the budget, on the economy, and on the 
people it was meant to assist. For us to get to the point where 
we can even think about finding a so-called solution, we had 
better make sure that every Member of Congress on both sides 
has a crystal-clear understanding of the challenge that lays 
ahead. Again, it is pretty apparent that that is not 
necessarily the case.
    So, again, that is the reason for us to be here today to 
begin that discussion. Let us all try and do our best to stay 
focused on this. Now, I understand that there will be many 
different solutions that will be put forward by many different 
quarters. They are all responsible, they are all credible, and 
they all deserve our consideration. They shouldn't be just 
lambasted out of hand without consideration, and they should be 
taken in total, as I see it, in the total picture of what 
retirement security is for an individual.
    You know, I don't know about the people that you represent 
but Social Security doesn't make it for most people in and of 
itself. Social Security is part of retirement security. If you 
are going to retire and feel secure, you have got to have 
health care, you have got to have savings, you have got to have 
investments that are working. You have got to have an economy 
that is growing. You have got to have long-term health care. 
You have to be able to make sure your veterans' benefits are 
there, and you have got to make sure your housing is secure. 
You want to live in a safe environment. You want to live in a 
safe community and neighborhood.
    So when you talk about living in a secure retirement, if 
you only focus on Social Security, I think you are missing the 
point. It is an important part of it for those who depend on 
it, certainly, and all of us recognize that and all of us 
believe that. I believe it should be looked at in a much larger 
context, so today we are going to focus on that.
    As I said yesterday, the easiest job in Washington is to 
say, no, that is not going to work; no, I don't like that 
proposal; no, we are not going to do it that way. That is the 
easiest thing to do. But we weren't elected to say no. Inaction 
is not in my opinion a solution to this very vexing challenge. 
So we have to begin that process today. So I would like us to 
focus on that problem.
    That is the purpose behind the hearing. We are very pleased 
to have I believe the administration's point person with regard 
to Social Security, the challenges of retirement security, and 
the economy before us today to discuss those issues. I focused 
on Social Security in my opening comments, but I know that we 
are very interested to hear as well how the economy is doing. 
We heard yesterday it is doing quite well. That is an important 
factor in us getting back to a balanced budget and dealing with 
the myriad of challenges that face our budget and our economy 
and the people that we represent. So we are pleased to have you 
before us today.
    With that, I am honored to turn it over to my friend, Mr. 
Spratt, for any comments he would like to make.
    Mr. Spratt. Thank you very much, Mr. Chairman.
    And, Mr. Secretary, welcome again. We appreciate you 
coming.
    It has been 4 years since President Bush first sent the 
budget up to Congress. At the time we received his first 
budget, the budget was in surplus left over from the previous 
administration. That weekend after the budget came, the 
President made a radio address describing his budget, and I 
made the response to his Saturday morning address. And in my 
response, I implored the President to use some of the $5.6 
trillion surplus then projected to deal with our long-term 
liabilities. I said, Mr. President, we may seem to be sitting 
on an island of surpluses, but we are surrounded by a sea of 
red ink. Not surprisingly, the President didn't take my advice. 
He committed $1.7 trillion of the surplus to tax cuts, nothing 
to long-term liabilities, and today we see the consequences.
    Frequently in discussing Social Security, people develop in 
looking at these 75-year projections a notion of futility that 
the amount of money needed to make the account solvent is just 
overwhelming and unattainable. This simple bar graph shows that 
in choosing tax cuts over Social Security reform, there is 
enough money in the tax cuts for the top 1 percent to make 
Social Security solvent. Almost enough money; $3.4 trillion as 
opposed to $3.7 trillion, which is the actuary's number for the 
present value of the shortfall in the Social Security account.
    But we didn't get anything done about that long-term 
liability 4 years ago. But the Office of Management and Budget 
(OMB), the Director, Mr. Daniel, did assure us that there would 
be a threshold condition--his word, a threshold condition--for 
every budget they submitted. He assured us that no budget they 
submitted would ever invade the Social Security surplus. That 
was the threshold condition.
    If you recall, the Clinton administration had moved the 
budget into surplus for the first time in 30 years. And when 
that surplus reached $236 billion in the year 2000, both 
parties in Congress, both sides of the aisle began to talk of a 
lockbox in which to keep the Social Security surpluses so that 
never again would those surpluses be used to buy new Government 
bonds and fund Government spending. We wanted to use the 
surplus to buy and retire outstanding Treasury bonds. 
Congressional Budget Office (CBO) told us that if Social 
Security followed this strategy diligently buying up 
outstanding bonds, then some $3 trillion in Treasury debt held 
by the public could be bought back, retired, over the next 10, 
12 years.
    Now, the lockbox had a corny name, I will grant you, but 
underlining it there was a serious idea. Each dollar of 
Treasury debt retired would be a dollar added to net national 
savings. That would in turn lower the cost of capital, and that 
in turn would spur economic growth. And, furthermore, when the 
baby boomers began to retire, the Treasury would be burdened 
with far less debt and be much stronger to meet the 
obligations, the long-term obligations of our Government, 
specifically Social Security.
    Well, the $5.6 trillion surplus was soon dissipated and 
replaced by ever-increasing deficits, $375 billion in the year 
2003, $412 billion last year, 2004, and $427 billion OMB tells 
us this year 2005. In each of these years, the Social Security 
surplus was borrowed and spent in toto, all of it. So much for 
the lockbox. Instead of paying off debt, this administration 
has built up debt, a mountain of debt.
    As this next table shows, the Treasury, the administration, 
who had to come to Congress three times in the last 4 years to 
ask for the legal ceiling on what the Government can borrow, 
how much debt we can incur, to ask that the debt ceiling be 
raised three times: $450 billion in 2002, $984 billion in 2003, 
$800 billion last November, a total of $2.234 trillion. At that 
rate, today we are incurring $1 trillion of additional debt of 
the United States every 18 months. Surely this is not a 
sustainable course.
    Now you decided that Social Security will be broke soon and 
needs fixing. But the solution that you are pushing, private 
accounts, really does little if anything to fix the solvency of 
the system. And by allowing payroll taxes to be diverted from 
the Social Security Trust Fund into private trust accounts, you 
add $4.9 trillion to the deficit over the first 20 years, by 
our calculation, $4.9 trillion to deficits over that 20-year 
period and to the national debt during that time, to be stacked 
on top of other debt that could easily reach $12 trillion 
within the next 10 years. Surely there is a limit somewhere.
    In pushing this proposal, the administration described 
Social Security in dire if not crisis condition, in need of 
urgent attention. You say that in 2018 Social Security will go 
cash negative. The Chairman just said it would hit a shortfall. 
Well, in one sense that may be true, but it is also true that 
Social Security at that point, 2018, will be sitting on a trust 
fund of over $2.5 trillion in Government bonds, and that corpus 
will increase to $7 trillion by the year 2028 when Social 
Security will begin redeeming its bonds to add to its dedicated 
revenues so that it can pay benefits in full. I don't consider 
a $5 trillion nest egg or a $7 trillion nest egg insolvency 
yet.
    The other night the President in the State of the Union 
said somehow in the year 2028 the Government of the United 
States is going to have to come up with $200 billion to give to 
Social Security. Well, I surely hope that the U.S. Government 
can come up with $200 billion to give to Social Security when 
it is sitting on a nest egg at that point in time of $7 
trillion in Treasury bonds.
    Now, there are detractors of Social Security who say that 
these trust funds are fiction, and that the Treasury bonds they 
hold are just scraps of paper, IOUs. I hope, Mr. Secretary, 
that you will set this record straight today, that you will 
assure us and bondholders around the world that the U.S. 
Treasury will uphold the full faith and credit of the United 
States and meet its obligations as they come due, and that 
these bonds are just as strong as the economy and the full 
faith and credit of our Government.
    To wrap up, Mr. Chairman, Mr. Secretary, if we on this side 
don't agree with the solution that you are advancing, it is 
partly because the logic of it escapes us. First of all, this 
problem is brought on because the Social Security Trust Fund 
may not have sufficient assets to meet its obligations in full 
through 2042 if you listen to the actuaries at Social Security, 
or through 2052 if you listen to CBO. The actuaries give us the 
present value of the shortfall at $3.7 trillion. Your solution 
is not to add to that shortfall to try to make it sufficient, 
but to subtract from it by allowing payroll taxes to be 
diverted into private accounts, which makes the problem worse; 
the shortfall greater, not better.
    Second, private accounts may or may not be a good idea, but 
they do little to make Social Security solvent over the next 75 
years. You achieve solvency by reindexing the primary insurance 
amount which over 50 years will slash the budget, slash Social 
Security benefits in half.
    Third, the critical dates that the administration keeps 
referring to, 2018, 2028 and 2042, will all be advanced by many 
years if the diversion of payroll taxes is allowed, 
particularly at the level of 4 percentage points off FICA. 
Social Security may then go negative, cash negative, as early 
as 2012 instead of 2018, and the trust fund may be exhausted as 
early as 2031 rather than 2042. To pay benefits in full, Social 
Security under the proposal you are making will have to begin 
borrowing in the 2020s and borrow in the trillions until the 
midpoint of the century. As the Secretary of Treasury, we would 
like you to explain to us how the U.S. Government can stack 
debt on top of debt in these amounts.
    Now, we all agree that Social Security is faced with a 
challenge, that the sooner we resolve it the easier it will be. 
But we simply can't see the merit in the solution that requires 
us to borrow $5.9 trillion over the first 20 years and 
trillions more thereafter, or in a solution that cuts benefits 
for new retirees in half over 50 years. And we can't buy the 
notion that this is the only solution we have to choose from.
    In 1983, I was here, the retirement trust fund was in dire, 
dire condition, in danger of running dry in July 1983. Mr. 
Reagan appointed, with congressional consent, a bipartisan 
commission headed by Mr. Greenspan. It recommended a number of 
changes that have assured the solvency of Social Security for 
60 years, from 1983 to 2042. This model was shown to work then, 
and there are still today menus, whole menus of ideas to choose 
from if we chose that model again.
    So I say to you, Mr. Secretary, why not tune up the model 
we have got, the Social Security system that has served America 
so well for more than 50 years, as opposed to trading it in for 
a vehicle that has never been around the track and never been 
proven to work.
    We look forward to your testimony and to the questions that 
we will put to your afterwards. Thank you again for coming.
    Chairman Nussle. Mr. Secretary, welcome to the committee. 
We are pleased to receive your testimony at this time, and your 
prepared remarks will be made a part of the record as well. 
Welcome.

             STATEMENT OF JOHN W. SNOW, SECRETARY,
                U.S. DEPARTMENT OF THE TREASURY

    Secretary Snow. Thank you very much, Mr. Chairman. Mr. 
Spratt, thank you. I greatly appreciate the chance to appear 
before you again. I always look forward to this opportunity, 
always a good exchange of views and the lively discussion that 
ensues.
    Let me say that in the intervening years since I appeared 
before you last, we have made an awful lot of progress with the 
American economy. I know how pleased you must be, as we are in 
the administration, with the fact the American economy is now 
on a really good strong course. It is a tribute to the 
Congress, the leadership the Congress provided in enacting the 
President's tax cuts, because at the very center of the strong 
recovery that the American economy is enjoying today are those 
tax cuts.
    And it is interesting to go back and look at the growth 
rates in the economy and job creation in the economy before 
those tax cuts took effect and what happened immediately 
thereafter. It was almost like a light switch went on in the 
American economy. As businesses began to take advantage of the 
expensing provisions that you made available, the greatly 
expanded expensing provisions, as the accelerated tax credits 
took effect, as the lower marginal tax rates took effect, as 
the dividends and capital gains reductions took effect, equity 
markets expanded, capital spending picked up, jobs picked up, 
and GDP picked up. And, Mr. Chairman, you know these numbers, 
but last year we had a 4.4 percent growth rate in GDP. We have 
had the best--for the last 18 months since the legislation took 
effect, the best growth rates in GDP in about 20 years; 2.7 
million jobs. And yet inflation stays low because productivity 
is high.
    The housing market is strong, the best we have ever seen. 
More home ownership in America today than any time in our 
history. National wealth, household wealth, the highest ever.
    I cite this to you to suggest we are on the right course, 
and we are going to continue on that course. And the budget 
that is before you is designed to assure that we do that.
    That is why the President has asked to make the tax cuts 
permanent. I think the results of the jobs and growth bill 
demonstrate the importance of a low-tax environment for the 
success of the American economy.
    I contrast our economy with Europe. Our economy has much 
lower tax rates, we have much higher growth rates, we have much 
higher employment rates. And we are creating lots of private 
sector jobs while the Euro zone isn't.
    But we also recognize that we need to focus on the deficit. 
This budget tries to do that. It sustains the path that the 
President called for to cut the deficit in half over the course 
of the next few years, by the time he leaves office, to bring 
it to a level--and this is important--to bring it to a level 
which is low by historical standards. Forty-year average is 
something like 2.3 percent of GDP. The President's budget 
carried out over the window, the budget window period, would 
bring that deficit down well below 2 percent.
    There are two keys to bringing the deficit down, and you 
know what they are. One is to continue the growth of the 
American economy; because if the American economy stays on a 
good growth path, not surprisingly, businesses become more 
profitable, more small businesses are established, 
entrepreneurship is rewarded, jobs are created, and we have 
businesses paying more taxes and we have individuals paying 
more taxes, and thus Government receipts rise. And we have seen 
that. And the budget lays out a path of increasing Government 
revenues as the economy gets stronger and stays on the growth 
path with--and this is a very important point--with revenues as 
a percent of GDP rising back up to their historic level of 
about 18 percent.
    That suggests to me that our problem with the deficit isn't 
that we are undertaxed. Quite the contrary, it seems to me to 
suggest quite plainly that the problem is that we spend too 
much.
    And that brings me to the second part of the equation. The 
first part is growth; the second part is spending restraint. 
And you can argue with the particulars of the budget that we 
have sent up, but the key message from the budget is spending 
restraint is awfully important to keep us on a path of fiscal 
responsibility.
    But the President is not simply focused on the 5-year 
window, important as that is. I think we are in good shape on 
that. He is also focused on the longer term, where I think 
Budget Director Josh Bolten yesterday talked to you about the 
long-term problems growing out of Medicare and Medicaid and 
Social Security, and the need to deal with these unfunded 
obligations.
    That is one reason the President has put Social Security 
forward as a major national issue. It is why he made it the 
focal point of his State of the Union message. Social Security 
is a great part of the fabric of America. It is important that 
we sustain it, it is important that we secure it, it is 
important that we make the benefits of Social Security 
available to future generations, to the young of America.
    And yet we all recognize, I think, that there are real 
problems there. Mr. Spratt acknowledged there were problems. It 
is hard not to acknowledge the problems. It is not what we are 
saying, it is what the actuary, the nonpartisan actuary of the 
Social Security Administration is saying. It is what CBO is 
saying, it is what the Government Accountability Office (GAO) 
is saying. And I am glad you will be hearing from them later in 
the day.
    All the people who really know the numbers come to the same 
conclusion: The system is in real trouble, real trouble. And in 
2018, the outflow exceeds the inflow. That is not a good sign. 
There is a trust fund with a surplus in it, that, Mr. Spratt, 
we will honor the bonds in the trust fund. Of course we will. 
They carry the full faith and credit of the United States. As 
with all obligations of the United States, they will be 
honored. But the bonds run out in 2042. And in 2042, with no 
surplus left in the fund, the fund must fall back on its own 
revenues, and its own revenues are only sufficient to meet 
about 72 percent of its obligations. So if we wait until 2042, 
we are going to shortchange the future retirees.
    We can do better than that. That is why the President has 
put this issue on the table. We can do better than that. And 
the personal accounts provide younger people an opportunity to 
build a retirement, to build a nest egg for retirement, to take 
advantage of what Albert Einstein called the most powerful 
force in the universe, Congressmen, the power of compounding. 
And a young person of 24 who retires now has 40 years-plus of 
compounding of market returns to build a nest egg for their 
retirement. With that, they will do better than they would 
under the Social Security system that can't fulfill its 
promises.
    So I think, while you may not agree with the solutions that 
have been put forward, at least I think we need to acknowledge 
that the President has provided real leadership here in taking 
the issue of Social Security to the American people, of 
focusing on our children's retirement security. He could have 
passed this one up. He could have passed it on to another 
President, he could have passed it on to another Congress. He 
decided that the responsible thing to do was to confront it and 
to address it.
    In confronting it and addressing it, though, he said to 
seniors, we are not going to affect your benefits. If you are 
55 or older, your benefits are absolutely secure. They won't be 
affected. He said to younger people, we need to work now to put 
in place savings vehicles for you so your retirement security 
can be better.
    And I think he has performed an extraordinarily important 
national service by calling attention to the problem.
    People object to the term bankruptcy, that Social Security 
is going bankrupt. Bankruptcy is in fact the condition--
impending bankruptcy is in fact the condition that Social 
Security faces in the very same sense that a private sector 
company--and my career has been in the private sector--that a 
private sector company that can't meet its obligations goes 
into Chapter 11 or Chapter 7 and restructures. In that sense, 
Social Security is heading for bankruptcy. We don't have to let 
it happen. By acting now, we can avoid those consequences, we 
can avoid a huge future burden on the young, and we can give 
them a much better retirement security.
    For all those reasons, Mr. Chairman, I thank you for the 
chance to be here and talk about this critically important 
issue. Thank you very much.
    Chairman Nussle. Thank you, Mr. Secretary.
    [The prepared statement of Secretary Snow follows:]

Prepared Statement of Hon. John W. Snow, Secretary, U.S. Department of 
                              the Treasury

    Good afternoon and thank you Chairman Nussle and Ranking Member 
Spratt for having me here today to discuss the President's budget. I 
think you'll find that it exhibits a dedication to fiscal discipline, 
transparency, and economic growth.
    By focusing on priorities and looking for savings in every agency, 
across the board, the President's administration has come up with a 
budget that we believe is fair while also holding the Government 
accountable. As the President announced in his State of the Union 
Address last week, this budget adheres to the principle of ``Taxpayer 
dollars must be spent wisely, or not at all.''
    It holds the growth of discretionary spending to just 2.1 percent, 
below the expected rate of inflation. Non-discretionary spending in 
this budget falls by nearly 1 percent, the tightest such restraint 
proposed since the Reagan administration.
    This administration appreciates that cutting taxes and exercising 
fiscal discipline must go hand in hand. We appreciate that this is the 
people's money with which we are dealing, and that we work for the 
taxpayers.
    That is why we are committed to making the President's pro-growth 
tax cuts permanent and building on our strengthened economic 
fundamentals as we submit to you a budget that will increase the 
efficacy of our Government programs without over-spending the 
taxpayers' money.
    Over the weekend, the finance ministers of the G7 met--the U.S. was 
represented by Treasury Undersecretary for International Affairs John 
Taylor--and they discussed the importance of promoting and achieving 
economic growth in our countries, as well as keeping our respective 
financial houses in order. These two issues are inextricably linked.
    The way that we, as the executives of the Federal Government, 
manage the taxpayers' money sends a message to the people of America as 
well as to our trading partners and investors around the globe. When we 
control our spending, we are showing our citizens and the world that 
fiscal discipline is a priority on par with our policies that promote 
economic growth.
    I'll talk more about fiscal discipline in a moment, but I'd like to 
start with a look at what we have recently achieved through pro-growth 
economic policies.
    Well-timed tax cuts, combined with sound monetary policy set by the 
Federal Reserve Board, have resulted in very good economic growth and, 
most importantly, continual job creation. The economy has created over 
2.7 million jobs since May of 2003. And while job growth can never be 
fast enough for those looking for work, the steady pace of job creation 
has been an unmistakable sign of an economy that has recovered from 
very tough times, and is now expanding.
    Whenever I speak with my counterparts in the G7, I am reminded that 
the American economy is the envy of the world. Our recovery and growth, 
our successful dedication to entrepreneurship--all these things are 
admired, and increasingly emulated, by our G7 partners.
    Is it any wonder that they want to learn the secret to our economic 
resiliency? A quick look at the facts reveals much to be envied: GDP 
growth for 2004 was 4.4 percent. Our economy has posted steady job 
gains for twenty straight months. The unemployment rate is down to 5.2 
percent--lower than the average rate of the 1970s, 1980s and 1990s. 
Real after-tax income is up by over eleven percent since the end of 
2000 and household wealth is at an all-time high. Inflation, interest 
rates, and mortgage rates remain at low levels. Homeownership rates are 
at record highs.
    Tax cuts can be hard on budgets and deficits in the short term, but 
if the tax cuts are geared toward improving incentives there are long-
term benefits as well as short-term ones, and this fact has been well 
illustrated by these outstanding economic results.
    I point to this record because it is so important that we continue 
on a pro-growth path. Continued economic growth is needed, and will be 
needed, to continue to improve our standard of living and until every 
worker in America who is still looking for a job can find one.
    For example, we've got to make the President's growth-enhancing tax 
cuts permanent--and that is included in this budget. The President's 
Panel on Tax Reform was also created with economic growth in mind. It 
is a group of some of the best minds in our country, and they'll be 
looking critically at the entire existing code and coming up with 
proposals that would make it fairer, less complex, and more pro-growth.
    While the Panel is working on that historic task, our efforts to 
grow the American economy will continue in many other areas--I am 
particularly interested in legislation that will reduce the burden of 
frivolous lawsuits on our economy--and this budget is part of the 
administration's overall pro-growth policy agenda.
    As I already mentioned, economic growth is good for our country for 
the jobs it creates and the prosperity it spreads. But it is also, 
importantly, part of a winning strategy on deficit reduction--one of 
the top priorities of this budget--because economic growth increases 
Treasury receipts.
    Treasury receipts are rising--in the second half of calendar 2004, 
individual income tax revenue is up 10.5 percent versus the same period 
in 2003--and will continue to rise, as long as we have economic growth. 
That must be accompanied, as I emphasized earlier, by strict fiscal 
discipline. That is why the President's budget proposes real savings. I 
know it will have its critics as a result, but its frugality is 
essential.
    Let me be very clear on this: we have deficits and they are 
unwelcome. But we are not under-taxed and higher taxes will not be the 
solution to reducing deficits. Fiscal discipline, combined with 
economic growth, is the correct path.
    Using this approach, we are making headway on deficit reduction, 
and we're on track to halve the deficit by 2009. The deficit is also 
forecast to fall to 3.0 percent of GDP in 2006 and to 1.5 percent by 
2009, well below the 40-year historical average of 2.3 percent of GDP.
    The 2004 deficit came in at 3.6 percent of GDP--nearly a full 
percentage point lower than had been projected. And the 2005 deficit is 
projected to show another decline.
    While we are pleased with this progress, we recognize that more 
needs to be done.
    We need to make the tough choices on spending and stand steadfast 
in our commitment to continuing economic growth in order to see that 
deficit whittled down.
    We also need to look at our long-term deficit situation. I spoke 
earlier about transparency, specifically the honesty of this budget, 
which deals openly with the needs of the times in which we live, from 
the war on terror to the need for continuing growth.
    In the interest of honesty and transparency, I encourage all of us 
to follow the politically courageous leadership of our President by 
looking at, and dealing with, the $10.4 trillion deficit facing our 
children and grandchildren in the form of an unsustainable Social 
Security program.
    The program is an important institution, a sacred trust, and it 
worked well for the times in which it was designed. It is, however, 
doomed by our country's demographics and in need of wise and effective 
reform.
    The arithmetic is simple. As people live longer and have had fewer 
children, the ratio of workers paying into the system and retirees 
taking benefits out has dwindled dramatically. We had 16 workers paying 
into a system for every one beneficiary in 1950, and today we have just 
three workers for every beneficiary. That ratio will drop to two-to-one 
by the time today's young workers retire.
    We all must agree that this demographic reality exists, that this 
problem exists. Social Security is secure for today's retirees and for 
those nearing retirement, it will not change for those people who are 
55 and over... but it is offering empty promises to future generations. 
When today's young workers begin to retire in 2042, the system will be 
exhausted and bankrupt.
    It is the future of the program that President Bush is concerned 
about, and it is the future of the program that we must address, this 
year, here on Capitol Hill. I echo the President's State of the Union 
Address in saying that we must join together to strengthen and save 
Social Security.
    We can, and should, do this without increasing payroll taxes. The 
level of increases that would be necessary, if we maintain the status 
quo, would have a terrible impact on our economy. It would negatively 
impact economic growth; jobs would be lost. We don't have to go that 
way.
    We can, and should, reform the system in a way that encourages 
younger generations of workers to build a nest egg that they own and 
control and can pass on to their loved ones.
    Saving Social Security is an undertaking of historic proportions. 
We have hard work ahead of us as we strive for consensus in the name of 
younger generations.
    We also have hard work ahead of us when it comes to strengthening 
the fundamentals of our economy: deficit reduction, good fiscal policy, 
energy policy, lawsuit abuse reform, and encouraging savings.
    I appreciate that this administration has an ambitious agenda... 
but it is a good one, worth the work it will take to move forward, 
together, on it.
    Let's start by passing this responsible, pro-growth budget.
    Thank you for having me here today; I'm pleased to take your 
questions now.

    Chairman Nussle. Let me start, if I might, by going back to 
what my friend Mr. Spratt opened with, and that is with regard 
to the deficit, because we are here to talk about the budget as 
well. I have just got to say this again. As many times as my 
friend--and he is my friend and he will continue to say it, and 
he is technically correct--that on September 11 and thereafter 
we started running deficits. It didn't just happen, on 
September 10 we were running a surplus, and on September 11 and 
12 and on and on and on, yeah, we started running deficits. But 
they didn't just happen. We made deliberate decisions about 
strengthening the economy, about dealing with the emergency, 
about strengthening our homeland security, about improving our 
intelligence, about prosecuting a war on global terrorism. 
Those decisions, many of which were bipartisan decisions, were 
deliberate.
    So, yes, we find ourselves in a deficit; yes, we are going 
to run a tight budget, Mr. Secretary, the way we did last year, 
and we are going to hopefully get results that we saw last 
year.
    As we all remember, and you came in and reported to us--and 
let me just show you a chart. You reported to us last year that 
we were going to run a $521 billion deficit, well, we didn't. 
When we closed the books, it was $412 billion. In 1 year we 
were able to reduce the deficit by $109 billion. I know my 
friends will tell me, don't get too pumped up about that 
because you didn't do it all by yourself, and I know that. Our 
constituents did it--it is called the economy.
    Our economy is a beautiful thing. When it gets unleashed 
and it starts growing, it can do miraculous things like it did 
last year. With tight spending restraint--we can be tighter. 
But with tight spending restraint and with a growing economy we 
can begin to reduce some of the challenges that we have such as 
the deficit. But the challenges of the war, the challenges of 
international relations that we have out there, the challenges 
of intelligence, of homeland security, they are still there. We 
want the economy to keep growing, so we don't want a tax 
increase right now.
    So we are going to keep the economy growing, and you can 
report back to the President that his budget is alive and well 
on Capitol Hill.
    Having had the opportunity to meet with the budget director 
yesterday and talking to my colleagues and our leadership and 
members, we believe that we can get it done. Now, it is going 
to be tough, because all of that spending, as you well know, 
got there for a reason, and each and every one of us can 
identify something that we voted for and some important 
challenge for our State, district, or country that we believe 
in. So it all got there for a reason. You have our commitment 
that we are willing to work with the President in order to 
reduce this deficit and continue to meet our challenges. But a 
growing economy is an important part of this factor.
    Now, turning to the subject that we have today. So, if our 
economy is growing and growing so well, let us just grow out of 
this problem. I mean, come on, Mr. Secretary, our economy is a 
beautiful thing. Let us just grow out of the problem of Social 
Security, I have heard people suggest that.
    The interesting thing about it is, I heard the same thing 
back in the 1980s and 1990s when Republicans said let us just 
grow out of something, and, boy, we were lambasted for saying 
we can just grow out of the problem. Now I hear it from my 
friend on the other side that, just let us grow out of the 
problem of Social Security.
    So I would like you to address the grow-out-of-it 
opportunity that we have. Can we grow out of the problem that 
we face with regard to the challenge of Social Security?
    Secretary Snow. Mr. Chairman, thank you. Unfortunately, no, 
we can't grow our way out of the Social Security problem. With 
the economy as a whole, growth helps us an awful lot in dealing 
with the deficit because we pick up the top line, the revenue 
line. Unfortunately, the way Social Security is structured, 
growth translates into higher benefit levels and higher payout 
levels. So growth in and of itself has very little effect 
because of the benefit formula in Social Security, in improving 
the solvency of Social Security. I wish it were otherwise, but 
the fact that the benefits are indexed to wages and wages 
reflect productivity and growth in the economy makes growth in 
and of itself not--not--very helpful in solving the 
sustainability issues of Social Security. It will help, I must 
say, it will help a lot in dealing with the larger Federal 
deficit, but it won't Social Security as such.
    Chairman Nussle. Well, I have also heard that there are 
those who suggest that the Government--the Government, you 
know, at the appropriate time, I assume they mean the Federal 
Government at the appropriate time, and I assume that means 
2018 or 2019 or whenever we start running into this challenge, 
that we should just replenish the account, we should just 
replenish the trust fund, we should just start paying the 
benefits. You know, just put the money in there. Why is that, 
in your opinion, something that might or might not work?
    Secretary Snow. Mr. Chairman, the notion of replenishing 
the trust fund sounds appealing on the face of it, but how 
would it be replenished? It would be replenished by tax 
increases in the most likely case. The tax increases that would 
be required to put Social Security on a sustainable basis would 
roughly double the current taxes, 50 percent increase in the 
current tax rate. And I would hate to see us go down that path 
because a 50 percent increase in Social Security taxes, which 
is required to put the system on a sustainable basis, would 
almost surely wreck the American economy. It would almost 
surely lead to very high unemployment rates, very slow growth 
rates, perhaps a recession.
    And I look at Europe and the Euro zone and their tax rates 
on labor versus ours, and you see the consequences, you see 
them visibly right before your eyes. Their growth rates are 
about half of ours, their unemployment rates are twice as ours. 
They aren't creating anywhere near the number of private sector 
jobs we are. We don't want to go that way, in my view.
    The other way is to cut other programs. That is a tough 
course to follow. And the third way is to borrow. And you will 
say, but you are borrowing; and I will say, yes, we are. But 
there is a big difference in the sort of borrowing we are 
proposing to fund the personal accounts and the sort of 
borrowing that would be required simply to put money into the 
trust fund.
    Chairman Nussle. What is that difference?
    Secretary Snow. Well, the big difference is that by doing 
it the way the President has proposed with his personal 
accounts, we are borrowing to save. Every dollar borrowed 
becomes a dollar saved, as opposed to every dollar borrowed 
becoming a dollar spent. That has far different effects on the 
national accounts of the United States and on the economy of 
the United States. The President's proposal will translate 
borrowing into savings.
    Chairman Nussle. Well, give me an example. I am borrowing 
$100, all right? Let us keep it real simple so I can explain it 
to my son who, according to the charts, isn't going to have 
Social Security. So I want to be ale to explain this to my 14-
year-old son. All right? So I have got $100 that I want to 
borrow. Now, what is the difference between borrowing that to 
save and borrowing it to spend? I mean, isn't it still 
borrowing $100?
    Secretary Snow. It is borrowing $100 in both cases. But in 
the case of your son and his personal account, the money, the 
$100, becomes part of the capital stock of the United States; 
it becomes part of the savings of the United States; it becomes 
capital used to strengthen the growth of the American economy. 
The spending--and it may well be for a very good purpose--but 
the spending is spent and it is gone. The savings becomes part 
of the capital base of the United States.
    Chairman Nussle. Does it grow?
    Secretary Snow. And with time certainly it would grow. One 
of the beauties of the personal accounts is the opportunity to 
use this power of compounding, which, according to virtually 
all financial analysts, if you get a mutual fund-type 
investment with 60 percent equities and 40 percent bonds, put 
the $100 away, over a 40-year period that $100 is going to be 
worth a huge multiple of the $100. So the $100 becomes many 
times the $100 available then to your son when he retires. The 
difference is it is savings rather than spending. Spending 
disappears; savings builds and grows.
    Chairman Nussle. And then I have got to understand why this 
is so urgent. I mean, you know, 2018, most politicians only 
worry about the next election around here. Some think a little 
bit further than that, but by and large we are not used to 
thinking more than about the next election. You have to pardon 
us a little bit. You know, 2018 is a lot of election from now 
for most people. So why is it so urgent? I mean, can't we just 
wait until--how about let us try 2016? Why does the problem get 
so much worse between now and 2016 that we can't just wait and 
deal with it then?
    Secretary Snow. Well, again, Mr. Chairman, citing the 
actuary of the Social Security system, every year we put this 
off, every year we postpone action, the problem becomes bigger 
and bigger and bigger and bigger. As I recall the actuary's, 
assessment, the problem rises at the rate of about $600 billion 
a year. And whereas today, if the problem were solved simply by 
reducing benefits or simply by the shortfall or solved simply 
by raising taxes, you could do so with a 3.2 or 3.3 percent 
reduction--or increase. If you wait, you are going to have to 
have a 6.5 percent, 7 percent-type increase. So by acting now, 
by acting now we have the ability to put in place solutions 
that are far less costly. And we also by acting now have the 
opportunity to put in place these accounts which will use the 
power of compounding, take that $100 and make it many times the 
$100 the future when younger people like your son move to 
retire.
    We also by acting now I think show good faith with markets. 
Markets are watching us. Markets ultimately render judgments on 
people in positions of political leadership. I think the 
markets are giving us credit. They are saying, yes, you are 
going to address this problem. The issue is important because 
that $10.4 trillion obligation is out there and it hangs over 
the markets. By showing responsible behavior in defeasing it, 
in removing it, we are keeping faith with the financial markets 
of the United States and the financial markets of the world. 
And that sustains low interest rates. And low interest rates 
are one of the principal things we have going for us in 
sustaining a strong economy.
    So for all those reasons, Mr. Chairman, I would suggest 
that we really have no option but to act now. The problem is 
urgent, and the sooner we act the better. And the longer we 
wait, the bigger the problem becomes and the harsher the 
solutions.
    Chairman Nussle. Thank you, Mr. Secretary.
    Mr. Spratt.
    Mr. Spratt. Thank you very much, Mr. Chairman.
    Mr. Secretary, we are trying hard to understand this 
proposal in full. This is a Budget Committee, and our 
understanding of it thus far is it will have an enormous impact 
on the budget for years to come. In fact, if the borrowings to 
finance transition are of the magnitude we expect, I don't 
think we will see a balanced budget again in our lifetimes.
    You know enough apparently to give us a number, $754 
billion, as the cost during the first 10 years, assuming 
implementation of your proposals in around 2009 to 2011. Can 
you tell us what you expect the cost to be in the first 10 
years after full implementation and in the second 10-year 
period thereafter?
    Secretary Snow. Mr. Spratt, I can't because----
    Mr. Spratt. Can you give us an approximation?
    Secretary Snow [continuing]. I don't yet have a detailed 
understanding of what will come out of this legislative 
process.
    Mr. Spratt. I am asking what you are proposing, not for 
what we produce.
    Secretary Snow. Well, until we know the details, though, of 
the proposals that will come from the negotiations with 
Congress, the process that has now been launched, it is very 
hard to quantify what those future costs would be. But, I mean 
I certainly would grant you that the borrowing wouldn't cease 
at the end of the 10-year period; it would have to go on. And, 
but I have not run any or seen any runs of an--actuarial runs 
of what the next 10 years and the 10 years after that would be, 
because I think it depends so much on the details. But we have 
to acknowledge that it is going to be a continuing budget item 
going forward.
    Mr. Spratt. Well, if you haven't seen the details as 
Secretary of Treasury, how can you pass judgment on them?
    Secretary Snow. We have seen the details and we have made 
available the details of the proposal for the first 10 years. 
But what happens with the cap, what happens with the 
contribution levels and so on, and what happens with the other 
aspects of the Social Security proposals is something that 
isn't knowable at this point.
    The President has put forward four or five options for 
dealing, in addition to the personal accounts, for dealing with 
the problem. He has invited Members of Congress to join him in 
thinking about the problem and coming up with other ideas. He 
doesn't think we have got all the good ideas.
    Mr. Spratt. But you are his point man. The reason we are 
putting the question to you is you are the chief numbers 
operator in the Bush administration, and we are trying to get 
some financial explanation of what the impact of this proposal 
will be on our budget. And we are finding it a very elusive 
pursuit. We aren't even able to find out what the cost is going 
to be over the first 20 years, although we know it is going to 
be significant. By our calculation, it is going to be close to 
$5 trillion in additional debt of the United States. Does that 
comport with your back-of-the-envelope analysis?
    Secretary Snow. Well, Mr. Spratt, as I say, I don't have 
the runs on that, the actuarial runs on that, so I can't 
confirm that. It sounds a little high to me. But certainly 
there would be continuing borrowing requirements and interest 
payments requirements. But remember, net-net we are simply 
making explicit an obligation which is implicit, and by doing 
that we are not adding to the long-term costs of the U.S. 
Government.
    Mr. Spratt. Well, first of all, we are accumulating debt in 
the regular budget at a rapid clip. I showed you the numbers, 
$2.234 trillion increase in the debt ceiling to accommodate the 
Bush budget for the first 4 years, $2.2 trillion. And we are 
running at that rate now, about $1 trillion in debt 
accumulation every 18 months. By 2012, 2015, we are likely to 
have $12 trillion in statutory debts subject to limit. If you 
go ahead and take then that debt, which is increasing as we 
speak, and add on top of it another $5 trillion, the Treasury 
is going to be in the private capital markets frequently 
borrowing big sums of money repeatedly and crowding out private 
borrowers, is it not?
    Secretary Snow. No, I don't think so. I don't think so at 
all in this case because, again, this borrowing is not 
borrowing to spend, this is borrowing to save. And it is 
borrowing to defease a very sizeable long-term obligation.
    Mr. Spratt. But it is still borrowing, and the Treasury of 
the United States has to go in the capital markets and say I 
want $1.5 trillion dollars for these Treasury bonds.
    Secretary Snow. But Mr. Chairman--I mean, Mr. Spratt.
    Mr. Spratt. I will take that.
    Secretary Snow. Mr. Spratt, there is a real difference 
here, and it is important to maybe take a minute and talk about 
this, because this isn't your traditional debt. It doesn't have 
the effects of traditional debt on markets. I have spent a lot 
of time now talking with the analysts in the Treasury 
Department who make the U.S. Treasury market, the people who 
are responsible for the largest debt market in the world, the 
U.S. treasuries. I spent a lot of time talking to people up on 
Wall Street about this. And Wall Street, I think, financial 
market people, people who worry about the bond market and 
credit ratings, they are going to applaud us, they are going to 
applaud you and the Congress for taking this issue on and 
defeasing that $10.4 trillion long-term liability. And they 
would readily find, I am convinced, the funding manageable.
    Mr. Spratt. There is still going to be debt of the United 
States, and there will be interest payments either quarterly or 
semiannually. Those payments will have to be made. We will have 
a huge and growing amount of debt service, and that debt 
service is going to displace priorities in our budget, is it 
not? It is going to be a mountainous amount of debt service if 
you have $5, $6, $7 trillion dollars of additional debt. It has 
to be serviced. Does it not?
    Secretary Snow. Well, certainly all debt has to be 
serviced. But, remember, when we do the borrowing it is of an 
equivalent value to the reduction that is occurring in the 
liability in the Social Security system, because the borrowing, 
the borrowing is exactly equal to the amount of money that is 
being taken out of the system and put into the personal 
accounts. So, in effect, it is a wash. The Social Security 
liabilities are coming down by an amount that is equal to the 
borrowing.
    Mr. Spratt. But the interest is a net payment of the U.S. 
Government. We will have to shell out the interest in 
increasing amounts, and it will displace other priorities in 
our budget.
    Secretary Snow. Well, not necessarily. No, that is not the 
way to look at this. If the borrowing doesn't affect----
    Mr. Spratt. So we can borrow money with impunity then.
    Secretary Snow. Well, no, you don't, because you don't 
borrow if you spend. You can borrow to save; you can't borrow 
to spend. And that is the key difference. This is borrowing to 
save. And if you look at this I think in the right way, the 
savings of the United States are going to rise, not fall. At 
least they won't be negatively impacted. If the savings of the 
United States aren't negatively impacted, then----
    Mr. Spratt. You are diverting money from the public trust 
fund into private accounts. At best, it is a wash. Instead of 
going into the public trust fund where it would be saved, it is 
going into private accounts where it is saved. So at best it is 
a wash.
    Secretary Snow. I would look at it a little differently. I 
would look at it this way. That is going from a pay-as-you-go 
system to, in a way, Mr. Spratt, the very lockbox you talked 
about, because the money is now going into a private account 
that could be analogized to a lockbox. It is in there, it can't 
get out. The Government can't take it away from you. They can't 
go spend it. It is in the lockbox. It is not called a lockbox, 
it is called a personal account, but it has the same effect.
    Mr. Spratt. Let me ask you to wrap up on this line of 
questioning. When can we expect the numbers? When can we expect 
to see a full financial display of how much debt we will have 
to incur to sustain this proposal?
    Secretary Snow. I wish I could give you an answer in terms 
of a specific time. The time will be as the details of the 
proposal get worked out with you and Members of the Congress, 
is the best answer I can give you, the most honest answer.
    Mr. Spratt. Let me ask you then another question about a 
different line. I have looked at model 2. And, as I take it, 
you are working off model 2 of the President's Social Security 
Commission. And model 2 clearly acknowledges, particularly if 
you read the actuary's letter that explains it, that the 
private accounts don't account for the achievement of solvency 
within 85 years. That has to be done through benefit reductions 
or revenue enhancements, one or the other. And, in particular, 
model 2 actuary's letter indicates that the primary source of 
solvency is achieved by reindexing the basic primary insurance 
amount. They go on to acknowledge, if you read it closely, that 
the replacement ratio, if this is done, over 50 years will be 
cut in half. That is a substantial reduction in benefits. And 
that is a means by which you achieve solvency. It doesn't have 
a thing to do with private accounts. Am I correct?
    Secretary Snow. I would have to go back and review model 2. 
I get model 2 and model 3 and model 1 sort of muddled 
sometimes. But I think essentially you are right; model 2 
doesn't rely on the personal accounts alone to fix the system. 
But I think model 2, and model 3, as I recall, have the 
personal accounts as an integral part of the solution.
    Mr. Spratt. The actuary indicated for that study that the 
cost of fixing Social Security would be equal to 1.89 percent 
of payroll. In other words, that was the shortfall expressed as 
a percent of payroll. The actuary's letter said that the manner 
in which the primary amount of insurance would be determined 
indexed to prices instead of wages would account for 2.07 
percent of payroll.
    So that was virtually the whole of the solution right 
there, in the reindexation solution of the bend points, 
redetermination of the primary insurance amount and over time, 
prospectively, it becomes a significant reduction in benefits.
    Secretary Snow. Yes, I think Plan 2 does, by indexing to 
prices rather than wages, have the effect long-term of reducing 
at least the growth rate--I think, is maybe a better way to put 
it--the growth rate of benefit levels. But even then, I think 
it has the retirees, the beneficiaries, having replacement 
rates which are better than their parents and grandparents.
    Mr. Spratt. Oh, no, not if we assume that the collateral 
account earns the bond rate of return, you will see a reduction 
in the--you will see a reduction in the replacement ratio of 
preretirement income for the median beneficiary retiring at age 
65 earning the median income of over 50 years, the replacement 
ratio will decline from 43 percent to 22 percent. They will get 
half what their grandparents got.
    Secretary Snow. The replacement ratio declines, but the 
actual----
    Mr. Spratt. Well, sure wages go up, no question about it.
    Secretary Snow. But the actual payout is higher than their 
parents or grandparents in real terms, and I think with the 
private--the personal accounts, with the personal accounts, the 
payout is higher than what would be available from Social 
Security alone, given the fact that Social Security can only 
pay out a fraction of the promised benefits.
    Mr. Spratt. Well, if you go back and read model 2, I would 
recommend it to your attention.
    Secretary Snow. OK, I will do that.
    Mr. Spratt. You will find that they cut the replacement 
ratio in half over that period of time, and that makes this 
system not a fundamental source of retirement benefits but 
almost an incidental. It changes the character of Social 
Security.
    Let me ask you--and I will then let others have a shot. If 
we assume that these--and everybody is subject to this change 
in the indexation of the primary insurance amount, everybody, 
whether they opt into private accounts or not; everybody gets 
their benefits recomputed according to this different model.
    Now, that raises a particular problem for one-third, 30 
percent, of the beneficiaries who are disabled beneficiaries or 
survivorship beneficiaries. They will have the same benefit 
reduction that others will have out through time, but in 
addition to that, they will not have the opportunity, because 
they will be drawing that benefit sooner than age 62 or age 65, 
they will not have the benefit of allowing the collateral 
accounts to build up. What happens to their benefits? It is 
critically important to the disabled and the survivor.
    Secretary Snow. You put your finger on a very, very good 
issue, and the President in his principles to deal with Social 
Security has focused on that and said that nothing should be 
done to diminish the well-being, the welfare of the disabled, 
as a result of any of the fixes.
    Mr. Spratt. So what do we do? What is the solution? The 
problem is inherent in the proposal as a problem, I understand 
that.
    Secretary Snow. I agree with that. It is in Model 2, it is 
inherent so you would have to take that fix into account, 
whether you--and there are various ways you could do that--but 
including not applying the index to the disabled or making a 
commitment that the disabled would receive payment----
    Mr. Spratt. Then you would have disabled beneficiaries 
receiving a return higher than comparable age beneficiaries 
would receive at retirement who worked a whole 35, 40 years.
    Secretary Snow. Now, you are putting your finger on the 
very reason the President said we want to work with Congress to 
find the answers.
    Mr. Spratt. Well, now you are passing the buck.
    Secretary Snow. Well, no, I am not.
    Mr. Spratt. I am asking you for what your proposal----
    Secretary Snow. I am saying this is an issue on which I 
think the administration and Congress should, should spend a 
lot of time focusing.
    Mr. Spratt. Well, what you are giving me as a fairly 
inchoate picture of what has been developed at this point in 
time. We have still got a very, very great number of items of 
fundamental vital importance that have to be defined before 
anybody can pass judgment on the validity of the attractiveness 
of this system.
    Secretary Snow. As the chairman said in his well-put 
opening comments, we are really trying to make sure we have an 
agreement on the nature of the problem. If we can have an 
agreement on the nature of the problem, I think finding the 
answers will come, will come a lot more readily.
    We are prepared to work with you, Mr. Spratt, on the 
answers. But I think finding the answers depends on having some 
agreement whether or not the Social Security actuary is right 
in saying that, in 2018, the outflow exceeds the inflow.
    Mr. Spratt. Well, wait now, the outflow does not exceed the 
inflow if you pay interest on your bonds. If you are paying 
interest on your bonds and add that to the inflow, then the 
inflow exceeds the outflow in 2018.
    Secretary Snow. I am saying the current system, if we could 
have agreement, that the current system was unaltered, just on 
its own, the way it is running, will be--produce inflows that 
are less than outflows in 2018 and will produce in 2042 an 
inability to pay the benefits then scheduled, that would be the 
basis for finding, I think, foundation for a discussion to 
produce some answers. But I am not sure we are there yet.
    Mr. Spratt. Well, I do not think we are there either. I 
mean, I think we have got a massive amount of detail and 
information necessary to flesh out this proposal. You would 
agree, I take it?
    Secretary Snow. I do not. I do not agree that the problem 
has not been well defined. I think the actuary, I think CBO has 
been helpful.
    Mr. Spratt. We cannot even agree on the method about which 
insolvency is to be achieved, about whether or not the 
reindexation of the primary insurance amount plays in that.
    Secretary Snow. What I think we do agree--all--I think 
everybody who has looked at this has agreed, everybody who has 
looked at it in a serious way, from an actuarial point of view, 
everyone has agreed his system is not on a firm foundation. The 
system is in trouble. The President has said we have looked at 
this in the past and we said, let us have a temporary fix.
    All we have ever had is temporary fixes, and all we have 
done is kick the problem down the road to future Congresses and 
future administrations. He is saying--I think he is to be 
commended for it--he has said let us get a permanent fix, let 
us really fix this thing right, let us not kick it down the 
road. Let us not kick it to another Congress. I think that is 
commendable.
    Mr. Spratt. Let me go back to words you use, this is not on 
a firm foundation, I will grant you, we have a problem in 2042. 
The easier, sooner we agree with it, the better it will be. But 
as to the foundation, in 2018, Social Security is sitting on $5 
trillion to $6 trillion in Treasury bonds; 2028, the amount of 
nest egg actually increases to $7 trillion. That is a pretty 
firm foundation for us to stand on while we try to work out a 
good sensible, fair and operable solution; isn't it?
    Secretary Snow. But the sooner we get to it, the better.
    Mr. Spratt. No question about it.
    Secretary Snow. The sooner we get to it is better for you 
and I, I think. If we do not get to it, that surplus gets 
exhausted and funded from some source----
    Mr. Spratt. No question about it. You keep saying 2018, and 
I keep saying, wait a minute, $5 or $6 trillion in Treasury 
bonds. That is pretty liquid.
    Secretary Snow. But it has to be financed. It has to be 
financed, and the--and I think it is by 2040 or so, the whole 
that has to be financed is on the order of $600 billion.
    Mr. Spratt. One final question.
    To me, it is obligations under the proposal that you are 
formulating. Social Security or the general fund of the 
Treasury will have to borrow substantial sums after 2020 to 
make up for the deficiency in the trust fund which is 
aggravated by the fact that you are going to be diverting a 
third of the revenues away from it.
    How far and how much from that point onward do you have to 
borrow? When do you cease having to borrow money? Is it 2062?
    Secretary Snow. Yes. I wish--I do not want to be evasive or 
sound evasive. It depends on what the fixes are we come up 
with. There are fixes that would have it in that timeframe. 
There are fixes that would have it sooner. There are fixes that 
would have it later. It really depends on what the ultimate 
solution is.
    Secretary Snow. Give us an approximation, the average and 
likely proposal you are going to make. Is it around 2062 you 
will be borrowing money to supplant, replace the benefits of 
Social Security? Some timeframe like that, you know, depending 
on--take 10, 15 years, either side of it, depending on what the 
form of the ultimate--the resolution is. But I will grant you 
that.
    Mr. Spratt. Thank you, sir, I appreciate your answers.
    Chairman Nussle. Mr. Portman.
    Mr. Portman. Thank you, Mr. Chairman.
    Mr. Secretary, I thank you for being with us today and 
getting into some of the details of Social Security. This is 
the Budget Committee, so I will start by commending you on your 
budget which does restrain spending and does promote economic 
growth while funding our key priorities, and we know that is 
the magic. We did it back in the late 1990s, to getting back to 
fiscal discipline. I think your budget presentation made by 
Joshua Bolten yesterday does exactly that.
    On Social Security, I wish I had more time. But I guess my 
response to my friend, Mr. Spratt, he knows I respect him, you 
know, you cannot have it both ways. I think we are totally 
irresponsible, as Members of Congress, to be telling our 
constituents that the trust fund will be in a position to fund 
Social Security without sacrifice.
    You know, what the trust fund is, thanks to Congress, you 
know, over the last 30-plus years, is something that we have 
borrowed from. And we borrowed from it today, and our deficit 
numbers reflect that. In other words, there is more than there 
should be. For us to sit here and say we are concerned about 
the costs of personal accounts, and there is a transition 
financing to personal accounts but we are not worried about 
financing the $5 or $6 trillion trust fund deficit, I think is 
irresponsible.
    I think Members of Congress need to be very careful about 
this, because it is dangerously misleading to our constituents. 
I mean the honest truth is, the way the trust fund works, it is 
sort of like the Government reaches into its wallet, pulls out 
a little money to spend and that money gets spent on everyday 
purposes of government, and then we put an IOU in the coffee 
can, saying I owe myself $5; that is how it has worked. I 
really think we needed to be very careful about how we talk to 
our constituents and deal with this issue.
    Mr. Baird. Would the gentleman yield for one moment?
    Mr. Portman. No, I will not, because I do not have enough 
time.
    Mr. Secretary, tell me, between 2018 and 2042, what is the 
amount of money that the Government would need to have by 
raising taxes or by borrowing more to be able to redeem the 
Government bonds in the trust fund, what is that amount of 
money, just between 2018 and 2042?
    Secretary Snow. I think that is about $2.7, $2.8 trillion.
    Mr. Portman. $2.7, $2.8 trillion. Where are we going to 
come up with it folks? I mean, this is the honest truth. I know 
it is painful, and it is hard for us to realize, but we have 
intergovernmental debt, and we have public debt. And they are 
very different things. Here, intergovernmental debt we have 
borrowed against. We are borrowing against it this year.
    For us to sit here and say, it is there, and it has been 
there for Social Security, and there is no pain involved in 
this, it is just wrong. We are going to have to raise taxes. We 
are going to have to borrow. We are going to have to cut 
benefits. We are going to have to do something.
    On the other hand to say, gee, we cannot do these personal 
accounts because they cost too much.
    Mr. Secretary, you said the $100 invested in personal 
accounts for 40 years would be a lot more than $100. I am 
assuming a 5 percent rate of return, which I think is 
conservative. That is $704; $100 becomes $704; $10,000 becomes 
$70, $100 becomes $100,000. I mean, $100 becomes $700,000. This 
is what Einstein talked about, the magic, the greatest force in 
the universe, the power of compounding interest. That is what 
we are talking about here.
    Yes, it is not cost-free in the interim period, but it 
actually, it actually helped solve the Social Security problem 
because of this buildup of assets, and the fact that then 
Social Security will have less of a responsibility for those 
people who choose voluntarily to get into the personal 
accounts.
    That is why it is such an exciting proposal and why I 
strongly support it. Yes, we need to deal with the transition 
financing, and we will. But we need to do so understanding that 
the other option of relying on the $5 or $6 or $7 trillion in 
trust fund is not cost-free either, and we ought not to mislead 
our constituents about that.
    In terms of the funds that would be used for the personal 
accounts, Mr. Secretary, you indicated that it is different 
because it is money that would go into savings. I would agree 
with that. But also it is different--isn't it--because it 
defrays our long-term liabilities. Can you talk a little about 
that as well?
    Secretary Snow. Yes, absolutely. Remember what is being 
done here. According to Social Security actuary, there is a 
$3.7 trillion hole, obligation, unfunded obligation of the 
United States over the 75-year horizon, and it is $10.4 over 
the permanent horizon, rising at about $600 billion a year.
    What the proposal does is not only create a better 
retirement than Social Security can make available for younger 
people and future generations, but it defeases that obligation. 
It removes that obligation.
    That is why I said earlier, Mr. Portman, that Wall Street 
looks favorably on this, because they know that we are 
improving the balance sheet of the United States. We are 
putting our long-term fiscal house in order.
    Mr. Portman. So it is borrowing that goes into savings, and 
it is borrowing that goes into defraying the liabilities we all 
know exist in Social Security.
    Let me just give you one final fact: That $100 you talked 
about--assuming a 5 percent rate of return--becomes $704. That 
is the 24-year-old you talked about. For that same 24-year-old, 
who will get on average, we are told, who will get a 1.8 
percent rate of return under the Social Security, that $100 
that person would invest in Social Security would result in a 
$204 return; $704 versus $204.
    Thank you, Mr. Secretary.
    Secretary Snow. Yes. One way of thinking about your 
younger--about that person and your children--is that they 
become owners in America, investors in America in exchange for 
being creditors on a Government promise that cannot be 
fulfilled.
    Chairman Nussle. Mr. Moore.
    Mr. Moore. Thank you, Mr. Chairman.
    Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for being here today. Mr. 
Chairman made the statement during his opening remarks that 
members and politicians do not look beyond the next election. I 
want to respectfully take issue with that, because I am very, 
very concerned about my children, about my six grandchildren 
and their contemporaries out there and how they are going to 
dig out of this financial hole that we are putting them in 
right now.
    We have a $7.6 trillion national debt in this country. We 
are paying almost $1 billion a day in interest on our national 
debt. Deficits are running well over $400 billion a year. I 
think, respectfully, we need to change the way we are doing 
business in this country, and this should not--should not--be 
about Democrats and Republicans. We are all in this together. I 
do, really do have grave concerns about the future generations 
in this country if we do not turn things around.
    You said, Mr. Secretary, how can the trust funds be 
replenished and how can we achieve a solvency here?
    Yesterday, Mr. Secretary, I filed a bill that is called 
the--well, it does not matter what it is called--but what it 
will do is establish a true, a true trust fund. That would save 
the American people. Money that comes in for Social Security 
taxes cannot be used for even worthwhile programs such as 
education, healthcare, tax cuts, Iraq, anything else, but has 
to be set aside and saved for Social Security purposes in the 
future. That does not totally solve this problem of solvency of 
Social Security over the next few years, and I think every 
member in this room--and I hope probably in the Congress--
believes there is a problem, maybe not a crisis, but a problem 
that needs to be addressed sooner rather than later.
    I would hope that we would start to be honest with the 
American people--and I do not think most people out there 
understand that the money that does come into the Social 
Security trust fundright now is used for every other purpose, 
and it is just not there--and we say, look up here, but do not 
look at what we are doing with the money down on the other 
hand.
    We need to start, I think, setting aside the money and 
preserving it for the intention and intended purpose. If we did 
that, again, we would be several steps in the right direction 
of extending the life of Social Security into probably several 
decades into the future.
    I want to ask a question though about this. I saw in the 
paper this morning, The New York Times, about a $720 billion 
estimated cost by the administration, just came out over, the 
next 10 years for the Medicare drug program. I do not know if 
you have seen that, Mr. Secretary, or if you are aware of that 
announcement.
    Secretary Snow. Not--I saw the headline in The New York 
Times, but I have not yet had an opportunity to really study 
the issue, Mr. Congressman.
    Mr. Moore. All right. Well, apparently some administration 
official offered an estimate of the cost of the Medicare drug 
benefit Tuesday saying it would cost $720 in the next 20 years. 
Congress has told us it would cost $24 billion. I do not want 
to get into all that.
    I do want to say this: It does cost a lot of money, a drug 
benefit through Medicare. What I handed you right before this 
meeting started was what I proposed--another bill I filed 
called the Meds Act.
    Back in 1992, the Secretary of Veterans Affairs was given 
the authority under Federal law to negotiate with 
pharmaceutical companies on behalf of about 25 million veterans 
for lower pharmaceutical drug prices. We have 44 million 
Medicare beneficiaries in this country. Each one right now is a 
one-person buying group. If we were to get a group discount for 
44 million Medicare beneficiaries, I would think they would 
achieve the same kinds of savings hopefully that the veterans 
would have. The veterans I had talked to are pretty pleased 
with the benefit they get. I would ask you to go back to the 
administration and ask them to consider something like this.
    This was specifically prohibited in the Medicare bill that 
Congress passed, and I think it would be a--I would ask you if 
you have any comments on that, Mr. Secretary.
    Secretary Snow. Congressman, I remember when we were at 
that nice luncheon in Kansas City when a subject like this came 
up. You were thinking about it then and yet put it into the 
form of legislation--let me just say----
    Mr. Moore. Thank you.
    Secretary Snow. I would be delighted to look at it and give 
you some thoughts on it.
    Mr. Moore. Thank you.
    The last issue I want to raise with you, and I am out of 
time, is this: I was with our European counterparts, NATO 
allies, in mid-November last year, and they raised the 
prospects of our $7.6 trillion debt. They talked about the fact 
that foreign nations, European countries, Japan and even China 
are financing our debt, a financial portion of our debt.
    They said they are concerned about the value of the dollar 
and what is going to happen in the future.
    Should we be concerned about that, Mr. Secretary?
    Secretary Snow. Not if we do the right things, and we are 
trying to do the right things, and not if other people who have 
a responsible role to play here do the right things as well. 
The current account deficit is--again, we have talked about 
this in Kansas City. The current account deficit is really the 
difference between the rate of savings in the United States, 
domestic savings, and domestic investment opportunities.
    Right now, with our economy doing so well and growing so 
fast relative to our trading partners, we are creating a lot 
more investment opportunities in the United States than we are 
savings, so we need to borrow from others to finance the good 
investment opportunities in the United States. It would help if 
trading partners would grow faster. We are talking to our 
trading partners about doing that and the things they could do 
to grow faster. It would be helpful if we could save more. That 
is where the deficit is so important, because if we save more, 
we eliminate a source of dis-savings.
    Alan Greenspan, Chairman Greenspan, gave a speech a few 
days ago, saying that he thought the current deficit was in the 
process of turning the corner and cresting and coming back the 
other way. I think there are some reasons to think that that 
truly is the case. It would be helpful on that score if China 
would move to a more flexible exchange rate and go through the 
process of letting their currency be set more in open 
competitive markets rather than set by administrative fiat.
    Mr. Moore. Thank you, sir.
    Chairman Nussle. Mr. Wicker.
    Mr. Wicker. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for your testimony.
    Let me follow up on a point that Mr. Portman was making. 
Right now, say you have got a couple out there in their late 
20s, early 30s, got a couple of kids, and they are struggling 
along trying to pay their bills. Right now, we are taking 6.2 
percent of everything they make in FICA taxes.
    As I understand it, what we are promising them right now is 
something that is going to get them somewhere around a 1 
percent return when they finally get to retirement age, plus or 
minus, but it is a very low 1 percent return. Is that right, 
Mr. Secretary?
    Secretary Snow. It is. It is a very low return.
    Mr. Wicker. Let me just observe: If we could do better than 
that for our hardworking families out there, we ought to do 
better than that. We ought to take action that gets them a 
better return if we are going to take that much out of their 
paycheck.
    I was gratified to hear our ranking member acknowledge that 
there is a problem. I mean, I think that is a start. There is a 
question about whether it is a crisis or how urgent it is. But 
at least we are all acknowledging that there is a problem.
    Now, in the past, when Congress has decided to address the 
problem, they have done what I think you referred to, Mr. 
Secretary, as a temporary fix, kicking the can down the road 
for a few years.
    There are things that we could do again, totally different 
from what I think the President is going to propose. We could 
adopt a means test for benefits in the future. In other words, 
we could take 6.2 percent of people's money--and they get to 
certain income levels--and say, well, you are not going to get 
it anyway. We could reduce benefits. Certainly, Congress has, 
in the past, raised the payroll tax. We could, again, raise the 
retirement age. Congress did that many years ago. It is just 
now sort of coming home to roost there. We could increase the 
earnings limit. Without doing anything else, we could adopt a 
lower cost-of-living index. All of those things, I think, are 
not going to be very popular among the American people.
    But let me ask you, if we did any of that, would it help 
that young couple that is 29-years-old or in their early 30s 
with two kids and paying 6.2 percent of everything they make, 
would it help them get a better return at the end of the day?
    Secretary Snow. It would, Congressman, that is a good way 
to frame the issue. It would if the personal retirement 
accounts are included as part of this as well.
    Mr. Wicker. OK. But I am not hearing much support from my 
friends on the left about the personal retirement accounts. 
Absent the personal retirement accounts, kicking the can down 
the road, means testing, reducing benefits long-term, raising 
taxes, raising the retirement age, raising their earnings 
limit, that still gives that couple 1 percent at the end of 
their working life, doesn't it?
    Secretary Snow. I think that is right, and that is why the 
opportunity the personal retirement account affords people 
should be part of any solution, because it does give them--I 
think the math on this is irrefutable. Congressman Portman took 
you through some of it, but the math on this is irrefutable.
    For a young person who has 40 years or 45 years to put away 
money and who earns the long-term average of a blended bond in 
equity, they are going to come out way, way, way ahead of that 
1 percent.
    Mr. Wicker. Right, but let me agree with a very important 
point the ranking member made. It is going to help when we can 
get specifics on the administration's proposal, because I 
certainly appreciate that you cannot answer the very specific 
questions that members on both sides of the aisle have, until 
we do get the specifics.
    But I do understand that whatever the administration 
proposes, it is going to be voluntary, is that correct?
    Secretary Snow. Absolutely. In other words, that couple can 
decide to get into personal savings accounts, or they can stay 
with their 1 percent for whatever reason.
    Also, there is going to be the same guaranteed benefit at 
the end of the day and whatever the administration proposal is. 
We are not just going to hang them out there to float.
    Secretary Snow. The whole proposal is voluntary for younger 
people. Of course, not available to 55 and older who are--all 
their benefits will be secured.
    Mr. Wicker. Yes, I would think you may start getting a few 
complaints from those 55 years of age and older that they 
cannot buy into these personal accounts.
    But thank you very much for your testimony.
    Chairman Nussle. Mr. Edwards.
    Mr. Edwards. Thank you, Mr. Chairman.
    Let me just say, what I am observing is that the same 
people who, I assume, in good faith 4 years ago, 3 years ago, 2 
years ago, wrote partisan budgets that turned a $270 billion a 
year Federal surplus in 3 years to the largest deficits in 
American history, having broken the promise that they could 
pass tax cuts and balance the budget, are now promising 
American people that to privatize the Social Security system is 
going to be better for them than a system that has been so 
deeply respected by generations of Americans.
    I think their promise that this Social Security 
privatization plan is going to help seniors, unfortunately, 
will be about as realistic as their promise that we could fight 
a war on terrorism, pass massive tax cuts and balance the 
budget. In regard to Mr. Portman's comment, I want to commend 
you, it is irresponsible to not recognize the cost of replacing 
the money borrowed from the Social Security trust fund, 
although I would point out that much of that borrowing occurred 
because the partisan budget passed much of the Republican 
leadership in the last 4 years.
    But what I would say is, I wish the gentleman had made the 
statement 4 years ago, or at least listened to Democrats when 
we were making that statement, saying the cost of long-term 
Social Security is one of the reasons we needed to take 
advantage of the surplus of the $276 billion of the Clinton 
administration era and pay down our Nation's debt.
    I think it was irresponsible for Republicans to not listen 
to Democrats for 4 years who urged our colleagues and said we 
cannot afford, given our long-term liabilities in this 
Government, to pass trillion after trillion dollar tax cut that 
is unpaid for.
    In regard to a couple of comments made by Secretary Snow: 
Mr. Secretary, you said the problem is, we spent too much. Let 
me just say, for the record--and this is factual--that the Bush 
administration has proposed significant increases in three of 
the five largest Federal programs that, out of thousands of 
programs, represent $2 out of every $3 spent by the Federal 
Government.
    In terms of tax cuts, lending and economic growth, I am not 
sure that cause and effect has really been proven. It has been 
alleged. I am not sure it has been proven. But the tradition 
generally is that, coming out of recessions, you have economic 
growth.
    It kind of reminds me, down in Texas, we have some roosters 
that think that they are the reason the sun rises in the east, 
because they crow every day and the sun comes up; not long 
after that, the sun comes up in the east.
    I am not sure that allegation has been proven. But what I 
do know is that the former Bush administration White House 
economic official who now heads up the nonpartisan 
Congressional Budget Office testified after doing a long report 
on tax cuts and borrowing to pay for them, said that, in the 
long run, paying for tax cuts by borrowing billions of dollars 
from American citizens and the communist Chinese and other 
foreign countries hurts economic growth, not helps economic 
growth.
    So I do not buy into the allegation, unproven, that somehow 
massive tax cuts paid for by borrowing has somehow led to 
economic growth.
    Mr. Secretary, in terms of Social Security, let me just ask 
you if you could give me quick yes or no answers or specific 
answers without elaboration:
    When does the Social Security trust fund go insolvent, 
according to your numbers, what year? Just the year is all I 
need.
    Secretary Snow. 2042 is the bankruptcy.
    Mr. Edwards. OK. When does the Medicare trust fund go 
insolvent, according to your numbers?
    Secretary Snow. I would have to check. I have not viewed 
the Medicare actuary's report here recently, but it is headed 
in the same way.
    Mr. Edwards. But the Secretary full well knows that the 
Medicare trust fund is going to be insolvent long before the 
Social Security trust fund.
    Now the chairman said his 14-year-old son, according to the 
charts, will not get Social Security.
    Mr. Secretary, factually, if no changes are made in Social 
Security, and we simply respect the legal obligations we owe 
the Social Security trust fund, is it, in fact, true that 
someone in his teens or 20s or 30s will receive no Social 
Security benefits?
    I believe that is a false statement, and it is a myth that 
is been perpetrated on the younger generation. Isn't it in fact 
true that Social Security beneficiaries that are in their 20s 
today--and they become beneficiaries--would actually get 
somewhere--estimates are 70 to 80 percent of present-day 
benefits if no changes were made? Isn't that correct?
    Secretary Snow. Yes. I think the trust fund in 2042 can pay 
out about 70 percent, 72 percent. That declines with----
    Mr. Edwards. OK. But the statement is, it is simply false, 
that teenagers and young people in their 20s and 30s would not 
get any Social Security benefits if we do not change the law. I 
do not think we ought to build the change on the most important 
social-problem safety net in the Nation's history based on a 
false myth.
    Mr. Portman [presiding]. Let us see, who is next?
    Mr. Bonner for 5 minutes.
    Mr. Bonner. Thank you, Mr. Chairman.
    Mr. Secretary, it is good to have you here today, and I am 
glad you are sitting down.
    Yesterday, I was reflecting when I was a freshman 2 years 
ago, when I was sitting on the front row where my friend
    Mr. Lungren from California is sitting, and I always had a 
great view of the witnesses. And the people on this row had a 
great view of my bald head. So I am glad to have this good view 
of you today.
    I am sad, though, that both yesterday with the OMB director 
and today, it seems that the talk of bipartisanship and the 
talk of Democrats and Republicans working together as Americans 
is nothing more than just that, and that is frustrating. I know 
it has got to be frustrating to you.
    I referred to an article that was in yesterday's Hill 
newspaper. For now, Democrats will offer no Social Security 
reforms. It is much as the statements yesterday with OMB 
director were made. On the one hand, the blasting criticism, 
waxing nostalgic for the glory years of the Clinton 
administration when all these surpluses were created, and yet 
then turning around with the same blasting criticism that all 
of these cuts are punitive--that the President's budget has 
proposed--and these cuts are going to be Draconian to the 
social problems, many of which were created by Great Society in 
the New Deal.
    I think it is frustrating for some of us people on this 
side to hear people, because we know when we have a vote on the 
budget, Mr. Edwards, there will be amendment after amendment 
after amendment offered by members on the other side that will 
raise money for all of these wonderful programs to put us in an 
awkward position. Because if we vote against it, then that 
becomes a campaign commercial back home because we are voting 
against these programs.
    Mr. Secretary, if we do nothing, if we do nothing, and the 
President could have come to the Congress last week with the 
State of the Union and said: Look, I inherited a recession, and 
we dealt with it, and we have turned it around, and we are now 
creating jobs and the economy is growing.
    We inherited 9/11 because, in a large part, of failed 
attempts in the past on both sides to take aggressive actions 
against terrorists, but we inherited 9/11, and we are having to 
pay for 9/11 now.
    Ladies and gentlemen, I am going to take a break. I am not 
doing to dig deep into this issue. We could have taken a pass 
on it. Instead, he did not. He is asking the American people to 
engage us and him in a conversation about what is the best 
thing to happen about one of America's most sacred programs, 
Social Security.
    So my first question is, if we do nothing, can the young 
couple that Congressman Wicker is talking about have anything 
to look forward to other than a measly return on a very 
significant portion of their paycheck taken out each month?
    Secretary Snow. No. The returns, Congressman, if nothing is 
done, will be very, very slight.
    In fact, for future generations, I think they will be 
negative, so that you get no return on your payroll taxes. You 
get a negative amount back.
    No, you are right about the President. He came to 
Washington to solve problems. Not to pass them on to future 
presidents and future generations. I think he is saying to the 
Congress, on the Democratic side, on the Republican side: If 
you do not like my proposals, come up with some other ones. I 
want to talk to you, I want to have a dialogue on this. I want 
to find the answers.
    Mr. Bonner. In fact, did he not say that in the State of 
the Union message when he cited several proposals Congressman 
Penny, Senator Moynihan, President Clinton and others who have 
made recommendations in the past on Social Security, did he not 
invite all 435 Members of Congress and the 100 Senators to come 
up with other proposals as well?
    Secretary Snow. Yes. Yes, he did. I think he truly is 
reaching out to the Congress for a bipartisan approach to this.
    Mr. Bonner. Well, Mr. Secretary, again, I want to thank you 
for coming up and helping, because there are a lot of questions 
that we have. This is not an easy subject. But it does not help 
when people go into any conversation and say that they are 
close-minded to new opportunities and to new options to 
consider. To me, if you go into a discussion where you already 
have said, we are not willing to consider new options, it 
really says that they are really not looking to solve problems.
    Thank you very much, Mr. Secretary.
    Secretary Snow. Thank you, Congressman.
    Mr. Portman. Mrs. Capps, for 5 minutes.
    Mrs. Capps. Thank you, Mr. Chairman.
    May I first respond to my colleague on the other side, 
directly across from me. Mr. Bonner is being critical of our 
side for not having a proposal and I would only respectfully 
recall the interchange between our ranking member, Mr. Spratt, 
and the Secretary, trying to elicit details of the President's 
proposal. Those details are woefully missing, and it is hard to 
respond to something which is lacking in substance. So we await 
further discussion.
    But now, Mr. Secretary, thank you for appearing today.
    The administration has expressed serious interest in 
limiting initial benefit levels to the growth at the rate of 
prices rather than the growth in rate of wages. This would mean 
a basic benefit cut over the next 50 years of over 40 to 50 
percent. Wouldn't this undercut Social Security's ability to 
help seniors maintain their standard of living in their 
retirement?
    Secretary Snow. Congresswoman Capps, we have not embraced 
Model 2, which I think is the Social Security Model 2, which I 
think is the one that has the index, going from wages to 
prices. The President did mention that as an option in the 
State of the Union message along with a variety, a variety of 
other options.
    By going to the Model 2-type solution, you actually 
overcorrect the problem, as I understand Model 2. It has a 
solution which is 100 percent plus of the deficiency of the 
shortfall in Social Security. I do not think we would ever 
recommend that.
    But even Model 2, as long as there are personal accounts 
giving the retiree, the beneficiary, the chance to come out 
ahead of where they would if we simply leave the system on 
automatic.
    Mrs. Capps. So I hear you saying that model which the 
President touted in the State of the Union does have serious 
flaws.
    But I want to ask you now about private accounts. You said 
that--you have said that the basic benefit cut would be made up 
by the value of these private accounts, which is better than 
doing nothing, according to your point of view.
    What happens to people whose private accounts do not pan 
out? Maybe they made a bad investment choice or retire at close 
to a low point in the market.
    This would be then tough luck?
    Secretary Snow. Well, then, the investment vehicles would 
be prudent and safe. They would be quite limited. People would 
be required to keep their money in those vehicles. They would 
not be allowed to, you know, as the President says, go off to 
the roulette wheels or the racetrack with their money. They 
would have to put it in these safe vehicles, and the vehicle 
would not be individual bonds or individual equities. They 
would be--they would be diversified funds of bonds or equities.
    Mrs. Capps. Well----
    Secretary Snow. Including a so-called life cycle fund that 
deals with your issue, because the life cycle fund 
automatically moves the ratio of equity to debt down so that 
you retire with a lot more debt of fixed income instruments 
than you do equity, and that mitigates any of those concerns.
    Mrs. Capps. So it is a different stock market than we know 
today, perhaps.
    I want to ask you about one other point I would like to 
bring up. Mr. Spratt raised this issue of fully a third of the 
beneficiaries who are survivors or disabled, a different 
population than we usually think of when we think of Social 
Security beneficiaries--many of us fall into that category.
    You agree that you cannot realistically cut the benefits of 
these people; correct? And so if you cannot or do not want to 
cut their benefits, won't you have to cut the benefits of 
retirees even more than the 40 to 50 percent Plan 2 envisions 
to keep the system up? In other words, the beauty of the system 
that we have today is that people with disabilities and who are 
survivors are part of the larger group that is protected in 
substantial ways?
    Secretary Snow. Right. Well, I think that the Plan 2 has a 
lot of merit to it. I would not discard it entirely. But it 
does not--it does not meet the President's principle of 
protecting the benefits of the disabled. So that is one of the 
President's core principles, and he would want to see the 
disabled protected in any legislation that came out.
    Mrs. Capps. Could I ask for a further explanation of how 
they would be protected?
    Secretary Snow. Well, there were a variety--there were a 
variety of means that could be made available to do that, 
technically dealing with the bend points, technically dealing 
with the crediting of years, changing the ratios, number of 
years work, crediting with years worked and so on. So there are 
a variety of things that can be done. The President's point is, 
it should be done, and he wants to work with Congress to find 
out the right way, the best way to do it.
    Mrs. Capps. But the bottom line would be shifting those 
costs to--well, those with private accounts?
    Secretary Snow. Well, there are a variety of ways to do it 
within the system. I think--I do not want to speculate on 
precisely how it would be done. That would be the result of the 
ensuing discussion we had hoped to have with you and Members of 
the Congress.
    Mrs. Capps. Thank you, Mr. Chairman.
    Chairman Nussle [presiding]. Mr. Secretary, just for point 
of clarification--because I have been hearing about this Plan 
2--is the President's plan Plan 2?
    Secretary Snow. No, no.
    Chairman Nussle. OK. I just wanted to make sure because I 
keep hearing this Plan 2--I see charts; Plan 2 is this, and 
Plan 2 is that. I mean is it Plan 2 or isn't it Plan 2?
    Secretary Snow. No, sir.
    Chairman Nussle. I understand you may not have a lot of 
specifics about--but, I mean, if you know that at least, let us 
make sure I am----
    Secretary Snow. No. The President in the State of the Union 
message--I think far from what someone suggested--did lay out a 
lot of details. The details went to the nature of the problem. 
He defined the problem. He talked about the declining ratio of 
people paying into the system to those taking out of the 
system, going from 40 when it was first established, to 16 in 
1950, to 3 today to 2 with the baby boomers. He talked about 
the nature of the problem.
    He then went on to talk in quite a bit of detail about the 
personal retirement accounts, laid out how they would work.
    Then, in addition, he suggested that, in addition to 
private, to the personal accounts, there were some other things 
that need to be considered, and he talked about the indexing, 
and he talked about CPIs, and he talked about things that 
Members of Congress and, I think, prior presidents have talked 
about, to put them on the table to say, here are the sorts of 
things we need to have in the dialogue to put Social Security 
on a sustainable basis. But he did not embrace commission Plan 
2.
    Chairman Nussle. Thank you.
    Mr. Mack for 5 minutes.
    Mr. Mack. Thank you, Mr. Chairman.
    Thank you, Mr. Snow for being here.
    Secretary Snow. Thank you.
    Mr. Mack. It is a great opportunity for me and for my 
constituents, I think, to talk a little bit about the 
challenges that are facing us. I think that we are--this is a 
historic time as it relates to our seniors and also younger 
workers.
    The current system is broken. I hear a lot of talk about, 
you know, when is it--you know, is it broken now? Is it broken 
in 18 years? Is it broken then in 2042? When is it broken?
    But it is broken, and it needs to be fixed. And I commend 
the President for taking this issue on. That is exactly what we 
need in leadership, is someone who is willing to take the tough 
issues on. It is long overdue, and I believe it needs to 
include all citizens from every walk of life.
    I know that this process will not be short, and I know it 
will not be easy, but I think the debate is an important one to 
have, and I think we should all agree to that.
    You know, as a parent, I do not believe that I would 
recommend to my children as they get older to buy a house that 
is built on a faulty foundation. That just would not be 
appropriate. It would not be the right thing to do. It would 
not be a loving thing to do as a parent, to recommend to your 
children to buy a home that is on a faulty foundation.
    I just would like to give you an opportunity, if you would, 
to talk to us a little bit about the benefits of taking this 
issue on now instead of waiting for later, as someone suggested 
to do--you know, let us wait 5, 10, 20, 30 years down the 
road--talk about the benefits of taking this issue on now and 
getting this in a sound position now, rather than later.
    Secretary Snow. Congressman, thank you for that, those 
comments and the question and the opportunity that gives me.
    Somebody has said that you do not--as you were suggesting--
you do not wait until you are in a crisis to deal with it. You 
try and anticipate a crisis and avoid it. If you know that the 
girders in your house, as somebody said, are weak, you do not 
wait up till they fall down to fix it. You fix it before they 
fall down. The reason, the reason to deal with this now, of 
course, is that we have a lot more options available to us. It 
is less costly to fix it now. The longer we wait, the bigger 
the problem becomes.
    The longer we wait, the more prejudicial the outcome will 
be. The less beneficial, the more prejudicial the outcome will 
be to your children and to future generations, because by 
starting it now, by getting it under way, they will be able to 
use this power of compounding over a long lifetime of work and 
thus build much bigger accounts and a much better, a much 
better retirement.
    According to the Social Security actuary, every year we 
wait, the problem grows by about $600 billion.
    Now, even by Washington standards, that is an awful lot of 
money. To have it growing every year at that rate means that 
this $10.4 trillion present value obligation becomes larger and 
larger and larger, overwhelmingly large.
    What we are talking about here is the fiscal future of the 
United States, and the fiscal and the retirement future of 
future generations. That is what this issue is about. The 
sooner we get about it, the more we fulfill our obligations, I 
think, as public servants to both our children, future 
generations and to the financial and fiscal well-being of our 
country.
    Mr. Mack. Thank you, and what was that number again, $600 
billion and what every year?
    Secretary Snow. Billion, rising, the 10.4 is rising, 
according to the Social Security actuary. These numbers we cite 
are not our numbers; sometimes people say, ``those are your 
numbers, they are not our numbers.'' we are using the numbers 
that come from the actuary of the Social Security 
Administration, a nonpartisan actuary.
    Mr. Cooper. Thank you very much.
    Chairman Nussle. Mr. Cooper, for 5 minutes.
    Mr. Cooper. Thank you, Mr. Chairman.
    Mr. Secretary, on page 149 of the December 2001 
Presidential Commission on Social Security Reform, they talk 
about the disability program under Social Security. Many of the 
comments of my colleagues have talked about the retirement 
program for Social Security.
    Secretary Snow. Right.
    Mr. Cooper. But it is well-known, or should be to everyone, 
that Social Security really has three benefits: The retirement 
plan, the survivors benefit, and the disability benefit.
    Now this commission in 2001 did a lot of great work. But I 
believe this is accurate to say that, regarding disability, 
they were unable to come to a conclusion. They said, in fact, 
that the benefit was a little bit too complicated for them to 
deal with.
    So I would like to ask you today, since the administration 
is planning on changing one of its most popular and successful 
programs in American history, I would like to ask you about 
that disability element.
    If a young person or middle-aged person or older person 
wanted to go out on the marketplace today, could they buy a 
benefit, a disability benefit, like the one in Social Security? 
Could they buy such a benefit from a private company? If so, 
what would the premium be?
    Secretary Snow. I think disability benefits are available 
in the open market. It would depend an awful lot on whether you 
are a violin player, a major league baseball player or you are 
climbing trees or working off 100-story buildings in New York 
City.
    So it is a little hard to answer the question in the 
abstract without knowing the details of the individual.
    Mr. Cooper. Well, let me get more specific.
    Since you are part of an administration proposing this 
fundamental change for all Americans, what is the valuation you 
would put today on the benefit that is available under Social 
Security disability? What is that worth actuarially?
    Secretary Snow. We will see if we have a number. I have not 
seen the actuary's valuation of the disability benefits 
implicit in the Social Security system.
    But what the President has said--and maybe this cuts to the 
chase--what the President has said is, he wants to sustain, 
protect, secure, make safe the disability benefits.
    Mr. Cooper. But all the estimates that we have seen involve 
out-year cuts and benefits, not sustain those benefits, so I 
think it is crucial for the administration, if they want to 
change the system, to know the value of what they are changing. 
It is my understanding--and I do not have the power that a 
Secretary of the Treasury does--it is my understanding that a 
disability benefit of this type is unavailable from any 
commercial source in the world today.
    Now, perhaps I am mistaken in that, and perhaps you can 
find a seller of disability insurance that is as good or better 
than Social Security is. I would love to have that information. 
So if you could supply that.
    Secretary Snow. We will. I will check on that, and I will 
check on the actuary's rendering of the valuation of 
disabilities as well.
    Mr. Cooper. But let me express some concern about your 
preliminary answer though. You said, if you were to buy a 
disability today, it might depend on if you were a violinist, 
had some other job or worked on 100-story buildings.
    But one of the great benefits of Social Security is it does 
not matter what your job is as long as you pay into the system. 
It protects everybody equally.
    Because it is hard to predict, especially in this modern 
life, what career you are going to have. It is certainly hard 
to predict your health situation. You were unable to attend a 
meeting last week because of your health, and that was 
unexpected.
    So the value of that disability benefit has to be valued 
before the administration takes liberties with it.
    Let me ask another question.
    Secretary Snow. I agree with you. Disability is an 
important, critically important part of Social Security, and we 
want to sustain the benefits of Social Security.
    Mr. Cooper. I see your brain trust behind you. Do any of 
them have any idea what the current value of the disability is?
    Brain trust?
    Chairman Nussle. Well, this is--the gentleman will suspend. 
The Secretary has been asked to testify. If he would like to 
refer to them for an answer, otherwise he has offered to give 
you that answer in the future.
    So we will conduct the hearing here.
    Thank you.
    Mr. Cooper is recognized for the balance of his time.
    Mr. Cooper. Thank you, Mr. Chairman.
    Another fundamental area to ask. It is one thing to take 
the existing Social Security pie and reslice that, and some 
folks may advocate partial privatization of the system. Others 
may not.
    But basically, you are just reslicing the same pie. What is 
the administration proposing to actually grow the pie to 
increase the amount of money that average Americans are able to 
save every year? Today, we have many wonderful ways of doing 
that--IRAs; 401(k)s; SEPs; other good savings programs; but 
many Americans are not fully utilizing those savings vehicles. 
What can we do to grow the savings rate in this country?
    Secretary Snow. Probably the single most important thing 
you can do to grow the savings rate in this country and thus 
help people have secureretirements is to adopt the President's 
personal savings account as a part of fixing Social Security.
    Mr. Cooper. Mr. Secretary.
    Secretary Snow. That is real savings, that is genuine 
savings.
    Mr. Cooper. No.
    Mr. Secretary, under the President's proposal he would take 
up to 4 percent of what is being paid into the current system. 
He is not suggesting a plan that would really boost savings and 
additional vehicles on top of the amount that would be 
allocated to Social Security. He is just talking about 
reshuffling that.
    Secretary Snow. In fact he is, Congressman, in fact, in the 
budget, you will see a section on lifetime savings accounts, 
retirement savings accounts, employer savings accounts for 
employees. No, we recognize--as I responded earlier in--on the 
current account question--we need to encourage more savings in 
the United States. The budget reflects the need to do that.
    But I would say that, in addition to all the things in the 
budget, the personal retirement accounts that the President is 
proposing are one other important way, because people will 
then, say, accumulate, accumulate a nest egg through power of 
compounding, have more at the end than they otherwise would 
have; by far, earn rates of return far higher than they could 
secure under the Social Security system.
    Mr. Cooper. You say that as if it were a guarantee.
    Chairman Nussle. The gentleman's time has expired.
    Mr. Hensarling for 5 minutes.
    Mr. Hensarling. Thank you, Mr. Chairman.
    Mr. Secretary, I want to start out thanking you and the 
President. As the father of two in diapers who knows a whole 
lot more about Barney and Big Bird than Social Security, I 
cannot tell you how much it warms my heart that somebody is 
looking out for the next generation and not the next election.
    There was an old advertising campaign many, many years ago 
by a company, I believe, called AAMCO Transmissions. The tag 
line was: You can pay me now or you can pay me later. I think 
the idea was that, if you had maintained your transmission and 
spent a couple of hundred dollars today, the thing would not 
completely go bust on you so that you would have to pay $2,000 
later and replace that transmission.
    I am sitting here looking--I am jumping the gun a little 
bit. But I have a GAO report here. I want to make sure we are 
all focused on this figure. If I am reading it correctly, our 
unfunded obligation to Social Security is $10.4 trillion. We 
were getting into a little bit of discussion of what an 
administration plan might cost. I have seen other plans that 
have transition financing, perhaps $1 trillion, a very large 
sum of money; but last I looked, a whole lot smaller than $10.4 
trillion. So, ultimately, to save Social Security, we will be 
saving not only Social Security, but we will be saving 
taxpayers money.
    Secretary Snow. Well, absolutely, Congressman. That is a 
critical point here.
    One way to look at this is $10.4 trillion obligation out 
there, and on a present value basis, you might spend $2 
trillion to defease it. What sensible business person would not 
spend $2 to get $10? That is the reality of what we are doing 
here. We are defeasing. We are removing a huge overhang 
liability on the balance sheet of the United States. And in the 
process we are also creating greater prosperity for future 
generations.
    Mr. Hensarling. Well, if I could ask you, and my second 
question here is we have heard a lot of talk of massive 
borrowing, how that could impact markets in order to save 
Social Security. If I have done my homework right, over the 
last 10 years, we as Congress have grown the size of the 
Government at an average of 4.5 percent a year, which is 
roughly twice the rate of inflation, and at least 50 percent 
greater than the family budget is measured by median worker 
income.
    I want to congratulate you and the President again, and the 
administration for submitting a fiscally responsible budget 
that will help save the family budget from the Federal budget.
    But my question is this: If we could just simply institute 
some fiscal discipline in this institution, and say we grew 
Government somewhere in the range of 3 to 3.5 percent a year 
instead of our traditional pattern of 4.5 percent a year over 
the last 10 years, and if we managed to save the remaining 
Social Security surpluses, wouldn't that take us a long way 
toward coming up with the transition financing to save Social 
Security?
    Secretary Snow. Well, certainly, if we could hold spending 
to the sorts of numbers we are talking about and sustain the 
sort of growth in the economy that we have got that is 
producing increases in Government receipts at well above the 
growth levels you are talking about on spending, you would be 
quickly getting the finances of the United States into strong 
and good shape. Absolutely.
    Mr. Hensarling. Thank you. My next question. I don't have 
the chart at my fingertips, but I have seen a chart from GAO 
before that has persuaded me that my grandparents, who were 
born at roughly the last turn of the century, received roughly 
an 11 to 12 percent rate of return on their Social Security. My 
parents, who were born in the late 1920s, early 1930s, 
apparently are receiving a roughly 7 percent rate of return on 
their Social Security. And it is an important part of their 
retirement. I believe that I am going to receive somewhere in 
the neighborhood of maybe a 2.5 percent rate of return on my 
Social Security. My daughter, who is almost three, and my son 
who is 16 months old, I believe could actually see a negative 
rate of return.
    I guess two questions. One, is that possible? And, if so, 
what has happened to the security of Social Security if we do 
that to future generations?
    Secretary Snow. Well, your numbers are right in the 
ballpark. Early generation did very well. Of course, some of 
them didn't pay in very long and had long lives, retirement 
lives, and collected for a long time. This is all really a 
matter of basic arithmetic, and the arithmetic is compelling. 
We have gone from having many, many people working and paying 
for every retiree to having fewer and fewer, and we are facing 
now, with the baby boomer retirees coming on stream, having 
only two people paying in for every retiree.
    Now, a pay-as-you-go system--and this is a pay as you go 
system--works real well when you have got, you know, when you 
talk about your grandparents there were 50 people paying in for 
every retiree. And then, you know, back 50 years ago there were 
16. Today there are 3. We are going to 2. The system just 
doesn't hold together. It is a matter of basic arithmetic. And 
the rates of return of future generations will clearly be 
negative on the path we are on.
    Chairman Nussle. Mr. Secretary, it is my understanding you 
have to be walking out the door at 1:00 p.m., and we are told 
that we are going to have four, maybe five procedural votes on 
the floor coming up here at any moment. So what I am going to 
do is to keep going around to talk to the Secretary here. But 
when the votes are called, what I will do is I will dismiss the 
first panel so that you can make your appointment, and we will 
take the second panel. What we will do with members, unless 
there is objection, I would like to continue down the row in 
calling people so that they can continue.
    We have a lot of members who want to participate in this, 
and I don't want to start all over with the senior members and 
have to work back to you. You have been very patient, our new 
members in particular. So I would like to continue that, unless 
I hear a strong objection. So, without objection, we will do 
that.
    Mr. Davis for 5 minutes.
    Mr. Davis. Thank you, Mr. Chairman, and Mr. Secretary.
    Let me if I can go back to a line of questions that the 
ranking member on this committee pursued with you earlier. The 
two of you talked about the relative difference in the size of 
extending the President's tax cuts and of the actual amount of 
the Social Security shortfall. And your answer was a fairly 
familiar one. You were saying that if we walk away from 
extending the tax cuts, that it will cause us economic damage. 
So I want to test that proposition a little bit.
    You agree that we had a pretty robust rate of economic 
growth from the 1990s, I would assume. Wouldn't you?
    Secretary Snow. Yeah, sure.
    Mr. Davis. I think your are off the microphone, but I heard 
you say, yeah, sure. And I agree with you on that.
    Secretary Snow. We had some good growth rates. 
Unfortunately, they ended in a bad way.
    Mr. Davis. Well, let me ask you about this then. Right now, 
the combined level of corporate and income tax as opposed to 
GDP and the combined rate of corporate and income taxes added 
together is as I understand it a very low share of the GDP 
today--a very high share of the GDP today. The combined rate of 
corporate and income is today a very low share of our GDP 
relatively speaking.
    Secretary Snow. It is. We have hit--for a variety of 
reasons it is low, but it is now rising and returning over the 
course of this budget to its historical level of roughly 18 
percent.
    Mr. Davis. But just to fix the level today, it is actually 
the lowest combined level since 1942, or since the middle of 
World War II. Is that not correct?
    Secretary Snow. As a percent of GDP, I think it is about 16 
percent, which is low by historical standards, yes.
    Mr. Davis. Now, in the 1990s, what was the relative rate of 
income and corporate taxation of GDP?
    Secretary Snow. Well, by the end of the 1990s, given the 
stock market and the technology bubble, while it lasted, which 
produced lots of option return and capital gains returns, the 
tax returns went up to about 21.6 percent of GDP.
    Mr. Davis. And, again, despite the 21 percent of GDP, we 
still had a high rate of growth during that time. The reason I 
make that point is that--and I think if, we went back, Mr. 
Secretary, you look at 1960s, we had a fairly high rate of 
growth then. Did we not?
    Secretary Snow. Yeah, we had a pretty good growth rate.
    Mr. Davis. We also had a very high level of taxation in the 
1960s. Didn't we?
    Secretary Snow. Well, thanks to President Kennedy, we got 
them lower.
    Mr. Davis. But we still had a relatively high rate of 
taxation combining corporation and income. In fact, the rate of 
the 1960s was once again higher than the rate today. In fact, 
considerably higher than the rate today. Isn't it?
    Secretary Snow. As a percent of GDP.
    Mr. Davis. Percent of GDP. So, once again, we have the two 
strongest growth periods since World War II, the 1960s and the 
1990s, where we had very high levels of taxation, far higher 
than the levels of taxation we have today as opposed to GDP. 
And it is clear that was not enough to check the economic 
growth. That is an important point, because I think that 
significantly undermines a good deal of the administration's 
argument, frankly.
    I think all of us would have the perspective, Mr. 
Secretary, that if we were trading away our economic future, if 
we were walking away from a recovery if we didn't extend the 
tax cut, particularly just the top 1 percent, I think a lot of 
us on this side of the aisle would buy into your arguments. But 
the problem is, you know, some of us in the room still believe 
that facts are the best evidence and not just faith. And the 
facts tell us that the two biggest periods of growth, the 1990s 
and the 1960s, we had very high levels of taxation, and it 
apparently did nothing to slow our economy.
    Let me move in the limited time I have to another round of 
questions or to another topic. As I understand the Social 
Security Administration, they are predicting that the slow, the 
shortfall of the Social Security between now and 2042, which 
troubles all of us, is apparently based on a growth rate 
projection of 1.8 percent. Do you agree or disagree with that?
    Secretary Snow. No, that is right.
    Mr. Davis. Now, 1.8 percent growth over the next 37 years, 
can you think of any period since the war where we have had 
over the course of one decade a growth rate of 1.8 percent?
    Secretary Snow. Yes.
    Mr. Davis. What would that be?
    Secretary Snow. That number which comes from the actuary, 
as I remember what the actuary said, the 1.8 is basically the 
productivity number for the 40 or 45 year period.
    Mr. Davis. But is there any comparable period, Mr. 
Secretary, where we have had--because that is a very anemic 
growth.
    Secretary Snow. That is it, that is the 45-year period.
    Mr. Davis. But is there any period since 1945--and I am 
thinking in terms of decades, where we have had growth that has 
been that anemic? And the proposition that I make, if the Chair 
will indulge me just 15 seconds to sum up. If we had that kind 
of a growth rate over the next several years, Mr. Secretary, 
over the 30-some years I should say, it strikes me that it 
would mean that our economy was in dire straits. And of course, 
if our economy were in dire straits, it follows for some of us 
that the stock market would probably be underperforming. So it 
is very curious that the administration that is always 
optimistic about growth is basing its Social Security program 
on a growth rate line of 1.8 percent, far worse than we have 
had in our recent experiences, and incredibly willing to gamble 
our seniors on Social Security being invested in the stock 
market. Can you respond to that?
    Secretary Snow. Oh, sure. I would be delighted to, because 
I think there is a huge misconception implicit in what you just 
said.
    The stock market correlates with productivity. There is a 
recent study by a professor, I think at the University of 
California who looks at over a 40, 50-year period the stock 
market and what it correlates with. And the stock market best 
correlates over any long period of time with productivity per 
capita.
    What is happening for the--and the actuary uses in that 
1.8, I think 1.6 of that 1.8 which is GDP, 1.6 of the 1.8 is 
the productivity. The point two is population. Now of course 
the population growth of the United States is slowing, but the 
productivity growth according to the actuary, which is based on 
the prior 45 years, is the same.
    Mr. Davis. But 1.8 is still a very slow growth rate.
    Secretary Snow. No, it not. 1.8 is the historic 45-year 
average productivity growth rate in the United States economy 
which has produced the returns to the stock market we have seen 
over that period. So the correlation is one to one.
    Chairman Nussle. Mr. Simpson for 5 minutes.
    Mr. Simpson. Thank you, Mr. Chairman.
    And I appreciate you being here today, Mr. Secretary, and 
taking the time to discuss this issue with us. First of all, in 
relation to what Mr. Davis said, it was interesting as I 
listened to that. I was over in Ireland earlier this year, 
talked to some of the officials over there, several of them. 
And they told me that about 15 years ago Ireland had the lowest 
per capita income in the European Union. They currently have 
the second highest per capita income in the EU next to 
Luxembourg. And I said, what did you do to change that outcome? 
And they said, we sat down and made some really tough 
decisions, and that is that we were taxing our people too much, 
that we were--that it would cost too much to produce in this 
country, and we made some tough choices. And we went through 
some very difficult times, but it has changed our economy 
around, and essentially every major corporation in the country 
now has a--in the world, has a company located in Ireland.
    So, and I think you are on the right track. And I 
appreciate--you know, this is something we have known ever 
since Adam Smith, but we haven't always followed it. But I 
appreciate the track that you are on and what you are doing for 
the economy.
    Secretary Snow. I visited there, myself, sometime back, and 
got a first-hand conversation with the people who created the 
so-called Celtic miracle, and they talked about where they were 
two decades back and the transformation that has occurred, 
largely because they embraced Adam Smith and market practices 
and low tax rates.
    Mr. Simpson. Right. I appreciate that. One of the things 
that concerns me is the rhetoric that is surrounding all this 
proposal, and in fact the American people out there are very 
confused about whether there actually is a problem with Social 
Security or not. Because when we start talking about the actual 
problem, we start talking about our favored plan to solve that 
problem and it gets mixed up with it, or the cause of the 
problem, or whatever. What is the administration doing? I 
appreciate the fact that the President has been out on the 
stump the last while, and ultimately we respond to voters.
    What are we doing to try to educate the American public to 
the nature of the problem? Because, to me, we have got to have 
a discussion with the American people about their retirement 
system, and also not only that it is their system but that it 
is a--as was mentioned by the chairman earlier, it is not their 
total retirement system, it is supposed to be supplemental 
retirement, and they need to also be saving for retirement in 
other areas.
    Too many people have depended on Social Security for their 
total retirement fund and figured, well, the Government will 
take care of that. I don't have to worry about retirement 
anymore. And somehow we have got to change that attitude. But 
we have to do, I think, a good job somehow of engaging the 
American people in this discussion. And unfortunately what 
happens right now is you have got the American senior citizens 
who are very engaged in this subject who the President says 
this won't affect; and I find it interesting that it is 55 and 
older that are not going to have their benefits affected and 
then we talk about the younger people.
    I am 54, I am worried. But we have to, the American senior 
citizen is engaged because they obviously depend on Social 
Security. The younger generation is not real engaged in this 
discussion because, just like I am sure you and the rest of us, 
we didn't care about Social Security when we were first 
entering the workforce, but they had better start caring about 
it relatively soon.
    How are we going to engage them?
    Secretary Snow. Well, Congressman, you put your finger on a 
critical issue here. I think the President knows he has got an 
obligation to lead this, to get out and use the bully pulpit 
and talk to the American people and really engage them on the 
problem and be straight with them, be honest with them, tell 
them the facts and get the facts out. You know, America is a 
Nation of problem solvers, we are a Nation of fixers, but we 
first have to understand what the problem is. That is why this 
hearing today, the other hearings are so important to get the 
facts out. And I am glad to hear people from both sides of the 
aisle agreeing that there is a problem, because that is where 
the solution starts, with identifying the problem.
    This is only going to be addressed when the American people 
say there is a problem and we want answers. And the President 
knows he has to take that message to the American people. He 
has asked us in the cabinet to do it, but he knows he has to 
lead that effort.
    Mr. Simpson. Do you think there is broad consensus about 
what the problem exactly is?
    Secretary Snow. I think there is a growing understanding of 
what the problem is, the demographics which are--this is all 
about arithmetic, it is not about ideology. It is simple, 
straightforward arithmetic. Nobody can repeal the laws of 
arithmetic. And the laws of arithmetic are dooming Social 
Security on its present course. And the sooner we act to fix 
it, the better the chances. I think that more and more people--
I wouldn't say it is fully understood by any means, but more 
and more people are beginning to get a sense of the dimensions 
of the problem and the need to act on it, and I think they are 
going to be asking their elected representatives around the 
country, what are you doing?
    Mr. Simpson. Well, I hope so. I have spent the last 2 years 
actually talking about the problem we have with entitlement 
spending and how that is driving really the budget deficit and 
a few other things, and Social Security particularly. And I 
have found that any number of people have come up afterwards 
and said I appreciate the fact that you are talking about that 
because I really didn't understand it before. So I appreciate 
the fact that you are engaged in this and the President is 
engaged in this. It is something that would be so easy for us 
to put off for another 10 years.
    Chairman Nussle. I am going to call on Mr. Allen for 5 
minutes, a quick 5 minutes, and then Mr. Bradley for 5 minutes, 
and then we will wrap up. We have as I understand a couple 
votes on the floor. Mr. Allen for 5 minutes.
    Mr. Allen. Thank you, Mr. Chairman.
    And thank you, Mr. Secretary, for being here. If I were 
trying to summarize your testimony so far, I would say that you 
are saying that mathematics is not important. There is basic 
math involved here. You don't know the details of the 
President's proposal, but you certainly know it includes 
private accounts. You don't know how much money will have to be 
borrowed after the first 10 years, but you do know it will save 
taxpayers money and it will be better, that younger people will 
be better off.
    What I take from this is the conclusion has been arrived at 
before the mathematics has been done. We are not talking about 
model two, but we are talking about something close to model 
two. We don't know all the details, we don't know how many 
trillions of dollars will be borrowed. But just to look at one 
analysis based on Social Security Administration economic 
assumptions--I would like to have chart 4 put up on the screen, 
and I will come back to that in a moment. I mean, just to take 
one--we will wait for that to come up.
    Now, you have said that you know that the plan will take 
care of the long-term Social Security liability, but you don't 
know how much borrowing the plan requires after the first 10 
years. It is those kinds of conflicts which makes some of us 
really skeptical.
    The second point I would say is that what I hear you saying 
is that deficits really--I think you are saying that deficits 
really matter between now and 2009. And we have to knock down 
the deficit from that estimated inflated, I would argue, level 
of $521 billion. But after 2009, it is OK to borrow trillions 
and trillions of dollars. As you may remember, your 
predecessor, Paul O'Neill had a little disagreement with the 
President over the 2003 tax cuts. And Vice President Cheney 
said to Mr. O'Neill that Ronald Reagan proved that deficits 
don't matter. But Mr. O'Neill's advice to the President was, if 
you pass the 2003 tax cuts, if you do that, you will not be 
able to do anything else that you want to do including, 
specifically he was concerned about privatizing Social Security 
because he is a believer in privatization.
    Yesterday, Josh Bolten was here and said that it is all OK, 
we don't have exact numbers but it is OK. This new idea of 
borrowing to save instead of borrowing to spend, he checked it 
out with some Wall Street analysts; you are telling us today 
you have checked it out with some Wall Street analysts, and 
also with Treasury analysts, it is OK, it is fine. Of course, 
someone on Wall Street is going to make billions of dollars in 
all probability from this plan. But thinking about my friends 
from the other side of the aisle, when it comes to estimates 
from this administration--today's Washington Post says: 
Medicare drug benefit may cost $1.2 trillion.
    Now, we have been through here before with estimates from 
the administration, and, frankly, particularly Republicans were 
sandbagged when the administration refused to give them--or us 
for that matter--the true estimated cost of the administration 
when it came to the cost of the Medicare benefit, which is 
exploding in cost. The American people are going to need more 
than someone standing up and saying Wall Street analysts say 
this is OK. Aren't they?
    Secretary Snow. Well, I hope you don't think that is all we 
are saying, Congressman.
    Mr. Allen. It is all I have heard. It is all I have heard 
about the source of the confidence as to the fact that 
borrowing $5 or $6 trillion in the first 20 years is not going 
to suck money out of the private capital markets. It seems to 
me it is inevitably going to suck money out of the private 
capital markets, drive up interest rates, and slow down the 
economy.
    Secretary Snow. Remember what is happening here. Remember 
what is happening. The structure of what is happening is 
essential to keep in mind. People will be taking money that 
otherwise would go into Social Security. Right? And they will 
be putting it into these private accounts. As they remove money 
from Social Security, they also give up a future claim on 
Social Security.
    Mr. Allen. Their benefits will be cut.
    Secretary Snow. They give up, the liability of the United 
States goes down by the amount of the money that is diverted. 
So from the Social Security point of view, this is not a cost 
to the Social Security system. But from the point of view of 
the balance sheet of the United States and the American 
economy, the money that is diverted is put into savings. It 
helps the savings. Net savings is not adversely affected. In 
fact, I think it would be positively affected.
    Chairman Nussle. Mr. Bradley for 5 minutes.
    Mr. Bradley. Thank you very much, Mr. Chairman.
    Mr. Snow, just two quick questions, please, if I might. My 
home State which is New Hampshire ranks second highest in the 
percentage of the population between the ages of 34 and 54. 
Could you just outline for me what the administration's 
thinking is as to how the personal accounts proposed are going 
to be structured to ensure that these middle-aged workers--and 
I guess with my gray hair I am getting almost beyond that--who 
don't have the same amount of time as younger workers, for 
instance Mr. Hensarling's children, will be able to build up 
their portfolios? That is question number one.
    And number two. There was a recent article last week in The 
Wall Street Journal about other country's experiences with 
personal accounts. Could you just touch on some of the issues 
that have arisen with regard to other countries and how you are 
incorporating that into your thinking?
    Secretary Snow. Right. Well, on the 34 to 54 age cohorts, 
any reduction in benefits we have said would have to be gradual 
so that they wouldn't face a sharp dropoff in their benefits 
and they would be able to help offset those benefits reductions 
with the personal accounts. One reason to start this soon is 
that that group of people will then have more time. Every year 
we put it off, they have one less year to get the virtue of 
compounding.
    I will be glad to share with you some research the Treasury 
has done on the variety of countries who have put in place 
approaches that are called personal accounts. They vary a lot 
and therefore it is hard to come up with one overall 
conclusion. The article that was in the paper that got some 
prominent feature on Chile, I think sort of badly distorted the 
reality of what has happened in Chile and did not reflect the 
real facts. But I will be happy to send you our analysis of--
and many, many, many countries. The United States is in a way 
not in the forefront but one of the later countries to come to 
the use of personal accounts, the market investments to help 
augment retirement. But I will be glad to do that.
    Mr. Bradley. Thank you. And I will yield my time.
    Ms. McKinney. Mr. Chairman, inasmuch as I haven't had an 
opportunity to address the Secretary, I would like to ask 
unanimous consent that I have a statement submitted for the 
record.
    Chairman Nussle. The gentlelady is--and would the 
gentlelady like to ask? I have got time for one question. You 
will get the last word. If you have one question you would like 
to ask? But certainly without objection, your statement will be 
part of the record, as is true for all members, without 
objection.
    Ms. McKinney. Well, thank you very much, Mr. Chairman, for 
the indulgence.
    I have a series of newspaper articles about the Senator 
Frist political fund losing, as they say, big time in the stock 
market. The Tennessean newspaper, the Washington Post reported 
that after big losses in the stock market, U.S. Senate Majority 
Leader Bill Frist campaign committee was short of money and 
couldn't make its loan.
    Now, Mr. Secretary, you are suggesting that the guaranteed 
retirement benefit in Social Security be replaced with a system 
that could yield for the average participant a result like 
Senator Frist. My question is, what happens then to the person 
whose investment goes bust?
    Secretary Snow. Congresswoman, thank you for that question. 
I think the President in the State of the Union message made it 
clear that these would be safe investment vehicles. This 
wouldn't be investments in individual stocks, it wouldn't be 
investments in options or hedge funds or trade or derivatives, 
anything like that. It is very important that these funds be 
deployed in a way that is safe and secure, and the investment 
vehicle that would be designed to accomplish that is very much 
like the investment vehicle available to you as a Government 
public official, the so-called Thrift Savings Plan. This would 
have some other features to it though.
    Ms. McKinney. But what I have is in addition, the Thrift 
Savings Plan is in addition to the Social Security. So what you 
are proposing is instead of.
    Secretary Snow. But you are asking me the nature of the 
investment opportunities, and the nature of the investment 
opportunities would be the same sort of safe and secure 
investment opportunities that you have through your savings 
plan.
    Ms. McKinney. But the benefit is--the guaranteed benefit is 
definitely not guaranteed under your plan.
    Secretary Snow. No. This is an opportunity for people to 
invest in bonds and stocks; and there is no guarantee on bonds 
and stocks except that over time they tend to do very, very, 
very well relative to the return you would get in the----
    Ms. McKinney. So the average taxpayer's personal accounts 
could end up like Senator Frist's; it could go bust.
    Secretary Snow. That is extraordinarily unlikely.
    Ms. McKinney. Thank you, Mr. Chairman.
    Chairman Nussle. I thank the gentlelady.
    Mr. Secretary, thank you for indulging us your time today. 
I will dismiss this panel. And when we resume after the series 
of votes we will resume with panel two. The committee stands in 
recess. [Recess.]
    We will resume the Budget Committee hearing. We are pleased 
to welcome our second panel to the witness table. We have 
before us today the two very distinguished public servants, who 
in their own right, deserve their own panel, to be quite 
honest. Typically we ask the two of them to give us their 
information singularly. We are asking them to do it today 
together because, quite frankly, have both of you have given us 
some ideas and sounded the alarms and suggested that we need to 
tackle these problems in many different ways.
    So I think, if there is any time to put the two of you 
together and, as they say, put your heads together, we have got 
two of the best thinkers that provide information to our 
Congress on our panel. We are pleased to have both of you here 
today.

   STATEMENTS OF HON. DAVID M. WALKER, COMPTROLLER GENERAL, 
 GOVERNMENT ACCOUNTABILITY OFFICE; AND DOUGLAS J. HOLTZ-EAKIN, 
          Ph.D., DIRECTOR, CONGRESSIONAL BUDGET OFFICE

    Chairman Nussle. By a coin flip and going in alphabetical 
order, we will call on Douglas Holtz-Eakin. Or you would like 
to go first? We will do it that way. We will go in reverse 
alphabetical order and call on David Walker, the Comptroller 
General of the Government Accountability Office. Welcome, 
General, and we are pleased to receive your testimony. Your 
entire testimony will be made a part of the record.

               STATEMENT OF HON. DAVID M. WALKER

    Mr. Walker. Thank you, Mr. Chairman. It is good to be back 
before the House Budget Committee, this time to speak about our 
Nation's Social Security program. I appreciate you putting my 
entire statement in the record. I will summarize some key 
points.
    I think it is important for the members to know at the 
outset that, in addition to working on this issue at GAO in my 
capacity as Comptroller General of the United States, I was 
also a trustee of Social Security and Medicare from 1990 to 
1995, so I am very deep on these issues and care about them 
very much.
    As I have testified on many times before Congress, Mr. 
Chairman, the Social Security system faces both a solvency and 
a sustainability challenge over the longer term. And while the 
Social Security program does not face an immediate crisis, it 
does have a $3.7 trillion gap in current dollar terms between 
promised and funded benefits. This gap is growing daily; and 
given this and other major fiscal challenges that face the 
country, it would be prudent to act sooner than later to reform 
the Social Security program. Failure to take steps to address 
our large and structural long-range fiscal imbalance which is 
driven largely by projected increases in Medicare, Medicaid, 
and Social Security spending, will ultimately have significant 
adverse effects on our country, children, and grandchildren. If 
I can, let me make a few key points.
    In looking at Social Security, several key points are 
important. First, solving Social Security's long-term financing 
problem is more important and complex than merely making the 
numbers add up. It is important to keep in mind that Social 
Security is not only a program for retirement income, but also 
a program for disabled workers and for survivors of deceased 
workers. It is important to keep all those dimensions in mind.
    Secondly, and the first chart (chart 1). Social Security 
reform is part of a broader fiscal economic challenge. We need 
to keep this in context with regard to the larger challenges 
that we face. This chart shows one scenario in GAO's long-range 
budget simulations. This one is based on CBO's baseline 
projection; you can see that we face large and growing 
structural deficits in the out years due largely to known 
demographic trends and rising health care costs.
    If you look at the simulation, you have to keep in mind 
three things. First, it is bound by the constraints imposed on 
CBO's 10-year baseline. Those relevant to this simulation are, 
number one, that no new laws will be passed. Number two, that 
discretionary spending will grow by inflation. And, number 
three, that all tax cuts will sunset as scheduled.
    So even under those assumptions you can see that we have a 
problem which increases with time, the white line being revenue 
as a percentage of GDP, the bar being spending as a percentage 
of GDP.
    The next one (chart 2), however, is much more sobering and 
dramatic. The only two differences between this one and the 
next one are number one, discretionary spending grows by the 
rate of the economy throughout the period. And, number two, all 
tax cuts are made permanent.
    Under the second scenario, the only thing that the Federal 
Government can do in the year 2040 or slightly beyond is pay 
interest on massive debt. That is obviously not an acceptable 
outcome. Next, please (chart 3).
    It is important to keep in mind that you can't just look at 
trust fund solvency alone. After all, the trust funds are 
nothing more than an accounting device. They are not true 
fiduciary trust funds. If you look on the financial statements 
of the U.S. Government, you will not find a liability of the 
U.S. Government owing to the trust funds. Further, the trust 
fund does not tell us whether or not the program is 
sustainable; it doesn't tell us how much of a burden the 
program represents on future budgets or on the economy. So it 
is important to keep in mind cash flows because cash is of 
critical importance. We have already turned a negative cash 
flow in Medicare Part A. That happened last year in 2004. We 
are projected to turn a negative cash flow in Social Security/
OASDI combined in 2018, and it will get progressively worse 
every year thereafter.
    I think it is also important to note that acting sooner 
rather than later will help to ease the difficulty in achieving 
reforms. Not only will you not have to make dramatic changes, 
but people have more time to adjust to whatever changes that 
you make.
    Just as importantly, by acting sooner, we can send a 
positive signal to the markets that will enhance our 
credibility that the Government is willing to act to deal with 
known long-range challenges before they reach crisis 
proportions. Furthermore, it would hopefully give elected 
officials the confidence necessary to take on truly more 
difficult challenges. Because Medicare is eight times worse 
than Social Security. Candidly, Medicare is going to be a lot 
tougher to solve. It is going to take many years, and you are 
going to have to do it in installments.
    Last, is it is very important to keep in mind that any 
Social Security reform proposals need to be evaluated as 
packages. There are going to be pros and cons of every Social 
Security reform proposal. It is also important to keep in mind 
that not all promised benefits are funded. And, therefore, it 
is not fair to compare reform proposals solely to promised 
benefits. They must be compared to both funded benefits and 
promised benefits to understand the relative trade-offs. And, 
in doing that, I would respectfully suggest to the committee 
that you consider the work that GAO has done for the Congress 
in this regard. We basically recommend analyzing Social 
Security reform proposals as a package against those two 
benchmarks and based on three criteria: Whether and to what 
extent the proposal will achieve sustainable solvency, not just 
over 75 years but for the long term; whether or not it meets 
the standard of adequacy and equity; and, whether or not it can 
be implemented and administered in a feasible and a cost 
effective manner.
    In summary, Mr. Chairman, Social Security may not be in a 
crisis, but it has a large and growing financing problem. It 
would be prudent to act sooner rather than later because, 
candidly, Social Security should be easy lifting as compared to 
the other work that has to be done. The Congress has an 
opportunity to exceed the expectations of every generation of 
Americans with or without individual accounts. I realize that 
is an issue that is going to be debated. In any event, 
individual accounts would have to be part of a comprehensive 
reform package in order to achieve the objectives that I 
outlined earlier. But with or without individual accounts you 
can exceed the expectations of every generation. I hope that 
the Congress will act. Thank you, Mr. Chairman.
    [The prepared statement of David M. Walker follows:]

 Prepared Statement of Hon. David M. Walker, Comptroller General, U.S. 
                    Government Accountability Office

    Mr. Chairman and Members of the Committee, I appreciate the 
opportunity to talk with you about our nation's Social Security 
program\1\ and how to address the challenges presented in ensuring the 
long-term viability of this important social insurance system. Social 
Security provides a foundation of retirement income for millions of 
Americans and has prevented many former workers and their families from 
living their retirement years in poverty. Fixing Social Security is 
about more than finances. It is also about maintaining an adequate 
safety net for American workers against loss of income from retirement, 
disability, or death.
    As I have said in congressional testimonies over the past several 
years, the Social Security system faces both solvency and 
sustainability challenges in the longer term.\2\ While the Social 
Security program does not face an immediate crisis, it does have a $3.7 
trillion gap between promised and funded benefits in current dollar 
terms. This gap is growing daily and, given this and other major fiscal 
challenges including expected growth in Federal health spending, it 
would be prudent to act sooner rather than later to reform the Social 
Security program. Failure to take steps to address our large and 
structural long-range fiscal imbalance, which is driven in large part 
by projected increases in Medicare, Medicaid, and Social Security 
spending, will ultimately have significant adverse consequences for our 
country, children, and grandchildren.
    Let me begin by highlighting a number of important points 
concerning the Social Security challenge and our broader fiscal and 
economic challenge.
     Solving Social Security's long-term financing problem is 
more important and complex than simply making the numbers add up. 
Social Security is an important and successful social insurance program 
that affects virtually every American family. It currently pays 
benefits to more than 47 million people, including retired workers, 
disabled workers, the spouses and children of retired and disabled 
workers, and the survivors of deceased workers. The number of 
individuals receiving benefits is expected to grow to almost 69 million 
by 2020. The program has been highly effective at reducing the 
incidence of poverty among the elderly, and the disability and survivor 
benefits have been critical to the financial well-being of millions of 
others.
     Social Security reform is part of a broader fiscal and 
economic challenge. If you look ahead in the Federal budget, Social 
Security together with the rapidly growing health programs (Medicare 
and Medicaid) will dominate the Federal Government's future fiscal 
outlook. While this hearing is not about the complexities of Medicare, 
it is important to note that Medicare presents a much greater, more 
complex, and more urgent fiscal challenge than Social Security. 
Medicare growth rates reflect not only a burgeoning beneficiary 
population, but also the escalation of health care costs at rates well 
exceeding general rates of inflation. Taken together, Social Security, 
Medicare, and Medicaid represent an unsustainable burden on future 
generations. Furthermore, any changes to Social Security should be 
considered in the context of the problems currently facing our nation's 
private pension system. These include the chronically low level of 
coverage of the private workforce, the continued decline in defined 
benefit plans coupled with the termination of large underfunded plans 
by bankrupt firms, and the shift by employers to defined contribution 
plans, where workers face the potential for greater return but also 
assume greater financial risk.
     Focusing on trust fund solvency alone is not sufficient. 
We need to put the program on a path toward sustainable solvency. Trust 
fund solvency is an important concept, but focusing on trust fund 
solvency alone can lead to a false sense of security about the overall 
condition of the Social Security program. After all, the Social 
Security Trust Fund is a subaccount of the Federal Government rather 
than a private trust fund. Its assets are not readily marketable nor 
are they convertible into cash other than through raising revenues, 
cutting other Government expenses, or increasing debt held by the 
public. Furthermore, the size of the trust fund does not tell us 
whether the program is sustainable--that is, whether the Government 
will have the capacity to pay future claims or what else will have to 
be squeezed to pay those claims. Aiming for sustainable solvency would 
increase the chance that future policymakers would not have to face 
these difficult questions on a recurring basis. Estimates of what it 
would take to achieve 75-year trust fund solvency understate the extent 
of the problem because the program's financial imbalance gets worse in 
the 76th and subsequent years.
     Acting sooner rather than later helps to ease the 
difficulty of change. The challenge of facing the imminent and daunting 
budget pressure from Medicare, Medicaid, and Social Security increases 
over time. Social Security will begin to constrain the budget long 
before the trust fund is exhausted in 2042. The Social Security cash 
surpluses that are now helping to finance the rest of the Government's 
budgetary needs will begin to decline in 2008, and by 2018, the cash 
surpluses will turn to deficits. Social Security's cash shortfall will 
place increasing pressure on the rest of the budget to raise the 
resources necessary to meet the program's costs. Waiting until Social 
Security faces an immediate trust fund solvency crisis will limit the 
scope of feasible solutions and could reduce the options to only those 
choices that are the most difficult. It could also contribute to a 
further delay of the really tough decisions on Federal health programs. 
Acting sooner rather than later would allow changes to be more modest 
while also being phased in so that future retirees will have time to 
adjust their retirement planning. Furthermore, acting sooner rather 
than later would serve to increase our credibility with the markets and 
improve the public's confidence in the Federal Government's ability to 
deal with our significant long-range fiscal challenges before they 
reach crisis proportions.
     Reform proposals should be evaluated as packages. The 
elements of any reform proposal interact; every package will have 
pluses and minuses, and no plan will satisfy everyone on all 
dimensions. If we focus on the pros and cons of each element of reform 
by itself, we may find it impossible to build the bridges necessary to 
achieve consensus. Analyses of reform proposals should reflect the fact 
that the program faces a long-term actuarial deficit and that benefit 
reduction and/or revenue increases will be necessary to restore 
solvency. This requires looking at proposed reforms from at least two 
perspectives or benchmarks--one that raises revenue to fund currently 
scheduled benefits (promised benefits) and one that adjusts benefits to 
a level supported by current tax financing (funded benefits).
    Today, the Social Security program does not face an immediate 
crisis, but rather a long-range financing problem driven by demographic 
trends. While the crisis is not immediate, the challenge is more urgent 
than it may appear since the program will experience increasing 
negative cash flow starting in 2018. Acting soon to address these 
problems reduces the likelihood that Congress will have to choose 
between imposing severe benefit cuts and unfairly burdening future 
generations with the program's rising costs. Acting soon would also 
allow changes to be phased in so the individuals who are most likely to 
be affected, namely younger and future workers, will have time to 
adjust their retirement planning while helping to avoid related 
``expectation gaps.'' On the other hand, failure to take remedial 
action will, in combination with other entitlement spending, lead to a 
situation unsustainable both for the Federal Government and, 
ultimately, the economy.
    Today we have an opportunity to address the relatively easier part 
of the overall entitlement challenge before the baby boom generation 
begins to retire and the challenge begins to compound. Medicare 
represents a much larger driver of the long-term fiscal outlook, but 
this does not mean that Social Security reform should be postponed 
until after it is addressed. On the contrary, it argues for moving 
ahead on Social Security soon. Unlike the case in health care, 
potential approaches to Social Security reform have already been 
articulated in various proposals in recent years. These approaches can 
serve as a starting point for deliberations. Since health care will be 
much harder to address, there is a significant danger that if we do not 
move ahead on Social Security now, we could end up reforming neither. 
Successful Social Security reform could also help build both trust and 
confidence and thereby facilitate consideration of the needed 
structural changes in the health care system.
    The Social Security system has required changes in the past to 
ensure its future solvency. Congress took action to address an 
immediate solvency crisis in 1983. While such an immediate crisis will 
not occur for many years, waiting until it is imminent will not be 
prudent. Furthermore, I believe it is possible to craft a solution that 
will protect Social Security benefits for the nation's current and 
near-term retirees, while ensuring that the system will be there for 
future generations. I believe that it is possible to reform Social 
Security in a way that will assure the program's solvency and 
sustainability while exceeding the expectations of all generations of 
Americans.

    SOCIAL SECURITY REFORM IS PART OF A BROADER FISCAL AND ECONOMIC 
                               CHALLENGE

    In my role as lead partner on the audit of the U.S. Government's 
consolidated financial statements and the de facto Chief Accountability 
Officer of the U.S. Government, I have become increasingly concerned 
about the state of our nation's finances. In speeches and presentations 
over the past several years, I have called attention to our large and 
growing long-term fiscal challenge and the risks it poses to our 
nation's future.\3\ Simply put, our nation's fiscal policy is on an 
unsustainable course, and our long-term fiscal imbalance worsened 
significantly in 2004. GAO's simulations--as well as those of the 
Congressional Budget Office (CBO) and others--show that over the long 
term we face a large and growing structural deficit due primarily to 
known demographic trends and rising health care costs. Continuing on 
this unsustainable fiscal path will gradually erode, if not suddenly 
damage, our economy, our standard of living, and ultimately our 
national security. Our current path also will increasingly constrain 
our ability to address emerging and unexpected budgetary needs.
    Regardless of the assumptions used, all simulations indicate that 
the problem is too big to be solved by economic growth alone or by 
making modest changes to existing spending and tax policies. Nothing 
less than a fundamental reexamination of all major spending and tax 
policies and priorities is needed. This reexamination should also 
involve a national discussion about what Americans want from their 
Government and how much they are willing to pay for those things. This 
discussion will not be easy, but it must take place.
    In fiscal year 2004 alone, the nation's fiscal imbalance grew 
dramatically, primarily due to enactment of the new Medicare 
prescription drug benefit, which added $8.1 trillion to the outstanding 
commitments and obligations of the U.S. Government. The near-term 
deficits also reflected higher defense, homeland security, and overall 
discretionary spending which exceeded growth in the economy, as well as 
revenues which have fallen below historical averages due to policy 
decisions and other economic and technical factors.
    While the nation's long-term fiscal imbalance grew significantly, 
the retirement of the baby boom generation has come closer to becoming 
a reality. In fact, the cost implications of the baby boom generation's 
retirement have already become a factor in CBO's baseline projections 
and will only intensify as the boomers age. According to CBO, total 
Federal spending for Social Security, Medicare, and Medicaid is 
projected to grow by about 25 percent over the next 10 years--from 8.4 
percent of gross domestic product (GDP) in 2004 to 10.4 percent in 
2015. Given these and other factors, it is clear that the nation's 
current fiscal path is unsustainable and that tough choices will be 
necessary in order to address the growing imbalance.
    There are different ways to describe the magnitude of Social 
Security's long-term financing challenge, but they all show a need for 
program reform sooner rather than later. A case can be made for a range 
of different measures, as well as different time horizons. For 
instance, the shortfall can be measured in present value, as a 
percentage of GDP, or as a percentage of taxable payroll. The Social 
Security Administration (SSA) has made projections of the Social 
Security shortfall using different time horizons. (See table 1.)



    While estimates vary due to different horizons, both identify the 
same long-term challenge: The Social Security system is unsustainable 
in the long run. Taking action soon on Social Security would not only 
make the necessary action less dramatic than if we wait but would also 
promote increased budgetary flexibility in the future and stronger 
economic growth.
    Although the Trustees' 2004 intermediate estimates project that the 
combined Social Security Trust Funds will be solvent until 2042,\4\ 
within the next few years, Social Security spending will begin to put 
pressure on the rest of the Federal budget. (See table 2.) Under the 
Trustees' 2004 intermediate estimates, Social Security's cash surplus--
the difference between program tax income and the costs of paying 
scheduled benefits--will begin a permanent decline in 2008. (See fig. 
1.) To finance the same level of Federal spending as in the previous 
year, additional revenues and/or increased borrowing will be needed in 
each subsequent year.



    By 2018,\5\ Social Security's cash income (tax revenue) is 
projected to fall below program expenses. At that time, Social Security 
will join Medicare's Hospital Insurance Trust Fund, whose outlays 
exceeded cash revenues in 2004, as a net claimant on the rest of the 
Federal budget. The combined OASDI Trust Funds will begin drawing on 
the Treasury to cover the cash shortfall. At this point, Treasury will 
need to obtain cash for those redeemed securities either through 
increased taxes, and/or spending cuts, and/or more borrowing from the 
public than would have been the case had Social Security's cash flow 
remained positive.
    Today Social Security spending exceeds Federal spending for 
Medicare and Medicaid, but that will change. While Social Security is 
expected to grow about 5.6 percent per year on average over the next 10 
years, Medicare and Medicaid combined are expected to grow at 8.5 
percent per year. As a result, CBO's baseline projects Medicare and 
Medicaid spending will be about 30 percent higher than Social Security 
in 2015. According to the Social Security and Medicare trustees, Social 
Security will grow from 4.3 percent of GDP today to 6.6 percent in 
2075, and Medicare's burden on the economy will quintuple--from 2.7 
percent to 13.3 percent of the economy.
    GAO's long-term simulations illustrate the magnitude of the fiscal 
challenges associated with an aging society and the significance of the 
related challenges the Government will be called upon to address. 
Figures 2 and 3 present these simulations under two different sets of 
assumptions. In figure 2, we begin with CBO's January baseline, 
constructed according to the statutory requirements for that 
baseline.\6\ Consistent with these requirements, discretionary spending 
is assumed to grow with inflation for the first 10 years and tax cuts 
scheduled to expire are assumed to expire. After 2015, discretionary 
spending is assumed to grow with the economy, and revenue is held 
constant as a share of GDP at the 2015 level. In figure 3 two 
assumptions are changed: discretionary spending is assumed to grow with 
the economy after 2005 rather than merely with inflation and the tax 
cuts are extended. For both simulations Social Security and Medicare 
spending is based on the 2004 Trustees' intermediate projections, and 
we assume that benefits continue to be paid in full after the trust 
funds are exhausted. Medicaid spending is based on CBO's December 2003 
long-term projections under mid-range assumptions.



    Both these simulations illustrate that, absent policy changes, the 
growth in spending on Federal retirement and health entitlements will 
encumber an escalating share of the Government's resources. Indeed, 
when we assume that recent tax reductions are made permanent and 
discretionary spending keeps pace with the economy, our long-term 
simulations suggest that by 2040 Federal revenues may be adequate to 
pay little more than interest on the Federal debt. Neither slowing the 
growth in discretionary spending nor allowing the tax provisions to 
expire--nor both together--would eliminate the imbalance. Although 
revenues will be part of the debate about our fiscal future, the 
failure to reform Social Security, Medicare, Medicaid, and other 
drivers of the long-term fiscal gap would require at least a doubling 
of taxes--and that seems implausible. Accordingly, substantive reform 
of Social Security and our major health programs remains critical to 
recapturing our future fiscal flexibility.



    Although considerable uncertainty surrounds long-term budget 
projections, we know two things for certain: the population is aging 
and the baby boom generation is approaching retirement age. The aging 
population and rising health care spending will have significant 
implications not only for the budget but also for the economy as a 
whole. Figure 4 shows the total future draw on the economy represented 
by Social Security, Medicare, and Medicaid. Under the 2004 Trustees' 
intermediate estimates and CBO's long-term Medicaid estimates, spending 
for these entitlement programs combined will grow to 15.6 percent of 
GDP in 2030 from today's 8.5 percent. It is clear that, taken together, 
Social Security, Medicare, and Medicaid represent an unsustainable 
burden on future generations.



    The Government can help ease future fiscal burdens through spending 
reductions or revenue actions that reduce debt held by the public, 
thereby saving for the future and enhancing the pool of economic 
resources available for private investment and long-term growth. 
Economic growth can help, but given the size of our projected fiscal 
gap we will not be able to simply grow our way out of the problem. 
Closing the current long-term fiscal gap would require sustained 
economic growth far beyond that experienced in U.S. economic history 
since World War II. Tough choices are inevitable, and the sooner we act 
the better.
    Some of the benefits of early action--and the costs of delay--can 
be illustrated using the 2004 Social Security Trustees' intermediate 
projections. Figure 5 compares what it would take to keep Social 
Security solvent through 2078 by either raising payroll taxes or 
reducing benefits. If we did nothing until 2042--the year SSA estimates 
the Trust Funds will be exhausted--achieving actuarial balance would 
require changes in benefits of 30 percent or changes in taxes of 43 
percent. As figure 5 shows, earlier action shrinks the size of the 
necessary adjustment.



    Both sustainability concerns and solvency considerations drive us 
to act sooner rather than later. Trust Fund exhaustion may be nearly 40 
years away, but the squeeze on the Federal budget will begin as the 
baby boom generation begins to retire. Actions taken today can ease 
both these pressures and the pain of future actions. Acting sooner 
rather than later also provides a more reasonable planning horizon for 
future retirees.

 DEMOGRAPHIC TRENDS DRIVE BOTH THE LONG-TERM FISCAL OUTLOOK AND SOCIAL 
                     SECURITY'S FINANCING CHALLENGE

    The Social Security program's situation is but one symptom of 
larger demographic trends that will have broad and profound effects on 
our Nation's future in other ways as well. As you are aware, Social 
Security has always been a largely pay-as-you-go system. This means 
that the system's financial condition is directly affected by the 
relative size of the populations of covered workers and beneficiaries. 
Historically, this relationship has been favorable to the system's 
financial condition. Now, however, people are living longer and 
spending more time in retirement.
    As shown in figure 6, the U.S. elderly dependency ratio is expected 
to continue to increase.\7\ The proportion of the elderly population 
relative to the working-age population in the U.S. rose from 13 percent 
in 1950 to 19 percent in 2000. By 2050, there is projected to be almost 
1 elderly dependent for every 3 people of working age--a ratio of 32 
percent. Additionally, the average life expectancy of males at birth 
has increased from 66.6 in 1960 to 74.3 in 2000, with females at birth 
experiencing a rise from 73.1 to 79.7 over the same period. As general 
life expectancy has increased in the United States, there has also been 
an increase in the number of years spent in retirement. Improvements in 
life expectancy have extended the average amount of time spent by 
workers in retirement from 11.5 years in 1950 to 18 years for the 
average male worker as of 2003.



    A falling fertility rate is the other principal factor underlying 
the growth in the elderly's share of the population. In the 1960s, the 
fertility rate, which is the average number of children that would be 
born to women during their childbearing years, was an average of 3 
children per woman. Today it is a little over 2, and by 2030 it is 
expected to fall to 1.95--a rate that is below what it takes to 
maintain a stable population. Taken together, these trends threaten the 
financial solvency and sustainability of Social Security.
    The combination of these factors means that annual labor force 
growth will begin to slow after 2010 and by 2025 is expected to be less 
than a fifth of what it is today. (See fig. 7.) Relatively fewer 
workers will be available to produce the goods and services that all 
will consume. Without a major increase in productivity or increases in 
immigration, low labor force growth will lead to slower growth in the 
economy and to slower growth of Federal revenues. This in turn will 
only accentuate the overall pressure on the Federal budget.



    The aging of the labor force and the reduced growth in the number 
of workers will have important implications for the size and 
composition of the labor force, as well as the characteristics of many 
jobs, throughout the 21st century. The U.S. workforce of the 21st 
century will be facing a very different set of opportunities and 
challenges than that of previous generations.
    Increased investment could increase the productivity of workers and 
spur economic growth. However, increasing investment depends on 
national saving, which remains at historically low levels. 
Historically, the most direct way for the Federal Government to 
increase saving has been to reduce the deficit (or run a surplus). 
Although the Government may try to increase personal saving, results of 
these efforts have been mixed. For example, even with the preferential 
tax treatment granted since the 1970s to encourage retirement saving, 
the personal saving rate has steadily declined. Even if economic growth 
increases, the structure of retirement programs and historical 
experience in health care cost growth suggest that higher economic 
growth results in a generally commensurate growth in spending for these 
programs in the long term.\8\
    In recent years, personal saving by households has reached record 
lows while at the same time the Federal budget deficit has climbed. 
(See fig. 8.) Accordingly, national saving has diminished but the 
economy has continued to grow in part because more and better 
investments were made. That is, each dollar saved bought more 
investment goods and a greater share of saving was invested in highly 
productive information technology. The economy has also continued to 
grow because the United States was able to invest more than it saved by 
borrowing abroad, that is, by running a current account deficit. 
However, a portion of the income generated by foreign-owned assets in 
the United States must be paid to foreign lenders. National saving is 
the only way a country can have its capital and own it too.



    In general, saving involves trading off consumption today for 
greater consumption tomorrow. Our budget decisions today will have 
important consequences for the living standards of future generations. 
The financial burdens facing the smaller cohort of future workers in an 
aging society would most certainly be lessened if the economic pie were 
enlarged. This is no easy challenge, but in a very real sense, our 
fiscal decisions affect the longer-term economy through their effects 
on national saving.
    The persistent U.S. current account deficits of recent years have 
translated into a rising level of indebtedness to other countries. 
However, many other nations currently financing investment in the 
United States also will face aging populations and declining national 
saving, so relying on foreign savings to finance a large share of U.S. 
domestic investment or Federal borrowing is not a viable strategy in 
the long run.

   HEALTH CARE IS A LARGER AND MORE DIFFICULT CHALLENGE THAN SOCIAL 
                                SECURITY

    As figure 4 showed, over the long term Medicare and Medicaid will 
dominate the Federal Government's future fiscal outlook. Medicare 
growth rates reflect not only a burgeoning beneficiary population but 
also the escalation of health care costs at rates well exceeding 
general rates of inflation. Health care generally presents not only a 
much greater but a more complex challenge than Social Security. The 
structural changes needed to address health care cost growth will take 
time to develop, and the process of reforming health care is likely to 
be an incremental one.
    While the long-term fiscal challenge cannot be successfully 
addressed without addressing Medicare and Medicaid, Federal health 
spending trends should not be viewed in isolation from the health care 
system as a whole. For example, Medicare and Medicaid cannot grow over 
the long term at a slower rate than cost in the rest of the health care 
system without resulting in a two-tier health care system. This, for 
example, could squeeze providers who then in turn might seek to recoup 
costs from other payers elsewhere in the health care system. Rather, in 
order to address the long-term fiscal challenge, it will be necessary 
to find approaches that deal with health care cost growth in the 
overall health care system.
    Although health care spending is the largest driver of the long-
term fiscal outlook, this does not mean that Social Security reform 
should be postponed until after health is addressed. On the contrary, 
it argues for moving ahead on Social Security now. The outlines of 
Social Security reform have already been articulated in many Social 
Security reform proposals. These approaches and the specific elements 
of reform are well known and have been the subject of many analyses, 
including GAO reports and testimonies. Reform approaches already put 
forward can serve as a starting point for deliberations.

               CONSIDERATIONS IN ASSESSING REFORM OPTIONS

    As important as financial stability may be for Social Security, it 
cannot be the only consideration. As a former public trustee of Social 
Security and Medicare, I am well aware of the central role these 
programs play in the lives of millions of Americans. Social Security 
remains the foundation of the Nation's retirement system. It is also 
much more than just a retirement program; it pays benefits to disabled 
workers and their dependents, spouses and children of retired workers, 
and survivors of deceased workers. In 2004, Social Security paid almost 
$493 billion in benefits to more than 47 million people. Since its 
inception, the program has successfully reduced poverty among the 
elderly. In 1959, 35 percent of the elderly were poor. In 2000, about 8 
percent of beneficiaries aged 65 or older were poor, and 48 percent 
would have been poor without Social Security. It is precisely because 
the program is so deeply woven into the fabric of our nation that any 
proposed reform must consider the program in its entirety, rather than 
one aspect alone. To assist policymakers, GAO has developed a broad 
framework for evaluating reform proposals that considers not only 
solvency but other aspects of the program as well. Our criteria aim to 
balance financial and economic considerations with benefit adequacy and 
equity issues and the administrative challenges associated with various 
proposals.

             GAO FRAMEWORK FOR EVALUATING REFORM PROPOSALS

    The analytic framework GAO has developed to assess proposals 
comprises three basic criteria:
     Financing Sustainable Solvency--the extent to which a 
proposal achieves sustainable solvency and how it would affect the 
economy and the Federal budget. Our sustainable solvency standard 
encompasses several different ways of looking at the Social Security 
program's financing needs. While a 75-year actuarial balance has 
generally been used in evaluating the long-term financial outlook of 
the Social Security program and reform proposals, it is not sufficient 
in gauging the program's solvency after the 75th year. For example, 
under the trustees' intermediate assumptions, each year the 75-year 
actuarial period changes, and a year with a surplus is replaced by a 
new 75th year that has a significant deficit. As a result, changes made 
to restore trust fund solvency only for the 75-year period can result 
in future actuarial imbalances almost immediately. Reform plans that 
lead to sustainable solvency would be those that consider the broader 
issues of fiscal sustainability and affordability over the long term. 
Specifically, a standard of sustainable solvency also involves looking 
at (1) the balance between program income and costs beyond the 75th 
year and (2) the share of the budget and economy consumed by Social 
Security spending.
     Balancing Adequacy and Equity--the relative balance struck 
between the goals of individual equity and income adequacy. The current 
Social Security system's benefit structure attempts to strike a balance 
between these two goals. From the beginning, Social Security benefits 
were set in a way that focused especially on replacing some portion of 
workers' preretirement earnings. Over time other changes were made that 
were intended to enhance the program's role in helping ensure adequate 
incomes. Retirement income adequacy, therefore, is addressed in part 
through the program's progressive benefit structure, providing 
proportionately larger benefits to lower earners and certain household 
types, such as those with dependents. Individual equity refers to the 
relationship between contributions made and benefits received. This can 
be thought of as the rate of return on individual contributions. 
Balancing these seemingly conflicting objectives through the political 
process has resulted in the design of the current Social Security 
program and should still be taken into account in any proposed reforms.
     Implementing and Administering Proposed Reforms--how 
readily a proposal could be implemented, administered, and explained to 
the public. Program complexity makes implementation and administration 
both more difficult and harder to explain. Some degree of 
implementation and administrative complexity arises in virtually all 
proposed changes to Social Security, even those that make incremental 
changes in the already existing structure. Although these issues may 
appear technical or routine on the surface, they are important issues 
because they have the potential to delay--if not derail--reform if they 
are not considered early enough for planning purposes. Moreover, issues 
such as feasibility and cost can, and should, influence policy choices. 
Continued public acceptance of and confidence in the Social Security 
program require that any reforms and their implications for benefits be 
well understood. This means that the American people must understand 
why change is necessary, what the reforms are, why they are needed, how 
they are to be implemented and administered, and how they will affect 
their own retirement income. All reform proposals will require some 
additional outreach to the public so that future beneficiaries can 
adjust their retirement planning accordingly. The more transparent the 
implementation and administration of reform, and the more carefully 
such reform is phased in, the more likely it will be understood and 
accepted by the American people.
    The weight that different policymakers place on different criteria 
will vary, depending on how they value different attributes. For 
example, if offering individual choice and control is less important 
than maintaining replacement rates for low-income workers, then a 
reform proposal emphasizing adequacy considerations might be preferred. 
As they fashion a comprehensive proposal, however, policymakers will 
ultimately have to balance the relative importance they place on each 
of these criteria. As we have noted in the past before this committee 
and elsewhere, a comprehensive evaluation is needed that considers a 
range of effects together. Focusing on comprehensive packages of 
reforms will enable us to foster credibility and acceptance. This will 
help us avoid getting mired in the details and losing sight of 
important interactive effects. It will help build the bridges necessary 
to achieve consensus.

       REFORM'S POTENTIAL EFFECTS ON THE SOCIAL SECURITY PROGRAM

    A variety of proposals have been offered to address Social 
Security's financial problems. Many proposals contain reforms that 
would alter benefits or revenues within the structure of the current 
defined benefits system. Some would reduce benefits by modifying the 
benefit formula (such as increasing the number of years used to 
calculate benefits or using price indexing instead of wage indexing), 
reduce cost-of-living adjustments (COLA), raise the normal and/or early 
retirement ages, or revise dependent benefits. Some of the proposals 
also include measures or benefit changes that seek to strengthen 
progressivity (e.g., replacement rates) in an effort to mitigate the 
effect on low-income workers. Others have proposed revenue increases, 
including raising the payroll tax or expanding the Social Security 
taxable wage base that finances the system; increasing the taxation of 
benefits; or covering those few remaining workers not currently 
required to participate in Social Security, such as older state and 
local government employees.
    A number of proposals also seek to restructure the program through 
the creation of individual accounts. Under a system of individual 
accounts, workers would manage a portion of their own Social Security 
contributions to varying degrees. This would expose workers to a 
greater degree of risk in return for both greater individual choice in 
retirement investments and the possibility of a higher rate of return 
on contributions than available under current law. There are many 
different ways that an individual account system could be set up. For 
example, contributions to individual accounts could be mandatory or 
they could be voluntary. Proposals also differ in the manner in which 
accounts would be financed, the extent of choice and flexibility 
concerning investment options, the way in which benefits are paid out, 
and the way the accounts would interact with the existing Social 
Security program--individual accounts could serve either as an addition 
to or as a replacement for part of the current benefit structure.
    In addition, the timing and impact of individual accounts on the 
solvency, sustainability, adequacy, equity, net savings, and rate of 
return associated with the Social Security system varies depending on 
the structure of the total reform package. Individual accounts by 
themselves will not lead the system to sustainable solvency. Achieving 
sustainable solvency requires more revenue, lower benefits, or both. 
Furthermore, incorporating a system of individual accounts may involve 
significant transition costs. These costs come about because the Social 
Security system would have to continue paying out benefits to current 
and near-term retirees concurrently with establishing new individual 
accounts.
    Individual accounts can contribute to sustainability as they could 
provide a mechanism to prefund retirement benefits that would be immune 
to demographic booms and busts. However, if such accounts are funded 
through borrowing, no such prefunding is achieved. An additional 
important consideration in adopting a reform package that contains 
individual accounts would be the level of benefit adequacy achieved by 
the reform. To the extent that benefits are not adequate, it may result 
in the Government eventually providing additional revenues to make up 
the difference.
    Also, some degree of implementation and administrative complexity 
arises in virtually all proposed changes to Social Security. The 
greatest potential implementation and administrative challenges are 
associated with proposals that would create individual accounts. These 
include, for example, issues concerning the management of the 
information and money flow needed to maintain such a system, the degree 
of choice and flexibility individuals would have over investment 
options and access to their accounts, investment education and 
transitional efforts, and the mechanisms that would be used to pay out 
benefits upon retirement. The Federal Thrift Savings Plan (TSP) could 
serve as a model for providing a limited amount of options that reduce 
risk and administrative costs while still providing some degree of 
choice. However, a system of accounts that spans the entire national 
workforce and millions of employers would be significantly larger and 
more complex than TSP or any other system we have in place today.
    Another important consideration for Social Security reform is 
assessing a proposal's effect on national saving. Individual account 
proposals that fund accounts through redirection of payroll taxes or 
general revenue do not increase national saving on a first order basis. 
The redirection of payroll taxes or general revenue reduces Government 
saving by the same amount that the individual accounts increase private 
saving. Beyond these first order effects, the actual net effect of a 
proposal on national saving is difficult to estimate due to 
uncertainties in predicting changes in future spending and revenue 
policies of the Government as well as changes in the saving behavior of 
private households and individuals. For example, the lower surpluses 
and higher deficits that result from redirecting payroll taxes to 
individual accounts could lead to changes in Federal fiscal policy that 
would increase national saving. On the other hand, households may 
respond by reducing their other saving in response to the creation of 
individual accounts. No expert consensus exists on how Social Security 
reform proposals would affect the saving behavior of private households 
and businesses.
    Finally, the effort to reform Social Security is occurring as our 
Nation's private pension system is also facing serious challenges. Only 
about half of the private sector workforce is covered by a pension 
plan. A number of large underfunded traditional defined benefit plans-
     plans where the employer bears the risk of investment--
have been terminated by bankrupt firms, including household names like 
Bethlehem Steel, US Airways, and Polaroid. These terminations have 
resulted in thousands of workers losing promised benefits and have 
saddled the Pension Benefit Guaranty Corporation, the Government 
corporation that partially insures certain defined benefit pension 
benefits, with billions of dollars in liabilities that threaten its 
long-term solvency. Meanwhile, the number of traditional defined 
benefit pension plans continues to decline as employers increasingly 
offer workers defined contribution plans like 401(k) plans where, like 
individual accounts, workers face the potential of both greater return 
and greater risk. These challenges serve to reinforce the imperative to 
place Social Security on a sound financial footing which provides a 
foundation of certain and secure retirement income.
    Regardless of what type of Social Security reform package is 
adopted, continued confidence in the Social Security program is 
essential. This means that the American people must understand why 
change is necessary, what the reforms are, why they are needed, how 
they are to be implemented and administered, and how they will affect 
their own retirement income. All reform proposals will require some 
additional outreach to the public so that future beneficiaries can 
adjust their retirement planning accordingly. The more transparent the 
implementation and administration of reform, and the more carefully 
such reform is phased in, the more likely it will be understood and 
accepted by the American people.

                              CONCLUSIONS

    Social Security does not face an immediate crisis but it does face 
a large and growing financial problem. In addition, our Social Security 
challenge is only part of a much broader fiscal challenge that 
includes, among other things, the need to reform Medicare, Medicaid, 
and our overall health care system.
    Today we have an opportunity to address Social Security as a first 
step toward improving the Nation's long-term fiscal outlook. Steps to 
reform our Federal health care system are likely to be much more 
difficult. They are also likely to require a series of incremental 
actions over an extended period of time. As I have said before, the 
future sustainability of programs is the key issue policy makers should 
address--i.e., the capacity of the economy and budget to afford the 
commitment over time. Absent substantive reform, these important 
Federal programs will not be sustainable. Furthermore, absent reform, 
younger workers will face dramatic benefit reductions or tax increases 
that will grow over time.
    Many retirees and near retirees fear cuts that would affect them in 
the immediate future while young people believe they will get little or 
no Social Security benefits in the longer term. I believe that it is 
possible to reform Social Security in a way that will ensure the 
program's solvency, sustainability, and security while exceeding the 
expectations of all generations of Americans.

                                ENDNOTES

    1. In this statement, Social Security refers to the Old-Age and 
Survivors Insurance and Disability Insurance (OASDI) program.
    2. GAO, Budget Issues: Long-Term Fiscal Challenges, GAO-02-467T 
(Washington, D.C.: Feb. 27, 2002); Social Security: Long-Term Financing 
Shortfall Drives Need for Reform, GAO-02-845T (Washington, D.C.: June 
19, 2002); and Social Security: Long-Term Challenges Warrant Early 
Action, GAO-05-303T (Washington, D.C.: Feb. 3, 2005).
    3. Saving Our Nation's Future: An Intergovernmental Challenge, 
Outlook 2005 Conference, The National Press Club (Washington D.C.: Feb. 
2, 2005). This product can be found on GAO's web site, www.gao.gov.
    4. Separately, the Disability Insurance (DI) fund is projected to 
be exhausted in 2029 and the Old-Age and Survivors' Insurance (OASI) 
fund in 2044. Using slightly different economic assumptions and model 
specifications, CBO estimated the combined Social Security trust fund 
will be solvent until 2052. See Congressional Budget Office, The 
Outlook for Social Security (Washington, D.C.: June 2004) and Updated 
Long-Term Projections for Social Security (Washington, D.C.: January 
2005).
    5. CBO estimates that this will occur in 2020. See CBO's Updated 
Long-
    Term Projections for Social Security (January 2005).
    6. The Congressional Budget Office, The Budget and Economic 
Outlook: Fiscal Years 2006 to 2015, (Washington, D.C.: January 2005).
    7. The elderly dependency ratio is the ratio of the population aged 
65 years or over to the population aged 15 to 64.
    8. Initial Social Security benefits are indexed to nominal wage 
growth resulting in higher benefits over time.

    Chairman Nussle. To your credit, if I may amplify your 
testimony, this is not the first time you have given us this 
advice. We appreciate that.
    Mr. Walker. Thank you.
    Chairman Nussle. Doug Holtz-Eakin, the Director of the 
Congressional Budget Office. We welcome you back to the 
committee, and we are pleased to receive your testimony. All of 
your statement will be made part of the record.

              STATEMENT OF DOUGLAS J. HOLTZ-EAKIN

    Mr. Holtz-Eakin. Thank you, Mr. Chairman, and members of 
the committee. The CBO is happy to be back to talk about this 
important issue and to continue to work with the committee on 
this and other areas. I wanted to simply submit the testimony 
as we have it written and talk about this program, which is 
very important from many perspectives, and bring to the 
discussion not merely a discussion of the system's finances, 
but the larger perspective of the economy, where the Social 
Security program is very important to beneficiaries in deciding 
their labor supply, how much they work and when they retire, 
where it is central to decisions on saving for retirement and 
the kind of portfolios people hold at the moment, where it has 
a big contribution to retirement income along with private 
saving and private pension plans, and where it has important 
implications for the distribution of well-being between parents 
and their children.
    It is one of the central pieces of economic policymaking in 
the United States. It is also a very important budgetary issue. 
It is our single largest Federal program at the moment and 
should be analyzed from budgetary perspectives as well.
    I thought I would devote my time to talking about three 
figures which outline the future of the Social Security program 
and shed light on the nature of the problem facing this 
committee from a budgetary and economic perspective. If we 
could look at the first of those.
    This summarizes the current CBO projections for the outlook 
for Social Security under the current law. It may differ in 
numerical detail from those you would hear from my colleague to 
the right or from those in the Social Security Administration. 
However, qualitatively, we all have the same message about the 
outlook for the program. And that is, that at the moment 
revenues dedicated to Social Security exceed the outlays for 
benefits to current retirees. And that will continue and grow, 
in fact, until shortly after the retirement of the leading edge 
of the baby boom generation.
    Beginning in about 2010, that excess will begin to 
diminish. It diminishes steadily in our projections until 2020, 
at which point the cash flow surplus switches to a cash flow 
deficit. At that point, Social Security is entitled to continue 
to pay full benefits, the red line, which will exceed dedicated 
revenues, the blue line, for decades. And those benefits will 
be paid in full from resources drawn elsewhere in the Federal 
budget. They will come from either lower spending elsewhere in 
the Federal budget, higher taxes, or greater borrowing from the 
public.
    In our projections, the trust fund, the accounting 
mechanism that gives the legal authority to pay full benefits 
will exhaust in 2052, at which point there will be an across-
the-board 22 percent diminishment in the ability to pay 
benefits, and the program can then continue paying out benefits 
equal to payroll taxes thereafter.
    That suggests a couple of things. Number one, in terms of 
timing, some form of the current Social Security program can in 
fact be sustained indefinitely, and that is the edge at the 
right where benefits are brought down to payroll taxes.
    In terms of other issues of urgency, whether things need to 
be done sooner or later, it is in the eye of the beholder. At 
some point, 2052 would be the across-the-board benefit cut. 
Others would point to 2020 in our projections when cash flow 
surplus turns to cash flow deficit. Others would note that 
surplus peaks in 2010, and that between 2010 and 2025, we will 
swing from providing $100 billion from Social Security to the 
remainder of the budget to $100 billion in today's dollars from 
the remainder of the budget for Social Security, and that 
budgetary pressure should be the driving consideration in 
reform. Any of those I think are plausible dates, and in the 
context of the larger Federal budget all will be noticeable 
events for this committee.
    If we go to slide two. This simple display also I think 
displays the size of the problem. There are many different 
measures of what is deemed to be how large a problem we have. 
To my eye, the size of the problem is illustrated by the fact 
that scheduled benefits under current law, the outlay line on 
top in red exceeds dedicated revenues under current law, the 
blue line at the bottom, as far as the eyes can see. And all 
measures that you will hear about the size of the problem have 
to do with adding up over different horizons and for different 
people the size of that gap between the outlays and the 
revenues. From a larger budgetary point of view, one could make 
the arithmetic case that we simply do not have a Social 
Security problem. That we can honor the benefit promises at the 
top. But I would note that, as a matter of arithmetic, if one 
makes that case, they must simultaneously make the case that 
they can find those resources elsewhere in the Federal budget 
and solve the larger looming problem that we face and that 
David illustrated so nicely.
    The third thing this shows us, if we go to slide three, is 
the difference between two notions of fixing the problem. One 
notion of fixing the problem that one hears quite frequently is 
fixing it in a 75-year actuarial balance sense. CBO's estimates 
are that over 75 years the actuarial imbalance is a bit above 1 
percent of taxable payroll. That would suggest that the problem 
is fixed if one simply raises, for example, the payroll tax by 
1 percentage point and has that as the solution to Social 
security. That is the rise in blue line from the bottom one to 
the dotted one above it. You will notice that, from a budgetary 
point of view, this diminishes but does not eliminate the cash 
flow shortfall between promised benefits and dedicated 
revenues.
    A different way to say is that any actuarial fix comes with 
it a budget financing plan, a dedication of future cash flows 
that must come out of the remainder of the Federal budget 
through either less borrowing or some other source that makes 
good on that 75 year actuarial fix. It is also the case that 
once you get to the end of 75 years, you have a problem 
remaining, this is not a sustainable fix in every sense.
    All of this will come to pass in an environment in which 
there will be even greater budgetary demands from other 
programs. So to the extent that you adopt a fix for Social 
Security, it must be developed in the context of rising demands 
for Medicare and Medicaid that will dwarf the rising outlays 
for Social Security. Social Security's outlays are likely to go 
up by about 50 percent, it is a fraction of GDP; Medicare and 
Medicaid, if things go well, may triple in size and could in 
fact be quite large.
    These are the budgetary problems that face this committee 
and the Congress as a whole as it faces Social Security. I 
would remind everyone in closing that these budgetary futures 
will be a reflection of economic policy issues, and that the 
threshold questions are whether this Social Security system is 
the one that the Congress wants for the 21st century, whether 
it is designed appropriately for a world in which there are 
very different demographics, where fertility is much different 
than it was at the time the program was put into place, where 
longevity is rising, and where the dependency ratio, as a 
result, is much greater.
    And in looking at the program, the new element that has 
been raised is the possibility of individual accounts. And 
there, I would suggest, that in addition to the financing 
considerations that we have heard so much about already today, 
one remember the economic policy considerations; that to the 
extent that one favors individual accounts and prefunding in 
that form, it is an argument in favor of increased reliance on 
individuals, in enhancing labor supply incentives in this 
program, in enhancing savings incentives in the program, and 
offering participants a potential for a higher rate of return.
    In contrast, those who favor a modification of a pay-as-
you-go Social Security system for the new demographics are 
highlighting the importance of universality in the program, the 
ability to redistribute through Social Security, and to offer 
genuine social insurance in which the retirement benefit is 
decoupled from the particulars of someone's labor market 
experience. These are important economic policy issues. They 
will reflect themselves in the budget and in Social Security 
more narrowly, and we look forward to working with the Congress 
in helping you as you make these decisions. Thank you, Mr. 
Chairman.
    [The prepared statement of Douglas J. Holtz-Eakin follows:]

          Prepared Statement of Douglas Holtz-Eakin, Director,
                      Congressional Budget Office

    Chairman Nussle, Congressman Spratt, and Members of the Committee, 
I appreciate the opportunity to appear before you today to discuss the 
Social Security system. Discussions about reforming the system have 
focused on the program and its trust funds. But important insights can 
also be gained by looking at Social Security from the perspectives of 
the economy and the Federal budget as a whole.
    First, from the perspective of the economy, beneficiaries make 
decisions about when to retire and how much to work before retirement 
partly on the basis of the amount of taxes they pay and the amount of 
benefits they expect to receive. Social Security also influences 
people's decisions about how much to save, and that saving plays a role 
in determining the size not only of people's retirement income but also 
of the Nation's capital stock as a whole. Consequently, Social Security 
has important implications for aggregate economic performance for the 
flow of income that the economy will be able to generate and for the 
total stock of wealth and overall economic resources that will be 
available in the future. As a result, Social Security can significantly 
affect the Nation's standard of living as well as the distribution of 
income within and among generations.
    Second, from a budgetary standpoint, Social Security is the single 
largest program of the Federal Government. This fiscal year, outlays 
for Social Security are expected to top $500 billion and account for 23 
percent of total Federal spending (excluding interest). Looking further 
ahead, the Congressional Budget Office (CBO) projects that Social 
Security outlays will grow from 4.2 percent of gross domestic product 
(GDP) in 2005 to 6.5 percent in 2050. Although that growth is 
significant, it pales in comparison with the projected growth of the 
Government's two big health programs, Medicare and Medicaid.
    Finally, Social Security can be analyzed from the perspective of 
the program itself. The most recent programmatic focus has been on the 
``sustainability'' of the system's finances. However, several other 
aspects of the program are also important. Throughout its long history, 
Social Security has had multiple goals--some related to redistributing 
income, others to offsetting lost earnings. In 2004, only about two-
thirds of Social Security's beneficiaries were retired workers; the 
rest were disabled workers, survivors of deceased workers, and workers' 
spouses and minor children. Policymakers will need to decide whether 
the program's goals are still appropriate, and if so, how changes to 
Social Security would aid or hinder the achievement of those goals and 
affect various types of beneficiaries and taxpayers. Those decisions 
will also need to take into account the dramatic increase in the 
elderly population that is expected in coming decades.
    My statement examines the prospects for Social Security from each 
of those three perspectives, in reverse order, beginning at the 
programmatic level.

              THE OUTLOOK FOR THE SOCIAL SECURITY PROGRAM

    Although there is significant uncertainty involved in making 
numerical projections of the future of Social Security, the basic 
trajectory is widely accepted. The outlook for the Social Security 
program is generally the same regardless of whether one turns to the 
long-term projections of Social Security's trustees or to those of the 
Congressional Budget Office.
    In 2008, the leading edge of the baby-boom generation will become 
eligible for early retirement benefits. Shortly thereafter, the annual 
Social Security surplus--the amount by which the program's dedicated 
revenues exceed benefits paid--will begin to diminish (see Figure 1). 
That trend will continue until about 2020, when Social Security's 
finances will reach a balance, with the revenues coming into the system 
from payroll taxes and taxes on benefits matching the benefit payments 
going out. Thereafter, outlays for benefits are projected to exceed the 
system's revenues. To pay full benefits, the Social Security system 
will eventually have to rely on interest on Government bonds held in 
its trust funds and ultimately on the redemption of those bonds. But 
where will the Treasury find the money to pay for the bonds? Will 
policymakers cut back other spending in the budget? Will they raise 
taxes? Or will they borrow more?

FIGURE 1.--SOCIAL SECURITY REVENUES AND OUTLAYS AS A SHARE OF GDP UNDER 
                              CURRENT LAW

                          (Percentage of GDP)



    Source: Congressional Budget Office.

    Note: Based on a simulation from CBO's long-term model using the 
Social Security trustees' 2004 intermediate demographic assumptions and 
CBO's January 2005 economic assumptions. Revenues include payroll taxes 
and income taxes on benefits but not interest credited to the Social 
Security trust funds; outlays include trust-fund-financed Social 
Security benefits and administrative costs. Under current law, outlays 
will begin to exceed revenues in 2020; starting in 2053, the program 
will no longer be able to pay the full amount of scheduled benefits.

    In the absence of other changes, the redemption of bonds can 
continue until the trust funds are exhausted. In the Social Security 
trustees' projections, that happens in 2042; in CBO's projections, it 
occurs about a decade later, largely because CBO projects higher real 
(inflation-adjusted) interest rates and slightly lower benefits for men 
than the trustees do. Once the trust funds are exhausted, the program 
will no longer have the legal authority to pay full benefits. As a 
result, it will have to reduce payments to beneficiaries to match the 
amount of revenue coming into the system each year. Although there is 
some uncertainty about the size of that reduction, benefits would 
probably have to be cut by 20 percent to 30 percent to match the 
system's available revenue.
    The key message from those numbers is that some form of the program 
is, in fact, sustainable for the indefinite future. With benefits 
reduced annually to match available revenue (as they will be under 
current law when the trust funds run out), the program can be continued 
or sustained forever. Of course, many people may not consider a sudden 
cut in benefits of 20 percent to 30 percent to be desirable policy. In 
addition, the budgetary demands of bridging the gap between outlays and 
revenues in the years before that cut may prove onerous. But the 
program is sustainable from a financing perspective.
    What is not sustainable is continuing to provide the present level 
of scheduled benefits--those based on the benefit formulas that exist 
today--given the present financing. Under current formulas, outlays for 
scheduled benefits are projected to exceed available revenues forever 
after about 2020 (see Figure 2). That gap cannot be sustained without 
continual--and substantial--injections of funds from the rest of the 
budget.

          THE IMPACT OF SOCIAL SECURITY ON THE FEDERAL BUDGET

    I would like to make three points about Social Security in the 
larger context of the total budget. First, Social Security will soon 
begin to create problems for the rest of the budget. Right now, Social 
Security surpluses are still growing and contributing increasing 
amounts to the rest of the budget. But as explained above, those 
surpluses will begin to shrink shortly after 2008, when the baby 
boomers start to become eligible for early retirement benefits. As the 
rest of the budget receives declining amounts of funding from Social 
Security, the Government will face a period of increasing budgetary 
stringency. By about 2020, Social Security will no longer be 
contributing any surpluses to the total budget, and after that, it will 
be drawing funds from the rest of the budget to make up the difference 
between the benefits promised and payable under current law and the 
system's revenues. Policymakers will have only three ways to make up 
for the declining Social Security surpluses and emerging Social 
Security deficits: reduce spending, raise taxes, or borrow more.

FIGURE 2.--SOCIAL SECURITY REVENUES AND OUTLAYS AS A SHARE OF GDP WITH 
                      SCHEDULED BENEFITS EXTENDED

                          (Percentage of GDP)



    Source: Congressional Budget Office.

    Note: Based on a simulation from CBO's long-term model using the 
Social Security trustees' 2004 intermediate demographic assumptions and 
CBO's January 2005 economic assumptions. Revenues include payroll taxes 
and income taxes on benefits but not interest credited to the Social 
Security trust funds; outlays include Social Security benefits and 
administrative costs. In this simulation, currently scheduled benefits 
are assumed to be paid in full after 2053 using funds from outside the 
Social Security system.

    CBO's projections offer some guidance about the potential impact of 
those developments on the budget. By CBO's calculations, the Social 
Security surplus (excluding interest) will reach about $100 billion in 
2007; but by 2025, that surplus is projected to become a deficit of 
roughly $100 billion (in 2005 dollars). That $200 billion swing will 
create significant challenges for the budget as a whole.
    Second, the demand on the budget from Social Security will take 
place simultaneously with--but be eclipsed by--the demand generated by 
Medicare and Medicaid. Currently, outlays for Social Security benefits 
equal about 4 percent of GDP, as does Federal spending on Medicare and 
Medicaid. But whereas Social Security outlays are projected to grow to 
almost 6.5 percent of GDP by 2050, spending on the two health programs 
is expected to grow substantially more. Over the past few decades, 
excess growth in health care costs--the extent to which per-beneficiary 
costs increase faster than per capita GDP--has been about 2.5 percent 
annually. If one assumes a fairly dramatic shift to a slower increase 
in health care costs--that excess cost growth will decline to less than 
half of its historical rate Federal spending on Medicare and Medicaid 
will still roughly triple by 2050, to 12 percent of GDP. The clear 
message is that although Social Security will place demands on the 
Federal budget, those demands will coincide with much greater demands 
from Medicare and Medicaid.
    Third, a key distinction exists between the programmatic 
perspective and the budgetary perspective in analyzing policy changes. 
From a programmatic standpoint, the 75-year actuarial imbalance in the 
Social Security system (the present value of expected outlays over 75 
years minus the present value of expected revenues over that period) 
equals 1.04 percent of the present value of Social Security's taxable 
payroll over those years, CBO estimates. That number suggests that, 
leaving aside economic feedbacks on the budget, immediately and 
permanently raising the payroll tax rate by about 1 percentage point or 
reducing initial benefits for newly entitled beneficiaries by 9 percent 
would address the 75-year imbalance in the system.
    From a budgetary perspective, however, annual benefits would 
continue to exceed revenues by a large margin after 2025 under either 
policy change (see Figure 3). Thus, neither policy would provide a 
permanent solution for the system's financing. Either policy could fix 
that financing for the next 75 years, but only if the projected cash-
flow deficits shown in Figure 3 were offset elsewhere in the Federal 
budget. In principle, lower net interest payments on Federal debt held 
by the public could provide that offset. But such a policy change would 
fix Social Security over the next 75 years only if the rest of the 
budget was not altered.

                    SOCIAL SECURITY AND THE ECONOMY

    Although looking at the overall budgetary context is important, 
Social Security and its possible reform also carry significant 
implications for the economy and economic policy.
    One of the major achievements of reform could be to resolve 
uncertainty about the future of the program. Uncertainty is an economic 
cost in its most fundamental form, and in the current context, there is 
uncertainty about the future of Social Security, its configuration, and 
who will be affected. The sooner that uncertainty is resolved or 
reduced, the better served will be current and future beneficiaries, 
who must make various decisions about their retirement (from how much 
they should save to when they will be able to stop working).

FIGURE 3.--SOCIAL SECURITY REVENUES AND OUTLAYS AS A SHARE OF GDP UNDER 
                         VARIOUS POLICY OPTIONS

                          (Percentage of GDP)



    Source: Congressional Budget Office.

    Notes: Based on a simulation from CBO's long-term model using the 
Social Security trustees' 2004 intermediate demographic assumptions and 
CBO's January 2005 economic assumptions. Revenues include payroll taxes 
and income taxes on benefits but not interest credited to the Social 
Security trust funds; outlays include Social Security benefits and 
administrative costs. The projections do not incorporate macroeconomic 
feedbacks.
    Under current law, annual outlays will begin to exceed revenues in 
2020; starting in 2053, the program will no longer be able to pay the 
full amount of scheduled benefits. Under either a 1 percentage point 
increase in the payroll tax rate or a 9 percent cut in initial 
benefits, outlays will exceed revenues by 2025, and scheduled benefits 
will not be able to be paid starting in 2083.

    A key uncertainty stems from a central policy question: to what 
extent should the Social Security program in the 21st century resemble 
the program in the 20th century? There are two separate aspects to 
consider: insurance and financing.
    In terms of insurance, the major issue is finding the appropriate 
balance between social responsibility and individual responsibility. On 
one side, some people argue that the nation needs a program of 
universal social insurance that allows for the redistribution of 
resources among individuals and provides a hedge against such adverse 
outcomes as poor health, unemployment, low wages, or simply bad luck. 
On the other side, some people argue that it would be better to have a 
retirement system that relied more on individuals (which proponents 
view as desirable in itself) and included provisions that strengthened 
incentives for individuals to work and save.
    In terms of financing, the major issue is striking the appropriate 
balance between prefunding retirement (with each generation saving for 
its own retirement) and employing a traditional pay-as-you-go method of 
financing (in which assets are not accumulated, but instead current 
revenues are used to finance benefit payments to retirees). Prefunding 
retirement benefits has the potential to increase the nation's capital 
stock, boost productivity, and raise GDP in the long run. However, 
prefunding requires some people to consume less or work more than they 
would otherwise during a transitional period.
    Although prefunding could be carried out either by having 
individuals save more or by having the Government save more (through 
smaller budget deficits or larger budget surpluses), analysts disagree 
about the extent to which the Government could actually prefund 
retirement benefits, for several reasons. The experience of recent 
years, for instance, raises questions about the likelihood that the 
Government would be able to maintain budget surpluses for long periods 
of time.
    Regardless of one's views about those issues, any approach to 
Social Security will have to confront the new demographic situation--
low fertility rates; declining mortality rates; and changing patterns 
of marriage, divorce, participation in the labor force, and 
immigration--as well as a host of other factors that are very different 
now than they were in the past. Reconfiguring Social Security to 
reflect those new realities, and better insulating the system from 
unexpected demographic or economic changes, will be major challenges 
for policymakers.

    Chairman Nussle. Thank you, Mr. Director. As I announced 
previously, I am going to go to members who have not had an 
opportunity to question the first panel to begin with. So Mr. 
Baird is recognized for 5 minutes.
    Mr. Baird. I thank the Chairman. I thank the gentleman.
    I would say at the outset that our experience, my 
experience on this committee, these two individuals have given 
us the most forthright, balanced, and objective information 
that we are privileged to receive. And I am grateful for their 
presentations, not only today, but previously.
    I want to just address a few quick items that were sort of 
left over from the last speaker. First of all, one of my good 
colleagues Mr. Portman, suggested that it is the Congress that 
has been spending the Social Security trust funds. I would 
point to page 363 of the President's budget offered to us by 
OMB, and would note that in 2005, the President proposes to 
spend $162 billion of the Social Security trust fund; in 2006, 
173 billion; in 2007, 197 billion, on up to a total of 256 
billion in 2010 alone. In 5 years, it amounts to over a 
trillion dollars. In 10 years, I suspect it would be $2 
trillion of expenditures not proposed by the Congress but 
proposed by the administration. Just to clear that.
    Secondly, the Treasury Secretary said that he thought it 
was appropriate to characterize Social Security as approaching 
bankruptcy. My assumption there is he seeming to be suggesting 
that if current demands exceed current revenues into a system, 
we are thereby bankrupt. If that were to apply to the Federal 
budget overall, do current--and I will ask the two gentlemen as 
experts in this area. Do current revenues for the U.S. 
Government exceed or fall short of current expenditures?
    Mr. Walker. They fall short. And if I can address the issue 
of insolvency versus bankruptcy. One of the things I find in 
Washington is that sometimes you have to go back to Webster's 
to look for the definition. The definition of bankruptcy is 
utter failure or impoverishment. The definition of insolvency 
is unable to pay debts as they fall due.
    I would respectfully suggest, for 2042, the program would 
be insolvent under that definition but not bankrupt.
    Mr. Baird. That is a very helpful clarification, and I 
appreciate it and share the opinion. I would be remiss if I 
didn't just make a marker here today about one of our concerns 
in the northwest about the President's proposed budget. I will 
not ask these gentlemen necessarily to comment on it, but it 
needs to be for the record. The proposed budget seems to depend 
for an increased source of revenues on gradually shifting what 
are currently cost based power rates in four power marketing 
areas of the country to market-based power rates, effectively 
leveling an increased taxation in the form of increased power 
rates on those four regions of the country. I personally am 
profoundly opposed to that. It goes against a proud tradition 
of this Government of supporting market-based rates in the 
public power supply systems, and would just like to put that 
down. And I believe it would have a profoundly negative impact 
if you increase power rates by up to 20 to 50 percent in those 
regions. I think it would be tantamount to a gross taxation on 
those consumers, and would be opposed to that.
    Let me ask a question that maybe you can help me address. 
Would you think it is good advice for a hypothetical family 
alluded to by Mr. Wicker and others to advise your children to 
go out and borrow money in order that they can invest it?
    Mr. Holtz-Eakin. At the individual level, the issue is the 
degree to which you have a comfort for risk. You can borrow and 
invest. That is known as leverage. It offers you the potential 
for higher rates of return and it carries with it greater risk. 
And in the United States' financial markets, individuals have 
the ability to tailor their investment strategy to the kind of 
risk that they are comfortable taking.
    Mr. Baird. Would it be a good----
    Mr. Holtz-Eakin. Truthfully, that is not the kind of advice 
you will ever get me to give personally or otherwise. I am much 
too much of a coward. But I would give them exactly those 
options and send them on their way.
    Mr. Baird. So in general, though, it would seem to me that 
to some extent banks must set their interest rates 
proportionate to what one might receive were they to invest the 
money in another way, and they must somewhere make a 
calculation that we think overall, again bearing in mind risk, 
that the amount of risk you would obtain from investing your 
borrowed money doesn't seem to me that the percentages would 
play out. In other words, would you say son or daughter go out 
and borrow a bunch of money from the bank and then put it in 
the stock market because that will get you more money for sure 
than the interest rates you will pay on the loan?
    Mr. Walker. Well, first, as you know, interest rates vary 
based upon the type of borrowing. Credit card interest rates 
are very, very high; interest rates for mortgages or home 
equity loans are a lot less. And so, therefore, one would have 
to determine with what degree of confidence that they have that 
they are going to end up gaining a net positive return from 
that leverage, understanding that there is nothing guaranteed.
    Mr. Baird. That is a good summary.
    The final question, and I don't think you have time 
necessarily to answer it. But I haven't heard anyone really 
talk about this and I have some questions. What would be the 
impact on the value of extent shares in the stock market of 
gradual or sudden influx of new purchasers of stocks under this 
type of scenario? In other words, we tend to talk about what 
happens to the Federal budget deficit vis-a-vis this, but 
wouldn't there be some substantial impact on the value of 
stocks in the market?
    Mr. Holtz-Eakin. The benchmark valuation will be driven by 
the underlying fundamentals in each company. And shares are 
worth no more than the future profits to which they give you 
claim. It could be the case that, given shifts in portfolios of 
this type you would see some transitory revaluation, but it is 
hard to imagine you would get a persistent revaluation of the 
same profits.
    Mr. Baird. Thank you. I thank the gentleman and I thank the 
Chair.
    Chairman Nussle. Mr. Walker, I have before me the Webster's 
No. 2 New College Dictionary. I would just like to read you a 
definition of the word ``crisis:'' A crucial or decisive point 
or situation.
    I think we are probably, at least according to Mr. Webster, 
at a crisis point if in fact we have got to make a decision now 
as you have counseled us. Problem is defined as, a question or 
situation that presents doubt or perplexity. I would suggest to 
you that politicians have problems with Social Security, and I 
would suggest that Social Security itself is in a crisis, 
according to these definitions. I am just having fun with you.
    Mr. Jefferson for 5 minutes.
    Mr. Jefferson. Thank you, Mr. Chairman. This is the first 
time I will have a chance to inquire about anything as a member 
of the Budget Committee, so I am pleased to have a chance to 
participate in these most important hearings. I am sorry that 
Mr. Portman isn't here, because my line of inquiry has to do 
with his assertions about the value of private accounts. He 
said, if I can remember correctly, that one might expect a 5 
percent return on private accounts as against a 1.8 percent or 
so percent return on that is now yielded by Social Security 
investments. But I note, however, that under the President's 
proposal, as I am given to understand it, CBO projects a 3.3 
percent return on private accounts; the Social Security 
Administration projects a 4.6 percent return; but in each case 
they also anticipate a crawlback of 3 percent.
    And I just want to see if you agree with me that if the CBO 
bears out to be correct at 3.3, with a clawback of 3 percent, 
then there is virtually nothing from the investment that would 
be yielded from private accounts. And if SSA is right and the 
return is 4.6 percent with a clawback of 3 percent, then there 
is actually a 1.6 percent return. Am I correct in my analysis 
of that?
    Mr. Holtz-Eakin. If I could, let me say a few words about 
the different rates of return that are floating around, because 
I think there is a fair amount of confusion, particularly about 
the work that we have done. One rate of return is the rate of 
return that is possible in a sustainable pay-as-you-go Social 
Security system. That rate of return with current beneficiaries 
being paid by current taxes, the rate of return is only the 
rise in the payroll tax base. That is the only way you can get 
a rate of return in that kind of a system. In our projections, 
that would be a number that would look like one and a half, 2 
percent real increase. We don't have a sustainable Social 
Security system, so rates of return are quite likely to be 
lower than that in the future as taxes are raised or benefits 
are cut.
    The second rate of return would be the rate of return 
possible in a prefunded system. One could imagine paying for 
one's own retirement. Instead of paying for current retirees, 
you pay for your own retirement by putting funds away. There, 
you could get, given historical rates of return, 3.3 percent 
after inflation simply by putting it in U.S. Treasuries.
    You could also then get a higher rate of return if you 
chose to take more risk. In our estimates, we assume the return 
on corporate equities is 6.8 percent, inflation adjusted, and 
corporate bonds would be in between. You could pick a portfolio 
and get a higher rate of return. Our rates of return are no 
different than anyone else's. Although they differ numerically, 
we acknowledge the higher rate of return----
    Mr. Jefferson. You have chosen the 3.3 percent figure even 
though you could check the figures and have chosen some other 
ones.
    Mr. Holtz-Eakin. Let me finish. Those are all the rates of 
return that we use, and so those are consistent with history, 
they are consistent with the economics that we have.
    The final question is, what would be the valuation now of a 
transaction that gave me the access to, say, corporate equity? 
It has a higher return historically, and we don't dispute that 
it comes with a higher risk. As Mr. Baird's question suggested, 
different people value that risk return trade-off differently. 
What we have done is examined the average as reflected in U.S. 
financial markets and note that in the U.S. financial markets 
individuals simultaneously hold Treasuries for the 3.3 return 
and equities that get 6.8 in the presence of risk. They 
therefore right now view their futures as valued equivalently. 
And that is the nature of our analysis. It is not quite the 
same thing as saying the individual account will get 3.3 
percent.
    Mr. Orszag. We should be building accounts where they 
belong and shoring up the traditional program as a core tier of 
financial security. Thank you very much.
    Mr. Jefferson. I understand.
    Mr. Holtz-Eakin. It was a long answer, I apologize.
    Mr. Jefferson. Right.
    Mr. Holtz-Eakin. There are many, many different returns 
there.
    Mr. Jefferson. At the end of the day, though, I am using 
the figure 3.3 percent, because that is--after all that 
summarizing, we ended up with a number that we used as a--I 
mean, the report that I have is that CBO's suggested rate of 
return, inflation adjusted, such and such.
    But my point is, there is a clawback in this provision, 
isn't there, of 3 percent? So whatever we do, whatever number 
we arrive at, we have taken away 3 percent which goes back to 
the Government. The individual person gets what the excess is, 
correct?
    Mr. Holtz-Eakin. Correct.
    Mr. Jefferson. So it would be incorrect to say that there 
is a 5 percent return, any percent return is pure investment 
that doesn't involve the clawback, that would be correct 
wouldn't it?
    Mr. Holtz-Eakin. One could evaluate the investment or, as 
David suggested, the whole package. If the package has 
investment plus diminished regular benefit, it is the net 
effect that would matter.
    Mr. Jefferson. Last question, if I could squeeze it in 
here. What would be the value of one's nest egg now that would 
yield $850, or something like the average return, the average 
Social Security check today that one gets every month? What 
would be the size of a nest egg that one would need to generate 
that sort of monthly income?
    Mr. Holtz-Eakin. I am sure that is a question for Dave. I 
will be happy to provide----
    Mr. Walker. We can find out. Mr. Jefferson, I think there 
is one thing that you and all members need to keep in mind, not 
all promised Social Security benefits have been funded.
    If you did nothing, then if you are 30 years of age or 
younger, your benefits are going to get cut by 27 percent plus, 
all at once, for your entire life. If you are over 30, your 
benefit is going to get cut by 27 plus percent, all at once, 
for the remaining portion of your life.
    We believe it is important, when you analyze proposals, you 
have benchmarks based on both promised benefits and funded 
benefits, because it is not fair to assume that all the current 
promised benefits are funded.
    There are going to have to be changes, with or without 
individual accounts, to make this program solvent, sustainable, 
and secure for future generations.
    Mr. Jefferson. On the nest egg, can someone answer that--
what size would the nest egg have to be to generate----
    Mr. Walker. I would be happy to try to provide something 
for the record. We could do some math on it and be happy to try 
to give you something.

 Mr. Walker's Response to Congressman Jefferson's Query About Nest Egg 
                                  Size

    One estimate of the nest egg required today to yield a monthly 
benefit is the present value of one's lifetime Social Security 
benefits. Based on CBO's Updated Long-Term Projections for Social 
Security (March 2005), the initial median monthly Social Security 
benefit for a peson aged 65 today\1\ is about $1,140. CBO estimates the 
lifetime scheduled benefits for that person to total about $127,000 (in 
present value 2004 dollars discounted at the Treasury rate.\2\
---------------------------------------------------------------------------
    \1\ This estimate reflects the benefit for a retired worker; it 
does not reflect disability or survivor benefits.
    \2\ All values are net of income taxes paid on benefits.
---------------------------------------------------------------------------
    However, as time goes on and both wages and Social Security 
benefits increase, the nest egg required to provide median scheduled 
Social Security benefits would increase. For example, the initial 
median monthly Social Security benefit for a perwson born in 2000 is 
about $2,083. CBO estimates the lifetime scheduled benefits for that 
person to total about $265,700 (in present value 2004 dollars 
discounted at the Treasury rate).
    As I noted at my testimony, scheduled Social Security benefits are 
not funded. If you did nothing, according to CBO's estimates a person 
born in 2000 would only receive 71 percent of scheduled benefits over 
his lifetime.

    Chairman Nussle. Mr. Lungren for 5 minutes.
    Mr. Lungren. Thank you, Mr. Chairman, and thank you for 
appearing. I am sorry I missed your live comments. I was over 
on the floor on the immigration bill.
    From the exchange I just heard, it reminds me of Larry 
Gatlin and the Gatlin Brothers, and the lyrics of the song they 
sang a number of years ago: ``all the gold in California is in 
a bank in Beverly Hills in someone else's name.'' There are a 
lot of people who assume that there is an account sitting there 
at the Department of Treasury with their name on it that is 
fully funded.
    I guess one of the things we have to do is to try to 
explain to people what the reality is. I think as you pointed 
out, we have promised benefits, but we haven't funded those 
benefits. The question is, how do we fund it, and do we do 
something to essentially change in part the nature of Social 
Security, so it is not only funded, but that we don't run into 
these problems in the future?
    I guess I would address this question to both of you to see 
your perspectives on that.
    Secretary Snow has said that each year that we don't do 
something it gets worse. They have put a number on it, $600 
billion a year.
    Can you give me your observations on the accuracy of that 
comment and how we come to that conclusion?
    Mr. Holtz-Eakin. My observation would be--I am not the 
source of the number, I don't know how it was calculated, but 
it has the feel of one of these actuarial numbers that looks 
out over the future horizon.
    As I noted in the remarks that you missed, ultimately those 
actuarial calculations carry with them some budgetary 
implications to make them whole. So to the extent that you want 
to go that way is a matter of preference. I think it is more 
useful to look at the cash-flow demands in the context of the 
other demands that this Congress will face, and that those 
happen very quickly, the surpluses begin to diminish. They are 
consequential aspects of the Federal budget, and I think that 
is a metric of how soon things happen that will be useful and 
reveal the trade-offs.
    Mr. Lungren. Let me ask it very simply, and that is, is it 
true that every year that we postpone doing something to change 
the system as it is now makes the system worse?
    Mr. Walker. That is true. The reason it is true is because 
of demographics, because every year you drop a positive year--
last year we had $151 billion surplus, and you add an 
increasingly bad year because of demographic trends. So it is 
true that it gets worse with the passage of time.
    Mr. Holtz-Eakin. Yes.
    Mr. Lungren. A question that I have for you, and this has 
been a subject that often has been talked about, I guess; it is 
option 2, or the Penny option, or whatever we call it, the Tim 
Penny option--which is to change the indexing from, as it is 
now, wage increases to price increases.
    There is some graph that the other side keeps putting up 
that shows you are going to diminish the benefits, and they do 
it as a percentage of replacement income, I believe.
    My question is a little different. Maybe I am wrong on 
this. I would like both of your observations.
    If we go to a price indexing, is it not in the nature of 
price indexing that you are preserving the purchasing power for 
the individual? In other words, there is purchasing power 
equity as opposed to what appears that they are suggesting. If 
you have wage indexing, you actually have more purchasing power 
10 years down the line as opposed to price indexed?
    Mr. Holtz-Eakin. Can we pull up slide 14?
    Slide 14 is an illustrative example of exactly the question 
that you asked, and it shows what would happen to the median 
person in the population.
    Go back one, please. Thank you.
    Under current law, black lines, price indexing, blue lines, 
current law--and these are for people, going from left to 
right, older to younger. The right-hand are those born in 2000. 
So, under current law, you will see that as we move to the 
right, ultimately benefits get cut due to trust fund 
exhaustion, and then begin to rise after that.
    The pricing indexing just sets the purchasing power roughly 
equal. You see the blue lines are the same for all cohorts 
going forward. That is the nature of that kind of a proposal.
    Mr. Lungren. So price indexing would allow you to have the 
same purchasing power year after year after year.
    Mr. Holtz-Eakin. Right. That is the blue lines I am looking 
at.
    Mr. Lungren. Right. But I am just trying to get that 
clarified, because when you go to this question of salary 
replacement percentage, or whatever it was they were using 
there, it shows--it gives a tremendous diminishing line. If 
what we are trying to do is preserve a system that allows you 
to purchase what you can now on into the future with price 
indexing, that means something different to me than I had 
thought.
    Mr. Walker. I think I can help you. I would say that the 
difference if you do price indexing, you are preserving 
purchasing power based on today's standard of living.
    Mr. Lungren. Correct.
    Mr. Walker. OK. If you do wage indexing, you are preserving 
a relative standard of living for tomorrow's standard of 
living, so that is the difference.
    Chairman Nussle. Mr. Case for 5 minutes.
    Mr. Case. Thank you, Mr. Chairman.
    Gentlemen, Social Security is the big picture, and so are a 
number of the other issues. I am going to go a step above that 
and talk about something that I raised with
    Mr. Bolten yesterday: debt over the long term.
    What I want to engage you in is getting straight in my mind 
where we stand with the debt of this country. Under the budget 
as submitted by the President, as I understand it, the total 
debt of our country today is roughly $7.6 trillion; is that 
about right, a little bit above the $7.3 trillion it was a few 
months ago?
    Mr. Holtz-Eakin. That presumably includes debt held in 
trust funds?
    Mr. Case. Yes, all debt; debt subject to the debt ceiling 
that we have voted on a number of times, total debt. The 
President's budget projection, which only goes out 5 years, 
projects the debt is going to go to $11.1 trillion in 5 years. 
Now, I just want to be sure that I have got straight what I am 
being told by everybody.
    That is that when we talk about that debt, when we talk 
about the President saying he wants to halve the budget deficit 
within 5 years, we are still talking about the accumulation of 
greater debt every single year; is that right? I mean we are 
not halving the budget, but halving the deficit. We have still 
got a deficit of somewhere between $200 and $300 billion a 
year. That is adding up, right?
    Mr. Holtz-Eakin. Yes.
    Mr. Case. Fueling a higher debt. That does not include, as 
I understand, any additional spending, because that is what it 
is. Spending for either outright expenditures having to do with 
the Iraq-Afghanistan war or whatever costs there are, short 
term, long term, permanent or temporary, of converting Social 
Security or to repair the alternative minimum tax or increased 
debt service for that matter. Is that your understanding?
    Mr. Holtz-Eakin. We will do a complete analysis. As you 
know, my understanding is there is recognition in there--the 
potential $80 billion supplemental for 2005 but nothing past 
that in Iraq.
    Mr. Case. Now, if we added up all of those assumptions, do 
you have any quarrel with the estimate by my ranking member 
that the total amount would be somewhere in the range of $2 
trillion additional to that debt?
    Mr. Holtz-Eakin. I am always loath to certify numbers on 
the fly, but we have done calculations similar to that in our 
January budget outlook, and I would be happy to work with you 
on that if you want me.
    Mr. Case. Is that in the range?
    Mr. Holtz-Eakin. Sounds about right, but I don't know the 
pieces.
    Mr. Case. Now, let me cover the next 5 years. I have been 
told, and I believe, that it gets a lot worse a lot faster 
after that first 5 years, unless we do something now or next 
year or sometime in the near future. Does that generically ring 
true to you?
    Mr. Holtz-Eakin. Oh, yes; generically these are the good 
times. The outyears with Medicare, Medicaid, Social Security, 
rising costs in the budget, are all far more daunting than what 
we are seeing right now.
    Mr. Case. For example, that debt number of $11.1 trillion 
does not include the potential extension of tax cuts that under 
current law sunset prior to the end of that budget cycle, is 
that right?
    Mr. Holtz-Eakin. That is true. I would add that in our 2003 
long-term budget outlook, we showed paths going out to 2050 for 
the budget, with and without the tax cuts, and alternative 
scenarios.
    The troubling fact is it is very unlikely that current law, 
fiscal policy is sustainable with or without the tax cuts over 
the long term, and that to attempt to maintain the levels of 
spending committed at the moment would be quite damaging.
    Mr. Case. I guess what I am trying to get at is, OK, we 
have got the President somehow saying that somehow it is cool 
and good, and it is OK, manageable, sustainable, that we see 
our total Federal debt run up 60 percent in the next 5 years, 
an increase to 60 percent, but it is actually a lot worse than 
that. We can add on $2 trillion more debt unless we have a wild 
increase in income somehow or a $2 trillion reduction in 
offsetting expenses somewhere else.
    We also have the potential at least of a much greater 
deficit arising, and debt, if we extend the reduction in 
revenue arising from the tax cut extension, right?
    Mr. Walker. That is right.
    The bottom line is that we face large and growing 
structural deficits due primarily to known demographic trends 
and rising health care costs; and it is not just on the revenue 
side, it is also on the spending side.
    There are a number of spending items--for example, the new 
Medicare prescription drug bill is going to cost a tremendous 
amount of money. The related costs will escalate beyond the 5-
year horizon.
    To help let us take last year. Last year the unified budget 
had a deficit of $412 billion, so the Government had to borrow 
that. But the Government also borrowed the $151 billion Social 
Security surplus and the $4 billion in surpluses elsewhere.
    So the ``on-budget,'' largely non-Social Security budget 
deficit was much bigger, and that is one reason why you have a 
difference between debt held by the public, trust fund debt, 
and total debt. When we have trust fund surpluses the 
Government spends it all on operating expenses and replaces the 
excess cash with IOUs. That affects the total number for the 
debt ceiling, but it is not shown as a liability on the 
financial statements of the U.S. Government.
    Mr. Case. I am afraid my time has expired. I was just 
getting going. Thank you.
    Chairman Nussle. Let me take a quick round, and then I 
understand that Gen. Walker has to get to another hearing.
    My very good friend, Mr. Baird, earlier was talking about 
this notion that was brought up before about the difference 
between borrowing to spend and borrowing to save. I was trying 
to think, because when I first heard this by the 
administration, I have to say, similar to my friend, I thought, 
well, wait a minute, borrowing is borrowing, you know. There 
really--is there really a difference?
    Then I got to thinking, now, wait a minute. I do it all the 
time--or, not all the time--I did it once when I bought my 
house. I mean, I borrowed to invest in something I couldn't 
afford right off the bat in cash. So we do borrow.
    My guess is my friend from Washington has probably a 
similar situation. He can't afford his house either. None of us 
can. But we borrow to save and invest in that home.
    We do the same thing for our kids, interestingly enough. I 
can't pay for my son to go to the college I went to. So I 
borrow, and I am going to make him, you know, work as well to 
pay for his fair share.
    The point is, is that I am willing to borrow to invest in 
something that is going to come back with a--maybe not a 
financial rate of return for me, but something I know is a 
pretty strong investment, or at least I hope it is. If it 
isn't, I am going to--like I said yesterday--build a woodshed.
    The same is true for business, and small business. I was 
reading here in an article in ``Entrepreneur Magazine'' 
recently, that in order to start your own Subway--not subway 
system but the new franchise, which is evidently one of the 
hottest-growing franchises in the country--you need, I think, 
$175,000. But it is a pretty good investment right now, with 
the low carb and diets and all that kind of stuff, to go out 
and sink and borrow and invest in a business that you want to 
get a rate of return. So borrowing for operating, as you 
indicated, is different than borrowing for savings or borrowing 
for an investment vehicle.
    So I understand that there are--you know, to borrow to go 
to Vegas, that is not interesting to me--and it certainly 
wouldn't be--according to what Mr. Holtz-Eakin just said, 
borrowing possibly to sink it into a security might also be a 
little bit riskier than I want to go. But businesses do provide 
that kind of function all the time.
    We do have a personal connection with this notion of 
borrowing in order to invest. So I see a difference between 
borrowing for spending in the operating budget versus borrowing 
for savings or investment. I just want to put that out there.
    The expected thing was this whole notion of rate of return. 
This is going to be a big challenge, because depending what 
number we pick and how we come up with that, it is going to be 
a huge debate, because some are going to say, wait a minute. 
Some are first of all going to say, this isn't the way to do 
it.
    Let us assume for a moment that they are not part of this 
discussion. Let us assume that it is a matter of do you take 
the high or the medium or the low. What advice would you have 
with regard to rate of return and how we go through the 
discussion of making this determination? You are going to give 
us advice, the actuaries are going to give us advice, the 
markets are going to give us advice, our constituents are 
certainly going to give us advice. What process would you 
suggest we go through in determining the rate of return for 
this vehicle that we want to set up, which is, as I said, it is 
similar to investing in our kids' education or investing in our 
home; which is borrowing some money, knowing full well that you 
are taking some risk, but it is a pretty good investment. 
People do it all the time. It is the No. 1 way people save for 
their retirement is in their home.
    So how would you help us through this process of going 
through this issue of rate of return?
    Mr. Holtz-Eakin. I would offer a couple of observations. 
The first is that you do not place great emphasis on 
differences between the CBO and SSA. We believe the long-term 
real return to Treasury is 3.3. They say it is 3 percent--that 
is, given the standards of economic science over these 
durations, the same estimate.
    We have corporate equities at 6.8 percent. Their estimate 
is very similar. So I think qualitatively these are the same 
kinds of perceived returns to different investment vehicles 
that have different levels of risk, be they Treasuries, the 
least risky; corporate bonds, a bit more risky. Corporate 
equity is the most risky out of the broad sets of choices. So 
that is number one.
    Number two, I don't think that there is any great 
disagreement about the historic returns, as I said, or, as a 
result, the possible outcomes that one could get if you held a 
portfolio over 50 years, again and again and again. On average, 
we think the corporate equities will turn out to be 6.8 
percent. That is what people historically have gotten and would 
likely continue to receive in the absence of large changes in 
the economy.
    The real tough question is to make sure that people 
understand the difference between looking backward and, right 
now, looking forward in doing the valuation exercise that 
financial markets do every day. Every day, financial markets 
and the participants look at return opportunities and their 
risk, and they value those opportunities. They evaluate them by 
putting their money in or selling them off because they decide 
that that the risk/return trade-off is unacceptable.
    This Congress and participants in this debate are making 
that same valuation decision. They are looking at potential 
risk and return--and we hope that we have displayed that to 
people in our analyses--and they can make a judgment as to 
whether it constitutes good public policy in the area of Social 
Security.
    The CBO, in my final observation, simply follows what we 
think of as bread-and-butter budgetary practice in doing this. 
When we value things on the budget, we look to the market. We 
ask what would it cost to buy these supplies for the military? 
We ask what would it cost to provide this aid to schools and 
education?
    In this instance, we ask what is the market's valuation of 
a dollar put out there for investments in the financial market, 
and markets equate $1 for Treasury and $1 for equity in a very 
particular way, which reflects the average tolerance for risk 
out there in American financial markets, and that is what we 
are going to use to do that valuation exercise.
    It is an extraordinarily difficult area. I anticipate that 
it will continue to be an area of great confusion. I once made 
a vow I would not talk about modern finance in public, and I 
have violated that vow several times now.
    I would be happy to work with the committee as we work 
through the understanding of the different risks and returns 
that are present in the current system and in any reforms.
    Chairman Nussle. Mr. Walker.
    Mr. Walker. Mr. Chairman, I would say two things. One, I 
think you need to consider input from a number of sources in 
analyzing what is an appropriate assumption to make with regard 
to rates of return. But I think you ought to give heavier 
weight to professional, objective, and credible organizations 
that do not have a vested interest in the outcome, like CBO, 
GAO and the Social Security actuaries.
    Secondly, I think you have to also understand to what 
extent is the rate of return relevant. We have to keep in mind 
this is a social insurance system.
    Rate of return is something that is interesting for an 
individual to understand how well they are doing, and it may be 
relevant in determining what type of offset there might be in 
order to be able to pay for the individual accounts. If there 
is a standard offset, for example, the example that Mr. 
Jefferson gave, then the rate of return is only relevant for 
purposes of determining what kind of deal the individual is 
going to get.
    On the other hand, if there is not a standard offset, it 
could be relevant for determining what the--you know, what 
other costs to the Government might be.
    Thank you.
    Chairman Nussle. Thank you.
    I understand, Mr. Walker, you need to leave for your----
    Mr. Walker. I need to leave in about 10 minutes,
    Mr. Chairman, if I that is OK. I wanted to make sure----
    Chairman Nussle. OK.
    Then Mr. Spratt is recognized for 5 minutes.
    Mr. Spratt. Has everybody had a chance?
    Chairman Nussle. On this panel, as I understand it, yes. 
What we are doing, we went around one time, now we are going to 
go around again.
    So, Mr. Spratt, quickly.
    Mr. Spratt. First of all, with respect to the time frame 
for talking about solvency, 75 years is the common standard--
the actuaries have established that--but Treasury and others 
sometimes use an infinite timeframe. The dollar difference is 
significant, it is $3.7 trillion for the 75-year-period. It is 
over $10 trillion for the infinite time period.
    Which is a better index?
    Mr. Walker. I personally use 75 years, but I think the 
important point is this: irrespective of what period of time 
you use, you want to try to make sure that whatever solution 
you come up with deals with the problem, hopefully 
indefinitely. In 1983, they solved the problem, but they knew 
on day one that they had only solved it for at most 75 years 
because of demographics. So whichever period you use, try to 
make sure you are achieving a solution that doesn't 
automatically require you to come back and deal with it again.
    Mr. Holtz-Eakin. I don't like either. I prefer to look at 
these in the cash-flow context that we displayed in the charts 
at the outset. If one is realistic about the fact that this 
will take place in the context of a larger set of budgetary 
demands, I think it is important to note not just the number, 
which is divorced of timing, but how fast things get big, and 
which things hit first. The demographics drive Social Security, 
it is true.
    The demographics also drive Medicare and Medicaid, but the 
health care costs also drive them so they get bigger and they 
get bigger quicker. Using these present-value horizons divorces 
the analysis of timing and makes it hard to examine budgetary 
trade-offs.
    For that reason, I would encourage you to think about the 
cash-flow futures, the qualitative information you get from the 
notion that the promised benefits lie above the dedicated 
revenues for as far as I can see. So you can pick a horizon and 
pick a number, but qualitatively the policy number is that 
cash-flow.
    Mr. Spratt. Well, given the problems we are projecting way 
into the future--longevity, fertility, productivity, and the 
factors that underlie that--isn't an infinite time frame 
terribly tenuous?
    Mr. Holtz-Eakin. The uncertainty increases as time goes 
out, which is a reason why we don't prefer it. Even if it 
arises at the CBO, we try to display the uncertainties because 
we think they are important. But mechanically, we calculate 
year by year numbers, so infinity is a problematic concept for 
us.
    I think you should look at this not in terms of a right-or-
wrong issue, but a risk-management issue, and know that making 
decisions about longer horizons involves greater uncertainty.
    Mr. Spratt. We had an exchange with the Secretary about the 
likely cost additions to the deficit and to the debt to move 
to, say, partial privatization.
    Our back-of-the-envelope analysis indicates that in the 
first 10 years of implementation, the costs would be $1.4 
trillion. In the second 10 years, the cost would be $3.5 
trillion. Therefore with 20 years, the first 20 years of 
implementation, the cost would be $4.9 trillion. And of course 
it wouldn't stop there, it would continue at least past the 
midpoint of the 21st century.
    Do those numbers sound as if they are roughly in the ball 
park to you, number one?
    Number two, if the Government has to borrow that kind of 
money, are there consequences for the Federal Government, for 
the economy?
    Mr. Holtz-Eakin. Let us just stipulate the numbers are 
right. We haven't had a chance to scrub them. I would say there 
are a couple of things that are important.
    The first is that this is borrowing that will be put right 
into savings. So from a national saving perspective, this is a 
wash. That is the difference between a budgetary view of the 
world and a broader economic view of the world.
    Number two, in any reform analysis, the borrowing for 
individual accounts is step two of a two-part process. Step one 
is what happens to the underlying program. Without knowing the 
answer of what happens to the underlying program, it is not 
possible to calculate the net borrowing with any real 
precision. Neither can you calculate the economically important 
impact, which is what will happen to net national saving, and, 
as a result, the ultimate growth in the economy. So to be 
honest----
    Mr. Spratt. You have to make behavioral assumptions amongst 
other things, don't you?
    Mr. Holtz-Eakin. You have to know the plan. Without knowing 
that, it is not possible to say with any great precision.
    Mr. Walker. Mr. Spratt, having individual accounts funded 
from the existing payroll tax revenue, even with other reforms, 
will accelerate the negative cash flow, because obviously the 
other reforms are likely to save money in the outyears, whereas 
the individual accounts are going to cost money in the near-
term years.
    But to a certain extent it is a timing difference. Because 
if you do nothing and if you want to deliver on the promised 
benefits, it is only a matter of how much and when you will 
have to borrow.
    The other thing is if we end up having to go to the markets 
to borrow more debt from the public rather than borrowing from 
ourselves--i.e., from the trust funds--then that could have an 
effect on interest rates, because obviously there is going to 
be more competition for capital. Now, whether or not it would, 
I don't know. I am not a Ph.D economist, but----
    Mr. Spratt. But this is going to occur in 2020, for 
example, as we begin to liquidate those trust fund bonds in a 
matter of ordinary course, the ones that have already 
accumulated, and the Social Security administrator has to go to 
the Treasury window, present their bonds for redemption. That 
is going to require that internally held debt be converted to 
externally held debt. So you have that burden in the market, 
several trillion dollars for that kind of conversion.
    Then you load on top of it $3, $4, $5 trillion more, plus 
the debt we are accumulating in the operating budget of the 
United States. It seems to me that sooner or later we hit the 
wall. I mean, there is a limit beyond which we can go and 
borrow without convincing the world's markets that there is a 
high risk that we will try to inflate our way out of it, that 
this somehow disavows some of the debt.
    Mr. Holtz-Eakin. Let us do all three in order.
    First, the operating or budget deficit. I won't repeat all 
the things I have said about what I view as the sustainability 
of our fiscal condition.
    Step two, redemption of bonds in the trust fund. 
Absolutely, those bonds will be redeemed. They are backed by 
the full faith and credit of the Federal Government. The 
question is how they will be redeemed; if indeed they are 
redeemed by simply borrowing from the public, that will 
represent essentially de facto increases in the operating 
borrowing, and we will have the same consequences.
    Step three, additional borrowing, which is immediately 
funneled into individual accounts. That, I think, is 
qualitatively different. I believe financial markets will be 
well equipped to see the difference. They will see additional 
Treasury borrowing; they will see a simultaneous increase in 
the demand for that same borrowing if individuals put 
Treasuries into their portfolios. If they don't, there will be 
a broadly defined increase in the demand for financial market 
investments.
    Mr. Spratt. Well, it may be perceived differently to some 
extent by the financial markets. But with respect to the 
Federal budget and how the debt affects its operation, it still 
has to be serviced, it still has to be paid. To the extent 
those things are honored, it displaces something else. It takes 
precedence. If anything, it is obligatory in a Federal budget 
that we have got to pay the interest, and we have got to pay 
the debt.
    Mr. Holtz-Eakin. I will be the last person to disagree with 
focusing on the budgetary consequences of Social Security 
reform. I mean, I think looking at the broad budget context is 
exactly right.
    My point is simply that financial markets will be in a 
position to see both the additional borrowing and any 
additional investments. They won't have to speculate about it. 
It will happen at the same time with observable cash flows, and 
that will make it easier for them to discern the net demands 
that the Nation makes on their capital markets.
    Mr. Spratt. One final question to Dr. Holtz-Eakin. Can we 
expect your analysis of the President's budget early in March, 
the first week in March?
    Mr. Holtz-Eakin. You will have the numerical analysis in 
time to mark up the budget resolution. You will get the full-
blown analysis with the words shortly thereafter.
    Mr. Spratt. One other question. Do you have enough data now 
to do a financial markup of the President's proposal?
    Mr. Holtz-Eakin. No.
    Mr. Spratt. Thank you.
    Mr. Portman [presiding]. Thank you, Mr. Spratt.
    I missed my questions earlier, so I will take my questions 
now, and then we will go on to Mr. Cooper.
    First of all, I appreciate your testimony today, as always. 
Both of you give us additional insights that are helpful. And 
we had an interesting discussion earlier, the Secretary of the 
Treasury, about so many of these issues.
    The one I focused on, of course, was the fact that we have 
this trust fund that is sometimes described as being available 
for retirement benefits without paying, in other words, without 
having to either borrow more, tax more, or cut spending. And 
that is simply not the case, because we have spent it.
    You talked about the personal accounts as being 
qualitatively different, Mr. Holtz-Eakin, and you focused on 
the fact that net national savings should be a wash, because 
you are taking funds in for investments.
    Some of those investments, as you rightly state, will 
actually go directly into Treasury; others will go into 
equities; others will go into corporate bonds. And in a very 
regulated way, the President has laid out a program, you know, 
that is not outside of Social Security. It is very much 
regulated by the Government and within Social Security.
    Can you talk a little about that aspect of it? In other 
words, when we are borrowing for whatever the number is--and 
Mr. Spratt has a number--it may be correct for personal 
accounts--aren't we both adding to our savings--and this is 
capital that will be available out there in the municipal--
therefore also helping the economy. In other words, your 
economic growth numbers that you need to come up with, your 
projections I assume would be affected by that.
    Then finally this notion of whether we have a long-term 
liability or not with regard to the trust fund. Couldn't you 
say in a sense that some of that liability is being prepaid--
and this is what Mr. Walker indicated earlier--that in effect, 
what we are doing with part of this is we are prefunding a part 
of the Social Security obligation, and in a sense, therefore, 
we are deferring some future liabilities.
    I guess my specific question would be to you, you know, how 
would you analyze all of this? What would your economic growth 
projections be? How would they be affected by this? How would 
you analyze it in terms of your impact on the budget deficit as 
compared to other kinds of borrowings; and, you know, how you 
believe this--what you termed as qualitatively different kind 
of borrowing--would affect the economy?
    Mr. Holtz-Eakin. With the caveat that the details will 
matter, the rough template by which one would go through the 
analysis, I think, is fairly straightforward. The first would 
be to look at the difference from current law in the nature of 
the traditional benefits under Social Security, and what that 
looks like to individuals on a forward-looking basis: Are they 
getting a better or worse deal from the traditional program 
compared to what they could have expected under current law? 
That will inform their saving and labor supply decisions from 
that perspective alone.
    The second would be to add in any individual accounts, and 
they would then make their decision about whether on the whole 
they have been made better or worse off in a financial sense by 
the reform. To the extent that every individual, say, on 
average, felt that they were better off, they would actually 
save less. By that, I mean, if they had more in their future 
and they were wealthier, they could consume more. If they felt 
that this increased their desire to save, we would see 
increases in personal saving. Then we would balance that 
against any change in the overall Government borrowing to look 
at what happens to national saving.
    That, in the end, is the key determinant in the ability to 
finance capital accumulation, that grows the size of the 
economy. So we would have to trace through for individuals and 
for the Government the net impacts on their financial futures 
and look at the economic feedbacks, and we would do that. 
Starting with a projection of the future, you would layer on it 
the new program, you would analyze at the individual level the 
benefits they get out and taxes they would pay.
    As you can imagine, all of this hinges critically on the 
nature of the reform, number one, but it also hinges critically 
on the baseline--in particular, for financial markets--the 
baseline perception of the outlook for Social Security.
    To give you the outer bounds, one could think that the 
baseline perception of financial markets is the gap between 
benefits promised and benefits--revenues dedicated. That gap is 
wide and forever. That would be a daunting thing for financial 
markets.
    Or they could take current law at face value and assume 
that after 2052 that closes. There is a very different baseline 
view of the outlook for Social Security depending on where you 
come down on that. We are actively engaged in talking with the 
financial markets and talking with experts in this area to see 
what their expectations are about the current program before 
you can analyze how they would react to any change.
    Mr. Portman. That is an interesting point and the 
behavioral model is interesting, too. But let me ask two 
questions.
    One, with regard to the Social Security proposal as it has 
been laid out, whether it is the President's proposal or others 
that have been talked about in the past--Senator Moynihan's 
commission laid out a few different options--is it your sense 
that financial markets would react favorably or unfavorably to 
those kinds of options? And this is relevant not because 
financial markets determine what our entire economy is going to 
look like, but they do have a big impact on interest rates. You 
say you are going to run some of these ideas past some people 
who might reflect for you the financial markets. Don't you 
already have a sense of that one way or another, and what is 
it?
    Mr. Walker. Mr. Portman, if I can excuse myself.
    I had mentioned to Chairman Nussle that I have got an 
oversight hearing before an oversight committee.
    I would be happy to answer any questions that anybody might 
want to----
    Mr. Portman. Thank you for your testimony, Mr. Walker.
    Mr. Walker. Thank you.
    Mr. Portman. If you want to take a crack at this question 
before you leave, you certainly may.
    Mr. Walker. No, that is OK. I think I will let Doug answer 
it.
    Mr. Holtz-Eakin. We have some sense of it, but I would 
hesitate to give it a convenient summary. Here is the hard 
part--and this is shared by the financial markets and the CBO 
and anyone who with will look at this area ultimately--with a 
voluntary election reform--the real money depends on how many 
people participate.
    The details then at the individual level about how this 
looks in terms of what they are going to get with their 
individual account, first, the unspecified-at-the-moment 
traditional program is a key part of how many people will take 
it; as a result, how much borrowing will be necessary to 
finance it and what the ultimate financial implications will 
be.
    I would say the financial markets in the CBO are roughly in 
the same place at the moment, which is--we would really like to 
see the details before we make that call.
    Mr. Portman. If you assume that two-thirds of those people 
who would be available would take advantage of the personal 
accounts, you indicated that you would have to make certain 
assumptions about their saving behavior, so on. Wouldn't they 
feel safe--or less safe, and therefore save more or less--but 
wouldn't it have an independent impact on economic growth 
simply that by having the savings out there--it would be, as we 
know probably, in bonds, corporate bonds or in Treasuries or in 
some kind of an index Treasury account--doesn't have that have 
an impact on the economy independently?
    Mr. Holtz-Eakin. To a first-order effect, no, because it 
will be balanced by the borrowing at the Federal level and then 
borrowings in the financial market would be unchanged.
    Mr. Portman. Thank you, Mr. Holtz-Eakin.
    We now have at least one more questioner, Mr. Cooper.
    Mr. Cooper. Thank you, Mr. Chairman.
    I apologize, I had a simultaneous hearing with Armed 
Services.
    First, I think Republicans and Democrats would both agree 
that four of President Bush's primary initiatives, probably 
four initiatives that he will be judged by history on, would be 
the Iraq war, tax-cut permanency, Social Security reform, and 
the Medicare drug bill.
    My chief of staff, Greg Hinote, thought this up. What do 
those completely different major initiatives have in common? 
The answer is, sadly, maybe tragically, none of those is 
accurately reflected in the President's budget.
    We learned today that the Medicare drug bill was seriously 
underestimated. Social Security reform is completely ignored in 
the budget. The Iraq war is not funded beyond September 30th of 
this year. And for tax-cut permanency, apparently they are 
thinking about changing the budget rules, so the cost of that 
scored a zero.
    Mr. Holtz-Eakin. If I could, I would like to point out that 
Mr. Spratt and Chairman Nussle were given a copy of the 
testimony we wrote to Chairman Thomas of the Ways and Means 
Committee today about this question of whether the Medicare 
drug bill is, in fact, more expensive than originally 
estimated.
    The answer to the question basically is no. I think that if 
one did an apples-to-apples comparison over the same budget 
windows, with the same components, we would estimate that it is 
about $6 billion more expensive than we anticipated. I don't 
think that the CMS estimates are radically different from that.
    So I think for the record it is important to recognize that 
there has not been a lot of clarity about these cost estimates 
from the beginning, but it doesn't look like the bill is any 
more expensive at the beginning than it was at the outset.
    Mr. Cooper. Even if we concede that point, three out of the 
four President's major initiatives are met, representing the 
budget, which almost makes a travesty of the operations of this 
committee. You know, we can talk about whether we are seeing 
150 programs the President promises to cut and things like 
that; that is the small potatoes.
    The big stuff, none of it is accurately represented in the 
budget, with the possible exception of the Medicare amendment. 
On Medicare, did you anticipate that Medicare was going to 
cover Viagra and other things like that in their medical 
benefits package? That was just in the news a week or two ago.
    Mr. Holtz-Eakin. Well, in our review of Medicare, to date 
we haven't changed our estimate very much. The most important, 
even in the young life of the MMA, is the issue of the final 
regulations. We are reading through the thousands of pages to 
see if the implementation matches what we envisioned when we 
did the cost estimate. The answer to that question will arrive 
with our estimate of the President's budget in March.
    Mr. Cooper. Different line of questioning. I asked 
Secretary Snow if he had a valuation for the disability 
component of Social Security benefits. He did not give me an 
answer; said he would try to supply one. Do you have a 
valuation for the disability component of Social Security 
benefits or the survivorship death benefit component of Social 
Security benefits? What would that be?
    Mr. Holtz-Eakin. Our analysis includes all three components 
of the program. It includes the dollar values. I don't know 
them off the top of my head. We can certainly get them to you. 
They are buried in our reports.
    I will point out that our numbers are the answer to the 
question: What do you get after the fact, given that you are 
disabled? The real valuation question is the insurance value if 
you don't know how it is going to turn out. We are still 
working, trying to put the best number on that.
    Mr. Cooper. So you at CBO still do not have a valuation, an 
insurance valuation of those benefits?
    Mr. Holtz-Eakin. Not a broad social insurance value that--
of the type that would be appropriate.
    Mr. Cooper. As far as you know, are those benefits 
commercially available from any company in the United States?
    Mr. Holtz-Eakin. Not the type of benefit offered in the 
broad pool at Social Security.
    Mr. Cooper. So, right now, would it be available for 
purchase nowhere else other than through the Social Security 
system?
    Mr. Walker. That benefit, no.
    Mr. Cooper. Final question. What if in a Social Security 
compromise reform package some part of the corpus of the Social 
Security Trust Fund was invested in some sort of safe market 
investment as opposed to just Treasury securities? That would 
achieve some of the goals of the folks who advocate privatized 
accounts, wouldn't it, by enabling a better rate of return 
possibly to be achieved, rather than just the ultraconservative 
investment and Treasury instruments?
    Mr. Holtz-Eakin. It would have the same implications as the 
analysis of individual accounts. You have higher return at 
higher risk, risk is present.
    Mr. Cooper. Only the risk would be spread across the 
society, as opposed to perhaps subjecting an individual who may 
have chosen unwisely--the risk would be spread, as opposed to 
individualized, right?
    Mr. Holtz-Eakin. The same total risk would be present. It 
could be distributed in many ways.
    Mr. Cooper. Has the CBO done a study of that sort of Social 
Security reform?
    Mr. Holtz-Eakin. In the late 1990s, there were a series of 
studies looking at Social Security reforms, including looking 
at investments in private accounts. I don't know the names off 
the top of my head, but we would be happy to get what we have 
to you.

           CBO Papers on Private Accounts and Related Issues

Social Security Privatization and the Annuities Markets (February 1998)

Letter to the Honorable Bill Archer regarding Professor Martin 
        Feldstein's proposal to set up personal retirement accounts 
        financed by tax credits (August 1998)

Social Security Privatization: Experiences Abroad (January 1999)

The Budgetary Treatment of Personal Retirement Accounts (March 2000)

Social Security: A Primer (September 2001)

Evaluating and Accounting for Federal Investments in Corporate Stocks 
        and Other Private Securities (January 2003)

Social Security Reform: The Use of Private Securities and the Need for 
        Economic Growth (January 2003)

Acquiring Financial Assets to Fund Future Entitlements (June 2003)

Administrative Costs of Private Accounts in Social Security (March 
        2004)

Long-Term Analysis of Plan 2 of the President's Commission to 
        Strengthen Social Security (July 2004)

Long-Term Analysis of H.R. 3821, the Bipartisan Retirement Security Act 
        of 2004 (July 2004)

    Mr. Cooper. I thank the Chairman.
    I see my time has expired.
    Chairman Nussle [presiding]. Thank you, Mr. Cooper.
    Mr. Davis for 5 minutes.
    Mr. Davis. Thank you, Mr. Chairman. I don't mean to prolong 
Mr. Holtz-Eakin by coming in late, but I had multiple hearings 
going on also.
    Let me go back to the line of questions I had with the 
Secretary, and I think it is an important policy to debate with 
this committee.
    Obviously, I think there is very broad agreement if we 
wanted to fix, quote-unquote, the Social Security shortfall, we 
would have the fiscal capacity to do it by dipping into the tax 
cuts, if you will, by suspending a portion of the tax cuts. The 
argument against doing that is based on the theory that if we 
walk away from the tax cuts that it will retard the great rate 
of growth.
    What I was exploring with the Secretary is that that has 
not empirically been the case in our economic history. In the 
1990s--well, today as I understand it, the rate of corporate 
individual taxation as to GDP is around 15 to 16 percent; is 
that about right?
    Mr. Holtz-Eakin. I am sorry, say it again.
    Mr. Davis. The rate of corporate individual taxation as to 
GDP is 15 to 16 percent of GDP today.
    Mr. Holtz-Eakin. We are at about 15 to 16 percent Federal 
receipts, a fraction of GDP.
    Mr. Davis. OK. So about 15 to 16 percent, very low levels 
historically, lowest since World War II.
    Now, we have also had--what has our growth been for the 
first half of this decade; growth of GDP for the first half of 
this decade?
    Mr. Holtz-Eakin. I don't know the number off the top of my 
head. It runs through a recession, then a recovery.
    Mr. Davis. But you would certainly say less than the 1990s 
when we had a robust recovery.
    Mr. Holtz-Eakin. Yes.
    Mr. Davis. And in the 1990s, we had a taxation rate--
combined corporate rate plus income--of around 21 percent, 22 
percent; you would agree with that?
    Mr. Holtz-Eakin. Only at the end. Tax receipts as a 
fraction of GDP edged above 20 percent toward the end of the 
1990s, largely driven by the equity-based income taxation.
    Mr. Davis. Was there any point where it dropped as low as 
16 percent during the 1990s?
    Mr. Holtz-Eakin. No.
    Mr. Davis. At the time of greatest growth in the 1990s; 
what would those years have been, 1996 to 2000 roughly, or 1996 
to 1999?
    Mr. Holtz-Eakin. Yes.
    Mr. Davis. What was the rate of taxation from 1996 to 1999 
as to GDP?
    Mr. Holtz-Eakin. Well, it rose during that period.
    Mr. Davis. OK.
    Mr. Holtz-Eakin. Receipts as a fraction----
    Mr. Davis. OK. So obviously higher than the 16 percent we 
have today, conservatively higher. You would agree with that.
    Mr. Holtz-Eakin. Yes.
    Mr. Davis. So we can conclude from the 1990s that a higher 
tax rate did appear to retard growth. Go back to the 1960s, 
when you and I were born, we had a very high--what some people 
thought was a confiscatory rate of taxation--corporate-based 
income was 28 or 29 percent in the 1960s, wasn't it?
    Mr. Holtz-Eakin. Rates were much higher in the 1960s.
    Mr. Davis. So as to GDP it would have been 28 to 29 
percent.
    Mr. Holtz-Eakin. No, as a fraction of GDP it wasn't that 
high.
    Mr. Davis. OK. Was it higher than 16 percent?
    Mr. Holtz-Eakin. The GDP number will be the average taxes 
raised. Economic behavior is going to be driven by marginal tax 
rates. We have seen big shifts across this period in average 
rates between individuals and corporations and the structure of 
the individual rates across that.
    So I am sympathetic to your point that not just taxes drive 
economic performance. I think that is absolutely right. I guess 
what I would also point out at the outset is in thinking about 
this in the context of Social Security, it is important to 
discuss what constitutes a fix.
    The reason I raise this is that in our projections 
scheduled benefits are about 2 percentage points above 
scheduled receipts as a fraction of GDP. On the long term, the 
tax cuts are about 1.4 percentages points of GDP.
    So if one wants to fix Social Security in a cash-flow 
sense, so that it never intervenes with the rest of the Federal 
budget, it requires a larger fix than the one you are 
discussing.
    If one wants to fix it in an actuarial sense, those numbers 
are typically smaller, but they require a simultaneous effort 
on the part of this committee, and in particular on the 
Congress in general, not to touch funds that are dedicated from 
the remainder of the budget to Social Security.
    Mr. Davis. So let me cut you off, because my time is 
expiring.
    Mr. Holtz-Eakin. So I know what the fix means here.
    Mr. Davis. Yes, I think that is an important distinction.
    But since my time is low, let me ask another point. Let us 
assume hypothetically we were to take the short-term approach 
as you describe it, and that we were to draw down the tax cuts, 
if you will, to deal with the temporary shortfall projected in 
Social Security.
    Wouldn't there be a commensurate rise in consumer and 
investor confidence that might make up for any lost confidence 
because some of the tax cuts were being repealed?
    Mr. Holtz-Eakin. First of all, we will have to figure out 
what ``temporary'' means. But let us leave that aside. I think 
the problem is as far as the eye can see.
    Mr. Davis. I guess I am asking a fairly narrow proposition, 
then.
    Mr. Holtz-Eakin. But if you ask what will happen to 
financial market confidence, you know, long-term interest rates 
reveal no lack of confidence at the moment in U.S. Treasury 
securities.
    Mr. Davis. Let me slip in another quick question in the 
last 15 seconds.
    Another thing that I asked the Secretary about was the 
basis for the projections around the shortfall by 2042. I 
thought the Secretary initially agreed with me and with the 
Social Security Administration that the projected growth of the 
GDP over that period of 30-some years was around 1.8 percent. 
Then he seemed to say that it wasn't the GDP, it was the level 
of productivity.
    Can you weigh into that and tell us what is accurate? Is 
the President's estimate of the shortfall based on 1.8 percent 
productivity or 1.8 percent GDP between now and 2042?
    Mr. Holtz-Eakin. Long-term GDP projections are usually put 
together by counting the number of bodies that will be 
available, growth in the labor force, and then how much more 
productive each body will be. Those are the two basic building 
blocks.
    Mr. Davis. OK.
    Mr. Holtz-Eakin. Over the long term, the key movement is 
not in productivity which remains, in those projections and in 
ours, pretty solid over the long term and similar to history. 
The key aspect is the slower growth in the labor force. That is 
present even in our 10-year budget projections where GDP growth 
averages 3.4 percent up to about 2010 and then drops to 2.7 
percent. That is the retirement of the baby boom, that is fewer 
people coming into the labor force. It reflects the fact that 
over the long term the native population is below replacement 
fertility.
    So it is true that the fundamentals are in the same good 
historical shape they were, but the bodies to which they were 
being applied are diminishing as we go forward.
    Mr. Davis. Let me--and I don't want to push my luck on the 
time--but just to push this to its logical conclusion, taking 
all of that aside--and that is not exactly what Secretary Snow 
said. I have probably been on your accuracy over his, given 
your impartiality as opposed to his.
    But let us assume that 1.8 percent number over 30-some 
years--would that not be a lower number than the growth that we 
have enjoyed, for example, than we have enjoyed over the last 
30 years?
    Mr. Holtz-Eakin. Yes, it would be.
    Mr. Davis. OK. And would that not likely indicate that the 
stock market possibly would not perform as robustly as we would 
want it to? I mean, he argued that there was--he rejected that 
correlation. Can you comment on that?
    Mr. Holtz-Eakin. Yes, I think there is no reason to 
automatically assume there is a bad stock market going forward. 
The fundamentals----
    Mr. Davis. There is no reason to assume either way, is 
there?
    Mr. Holtz-Eakin. No, I think that there is no reason to 
dramatically change your view of the future of returns to 
equities based on that number in any way. I mean, if the 
productivity numbers are about the same, if the productivity 
numbers are about the same, productivity drives profitability 
and the pricing in the market. While we can fiddle at the edges 
with the number, I think qualitatively those projections and 
the ones we do are all in line.
    Mr. Davis. OK. Thank you Mr. Chairman.
    Chairman Nussle. Thank you, Mr. Davis.
    There has been a discussion--while you are still here to be 
able to respond--we did discuss yesterday this issue of the 
percentage of Federal receipts as to GDP and determined that, 
in fact, if the permanence goes forward--in other words, there 
is no change in our current tax policy--which is assumed in the 
budget, by the way, per Mr. Cooper--that the percentage would 
rise. I believe it was to 17.2 percent. I can't remember the 
number. So you will have an increase in your percentage of GDP, 
even with tax permanence.
    Thank you, Dr. Holtz-Eakin for your testimony today. We 
appreciate your coming before us again. We look forward to 
working with you on Social Security and the budget.
    No further questions for you.
    We are going to move on to the next panel.
    Mr. Holtz-Eakin. Thank you.
    Chairman Nussle. We are pleased to be joined now by Dr. 
Peter Orszag.
    Dr. Orszag is a senior fellow at the Brookings Institution. 
He is also a retirement policy expert, one with whom I have 
agreed and disagreed, but always respect his work.
    Dr. Orszag, thank you for being with us. We have had a long 
day. As you can see, we have lost a few members to other 
hearings.
    But if you would please proceed after we have an 
opportunity for my colleague, the ranking member, to make any 
introductory remarks.
    Mr. Spratt, I already welcomed him.
    Mr. Spratt. Dr. Orszag, Mr. Orszag, thank you very much for 
coming, and, more than anything, thank you for your 
forbearance. We are sorry you had to wait so long. We will let 
you be the clean-up hitter and we expect you to hit it out of 
the park.
    Thanks for your interest and thanks for coming and your 
excellent contributions.
    Chairman Nussle. Dr. Orszag.

    STATEMENT OF PETER R. ORSZAG, PH.D., SENIOR FELLOW, THE 
                     BROOKINGS INSTITUTION

    Mr. Orszag. Thank you. I want to make four or five points, 
and I would emphasize that there are a lot of details that have 
not been filled in yet, but those that we do have are 
insightful--and even more insightful when I turn on my 
microphone.
    First, under the administration's proposal, workers who opt 
for individual accounts would pay back that diverted revenue 
plus 3 percent interest at retirement through reduced Social 
Security benefits.
    In many ways this is quite similar to a loan. The worker 
receives cash up front, gets to invest that money, but then has 
to pay back the principal plus interest later. In many ways, 
again, this is quite similar to a loan. The form of repayment 
is not critical to the underlying nature of the transaction.
    Let me give you a specific example. Someone in high school 
today, who would turn 21 in 2011, could put $500 in 2011 into 
his or her account, $1,000 in 2015, et cetera--these are all 
inflation-adjusted dollars--but would also owe a debt back to 
Social Security at retirement at age 65 in 2054 of roughly 
$150,000.
    So that worker, just like with borrowing money, that worker 
winds up better off only if his or her account exceeds that 
$150,000. It is worth noting that under the administration's 
assumptions, if the worker did invest in bonds, in Government 
bonds, that account would only grow to $142,000, less than the 
$150,000 debt owed back to Social Security. The reason is that 
the administrative costs on the accounts open up a wedge 
between the Government bond rate and the net return to the 
individual.
    Of course, this is not a--this analogy should not be taken 
literally. There is not a contract involved in this 
transaction. But nonetheless, it is a very useful analogy. 
Basically the outcomes are equivalent to someone borrowing 
money at a 3 percent real interest rate, with the repayment 
undertaken through reductions in traditional Social Security 
benefits.
    Second point. The administration itself has said that there 
is a net neutral effect from this proposal on the solvency of 
Social Security. And viewing it from the prism of a loan, one 
can see why the Treasury rate is assumed to be 3 percent. If 
you loan money at 3 percent, and you are borrowing at 3 
percent, it is a wash as long as the loan is fully repaid. But 
I want to emphasize that that is actually the best possible 
outcome, because there are many situations in which these 
implicit loans will not be fully repaid. Let me give you a few 
examples.
    First, the administration has highlighted that if you would 
die before retirement, your account will pass to an heir. A key 
question is what happens to the liability associated with that 
account? Does that also pass to your heir, in which case the 
bequest is a mixed blessing; the young will inherit both an 
account and a debt.
    Under the President's Commission models, all that happened 
was the account was passed along, not the debt. That means 
Social Security and the Federal Government is out that money.
    Similarly, there are many workers who work for less than 40 
quarters or 10 years. They don't have any traditional Social 
Security benefits because they are not eligible for retirement 
benefits under the current program. They have no traditional 
benefit under which to offset the cost of the diverted revenue 
plus interest. And you can keep going down the line.
    There are a variety of situations in which--at least based 
on the specification we have seen to date--the situation, the 
accounts would actually make solvency worse, not better, even 
over the infinite horizon that the administration prefers. That 
conclusion is only strengthened over the 75-year horizon that 
is traditionally used.
    Third point. It has already been emphasized that there is a 
significant increase in public debt associated with these 
accounts.
    I want to point out that that increase is a permanent 
increase in the very long term if just the accounts by 
themselves raise public debt as a share of GDP by about 25 to 
30 percent of the economy. The reason is that even if each 
individual loan is eventually repaid through reductions in 
Social Security benefits, at any point in time there are always 
some loans outstanding. That means that public debt is always 
higher than in the absence of the accounts.
    Now, there was a discussion earlier about whether this 
matters, about whether that is just trading one form of debt, 
public debt, for another form which is future benefit promises.
    I would argue that it does matter. I don't know any country 
that has gotten in trouble or had trouble, a financial crisis, 
because of a high implicit debt; that is, large future benefit 
promises. I know of many that have gotten in trouble with a 
large explicit debt.
    Trading implicit debt for explicit debt is not a neutral 
transaction. Explicit debt has to be financed in the financial 
markets. It has to be rolled over. Arguing that a dollar of 
debt today doesn't really matter, because we will have a dollar 
less public debt in present value in 50 or 60 years, I think is 
a problematic argument in the real world. It works in economic 
theory; it doesn't work in real-word financial markets.
    My final point is that because the accounts do not do 
anything to improve long-term solvency, and likely harm it, 
there are other changes that will be necessary to restore 
solvency to Social Security. If there is no additional revenue 
dedicated to the program, there are very severe benefit 
reductions that have to occur in order to eliminate the 
deficit.
    So if you combine the benefit reductions that are tied to 
the accounts, and then add on top of that the benefit 
reductions that are necessary under the administration's type 
of approach to eliminate the long-term deficit in Social 
Security, the traditional program truly withers on the vine 
over time.
    Take that young worker I already talked about. The 
traditional benefit would go from replacing 36 percent of 
previous wages to 7 percent of previous wages, a dramatic 
decline, roughly a fifth of the current-law benefit. Now, that 
worker would have an account which could make up part of the 
difference. But if you use the Congressional Budget Office 
analysis, it does not make up the full difference, so there are 
very substantial benefit reductions that are entailed in these 
accounts, plus trying to eliminate the long-term deficit in 
Social Security.
    My final point would be--my view is that we do need 
individual accounts. We already have them, they are called 
401(k)s and IRAs. Mr. Portman has been one of the leaders of 
building savings in the areas of those vehicles. I think that 
is where our attention should be in terms of building wealth 
and ownership. There is a growing body of evidence about what 
works there. It is not necessary to mortgage future Social 
Security benefits to increase account ownership.

Prepared Statement of Peter R. Orszag, Joseph A. Pechman Senior Fellow, 
                      the Brookings Institution\1\

    Mr. Chairman, thank you for inviting me to testify before you this 
morning. On February 2, the Bush Administration released some details 
about its proposal to replace part of Social Security with individual 
accounts. Even with these admittedly incomplete details, several points 
now appear clear: \2\
     Under the Administration's plan, payroll taxes deposited 
into an individual account are essentially a loan from the government 
to the worker. The Administration's proposal is the equivalent of a 
loan that mortgages future Social Security benefits: Workers opting to 
divert payroll taxes into an account today would pay back those funds, 
plus interest, through reductions in Social Security benefits at 
retirement.\3\ In other words, just as with a loan, the worker receives 
cash up front and then owes money back, with interest, later. Someone 
who borrows money to make an investment benefits if the assets 
purchased with the borrowed funds grow faster than the debt; the person 
is worse off if the debt grows faster than the investment. Similarly, 
under the Administration's plan, workers wind up with higher retirement 
income if the income from their accounts exceeds the benefit reductions 
that pay off the loan, and vice versa.
     The accounts not only fail to reduce the Social Security 
deficit, but will likely increase it. Even an Administration official 
has acknowledged that the accounts proposed by the President would have 
a ``net neutral effect'' on Social Security's financial condition over 
the long term. The reality is likely to be even worse, however: The 
accounts will likely harm Social Security's long-term deficit. The 
reason is that not all the ``loans'' from diverted revenue will be 
repaid in full; in several situations, which I will describe below, 
subsequent benefit reductions will be insufficient to offset the cost 
of the diverted revenue plus interest. As a result, even over the 
``infinite horizon'' that the Administration favors, the accounts not 
only fail to reduce the deficit in Social Security; they make it worse. 
Over the traditional 75-year horizon used to evaluate Social Security 
solvency, this conclusion is only strengthened.
     The accounts by themselves entail a significant and 
sustained increase in public debt. By themselves, the individual 
accounts would increase public debt by more than $1 trillion during the 
first decade they were in effect and by more than $3.5 trillion during 
their second decade. The increase in public debt, moreover, would be 
permanent: Even if each individual ``loan'' were eventually repaid in 
full, public debt would remain higher than in the absence of the 
accounts over the long term. The reason is that even if each loan were 
eventually repaid, some loans will always be outstanding. As a result, 
the government will never, at any point in time, yet have been paid 
back for all the revenue diverted into accounts--and therefore public 
debt will always be higher than without the accounts. The bottom line 
is that the Administration's account proposal would raise public debt 
by more than 30 percent of GDP over the very long term. And even if the 
account proposal were combined with other measures that (unlike the 
accounts) would reduce the deficit in Social Security, public debt 
would remain higher than in the absence of the plan for several 
decades. Such higher levels of public debt are problematic because they 
increase the exposure of the government to a collapse in financial 
market confidence.
     The Administration's ultimate plan will have to rely on 
severe benefit reductions to eliminate the Social Security deficit. 
Since by the Administration's own admission the accounts do not reduce 
Social Security's deficit, and since the Administration is opposed to 
dedicating additional payroll taxes to the program, the 
Administration's plan to eliminate the long-term deficit in Social 
Security must involve severe reductions in benefits (or introduce some 
new revenue source for the program). In particular, any plan that 
closes the deficit, includes the accounts the Administration has 
already proposed, and fails to dedicate additional revenue to Social 
Security must involve substantial cuts in traditional benefits beyond 
those required to pay back the loans to workers opting for individual 
accounts.\4\ The combined effect would be a stunning decline in the 
defined benefit component of Social Security over time. For example, if 
one prominent type of benefit reduction (often referred to as ``price 
indexation '') were combined with the loan repayments necessary under 
the Administration's accounts, traditional benefits for a young average 
earner today could decline drastically--instead of replacing more than 
a third of the worker's previous wages, Social Security's defined 
benefits would replace well under a tenth.
    Building ownership and wealth should not come at the expense of 
mortgaging future Social Security benefits. Nor should Social Security 
reform be associated with a significant increase in public debt: such 
an increase is not necessary to reform Social Security or even to 
create individual accounts. Furthermore, the accounts in the 
Administration's plan by themselves would not increase national 
savings, and could end up reducing it (if individuals decide to 
contribute less to their 401(k)s and IRAs because they see other money 
accumulating in their individual account).\5\
    A better approach would shore up the existing Social Security 
system while raising saving in addition to Social Security. Several 
common-sense steps could substantially boost saving outside of Social 
Security.

                            THE LOAN ANALOGY

    Under the Administration's proposal, the individual account system 
would involve two components: the individual account assets, which 
would contain a worker's deposits and the accumulated earnings on them, 
and a ``liability account.'' If a worker chose to participate in the 
individual account system, 4 percent of payroll taxes (initially up to 
a limit of $1,000, with the limit gradually eased over time) would be 
diverted into the account, accumulate during the worker's career, and 
be available to the worker upon retirement.\6\ Since the revenue 
diverted to this account would reduce the financing available to the 
traditional Social Security system, a ``liability account'' would also 
be created. This liability account would track the amounts diverted, 
and accumulate them at a 3 percent real interest rate. The liability 
account would determine the debt owed back to Social Security at 
retirement because of the diverted funds.
    Upon retirement, the worker's debt to the Social Security system 
would be repaid by reducing his or her traditional Social Security 
benefits--that is, the monthly check paid to a retiree. Specifically, 
the monthly benefit reduction would be computed so that the present 
value of the reduction would equal the accumulated balance in the 
liability account. In other words, the reduction in monthly benefits 
would be just enough, in expected present value, to pay off the 
accumulated debt to the Social Security system.
    This system is quite similar to a loan: As under a loan, the worker 
receives cash up-front and can invest the money. The worker pays back 
the borrowed funds, with interest, later. The specific form of the 
repayment, through a reduction in traditional Social Security benefits, 
does not alter the underlying nature of the transaction.\7\
    To take a specific example, consider a medium-earning worker aged 
21 at the beginning of 2011 who elects to participate in the accounts. 
In inflation-adjusted dollars, the worker would divert about $500 in 
payroll taxes into his or her account in 2011, about $1,000 in 2015, 
about $1,500 in 2020, and so on. Those funds would build, along with 
the investment returns on them, and be available to the worker upon 
retirement. This worker would also, however, incur a debt to Social 
Security that would accumulate to more than $150,000 by the end of 
2054, when the worker would be 65.\8\ Repayment of the $150,000 debt to 
Social Security would consume roughly half of the worker's retirement 
benefit under the current benefit formula.\9\
    If the assets in the worker's account upon retirement exceed 
$150,000, the worker would experience a net increase in retirement 
income, and vice versa, compared to not participating in the 
account.\10\ Thus the worker's retirement income, on net, increases if 
the account yields 3 percentage points per year above administrative 
costs and inflation. The worker's retirement income declines if the 
account yields less than that.
    Note that because of administrative costs, it is impossible for the 
worker to break even while holding government bonds and for the 
government to be held harmless on the transaction. The reason is that 
one party or the other must bear the administrative costs of the 
investment. Under the Administration's assumptions, for example, the 
real interest rate on government bonds is 3 percent per year. Under 
that assumption, the system would hold the government harmless as long 
as the worker reached retirement and paid back the loan (the government 
would be held harmless since the loan carries the same real interest 
rate as the projected government borrowing rate). The worker, however, 
would be worse off if she opted for an account and held government 
bonds in it. Such an account would have a net real yield of 2.7 percent 
per year (the 3 percent real return on government bonds minus the 
assumed 0.3 percent per year in administrative costs), leaving the 
worker with a net reduction in retirement income. The worker's account 
in this case would grow to only about $142,000, or almost $10,000 less 
than the worker's debt of more than $150,000 back to Social Security.
    Although the loan analogy is insightful in understanding the basic 
effects of the proposal, there are some important distinctions between 
a conventional loan and the proposed system. For example, under the 
Administration's proposal, workers must make a one-time decision to 
participate in the accounts; after that initial decision, they are 
required to continue diverting revenue over the rest of their 
careers.\11\ (The ability to invest the additional borrowing in 
Treasury bonds does not necessarily insulate the worker from the 
effects of the borrowing, given administrative costs and the 
possibility that the realized interest rate on government bonds may in 
the future diverge from the interest rate on the ``loan. '') 
Conventional loans do not typically require the borrower to continue 
borrowing over time. In addition, the proposed accounts carry 
restrictions that are not typical of conventional loans: The Social 
Security loan can only be used for purchasing assets such as stocks 
held until retirement, and can only be repaid in a specific form 
(through a reduction in future Social Security benefits).\12\ Finally, 
unlike a conventional loan, this transaction would presumably not 
involve a contract.\13\ Despite these important distinctions, the loan 
analogy is useful in evaluating the impact of the proposal.

          ACCOUNTS DO NOT IMPROVE SOLVENCY AND LIKELY HARM IT

    The loans to workers opting for the accounts carry a 3 percent real 
interest rate. This rate is equal to the expected real interest rate on 
government bonds projected by the Social Security trustees in their 
intermediate cost assumptions. Since the interest rate on the loans is 
equal to the interest rate that the Social Security system is assumed 
to earn on its own funds, the system is held harmless on each 
individual loan, under the trustees' assumptions, as long as the loans 
are repaid in full. This is why a senior Administration official was 
quoted on February 2 as saying, ``So in a long-term sense, the personal 
accounts would have a net neutral effect on the fiscal situation of the 
Social Security and on the Federal Government.'' A reporter than asked: 
``And am I right in assuming that in the way you describe this, because 
it's a wash in terms of the net effect on Social Security from the 
accounts by themselves, that it would be fair to describe this as 
having--the personal accounts by themselves as having no effect 
whatsoever on the solvency issue?'' The senior Administration official 
replied: ``That's a fair inference.'' \14\
    Two crucial points are worth noting about this statement. First, 
even the Administration now acknowledges that the accounts do nothing 
to reduce the long-term deficit in Social Security. In other words, 
according to the Administration itself, individual accounts are simply 
a non-answer to the question of how the deficit in Social Security will 
be addressed.
    Second, the statement by the Administration official is likely to 
be incorrect: The accounts are likely to harm Social Security's 
solvency. The reason is simply that there are several likely situations 
in which the loan repayment back to Social Security (through reduced 
Social Security benefits) would be insufficient to offset the cost of 
the diverted revenue. Only if repayment is always made in full will the 
Administration official's statement prove to be correct. If repayment 
is incomplete in some circumstances, the accounts not only fail to 
reduce the Social Security deficit, they actually widen it.\15\
    Several likely scenarios suggest that at least some of the loans 
will not be repaid in full, and therefore the accounts will harm the 
system's long-term finances:
     Pre-retirement deaths. If a worker dies before retirement 
without a living spouse, the amount in the individual asset account may 
be distributed to heirs, but the amount in the individual liability 
account could be extinguished. This is how the system worked under the 
proposals put forward by the President's Commission to Strengthen 
Social Security in 2001; the Administration has apparently not 
clarified whether the same approach would be adopted now. Under this 
approach, some loans are not paid off--and the system is thus made 
financially worse off. The effect may be significant, since roughly 
one-seventh of workers die before retirement. (The alternative is to 
have the debt inherited along with the account. In that case, the 
Administration should clarify that the pre-retirement bequests 
facilitated by the accounts may be a decidedly mixed blessing: the 
heirs will inherit both an account and a debt.)
     Backsliding on loan repayments. The benefit reductions 
necessary to pay off the ``loans'' from Social Security--especially if 
combined with additional benefit reductions to improve solvency--may be 
so large that they could prove politically untenable over time. For 
example, retirees may pressure the government to reduce the loan 
repayments during periods of weak stock market performance. If such 
pressures were accommodated and full loan repayments not enforced, the 
actuarial effect of the accounts could be negative over an infinite 
horizon.
     Traditional benefits insufficient to finance loan 
repayment. Even without political pressure to reduce loan repayments, 
some repayments may be curtailed simply because the traditional defined 
benefit component of Social Security is too small to pay back the loan 
in full. In other words, for some workers, the required benefit 
reductions may exceed the size of the traditional defined benefit part 
of Social Security that is supposed to provide the repayment 
financing.\16\ In such a situation, the loan would apparently not be 
repaid in full; in other words, workers would apparently not be forced 
to repay debts back to Social Security that exceed their traditional 
benefits. An extreme version of this could arise for workers with less 
than 10 years of covered earnings, who do not even qualify for Social 
Security retirement benefits. Such workers would have no traditional 
benefit against which to apply the loan repayment. If someone working 
for, say, 5 years were allowed to keep his or her account, the loan may 
never be repaid, since the worker would not have any traditional 
benefits with which to repay it. Again, the net result from these types 
of situations would be that the accounts harm Social Security solvency 
over the long term.
     Interest rate on Trust Fund more than 3 percentage points 
above inflation. The interest rate on the loan to workers is apparently 
specified as 3 percentage points above inflation. That holds the Social 
Security system harmless on each individual loan, assuming each is 
repaid in full, as long as the interest rate actually turns out to be 3 
percentage points above inflation. But if real interest rates turn out 
to be higher than 3 percent, the system would not be compensated 
sufficiently for the diverted funds, and the accounts would widen the 
Social Security deficit. It is therefore noteworthy that the 
Congressional Budget Office assumes a long-term real interest rate on 
government bonds of 3.3 percent.\17\ In other words, under CBO 
assumptions, the Administration's proposal (with a 3 percent real rate 
charged on the loans to workers) would harm solvency even over an 
infinite horizon. If real interest rates on government bonds turn out 
to be lower than the 3 percent rate applied to the loans, the opposite 
would be true.
    These effects mean that even over the problematic infinite horizon 
preferred by the Administration, the accounts may harm solvency. That 
conclusion is only strengthened over the 75-year horizon traditionally 
used to evaluate Social Security solvency. Over that 75-year horizon, 
the accounts unambiguously widen the deficit even if all loans are 
ultimately repaid in full. (The reason is that some loans issued over 
the next 75 years will not have been repaid by the end of the 75th 
year.)

         ACCOUNTS ENTAIL A SIGNIFICANT INCREASE IN PUBLIC DEBT

    According to a memorandum from the Office of the Chief Actuary, the 
Administration's accounts would raise debt held by the public by $743 
billion as of the end of Fiscal Year 2015.\18\ The increase in debt, 
moreover, would not subside thereafter: If the accounts were continued 
past 2015, they would raise debt by more than $3.5 trillion by 
2025.\19\ Over the first 10 years that they were in existence (2009-
2018), the accounts would raise debt by more than $1 trillion; during 
their second decade (2019-2028), they would raise debt by more than 
$3.5 trillion.\20\ (There has been some confusion over $743 billion 
figure and the more than $1 trillion figure. The $743 billion figure 
applies to the next 10 years. The more than $1 trillion figure applies 
to the first 10 years the accounts would be in existence, from 2009 
through 2018.)
    The loan analogy helps to explain this increase in debt, and it 
also provides insight into a surprising result: The debt increase would 
be permanent. To finance a loan to a worker (provided in the form of 
revenue deposited into an individual account) under the 
Administration's proposal, the government borrows funds. If the worker 
repays the loan, the additional government debt on that transaction is 
extinguished, so public debt returns to the same level as if that 
worker had not opted for an account. But note that at any point in 
time, even if all loans were eventually repaid, some loans would always 
be outstanding. As a result, public debt at any point in time would 
forever remain higher with the accounts than without them.
    Figure 1 illustrates the impact of the Administration's accounts on 
debt held by the public. Three aspects of the figure are noteworthy. 
First, debt increases sharply as a share of Gross Domestic Product 
(GDP) for roughly five to six decades. Second, the higher level of debt 
is perpetuated, rather than eliminated, in the long term. Finally, the 
additional, ongoing higher level of debt in the long term is 
substantial--the increase in debt outstanding of more than 30 percent 
of GDP is only somewhat smaller than today's level of publicly held 
debt relative to GDP (38 percent).



    Even if the accounts were combined with proposals to eliminate the 
underlying deficit in Social Security, the increase in debt is likely 
to be extended and substantial. For example, the leading proposal from 
the President's Commission to Strengthen Social Security in 2001 would 
have changed the determination of individual benefits to incorporate 
what is commonly--but somewhat misleadingly--referred to as ``price 
indexing.'' \21\ The change may sound innocuous, but as explained 
below, it would dramatically reduce benefits over time. For the 
immediate purpose, note that price indexation is sufficient by itself 
to more than eliminate the long-term deficit in Social Security. Yet 
even if the accounts proposed by the Administration were combined with 
this price indexing proposal, debt held by the public would remain 
higher than in the absence of the combined proposal for roughly five 
decades.
    Some advocates of the Administration's plan argue that the debt 
shown in Figure 1 merely creates ``explicit debt'' in exchange for 
``implicit debt'' that the government has already incurred (in the form 
of future Social Security benefits). From this perspective, advocates 
argue that the loan transactions merely trade more explicit debt for a 
reduction in implicit debt (since the loan repayments will reduce 
future Social Security benefits). The argument is then put forward that 
these two types of debt--``implicit debt'' and ``explicit debt''--are 
essentially the same, so that converting one into the other does not 
represent an increase in Federal liabilities and should not raise 
concerns.
    This argument is, however, flawed. The two types of debt are not 
equivalent. The explicit debt that the government would incur as a 
result of the Administration's proposal for individual accounts would 
have to be purchased by creditors in financial markets. When the 
additional debt matured, it would have to be paid off or rolled over. 
By contrast, the implicit debt associated with future Social Security 
benefit promises does not have to be financed in financial markets now. 
A government with a large explicit debt thus has less room for maneuver 
and is more vulnerable to a lessening of confidence on the part of the 
financial markets than a government with a large implicit debt. 
Converting implicit debt into explicit debt is thus problematic.
substantial benefit reductions necessary to eliminate long-term deficit
    Since the accounts do not reduce Social Security's deficit (and may 
expand it), and since the Administration appears to be opposed to 
dedicating additional payroll tax revenue to the program, the 
Administration's approach to eliminating the long-term deficit in 
Social Security must involve some new source of revenue dedicated to 
the program or rely on severe reductions in benefits beyond the loan 
repayments linked to the accounts. In other words, any plan from the 
Administration that closes the deficit, includes the accounts it has 
already proposed, and fails to dedicate additional revenue to Social 
Security must entail two types of benefit reductions. The first type of 
benefit reductions would repay the loans to workers opting for the 
accounts. The second type would be intended to eliminate the long-term 
deficit in Social Security. The combined effect of these two types of 
benefit reductions would be a stunning decline in the defined benefit 
component of Social Security over time.
    To examine the impact of relying solely on benefit reductions to 
eliminate the underlying deficit in Social Security, consider the 
proposal from Model 2 of the President's Commission in 2001. This 
proposal would have changed the determination of individual benefits to 
incorporate ``price indexing,'' instead of the wage indexing that is 
currently used to determine initial benefits. Had this ``price 
indexing'' rule been fully in effect by 1983, at the time of the last 
major reform to Social Security, benefits for newly eligible retirees 
and disabled workers now would be almost 20 percent lower and 
continuing to decline relative to current law. These benefit reductions 
would apply regardless of whether a worker elected to participate in 
the individual accounts.
    Under current law, benefits for new retirees roughly keep pace with 
wage growth.\22\ Successive generations of retirees thus receive higher 
benefits because they had higher earnings--and paid higher payroll 
taxes--during their careers. This feature of the Social Security system 
makes sense, since a goal of Social Security is to ensure that a 
worker's income does not drop too precipitously when the worker retires 
and ceases to have earnings. A focus on how much of previous earnings 
are replaced by benefits (which is called the ``replacement rate '') 
recognizes the real-world phenomenon by which families, having become 
accustomed to a given level of consumption, experience difficult 
adjustment problems with substantial declines in income during 
retirement.
    Under what is called price indexing, by contrast, initial benefit 
levels upon retirement would increasingly lag behind wage growth. In 
particular, real benefit levels would be constant over time, rather 
than increasing in line with real wages. Since real wage growth is 
positive on average, the change would reduce initial benefit levels and 
the size of the reduction would increase over time.\23\
    Under this proposal, if average real wages were 10 percent higher 
after 10 years, the roughly 10 percent benefit growth to keep pace with 
this wage growth would simply be removed. The provision thus is more 
accurately described as ``real wage growth negating'' than as ``price 
indexing,'' since it simply cancels the benefit increases from real 
wage growth.\24\
    Several commentators have underscored the troubling consequences 
that would result from ``price indexing.'' Edward Gramlich, a leading 
economist who chaired the Advisory Commission on Social Security in the 
mid-1990's and who is now a governor of the Federal Reserve System, has 
been quoted as saying that if this methodology had been adopted when 
Social Security was created, [retirees] ``would be living today at 1940 
living standards.'' \25\ An earlier analysis of the proposal 
underscored that: ``This is like saying retirees who could afford 
indoor plumbing when they were working should, in retirement, not be 
able to afford indoor plumbing because their parents' generation could 
not afford it.'' \26\ Even some leading proponents of the 
Administration's broad approach have acknowledged this point. For 
example, John Goodman, president of the National Center for Policy 
Analysis, recently commented about the price-indexing proposal: ``What 
people are forgetting is why the system is there in the first place. 
The reason is that people don't want to reach retirement age and have 
their standard of living cut in half.'' \27\
    Two implications of reducing benefits to cancel out real wage 
growth are immediately obvious. First, the longer the ``price 
indexing'' provision stays in effect, the larger the benefit cuts, 
assuming ongoing real wage gains. Second, the more rapid real wage 
growth, the larger the benefit cuts.\28\
    The bottom line is that under ``price indexing,'' the role of the 
Social Security system in allowing the elderly to maintain their 
standard of living after retirement would decline sharply over time.
    Consider the effect of the price indexing proposal combined with 
the loan repayment for workers opting for the accounts put forward by 
the Administration. Specifically, as above, consider a medium earner 
who is 21 in 2011, and assume the worker claims benefits at age 65 in 
2054. Given the economic assumptions used by the Congressional Budget 
Office, price indexing would first reduce this worker's retirement 
benefit by more than 35 percent.\29\ Then the loan repayment for the 
revenue diverted into the worker's account would consume about half of 
the benefit provided by the current benefit formula. As a result, the 
worker would have a traditional benefit equal to less than one-fifth of 
the benefit provided by the current benefit formula.



    To be sure, the worker would also have an individual account. But 
the Congressional Budget Office has correctly emphasized that the 
projected income from such accounts must be adjusted for its riskiness. 
With the type of risk adjustment adopted by the Congressional Budget 
Office, the income from the individual account would make up about half 
of the initial benefit under the current formula.\30\ The net result 
would leave the worker with total combined benefits that were roughly 
35 percent lower than under the current benefit formula.
    Perhaps more surprisingly, the reduction in benefits even including 
the account income is roughly twice as large as would be required if 
benefits in 2054 were simply reduced to match incoming payroll revenue 
in that year. This level of ``payable benefits'' is about 20 percent 
higher than the income from the account plus the remaining traditional 
benefit after price indexing and the loan repayment, under the type of 
assumptions used by the Congressional Budget Office.
    Figure 2 illustrates these effects in terms of the replacement rate 
at retirement in 2054. Financial planners suggest that a comfortable 
retirement requires income during retirement equal to about 70 percent 
of pre-retirement earnings. The current benefit formula would provide 
about half the necessary amount, requiring the worker to save enough in 
addition to Social Security to replace roughly 35 percent of pre-
retirement earnings. If benefits were reduced to match incoming payroll 
revenue in 2054, traditional benefits would replace a little under 30 
percent of pre-retirement wages, requiring the worker to save a little 
more than 40 percent of previous earnings.\31\ If the Administration's 
accounts were combined with price indexing, however, the traditional 
benefit after both price indexation and the loan repayment were applied 
would replace less than 10 percent of previous wages. The income from 
the individual account would replace a little under 20 percent of 
previous wages. The net result would be that the worker would have to 
save substantially more in addition to Social Security; such savings 
would have to be enough to replace almost half of pre-retirement 
earnings.
    Figure 2 shows that combining price indexing with the loan 
repayments on individual accounts would cause the traditional benefit 
to wither on the vine over time.

                               CONCLUSION

    Individual accounts that mortgage future Social Security benefits 
raise a number of troubling questions, as this testimony has 
highlighted. A better approach involves raising saving above and beyond 
Social Security. As illustrated in Figure 2, individual accounts--in 
the form of the 401(k)s and IRAs--have a critical role to play in 
filling the hole between the foundation provided by Social Security and 
a comfortable retirement. Many Americans, however, have not accumulated 
enough financial assets on top of Social Security. Half of households 
on the verge of retirement have only $10,000 or less in a 401(k) or 
IRA. Yet we now know what works to get people to save in 401(k)s and 
IRAs, and we're not doing it.
    Individual accounts can and should be strengthened outside Social 
Security, where they belong. Social Security itself can then be shored 
up through a combination of benefit and revenue changes that would 
retain the program's critical role in delivering a solid foundation of 
financial security.\32\

                                ENDNOTES

    1. The views expressed here are those of the author alone. This 
testimony draws upon joint work with Peter Diamond, Jason Furman, 
William Gale, and Robert Greenstein. For a detailed discussion of the 
issues involved in payouts from individual accounts, see National 
Academy of Social Insurance, Uncharted Waters: Paying Benefits from 
Individual Accounts in Federal Retirement Policy, 2005.
    2. The Administration still has not specified many important 
aspects of the accounts. I have tried to reflect the proposal as I 
understand it, based on official White House documents and on the 
memorandum from the Office of the Chief Actuary. In some cases, 
however, these documents contradict each other. As more details about 
the proposal become available, some of the specific figures cited in 
this testimony may be slightly affected, but the fundamental points 
will not be. For other analyses of the Administration's proposal, see 
Jason Furman, ``New White House Details Show the Proposed Private 
Accounts Would Worsen Social Security's Finances,'' Center on Budget 
and Policy Priorities, February 4, 2004; Jason Furman and Robert 
Greenstein, ``An Overview of Issues Raised by the Administration's 
Social Security Plan,'' Center on Budget and Policy Priorities, 
February 3, 2004; and Jason Furman, ``How the Individual Accounts in 
the President's New Plan Would Work: Plan Would Allow Individuals to 
Mortgage Half of Their Social Security Benefit,'' Center on Budget and 
Policy Priorities, February 4, 2004.
    3. Although the system operates like a loan, it is not literally a 
loan because the transaction does not involve a contract. For some 
purposes, such as budget scoring, the fact that the transaction does 
not involve a contract and therefore is not legally a loan may be 
determinative. For further discussion of the budget scoring issues 
involved in proposals of this type, see Jason Furman, William G. Gale, 
and Peter R. Orszag, ``Should the Budget Exclude the Cost of Individual 
Accounts?'' Tax Notes, January 24, 2005.
    4. Such a plan would entail two types of benefit reductions: those 
that would apply only to workers opting for the accounts, which would 
be intended to repay the loan to the worker, and benefit reductions 
that would likely apply to all future workers, regardless of whether 
they opted for an account, which would be intended to eliminate the 
long-term deficit in Social Security.
    5. Specifically, if individuals understand that the individual 
accounts are equivalent to a loan, they may not reduce their other 
savings. But if they do not understand the nature of the offsetting 
benefit reduction, then they may mistakenly consider the individual 
account an asset and reduce other asset accumulation accordingly.
    6. The limit would increase by $100 above wage inflation, at least 
through 2015. The Office of the Chief Actuary, in its memorandum on the 
proposal, indicated that the parameters of the system past 2015 had not 
been specified. It is noteworthy, however, that the White House Fact 
Sheet indicates that: ``Under the President's plan, personal retirement 
accounts would start gradually. Yearly contribution limits would be 
raised over time, eventually permitting all workers to set aside 4 
percentage points of their payroll taxes in their accounts.'' Given 
this statement, the analysis in this testimony assumes that the 
threshold would continue to increase more rapidly than wages until all 
workers could contribute 4 percent of taxable earnings. None of the 
qualitative conclusions are affected by this specific assumption.
    7. In effect, the individual accounts proposed by the 
Administration represent a ``Social Security line of credit.'' Workers 
drawing upon that line of credit receive payroll revenue in their 
individual account today, but must pay back the funds at retirement.
    8. Since the worker was 21 at the beginning of 2011, he or she 
would turn 22 during 2011. The worker would therefore turn 65 during 
2054.
    9. Note that the worker would be diverting less than one-third of 
the Social Security payroll tax into the account, but the benefit 
reduction would total roughly one-half of the benefit under the current 
benefit formula. The reason is that the loan is correctly charging the 
marginal return on funds within the Social Security system, not the 
average return.
    10. The outcome is identical to the worker borrowing from future 
Social Security benefits at a 3 percent real interest rate. The worker 
benefits only if the return to the assets purchased with the borrowed 
funds exceeds 3 percentage points above inflation. As emphasized in the 
text, because of administrative costs, the worker would have to earn 
more than 3 percentage points above inflation on the underlying 
investments in order to break even; the net return above inflation and 
after administrative costs must be 3 percent per year to break even.
    11. As the White House Fact Sheet put it, ``At any time, a worker 
could ``opt in'' by making a one-time election to put a portion of his 
or her payroll taxes into a personal retirement account. Workers would 
have the flexibility to choose from several different low-cost, broad-
based investment funds and would have the opportunity to adjust 
investment allocations periodically, but would not be allowed to move 
back and forth between personal retirement accounts and the traditional 
system.'' (See below:)
http://www.whitehouse.gov/infocus/social-security/200501/
socialsecurity3.pdf.
    12. It is unclear whether these restrictions would be sustainable. 
Most workers currently enjoy some form of access to the balances in 
their 401(k) accounts prior to retirement. A critical question 
regarding the Administration's proposal is whether Congress would 
sustain the prohibition on pre-retirement access even if it were 
initially adopted. Workers will likely argue that they should indeed 
have earlier access. At the beginning, such an argument may be made 
only in hardship cases--such as a terminal disease. Over time, this 
might evolve into withdrawals for education or first-time home 
purchases, or into an ability to borrow against an account. Such pre-
retirement liberalization would then severely undercut the role of 
Social Security as financing retirement.
    13. As noted in a footnote above, this distinction may be 
determinative for the purposes of budget scoring.
    14. Transcript of briefing as posted on Washington Post website:
http://www.washingtonpost.com/ac2/wp-dyn/A59045-
2005Feb2?language=printer.
    15. In theory, one could construct the system so that those 
actually repaying the loans overpaid, in order to compensate for the 
losses from those who underpaid. But this would impose even greater 
costs, beyond the administrative cost issue noted in the text, on 
workers who elected the accounts and then held bonds in them until 
retirement.
    16. The example provided in the text above suggested that a medium-
earner's loan repayments back to Social Security could represent about 
half of the benefit under the current benefit formula. For higher 
earners, the pay-back on the loan would be an even higher share of 
benefits under the current benefit formula. Compared to the reduced 
benefits that would exist under the Administration's approach to 
restoring solvency in Social Security, furthermore, the loan repayments 
would be even larger.
    17. Congressional Budget Office, ``Updated Long-Term Projections 
for Social Security,'' January 2005, Table W-5, http://www.cbo.gov/
Spreadsheet/6064--Data.xls.
    18. ``Preliminary Estimated Financial Effects of a Proposal to 
Phase in Personal Accounts--INFORMATION,'' Memorandum from Stephen C. 
Goss to Charles P. Blahous, February 3, 2005.
    19. These figures, like the ones in the memo from the Office of the 
Chief Actuary, assume two-thirds participation in the accounts.
    20. Such increases in debt would occur even if the maximum account 
size were capped at its (wage-adjusted) 2015 level, rather than 
continuing to be increased more rapidly than wages after 2015 to ensure 
the White House goal that all workers could eventually contribute 4 
percent of payroll to the accounts.
    21. This approach has also been employed in legislation introduced 
by Senator Lindsey Graham. As noted below, it is more accurately called 
``real wage growth negating'' than ``price indexing,'' since it removes 
the impact of real wage growth on benefit levels, rather than 
incorporating a price index directly into the benefit formula.
    22. Initial retirement benefits are based on a worker's average 
indexed monthly earnings. Average indexed monthly earnings, in turn, 
are determined by taking earnings in previous years and scaling them up 
by subsequent national average wage growth. The wage indexing occurs 
through the year in which a worker turns 60, with later wages used on a 
nominal basis (unindexed). The initial benefit level is thus indexed to 
wage growth through age 60. After initial benefit determination, 
benefit increases are indexed to price growth. Price indexing of 
benefits begins after the year in which a worker turns 62. Thus there 
is a gap with no indexing to either wages or prices, which should be 
corrected--and could be addressed on a revenue-neutral basis if 
desired. The formula relating full benefits (the so-called Primary 
Insurance Amount) to earnings is also indexed to average earnings. In 
2005, the Primary Insurance Amount is equal to 90 percent of the first 
$627 of AIME; 32 percent of AIME over $627 and through $3,779; and 15 
percent of AIME over $3,779. The ``bend points'' at which the 90, 32, 
and 15 percent factors apply are indexed to wage growth.
    23. The 2004 Trustees Report projects long-run growth of prices of 
3.0 percent per year and long-run growth of taxable wages of 4.1 
percent per year, resulting in a growth of real wages of 1.1 percent 
per year. But real wage growth may turn out to be larger or smaller 
than this amount.
    24. More precisely, the proposal would multiply the 90 percent, 32 
percent and 15 percent factors used to compute the Primary Insurance 
Amount by the ratio of cumulative price growth to cumulative wage 
growth between the start date and the year in which a worker becomes 
entitled to claim benefits. It is thus important to note that wage 
indexing would still be part of the determination of benefits.
    25. Greg Ip, ``Social Security: Five Burning Questions,'' Wall 
Street Journal Online, December 19, 2004.
    26. ``Price-Indexing the Social Security Benefit Formula Is a 
Substantial Benefit Cut,'' prepared by the minority staff of the Social 
Security Subcommittee, House Committee on Ways and Means, November 30, 
2001.
    27. Cited in Edmund L. Andrews, ``Most G.O.P. Plans to Remake 
Social Security Involve Deep Cuts to Tomorrow's Retirees,'' New York 
Times, December 13, 2004.
    28. This second implication may not be widely understood: The 
proposal reduces benefits more if real wage growth is more rapid than 
expected. Yet if real wage growth is more rapid, the actuarial deficit 
over 75 years in the absence of this provision would be smaller, not 
larger. The use of real wage negating is thus even more troubling than 
simply reducing benefits based on expected real wage growth today. The 
larger actual real wage growth turns out to be, the smaller the need 
for benefit reductions--but the larger those reductions actually are 
under the real wage negating approach. In other words, the approach 
introduces variation in benefit reductions relative to scheduled 
benefits that are larger the less the financial need of Social Security 
for such reductions.
    29. The figure assumes that price indexing applies to workers who 
are 54 years old and younger in 2005.
    30. The risk adjustment implemented by the Congressional Budget 
Office is consistent with the approach adopted by the Administration in 
evaluating stock investments by the National Railroard Retirement 
Investment Trust. As the Analytical Perspectives of the 
Administration's Fiscal Year 2006 budget notes (page 421), ``Economic 
theory suggests...that the difference between the expected return of a 
risky liquid asset and the Treasury rate is equal to the cost of the 
asset's additional risk as priced by the market.''
    31. The CBO assumptions show a cost rate in 2054 of 6.39 percent of 
GDP and an income rate of 4.95 percent of GDP. A benefit reduction of 
23 percent (1-4.95/6.39) would thus reduce cost to income. A reduction 
of 23 percent compared to the current benefit formula would leave this 
worker with a replacement rate from Social Security of roughly 28 
percent (.77*.36).
    32. For one plan that achieves sustainable solvency without the 
severe benefit reductions implied by price indexing, see Peter A. 
Diamond, and Peter R. Orszag, Saving Social Security: A Balanced 
Approach (Washington: Brookings Institution Press, 2004).

    Mr. Portman [presiding]. Thank you, Dr. Orszag, for your 
testimony. I appreciate the fact that you have spent so much 
time on not just the Social Security side but retirement 
security generally. And I, as you know, happen to agree with 
you that we need to do both additive. I also find I disagree 
with you with regard to the possibility of doing something 
within Social Security as well.
    Just a couple of quick questions about your testimony, 
first with regard to administrative costs. You indicate that 
that is the major reason you would see the 3 percent, which you 
note is the bond rate that has been used in some of the 
analysis, not being--not leading to someone with a personal 
account to have a much higher rate of return than someone, say, 
entering the workforce today, which I think the estimate is 
about 1.8 percent return. What do you assume by the 
administrative cost? Do you believe the administration's 
numbers that they had out last week of a 30 to 40 basis point 
administrative cost.
    Mr. Orszag. In that calculation, I did assume the 30 basis 
point number that the administration has used. So that is the 
assumption that I used. I do want to comment on that for a 
second, though, because that administrative cost assumption 
assumes a very centralized type of account in which investment 
choices are restricted. There are a variety of restrictions. It 
is not clear to me that that ultimately will be sustainable 
given the way these accounts are being sold, And if you have a 
more decentralized system where you can hold the accounts at 
any financial services firm, the administrative cost could be 
much higher.
    Mr. Portman. But you basically take the Thrift Savings Plan 
model and think that, assuming that they were that regulated 
and that centralized, that that administrative cost could be 
that low.
    With regard to your second point, I agree with you, there 
are some unanswered questions here. You didn't mention the 
annuitization of the funds but you talked about the liability 
that is reflected in the choice to take a personal account and 
if someone were to predecease their retirement age that that 
account would then be, as some have said, available for kids 
and grandkids, family. It is also relatively easy under the 
Social Security system to determine what that liability would 
be, isn't it? In other words, couldn't you come up with a 
calculation as to what the liability is with regard to that 
account going forward at any particular age and be able to 
provide that personal account as a lump sum in addition to 
whatever the liability was?
    Mr. Orszag. Yes. My only point there was--and again we are 
talking about roughly 14 percent of the workforce dying before 
retirement. To talk about only the bequests either raises the 
question of these accounts actually harming the solvency of 
Social Security even over an infinite horizon or the hidden 
subtext that there will be a debt passed on along with the 
account. That was my only point.
    Mr. Portman. But it is not impossible to make that 
calculation?
    Mr. Orszag. That is correct.
    Mr. Portman. The 40 quarters issue is an interesting one, 
because some people don't make 40 quarters, therefore they 
don't get the traditional benefit. Do you think it would be 
appropriate for those people to have a personal account at all?
    Mr. Orszag. Again, an unanswered question. I mean, 
presumably what would happen is that the accounts would not be 
delayed until after you had worked 40 quarters. So I guess the 
question is, are you confiscating the accounts, or are the 
deposits not going in?
    Mr. Portman. That is a good point.
    Mr. Orszag. I was going to say, there is another situation 
that I think is worth paying attention to in which the 
traditional benefit would not be sufficient to pay back the 
diverted revenue plus interest. That is, if you combined this 
proposal with price indexing, which is the leading way of 
actually--leading proposal apparently to restore solvency 
within the traditional program for the top end of the income 
distribution (and it is not a trivial share, we are still 
working on the numbers but it is not 1 or 2 percent of the 
workforce, much higher than that), the traditional benefit 
would not be sufficient to offset the cost of the diverted 
revenue plus interest. That means the system would actually 
lose money for any high earners who went into the accounts 
because the traditional benefits just wouldn't be there--be 
sufficient to pay back the diverted revenue plus interest. And 
there are a wide variety of these kinds of situations that 
could arise.
    Mr. Portman. Your third point was that with no new revenue 
you need to look at the benefits side. Do you have a favorite 
proposal?
    Mr. Orszag. I think there are a variety of proposals on 
both the benefit and revenue side. I have co-authored a plan 
with Peter Diamond of MIT. That is one way of doing it. We 
tried to balance or combine benefit and revenue changes. One 
can move beyond just talking about the payroll tax, and I know 
there is some discussion of that. One could talk about 
dedicating a state tax revenue or dedicating various different 
kinds of revenue to the system.
    The key point is without any additional revenue dedicated 
to the program you are looking at very substantial reductions 
in replacement rates or reductions relative to the current 
benefit formula to restore solvency to the program beyond, in 
my opinion, what is justified for that core tier of retirement 
security.
    Mr. Portman. One of the interesting things as you look at 
our tax system and how it relates to Social Security is the 
fact that, as you know, many workers, low-wage workers, even 
some low to middle wage workers do not have a personal 
individual income tax liability; some in fact get a tax check 
back from the Government through the EITC, earned income tax 
credit. Therefore, to look at retirement as you and I have from 
the outside as it affects Social Security, it is difficult 
without offsetting payroll taxes in the way the President is 
talking about to affect those people who you most want to 
encourage to save, and that would be lower income workers, 
middle income workers who do have a payroll tax liability. And 
so my challenge to you would be, as much as I agree with you on 
the individual accounts, as you know, and even on the savers 
credits and so on, how do you get at the solvency of Social 
Security with these outside accounts? And, number two, how do 
you really help the low wage worker who for the most part does 
not have an income tax liability, therefore a tax deduction, a 
tax credit is not useful?
    This is one thing that I think needs to be looked at. And 
as you know, I believe in the individual accounts, I also 
believe we ought to do much more on the 401(k) and the IRA side 
and even some new vehicles. But using that payroll tax does 
provide certain advantages that you don't have given the fact 
that increasingly under George Bush's leadership fewer people 
are paying Federal income tax and the burden is shifting more 
to the upper end. So it is harder to use the income tax, 
Federal income tax to effect savings among lower and middle 
income workers. Can you give us a response to that?
    Mr. Orszag. Sure. Let me answer that second question first 
and then come back to solvency. I actually think the whole way 
that we have been trying to encourage savings in the United 
States, private savings, is wrong, that trying to do it through 
financial incentives is not the most auspicious mechanism for 
raising savings. The fact of the matter is most families are 
busy, they don't focus on the decision. The decisions to save 
are complicated, and so there is a lot of inertia and just 
delaying the decision. If you put in plans where, for example, 
you are automatically in a 401(k) plan unless you opt out, 
which alters that inertia decision, participation rate even at 
the very bottom, below $20,000 in income, jumped from about 7, 
it shows, from 15 percent to 80 percent. Similarly, outside of 
401(k) plans I think we just need to make it more automatic. 
Get those tax refunds automatically into an IRA, set up payroll 
deduction IRAs in a more universal way. I will even say, I 
mean, even at Brookings--give you an example, a little personal 
example. Because of changes in the 2001 tax law, the amount 
that--the maximum amount that can be put in a 401(k) or a 
403(b) is increasing each year and increased this year. We got 
a form at Brookings saying if you wanted to put in the maximum 
amount this year you need to fill out this form. If you don't 
fill it out, you are going to stay at the lower level from last 
year. I would bet that half of my colleagues have not filled 
out that form. They just lose it. We need to make the whole 
process more automatic so that the default is that you are 
always saving. I would sign up for saving the maximum amount 
for the rest of my life until I tell someone otherwise, and I 
think many of my colleagues would also. The same thing. I think 
we just need to make it more automatic. We are looking in the 
wrong way when we--families that are too busy to focus on the 
decisions will still be too busy to focus on the decisions when 
we throw more financial incentives at it.
    So that is my answer. I don't think that we should attack 
the problem primarily through financial incentives. They can 
help, but the big thing is to get the structure right.
    And in terms of the solvency of Social Security, the way I 
think about it is the following. Financial planners say that we 
need 70 percent of preretirement income to live comfortably in 
retirement. Social Security for the average earner is providing 
about a half of that, 35 percent; the other half happens to 
come from the sorts of things we were just talking about. I 
think that bottom tier, that foundation should be provided in a 
form that lasts as long as you are alive; that is, protected 
against inflation and that doesn't fluctuate with the stock 
market. And that is exactly what the current program does. So 
in my view, while there might be some benefit adjustments that 
are necessary, taking that 35 percent replacement rate and 
going all the way down to 20 for young workers and then even 
further below that, which is what would be happening under 
price indexing, is not a very sound approach. So I have a 
proposal that avoids that kind of outcome. There are lots of 
ways of avoiding that kind of outcome. But I don't see 
individual accounts within that core tier as providing the kind 
of benefit that they can provide above that core tier.
    Mr. Portman. I appreciate your answer. I know that at least 
one proposal that you support it, and I admire your courage, 
raises payroll taxes which, as you know, is something the 
President has ruled out and I don't think would be very popular 
here on the Hill. And also it has some negative economic 
impacts. Others have talked about using general revenues, which 
is in essence not allowing the taxes to become permanent that 
are currently in place, the tax relief. So I do appreciate your 
stepping forward with a proposal. But I would just say I think 
the challenge we have got is how do you link this notion of 
higher private savings and the private vehicles with our 
solvency? And with that I will turn to my colleague and ranking 
member, Mr. Spratt.
    Mr. Spratt. Mr. Portman, I don't know if you have seen the 
book, but Peter Orszag has worked his way through all of these 
problems in a very commendable fashion to come up with a 
proposal that I think has been reduced to legislation. Hasn't 
it, Peter?
    Mr. Orszag. Not to my knowledge. It has been scored by the 
Social Security actuaries and also by the Congressional Budget 
Office though.
    Mr. Spratt. In it you develop the idea of a legacy debt, 
that Social Security owes for the overpayment of benefits in 
past years, particularly when the early employees retired after 
not having put a full 40, 35 years into the system but 
nevertheless drew, relatively speaking, pretty substantial 
benefits. Would you elaborate upon that?
    Mr. Orszag. Sure. And, in fact, this comes back to Mr. 
Portman has asked about the rate of return for current 
generations of 1 or 2 percent on Social Security, why is that 
any lower than the Government bond rate of 3 percent. And it 
has to do--precisely to do with the legacy debt that you 
mentioned. Early retirees under Social Security were given 
rates of return that were well above market rates of return. 
Think about it, someone had paid in for 5 or 10 years and then 
received benefits for perhaps 20 or 30 or 40 years. By the way, 
that decision was probably a good one. These people had lived 
through the Great Depression, fought in World War I and World 
War II, that that decision probably from society's perspective 
made sense. But because we gave away excess returns early, we 
all now collectively face the prospect of having to pay off 
again what we call that legacy debt.
    The legacy debt comes because we gave away excess returns 
under the program early, and there is nothing that we can do to 
erase that debt. I mean, a lot of these comparisons of rates of 
return pretend that we can just erase that debt. Right now what 
that would mean in practice is cutting off current 
beneficiaries. That is the only real way that we can erase the 
debt. And then of course their rates of return would be harmed. 
We gave away that money or we made a decision as a society to 
provide super normal rates of return. That is now water under 
the bridge and we all must face it.
    That is the difference, and I think economists on both 
sides of the aisle agree on this. That is the reason that 
Social Security provides a 1 to 2 percent rate of return and 
the Government bond rate is 3 percent, and there is nothing we 
can do at this point to take back the money that we had given 
away early on.
    Mr. Spratt. You propose, however, a rectification in your 
book.
    Mr. Orszag. Well, I think the key thing is that is water 
under the bridge. We all now collectively have to face the fact 
that we are all going to have to finance that in some way, and 
the key question is how do we share that burden. There are 
extremes. You could put off reform for a long period of time 
and have far distant generations bear an undue burden. You 
could move immediately to a fully funded system which would 
require current workers to bear the full burden. We think those 
two extremes don't make any sense and that something in between 
does.
    So I guess there are really two points here. One is, this 
is a key underlying issue in Social Security reform. And it is 
not issue--it is not sort of--it doesn't bubble to the surface 
enough how different generations are sharing that burden.
    The second thing is any plan will distribute that burden in 
some way, and it is very important to look at how the burden is 
being distributed.
    And just a final point, and I guess this come back to the 
individual accounts. Individual accounts are often pitched as 
helping young workers today. That is sort of where the natural 
pitch is made to. But the fact of the matter is if the 
individual accounts were honestly financed; that is, through 
additional revenue or offsetting changes today, the young 
workers today are the ones who bear that legacy debt. They are 
the ones who bear that transition cost. Or another way of 
putting it is they are the ones who have to pay twice. They 
will have to pay for current beneficiaries and then for their 
own retirement. So focusing on the legacy debt illuminates 
questions like that; much of the rhetoric surrounding the 
debate obscures it.
    Mr. Spratt. Let me ask you about the 75-year time frame as 
opposed to the infinity time frame. You deal with that in your 
book, and you come down on the side of sticking with the 75-
year time frame primarily because projecting so far over the 
horizon and into the future is terribly tenuous.
    Mr. Orszag. I think it is illuminating that out of the 
$10.4 trillion infinite horizon imbalance, more than 60 percent 
of it occurs after 2078; that is, between 2078 and eternity. 
And while I think it is important that we are aware of how 
sensitive the projections are out in 2100 or 2200, I don't 
think that it is the best basis for policy making. It is just 
too sensitive. If we change the discount rate from 3 percent to 
2.9 percent or the interest rate from 3 percent to 2.9 percent, 
and that number swings all over the place. So if that is the 
goal that you are trying to hit, I worry that reasonable 
changes in the parameters cause you to be chasing your tail.
    Mr. Spratt. Extended out over a long period of time?
    Mr. Orszag. Extended out beyond the traditional 75-year 
window.
    Mr. Spratt. Discuss with us for a minute what happens to 
disability payment if we have the significant disability and 
survivorship benefits. You may have heard the exchange earlier 
with Secretary Snow.
    Mr. Orszag. I did.
    Mr. Spratt. If indeed you recompute the primary insurance 
amount, indexing the income streams to prices rather than wages 
as they are indexed today, and over time reduce the replacement 
ratio by 50 percent, what does this do to the 30 percent of 
those who are on Social Security and are drawing either 
survivorship or disability benefits?
    Mr. Orszag. Well, let me answer the question in two 
different ways. Under the President's commission model 2 and 
model 3, the reductions that you are describing were assumed to 
apply, or at least in their numbers they assume that they 
applied to disabled workers, to young surviving children, to a 
whole variety of other very vulnerable beneficiaries. The 
implication of that is very severe reductions in benefits for 
the most vulnerable set of beneficiaries under Social Security.
    Now, the administration currently says that there will be 
no changes in the disability component or the survivor's 
component of Social Security. I would just warn you that to say 
that there are no changes in the disability component is not 
necessarily to say that there are no changes in disability 
benefits, and the President's commission danced around that 
question. I think it is a very important topic and something 
that policymakers like all of you need to pay a lot of 
attention to, to look in the fine print about exactly what is 
happening to those beneficiaries.
    Mr. Spratt. Now, let me ask you about the proposal in model 
2, which I presume will be an integral part of the President's 
proposal once it is fully formulated, to recompute the primary 
insurance amount using prices instead of wages to index the 
income streams. We showed a chart earlier that shows how the 
replacement ratio for the median beneficiary declines by about 
50 percent, from 43 percent of preretirement income to 22 
percent of preretirement income over a period of 40 or 50 
years. That also includes the return that would--the net return 
that that beneficiary would receive in his collateral savings 
account, whatever it is called. With a return at a rate equal 
to the bond rate, which is 3 percent real rate of return, how 
much would the rate of return have to be in the collateral 
account for the PIA or the replacement ratio to remain 
constant?
    Mr. Orszag. First, just to give you the numbers, the 
Congressional Budget Office analysis of model 2, which is the 
one that you are referring to, makes it very clear that even 
including the individual account and even comparing to payable 
benefits, not scheduled benefits, model 2 pays less than what 
the system could afford even after the trust fund is exhausted 
and benefits were reduced to match incoming payroll revenues. 
So, in particular, table 2 of their analysis shows that in the 
middle household earnings quintile, or for basically the 
typical household in the middle of the distribution, that lower 
level of payable benefits would be $19,900 a year. Model 2 
would give $14,600 a year, including the individual account as 
analyzed by CBO. So that is roughly a $5,000 a year 
differential, a very substantial amount for a typical family. 
To make up that difference would require an implausibly large 
rate of return on stocks as long as you are assuming some mix 
between stocks and bonds.
    Mr. Spratt. Of what magnitude? Can you give us a ball park 
figure?
    Mr. Orszag. Above 10 percent real on a sustained basis, 
assuming a 60/40 split.
    Mr. Spratt. So to be held harmless, so to speak, the 
account would have to make above 10 percent, and that is after 
the clawback of 3 percent real?
    Mr. Orszag. Just to be clear, that is on the stock 
component, and then of course there is the bond component, too. 
Stocks would have to be yielding well in excess of their 
historical average.
    Mr. Spratt. But is that after the deduction of 3 percent--
--
    Mr. Orszag. Yes, I am sorry. That is net of the benefit 
offset.
    Mr. Portman. OK. So you have to make well above 10 percent 
on the whole account?
    Mr. Orszag. Again, just to repeat, you need to make more 
than 10 percent on the stock component. The bond component 
would then be accruing at the interest rate that CBO assumes. 
After all of that, subtracting the benefit offset, you would 
just make back up to the 19,900 only if stocks were yielding 
well above 10 percent real, which again is substantially higher 
than their historical average.
    In other words, under CBO's assumptions it is unlikely that 
you would get back the payable benefits. And in fact you can 
see that in the CBO analysis. If you look at figure 3B, they 
show you the range of uncertainty over benefits compared to the 
payable benefits baseline. And out in the outyears, even with 
80-percent probability, one would--plus or minus 40 percent on 
either side, you are not getting back to payable benefits. So 
it is a very small probability that you will get back even to 
payable benefits let alone to the current benefit formula under 
CBO's assumptions.
    Mr. Spratt. Now, let me ask you. Have you had an 
opportunity to run the numbers on what amount of debt 
accumulation would be necessary, at least in the first 20 
years, to float model 2 or to float a proposal based upon that, 
particularly if the diversion is four points off FICA as 
opposed to two points off FICA?
    Mr. Orszag. Yes, and I think this chart actually shows you. 
This shows you as a percent of GDP. But just to give you the 
numbers in dollars, starting from when the accounts actually 
begin in 2009, the first decade they are fully--or, in effect; 
they are not even fully in effect. The first decade they are in 
effect the additional debt would be more than $1 trillion. And 
then in the second decade it would be more than $3.5 trillion. 
The details will matter--will depend a little bit on whether we 
should take a briefing from a senior White House official at 
face value in suggesting that the accounts will ultimately grow 
to 4 percent of earnings and exactly how that happens. But that 
is the order of magnitude that we are talking about.
    Mr. Spratt. About $4.5, $4.6 trillion over the first 20 
years of implementation?
    Mr. Orszag. Correct.
    Mr. Spratt. OK. Do you have any opinion as to what that 
would do to--you have heard the discussion today. Is that debt, 
or is that something else, since we supposedly have a wash 
here, that we are only prepaying future obligations and that 
financial markets will treat this differently? What is your 
view of what that sort of debt accumulation will do to the 
budget and to the economy?
    Mr. Orszag. I think we are running an increasing risk over 
time of running into problems, rolling over our debt, and 
maintaining the confidence of investors. Implicit debt and 
explicit debt are different things. Implicit debt does not have 
to be rolled over in financial markets. By issuing the 
trillions of dollars in additional explicit debt, we are 
increasing the risk that we run into problems with financial 
market confidence, in my view.
    And just to rephrase that, the consequences of a collapse 
in financial market confidence are more extreme, and the 
probability of that diminution in financial market confidence 
seems to me higher when we trade future implicit debt for 
current explicit debt.
    Mr. Spratt. Thank you very much.
    Mr. Portman. Well, I believe Mr. Cuellar has now left us, 
so Dr. Orszag, thank you very much for your testimony. It was 
an interesting exchange. I will say that you talked about some 
CBO numbers that we don't have yet, and we are eager to get 
them. When we look at the potential range of benefits as a 
share of GDP, we are getting some different numbers based on 
some projections that we have, but we do not have all the 
numbers you have. So we are looking forward to those.
    Mr. Orszag. This is with regard to model 2.
    Mr. Portman. I am not sure that we would entirely agree 
with the 80 percent range of uncertainty number that you listed 
based on model 2. But in any case we will have more of those 
figures as this debate goes forward.
    Mr. Spratt. Mr. Chairman.
    Mr. Portman. Mr. Spratt.
    Mr. Spratt. Can I take a second to tout his book, Saving 
Social Security, published by Brookings, Diamond and Orszag. I 
guess you can find it on their web page.
    Mr. Orszag. You can indeed.
    Mr. Spratt. An excellent discussion of all of this.
    Mr. Portman. Mr. Spratt, you really should be holding up a 
1-800 number. That would be more----
    Mr. Spratt. If I had it, I would.
    Mr. Portman. Or something dot.com.
    Anyway, Peter, thank you very for your testimony today, and 
with that our hearing is adjourned.
    [Whereupon, at 2:41 p.m., the committee was adjourned.]

                                  
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