U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

50–756 CC 1998

THE FUTURE OF SOCIAL SECURITY FOR THIS

GENERATION AND THE NEXT

HEARING

BEFORE THE

SUBCOMMITTEE ON SOCIAL SECURITY

OF THE

COMMITTEE ON WAYS AND MEANS

HOUSE OF REPRESENTATIVES

ONE HUNDRED FIFTH CONGRESS

FIRST SESSION

JUNE 24, 1997

Serial 105–38

Printed for the use of the Committee on Ways and Means

(
ii

COMMITTEE ON WAYS AND MEANS

BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois

BILL THOMAS, California

E. CLAY SHAW, JR., Florida

NANCY L. JOHNSON, Connecticut

JIM BUNNING, Kentucky

AMO HOUGHTON, New York

WALLY HERGER, California

JIM MCCRERY, Louisiana

DAVE CAMP, Michigan

JIM RAMSTAD, Minnesota

JIM NUSSLE, Iowa

SAM JOHNSON, Texas

JENNIFER DUNN, Washington

MAC COLLINS, Georgia

ROB PORTMAN, Ohio

PHILIP S. ENGLISH, Pennsylvania

JOHN ENSIGN, Nevada

JON CHRISTENSEN, Nebraska

WES WATKINS, Oklahoma

J.D. HAYWORTH, Arizona

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

CHARLES B. RANGEL, New York

FORTNEY PETE STARK, California

ROBERT T. MATSUI, California

BARBARA B. KENNELLY, Connecticut

WILLIAM J. COYNE, Pennsylvania

SANDER M. LEVIN, Michigan

BENJAMIN L. CARDIN, Maryland

JIM MCDERMOTT, Washington

GERALD D. KLECZKA, Wisconsin

JOHN LEWIS, Georgia

RICHARD E. NEAL, Massachusetts

MICHAEL R. MCNULTY, New York

WILLIAM J. JEFFERSON, Louisiana

JOHN S. TANNER, Tennessee

XAVIER BECERRA, California

KAREN L. THURMAN, Florida

A.L. SINGLETON, Chief of Staff

JANICE MAYS, Minority Chief Counsel

SUBCOMMITTEE ON SOCIAL SECURITY

JIM BUNNING, Kentucky, Chairman

SAM JOHNSON, Texas

MAC COLLINS, Georgia

ROB PORTMAN, Ohio

JON CHRISTENSEN, Nebraska

J.D. HAYWORTH, Arizona

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

BARBARA B. KENNELLY, Connecticut

RICHARD E. NEAL, Massachusetts

SANDER M. LEVIN, Michigan

JOHN S. TANNER, Tennessee

XAVIER BECERRA, California

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records

of the Committee on Ways and Means are also published in electronic form. The printed

hearing record remains the official version. Because electronic submissions are used to

prepare both printed and electronic versions of the hearing record, the process of converting

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process

is further refined.
iii

C O N T E N T S

Page

Advisory of June 17, 1997, announcing the hearing ............................................. 2

WITNESSES

American Academy of Actuaries, Ron Gebhardtsbauer ........................................ 23

Cato Institute, Stephen Moore ............................................................................... 5

Employee Benefit Research Institute, Kelly Olsen, and Paul J. Yakoboski ....... 37

Kingson, Eric, Boston College ................................................................................. 12

National Center for Policy Analysis, John C. Goodman ....................................... 27
(1)

THE FUTURE OF SOCIAL SECURITY FOR THIS

GENERATION AND THE NEXT

TUESDAY, JUNE 24, 1997

HOUSE OF REPRESENTATIVES,

COMMITTEE ON WAYS AND MEANS,

SUBCOMMITTEE ON SOCIAL SECURITY,

Washington, DC.

The Subcommittee met, pursuant to notice, at 9:59 a.m., in room

B–318, Rayburn House Office Building, Hon. Jim Bunning (Chairman of the Subcommittee) presiding.

[The advisory announcing the hearing follows:]
2

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

SUBCOMMITTEE ON SOCIAL SECURITY

FOR IMMEDIATE RELEASE Contact: (202) 225–9263

June 17, 1997

No. SS–6

Bunning Announces Fourth Hearing in Series on

‘‘The Future of Social Security

for this Generation and the Next’’

Congressman Jim Bunning (R–KY), Chairman, Subcommittee on Social Security of the Committee on Ways and Means, today announced that the Subcommittee will

hold the fourth in a series of hearings on ‘‘The Future of Social Security for this

Generation and the Next.’’ At this hearing, the Subcommittee will examine the

views of Social Security policy experts on Social Security reform. The hearing will

take place on Tuesday, June 24, 1997, in room B–318 Rayburn House Office Building, beginning at 10:00 a.m.

In view of the limited time available to hear witnesses, oral testimony will be from invited witnesses only. However, any individual or organization may submit

a written statement for consideration by the Committee and for inclusion in the

printed record of the hearing.

BACKGROUND:

The Subcommittee’s first three hearings in the series have focused on the rec- ommendations of the Advisory Council on Social Security, the fundamental issues

to consider when evaluating options for Social Security reform, the findings of the

1997 Social Security Board of Trustees, and the views of organizations with different generational perspectives on Social Security reforms.

A wide range of approaches have been proposed to restore Social Security’s finan- cial solvency. These range from maintaining the program’s current structure to revamping the system entirely. Various Social Security policy experts and policy institutes or ‘‘think tanks’’ have led the debate on Social Security reform. Many of these

experts, who represent a wide-range of perspectives, have been key presenters and

organizers of forums and conferences aimed at examining reform proposals.

In announcing the hearing, Chairman Bunning stated: ‘‘Engaging the public in

Social Security reform is vital. Many Social Security policy experts are at the cutting edge of the debate. Their views have been carried by the media to the American

public. Extensive knowledge and years of experience have shaped the thoughtful

views of these experts. The Subcommittee looks forward to considering their perspectives.’’

FOCUS OF THE HEARING:

The Subcommittee will receive the views of policy experts on Social Security reform. Specifically, Members would like to hear the views of each expert regarding:

(1) the degree to which Social Security reform is necessary, (2) an assessment of the

Advisory Council recommendations and other reform proposals, (3) specific recommendations for Congress to consider as it moves forward, and (4) how soon Congressional action is needed.
3

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

Any person or organization wishing to submit a written statement for the printed

record of the hearing should submit at least six (6) copies of their statement and

a 3.5-inch diskette in ASCII DOS format, with their address and date of hearing

noted, by the close of business, Tuesday, July 8, 1997, to A.L. Singleton, Chief of

Staff, Committee on Ways and Means, U.S. House of Representatives, 1102 Longworth House Office Building, Washington, D.C. 20515. If those filing written statements wish to have their statements distributed to the press and interested public

at the hearing, they may deliver 200 additional copies for this purpose to the Subcommittee on Social Security office, room B–316 Rayburn House Office Building, at

least one hour before the hearing begins.

FORMATTING REQUIREMENTS:

Each statement presented for printing to the Committee by a witness, any written statement

or exhibit submitted for the printed record or any written comments in response to a request

for written comments must conform to the guidelines listed below. Any statement or exhibit not

in compliance with these guidelines will not be printed, but will be maintained in the Committee

files for review and use by the Committee.

1. All statements and any accompanying exhibits for printing must be typed in single space

on legal-size paper and may not exceed a total of 10 pages including attachments. At the same

time written statements are submitted to the Committee, witnesses are now requested to submit

their statements on a 3.5-inch diskette in ASCII DOS format.

2. Copies of whole documents submitted as exhibit material will not be accepted for printing.

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material

not meeting these specifications will be maintained in the Committee files for review and use

by the Committee.

3. A witness appearing at a public hearing, or submitting a statement for the record of a public hearing, or submitting written comments in response to a published request for comments

by the Committee, must include on his statement or submission a list of all clients, persons,

or organizations on whose behalf the witness appears.

4. A supplemental sheet must accompany each statement listing the name, full address, a

telephone number where the witness or the designated representative may be reached and a

topical outline or summary of the comments and recommendations in the full statement. This

supplemental sheet will not be included in the printed record.

The above restrictions and limitations apply only to material being submitted for printing.

Statements and exhibits or supplementary material submitted solely for distribution to the

Members, the press and the public during the course of a public hearing may be submitted in

other forms.

Note: All Committee advisories and news releases are available on the World

Wide Web at ‘HTTP://WWW.HOUSE.GOV/WAYSlMEANS/’.

The Committee seeks to make its facilities accessible to persons with disabilities.

If you are in need of special accommodations, please call 202–225–1721 or 202–226–

3411 TTD/TTY in advance of the event (four business days notice is requested).

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above.

Chairman B

I want to inform the panel and the participants and all of our

UNNING. The Subcommittee will come to order.

f guests that I must be on the floor for the debate for most-favorednation status for China and that Congressman Rob Portman is on

his way here to start this hearing. I apologize, but I did not do the

floor planning; I have little to say about what bills come up on the

floor at what time, but I am committed to being on the floor to de4

bate most-favored-nation status for China, and Mr. Portman will be

here as soon as possible, and we will recess until he gets here.

[Recess.]

Mr. JOHNSON of Texas [presiding]. The hearing will come to

order.

Welcome. I guess you all are aware that Mr. Bunning is down

doing the large work on the floor of the House, and Mrs. Kennelly

I think has to leave too, fairly soon; but without objection, we will

enter his statement in the record, and in the interest of our expediting affairs, we dispense with opening statements, normally; however, I will at this time recognize the Ranking Democrat Member,

Mrs. Kennelly.

[The opening statement of Mr. Bunning follows:]

Opening Statement of Hon. Jim Bunning

This morning we begin our fourth hearing in the series ‘‘The Future of Social Security for this Generation and the Next.’’ The testimony we hear today will focus

on the views of policy experts on Social Security reform.

Engaging the public in Social Security reform is vital. Various Social Security policy experts and policy institutes—or ‘‘think tanks’’ as we all know them—have been

leaders in the debate on Social Security reform.

These witnesses bring to our Subcommittee a broad range of extensive academic

resources and professional experience of their respective organizations and constituency groups.

Comprehensive knowledge and years of experience have shaped the thoughtful

views of our policy experts today. It’s nearly impossible for Members of Congress

to gather all of the facts on every issue that arises. For that purpose, I am very

grateful that these witnesses, who have dedicated so much time and talent to further these discussions, will share their perspectives with the subcommittee this

morning.

Mrs. K

At our last hearing, we heard from the Public Trustees of the SoENNELLY. Thank you, sir.

f

cial Security Trust Fund. They urged us to act as soon as possible

to restore the solvency of the Social Security system. The longer we

wait, the more difficult the task will become, and I know our witnesses are very aware of that today.

Many proposals have been offered to resolve the problem. The

Social Security Advisory Council offers us three plans. The Council

on Economic Development, the Cato Institute, and several Members of Congress have put forward additional options. These hearings have allowed us to delve deeply into each of these proposals.

We have had the opportunity to question their authors and to consider the many advantages and disadvantages of each approach.

Among our past witnesses was the Congressional Research Service, which set out a series of criteria by which any Social Security

reform proposal ought to be judged. I intend to raise some of these

issues here today. They include questions about trust fund solvency, the impact on the deficit and the debt, the growth of entitlements, impact on national savings, and risks versus returns to the

individual.

One thing is certain—there are many issues yet to be resolved,

some of them technical, some of them philosophical, and many of

them, if not all, are important. But I believe we can work together

on an answer. I am optimistic that ultimately, we will find a solu5

tion which will assure the retirement security of both current and

future generations.

I look forward to hearing the witnesses today, and I apologize to

you for what is happening. Most-favored-nation status for China is

on the floor today, and it is a very contentious issue. The votes are

possibly very close. Mr. Bunning, of course, is there now, and I am

the third speaker, so I will have to go very shortly. But I want to

tell our witnesses and make them very aware that the reason these

hearings are held is to get on the record the witnesses’ testimony;

it is then distributed to Members of Congress. So be sure that you

know today that maybe the attendance is not exactly what you

might expect, but the fact of the matter is your words will go into

every office and be read by every Member, and I want you to know

that.

Mr. JOHNSON of Texas. Thank you, Mrs. Kennelly.

Thank you all for being here today. We appreciate it. For the two

of you who have just arrived, if you have a statement that you wish

to enter into the record, without objection, we will allow you to do

that.

Mr. NEAL. Mr. Chairman, I simply want to acknowledge the

presence of the scholarly gentleman from my State, Dr. Kingson,

from one of the greatest institutions in America, Boston College.

We eagerly await his testimony.

I am going to follow Mrs. Kennelly on the floor, but I am also

anxious to hear what he has to say about IRAs, since I am the lead

Democratic sponsor of IRAs in the House. I read his testimony last

night, and there will be some genuine room for disagreement on

that issue.

But we welcome a great friend of Congressman Tierny as well,

I believe.

Thank you, Mr. Chairman.

Mr. JOHNSON of Texas. Thank you for that introduction.

Now we will go ahead and proceed. We will allow each of you to

make your statements, and we would request that you keep them

as short as possible. You will be able to enter your entire statement

in the record. Then we will ask you some questions.

Stephen Moore, director of fiscal policy studies at the Cato Institute.

STATEMENT OF STEPHEN MOORE, DIRECTOR, FISCAL POLICY

STUDIES, CATO INSTITUTE

Mr. MOORE. Thank you, Mr. Chairman.

First of all, let me commend the Members of this Subcommittee

for holding a hearing on the future of Social Security. I commend

you for your courage to talk about this issue in an honest and open

way.

First of all, in compliance with the truth in testimony provisions

passed by this Congress, let me say that the Cato Institute does

not receive one penny of government funds.

Let me concentrate my remarks this morning on the issue of the

rate of return of Social Security. I am not going to get into the

issue of the financial viability of the system. I want to talk about

whether we can do better for our workers if we chose another option other than Social Security.
6

And let me get right to the heart of the matter. Social Security,

especially for our young workers, the Generation X workers, if you

will, and especially workers under the age of 40, is a very bad deal.

It is a bad deal for virtually every worker in virtually ever circumstance.

If I may, if you have copies of my testimony, let me ask you to

turn to the chart that I presented, because this really does get to

the heart of the matter. Basically, what we have done—this is the

chart I am referring to, just so you are aware—what we have done

essentially at Cato is looked at the rate of return that a worker

might get if, rather than putting that money into the Social Security Trust Fund, that workers were allowed to put that money into

an individual, what we call a personal security account.

Essentially what I would like you to do is concentrate for a moment on the panel on this chart, ‘‘Year of Birth 1970.’’ What this

shows, if you look at the first panel—let us concentrate for a

minute on a low-wage worker. If you see this little panel here that

says $769, that is essentially the monthly benefit that a low-wage

worker will receive from Social Security. This is someone who was

born in 1970. This low-wage worker, by the way, is someone whom

we assume is going to make roughly the minimum wage their entire lifetime.

So we ask the question, OK, what happens if, rather than put

the money into the trust fund, we allowed that worker to put that

money into private capital markets. In terms of rate and return,

since obviously, we are projecting into the future, we looked at the

rate of return that you could get in the capital markets over the

last 75 years and projected out that—essentially, the assumption

here is that you can get the same rate of return in the next 50

years that people have gotten in financial markets over the last 75

years.

Let me just make the case that over the last 15 years or so, the

financial markets have been much, much higher than actually the

average over the last 75 years.

If you buy that assumption, which I think is very reasonable,

what you find is that if that low-wage worker were able to put all

of that money into bonds, which would be a very risk-averse portfolio—no one would put all of his savings into bonds—but if he did,

he would still get a benefit from a bond portfolio that would be

about 50-percent higher than what that worker would get from Social Security.

If that low-wage worker were to put all the money into stocks,

which would be a much riskier portfolio, he would get a rate of return about three times higher from a stock portfolio than what

they would get out of Social Security.

Now, obviously, as the worker’s income rises, the benefit of opting out of the system is higher. So that, for example, if you look

at the second half of this panel, that is a high-wage worker; that

is anyone who makes over $62,000 a year who essentially caps out

on the amount he pays into Social Security. That worker could do

roughly three times better if he invested in bonds and, incredibly,

about a six times higher rate of return if he could put the money

into stocks.
7

Let me make a couple of points about this. I think these are very powerful numbers, and when I show these especially to young

workers, they say, ‘‘I want this option. I want this option of getting

the best deal I can on the money that I am putting into my retirement account.’’

I think a couple of points need to be emphasized. First of all, it

is very true that Social Security is an income redistribution program. There is a progressive feature to the benefits. And some people who are opposed to this idea say, well, this would not be a good

deal for young, low-wage workers because they are going to lose the

progressive feature of the benefit. And a point I want to emphasize to you is that if we were to allow even the lowest wage workers in our society to put money

into private capital markets, even the lowest wage worker would

do substantially better, even given the progressive feature of the

benefit structure than if they stayed in Social Security. So, there

is not a single worker in the system who is young today who would

not do better if they could opt out and go to the private account

system. Let me make one other point, and then I will pass the microphone over to the next speaker, and that is, realize also that this

is essentially the worst case scenario for personal savings accounts,

because the assumption that is made in this analysis is that we are

going to make no changes to Social Security. That is, we are not

going to reduce the benefits, and we are not going to increase the

taxes. But everyone here knows that that is unrealistic; even the

people who are advocates of maintaining the status quo agree that

essentially we are going to have to do something about the tax rate

and reduce future benefits.

If you do that, that essentially simply makes the point that that worker, if he were able to—well, let me put it like this. If you raise

the tax, if you allowed that worker to put that additional money

into private accounts, then the deal would be all the better for that

young worker.

So what I am trying to say, I guess, is that all the conventional

reforms to Social Security—raising the tax rates, increasing the retirement age, and lowering benefits in the future—only make Social Security a worse deal for our young workers. The only deal

that makes it a good deal for young workers is to allow them to

start to put at least some of this money into personal security accounts.

Thank you.

[The prepared statement and attachment follow:]

Statement of Stephen Moore, Director, Fiscal Policy Studies, Cato Institute

Mr. Chairman, my name is Stephen Moore and I am Director of Fiscal Policy

Studies at the Cato Institute. In keeping with the new truth in testimony rules, let

me first say that the Cato Institute does not receive a single penny of government

funds.

Thank you for the opportunity to comment today on the future of Social Security.

I wish to commend this Committee for its willingness to explore the long term prognosis for Social Security.

As everyone on this Committee knows, the long term financial outlook for Social

Security is bleak. Depending on how it is measured the unfunded liability of the

system ranges from $3 trillion to $5 trillion. This is much like a second national

debt. Yet the financial sustainability of Social Security could be assured with a series of conventional reforms that include raising payroll taxes and reducing future
8

benefits. Though young people, of course, are none too enthusiastic about these ‘‘pay

more in, get less out’’ solutions.

But the major point that I wish to communicate to you this morning is that the

case for converting Social Security into a system of Personal Security Accounts

(PSAs) is not primarily based on the system’s financial problems. The real economic

and political crisis looming over Social Security relates to the issue of rate of return.

For baby boomers and especially for Generation X workers, Social Security offers

a low rate of return—even negative for many workers.

I would ask each of you to review for a moment the attached charts from a recent

Cato Institute study. They compare the rate of return for Social Security versus investment in private capital markets? The data was compiled for the Cato Institute

by Bill Shipman principal of State Street Global Advisors in Boston. It has been reviewed by professional actuaries and certified as accurate.

To derive an estimated rate of return from capital markets in the future, the

study assumes that over the next forty to fifty years, workers will be able to obtain

a rate of return in capital markets equal to the average historical rate of return on

bonds and stocks from the past 70 years (1926–95). For stocks that annual historical

rate of return has been 10 percent (nominal); while for bonds the return has been

6 percent (nominal). (Incidentally, over the past twenty years, the financial markets

have far exceeded the historical average.

The chart shows that a typical baby boomer born in 1950, will pay over his or

her lifetime several hundred thousand dollars more in payroll taxes (plus interest

and a normal rate of real return) than the benefits he or she receives.

But the real losers are those in the Generation X cohort—or those born after

1970. These young workers can expect to pay $2 to $5 of taxes (including the foregone normal rate of return on those dollars) for every dollar in benefits collected.

Or to state the point differently: if Congress were to allow a 25 year old working

woman today to invest her payroll tax contributions in private capital markets, her

retirement benefit would be two to five times higher than what Social Security is

offering. For our young workers, these are very powerful numbers.

Consider the situation of a low wage worker—someone whose lifetime salary is

near the minimum wage. Because of the progressive benefit feature of Social Security, this is typically thought to be the worst case scenario for personal security accounts. It turns out that based on current law, for that worker Social Security promises an annual benefit of roughly $9,000 a year (1995 dollars). If that money were

invested in private markets in a portfolio with half stocks and half bonds, the worker would receive an annual benefit upon retirement in the form of an annuity of

almost $20,000 per year—or well over twice what Social Security offers. If the

money were put entirely into stocks, the worker would have an annual benefit of

more than $25,000—or three times what Social Security offers.

Not every worker, obviously will obtain the ‘‘average’’ rate of return. By definition,

some workers will do better, some will do worse. But under a PSA system, Congress

could place reasonable restrictions on how the money were invested, to protect

against losses. For example, Congress might restrict the investments to a select

number of mutual funds, where a certain portion of the fund is invested in corporate

bonds and treasury bonds. Hence, low-wage workers who might not know much

about financial markets, would not choose individual stocks. But a critical point

here is that even if these accounts were restricted to an unrealistically risk-averse

portfolio, in this case 100 percent corporate bonds, the rate of return would still be

higher than under Social Security. In fact, it is virtually impossible to construct an

investment scenario where even the lowest income worker does better under Social

Security than under a PSA.

So here is the critical point for the members of this Committee to bear in mind

when crafting proposals for the future of Social Security: even if the trust fund were

entirely solvent—and even if every dollar of promised benefits were to be paid with

no tax increases—the system would be a bad deal for our young workers.

Now let’s return to the situation of a low-wage worker. I have discovered in conversations with members of Congress and with working Americans that there is an

understandable concern about how this will impact our lowest income workers who

are most likely to depend exclusively on Social Security payments when they retire.

To be viable, any PSA plan must make these most disadvantaged workers better

off, not worse off. The chart presented above actually understates the advantage of

Social Security privatization to the poor and to minorities. The reason that it understate the benefits of PSAs to the poor and minorities is that these are the workers

who are most likely to have started their working years at an earlier age, to have

worked more years over their career, and to die earlier after retirement. For precisely these reasons, even accounting for the progressive nature of the benefit struc9

ture, low-income and black workers actually pay in the most relative to the benefit

they forego from a private system.

Social Security offers the worst rate of return for that part of the population that

it is supposedly most benefited from the system: minorities and the poor. Moreover,

it is precisely because the poor elderly tend to have no other source of retirement

income, that they stand to gain the most from a privatized system that would yield

them a 30 to 50 percent higher monthly payment.

I have attached for the record a recent Cato study by my colleague Michael Tanner that explains in greater detail why the poor would gain the most from PSAs.

[The information was not available at the time of printing.]

Incidentally, the Tanner study is also relevant to the spurious argument that

workers can not be given the right to opt out of the system because of an ‘‘adverse

selection’’ problem. There is no adverse selection problem associated with a voluntary Social Security Personal Security Account plan, since with very few exceptions, every worker in America would be financially better off investing in private

capital markets than by staying in the current system.

The argument is sometimes made that there are always risks involved in investing money privately. The stock market doesn’t always go up in the short term—

though in the long term it must or America will be a very poor country in the next

century. Rates of return are not guaranteed. Stock markets crash. Bear in mind,

however, that the historical rate of return assumed in this analysis takes into account the Depression-era stock market crash, the 1987 crash and the decade long

sag in the market from the late 1960s to the early 1980s.

So yes, there are investment risks associated with PSAs. But remember, from the

point of view of the worker, there are also huge political risks associated with staying in the government-run Social Security system. There is the risk that benefits

will be cut in the future or that the payroll tax will be raised.

In fact, I would maintain that given the current financial plight of Social Security,

it’s a virtual certainty that Congress will enact either or both of these Social Security ‘‘reforms.’’ Hence, the rate of return comparisons presented above are an unlikely ‘‘best-case scenario’’ for Social Security. The charts assumes that no change

in promised benefits and no change in the payroll tax rate will occur over the next

forty years.

Even the staunchest opponents of privatization and the most vocal advocates of

maintaining the structure of the current system agree that benefits and taxes need

to be revised. Former Social Security Commissioner Robert Ball, a leading foe of privatization, advocates a slight rise in the payroll tax, an increase in the retirement

age, and other assorted reductions in future benefits. Each of the proposals advocated by the Advisory Council suggested benefit reductions and future tax increases.

It is imperative for this Committee to understand a critical point about the future

of Social Security: any or all of the conventional ‘‘fixes’’ to the program will only

make the system a worse deal for young people.

Consider, for example, the proposal to raise gradually the payroll tax by two percentage points (above the current 15.3 percent rate) and a gradual rise in the retirement age before collecting benefits (as is now being considered for Medicare). If this

combination of reforms were enacted, rather than paying $2 to $5 of taxes for every

dollar of benefit received, our young worker would now pay $3 to $6 of taxes for

every dollar of benefit.

This is why all conventional fixes, if they are not tied to an exit strategy that allows young workers to capture the returns from private markets, are a bad deal for

the young. This also explains why the 18–30 year old demographic group is the most

enthusiastic about a private alternative to Social Security. A personal security account (PSA) system is the only option available to Congress that improves the financial situation of young workers. All of the rest of the leading proposals make the

young financially worse off.

I believe that most of the members of this Committee would be in favor of moving

gradually to a PSA system if there were a way to do so without blowing a hole in

the deficit. We all agree that benefits to current retirees (and soon to be retirees)

cannot and should not be cut. We must keep the promises that have been made to

seniors.
10
11

If we allow workers to place all or a portion of payroll tax revenue into private

accounts, and we continue to pay benefits to the elderly, then the budget deficit will

rise in the short term. To overcome this paradox the members of this Committee

must keep in mind that the $3 trillion of unfunded Social Security liabilities are

sunk costs. Sunk costs are sunk. The liabilities will need to be paid off regardless

of whether Social Security is privatized or not. PSAs simply push those liabilities

forward, making them transparent, so they are recognized and dealt with today, not

25 years from now. The budgetary impact of PSAs is the equivalent of paying off

a future liability immediately, as companies often do to get unfunded pension liabilities off their books.

Much of the problem stems from the fact that the United States government is

about the only institution in the world that still uses a cash-flow accounting system.

If the federal government ran its books—using accrual accounting—as every business does, all of the bookkeeping problems with Social Security PSAs would disappear. Tax revenues would decline, but so would offsetting future liabilities—because today’s workers would no longer be accumulating rights to benefits. If any individual worker wished to exit from the system and stop paying the tax, then the

financial impact on the system would be roughly a wash—unless that worker pays

more into the system than he gets out of it. If the worker could be impelled to pay

the government to get out of the system, then the impact on the government’s balance sheet would be positive.

And herein lies the way out of the dilemma facing Congress. It starts with the

recognition that the financing problem of converting to a privatized Social Security

system is a short-term cash-flow problem, not a balance sheet problem. From a public policy standpoint, what Congress should be primarily concerned with is how to

improve the federal government’s balance sheet. It turns out that the gains are so

large from privatization of Social Security—Martin Feldstein of the National Bureau

of Economic Research estimates that the net economic benefit from Social Security

privatization is $10 trillion—that a plan could easily be devised whereby the gains

are shared by the government and the worker—to the benefit of both.

Here is one potential method of sharing the gains. What if we offered the following deal to every American worker? If you promise to forfeit any claim on Social

Security benefits—even those you have already accumulated—we will let you invest

all of your future payroll taxes into private markets. Since the rate of return is so

much higher in the private markets than with Social Security, many workers would

gladly accept this deal. It turns out, for example, that the age of ambivalence between staying in the system and continuing to pay the tax, versus forfeiting future

benefits and putting the subsequent payroll tax revenues into a PSA, is roughly 40

years old—for an average income worker.

For a worker just now entering the workforce, the decision would be clearcut. For

example, take a typical female worker who just started working and earns a salary

of $22,500, which will go up with the rise in average wages over her lifetime. When

she retires Social Security will pay her a $12,500 annual benefit in today’s dollars—

assuming no change in benefits. If she were permitted to simply place her payroll

taxes in a mutual fund with a 7 percent real rate of return (the average rate over

the past fifty years), she would have a nest egg worth $800,000 to $1 million at retirement age. This would allow the worker to draw a $60,000 benefit per year until

death (assumed at age 80). This is five times higher than what Social Security offers

for the same level of investment.

For workers in their 20s and 30s the rate of return is so much higher in private

markets than under Social Security that most would be willing to pay in effect an

exit tax for the right to invest payroll tax payments privately. The exit fee is the

forfeiture of benefits already accrued. There is no adverse selection problem under

this scheme because the government makes money on every worker who opts out—

regardless of their income.

How big are the gains to the government from this opt-out transition system? Bill

Shipman and Marshall Carter with State Street Global Advisers calculate that if

every worker under 40 opted out, the reduction in the unfunded liability of Social

Security would be on the magnitude of $1 to $1.5 trillion. Hence, up to one-third

of the current unfunded liability would be eliminated through this transition plan.

In summary, allow me to enumerate the economic advantages of converting out

of our pay-as-you-go government-run Social Security system to a program of PSAs:

(1) Privatization offers a much higher financial rate of return to young workers

than the current system.

(2) Privatization gives workers—rather than politicians—control over their own

retirement nest egg. The funds deposited in private retirement accounts, are funds

that can never be easily taken away by the government.
12

(3) A privatized system will increase worker ownership in American businesses

and assets. This is a ‘‘share the wealth’’ strategy that will help create a nation of

capitalists and raise the level of savings and investment.

(4) Privatization is the equivalent of a tax cut for workers. Currently the Social

Security payroll tax is treated by many young workers as simply a tax, not a deferred form of compensation. The tax reduces their take-home pay—and thus reduces the incentive to work. Since the privatization option deposits these funds into

a personal account, they are now ‘‘owned’’ by the worker.

(5) The increased flow of funds into private capital markets will reduce the cost

of capital, and thus increase capital formation, business creation, and ultimately

wages and living standards.

(6) By sharing the trillions of dollars of economic gains from the higher rate of

return from private accounts, Congress could adopt a strategy that would improve

the financial status of individual workers and the federal government. This establishes a win-win situation for the government and the worker.

Thank you again for the opportunity to testify before this Committee.

Mr. J

Dr. Kingson, Associate Professor at Boston College, as enunOHNSON of Texas. Thank you.

f

ciated by Mr. Neal. Go right ahead, sir.

STATEMENT OF ERIC KINGSON, ASSOCIATE PROFESSOR,

GRADUATE SCHOOL OF SOCIAL WORK, BOSTON COLLEGE,

CHESTNUT HILL, MASSACHUSETTS

Mr. KINGSON. Thank you, Mr. Chairman, and thank you, Mr.

Neal, for a nice, warm introduction from Massachusetts.

Today, I would like to make six main points. I guess I should

begin by making a very important point. It is an honor to be here,

and I am very appreciative of the opportunity and pleased that you

are taking a very careful look at the Nation’s Social Security Program and its future.

The six points that I would like to make today are, first, that

there is a significant financing problem, and in my opinion, it

should be addressed sooner rather than later. Under the best estimates, the most commonly accepted estimates, the combined OldAge, Survivors, and Disability Insurance, OASDI, Trust Fund, as

you are well aware, has sufficient funds to meet all obligations

through the year 2028, and after that, the income is roughly threequarters of anticipated outgo. Clearly there is a problem, and clearly we should address it.

The second point is that there are no magic bullets. We cannot

wish this problem away; neither should we pretend that there are

pain-free solutions. Unfortunately, we are not in Lake Woebegone,

where everything is above average. This is the real world, and

there is going to be pain whatever we do in terms of addressing the

Social Security problem. That means whether or not this Subcommittee or Congress chooses to privatize or not, there will need

to be either substantial benefit reductions and/or tax increases—

not impossible to do, but that is the reality we face. And in fact,

if we choose to privatize, the benefit reductions or tax increases

will have to be substantially larger to address the Social Security

financing problem.

Regardless of whether you oppose or favor the privatization of

Social Security, it is important, I believe, that you recognize that

the PSA, the personal security accounts, the individual security ac13

counts, and other privatization plans greatly complicate addressing

the financing problems of Social Security.

If a portion of current Social Security contributions is diverted to

IRA-like accounts, new revenues must be found to finance Social

Security pensions to all current and many future beneficiaries. In

other words, all privatization plans must address the transition

problem, the question of how to meet obligations to current beneficiaries and to older workers while simultaneously advance funding the retirement of the young and many middle-aged workers.

And many of these plans, as you are aware, would increase the

Federal deficit, placing pressures on other Federal expenditures.

In this respect, I think it is very important to acknowledge one

of the Advisory Council proposals, which I strongly disagree with,

for the honesty and forthrightness of the analysis behind the personal security account proposal. The proponents of the PSA plan do

not try to hide the fact that their plan requires dramatic financing.

They call for a temporary, 72-year tax increase of the equivalent

of 1.5 percent of payroll, and on top of that, $2 trillion of borrowing,

to address the transition problem. They acknowledge these costs up

front and, by so doing, allow us to discuss the transition costs openly and honestly.

Even the more modest individual accounts plan requires much

larger benefit cuts in the public program—about 30 percent for the

average American worker—much larger than would otherwise be

needed if we chose not to go a partial privatization route. And for

those who might say, well, this plan increases national savings, indeed it does, but so would any plan that incorporates a 1.6 percent

of payroll tax increase over and above the existing payroll tax,

which is essentially what that plan does. We could increase national savings that way, with or without a Social Security reform.

The third major point is that Social Security is a program that

protects the entire family, and this protection is well worth protecting—something we could discuss later.

The fourth point is that privatization of the Nation’s Social Security Program would undermine the well-being of tens of millions of

baby boomers as well as those who follow them into retirement.

Private pension coverage has shown evidence of slight decline for

young workers, and also, we have seen evidence that employment

for American workers is less secure than it had been for earlier

generations. This is precisely the wrong time to introduce additional risks in the personal lives of working Americans, the kinds

of risks that would be introduced by privatization. It would also

guarantee higher levels of inequality in our society—again, something that has been growing and not something we should seek to

advance. This is true of even the individual account plan. Although

it may sound relatively reasonable relative to the PSA plan or some

of the extreme plans, it too has the potential to undermine the Social Security Program and the economic security of new retirees. It

creates a political risk that those workers who do better in the system—and there will be some, given averages, who do better—will

have less interest in maintaining the public portion.

One other point. There are many reasonable options, none without pain, but there are financing options that can address this financing problem without pulling apart the Nation’s commitment to
14

1 As the Committee knows, under intermediate assumptions as reported in the 1997 trustees

report, the combined OASDI trust fund is estimated to be able to meet its commitments until

2029. However, it is not in actuarial balance for the 75 year period over which long-range estimates are made. Tax returns (payroll tax receipts and receipts from taxation of benefits) will

be exceeded by outlays in 2012. Total income, including interest earnings, is expected to exceed

expenditures through about 2018 and the combined OASDI trust fund is able to meet its commitments through 2029. Under the most commonly-accepted intermediate assumptions there is

a projected 2.23 percent of payroll short-fall (¥5.54 percent of payroll shortfall under the high cost assumptions and a +0.21 percent of payroll surplus under the low cost assumptions.) This

deficit represents a roughly 14 percent shortfall over the 75-year estimating period; a 25% shortfall after 2028. Since the deficit years fall in the middle and end of the estimating period, the

short-falls in the out years are substantially larger than suggested by the overall 2.23 percent

of payroll estimate (i.e., ¥4.88 percent of payroll from 2047–2071).

a public, universal system. The Advisory Council on Social Security, with all its splits, agreed to a number of proposals that would

address roughly 60 percent of the problem. Finally, I would simply note that there are very important moral values at stake here. Social Security is a mechanism that gives expression to community, the best expression of community, according to former Senator Bill Bradley. Behind all the discussion of

‘‘bend points,’’ ‘‘year of exhaustion,’’ ‘‘dependency ratios,’’ and all of

this technical discussion are millions of Americans and large questions about what we owe each other as a society, how we want to

encourage families to protect themselves against basic risks we all

face, and what mix of private and public responsibility we want. In other words, this is not simply a mere accounting exercise, as I know you are aware; this is an exercise that will say much about

what we are as a nation, and will say much about how we see our

role in terms of protecting all our neighbors and all our parents.

And I think that that part of the discussion needs to be brought

up front often so we do not lose sight of the moral basis of Social

Security and the way different Americans may be affected by potential reforms.

Thank you.

[The prepared statement and attachments follow:]

Statement of Eric Kingson, Associate Professor, Graduate School of Social Work, Boston College, Chestnut Hill, Massachusetts

Mr. Chairman and members of the Subcommittee on Social Security of the Ways and Means Committee, it is an honor to appear before you to discuss the future of

the nation’s commitment to a sound Social Security program. My name is Eric

Kingson. I am an associate professor of social policy at the Boston College Graduate

School of Social Work. My scholarship and research address the political and economic consequences of population aging, including Social Security, the aging of the

Baby Boom cohorts and issues of generational justice. I have previously directed a

study for the Gerontological Society of America which examined various ways of

framing policy discussion about the aging of America, and I was an advisor to the

1982–3 National Commission on Social Security Reform and to the 1995 Bipartisan

Commission on Entitlement and Tax Reform.

THE MAJOR POINTS I WISH TO MAKE TODAY ARE:

• According to the best estimates, Social Security has a significant financing prob- lem. Under the best estimates, the combined OASDI trust fund has sufficient revenues to meet all obligations through 2028. Thereafter, anticipated revenues are projected to only meet three-quarters of estimated trust fund obligations.1

• The projected financing problem should be addressed sooner rather than later. For several years now the Social Security trustees have been sounding the warning

bell. While there is no immediate crisis, there is a need to advance policies which

will put the program back into actuarial balance. Now, one could argue that we

could wait 10–15 years before acting. After all, the program is currently running

large annual surpluses ($71 billion in 1996 alone) and under all plausible scenarios,

shortfalls do not occur for at least 20 years. But I believe it would be a mistake
15

2The ability to monitor changing economic and demographic trends and anticipate the implications of such changes is a strength of Social Security. Projections provide useful indicators of

probable experience, even forty, fifty or seventy-five years into the future. By doing so, they provide a useful tool for making the mid-course corrections that are necessary from time to time.

Because the contours of the future are uncertain, projections—especially long-term ones—are

subject to error, and, not surprisingly, actual experience is almost always more or less favorable

than forecasted. In fact, the history of the program tells us that continued policy and programmatic change, in response to shifting demographic, economic and political forces, is almost

the one thing that can be predicted with certainty. 3Public investment in the stock market of a portion of the growing trust fund accumulations

such as what is proposed for consideration under the Maintain Benefits (MB) plan might increase rate of returns but it will not eliminate the need for benefit reductions and/or tax increases. 4The actuaries project sufficient funds to meet 67% of anticipated expenditures during the

last 25-year period (2047–2071) in the 75-year estimating period (1997–2071). 5The benefit formula changes in the IA plan include the 3% cut from lengthening of the averaging period, a roughly 17 percent cut in future benefits for average earners—20 percent for

high income and 8 percent for low earners—and a 8 percent cut from proposed increases in the

age of eligibility for full Social Security. (See Insurance Update, Volume 1, Issue 3, December

1996, page 3. Also, Advisory Council on Social Security (1997). Report of the 1994–1996 Advisory Council on Social Security, Volume I: Findings and Recommendations. Washington, DC:

U.S. Government Printing Office, page 62.

to postpone action on the long-term problem. Changes that may affect the income

of future retirees should be put in place with sufficient lead time to allow workers

to adjust their retirement expectations and savings behavior. Moreover, postponing

action will undermine public confidence in the program and fuel cynicism about the

ability of the nation to address its problems.2

• There are no magic bullets. We cannot wish the problem away; neither should

we pretend that there are ‘‘pain free’’ solutions. Whatever this Committee recommends and the Congress ultimately enacts—and that includes any form of privatization—will require either benefit reductions or tax increases. Privatization

schemes such as the Personal Security Account (PSA) and Individual Account (IA)

plans will require larger benefit reductions than would otherwise be needed in the

public program and/or larger tax increases (or the equivalent of tax increases).3

• The rhetoric of Social Security reform is creating serious public misunderstanding about the financing problems of Social Security and how best to address these

problems. Some members of the public believe nothing needs to be done. Many others offer the opinion that Social Security will not be there for them. The ‘‘language

of Social Security reform’’ often adds to the problem. For instance, among the public

and some journalists, there is an often repeated belief that the projected exhaustion

of the combined OASDI trust fund equates to the total inability of the program to

meet its obligations. Yet, as members of this committee are well aware, even in the

unlikely event that nothing were done to correct for the projected exhaustion of the

OASDI trust fund, sufficient revenues are projected to meet all obligations through

2028 and roughly 75 percent from 2029 through 2071.4 Such exaggerations of the

problem are often used by the proponents of radical change to provide rationale for

privatizing or otherwise dismantling the nation’s commitment to a universal and

public Social Security program.

• Regardless of whether you favor or oppose privatization proposals, you should

recognize that the PSA, IA & other privatization plans greatly complicate the Social

Security financing problem, making it more difficult to address. If a portion of current Social Security contributions are diverted to IRA-like private accounts, new

revenues must be found to finance Social Security pensions to all current and many

future beneficiaries. In other words, all privatization plans must address the ‘‘transition problem’’—the question of how to meet obligations to current beneficiaries and

older workers while simultaneously advance-funding the retirement of young and

many middle-aged workers. And many privatization schemes would also grow the

federal deficit, placing additional pressures on federal expenditures.

In this respect, the architects of the PSA plan should be complimented for having

the courage to acknowledge the very large costs inherent in any shift towards a private scheme. They do not try to hide the fact that the financing of their plan requires a ‘‘temporary’’ 72-year ‘‘transition tax’’ of 1.52% of payroll plus the borrowing

of roughly $2 trillion dollars from general revenues in 2002 to 2034, to be paid back

from 2035 to 2069. But, even so, imagine how much more difficult the balancing of

the federal budget will be should the PSA plan become law. Even the more modest

IA privatization plan would require an unnecessarily large benefit cut—roughly 30%

for an average earner 5—in the remaining public Social Security program. And it

would mandate, over and above the current payroll tax contributions, an additional
16

6 It should be noted that it may be prudent for low-income people to invest conservatively since they would have little to fall back on.

1.6 percent ‘‘employee contribution’’—a tax by any other name—to a private account.

In other words, there are no free lunches here. • The nation’s universal and public Social Security program protects the entire family and this protection is worth maintaining. Social Security provides widespread

and basic protection to America’s families and employees. It is also the main source

of disability and survivors protections for America’s families. For a 27 year old couple with two children under age 2 and with earnings equal to average wages, Social

Security is the equivalent of a $300,000 life insurance policy; a $207,000 disability

policy. It provides Americans with the equivalent of $12.1 trillion dollars in life insurance protection, more than the entire value ($10.8 trillion) of all the private life

insurance protection in force. Included among its 44 million beneficiaries are three

million children under 18 who receive benefits each month. In Massachusetts, my

home state, about 1,036,000 persons receive benefits—totaling $670 million dollars

a month. They include 730,000 of Massachusetts’ retired workers and their spouses,

119,000 widows and widowers, 106,000 disabled workers and their spouses and

71,000 children. And the program is of equal importance to families in every state

(see tables 2 & 3). • Social Security is the building block that has transformed old age. Social Secu- rity is the only pension protection available to six out of ten working persons in the

private sector. For the middle class, it provides the foundation of a secure retirement, ideally to be built upon by other pension coverage, private savings, sound investments, accumulated equity in their homes and, for some, work in their later

years. But even for those who are relatively well off, say the roughly 4.8 million elderly households with incomes between $18,732 and $31,179 in 1994, Social Security provides nearly half of the total income (see table 4) going to their homes. For

the bottom 60 percent of the elderly income distribution—those 14.6 million households with incomes under $18,731 in 1994, Social Security provides over 70 percent

of all household income (see tables 4 and 5). Indeed, absent Social Security, the poverty rate among the old would increase to roughly 50 percent (see table 6). And importantly, the security of beneficiaries is protected by cost-of-living protection which

assures that benefits, once received, maintain their purchasing power into advanced

old age—the point in time when elderly persons, especially widows, are often at

greatest economic risk. • The well-being of baby boomers and those who follow them into retirement will be best served by financing reforms that maintain the basic structure of Social Security. We should encourage personal savings and we should seek to expand employerbased pension coverage. But neither we nor the public should accept as an untested

article of faith that a privatization scheme can do more to protect the vast majority

of baby boomers. With private pension coverage showing evidence of a slight decline

for young workers and with employment becoming less secure for most Americans,

this is hardly the time to gamble on radical changes that can only result in increased insecurity and greater disparity in the incomes of Americans. As with today’s elderly populations, there is nothing on the horizon that can assure the widespread and secure protection of Social Security to the vast majority of tomorrow’s

retirees. • Privatizing the nation’s public Social Security program would undermine the well-being of tens of millions of baby boomers and those who follow. As my colleague

at Boston College, John Williamson and I have written, ‘‘privatization places lowand moderate-income workers at significant political risk. As Social Security is currently structured low-income workers get a better return than high wage workers

on their contributions, a factor that keeps millions of the elderly out of poverty during their retirement years. But in separating out the interests of higher-income

workers from the public portion of the program, privatization schemes ensure erosion of political support for the program’s redistributive role—an outcome which

would further increase the economic and social distance between rich and poor.’’

‘‘Middle and low income workers would face especially serious market risks. Long run returns on stock market investments have generally been quite favorable. But

no promises can be made about what will happen to an individual’s nest egg in the

few years, months or even days before retirement. Low- and even many middleincome workers cannot afford good investment advice. They are more likely to make

poor investment decisions, for example, investing too conservatively during early

working years or taking unacceptably high risks just prior to retirement.’’ 6 ‘‘And

most privatized schemes do not provide inflation protection for retirees, yet another

example of how they shift risk from government to the individual. The affluent are

better positioned to tolerate such risks, but the impact on low and middle income
17

7See John B. Williamson and Eric R. Kingson (January 10, 1997), ‘‘The Pitfalls of Privatization,’’ Boston Globe. 8See Advisory Council on Social Security (1997).

9This proposal to increase the age of eligibility for full benefits represents an 8 percent cut

in benefits. This and other proposals to raise the age of eligibility for full benefits provide an

example of the need to carefully assess the distributive implications of proposed benefit reductions (and/or payroll tax increases). In many respects this type of benefit reduction represents

a fair and understandable way of reducing expenditures. Life expectancies, and hence the number of years beneficiaries receive retirement benefits, have increased and are expected to inContinued

retired persons could end up being devastating.’’ And there are other risks, including the possibility that a future Congress might undermine the retirement savings

goal by allowing the holders of these private accounts to draw on them for medical

emergencies, education or other non-retirement purposes.

Privatization may be a bad idea for most Americans, but not necessarily for everyone—at least if we assume that the winners in the ‘‘privatization lottery’’ do not

have a stake in promoting the well-being of the rest of society. Though trading off

some surety of protection, [on average] the most affluent workers would likely do

better under privatization plans—at least in so far as they do not experience serious

declines in their earning capacities during middle age. But without question the

most certain ‘‘winners would be the banks, mutual funds and investment companies

who stand to benefit from the millions of transactions and trillions in private sector

investment that would follow even a small partial privatization.’’ 7

• Even though the IA plan may sound reasonable relative to the PSA and even

more extreme privatization plans, it too has the potential to undermine the Social

Security program and the economic security of new generations of retirees. Not only

does it require additional benefit cuts and tax increases in the remaining public program, but it also assures that those successful investors—often the highest income

workers and the nation’s opinion leaders—would be tied to an expansion of the private accounts approach.

To fund a privatization and to adjust for the expectation that high income people

would benefit most from a privatization, the benefit cuts in the remaining public

program would be considerably larger for America’s best off workers. Such workers

would inevitably compare the favorable rates of return they are receiving in the private plan to the shrunken rates they would then receive in the remaining public

plan. Over the long run, this would likely create splits in public support for the remaining public Social Security program. In other words, in my opinion, the IA plan

is the equivalent of ‘‘the proverbial camel’s nose under the tent’’—the beginning of

a process which will destroy the nation’s public Social Security program. And for

those who point out that this approach would increase national savings, I would

simply say, ‘‘Of course it does! Whenever you mandate any ‘‘tax increase’’—in this

case a 1.6% of payroll contribution to private accounts—over and above existing

taxes, you will increase national savings.’’

• Important areas of agreement should not be overlooked. Even among the split

1994–6 Advisory Council, its members unanimously agreed that there is a manageable financing problem, and that it should be addressed sooner rather than later.

They also unanimously agreed with maintaining some redistribution to low income

persons, that means-testing Social Security is not desirable, that full COLA protection is critical to the financial well-being of beneficiaries and that any ‘‘sacrifice in

bringing the system into balance should be widely shared and not borne entirely by

current and future workers and their employers.’’ 8 And they agreed that additional

income protection is needed for aged widows—a group of elders at substantial economic risk. All three plans improve the rate of return for future beneficiaries

through some form of investment of the growing Social Security trust fund assets

in the private sector. All three call for increased tax revenues or their equivalent

although the MB plan would not initiate a 1.6% of payroll increase (0.8% on employer and employee) until 2045 and the PSA plan calls for a 72-year increase of

1.52 beginning in 1998.

• Many financing reform packages can be put together without violating the basic

commitments to the nation’s public Social Security program. For example, Council

majorities supported four changes that addressed 60 percent of the financing problem. There was strong support for extending coverage to all new state and local

workers; reducing benefits by roughly three percent through a technical change in

the benefit formula; and taxing Social Security benefits in roughly the same manner

as income from contributory defined-benefit plans. And there was majority support

for a proposal to accelerate the planned increase in the normal retirement age to

67 in 2011 instead of 2022, and to index it to changes in life expectancy thereafter.9
18

crease even further. Even after age 67 is phased in as the new normal retirement age, as

planned under the current law, beneficiaries of the future will generally receive retirement benefits for more years than current beneficiaries. Moreover, this change, some suggest, will encourage work effort on the part of the old. However, others point out that there is little evidence

that workers will substantially increase their work effort, even if employment opportunities are

available. Of most concern, this change undermines the adequacy goal of Social Security, with

much of the long-term savings to the trust fund coming disproportionately at the expense of future lower-income persons who may be unable to work due to limited employment opportunities

and health problems. Among both proponents and opponents of retirement age changes, there

is recognition that such changes will have potentially deleterious effects on some marginallyemployable older workers of the future, leading many to suggest the need to consider ameliorative policy interventions if the normal retirement age is increased. For example, Congressman

Pickle’s bill (H.R.4275) proposed pairing an increase in the Social Security retirement age to 70

with a reduction in the SSI eligibility age to 62. 10 Edith Fierst, a member of the Advisory Council, notes that Social Security’s actuaries estimate that taxing ‘‘the cost of employer-provided group health and life insurance ... as though

it were cash compensation’’ would address roughly one-third of the predicted shortfall). (See

E.U. Fierst (1997). Supplemental statement. In Advisory Council on Social Security (1997), pp.

135–154). 11During the 1980s as the income distribution widened (with more people being pushed well

above average wages), the proportion of wages covered by the payroll tax dropped from roughly

90% to 88%. It is projected to drop to 85.5% ten years hence. (Alternatively, some would suggest

giving consideration to treating 100% of employer payroll as taxable for Social Security purposes. This approach would address nearly one-half of the projected financing problem and is

consistent with the view that the employer’s contribution is part of a pool of funds that promotes

the social goals of Social Security.)

Taken, together, these four changes address sixty percent of the projected financing

problem (+1.31 percent of taxable payroll)—arguably a pretty substantial downpayment on the projected shortfall for those seeking moderate approaches to addressing the financing problem. And many other options exist as well.

For example, the MB plan suggests considering the gradual investment of up to

40 percent of OASDI trust fund assets in broad private market funds, a change that

would indirectly increase rates of return to individuals while also eliminating about

two-fifths (+0.90 ‘‘percent of taxable payroll’’) of the projected financing problem.

Some have suggested moderate across the board benefit cuts or even further increases in the age of eligibility for full benefits. Others might treat some portion of

fringe benefits as taxable for Social Security purposes 10 or incorporate a modest increase in payroll taxes forty or fifty years from now. Still others would restore and

maintain the proportion of wages covered by the payroll tax at the 90% level by

2000, addressing about 14% of the projected financing problem (+.31 percent of taxable payroll).11 My purpose is not to advocate any particular package, but to point

out that the financing problem can be addressed without privatizing or otherwise

altering the basic structure of the program.

• A public Social Security program is, to paraphrase former Senator Bill Bradley,

the best expression of community in America today. Indeed, more is at stake in this

discussion than the technical aspects of how to address the financing problems of

Social Security. Behind all the discussion of ‘‘bend points,’’ ‘‘year of exhaustion,’’ ‘‘dependency ratios,’’ and ‘‘percents of taxable payroll,’’ this debate is fundamentally

about our sense of responsibility to each other; about the basic protection that each

working American should be assured of for themselves and their families in old age,

disability or on the death of a loved one; about the mix of public and private efforts

we should encourage to assure that security. In other words, the disturbing tendency in media and public discourse to reduce Social Security discussions to mere accounting exercises of the financial cost of the program overlooks the benefits this

program provides and the real consequences to the well-being of individuals and

families of various possible changes. Social Security is an institution that has

strengthened the nation’s families and communities. In a very fundamental way it

is an expression of the moral commitment of our nation to serve as our brothers’

and sisters’ keepers and to honor thy mothers and fathers. In the process of addressing long-term financing problems, it is important that we not lose sight of this moral

dimension of the program which is one of the joining institutions of our society.

f
19

TABLE 1. Year of Trust Fund Exhaustion a

Set of Assumptions OASDI DI OASDI

Projected OASDI

Deficit as % of Taxable Payroll

Alternative I (Low Cost) ............... Never Never Never +0.21

Alternative II (Best Estimate) ..... 2031 2015 2029 ¥2.23

Alternative III (High Cost) ........... 2022 2007 2018 ¥5.54

a ‘‘Exhaustion of a trust fund means that its accumulated assets are depleted. Payroll tax and other income

will continue to flow into the fund, however.’’

Source: 1997 Trustees Report
20
21

TABLE 4. Importance of Various Sources of Income to Elderly Households, 1994*

(ALL MEMBERS OVER AGE 65)

All Aged

Units

Quintiles

Units

Under

$7,730

(Q1)

$7,730–

$12,213

(Q2)

$12,214–

$18,731

(Q3)

$18,732–

$31,179

(Q4)

$31,179

and over

(Q5)

Number of Units ..............

(in millions) ...................... 23.9 4.9 4.7 4.8 4.8 4.8

Percent of Total Income

From: **

Social Security .......... 42.1 81.2 81.1 65.9 48.3 22.7

Railroad Retirement 0.6 0.7 1.0 0.7 1.0 0.4

Government employee pension ....... 8.4 0.8 2.4 5.3 10.2 10.2

Private pension/annuity ...................... 9.7 1.7 4.0 8.1 12.7 10.5

Income from assets .. 17.6 2.7 5.4 10.3 14.4 24.4

Earnings .................... 18.0 0.2 2.2 6.2 10.9 28.5

Public Cash ...............

Assistance ................. 0.9 11.0 2.0 0.8 0.4 0.1

Other ......................... 2.7 1.6 1.9 2.8 2.2 3.2

*All members of households are 65 or over. Aged units are married couple living together—at least one of

whom is 65—and non-married persons 65 or older.

**Details may not sum to totals due to rounding error.

Source: US Department of Health and Human Services, Social Security Administration, Office of Research

and Statistics, Income of the Population 55 and Over (Washington, D.C: January 1996), pp. 109–113.

TABLE 5. Share of Aggregate Income to Elderly Households,* 65 and over in 1994

African-American

Units 65 & Over

Hispanic Units 65 & OverWhite Units 65 & Over

Percent of Cash Income From:**

Numbers (in millions) ................ 2.2 1.2 21.2

Social Security ........................... 48.4 49.3 41.9

Railroad Retirement .................. 0.6 0.2 0.6

Government Employee Pensions ........................................ 10.6 4.6 8.2

Private Pensions or Annuities .. 7.3 6.9 9.9

Earnings ..................................... 22.6 22.4 17.5

Income from Assets .................... 3.9 6.9 18.5

Public Assistance ....................... 3.3 6.3 0.7

Other ........................................... 3.2 3.6 2.2

* Aged units are married couple living together—at least one of whom is 55—and non-married persons 65 or

older. ** Details may not sum to totals due to rounding error.

Source: US Department of Health and Human Services, Social Security Administration, Office of Research

and Statistics, Income of the Population 55 and Over (Washington, D.C: May 1996), pp. 112.
22

TABLE 6. Elderly Households* Below Poverty Line in 1994, With and Without Social Security Benefits, Among Households Receiving Social

Security Benefit

All Aged Units African-American Elderly Units Hispanic Elderly Units White Elderly Units Women not Married

65 and OverNumber of Units* with SS Benefits (in millions) ......................... 23.9 1.9 0.9 19.6 9.9Percent**

Below Poverty line ............................................................ 14 29 21 10 20Kept Out of Poverty by Social Security .......................... 42 39 40 42 44Total Below Poverty Without Social Security ................ 54 69 61 53 64

85 and OverNumber of Units* with SS Benefits (in millions) ......................... 2.5 0.2 0.1 2.2 1.7Percent**

Below Poverty line ............................................................ 17 30 25 15 20Kept Out of Poverty by Social Security .......................... 49 47 46 50 48Total Below Poverty Without Social Security ................ 66 76 71 65 68

Source: US Department of Health and Human Services, Social Security Administration, Office of Research and Statistics, Income of the Population 55 and Over (Washington, D.C: Janu- ary 1996), p. 123

* Aged units are married couple living together—at least one of whom is 55—and non-married persons 65 or older.** Details may not sum to totals due to rounding error.
23

TABLE 7. Total Money Income of Elderly Households, 65 and over, in 1994

Married Couples Non-Married Persons

Numbers (in millions) ..................................... 9.7 14.2

Total Percent ................................................... 100.0 100.0

Less than $10,000 ........................................... 5.3 34.4

$10,000 to $19,999 .......................................... 26.2 33.0

$20,000 to $29,999 .......................................... 24.2 12.3

$30,000 to $39,999 .......................................... 15.2 7.2

$40,000 to $59,999 .......................................... 14.3 6.9

$60,000 to $99,999 .......................................... 9.7 4.4

$100,000 or more ............................................ 5.1 1.9

Median Income ................................................ $27,013 $13,538

* Aged units are married couple living together—at least one of whom is 65—and non-married persons 65 or

older.

** Details may not sum to totals due to rounding error.

Source: US Department of Health and Human Services, Social Security Administration, Office of Research

and Statistics, Income of the Population 55 and Over 

f

(Washington, D.C: January 1996), pp. 26, 27

Mr. JOHNSON of Texas. Thank you, sir.

Ron Gebhardtsbauer, a senior pension fellow at the American

Academy of Actuaries. Go right ahead, sir.

STATEMENT OF RON GEBHARDTSBAUER, SENIOR PENSION

FELLOW, AMERICAN ACADEMY OF ACTUARIES

Mr. GEBHARDTSBAUER. Good morning, and thank you for inviting

me to speak today. As you mentioned, my name is Ron

Gebhardtsbauer, and I am the senior pension fellow at the American Academy of Actuaries. We are the nonpartisan public policy

organization for actuaries in the United States, and we analyze legislation but do not endorse or propose legislation.

Today I am going to speak to your four questions, namely: Is reform necessary and how soon do we need to act, what are our assessments of some of the recommendations and proposals, and finally, what is the next step.

For the first question, I will just second the speakers ahead of

me and say Social Security does have a financial problem, because

eventually, they will not be able to pay full benefits. But even sooner—which answers the second question—even sooner, the year

2008, we have some budget concerns.

Right now, Social Security brings in more than $30 billion to the

system that it does not pay out right away, so it helps the deficit.

This will go on until the year 2008, and that is the time when the

baby boom starts retiring. At that time, the money coming in from

Social Security tax income will be less that what it pays out, therefore the surplus goes down. So that if Congress balances the budget

using Social Security surplus, that means that in the year 2008, it

will start going out of balance because the surplus in Social Security is going down.

So that means we need to fix it by the year 2008, but we probably do not want to wait until then if Congress feels that it is also

important to enact rules that help us plan for these changes, enacts

rules that are less drastic and ones that we can phase into gradually and not have notches.
24

Your third question is what is our assessment of some of the Advisory Council recommendations and other proposals. I have a prior

speech that I have made, and I have given you copies of it—and

it goes into detail, so that I can just talk about the larger significant advantages and disadvantages.

All three of the Advisory Council options have the big advantage

that they solve the Social Security problem. They put it into actuarial balance—and this is important—they get the trust fund to be

stable at the end of the 75-year period, because if all we do is put

it into actuarial balance and do not get those trust funds stable at

the end of 75 years, then we will be back here in 10, 20 years, trying to fix it again.

So the Advisory Council’s number one proposal, the maintain

benefits proposal, creates stable trust funds by increasing contributions in the year 2045, way in the future.

The other two options increase the retirement age, and that is

probably a more permanent solution because it is addressing the

need, the fact that people are living a lot longer; and so as people

live a lot longer, it would gradually go out of actuarial balance and

increasing the retirement age stops that.

But each of the Council’s proposals have disadvantages. The

maintain benefits proposal increases contributions way out there in

the future for a future generation and does not require it of ourselves. Can we require them to put in more than we are putting

in?

In addition, it invests some of its trust funds in the stock market,

which has the advantages of higher return and really saving the

money outside the government, but it has governance concerns.

Well, you could remedy that by delegating the responsibility of voting to the money managers, but if this system eventually has 5 to

10 percent of U.S. markets in it, it might be tempting to change

those rules.

The next option is the individual account option. Its main concern is that the benefits are not as good right away, and that is

because it does not take any money from Medicare, which one of

the other options, maintain benefits, does. In addition, it keeps all

its trust fund money invested in Treasuries and not stock, so it

does not have higher benefits. And the third reason is because it

has a transition. Whenever you move toward a personal account,

and you have a transition, somebody has got to pay twice or more

than just for themselves, and that is what happens to that system—either you pay more, or your benefits are less.

The third option is the personal security account option. It gives

better benefits because they invest more money than the other ones

in the stock market. Where do they come up with that money?

Well, they borrow it from the U.S. Government. And in fact, in the

first 7 years of this plan being in effect, it increases the deficit by

over $1 trillion. So in other words, the transition cost there is paid

for through increased interest rates, higher borrowing costs, higher

inflation and higher taxes. So what it does is make Social Security

a better deal at the expense of taxpayers and also industry.

Also, this other option will have risks. The other options, the

other two, if they borrow just as much money and invest in the

stock market, could do just as well and not have risks, but this one
25

is going to have more risk because it will put on the individual the

investment risk, the inflation risk, and the longevity risk—they

might outlive their money. And so the individual account method

handles this by putting restrictions on some of those investments;

you can only invest it here, and you have to have an annuity. But

these restrictions then cause governance concerns, and the PSA

group decided to opt for more risk instead of more restrictions and

governance concerns.

Finally, on the PSA option, we have to discuss the issue of sustainability—can that system be sustained. Can we continue to require people to put mandatory contribution into accounts, and is

this $400 benefit that it pays to everybody, that is going to have

a poor money’s worth, sustainable, or could that be turned into welfare?

Finally, all the proposals that we have to deal with, we should

look outside Social Security and see what their effects are. What

are the effects of these proposals outside the system—for instance,

on retirement income of an individual, which includes personal savings and also employer benefits, which are the other two legs of the

retirement stool. We do not want to heal one leg by reducing or

eliminating the other legs and end up with a one-legged stool.

So we may have a way to use employers, and I cannot go any

further, but maybe we can talk about it later, how we can use employers.

Finally, I want to thank the Subcommittee for having this hearing and educating the public on some very important and complex

issues.

Thank you.

[The prepared statement follows:]

Statement of Ron Gebhardtsbauer, Senior Pension Fellow, American

Academy of Actuaries

Chairman Bunning, committee members, staff, and fellow panelists, Good Morning. My name is Ron Gebhardtsbauer and I am the Senior Pension Fellow at the

American Academy of Actuaries. The Academy is the non-partisan public policy organization for actuaries in the United States that analyzes, but does not endorse

or propose legislation.

In order to save time, I have provided the subcommittee with copies of a more

comprehensive presentation on this subject, so that I can focus on the four questions

the subcommittee has asked the Academy to address regarding the Old-Age Survivors and Disability Insurance program, or Social Security.

The subcommittee’s first question concerns the degree to which Social Security reform is necessary. To the extent that this nation wants to sustain the successes of

the current Social Security program (e.g., alleviating poverty among the elderly), Social Security needs to be modified sooner rather than later. Without changes in the

law, the government’s actuarial predictions show that only 75% of benefits will be

payable from income after the Trust Funds are exhausted in 2029, and as our country ages, this becomes 69%. This can be easily seen by looking at the demographics.

Today there are about 3 workers for every beneficiary. In 2029, when virtually all

the baby boom cohort will be retired, there will be about 2 workers for every beneficiary. This projection is quite accurate because it is based mostly on people already

born.

There is also a U.S. budget concern which occurs much sooner, and this is responsive to the next question posed by the subcommittee, namely, ‘‘How soon is Congressional action needed?’’ At present, Social Security’s tax income exceeds its outgo by

$30 billion, which helps the U.S. deficit look lower than it actually is. This $30 billion annual surplus starts to decrease around the year 2008, which is exactly when

the baby boom generation starts to retire. By 2012, Social Security’s tax income will

be less than what it pays out. Thus, if Congress balances the U.S. budget in 2002

using Social Security’s surplus, then Social Security could put the U.S. budget out
26

of balance in the year 2008. Therefore, if a balanced budget is a goal of Congress,

then the Social Security fix should be in effect by 2008. But action is needed even

sooner than that if Congress wants to: • enable workers to plan ahead for the changes • have gradual implementation (i.e., less chance of notches) • include more people in the solution • have a less drastic solution, • restore faith in the system again. Congress should analyze the potential solutions carefully, which leads to the third question: What is the Academy’s assessment of the Advisory Council recommendations and other proposals?’’ The attachment goes into the details about most provisions, so I will just discuss the more significant ones. The advantages of the three Advisory Council options are clear. All three options solve the financial problems of Social Security for the upcoming 75 year period and

maintain a stable Trust Fund at the end of that period. It is important to stress

that second part. It is not sufficient to just put Social Security back in actuarial balance over the next 75 year period. If that is the only action Congress takes, then

in 20 years there will be another crisis. This is because, as future deficit years get

included in the 75 year period, the system gets thrown out of balance a little each

year. The Maintain Benefits group solves this by increasing contributions by 1.6%

of covered pay starting in the year 2045. The other two Advisory Group options

solve this by increasing the Normal Retirement Age to 67 by 2011 and age 70 by

2083. This produces a more permanent solution. Unless, the Normal Retirement Age

increases with longevity, the system will eventually go out of balance. Each Advisory Council option also has disadvantages.

The Maintain Benefits (MB) option requires future workers to contribute 1.6% of

wages more into Social Security than current workers will ever pay. Furthermore,

in order for their option to be in balance, the Social Security Administration would

have to invest 40% of their surplus in passive equity indexes. This has advantages.

For example, the additional savings from the MB option would really be saved if

invested outside the government, and their long-term yields would improve. Indexes

avoid the concern that Social Security would manipulate the market and proxy voting could be delegated to the money managers, like at PBGC and the Federal Thrift

Savings Board, two other government agencies that have equity investments. However, with an estimated 5% to 10% of the domestic market, there are concerns that

these restrictions could be loosened in the future. Other alternatives with less governance concerns (but also smaller returns) would be to invest in other indexes,

such as those for mortgages (but that would entail competition with banks), municipal bonds (their lower returns would be supplemented by less tax expenditures), and

corporate bonds (this would have an advantage of lower borrowing costs for industry).

The Individual Account (IA) option gradually reduces OASDI benefits by up to

20% for middle and upper income workers in order to keep costs within current contribution levels. The reason these reductions are so much more than the MB option,

is because their Defined Benefit portion invests only in Treasuries and thus, has

a lower return on investment, or a lower money’s worth, for middle and upperincome Americans. However, when combined with annuities from their Individual

Accounts, their money’s worth ratios generally increase up to those of the MB plan.

Eventually, as their savings in stocks exceeds those of the MB plan, their money’s

worth ratios could eventually be better for many people. This demonstrates the

point that any transition from a DB-type plan toward a DC-type plan will take

many years and one group must pay ‘‘twice.’’ The Individual Account option does

this by increasing contributions by 1.6% of covered pay.

The Personal Security Account (PSA) option has greater yields and benefits for

most people, because this system invests the most money into the stock market. It

must be noted, however, that it does this by increasing the U.S. deficit by over $1

trillion in the first 7 years. It is not a revenue-neutral bill. This could increase interest rates, borrowing costs, inflation, and taxes and, in fact, they pay for this transition cost through raising payroll taxes by 1.52% of pay. Another significant point

is that the MB and IA options could achieve better yields and benefits than the PSA

option if they also borrowed as much from the U.S. Treasury, and they would do

it with less risk to the individual.

The PSA option places many more risks and responsibilities on the individual,

such as investment risks, higher administrative expenses, longevity risks, leakage

risks, and inflation risks. In the IA option, the risks on the individual are reduced

by restrictions on investments, payroll deductions to a government clearinghouse

(similar to the Federal Thrift Plan), requirements for inflation-indexed annuities,

and restrictions on withdrawals before retirement. However, these restrictions in27

crease the governance concerns and create a greater bureaucracy, so proponents of

the PSA plan opted for risk over restrictions.

Another concern with the PSA option relates to the sustainability of this very dif- ferent view of Social Security because of the following questions. Would Congress

continue to mandate both low-income and high-income Americans to invest in their

accounts, without allowing them access during difficult times? Would the flat $400

monthly benefit with its poor money’s worth for middle and upper income workers

succeed? Would a means test eventually be applied to it and thus turn it into welfare? Would tax avoidance occur? Under the current Social Security system, the

more money you put in, the more money you get out. This would not be the case

for the $400 benefit. Experience from other countries shows that tax avoidance occurs when one gets nothing for the additional taxes. Finally, it is important to look outside the Social Security system and determine the effects of the various proposals on an individual’s total retirement income. This

would include employer pensions, personal savings, and possibly part-time work,

sometimes referred to as the other legs of a retirement stool. Diversification can be

helpful here. For example, when the stock market is down, traditional employer

pension plans can be more valuable than mandatory Individual Accounts. When

low-income individuals have small savings and pensions, Social Security’s adequacy

element is more helpful. Thus, Congress should be aware of the consequences if one

leg is saved by harming the other legs, and thus end up with a one-legged stool.

For example, some fixes like means testing Social Security benefits and additional

contribution mandates would reduce other legs of the stool, namely, personal savings and employer pensions. Congress should be careful not to eliminate the employer leg. Employer pension plans generally achieve better yields than individuals

(by 150 to 250 basis points each year) and have been very helpful not only to individuals, but also to the national economy. Maybe there is a way to use employers.

For example, if an employer has an adequate pension plan, then maybe the individual account mandate could be waived. Not much has been developed in this area,

and the American Academy of Actuaries would be glad to discuss this further with

the subcommittee.

Finally, the subcommittee asked for specific recommendations for moving forward. Some proponents of reform suggest passing some provisions now, such as reducing

COLAs and mandating coverage to all state and local government employees. These

changes will help reduce the U.S. deficit over the next 15 years, but will not help

the financial stability of Social Security until after that. This may be an appropriate

reform if the policy objective is also to reduce U.S. deficits. However, if Congress

wants the additional savings to help the Social Security program and not the U.S.

budget, then these provisions may need to be enacted in conjunction with private

investment options. Since the concept of private investment entails a much different

view of Social Security, we would suggest that Congress allow sufficient time to educate the public and consider all of the ramifications.

Once again we commend the subcommittee for taking a leading role in educating

the Congress and public on a very complex, but important topic.

Mr. J

Mr. Neal, I happen to have someone here from Dallas, Texas,

OHNSON of Texas. It surely is complex, for sure.

f

that I am going to challenge you with. I am going to introduce John

Goodman, of the National Center for Policy Analysis, who will

speak next. He is from my area of the country.

Mr. NEAL. You have the gavel; you can do what you want.

[Laughter.]

Mr. JOHNSON of Texas. Thank you.

John, go ahead.

STATEMENT OF JOHN C. GOODMAN, PRESIDENT, NATIONAL

CENTER FOR POLICY ANALYSIS

Mr. GOODMAN. Thank you, Mr. Chairman and Members of the

Subcommittee, I am honored to be here and would like to commend

all of you for having these very important hearings. Our institute

also receives no money from the government.
28

The key to understanding elderly entitlement programs is to recognize that they are based on the principle of pay-as-you-go finance. What that means is that every dollar of payroll tax that is

collected is spent—is spent the very minute, the very hour, the

very day that it comes in the door. If it is not spent on Social Security benefits, it is spent on something else, but it is nonetheless

spent. No money is being stashed away in bank vaults, no investments are being made in real assets. What that means is that in

order to pay promised benefits in future years, we are going to

have to collect taxes from future generations of workers.

How high will those taxes have to be? Well, each year, the Social

Security Trustees put out a report estimating what those taxes are

going to have to be, and I have brought those numbers with me

today.

According to the intermediate forecast of the Social Security

Trustees, if we move out to the year 2045, when today’s college students will be reaching retirement age, we are going to need a payroll tax 50 percent higher than the one we have today, just to pay

Social Security benefits currently promised into law.

According to the pessimistic forecast of the Trustees, we are

going to need twice the payroll tax that we need today to pay benefits already promised by law.

Now, I realize we are here this morning focused on Social Security and not Medicare, but these two programs are funded by the

same payroll tax, and also, the benefits have overlapping effects, so

let me just complete the unfortunate picture for you.

According to the intermediate forecast, at the time when today’s

college students retire, in order to pay Social Security plus both

parts of Medicare, we are going to need almost one-third of the income of future workers. And according to the pessimistic forecast,

in order to pay Social Security plus both parts of Medicare, we are

going to need more than half of the income of future workers.

Now, what about the trust funds? The trust funds, of course, hold

a special kind of government bond, and all too often there is a

tendency to treat this as though it meant something real. In fact,

it does not. Professor Robert Eisner has pointed out that we could,

with the stroke of a pen, double or triple the number of pieces of

paper in these trust funds and that would have no economic effect

whatsoever. Conversely, we could with the stroke of a pen simply

wipe out the trust funds, and that would also have no economic effect whatsoever.

The reason is that every bond, every asset held by the trust fund

is offset by liability of the Treasury, so if you sum over both agencies of government, assets and liabilities cancel out, and you have

no ability to pay any benefits.

The bonds in the trust funds—the Trustees cannot sell them on

Wall Street, they cannot sell them to foreign investors. The only

thing they can do is hand them back to the Treasury, and the

Treasury wipes out its liability, and now it is at zero base. The only

way the Treasury can pay benefits is by going out and borrowing

or by collecting more taxes from future generations of workers.

Remember, every payroll check that is written for Social Security

taxes is written to the U.S. Treasury, and every Social Security

benefit check is written on the U.S. Treasury. The trust funds are
29

simply a lateral accounting device with no real economic significance.

For that reason, I must take issue with Dr. Kingson when he

says in his testimony that we have sufficient revenue to pay benefits out to the year 2028. Not true. That treats these special bonds

as though we could pay benefits with them, and we cannot. The

Trustees very clearly have indicated in their intermediate forecast

that in the year 2028, we are going to need twice the payroll tax

we have today in order to pay benefits currently promised into law.

What can be done about all of this? I think the Advisory Council

had some interesting ideas; I think none of them goes far enough.

If we look around the world today, there are governments that are

behaving responsibly, that are moving rapidly away from pay-asyou-go finance and toward a system under which each generation

pays its own way.

Chile, in our hemisphere, has made the most radical change, and

Chile has been copied south of our borders by Argentina and Colombia and Peru, and it is about to be copied by Mexico and Bolivia

and Ecuador. Similar privatization schemes have been put into

place in Hong Kong and Australia. Singapore never had a pay-asyou-go system; it always had a funded system. Britain has gone

halfway toward a funded system.

These are all countries, many of them democracies, some of them

with cultures similar to ours, that have moved away from pay-asyou-go finance and have realized that in order to have a sound system which can pay benefits during the retirement years, it must

be based upon the principle that each generation must pay its own

way.

Thank you, Mr. Chairman.

[The prepared statement follows:]

Statement of John C. Goodman, President, National Center for Policy

Analysis

SOCIAL SECURITY: THE NEED FOR RADICAL REFORM

The key to understanding elderly entitlements is to realize that they rely on payas-you-go financing. Every dollar of Social Security tax revenue is immediately

spent on payments to beneficiaries or borrowed by the federal government in exchange for special bonds that go into the Social Security Trust Fund. No Social Security tax revenues are invested in real assets. As a result, in order to pay benefits

in future years, the government must collect new taxes from succeeding generations

of workers.

Like our own system, the vast majority of the social security systems in the world

today are pay-as-you-go. Not only do they face the same problems we face, most developed countries are in worse shape. Within a generation (by the year 2020), 16

percent of the U.S. population will be elderly. But one out of every five people will

be elderly in Denmark, Finland, Greece, Italy, Sweden and Switzerland. One out of

four will be elderly in Japan. Indeed, by this measure only Ireland, Australia and

New Zealand are in better shape than the United States.

Less-developed countries with their higher birth rates and younger populations

should be able to weather their problems for several more decades at least in principle. But because many of these countries have mismanaged their retirement systems, they too face imminent crises. Some have already acted, paving the way for

others. Among the most notable alternatives to pay-as-you-go social security are the

following:

• Britain allows employers and workers to opt out of the second tier of public social security by setting up private pension plans with benefits at least as generous

as the government system.
30

1 1997 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.

• Chile requires workers to save for their own retirement by making regular deposits to private pension accounts, which are similar to the American equivalent of

Individual Retirement Accounts (IRAs).

• The Chilean system has been copied to one degree or another in Argentina,

Australia, Colombia, Hong Kong and Peru and will soon be implemented in Bolivia,

Ecuador, El Salvador, and Mexico.

• Singapore requires employees and employers to contribute jointly to individual

investment accounts, which may be used not only for retirement income but also to

pay medical expenses or make the down payment on a home.

These privatized systems are fully funded, and each generation provides for its

own retirement. The systems avert the long-term financial crisis inherent in a

chain-letter approach. They also encourage saving, which in turn generates higher

economic growth.

FUTURE TAX BURDENS

Tables I and II show how bad the future looks for the United States under our

current system. These tables are based on calculations made by the Social Security

Administration actuaries and contained in the Trustees Report on the elderly entitlement trust funds.1

Consider the year 2040, about the time when many of today’s college students will

be reaching their retirement years. According to the intermediate forecast, the fraction of employee earnings we will need that year to pay Social Security benefits will

be almost 50 percent higher than today. We will need almost one-third of workers’

incomes in order to pay Social Security plus both parts of Medicare.

Table I

Elderly Entitlement Spending As a Percent of Taxable Payroll 1

Intermediate Assumptions

Year Social

Security

Social

Security

plus Part A

Medicare

Social Security

plus Total

Medicare 2

SS Plus

All Government

Health Care

for the Elderly 3

2000 ................................................ 11.49% 15.45% 17.07% 19.54%

2005 ................................................ 11.71% 16.24% 18.11% 20.95%

2010 ................................................ 12.15% 17.23% 19.43% 22.67%

2015 ................................................ 13.20% 19.02% 21.80% 25.65%

2020 ................................................ 14.62% 21.36% 24.13% 28.35%

2025 ................................................ 15.92% 23.62% 28.27% 33.89%

2030 ................................................ 16.78% 25.41% 30.58% 36.85%

2035 ................................................ 17.19% 26.47% 32.04% 36.36%

2040 ................................................ 17.02% 26.88% 32.65% 39.74%

2045 ................................................ 17.00% 27.17% 32.94% 40.16%

2050 ................................................ 17.16% 27.52% 33.14% 40.35%

2055 ................................................ 17.51% 28.05% 33.56% 40.79%

2060 ................................................ 17.84% 28.64% 34.19% 41.54%

2065 ................................................ 18.07% 29.20% 34.92% 42.50%

2070 ................................................ 18.26% 29.76% 35.75% 43.62%

1Taxable payroll used to compute all the tax rates in this table is the tax base for the Old Age, Survivors

and Disability Insurance program (referred to as Social Security). It consists of wages and salaries of workers

in employment covered by Social Security up to a maximum of $65,400 in 1997 for any worker. Actual taxable

payroll for Medicare Part A is larger than that for Social Security because there is no maximum and more

workers are covered. See 1997 Board of Trustees Report, Table III.A.2. Spending is net of the income tax revenues collected on Social Security benefits. Taxation of benefits is projected to amount to 0.21 percent of taxable payroll under intermediate assumptions and 0.27 percent under the pessimistic assumptions in 1996, increasing to 0.64 percent of taxable payroll under the pessimistic assumptions by the year 2070. See Board of

Trustees Report, Table II.F.17. 2The Part B calculations are based on the Trustees’ intermediate projections of the ratio of Part B to Part A

as a percentage of gross domestic product, and assume that Part B participants will continue to pay 25 percent of this amount through premiums. See 1997 Report of the Board of Trustees of the Federal Supplemental

Medical Insurance Fund, Table III.A.1. 3 Includes spending for the elderly under all government health programs. In 1987, per capita spending by

people age 65 and over from Medicaid and other government health programs was 40.4 percent of Medicare

spending. This study assumes the same relationship over the 75-year projection period. See Daniel R. Waldo

Sally T. Sonnefeld, David R. McKusick, and Ross H. Arnett, III, ‘‘Health Expenditures by Age, Group, 1977

and 1987.’’ Health Care Financing Review, Vol. 10, No.4, Summer 1989, Table 4.
31

Table II

Elderly Entitlement Spending As a Percent of Taxable Payroll 1

Pessimistic Assumptions

Year Social

Security

Social

Security

plus Part A

Medicare

Social Security

plus Total

Medicare 2

SS Plus

All Government

Health Care

for the Elderly 3

2000 ................................................ 11.97% 16.24% 1.99% 20.66%

2005 ................................................ 12.97% 18.27% 20.46% 23.78%

2010 ................................................ 13.74% 20.14% 22.92% 27.00%

2015 ................................................ 15.00% 22.94% 26.74% 31.99%

2020 ................................................ 16.77% 26.75% 32.29% 39.31%

2025 ................................................ 18.52% 31.01% 38.55% 47.66%

2030 ................................................ 19.95% 35.03% 44.06% 55.02%

2035 ................................................ 20.88% 38.17% 48.44% 60.96%

2040 ................................................ 21.45% 40.23% 51.22% 64.73%

2045 ................................................ 22.11% 41.73% 52.86% 66.78%

2050 ................................................ 22.97% 42.94% 53.78% 67.69%

2055 ................................................ 24.11% 44.39% 54.99% 68.89%

2060 ................................................ 25.29% 46.06% 56.73% 70.87%

2065 ................................................ 26.34% 47.78% 58.80% 73.40%

2070 ................................................ 27.31% 49.47% 61.01% 76.18%

1Taxable payroll used to compute all the tax rates in this table is the tax base for the Old Age, Survivors

and Disability Insurance program (referred to as Social Security). It consists of wages and salaries of workers

in employment covered by Social Security up to a maximum of $65,400 in 1997 for any worker. Actual taxable

payroll for Medicare Part A is larger than that for Social Security because there is no maximum and more

workers are covered. See 1997 Board of Trustees Report, Table III.A.2. Spending is net of the income tax revenues collected on Social Security benefits. Taxation of benefits is projected to amount to 0.21 percent of taxable payroll under intermediate assumptions and 0.27 percent under the pessimistic assumptions in 1996, increasing to 0.64 percent of taxable payroll under the pessimistic assumptions by the year 2070. See Board of

Trustees Report, Table II.F.17. 2The Part B calculations are based on the Trustees’ intermediate projections of the ratio of Part B to Part A

as a percentage of gross domestic product, and assume that Part B participants will continue to pay 25 percent of this amount through premiums. See 1997 Report of the Board of Trustees of the Federal Supplemental

Medical Insurance Fund, Table III.A.1. 3 Includes spending for the elderly under all government health programs. In 1987, per capita spending by

people age 65 and over from Medicaid and other government health programs was 40.4 percent of Medicare

spending. This study assumes the same relationship over the 75-year projection period. See Daniel R. Waldo

Sally T. Sonnefeld, David R. McKusick, and Ross H. Arnett, III, ‘‘Health Expenditures by Age, Group, 1977

and 1987.’’ Health Care Financing Review, Vol. 10, No.4, Summer 1989, Table 4.

Two things are especially worth noting about this projection. First, although the

public focus has been almost exclusively on Social Security, government actuaries

are forecasting that the burden of Medicare will be almost as large as the burden

of Social Security. Second, future workers will pay a larger share of their income

just to support the elderly than today’s workers pay to fund all government services,

including programs for the elderly and the poor, national defense, highways, etc.

Nor is this the worst that can happen. Under the pessimistic forecast, the future

Social Security tax burden will be almost twice its current level and the elderly will

spend more than $2 of Medicare money each year for every $1 they receive in Social

Security checks. Workers will have to pay almost half of their earnings just to fund

benefits already promised the elderly under current law. Put another way, under

the pessimistic forecast, we have already pledged more than half the income of future workers without regard to any personal needs they workers and their families

may have and without regard to the need to fund any other government program!

With a bit more realism, things get even worse. (See Figures I & II.) Medicare

is not the only way we pay for the medical bills of the elderly. We also pay through

Medicaid (for the poor), the Veterans Administration (VA) system and other programs. In addition, the federal government is increasingly trying to shift more of

the Medicare burden onto private employers which means, onto workers in their

role as participants in employee benefit plans.
32
33
34

2The additional 0.1 accounts for childhood mortality that occurs before females reach child- bearing age.

No matter what pocket the funds come out of, however, the overall burden the

elderly create for the generation of working age remains the same. To assess the

total burden, health economists at the National Center for Policy Analysis have estimated elderly health care expenses borne through all government transfer programs. The results (shown in the final column of Tables I and II) indicate that we

have effectively pledged 40 percent of the income of future workers under the intermediate assumptions and almost 65 percent of workers’ incomes under the pessimistic assumptions.

Clearly, we are on an unsustainable path.

THE CAUSE OF THE PROBLEM

Among the reasons the future looks so bleak: (1) women are having fewer chil- dren; (2) people are living longer; and (3) state-of-the-art medical care is becoming

increasingly expensive.

The U.S. Fertility Rate.

In developed countries, the fertility rate must be 2.1 to keep the total population at its current size. That is, each adult man and woman must be replaced by approximately two children.2 In 1960, virtually all developed countries had fertility rates in excess of 2.1, and most had substantially higher rates. Since then, fertility rates

have dropped dramatically almost everywhere. In the United States, the fertility rate is currently 1.9 and is expected to remain below the replacement rate for the foreseeable future. In other countries, the situation is even worse. In Italy (a Catholic country!), the rate is 1.3. In Germany, it’s

1.4. Among all developed Western countries, only Ireland is above the replacement

rate.

What happens to countries that are below the replacement rate? Eventually the population peaks and begins declining. Based on pessimistic assumptions, the U.S.

population will peak about the year 2030 and decline continuously thereafter. If this

estimate is correct, 100 years from now we will have about the same number of people in the United States as we have today. But whereas today most people are

young, a century from now most people will be old.

Life Expectancy.

When our Social Security system was started, life expectancy for a male at birth was only 59 years. Reaching the retirement age of 65 was viewed as an adverse contingency sort of like becoming disabled. Supporting the few people who would be so

afflicted seemed easily affordable. Today, of course, we have a different perspective. Life expectancy at birth is 72.1 years for men and 78.9 years for women. Both men and women are more likely to

reach the retirement age. And once there they can expect to draw benefits for an

increasing number of years. At age 65, men can now expect to live to be 80, women

to be 84. These numbers are projected to increase in future years. The combination of fewer children and longer life expectancy produces an in- creased projected burden for future workers. Whereas in 1950 we had 17 workers

supporting each retiree, today that number is 3, and the ratio could drop as low as

one to one in the next century. In that case each worker would be producing to support himself (or herself) and his family plus one elderly person. But the elderly person would not be the worker’s own parent. Payroll taxes would simply be dumped

in a common (Social Security) pool.

Medical Science.

As people get older, they consume more health care. Although the elderly today constitute only 12 percent of the population, they account for about one-third of all

health care spending. By the time today’s college students reach their mid-fifties,

one out of five people will be old and they will consume two-thirds of our health

care resources. Even with existing to technology, health care for the elderly will be

expensive. How much more expensive will new techniques be?

Seventy years ago, no one could have imagined the medical procedures that are commonplace today. Similarly, we cannot predict what medical science will achieve

over the next 40 years. However, we do have two advantages over forecasters in the

past. First, we know that modern society has given medical researchers a blank

check. Implicitly we have told them: invent it; show us that it improves health care;

and we will buy it. As a result, we have virtually guaranteed that the medical research and development industry will work hard at making new discoveries that
35

3For example, researchers now believe that more than half of all cases of colon and rectal

cancer are directly related to a genetic predisposition to such cancers. See Lisa A. CannonAlbright et al., ‘‘Common Inheritance of Susceptibility to Colonic Adenomatus Polyps and Associated Colorectal Cancers,’’ New England Journal of Medicine 319, No. 9 (September 1, 1988), pp.

533–37.

will cost us more money. Second, we have a fairly good idea of the direction in which

medical science will progress.

For example, it is virtually inevitable that scientists will produce a complete mapping of the genetic code. The only question is, when. Because many life-threatening

diseases are related to our genetic resistance to them, an understanding of individual genetic makeup opens the door to the prevention of disease by artificial intervention. For example, Americans are constantly exposed to carcinogens. They occur

naturally in the food we eat, the water we drink and the air we breathe. But some

people, partly because of their genetic endowment, resist exposure better than others.3 Once we understand the mechanism of susceptibility or resistance (which probably will not require a complete understanding of the genetic code), we will be able

to sharply reduce and perhaps eliminate death from cancer.

The greatest uncertainty is what the achievements of modern science will do to

the future financial burden of income maintenance and health care for the elderly.

For example, heart disease, cancer and strokes currently account for 75 percent of

all deaths among the elderly. Moreover, these three diseases are responsible for 20

percent of all physician visits, 40 percent of all hospital days and 50 percent of all

days spent in bed. If we could eliminate all three diseases, we would also eliminate

three major categories of health care spending. But it is not clear that our total financial burden would go down, for the elderly would live longer and collect more

Social Security checks. They would then eventually die of some other possibly

expensive-to-treat disease.

THE ILLUSORY TRUST FUNDS

Most countries with pay-as-you-go retirement systems don’t even have trust

funds. We would probably be wise to follow their example. The funds not only mislead people who think their taxes are actually being invested in something they distract attention from the real funding problem.

Every payroll tax check sent to Washington is written to the U.S. Treasury. Every

Social Security benefit check is written on the U.S. Treasury. The trust funds do

not collect taxes; nor do they pay benefits. They are nothing more than a lateral

accounting system totally unessential to any real activity.

Technically, the trust funds hold interest-bearing U.S. government bonds, representing the accounting surplus of payroll taxes collected minus benefits paid. But

these are very special bonds. They don’t count as part of the official National Debt.

The Social Security Trustees cannot sell them on Wall Street, or to any foreign investor. They can only hand them back to the Treasury. In this sense, these bonds

are nothing more than IOUs the government has written to itself.

On paper, the Social Security trust funds have enough IOUs to ‘‘pay’’ Social Security benefits for about 17 months on any given day; the Medicare trust fund can

‘‘pay’’ benefits for about one year. In reality, they cannot pay anything. Handing

IOUs back to the Treasury does not increase the size of Uncle Sam’s bank account

one iota. In order for the Treasury to write a check, it must first tax or borrow.

The existence of the trust funds has merely served to make it appear that the

federal deficit is less than it really is each year and to mask the unsustainability

of our Social Security system in its current form. For example, the annual report

of the Trustees of the Social Security trust funds tends to focus almost exclusively

on the concept of actuarial balance. This treats bonds in the trust funds as assets

(the way accountants would do if they were auditing a private pension fund) and

ignores the fact that every asset of the trust funds is a liability of the Treasury.

For the government as a whole these assets and liabilities net out to zero.

If the trust funds were simply abolished, there would be no effect on real economic

activity. No private bondholders would be affected. The government would not be

relieved of any of its existing obligations or commitments. Economist Robert Eisner

has suggested that we abolish the trust funds or, with the stroke of a pen, double

or triple the number of IOUs t hey hold. Either option would allow us to dispense

with artificial crises and get on to the real problem: how is the Treasury going to

pay the government’s bills?
36

A PROPOSAL FOR REFORM

The Advisory Council on Social Security has proposed three possible approaches

to Social Security reform. One proposal would have the government invest the trust

fund surplus in the stock market. This solution is unacceptable in a free country.

Government investment in private sector corporations implies government control.

The other two proposals are improvements over the current system, but neither goes

far enough to provide a permanent solution.

Let me direct your attention instead to the working model of social security reform in Chile, the first nation in the Western Hemisphere to adopt a social security

system (1929) and the first nation in the world to completely privatize one (1981).

Chile converted to a system of individual pension savings accounts, but it gave

workers participating in the old system a choice of staying there or switching to the

new system, and guaranteed secure pensions for those already retired. The change

has resulted in both higher retirement benefits and greater economic growth for the

country. Chile’s reform is serving as the model for reform in a number of other countries, and it can serve us as well.

Currently, employees must pay 10 percent of their wages to an individual pension

savings account, and can contribute up to another 10 percent, all tax deductible. Individuals cannot direct their own investments. However, they can choose among 20

competing private investment companies, which are somewhat similar to U.S. mutual funds. These strictly regulated funds are required to invest conservatively in

a diversified portfolio of stocks and bonds to insure that the premiums grow with

the growth of the Chilean economy. People dissatisfied with one fund can easily

switch to another. The government guarantees a minimum pension benefit to all

workers, and supplements the private benefits as necessary from general revenues

to reach the minimum. Workers must also contribute to buy private life and disability insurance and to cover administrative costs, bringing the total required contribution to about 13 percent.

Retirement benefits, which depend on the rate of return earned by the private accounts, have generally been anywhere from 50 to 70 percent higher under the new

system. Disability benefits are at least twice as high and survivors’ benefits at least

50 percent higher. Retirees can buy an annuity with an insurance company or make

a scheduled series of periodic withdrawals from the account. People who have contributed more than 10 percent can either receive a larger annuity payment or retire

early. Retirees pay taxes on what they receive, but usually at a lower rate than they

would have paid while working.

People who switched from the old system to the new one received special bonds

called recognition bonds that credited their contributions under the old system. The

bonds are indexed to inflation and earn interest, and are part of the individual’s

pension fund account. Chile guaranteed that no retiree would suffer from the reform, and financed the transition by selling government assets, primarily stateowned enterprises.

Not only has the private pension system benefited participants individually, but

it also has helped to fuel economic growth in Chile. The individual funds now total

about half of Chile’s gross domestic product, the net worth of the average Chilean

is about four times his annual salary and real economic growth has averaged more

than 6 percent during the past decade. The Chilean savings rate has grown to 26

percent.

Chile has demonstrated by example that a nation does not have to remain tied

to a system when radical reform is politically possible and economically desirable.

Mr. J

I will give you a chance to respond, Dr. Kingson, later, if you

OHNSON of Texas. Thank you, Mr. Goodman.

f

want to.

Kelly Olsen, research analyst, and Dr. Paul Yakoboski, research

associate, both from the Employee Benefit Research Institute.

Which one of you prefers to proceed?
37

STATEMENT OF KELLY OLSEN, M.S.W., RESEARCH ANALYST,

EMPLOYEE BENEFIT RESEARCH INSTITUTE; AND PAUL J.

YAKOBOSKI, PH.D., SENIOR RESEARCH ASSOCIATE,

EMPLOYEE BENEFIT RESEARCH INSTITUTE

Ms. OLSEN. Good morning. Since its founding in 1978, the Em- ployee Benefit Research Institute, EBRI, has been committed to the

accurate statistical analysis of economic security issues. For the

past year, we have been conducting a Social Security Reform Analysis Project to provide policymakers, the media, and the public

with a neutral analysis of reform options. Consistent with our mission, we do not lobby or advocate a specific policy solution. As Dr. Kingson mentioned, the 1997 Trustees project that under intermediate assumptions, the trust fund will be depleted by 2029.

At that time, the Federal Deposit Insurance Corp., FICA income

alone will be able to pay about 75 percent of promised benefits,

leaving a shortfall of around 75 percent of obligations. However,

the shortfall could be sooner and/or larger. One reason is because

the mortality assumptions used by the Trustees to calculate the

projection appear relatively optimistic in comparison with those

used by other government entities and academics. For example, the high estimate used by the Census projects 13.3 million more persons over age 85 by 2050 than the high estimate

used by the Trustees. The importance of considering any projected Social Security shortfall as serious is underscored by the program’s role in the income of the elderly. Because over 60 percent of the aged population

depends on Social Security for at least one-half of their income, Social Security is the single most important income source for aged

Americans.

While disagreement and uncertainty surround the degree to

which reform is necessary, the degree to which fundamental reform

is desirable presents a more contentious policy issue. Individual,

participant-directed Social Security accounts, as we have heard

today, are central to many current reform proposals, and while the

use of individual accounts is not a necessary condition for resolving

the program’s projected shortfall, a majority of the Social Security

Advisory Council agreed that this approach is more desirable than

reforms that would exclusively fix the system by raising taxes and/

or cutting benefits.

While other considerations for assessing reform options are discussed in our full written statement, we would like to focus our

comments today on the increased uncertainty in benefit levels in

an individual account system due to differences in individual investment choices. Clearly, if a participant’s Social Security benefit

is tied to the balance, it is important to ascertain how persons are

likely to make investment decisions. Yet, because data has been

limited before now, all who have studied Social Security outcomes

under a system of individual accounts have assumed that each age

cohort invests in exactly the same manner, and that is not a very

realistic scenario.

Through EBRI’s Employee Understanding Project, we have gathered the largest known database of individual investment data

from a number of private pension plans and investment firms, and

now, Dr. Yakoboski will discuss their results and the implications.
38

Mr. YAKOBOSKI. Our findings to date indicate that even people within the same plan and of the same age groups and similar demographics invest their retirement in very different ways. Hence,

while data on averages are informative, they hide variation in investment choices.

For example, in one large plan that we examined, we found that 20 percent of participants ages 20 to 29 held absolutely no equity

investments in their 401(k) accounts, while in the same plan,

among the same age group, one-quarter of participants were heavily diversified in equities and had over 80 percent of their assets

invested in equity-based options. And I would also like to note that

this particular plan had a relatively sophisticated education program.

Our data show similar results in other plans. Therefore, it seems

likely that similar people are going to invest individual Social Security account assets differently and thus receive different benefit

levels. A fundamental for Congress then becomes are you comfortable with people within the same income level, sharing the

same demographic characteristics, receiving different levels of Social Security benefits under a national retirement system.

For some of you, the answer to this question and others hinges

on ascertaining the likelihood that different people will receive

vastly different benefits under a system of individual Social Security accounts. EBRI’s policy simulation model that we are currently

working on will present quantitative results on this issue.

The new reform proposals Congress is being presented with add

complexity to the Social Security finance debate. Our model is designed to provide a value-neutral scorecard for all types of reforms

to which policymakers and the public can subject their own objectives and values. We look forward to presenting the Subcommittee

and its staff with the results of our model as they become available

in the fall.

Thank you.

[The joint statement follows:]

Statement of Kelly Olsen, M.S.W., Research Analyst, Employee Benefit

Research Institute; and Paul J. Yakoboski, Ph.D., Senior Research

Associate, Employee Benefit Research Institute

The views expressed in this statement are solely those of the authors and should

not be ascribed to the officers, trustees, or sponsors of EBRI, EBRI–ERF, or their

staffs. Neither EBRI nor EBRI–ERF lobbies or takes positions on specific policy proposals. EBRI is a nonprofit, nonpartisan, public policy research organization.

The 1997 Social Security Trustees report that, under intermediate assumptions,

Social Security outgoes will exceed income beginning in the year 2018. However,

since 1983, the Trustees’ projections as a whole have tended to be optimistic. Given

that the mortality assumptions currently used by the 1997 Social Security Trustees

are optimistic in comparison with assumptions used by other government entities

and academics, there may be reason to believe that Social Security outgo will exceed

income before 2018.

The importance of considering any projected Social Security shortfall as serious

is underscored by the program’s role in the income of the older population. Because

over 60 percent of the elderly depend on Social Security benefits for at least onehalf of their income, Social Security is the single most important income source for

aged Americans.

While disagreement and uncertainty surrounds the degree to which reform is necessary, the degree to which fundamental reform is desirable presents a more contentious policy issue for Congress. Individual, participant-directed Social Security accounts are central to nontraditional reform approaches. Using individual accounts

could increase program revenue by allowing participants to invest Social Security
39

funds in equities, which have provided higher rates of return, on average, than the

Treasury bonds in which the government currently invests Social Security funds.

The following three issues surrounding individual accounts will prove to be critical as the reform debate ensues.

• Would individual Social Security account balances be paid out in the form of

annuities or lump-sum distributions? Results from the annual Retirement Confidence Survey, co-organized by EBRI, the American Savings Education Council, and

Mathew Greenwald & Associates, reveal that most retirees do not purchase annuities. Moreover, the effectiveness of the majority of retirees at managing their savings throughout retirement is unknown.

• Would Congress allow access to individual account funds for purposes other

than retirement? If Congress allows preretirement access, this decision will surely

have negative implications for retirement income security.

• Would Congress be comfortable with people at the same income level and of the

same demographics receiving different levels of Social Security benefits under a national retirement system? In addition, would it be acceptable for some individuals

to end up with no individual account balance to supplement a reduced Social Security base benefit? EBRI research shows that similar people invest their Social Security funds differently, and are therefore likely to have different individual account

balances at retirement. Using the data behind this conclusion, EBRI will explore the

actual disparities likely to occur in a system of individual Social Security accounts

through the EBRI–SSASIM2 policy simulation model, the cornerstone of EBRI’s Social Security Reform Analysis Project.

Congress is now and will continue to be inundated by multiple reform proposals

coming from a range of perspectives. The additional uncertainty surrounding the introduction of individual Social Security accounts will make this round of the Social

Security reform debate more complex than its predecessors. The EBRI–SSASIM2

policy simulation model is designed to provide a value-neutral scorecard for all types

of reforms, to which policymakers and the public can subject their own objectives

and values. We look forward to presenting the Committee and its staff with results

from our model.

We are pleased to appear before you this morning to discuss issues of Social Security reform. I am Kelly Olsen, a research analyst with the Employee Benefit Research Institute (EBRI) and seated beside me is Paul Yakoboski, a senior research

associate with the Institute.

Since its founding in 1978, EBRI has been committed to the accurate statistical

analysis of economic security issues. Through our research, we strive to contribute

to the formulation of effective and responsible health and retirement policies. For

the past year, we have been conducting a Social Security Reform Analysis Project

to provide policymakers, the media, and the public with value-neutral analysis of

reform options. Consistent with our mission, we do not lobby or advocate specific

policy solutions.

To What Degree Is Social Security Reform Necessary?

The 1997 Social Security Trustees report that, under intermediate assumptions,

Social Security outgoes will exceed income beginning in the year 2018. The Trustees

predict that by 2029, the combined Old Age, Survivors, and Disability Insurance

(OASDI) trust funds will be exhausted, and FICA income alone will be able to pay

approximately 75 percent of promised benefits (Chart 1). Over the next 75 years,

Social Security’s shortfall is projected to equal 2.23 percent of taxable payroll.
40

Projections under the Trustees’ intermediate assumptions, however, are not necessarily fully reflective of the program’s future experience. In fact, since 1983, the

Trustees’ projections as a whole have tended to be optimistic. Variation between

projections and actual experiences has occurred in part because projections depend

on many assumptions about the future. These assumptions introduce a large element of uncertainty. For example, the 1997 Social Security Trustees project the

trust funds will experience anywhere from a 0.2 percent surplus to a 5.54 percent

shortfall under three scenarios, each of which is based on what many experts believe to be reasonable actuarial and economic assumptions. Several of these assumptions are controversial. In addition, outcomes are quite sensitive to the value chosen

for some assumptions in that small differences in value can translate into vastly different policy projections.

Mortality rates are one of the most controversial assumptions used in projecting

Social Security’s long-range financial status. In addition, projections are quite sensitive to different mortality values. Clearly, the longer people live, the more pressure will be placed on Social Security finances. The mortality assumptions used by

the 1997 Social Security Trustees appear rather optimistic in comparison with mortality assumptions used by other government entities and academics (Chart 2).

CHART 2

ALTERNATE ESTIMATES OF US POPULATION AGES 85 and Older in 2050

(ALL ESTIMATES ARE EXPRESSED IN MILLIONS OF PEOPLE)

Estimate Source Population

85+

Census Bureau (low) ....................................................................................................... 9.6

Olshansky* ...................................................................................................................... 11.4

Trustees Report (low)♦ ................................................................................................... 11.8

Trustees’ Report (intermediate) ..................................................................................... 14.6

Trustees’ Report (high) ♦ ............................................................................................... 17.8

Census Bureau (mid) ...................................................................................................... 18.2

Lee* .................................................................................................................................. 21.4

Census Bureau (high) ..................................................................................................... 31.1

Vaupel* ............................................................................................................................ 39.0

Manton* ........................................................................................................................... 48.7

Source: Census Bureau estimates were published in February 1996. Research by sources marked with an

asterisk (*) have been supported by the National Institute on Aging. Estimates marked with a diamond (♦)

are produced by the EBRI–SSASIM2 model; all others are drawn from information supplied by the National

Institute on Aging.
41

Should the Trustees’ mortality assumptions prove optimistic by actual experience,

the year that programmatic outgo exceeds income could be pushed ahead from 2018

to an earlier date. Likewise, the trust fund could be exhausted several years earlier

than 2029, and FICA income exclusively might be able to cover fewer than 75 percent of benefits promised thereafter. However, only time will ultimately tell the degree to which Social Security reform is necessary.

The importance of considering any projected Social Security shortfall as serious,

however, is underscored by the program’s role in the income of the older population.

Because over 60 percent of the elderly depend on Social Security benefits for at least

one-half of their income, Social Security is the single most important income source

for aged Americans. With the average annual benefit in 1997 at $8,940, the average

beneficiary is maintained at just above the poverty level by Social Security. Although income from personal savings, employment-based pensions, and possibly

earnings are supposed to supplement Social Security benefits for all retirees, these

sources significantly supplement the Social Security benefit of primarily those

among the uppermost income quintile. In fact, just 20 percent of the elderly population received a total income over $22,254 in 1995.

An Assessment of the Advisory Council’s Recommendations and Other Reform Proposals

While disagreement and uncertainty surround the degree to which reform is necessary, the degree to which fundamental reform is desirable presents a more contentious policy issue for Congress. Individual, participant-directed Social Security accounts are central to nontraditional reform approaches. While the use of individual

accounts is not a necessary condition for resolving the program’s projected shortfall,

a majority of the 1994(96 Social Security Advisory Council members agreed that this

approach is more desirable than reforms that would exclusively fix the system by

raising taxes and cutting benefits. Individual account reforms, which have been proposed by numerous other groups, are receiving a great deal of policy and media attention. As a result, the issues surrounding individual accounts have found new importance in the Social Security reform debate.

One important issue associated with individual Social Security accounts is whether benefits would be paid out in the form of annuities or lump-sum distributions.

By conducting the annual Retirement Confidence Survey, co-organized by EBRI, the

American Savings Education Council, and Mathew Greenwald & Associates, we

found that only 21 percent of surveyed retirees annuitized their IRA balances, and

just 12 percent annuitized their distributions from other retirement plans such as

401(k) plans. Given that most retirees do not purchase annuities, we do not know

how effective the majority of retirees are at managing their savings throughout retirement. This lack of knowledge raises the following questions when considering

creating a system of individual Social Security accounts: how much confidence

should we have in retirees’ ability to manage balances from individual Social Security accounts if Congress does not require these balances to be annuitized? If

annuitization is not required, how effective can we expect individual Social Security

accounts to be in providing retirement income throughout a person’s retirement

years?

Another issue central to individual Social Security accounts is whether Congress

would allow access to individual account funds for purposes other than retirement.

If individual Social Security accounts were to become the largest source of assets

for most households, would voters demand access to their accounts through lumpsum distributions in times of financial hardship? If not, would Congress be comfortable letting people with large individual Social Security account balances to be

evicted from their homes or be unable to afford critical medical care because they

do not have access to their balances prior to retirement? On the other hand, if Congress allows preretirement access, this decision would surely have negative implications for retirement income security.

While lump-sum distribution and preretirement access issues are critical to the

assessment of individual Social Security accounts, we would like to focus most intensively today on one largely unexplored aspect of individual account reforms: the increased uncertainty in individual’s benefits due to differences in their investment

behavior. Clearly, if a participant’s Social Security benefit is tied to the balance of

his or her individual Social Security account, it is important to ascertain how persons are likely to make investment decisions. It is unfortunate that to date, realistic

investment data have been unavailable. As a result, all researchers who have studied Social Security reform outcomes under a system of individual Social Security accounts have assumed that each age cohort invests in exactly the same manner in

terms of asset allocation.
42

Through EBRI’s Employee Understanding Project, we have gathered the largest

known database of individual investment data from a number of private pension

plan sponsors and from investment firms. Although the Project is ongoing, preliminary results show that different people-even people who have similar demographic

characteristics and participate in the same retirement plan-invest their money in

very different ways. Hence, while these data are informative, they do not show

much detail on the variation of investment preferences among workers. For example, we have found that within one employer’s retirement plan, a sizeable fraction

of participants do not invest any funds in equities, while another fraction has invested heavily in equities (Table 3).

TABLE 3

ALLOCATION DISTRIBUTIONS OF PARTICIPANT ACCOUNT BALANCES IN ONE LARGE

EMPLOYMENT-BASED RETIREMENT SAVINGS PLAN, 1994

Total Participants

(as a Percentage)

Equity Investments

Zero <20% 20%–80% 80%+

Total ......................................................................... 25.4 7.1 47.8 19.7

Ages 20–29 ............................................................... 19.8 7.4 48.5 24.3

Ages 30–39 ............................................................... 20.0 6.5 51.5 22.0

Ages 40–49 ............................................................... 24.9 7.5 47.5 20.2

Ages 50–59 ............................................................... 31.7 6.7 45.5 16.1

Ages 60 and Older ................................................... 55.2 8.1 31.4 5.2

Source: Employee Benefit Research Institute, Issue Brief Number 176, August 1996.

In one large company, we found that almost 20 percent of participants ages 20–

28 held no equity investments, while almost a quarter were heavily diversified in

equities. Interestingly, the ‘‘problem’’ explaining this plan’s large variance in investment behavior is not due to a lack of participant education, as this particular employer has a sophisticated employee investment education program. From this example, we can logically conclude that different people-often of the same socioeconomic group-are going to receive different returns on their individual Social Security accounts. A first question for Congress to consider then becomes: are you comfortable with people at the same income level and of the same demographic characteristics receiving different levels of Social Security benefits under a national retirement system? A second question: would it be acceptable for some individuals to end

up with no individual account balance to supplement a reduced Social Security base

benefit?

Recommendations for Congress to Consider as it Moves Forward

For some of you, the answer to these questions hinges on ascertaining the likelihood that different people will receive vastly different benefits under a system of

individual Social Security accounts. The EBRI–SSASIM2 policy simulation model

will soon present quantitative results on this issue. The model will be able to do

so because of its unprecedented capabilities for modeling individual accounts as well

as its ability to account for uncertainty under a range of possible economic and demographic scenarios, such as different mortality rates. In addition, the information

EBRI has obtained from its Employee Understanding Project will be included in

order to show how realistic individual investment patterns would affect disparities

between individual benefit amounts under an individual Social Security accounts

system.

Congress is now and will continue to be inundated by multiple reform proposals

coming from a range of perspectives. The additional uncertainty surrounding the introduction of individual Social Security accounts will make this round of the Social

Security reform debate more complex than its predecessors. The EBRI–SSASIM2

policy simulation model is designed to provide a value-neutral scorecard for all types

of reforms, to which policymakers and the public can subject their own objectives

and values. We look forward to presenting the Committee and its staff with results

from our model. Thank you.

Mr. JOHNSON of Texas. Thank you. We look forward to that.

f
43

Dr. Kingson, do you have any remarks, quickly, like one sentence, sir? You are from Boston; you ought to know how to do that.

Dr. KINGSON. One sentence is that I cannot believe that the Federal Government will renege on its debt to the people of the United

States, to be honest, in terms of Treasury bonds that we may be

holding or in terms of obligations the Social Security Trust Fund

has on the Treasury.

Mr. JOHNSON of Texas. No, I do not think Dr. Goodman was referring to that. I do not think we will renege on them, either. What

he was talking about was a big influx all at once of trying to call

those debt instruments in order to pay for what is going on.

Do you want to respond?

Mr. GOODMAN. Yes. It is a pay-as-you-go system, and I think all

the witnesses here have conceded that in principle, but fail, in Dr.

Kingson’s case, to think through the logical consequences of that.

That means that out in the year 2028, tax revenue collected in

1997 is not going to pay any benefits; you are going to have to collect revenue in that year to pay benefits in that year, and the

amount of revenue you are going to have to collect is twice the payroll tax that we have today.

Mr. JOHNSON of Texas. Do you mind letting him comment?

Mr. KINGSON. I would just add, without going into the numerical

issues there, the general point is that each generation of workers

must pay for nonworking people, whether the claims on the resource are held publicly or privately, whether it is held through Social Security or through some private accounts. It is an inescapable

law of economics—we will have to meet the obligations to our older

persons, in this case, ourselves. And one way or another, whether

it is through a public system or a private system, the questions

that come up really relate very significantly to the distributional

issues that were just raised in the last testimony—how we are

going to do it and how much uncertainty we want to introduce in

the future.

Mr. JOHNSON of Texas. That is a big question. I would just like

to ask you quickly, you indicated that if privatization occurred,

taxes would be higher, and the deficit would be higher. Does that

have to happen necessarily, and wouldn’t that happen if we kept

the system as it is today?

Mr. KINGSON. It will have to happen if we keep the system as

it is today, to some degree. We either have to reduce benefits or

raise taxes or do both to a substantial extent. It depends on how

we define the ‘‘substantial.’’ We have a roughly 25-percent shortfall

after 2028, and we ought to deal with that much sooner, as one of

the other presenters—as I think all the presenters have suggested.

The question again, sir?

Mr. JOHNSON of Texas. Taxes higher, deficit higher.

Mr. KINGSON. Yes. The privatization proposals require additional

benefit cuts in the public program or additional tax increases. The

PSA is a good example of that. The personal security account includes large borrowing from general revenues to fund the transition period, plus it includes—and I say this with some humor—a

temporary, 72-year tax increase of 1.5 percent—1.52. They have

put it up front. They have not tried to hide it. They still believe
44

very honestly that it is good policy and something for you to think

about.

Mr. JOHNSON of Texas. Thank you.

Mr. Portman.

Mr. PORTMAN. Thank you, Mr. Chairman. I enjoyed the dialog,

and I appreciate all the testimony today.

I have some concerns over the statement that all obligations will

be met until 2028, also. I think it creates among my constituents

and the public at large a sense of security that, really, a bunch of

politicians are now talking about Social Security and some academics, but if it is not a problem until 2028, why are we worried about

it. So I think it is important that we flesh out what this really

means, and Dr. Goodman got into it a bit.

The way I see it is that once those obligations are due, when the

baby boomer generation—my generation, our generation—begins to

retire, we will have these Treasury bonds which I agree, the Government is not going to renege on, but the Government is going to

have to go out and borrow money or raise taxes in order to make

good on that obligation.

So I just wish that somehow, we could refocus this debate not on

2028, and some people use the later dates, 2034, 2040, and so on,

to sort of push aside this debate. I think the crisis is upon us, and

I think that is something that there is a consensus at this table

for, and if we do not start using numbers that have a more immediate sense, particularly as we go into the new millennium, even

the year 2001 seems a long way away right now, but as we approach that time, I think we have got to focus on the 2008 and the

2010 and the 2012 timeframe.

Do you have any disagreement with me with regard to the impact when the baby boomers begin to retire? I think it is like an

EEE bond or something—I do not think the Government is going

to renege—but where is the money?

Mr. KINGSON. I do not disagree that we should address this problem soon, and for a number of reasons. We need to give workers

an opportunity to adjust their retirement expectations to the extent

there may be benefit reductions—modest ones.

The longer we wait, the more difficult it becomes to address.

Right now, we are dealing with a real problem, one for which there

is a range of reasonable solutions. The recent Advisory Council,

while they disagreed, I think they fundamentally agreed on extending coverage for State and local workers; fundamentally agreed on

further taxation of Social Security benefits, on a slight benefit cut

of about 3 percent for all future beneficiaries; and while there was

not a strong agreement, there was an agreement on raising the age

of eligibility.

If you just start with that——

Mr. PORTMAN. You say it is about 60 percent of the problem.

Mr. KINGSON [continuing]. You deal with 60 percent of the problem. And then you have a range of choices. Some might want to

raise the eligibility age further. Some might want to cut benefits

through some other mechanism. Some might want to put a tax increase in, somewhere in the far future, to deal with the outyears,

along with raising the age of eligibility. But you can have a serious

discussion.
45

When we have a discussion that creates the sense of an impossible task, I think it often serves an agenda to privatize Social Security—a genuine agenda—but an agenda that is interested in

radically departing from what we have. I think we ought to look

at it on its own merits, because that privatization approach can be

very undermining in other ways.

Mr. PORTMAN. I do think, though, that we have to have people

believing that this is in fact a crisis that is upon us, and if we do

not act now, the adjustment will be all the more severe. And I

think all of us can stipulate as to your comments earlier as to the

importance of the program. You talked about 60 percent of the people requiring more than 50 percent of their income. So stipulating

that, let us assume motives are pure.

Dr. Goodman, with regard to your comments, I think you do lay

out, really, a frightening prospect. You, then, do not talk about how

we bridge that gap in terms of the transition period. Could you

briefly give me your thoughts on the transition? How would you get

from here to there?

Mr. GOODMAN. Oh, there are a number of ways of getting from

here to there, and I would be happy with any of them, because they

are all better than the alternative. The alternative is an

unsustainable path which leads us to a very, very scary future.

I would like to just give one human example of what the future

looks like.

Mr. PORTMAN. Yes, please.

Mr. GOODMAN. A college student who leaves college today and

enters the labor market earning the average wage can expect to

pay at least a quarter million dollars in taxes over his work life

and probably a lot more than that. But when he reaches retirement

age, after paying all of those taxes, will he be able to collect any

benefits? Not unless future generations of workers not even yet

born are willing to fork over half their income.

Are they going to be willing to do that? Well, I do not think anyone today has any assurance that they will. So what I would do is

go the whole way with Social Security and Medicare, go to a private system. We are going to have to increase debt in the short

run, but it is worth it, because we have to make the transition to

a fully funded system.

Mr. PORTMAN. OK. Let me just make one final comment, because

my time is running out.

Dr. Gebhardtsbauer mentioned earlier the issue of the threelegged stool, and you started getting into private employers and

their role. You were then cutoff, as I am about to be. But I think

something that is very important that we need to link here is the

role that the private employer and what employees currently contribute to this in terms of 401(k)s, profit-sharing plan, the new simple plan, and so on. Do you think there is a need or a possibility

of more of a link into the future with the private sector?

Mr. GEBHARDTSBAUER. That is right. Employer plans, as we

know, have been very advantageous for both individuals and the

Nation because of this huge pool of money that has been invested

very efficiently, often getting much better returns than individuals

themselves would get.
46

One idea, for instance, is that if you have an individual account

and either employers or employees must put their money into that

individual account, they will have to find that money somewhere,

so they will take it out of their employer plan, or they will take

it out of their 401(k) plan and lose the match. So, we maybe do not

want that to happen.

Mr. PORTMAN. Right.

Mr. GEBHARDTSBAUER. Maybe there is a way to say that if your

employer already has a pension plan, maybe we will waive the requirement for an individual account if this employer plan is just as

good.

Mr. PORTMAN. Thank you.

I thank the Chairman.

Mr. JOHNSON of Texas. Thank you, Mr. Portman.

Mr. Neal.

Mr. NEAL. Thank you, Mr. Chairman.

Sessions like this are instructive in attempting to address, I

think, one of the most critical aspects of the Social Security debate,

which is building consensus for any change. And clearly, on our

side, there is going to be a reluctance if not resistance and intransigence to any sort of privatization of the Social Security system.

We deem that to be one of the great social accomplishments in the

history of this Republic.

At the same time, we acknowledge, I think, that there are going

to have to be changes in the Social Security system. And we have

used the word ‘‘transition’’ this morning during the testimony, and

at the same time, part of our job here, I think, is to encourage

greater savings among the American people for retirement.

Alan Greenspan comes to Capitol Hill, and we oftentimes treat

what he says to be gospel as it relates to interest rates, but we

miss one of the broader arguments that he has made, and that argument simply, as he offers it, is that the most fundamental economic problem the Nation confronts is our low national savings

rate.

And we have pushed hard—150 Members of the House have

signed a bill that is offered by Mr. Thomas from California and myself, that deals with the issue of using the individual retirement account as kind of a bridge, not to subtract from the Social Security

system—certainly, we are not making the argument to go down the

road to privatization—but we are arguing that the rich are going

to save anyway. Why not provide a vehicle for the middle class and

for lower income groups who wish to set aside some savings for retirement?

I would be curious as to the reaction—I did see Dr. Kingson’s testimony, and he has some suspicions about IRAs and the application

of IRAs—but I would be curious as to what the panelists might

have to say about the use of the individual retirement account.

Mr. MOORE. Well, it is no great mystery why we have a low savings rate in this country. We severely push savings via the Tax

Code. This is one of the reasons I believe we ought to move toward

a flat tax proposal that exempts savings from taxation, which is

sort of a super-IRA, which essentially treats all savings in the form

of tax-deferred savings.
47

I think that the evidence is very strong from what happened in

the eighties when we instituted IRAs that savings went up for people who took advantage of them. They are a very popular savings

tool for middle-income Americans.

I think we made a mistake in 1986 when we restricted IRAs, and

so I would urge Congress to expand them, as it looks like you are

going to do to some extent in this tax bill.

Let me just make one more point, though. I know that you are

not a fan of the personal security accounts, but I would just mention that countries that have moved from pay-as-you-go systems to

personal savings accounts have dramatically increased their savings rate. In Chile, for example, their savings rate went from about

10 percent to 26 percent. Now, I am not saying that the whole reason for that increase in savings was due to PSAs, but I think it created—one of the things you do when you allow people to put money

into these individual accounts is that you create a kind of culture

of savings; and quite frankly, that culture does not exist today in

the United States.

Mr. NEAL. Doesn’t that subtract from the idea of community, universality?

Mr. MOORE. Well, I think the point about the PSAs that liberals

should keep in mind, people who want to protect the poor and so

forth, is that you will be doing better for your lowest income workers in your district if you allow them to put money into these personal savings accounts.

Let me make one last point about this that you might want to

think about in terms of whether you would favor this or not, and

that is you can do this kind of plan and still preserve—and I think

this is an essential feature—you have got to preserve some kind of

safety net mechanism where, when a person retires, if he does not

have enough money in that personal savings account, you basically

tax other people’s accounts so that that person retires with a minimum benefit level. And you can do that very easily because the advantages to all the other workers are so high.

Mr. KINGSON. I am not sure where to begin. First, let me make

one comment on Chile, because it is so often referred to, and maybe

even make a comment on academics.

Unfortunately, one of the occupational hazards of being an academic is that you do look at all sides, so that when it comes to testimony, we become two-handed academics—on the one hand, on the

other hand. I am going to do a little bit of that.

In terms of Chile, what is often not looked at is the fact that

when this system was put into effect during a military dictatorship

and with a budget surplus in general government revenues and

with a radically failed Social Security Program, it was put into effect with an 18-percent mandated wage increase. That might be

very popular—if we wanted to put in a mandated wage increase,

who knows—maybe that would work.

Another thing that is often not mentioned by those claiming that

‘‘all’’ younger workers would benefit, is that the stock market collapsed in 1929, and the real value of stocks I believe did not come

back to the 1929 level until 1954. That is a long time if you are

depending on the stock market for your retirement security or if
48

economic security is to be depended upon primarily through private

savings.

Now, as for the question of private savings, of course we should

encourage it, and here is the other arm. The encouragement of

IRAs is not unreasonable. What I worry about with IRAs, however,

is the transfer of savings from one mechanism to another. Another

thing I worry about is an exclusive, IRA-like system, where we do

not have a public sector to do what it is designed to do—provide

a floor of protection under the middle class and a base to encourage

savings on top of that and a floor of protection under those who are

not so fortunate to be middle class.

Another thing I would worry about with IRAs is the increased

risk that people face and the unequal outcomes that would come

from it.

Mr. NEAL. My time has expired.

Mr. JOHNSON of Texas. Can I just follow up for a moment? You

said a lot about reduced rate for younger workers, and I wonder

how we can improve public confidence in a program through a

transition period and/or if we leave it like it is, how we provide a

better return for younger workers in view of what you have been

saying?

Yes, Dr. Kingson.

Mr. KINGSON. First, I would start by saying that we need to look

at the fundamental purpose of a social insurance program as opposed to a private savings program. The basic purpose of this program is to provide broadscale protection to the American public. To

then come back and assess it in terms of rate of return, in my opinion, is the wrong calculus—not that it is unimportant, but rate of

return does not take into account the inflation protection; it does

not necessarily take into account the survivors’ benefits worth

$300,000 for a young family; it does not take into account disability

protections often. But mostly, it does not take into account the

issue of risk. It also does not take into account that the purpose

of this program early on, again, and now, is to provide widespread

protection. If the goal were to provide only a fair rate of return,

then we would have given previous retirees far smaller benefits

when they began.

Ida Fuller was the first Social Security beneficiary in 1940. Ida

lived until the midseventies and collected some $21,000. If rates of

return were our main concern, what we would have said to Ida is:

You are only going to get back maybe $500, because you only contributed from 1935 to 1940, or something like that. That would not

have made much sense if your goal is to protect older workers. So

we blanketed in the older worker. To then come back and say that

rates of return are declining is assessing it from a very different

perspective.

Mr. JOHNSON of Texas. Mr. Moore, do you have a comment?

Mr. MOORE. I just want to respond to this issue of risk with personal security accounts. That is, it is, of course, true—there is risk

if you invest in private markets, but we ought to realize also that,

especially for young workers, there is what I call huge political risk

with Social Security. Young workers who are 22 or 23 years old are

taking a large risk that this program will be in existence in 50

years.
49

It is not well known among a lot of Americans and even a lot of

Members of Congress that no individual American worker has a

legal right to Social Security, even though I have already paid in

$150,000 of taxes from the time I started working, if tomorrow,

Congress had the votes to abolish the program, I would have no

legal right to those benefits.

Now, on the contrary, however, if you allow me to put that

money into a personal security account where I have my name on

it, and I have ownership in that account, Congress cannot come

and take that money from me.

So what you are essentially doing by moving to PSAs, I believe,

is transferring from a financial risk—and Mr. Kingson is right,

there is financial risk when you put your money into private capital markets, but you are transferring that to what I think is a

much higher risk, and that is the political risk that you are going

to raise the tax, lower the benefit, increase people’s retirement age,

and make the system an even worse deal than it already is.

Mr. JOHNSON of Texas. Dr. Goodman, would you like to have a

quick response?

Mr. GOODMAN. I want to say something about investments in the

stock market and the risk to the employee. If we wanted to for political reasons, we could say that for this generation, the generation

that goes through the transition, the Federal Government will

guarantee each and every worker who goes into a private system

that he will not be worse off than if he had stayed in the public

system. If we do it the way that Chile did it, we can make that

guarantee to every worker, and we will virtually have to pay out

no money from the Treasury; in other words, it’s a very safe guarantee to make.

Mr. JOHNSON of Texas. But Dr. Kingson made a good point, I

think, when he indicated that was a dictatorship when they did

that. How can we do that in a democracy?

Mr. GOODMAN. That is a cheap shot; that is a really cheap shot.

It is true, it is true—it was a dictatorship, but Australia is not a

dictatorship, and they did the same thing.

Mr. JOHNSON of Texas. True.

Mr. GOODMAN. Hong Kong I guess has a dictatorship, and they

did it, too.

Mr. JOHNSON of Texas. Did Australia do it in exactly the same

way as Chile?

Mr. GOODMAN. Pretty much—now, they did not go from a payas-you-go system to a funded system. They started from a welfare

system and went to a funded system. But all over Latin America,

democracies are doing this—Argentina has done it, Colombia has

done it, Peru has done it. Countries that have said they are now

in the process of doing it are Mexico, Bolivia, and Ecuador, so it

is very doable. It can be done in democracies, you do not need dictators, and it is very popular.

This is an extremely popular program in Chile. You can approach

Chilean workers on the street, and they are carrying a little passbook, and they can pull it out and show you how much they have—

four or five times or more of their annual wage. Most American

workers cannot do that.

Mr. JOHNSON of Texas. No.
50

Mr. KINGSON. May I just put a point of information in on that?

Having spent some time on a sabbatical studying their retirement

policies in Australia, the Australian Government did make changes

in the old age system. It has a means-tested system, but it is a

very high means test, somewhat akin in fact to the Concord Coalition’s idea, which I would also disagree with, but it has not developed a Chilean-style system at all. What it has developed is an expansion of the occupational savings by mandating additional pension savings.

The reason I am doing this is that what I find disturbing—we

can all look at a problem if we know what the facts are, but it is

hard to talk if we all come up with our own facts.

In reading through some of the testimony today, one of the

things that troubles me are fairly inappropriate suggestions regarding the great benefit of these programs to low-income workers,

with wild assumptions. In Mr. Goodman’s case, there is the discussion that low-income minority persons lose out in Social Security,

and the assumptions are not really presented—the problems I

see—and I would like to submit this for the record—are that, one,

it does not really take into account the large benefit reduction—the

large benefit tilt—that favors low-income persons. Indeed, minority

persons and low-income persons have shorter life expectancies,

therefore, at retirement would probably get smaller benefits. But

for other reasons, in our society, on average, they have lower wages

and therefore get a higher rate of return in the program; they have

higher participation in the disability programs, higher participation

in survivors.

For example, among children under age 18 who are Social Security beneficiaries, there are roughly 3 million beneficiaries, 1 million of whom are nonwhite. Roughly 725,000 are AfricanAmericans. Among disabled workers, 4.2 million disabled workers,

about 1 million are nonwhite.

But we get only half of the story. The same thing, from my point

of view as I read through the testimony of Mr. Moore. We are told

that a typical female worker who just started working and earns

about $22,500—and that goes up over average wages—would have

a nest egg of about $800,000 to $1 million at retirement age, and

this would produce roughly $60,000 a year until death, assuming

she died at age 80. Well, this worker would be assumed to live 21

years at age 65, not just 13 years, as in the example. What would

that changing this 13-year assumption do to the projected stream

of benefits?

The assumptions need to be made explicit behind some of these

projections that are being put out.

Mr. JOHNSON of Texas. I think that is why we are having this

hearing, to try to get some of this sorted out. I need to have some

more questions answered, but Mr. Gebhardtsbauer, if you have one

quick statement to make, please go ahead.

Mr. GEBHARDTSBAUER. Yes. I just wanted to mention one more

thing about Chile, and that is that whenever you switch over to

this new system, you are going to have transition costs. And Chile

had a fair amount of surplus at that time—not enough, but more

surplus—we have deficits right now.
51

Our current system right now actually has $9 trillion in unfunded liabilities; it is not the $3 trillion that you sometimes see

in reports. That is only on an ongoing assumption. The closed

group assumptions, which is what you need to really transition, is

a $9 trillion unfunded liability, and we do not have——

Mr. JOHNSON of Texas. Right. That makes our national debt

right around $13 trillion.

Mr. GEBHARDTSBAUER. Yes. That is like the whole stock market,

almost. But if you have some surplus, that would give you a good

start—maybe you would not need the whole $9 trillion. But some

of the techniques that are used in some of the proposals are to take

advantage of better returns in the future so that you can get a benefit instead of being paid off your portion that is unfunded.

So there are different ways to go, and I just wanted to point that

out about Chile.

Mr. JOHNSON of Texas. Thank you.

Mr. Hulsof.

Mr. HULSOF. Thank you, Mr. Chairman.

I wanted to ask Dr. Goodman particularly—we have been talking

about this Chilean system—correct me if I am wrong, but at that

time, the Chilean people had very little confidence in their system,

and they were ready for this major reform or transition. I think Dr.

Kingson quoted Senator Bradley in his testimony, that the American people believe in the concept of Social Security.

Do you think we can, as a matter of public confidence, ready the

American people for such a radical overhaul of our Social Security

system?

Mr. GOODMAN. Absolutely. In all of these countries, you need

leadership; you need leadership to make a change. That is very important. In the United States right now, people are not all that confident about the Social Security system. Polls at least among young

people show that a higher percentage think they are going to see

a UFO than think they are going to receive Social Security benefits. So there is a great deal of distrust of the system among young

people, and properly so. And they may not know exactly what the

facts are, but I think their instincts are correct.

Now, with respect to the minority population, let me address

that, because Dr. Kingson brought it up. The life expectancy of a

black male at birth today is about 65 years. When that black male

reaches age 65, the Social Security retirement age at that time will

be 67. So we have a system that, at least on paper, has the average

black male paying taxes all his work life and dying 2 years before

he receives any benefits. And that is the system that Dr. Kingson

says is so great for the minority population. True enough, he may

have a slightly higher probability of getting disability benefits, but

as a retirement system, that is lousy for minorities.

I think that if that message were more broadly understood, you

would find a lot of support in the United States for moving toward

a system where, if you die early, you still have something you can

leave to your heirs.

Mr. HULSOF. Mr. Gebhardtsbauer, I noticed you nodding in assent through some of the question and then the answer, and I also

understand that you have participated in a number of townhall

meetings. Is that correct?
52

Mr. GEBHARDTSBAUER. That is correct.

Mr. HULSOF. In our townhall meetings, we get questions, and I

have been trying to just lay the groundwork without really prodding or pushing the members of the townhall meetings or those

who are in attendance in any direction.

What has been your experience as far as educating the public on

what options they have available to them?

Mr. GEBHARDTSBAUER. Actually, I could not quite finish the last

part of my speech, but it said what is the next step. And I would

say that because using private investments is such a big change

over the current method—it has lots of advantages, but we need to

do a lot of education, and I commend your leadership in doing it.

I guess it sounds like you have also done that in your areas.

It definitely brings up a lot of positive and negative feelings from

especially seniors, who actually would be less affected; people who

are more likely to be in Generation X, who believe that nothing is

going to be left there for them are more likely to be interested in

switching. And I guess the question also is how much are we going

to switch; are we going to completely go to a system that is totally

based on personal accounts? That would be more radical and harder to convince people of. Or, maybe we can just go partially.

And then the question also, whenever you go to using private investments, is you are either going to have the concern of governance issues if you have the government investing the money, and

you also then have the risk issues if the individuals are doing it.

Mr. HULSOF. Mr. Moore, let me ask you—and I think I actually

fall somewhere between the baby boom generation and Generation

X; I am probably a lost individual——

Mr. MOORE. What year were you born?

Mr. HULSOF. Well, I would prefer to keep that private. [Laughter.]

Mr. HULSOF. 1958, actually.

Mr. CHRISTENSEN. Trust me, you are not Generation X.

Mr. MOORE. I was born in 1960, so we are both about the same

age.

Mr. HULSOF. OK. Well, looking at the audience, I would suggest

that probably two-thirds identify more closely with Generation X.

And certainly, going back and doing the graduation speeches and

talking to those folks who are going to be joining the work force

soon, you mentioned that we in Congress could place reasonable restrictions on how money is to be invested or what-have-you to protect against losses. How do you think that would work, or what do

you think the public reaction would be to us legislating those protections?

Mr. MOORE. Well, the libertarian in me would say that people

would be able to invest it however they want, but I do not think

that that is very politically realistic. I think the most realistic kind

of proposal for Congress to think about is something that would essentially set up—I do not think you can allow individual workers

to self-direct their money currently because of the problem that the

folks from the Employee Benefit Research Institute were saying,

that some people still do not have a good sense of how to invest.

And hopefully, by the way, that is something that will change over

the next generation.
53

What I would like to see is some plan where the individual worker would be able to choose between, say, one of 20 mutual funds—

a fidelity fund, a Merrill Lynch fund, and so forth, so you are not

picking stocks, you are essentially picking a fund. That is something that is fairly easy for workers to do. And you could set various restrictions in Congress about what kind of portfolio would be

in that mutual fund. For example, maybe one-third of that fund

would have to be invested in Treasury bills, one-third in corporate

bonds, one-third in stocks, so that you essentially do diversify the

portfolio and do protect against some of the risks that Dr. Kingson

was quite importantly mentioning, that if you put all your money

in stocks, you do face a risk of losing your money. So you would

want to have a diversified portfolio that reduces risk, and if you do

that, I think you can protect workers from the downside risks that

Dr. Kingson was talking about.

Mr. HULSOF. My time has expired.

Thank you, Mr. Chairman.

Mr. JOHNSON of Texas. Thank you.

Mr. Becerra.

Mr. BECERRA. Thank you, Mr. Chairman.

Let me talk about the Chilean model, or let me return to the

Chilean model, and try to get a better sense of how much we can

overlay the Chilean model upon the United States.

The Chilean model, as I understand it, was one where, prior to

its establishment, there really was no coherent, embedded retirement system in place for the country of Chile. Is that correct? No?

Mr. GOODMAN. What was happening in Chile, and what has happened in a lot of Latin American countries is that they start out

with a Social Security system that looks very much like ours and

then, because of the political pressures, they start getting separate

funds, so you have a separate fund for the firemen and another one

for the police officers, and then you get different benefits, and politics eventually just destroys the whole system.

So if you looked at it on paper, you would say it was a bit of a

mess, but nonetheless most people were participating in some sort

of pension system.

Mr. BECERRA. And that is perhaps what I mean. I do not think

anyone would call our system a mess. We do know we need to

make some changes, but we could go on until the year 2080 and

know that at least we are going to give folks three-quarters of what

they might otherwise expect.

Mr. GOODMAN. No, that is wrong. That is not right, that is not

right. You cannot in the year 2080 give people three-quarters of

what they have been promised unless you double and triple the

current tax rate.

Mr. BECERRA. I thought we had enough funding available to take

us to about the year 2028, 2029.

Mr. GOODMAN. No. That was a debate we had earlier, and maybe

you were not here. Dr. Kingson said that based upon government

bonds in the Social Security Trust Fund, but then I pointed out

that every asset of the fund is a liability of the Treasury, so that

when the trust fund hands that bond back to the Treasury, it simply cancels out; you do not have any money, you cannot pay any

benefits. The only way you can pay a benefit is to borrow or tax.
54

Mr. BECERRA. Give me a sense, Dr. Goodman, of how long you

think we could go with the current system if we were to not make

any major adjustments to it.

Mr. GOODMAN. Well, what is in my testimony is right out of the

Trustees’ Report on how high the tax rates are going to have to be,

and around the year 2030, we are going to have twice the payroll

tax we have today, a 30-percent payroll tax to pay Social Security,

plus both parts of Medicare.

Mr. BECERRA. If I could just get from you the response to the

question: How far could we go with our current system if we did

not do any major tinkering to it?

Mr. GOODMAN. Well, we are going to run out of money very

quickly.

Mr. BECERRA. Define ‘‘quickly.’’

Mr. GOODMAN. In just a couple of years.

Mr. BECERRA. In a couple of years?

Mr. GOODMAN. Yes.

Mr. BECERRA. Do you mean by the year 1999, we will not have

money in the Social Security account to pay it?

Mr. GOODMAN. Within the next 5 years, we are going to have to

do something. We are going to have to raise taxes, or cut benefits.

We are going to have to do something.

Mr. BECERRA. And if we do not do anything, what happens?

Mr. GOODMAN. Then the Treasury cannot send out the checks.

Mr. JOHNSON of Texas. Ms. Olsen, do you all have answers to his

questions?

Ms. OLSEN. Well, in terms of the Chilean system——

Mr. JOHNSON of Texas. No, no. His question was when are we

running out of money, I believe.

Mr. BECERRA. If we do not tinker with the system——

Mr. JOHNSON of Texas. Is that true?

Mr. BECERRA. Yes. If we do not tinker with the system, how long

will the money be there; how long will we last in providing some

form of retirement benefits under Social Security?

Ms. OLSEN. Well, as long as there is FICA income coming into

the system, there will be benefits paid out.

Mr. BECERRA. OK.

Ms. OLSEN. The only way to get rid of Social Security is to eliminate FICA taxes altogether.

Mr. BECERRA. Given the actuarial projections, how long could we

go providing people with the benefits that they are expecting at 100

percent of what they are expecting?

Mr. GEBHARDTSBAUER. Maybe I can help here. The reason why

you are probably coming at it from different angles is because Mr.

Goodman is talking about Social Security including Medicare.

When you include Medicare, assuming Medicare is not fixed, then

you run out of money much faster. But if you assume Medicare is

fixed——

Mr. BECERRA. As far as I know, Social Security is a fund separate from the Medicare; is it not?

Mr. GEBHARDTSBAUER. Right. And if you look at just Social Security, then, yes——

Mr. BECERRA. I think this is a hearing on Social Security.
55

Mr. GEBHARDTSBAUER [continuing.] Seventy-five percent of benefits can be paid around the year 2030, and by the time you get out

to the year 2070, about 69 percent is payable, and that is in the

Trustees’ Report that just came out.

Mr. BECERRA. OK. Dr. Goodman, do you disagree with that statement by Mr. Gebhardtsbauer—just a quick ‘‘yes’’ or ‘‘no’’ will be

fine.

Mr. GOODMAN. No.

Mr. BECERRA. OK, then, let me move on.

Mr. GOODMAN. We are going to be able to borrow one trust fund

from another, but all trust funds combined will not be able to pay

benefits in the year 2000.

Mr. BECERRA. If I could move on, please—and I will probably

give you a chance to answer the questions, but I want to make sure

I do not see that green light turn yellow and then red.

If Mr. Gebhardtsbauer is correct that we will have moneys to

provide benefits up until a certain time—2028, 2030—and then it

starts to reduce until we get to about 2070 or so, we do have some

time to come up with some solutions.

My understanding is that the Chilean model, while there were

various programs to provide retirement benefits, I gather that no

one 20 years ago could tell you that they would want to invest in

any model that Chile had at that time. Things may be different

now, and I think that that is a tribute to the success of the Chilean

people and their economy, but I doubt until recently that anyone

felt any level of comfort that the Chilean model would be one we

could use.

Given that, we have a stable system that can take us some distance in, and then, hopefully, we will adjust it. But I believe most

folks would say that politically and economically, we are at a stable

point where we can make decisions, understanding we are not

going to run out of benefits right now, and we are going to have

to make some decisions, correct—but why would you want to compare yourself to a model that, until recently, was totally unstable?

Mr. GOODMAN. Let me just say that in terms of the population

statistics, all Latin American countries are in better shape then we

are—they are younger, they have growing populations. Therefore,

if they had our system, their payroll tax would be much less than

ours——

Mr. BECERRA. So isn’t it the case that they do not have to worry

so much about the baby boom generation as we do.

Mr. GOODMAN. That is right, that is right, but because of political pressures and other reasons, they screwed up their systems,

and——

Mr. BECERRA. If I could ask my question, if you want to continue

to discuss or engage in a dialog—then, why would we want to compare ourselves with Chile when they are not experiencing what we

are experiencing, and that is the baby boom generation coming

home to roost? And if you have to deal with that, how are you

going to deal with going private, or partially private, if you have

a system that you are already saying in the next several years will

have to start looking for additional funds if it wants to provide for

the future generations? What is the proposal if we go private to

provide the services and benefits for those currently on the rolls?
56

Would we tax those who are still working, or would we reduce the

benefits of those who would be eligible for Social Security?

Mr. GOODMAN. I think we have to guarantee benefits to those

who are currently retired. Now, what we did——

Mr. BECERRA. Would you tax those who are paying, who are

working and paying into Social Security? If you are going to provide the same level of benefits, and you are going to provide some

form of private——

Mr. GOODMAN. We have to tax and borrow to maintain the same

level of benefits during the transition period.

Mr. BECERRA. Whom would you tax?

Mr. GOODMAN. The public.

Mr. BECERRA. OK, ‘‘the public,’’ meaning generally, or those who

are working, or those who are making a certain amount of income?

Everyone gets taxed?

Mr. GOODMAN. What I would do is what Chile did. I would issue

recognition bonds and pay them off over a period of time. The natural growth of the economy is going to generate—the higher rate of

growth, as Martin Feldstein pointed out—is going to generate more

money, making it possible over a period of time to pay off those

bonds.

Mr. BECERRA. I understand that, and that is what we heard in

the eighties before the deficits ballooned, but——

Mr. JOHNSON of Texas. Mr. Becerra, I turned the lights off for

you and gave you a little extra time. Can you wind it down?

Mr. BECERRA. Mr. Johnson, you have been quite gracious. I will

go back to that if there is a second round of questioning, and I

thank the Chair.

Mr. JOHNSON of Texas. Thank you, sir.

Mr. Christensen.

Mr. CHRISTENSEN. Thank you, Mr. Chairman.

I wanted to get Mr. Gebhardtsbauer’s position on the Consumer

Price Index, CPI. Earlier this year, we debated a little bit on both

the House and Senate side on whether or not we were going to

make the CPI part of the whole discussion. I wanted to get your

position from an actuarial standpoint on the CPI and how it affects

the Social Security system.

Mr. GEBHARDTSBAUER. OK. The Boskin Commission came out

and said that the CPI could be overstated by 1.1 percent, and if in

fact, then, Congress were to reduce the COLA by 1.1 percent, that

would solve about two-thirds of the Social Security financial problem right there—increase the retirement age to 70, combine those

two, and the whole thing is solved.

But there is a concern that maybe, if you subtract 1.1 out of the

CPI, then you are oversubtracting. Right now, when people get the

COLA, their buying power is actually increasing every year in retirement, at least the benefit from Social Security, because it is

overstating the CPI.

The problem with subtracting a full 1.1 is that that might slightly understate it so that each year, the buying power would go

down. So it does not affect you much for 1 year or 2 years, but the

very elderly in their nineties and hundreds would be the ones who

would be affected the most in that situation. So I guess that is why
57

Congress has tried to find out what is the right cost-of-living inflation index that we need to apply to this benefit.

Mr. CHRISTENSEN. Another question I have—I guess Mr. Moore

is gone now, but he was talking about the percentage of investment

that the Government might be able to control in terms of having

20 mutual funds chosen.

Dr. Goodman, have you looked at any ideas as far as Cato’s plan

on how they would go about selection of those 20 companies, how

they would decide which funds to pick? Also, if they were to proceed to this, would this be a concern for the markets to have that

much government influence in the markets? I am a big supporter

of not burying our heads in the sand and just saying we do not

have a problem; I think we need to fix this problem, and we need

to move toward a system like Senator Kerry from Nebraska has

been talking about. He has been the lonely voice out in the woods

for some time now, and on many things I disagree with Senator

Kerrey, but I think he has been very good on these entitlement

areas and working hard to try to bring some sense into this area.

What about the government being involved in the private markets? How would that affect——

Mr. GOODMAN. I think we have got to be very clear about what

we want to achieve, and what we are talking about is forced savings. We are talking about requiring people to put, say, 10 percent

of their income every year into a savings account. Now, why are

we doing that? Because we want them at retirement age to have

a reasonable income during their retirement years. If you let them

go off and play the futures market and make really risky gambles,

many of them will have nothing at the time they have reached

their retirement years, and then you have lost the rationale for the

whole program.

So what Chile did—and I think it is a good model to follow, and

I think this is what Cato has in mind—was they said, look, we

want to put very few government restrictions on the pension funds,

but you have got to have a diversified portfolio, and you have got

to abide by certain other financial regulations. The government

does not tell them what stocks or bonds to buy. They have perfect

freedom to do that. But they do have to have a diversified portfolio,

and the reason is because over time, that portfolio will keep pace

with the economy, so that when an individual retires, he will have

a pension that reflects the growth of the economy, which was the

reason for the whole thing in the first place.

Mr. CHRISTENSEN. Dr. Gebhardtsbauer.

Mr. GEBHARDTSBAUER. I am sorry—what was the specific question?

Mr. CHRISTENSEN. Your position on the government being in the

markets.

Mr. GEBHARDTSBAUER. Well, right now, there are a couple of

agencies, the Pension Benefit Guaranty Corp., PBGC, and the Federal Thrift Plan, that actually are investing in the markets. The

PBGC, actually, when it takes over a pension plan, keeps those assets from, say, Pan Am or Eastern—I used to be the Chief Actuary

at the PBGC. They keep the assets, but they do not vote them.

They give that to their investment managers.
58

In the Federal Thrift Plan, I guess there was the concern—I was

also the Chief Actuary at OPM when we created the Federal Thrift

Plan——

Mr. CHRISTENSEN. Is there anything you haven’t done?

[Laughter.]

Mr. GEBHARDTSBAUER. I still have lots to do—wait for my Social

Security benefit.

In the Federal Thrift Plan, they invest in a stock index, and that

way, the government is not picking and choosing what stock to do,

so that eliminates the concern that the government could be favoring one industry or another or going into social investments.

There is also the concern about voting, so in the Federal Thrift

Plan, too, they delegate that also to the individual investment managers.

I guess the concern is what happens if someday, Congress in fact

would have lots more money than the Federal Thrift Plan has. I

think they only have, like, $25 billion right now, and the Social Security trust funds could easily get to $1 trillion. So, what would

happen if the Government had $1 trillion? Would they change the

rules and start favoring one group over another?

Mr. KINGSON. If I could just add to that, sir——

Mr. CHRISTENSEN. I am just about out of time. I would just close

by saying, Mr. Chairman, that the number one topic when I am

talking to high school classes and seniors is the fact that they are

not going to see their money. When I ask how many people are

working, almost all the seniors are working, and 25 percent of their

money is going into a deep, dark, black hole that they do not ever

expect to see. I think it is unfortunate that we have people back

here who are not willing to expand their thinking and look into

ideas that will protect the system for the long term and not just

the political term.

I encourage us to keep holding these kinds of hearings, and I applaud your efforts and thank Mr. Bunning as well.

Mr. JOHNSON of Texas. I think these hearings are very beneficial.

A quick comment, Dr. Kingson.

Mr. KINGSON. Yes. One thing that I think is important to note

is that in shifting to a private mechanism, one shifts the risk—

under two of the Advisory Council plans, we shift risk onto individuals. There was a third plan discussed which takes advantage of

possible higher rates of return—I would even say probable higher

rates of return—but which does not shift the risk onto individuals.

Under the maintain benefits plan, they suggested looking at partially investing some portion of the trust fund.

I think the other thing that is awfully important to recognize—

it was just mentioned about high school students not having faith,

or others—I think there is great public misunderstanding of the Social Security discussion. A lot of people think that the exhaustion

of the trust funds in 2028, 2029, means that there is no money in

them once that time takes place. And as we know, that is not so.

It means we only have three-quarters of the funds, which is not

great; we need to do something about it. But this lack of understanding, or lack of understanding affects public opinion. When

young people are asked, one, they may not think it is going to be

there; two, they might not really think they have to pay twice if
59

you shift to a private plan—once for the promises that are made

and once for themselves. So that a lot of the discussion around public understanding and public opinion I think needs to be brought

out carefully, as has been done today in this kind of forum.

Mr. JOHNSON of Texas. Yes. I think the transition is important

to each of us, but Mr. Gebhardtsbauer, you indicated the CPI

would solve the whole problem. Let me ask you a different question: Why do you think we should use the CPI, because I frankly

think it is artificial.

Mr. GEBHARDTSBAUER. The American Academy of Actuaries does

not endorse or propose legislation.

Mr. JOHNSON of Texas. Does or does not?

Mr. GEBHARDTSBAUER. Does not. So we cannot take a stand on

something like that.

Mr. JOHNSON of Texas. OK. Well, there have been too many estimates on what it is. You said one-plus, and we are in as low as

three-tenths or four-tenths of 1 percent. So nobody knows. As Dr.

Kingson says, we do not have the facts on that issue yet, I do not

believe.

Mr. GOODMAN. I just do not agree.

Mr. JOHNSON of Texas. You do not. You think we should use the

CPI?

Mr. GOODMAN. I do not agree with the comment that an adjustment in the CPI can solve three-fourths of our problems. Once

again, that is going back to this accounting that treats the bonds

and the trust funds as though they are something you could pay

benefits with, which they are not.

All that reducing the price index is doing, is just cutting benefits,

so if you are willing to cut benefits enough, then, yes, you can solve

the problem. But I do not think most of us think that is the right

way to do it.

Mr. JOHNSON of Texas. I hear you; I think we all agree on that.

One more line of questions, Mr. Becerra.

Mr. BECERRA. Actually, I would like to follow up on the questions

you were asking on the CPI.

Mr. JOHNSON of Texas. Go ahead.

Mr. BECERRA. Have we come up with a better system to try to

gauge the rate of inflation? I think everyone would agree that the

CPI was never intended to be our gauge of inflation, but has become so. Have we figured out what combination of variables best

gives us a read on what the real inflation rate is?

Mr. GOODMAN. Well, what I would do is what I understand the

Treasury is moving toward anyway, and that is to issue an indexed

bond—and this guy will know more about it than I will—but I understand it is the GNP, Gross National Product, deflator that is

used to gauge the rate of inflation for the country as a whole. And

I would be inclined to say, well, look, if that is good enough for the

country as a whole, let it be good enough for retirees.

Mr. JOHNSON of Texas. Mr. Gebhardtsbauer, a comment?

Mr. GEBHARDTSBAUER. Since you brought it up, I do want to congratulate the Government on having those indexed bonds, because

someday, we will hopefully be able to buy an annuity that will go

up with inflation. So that is something that will help the private

sector, actually, meet some of these needs.
60

But back to your concern on the CPI, I guess what the Bureau

of Labor Statistics has come up with is—they have made some

changes already, and I think it has already reduced the CPI a little

bit—maybe 0.2 percent—and it looks like within another couple of

years, they are going to implement something that will reduce it

by another 0.3 percent, so in total 0.5. That is gradually getting

there, but of course, it would not be used until 1999, so we do not

get that over the next few years.

Mr. BECERRA. Dr. Kingson.

Mr. KINGSON. Thank you, sir.

I think it is very important that Congress move cautiously in this

area for just the reasons that were mentioned, that we do not have

all the facts, and there are lots of variants. We know that nobody

wants to provide a cost-of-living adjustment that is in excess of

what the change in the annual rate of inflation is, but neither do

we want to do the reverse, because then we would have a national

policy which guarantees that the longer you live, the less you have

to spend. And where we have our greatest problems in terms of the

economics of older people is in advanced old age, especially among

aged widows, which is one reason why there was a virtual consensus among the Advisory Council to do something that would increase the benefits of aged widows, essentially, by providing somewhat higher widow/widower benefits in the program while cutting

spouse benefits some. It was a relatively no-cost change. You take

a bit from a group that has a relatively low poverty rate, married

elders, and you add it to a group which is a greater risk, those

women who live longer, primarily, single women who live longer.

And I think the caution of the Bureau of Labor Statistics is very

appropriate, and I think it is important that there not be a political

decision made to move on a national index base, even though I

could see some great advantages, because as the gentleman to my

left said, if the CPI overstates by half a percent, we address onethird of the financing problem without political—without a lot of

fight.

Mr. BECERRA. Thank you.

Thank you, Mr. Chairman.

Mr. JOHNSON of Texas. Thank you all for being here today. We

appreciate your participation.

Before we conclude, I would like to advise the witnesses that the

Chairman may be sending you additional questions to answer for

the record, if you would help us in that vein. I am sure there are

more questions that will come to mind concerning the effects that

your reform proposals would have on the Social Security system.

[Questions were submitted to the panel from Chairman Bunning.

The responses follow:]

QUESTIONS SUBMITTED BY CHAIRMAN BUNNING TO MR. MOORE

1. You emphasize that all conventional fixes (like raising payroll taxes or raising

the normal retirement age) for Social Security are a ‘‘bad deal’’ for young people,

since these changes only worsen their rate of return. You believe these changes

must be tied to an exit strategy that allows young workers to capture the returns

from a private market.

To solve the transition problem, you mention that, according to Martin Feldstein

of the National Bureau of Economic Research, the net economic benefit from Social

Security privatization is $10 trillion, and that a plan could be devised whereby the
61

gains are shared by the government and the worker to the benefit of both. As you

know, we need to be very careful about two issues, one being the Trust Fund balance over the long run and the other ensuring that the government’s overall deficit

is reduced or at least left unaffected by any proposed changes. I’m interested in

knowing more details as to the justification of the net economic benefit from Social

Security privatization.

2. You propose offering a deal to every American worker where they promise to

forfeit any claim on their Social Security benefits—even those they have already accumulated—in order to invest all of their future payroll taxes into private markets.

You estimate that under this approach, up to 1⁄3 of the current unfunded liability

would be eliminated through this transition plan. Would you provide further details

as to how this would work? Do you really believe younger workers would walk away

from what they have contributed?

In your proposal, there appears to be no tier 1 basic safety net benefit, as proposed in the Personal Security Accounts plan offered by certain members of the Advisory Board. Do you see no need for a safety net?

Under your proposal, do workers have the freedom at retirement to use the proceeds of their personal savings account anyway they choose? What happens if they

spend it all quickly or live much longer than they may have expected?

3. As individuals build up balances in their individual accounts, won’t there be

pressure on the Congress to authorize early withdrawals, since after all, the accounts really do belong to the individual?

4. How do you respond to the allegation that some investors will not do as well

in terms of returns on their personal savings accounts and will be forced to turn

to means-tested income support such as SSI, thus driving up the cost of these taxpayer-supported programs?

5. Of what importance are cost-of-living adjustments and should they be preserved?

6. What are your views regarding adjusting the Consumer Price Index as an option to consider as part of Social Security reform?

7. How do we restore younger worker confidence in Social Security?

8. What are your views on the Advisory Council’s recommendation to study the

investing of up to 40% of the Trust Funds? How would the market be affected by

such a large infusion of money?

What percentage of private industry would the government own? Shouldn’t the

government stay out of private industry? How would this be done?

Wouldn’t the government wind up taking an active role in the direction of the

companies whose assets it owns? Might this role for government have a depressing

effect on stock yields and therefore on the yields for seniors?

Since the government would control the investment of the Trust Funds, how do

you avoid the risk that the government might ultimately influence the selection of

stocks for political purposes unrelated to the best interests of the workers contributing to the plan?

9. Could you suggest a way that employers and employees together could opt to

replace a personal savings account or individual account with an employer plan that

would spread the risk more and yield a higher return?

10. In light of the fact that the Trustees’ long-range ‘‘intermediate’’ projections

made in 1983 now appear to have been optimistic, if one were to ask you to design

a package of reforms today, would you use the ‘‘intermediate’’ assumptions or the

‘‘high cost’’ assumptions? Said another way, should we build a financing cushion in

the next set of changes we make to Social Security in the event the most recent

intermediate forecast proves to be optimistic?

11. Given that entitlement spending overall has been projected by the Congressional Budget Office and others to grow dramatically as a percent of GDP in the

future (when the baby boomers are in retirement), do you think it would be wise

to build tax increases into any Social Security reform plan?

12. Do you think the public wants, or is expecting, at least some market investment to underpin the Social Security system in the future, whether it is through

personal accounts or collectively through the Trust Funds?

13. While the Advisory Council was not able to agree on everything, they did

agree that any sacrifices in bringing the system into balance should be widely

shared and not borne entirely by current and future workers and their employers.

The council’s suggestion was to apply appropriate income taxation to Social Security

benefits. Do you believe the burden should be shared by all?
62
63
64
65
66
67
68
69

1This is in inflation-adjusted dollars. Additionally, the purchasing power of her benefit would

be protected by the COLA. Assuming this worker was 20 years old in 1997 and reaches age

65 in 2042, by my rough estimates her yearly benefit in current 2042 dollars would be $62,500.

Her life expectancy on reaching age 65 under intermediate assumptions used in the 1997 Trustees report is estimated AT 21 years. 2From his statement it is not clear whether Mr. Moore is counting only her FICA contribution

or that of her employer and employee. Neither is it clear whether he is counting only the portion

of the FICA that is dedicated to disability and survivors insurance contributions, or for HI. 3 Again, from the testimony it is not clear whether he is talking about nominal (current) or

inflation-adjusted (constant) dollars. If the former, then it is greatly over-stating the real value

of the ‘‘nest-egg and the yearly benefit. Also, it’s not clear whether he is assuming COLA protection under his plan. If not, then $80,000 a year shrinks substantially in purchasing power over

time. 4This seems like a peculiar assumption given that the life expectancy for women reaching age

65 in 2040 is 20.9 years (in 2045 21.1 years) under intermediate assumptions in the 1997 Trustees Report. A 21 year life expectancy would reduce the value of the estimated benefit by a significant amount as would cost-of-living protection.

THE RESPONSES OF

f

DR. KINGSON

1. You argue that privatization places low-and moderate-income workers at significant political risk and that privatization ‘‘schemes’’ ensure erosion of political support

for Social Security’s redistributive role. How do you respond to Mr. Moore’s comment

that low-income workers will do better in a privatized system?

Mr. Moore overlooks important aspects of the Social Security program. Moreover,

I find many of the assertions in Mr. Moore’s testimony confusing and hard to fully

assess. Some of the assumptions behind his analysis are not spelled out and others

seem questionable.

In his testimony Mr. Moore gives the example of a ‘‘typical female worker who

just started working and earns a salary of $22,500, which goes up with average

wages over her lifetime. When she retires,’’ he states that ‘‘Social Security will pay

her a $12,500 1 annual benefit in today’s dollars—assuming no change in benefits.

If she were permitted to simply place her payroll taxes 2 in a mutual fund with a

7 percent real rate of return ..., she would have a nest egg worth $800,000 to $1

million at retirement age.3 This would allow the worker to draw a $60,000 benefit

per year until death (assumed at age 80).’’4 According to Mr. Moore, ‘‘This is five

times higher than what Social Security offers for the same level of investment.’’

• I do not understand why Mr. Moore would assume death at age 80 when average life expectancy for a woman reaching age 67 in 2044 is about 20 years? What

would happen to his estimates if you assumed 20 years of remaining life instead

of 13?

• It is not clear whether the assumed yearly benefit includes cost-of-living protection. I do not think it does. What would happen to the estimate if it did?

• It is not clear whether these calculations include adjust for the value of disability, retirement and health benefits? Similarly, no mention is made of the possibility

of a lower real rate of return (e.g., 5% instead of 7%).

• How might different interest rates change the projected ‘‘nest-egg.’’ And even

if the average rate of return is 7%, plainly some would do better and some would

do worse. In the real world, might this present significant problems?

In short, I do not think Mr. Moore has presented information that supports his

assertion that lower-and moderate-income persons would to well to trade-off the certainty of protection under the current system for the possibilities he suggests may

exist under his proposed system. Below, please find an estimate of benefits payable

under the existing system.
70

Estimated Benefits Payable to Workers Reaching age 65 in 2045

Year reaching 65 Current dollars Constant 1997 % of Earnings

Retiring at age 65

Low Earner ................................. $44,060 $8,510 49.4

Average Earner .......................... $72,740 $14,049 36.7

High Earner ............................... $96,112 $18,563 30.3

Reaching age 67 in 2047

Low Earner ................................. $54,903 $9,899 56.5

Average Earner .......................... $90,888 $16,387 42.1

High Earner ............................... $119,532 $21,552 34.6

Source: 1997 Trustees Report

2. Of what importance are cost-of-living adjustments and should they be preserved?

Cost-of-living adjustments are an important feature of the Social Security pro- gram. They assure that benefits, once received, will maintain their purchasing

power no matter how long the beneficiary lives. Without COLA protection, OASDI

could not achieve its goal of providing widespread protection against loss of income

due to retirement, disability or survivorship. In effect, without full-COLA protection,

we would have a national policy which systematically reduced the value of benefits,

the longer someone lived. 3. What are your views regarding adjusting the Consumer Price Index as an option to consider as part of Social Security reform? If the CPI still overstates inflation, then further technical adjustments will be forthcoming as an outcome of the Bureau of Labor Statistics’ review of this index.

I do not believe that BLS should be politically mandated to make specific changes,

as this would undermine the integrity of its data gathering functions and its statistics. (For additional comment, please see the discussion that followed the statements

of the witnesses.)

In the context of a Social Security financing reform package, it is not unreason- able to consider a one-time reduction (e.g., a ‘‘delay’’) in the COLA as done as part

of the 1983 Amendments. Should Congress choose to implement such a change, then

I believe it would be important to simultaneously implement a one-time increase in

SSI benefits to offset the effects of this COLA cut on some of the most economically

at-risk beneficiaries.

4. How do we restore younger worker confidence in Social Security?

Educate the public about the value of the existing program, the extent of the pro- jected financing problem and the policy choices. Discourage sensational rhetoric. Address the projected financing problem. (For additional comment, please see the discussion that followed the statements of the witnesses.)

5. What are your views on the Advisory Council’s recommendation to study the in- vesting of up to 40% of the Trust Funds. How would the market be affected by such

a large infusion of money? What percentage of private industry would the government own? Shouldn’t the gov- ernment stay out of private industry? How would this be done? Wouldn’t the government wind up taking an active role in the direction of the com- panies whose assets it owns? Might this role for government have a depressing effect

on stock yields and therefore on the yields for seniors? Since the government would control the investment of the Trust Funds, how do you avoid the risk that the government might ultimately influence the selection of stocks

for political purposes unrelated to the best interests of the workers contributing to the

plan?

In the context of the current financing problem, I believe serious consideration

should be given to this option. Yes, there are risks that the government might seek

to inappropriately influence the private sector through its ownership of stocks, but

as the proponents of this plan have suggested there are also safeguards that could

be implemented to substantially reduce—if not entirely eliminate such a risk. I am

reminded of the political events leading up to the enactment of the 1983 Social Security reforms which included the provision to treat up to 50% of Social Security

benefits as taxable income. Congress had previously gone on record—unanimously

or nearly unanimously I believe—as opposing taxation of benefits. But in the context

of the hard choices before the Congress, taxation of benefits emerged as an important—arguably the key—element of the compromise. It was simply less painful than

many of the other options under consideration.

6. Could you suggest a way that employers and employees together could opt to replace a personal savings account or individual account with an employer plan that

would spread the risk more and yield a higher return?
71

No.

7. In light of the fact that the Trustees’ long-range ‘‘intermediate’’ projections made in 1983 now appear to have been optimistic, if one were to ask you to design a package of reforms today, would you use the ‘‘intermediate’’ assumptions or the ‘‘high cost’’

assumptions? Said another way, should we build a financing cushion in the next set

of changes we make to Social Security in the event the most recent intermediate forecast proves to be optimistic?

Use of the intermediate assumptions is perfectly appropriate for addressing the projected long-term financing problem. For a projected long-term financing problem,

I would not consider the use of the pessimistic assumptions to be any more appropriate than the use of the optimistic assumptions. This said, I think the financing

reforms should also seek to implement reforms that would not leave a structural

deficit after the 75-year estimating period. 8. Given that entitlement spending overall has been projected by the Congressional Budget Office and others to grow dramatically as a percent of GDP in the future

(when the baby boomers are in retirement), do you think it would be wise to build

tax increases into any Social Security reform plan? Just as I would give serious consideration to benefit cuts, I would also give serious consideration to some modest tax increase 25, 40 or 60 years in the future. I would

also give consideration to adjustments in the maximum taxable ceiling or to the

treatment of some tax-exempt fringe benefits as taxable for Social Security purposes.

9. Do you think the public wants, or is expecting, at least some market investment to underpin the Social Security system in the future, whether it is through personal

accounts or collectively through the Trust Funds? I do not know the answer to this question. I do believe, however, that the public

may need more information to develop an informed opinion on this issue. 10. While the Advisory Council was not able to agree on everything, they did agree that any sacrifices in bringing the system into balance should be widely shared and

not borne entirely by current and future workers and their employers. The council’s

suggestion was to apply appropriate income taxation to Social Security benefits. Do

you believe the burden should be shared by all?

Yes, but, as members of your Committee well know, when it comes to burden

sharing often there are as many different views of what is ‘‘fair’’ as there are people

in a room.

THE RESPONSES OF

f

MR. GEBHARDTSBAUER

1. In your testimony, you emphasized that it’s not enough for Congress to just put

Social Security back in actuarial balance over the next 75 year period, we must also

maintain a stable Trust Fund at the end of that period to be sure we aren’t dealing

with this problem 20 years down the road (mostly due to the fact that individuals

keep living longer.) The Maintain Benefits group solves this problem by increasing

contributions by 1.6% of covered pay beginning in 2045. The other two Advisory

Council proposals solve this by increasing the normal retirement age to 67 by 2011

and to age 70 by 2083. What are the disadvantages you see in raising the normal

retirement age?

As you suggest, there are advantages and disadvantages to any solution for putting Social Security in actuarial balance. The following are some disadvantages to

raising the Normal Retirement Age (NRA).

SAME AS A BENEFIT DECREASE:

Increasing the NRA by one year is the same as decreasing benefits by 7% (except

it has the advantage of not decreasing disability benefits). For example, if the NRA

is increased from age 67 to age 70, the benefit of someone who wants to retire at

age 65 is reduced by almost 21%. This disadvantage (benefit decreases could adversely affect beneficiaries) can also be seen as an advantage (it corrects for the hidden benefit increase due to longer lifespans). Note that the age 70 normal retirement age is not reached until 2083 in the Individual Account (IA) and Personal Security Account (PSA) plans. Thus, the benefit decreases suggested are quite gradual

(in order to reduce the effects of a notch).

BENEFITS AT 62 MIGHT NOT BE ADEQUATE:

If the current benefit structure was designed to provide the appropriate minimal

benefit, then this decreased benefit will not be adequate. This is of particular con72

cern at the youngest eligibility age 62. When the NRA reaches age 70, the age 62

benefit will be 55% of the NRA benefit, and thus, probably inadequate. In order to

avoid this problem, the earliest retirement age of 62 could be increased to age 65

gradually. However, this would be a disadvantage for those who wanted to retire

earlier, but would now be ineligible for a retirement benefit (unless they could qualify for disability retirement).

WORKING UNTIL AGE 70:

Just because Americans are living longer, does not mean the population is healthier or can work longer. However, recent studies are showing that the elderly

are healthier. Employing them would increase national productivity. In addition,

many people worked beyond 65 in the past, before Social Security was available.

EMPLOYER CONCERNS:

Social Security does not exist in a vacuum. Private sector retirement systems will be affected. Employers who do not want an aging workforce may need to increase

benefits for their pension plans in order to make up for the decrease in Social Security benefits (caused by the increased NRA). Aging workforces can also lead to increased unemployment, health, and disability costs for employers. On the other

hand, it appears that large numbers of retirements of healthy baby-boom workers

starting in 2008 may prompt employers to rethink their retirement strategies. Employers may not want their workers to retire in such large numbers. Retirement

plans can encourage this strategy if retirement ages are increased in tandem with

Social Security. This could reduce employer pension costs also.

SOME CITIZENS NOT AFFECTED:

The retirement age change in the IA and PSA options affect covered workers who reach age 62 on or after 2005 (i.e., those born in 1943 and later) and not those born

earlier. Age 67 would apply to those born in 1949 (1960 and later under current

law). Thus, this change affects baby boomers and younger workers, but not the retired or near-retired. This can be seen as a disadvantage (older workers and retirees

are not sharing in this particular solution) or as an advantage (no sudden changes

for those near or in retirement who can not change their plans easily). A summary

of the IA and PSA retirement age changes are enclosed. 2. You mentioned that experience from other countries shows that tax avoidance

occurs when one gets nothing for additional taxes. Would you provide more detail

as to which other countries have this experience and what actually happened? A paper presented by Joyce Manchester (Visiting Fellow-World Bank) at the 1997 Pension Research Council at Wharton names countries where under-reporting of

taxable income occurs when people get little additional benefit from paying additional contributions. In her speech she also cited Italy as an example. She stated

that people under-report income when: • Benefits are not linked to contributions • Benefits are only based on the last 5 years of income

• Low returns on contributions make the value of the additional benefits worth

much less than the amount contributed.

Even in the United States, many self-employed women with lower wages than

their husbands under-report their income, since they get little or no improvement

in their Social Security benefits if they do report their income (see pages 13 and

14).

3. Of what importance are cost-of-living adjustments and should they be preserved?

If COLA’s are eliminated, the effects will be most felt by the very elderly of the

future. For example, if inflation is 4% over the next 30 years, someone age 95 then

will have fallen behind by 4% for each of the next 30 years. Thus, their purchasing

power at age 95 will be only 31% (=1/1.04¥30) of what it was at age 65. This is

quite a concern, since:

• Employer pensions often don’t have COLA’s,

• Medical and long-term-care expenses are higher in the last couple years of life,

and

• Poverty rates are higher at the most elderly ages, especially among women, who

are more likely to be widows living alone. (See attached chart on poverty rates.)

Poverty rates assume it costs widows about 75% of the amount before widowed to

maintain the same standard of living.

Social Security’s loss of purchasing power was a concern for Congress before

COLA’s were automatic, so they occasionally passed ad hoc COLA’s which ended up

being more expensive than CPI increases would have been. Automatic COLA’s were

introduced as a way to reduce costs. Thus, eliminating them could also increase outlays.
73

1 If the 1.1% decrease is done through BLS corrections to the CPI, the savings is not as great,

because nominal wages and interest rates may also come down.

4. What are your views regarding adjusting the Consumer Price Index as an option

to consider as part of Social Security reform?

The American Academy of Actuaries does not endorse legislative proposals, but

rather provides analysis of advantages and disadvantages. Therefore, while we do

not recommend arbitrarily reducing the COLA, we do note that the Chief Actuary

of Social Security has estimated that subtracting 1.1% from the CPI (and no other

changes) would lower Social Security’s long-range actuarial deficit by about twothirds.1 Coupled with an increase in the normal retirement age to 70, it would solve

Social Security’s current long-range actuarial deficit.

However, if the COLA is reduced by 1.1%, the problems noted in the last question

will arise if this reduction sets a COLA that is lower than the actual increases in

the cost-of-living. The purchasing power of retirees will fall behind each year. Thus,

the very elderly of the future will be hurt the most. Currently, changes in the CPI,

being reputedly higher than the actual increases in costs-of-living, helps the very

elderly the most.

Finally, the Bureau of Labor Statistics has made changes to the CPI that are expected to reduce the annual COLAs by 0.2% and suggests that it might make further changes that would lower the annual COLAs by another 0.3% in 1999. If Congress lowered the 1998 COLA by 0.3%, it would reduce outlays by 0.3% in 1998,

with reduced outlays in future years gradually reducing to zero over current retirees’ lives.

5. How do we restore younger workers’ confidence in Social Security?

Robert Friedland of the National Academy of Social Insurance made a presentation before the 1994–1996 Advisory Council entitled ‘‘Public Confidence in Social

Security.’’ In it, he discussed their focus groups, supplemented by Gallup polls in

1994. They found that most people get their lack of confidence in Social Security

from experts and media saying Social Security has financial problems. Young people

‘‘wanted someone with authority to walk in the room and say’’ Social Security will

be fixed. (See page 295 of Volume II.) Thus, fixing Social Security’s financial problems would probably help restore the people’s confidence in the system. The presentation also suggested that annual benefit statements might help those people that

do not trust the government or its ability to manage (page 297). Private sector pension plans must furnish benefits statements upon a participant’s request.

6. I’d like to know your views on the Advisory Council’s recommendation to study

the investing of up to 40% of the Trust Funds. How would the market be affected

by such a large infusion of money?

What percentage of private industry would the government own? Shouldn’t the government stay out of private industry? How would this be done?

Wouldn’t the government wind up taking an active role in the direction of the companies whose assets it owns? Might this role for government have a depressing effect

on stock yields and therefore on the yields for seniors?

Since the government would control the investment of the Trust Funds, how do you

avoid the risk that the government might ultimately influence the selection of stocks

for political purposes unrelated to the best interests of the workers contributing to the

plan?

EFFECTS ON U.S.:

Most studies suggest that investing Social Security funds in private markets

would probably drive up stock prices, and consequently lower their returns in the

future. (The initial appreciation in stock prices would be a windfall for those already

in the stock market.) Unless amounts invested in the private sector are found from

reduced U.S. expenditures or additional contributions, the U.S. Treasury would have

to find another source for its borrowing. In order to attract more funds, the U.S.

Treasury would have to offer higher interest rates. This would increase the deficit

and eventually taxes. Thus, Social Security becomes a better deal to covered workers at the expense of U.S. taxpayers.

OTHER CONSEQUENCES:

If lower market yields result, it would also affect pension plans and others that

are heavily invested in the stock market. Funds in Defined Contribution plans

would yield smaller benefits and Defined Benefit contributions would have to increase in order to fund the same benefits. Corporations might have higher borrowing costs to compete with the U.S. Treasury for funds. Higher corporate bond yields

then might offset the lower equity yields in pension plans that had them.
74

INVESTMENT RISK:

The Social Security Funds would be subject to market volatility risk. Since they

are closer to pay-as-you-go than advance-funded pension plans, this risk should be

analyzed carefully, to see how much funds can safely be invested in equities. On

the other hand, Social Security does not allow lump sums (which some pension

plans do offer) and contributions each year will greatly offset the amount needed

for distribution each year. This would reduce the risk that large amounts of funds

would need to be withdrawn when stock prices are down. However, when the baby

boomers start to retire (from 2008 to 2030), the stock market might fall dramatically

when retirement funds are pulled out to pay benefits to the large baby boomer cohort. This could lower equity returns dramatically.

GOVERNANCE CONCERNS:

The above comments also apply to the IA and PSA options. However, the Maintain Benefits (MB) option also has the governance concern that you mentioned because the government holds the equity funds (while it avoids placing the many serious risks on individuals of a more privatized system). It is very difficult to determine what percent of the market would be held by the government. Thomas Stanton’s presentation to the Advisory Council (pages 423 of Volume II) compares equity

amounts in 2020 with total corporate equities in 1994 by deflating the equities at

5.5% per year. Under his method, the MB equities in 2020 of $3.2 trillion (as projected on page 196 of Volume I) would deflate to $0.8 trillion in 1994 or 13% of corporate equities. He states that this amount would probably be manageable by current equity managers. However, the Advisory Council projected stocks to yield 11%

annually. If the size of the stock market were to increase commensurate with this

assumption, the above 13% would be much lower. Finally, we note that stocks in

the IA and PSA options will eventually far exceed amounts in the MB option (but

they of course are held by individuals, not Social Security). One way to decrease

these percentages is to allow investments in corporate bonds, mortgages, and mutual funds. This could cut the above percentage in half, since these additional markets are just as big as the domestic equity market. Foreign markets could further

reduce these percentages. These other investments would have their governance

concerns too, however.

Two agencies in the federal government (the Federal Thrift Savings Plan and the

Pension Benefit Guaranty Corporation) reduce the governance concern by delegating

voting rights to the investment managers. The PBGC has done this successfully for

over 20 years. In addition, the Federal TSP only invests in indexes. This reduces

the concern that they could manipulate companies with their huge amounts of

money. In addition, they are by law fiduciaries investing money in the sole interest

of their beneficiaries. This keeps investment managers from having other reasons

for investment decisions. However, laws can be changed by a future Congress. For

example, Florida’s legislature just mandated the state retirement fund to eliminate

investments in tobacco.

7. Could you suggest a way that employers and employees together could opt to replace a personal savings account or individual account with an employer plan that

would spread the risk more and yield a higher return?

If reform legislation mandates additional employee contributions to individual accounts, it may harm their employer retirement benefits and personal savings. Many

lower-paid employees could take their contribution from their 401(k) deferrals and

lose the employer match. Higher-paid employees would then be prohibited from

making their full contribution to the 401(k) plan, due to non-discrimination rules.

If the mandate is for additional employer contributions, then employers may reduce

contributions to their pension plans.

Papers from the World Bank laud the fact that retirement income in the U.S.

comes from more than one source (i.e., the 3-legged retirement stool). Diversification

of the sources of retirement income is very important. However, if the Social Security leg is strengthened by harming the other legs (private pensions and personal

savings), the result could be an unbalanced retirement stool.

There are ways to preserve the employer pension leg. For example, if a mandatory

contribution is required, employer pension plans could be one of the options for the

mandate. The government might require some special rules for the pension plan to

qualify, such as:

• A minimum benefit or contribution,

• A minimum vesting schedule, or

• A minimum cash-balance-type benefit in a Defined Benefit plan, that is vested

within the first year.
75

Employer plans (including Defined Benefit plans) with 401(k) features could qualify as an option for all employees that made a minimum contribution. Section 414(h)

pickup plans could be expanded to all employer types and also qualify as an option.

The private and public pension sectors already exist for over 80 million employees

and would be able to handle the imposition of reform legislation much easier than

if the mandate is placed on each individual. Congress may want to consider this option if it decides to go forward with mandatory individual accounts.

In addition, simplification of pension laws is still needed to encourage more plans.

Most small employers still do not have pension plans (therefore it would be difficult

for small employers to find the money for any IA mandatory contribution). The tax

advantage of employer pension plans (over other investment possibilities, such as

savings accounts, IRAs, and stocks eligible for capital gains treatment) is also necessary to preserve them. Some forms of tax restructuring would remove the tax advantages of employer-sponsored pension plans. We have attached a report which discusses how this could negatively affect individuals, employers, and the nation.

8. In light of the fact that the Trustees’ long-range ‘‘intermediate’’ projections made

in 1983 now appear to have been optimistic, if one were to ask you to design a package of reforms today, would you use the ‘‘intermediate’’ assumptions or the ‘‘high cost’’

assumptions? Said another way, should we build a financing cushion in the next set

of changes we make to Social Security in the event the most recent intermediate forecast proves to be optimistic?

The Academy uses the intermediate assumptions for its monograph and issue

briefs (also enclosed). Social Security’s 1990 Technical Panel assumptions were practically all implemented. In addition, the 1994–1996 Advisory Council, reflecting

some outside criticism, suggested assuming longer lifespans and higher fertility

rates. However, their suggested assumptions approximately offset each other. As

stated in the Advisory Council report, they find the assumptions reasonable in the

aggregate.

In addition, as discussed in our testimony, it is not sufficient to just put the Social

Security system in actuarial balance. The legislation must also create a stable fund

balance at the end of the 75-year period. For example, the IA and PSA options create a stable fund balance by increasing the Normal Retirement Age.

9. Given that the entitlement spending overall has been projected by the Congressional Budget Office and others to grow dramatically as a percent of GDP in the future (when the baby boomers are in retirement), do you think it would be wise to

build tax increases into any Social Security plan?

Whether or not to increase taxes (and how much) is a policy decision for Congress.

If the solution is entirely on the tax side, and benefits are not reduced, the 1997

Trustee Reports of Social Security and Medicare Programs show that taxes would

have to double from 7.38% of GDP today to 15.08% of GDP in 2071. This is about

40% of taxable payroll in 2071.

1997 2071 % Increase

OASDI ...................................................................................... 4.65% 6.68% 44%

HI ............................................................................................. 1.76 4.98 183%

SMI ........................................................................................... 0.97 3.42 253%

Total ........................................................................... 7.38% 15.08% 104%

Congress should consider how much they will need to increase taxes for Medicare

(if any), before they decide to increase taxes for Social Security. It may greatly affect

the thinking on this issue.

10. Do you think the public wants, or is expecting, at least some market investment

to underpin the Social Security system in the future, whether it is through personal

accounts or collectively through the Trust Funds?

As a result my participation in Social Security symposiums sponsored around the

country by members of Congress, I have heard many attendees say who they think

should invest the stocks. In general, these conversations have revealed that younger

people, men, and higher-paid people may be more likely to be in favor of individual

accounts, while older people, women, and the lower-paid may be more likely to not

favor them. It is interesting to note that this latter category is also the same group

that invests in a more conservative basis in their IRAs and 401(k)s. This is probably

due to the fact that they have less future earning power to offset any possible investment losses that could occur.

11. While the Advisory Council was not able to agree on everything, they did agree

that any sacrifices in bringing the system into balance should be widely shared and
76

not borne entirely by current and future workers and their employers. The council’s

suggestion was to apply appropriate income taxation to Social Security benefits. Do

you believe the burden should be shared by all? The Academy does not take policy positions. However, we do note that taxing So- cial Security benefits like pension benefits by eliminating the thresholds would be

a big simplification for retirees calculating their taxes. One might be concerned that

very low-income retirees would then be stuck with a large tax increase. However, as pointed out in the Advisory Council report, 30% would still not be taxed. For example, exemptions and deductions for an elderly couple are $13,400

(=$2,550 x 2 + $8,300). This could easily be more than their Social Security benefit,

so it would not be taxed anyway. In addition, middle income people will not be affected as much due to the progressive nature of our tax system. However, pension

tax law also requires a determination of the portion paid by the employer. This portion is taxed at distribution. We note that determining the portion of Social Security

benefits not taxed yet would be a detailed calculation and difficult for retirees to

verify. Thus, Congress might stay with the 85% imputation rule that already exists.

This 85% is quite accurate for workers at the wage base and above. For middle and

low-income people, however, the untaxed portion is closer to 90 or 95%. Thus, a

more exact calculation would increase their taxes. Thus, the imputation is simpler

and it has the added advantage of not affecting middle and low-income people more

than higher income people. In response to your question about whether current retirees should share in the solution, we note that further taxation and COLA reductions are two ways in which

current retirees could be affected. Many current retirees have received or will receive more from Social Security than they contributed. They have had a good return

on their contributions. On the other hand, they are also responsible for preserving

our democracy in the 1940’s, caring for their parents in earlier years before some

were fully covered by Social Security, and creating a very productive nation in the

1950’s. They may have paid in other non-financial ways. We want to thank you again for holding the hearing and inviting us to testify. We are more than happy to answer further questions or meet with you to discuss

these and other items at any time.

THE RESPONSES OF

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DR. GOODMAN

1. Of what importance are cost-of-living adjustments and should they be preserved?

Cost-of-living adjustments are not included in most private pension plans. Workers

who pay the taxes that provide the Social Security COLAs do not uniformly receive

COLAs themselves, so the beneficiaries are doing better than the people paying for

the benefits. It would be politically difficult to remove COLAs from Social Security,

however. As long as we continue the current pay-as-you-go system, COLAs probably

should be measured more accurately than they are now. I must point out that under

the fully funded system of individual accounts that I proposed in my testimony,

COLAs would be a moot point.

2. What are your views regarding adjusting the Consumer Price Index as an option to consider as part of Social Security reform?

As mentioned in answer 1, COLAs should more accurately reflect the increase in

the cost of living. But this could cut two ways. The Boskin report appears to be substantially correct, but it has been suggested that there should be a separate CPI for

the elderly since their spending differs from the nonelderly—and the finding might

be that the COLA for the elderly should be increased. In any event, I am concerned

that a quick fix based on refiguring the COLA may forestall fundamental reform of

the system.

3. How do we restore younger worker confidence in Social Security?

With so much discussion of increasing the eligibility age and reducing benefits,

younger workers are right to lack confidence in Social Security as currently constituted. In my view, a system of individual accounts similar to the Chilean system

would restore the confidence of workers of all ages and contribute greatly to American economic growth.

4. What are your views on the Advisory Council’s recommendation to study the

investing of up to 40% of the Trust Funds. How would the market be affected by

such a large infusion of money?

What percentage of private industry would the government own? Shouldn’t the

government stay out of private industry? How would this be done?
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Wouldn’t the government wind up taking an active role in the direction of the

companies whose assets it owns? Might this role for government have a depressing

effect on stock yields and therefore on the yields for seniors?

Since the government would control the investment of the Trust Funds, how do

you avoid the risk that the government might ultimately influence the selection of

stocks for political purposes unrelated to the best interests of the workers contributing to the plan?

Government’s investing a portion of the Trust Funds is a terrible idea. First, our

current Trust Fund surpluses are used to finance deficit spending and conceal the

true deficit, and there is no reason to believe any return from such an investment

would not be used in the same way. Second, such an investment would in effect move

American industry toward nationalization at a time when the rest of the world is

moving to privatize state-owned businesses. Third, the temptation to politicize a government-managed fund is too great to resist. We could be sure of political interference

at every turn, particularly with the huge amounts involved. One estimate is that the

Trust Funds would grow to be about 45 percent of the capital stock in the U.S., exclusive of owner-occupied housing and unincorporated businesses.

Let me refer here again to the Chilean system. In Chile, workers can invest their

funds in one of about 20 pension fund administrators (called in Spanish AFPs), private entities authorized and supervised by the government. Individuals can move

their accounts from one AFP to another, so the AFPs compete for business on the

basis of investment returns and management costs. The AFPs are closely restricted

in the types of investments they can make. At the end of 1990, the AFPs had invested

44.1 percent of their funds in government bonds, 17.4 percent in bank time deposits,

16.1 percent in mortgage bonds, 11.3 percent in common stocks and 11.1 percent in

corporate bonds.

5. Could you suggest a way that employers and employees together could opt to

replace a personal savings account or individual account with an employer plan that

would spread the risk more and yield a higher return?

No. I think it would be more desirable to move away from employer-based retirement systems. A retirement system permitting more portability, such as one permitting larger contributions by employees and employers to IRAs and SEPs, or to similar retirement instruments, would produce a system more in keeping with the needs

of today’s workers and retirees. It is simple enough, with diversification, to spread

the risk and gain a higher return with these instruments.

6. In light of the fact that the Trustees’ long-range ‘‘intermediate’’ projections

made in 1983 now appear to have been optimistic, if one were to ask you to design

a package of reforms today, would you use the ‘‘intermediate’’ assumptions or the

‘‘high cost’’ assumptions? Said another way, should we build a financing cushion in

the next set of changes we make to Social Security in the event the most recent

intermediate forecast proves to be optimistic?

We did build a cushion in 1983—and the government has been spending it. The

next set of changes we make to Social Security should be complete reform with a

transition to a system of fully funded individual accounts and a provision for transition from the current system.

7. Given that entitlement spending overall has been projected by the Congressional Budget Office and others to grow dramatically as a percent of GDP in the

future (when the baby boomers are in retirement), do you think it would be wise

to build tax increases into any Social Security reform plan?

No.

8. Do you think the public wants, or is expecting, at least some market investment to underpin the Social Security system in the future, whether it is through

personal accounts or collectively through the Trust Funds?

I don’t know.

9. While the Advisory Council was not able to agree on everything, they did agree

that any sacrifices in bringing the system into balance should be widely shared and

not borne entirely by current and future workers and their employers. The council’s

suggestion was to apply appropriate income taxation to Social Security benefits. Do

you believe the burden should be shared by all?

Yes, but not necessarily through the income tax. However, we need to be concentrating on reform rather than simply bringing the current system into balance.

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THE RESPONSES OF MS. OLSEN AND MR. YAKOBOSKI

Question 1: One of the technical panels of the Advisory Council covered the issue

of ‘‘assumptions and methods,’’ and I believe one of the conclusions of this panel was

that the ‘‘intermediate’’ projections of the Social Security Trustees provide a reasonable evaluation of the financial status. It is very confusing for the public to begin

to understand the problems facing Social Security in the long run, when every day

it seems we are seeing another estimate in the press or in some news story that Social

Security will go bust in a different year. These years seem to range from just past

2000 to 2050? No wonder the public is confused and skeptical about the program’s

future. You point out some disagreement with some of the Trustees’ assumptions.

What can we do to inform the public of the right numbers and what are the right

numbers for us to use as we address future Social Security reform?

Response to Question 1: The Chairman’s uncertainty about which projections to

use is very appropriate when approaching a range of differing reasonable projections

about the future of the program. In fact, in order to be most flexible and sensible,

policy decisions at this juncture must reflect the uncertainty surrounding the extent

and timing of Social Security’s financial issues. Quite simply, no one knows the

‘‘right’’ numbers. However, there are definitely numbers based on more reasonable

and less reasonable assumptions. The trustees issue three sets of assumptions, and

the conservative approach to education would be to always provide the range the

differing assumptions produce. This would tell the public, for example, that benefits

could exceed taxes as early at 2005 or as late as 2020.

EBRI does not have reason to believe that the range of Trustees’ assumptions are

unreasonable, but the range should be shown, as the intermediate assumptions are

just that, one set of assumptions. Our point is that since the Census Bureau and

private researchers almost invariably assume higher life expectancy among the elderly than the Trustees’ intermediate assumption, the Trustees’ intermediate projections may be somewhat optimistic. However, as the Chairman is aware, recognizing

uncertainty does not warrant inaction, as most reasonable estimates predict that

program outgo will exceed program income sometime during the first half of the

next century. Instead of focusing on ascertaining a specific shortfall date, a more

constructive course of action at this juncture for the Congress and the public is careful consideration of the appropriate national response. At the heart of the Social Security debate are philosophical considerations about the appropriate role of government, business, and households in meeting the challenges of an aging society that

must be addressed before the Congress considers actuarial arguments about the specific date of insolvency and specific technical solutions to program shortfalls. The series of hearings on ‘‘The Future of Social Security for this Generation and the Next’’

pointed out many of these fundamental political and social choices that will have

to be made when (and if) a shortfall occurs. We hope that your colleagues on other

relevant committees will follow your lead in pursuit of such discourse.

Question 2: In your testimony you discussed research which showed that only 21

percent of those retirees interviewed annuitized their IRA balances and just 12 percent annuitized their distributions from other retirement savings plans. How can we

determine how effective the majority of retirees are at managing their retirement savings throughout retirement?

Response to Question 2: Retiring with large lump-sum distributions from retirement plans is a very recent phenomenon, with most beneficiaries still in retirement.

As of yet, there is unfortunately a dearth of data on these individuals. We do know,

however, that effective self-annuitization requires significant thought. It is accomplished by dividing the account balance each year by one’s life expectancy at that

point in time and limiting annual consumption to the amount determined by the

calculation. This step must be repeated each year, and the annual amount will vary

from year to year depending on investment income and changing life expectancies.

The extent to which it is reasonable to believe people will effectively manage their

retirement savings is therefore directly proportionate to the percentage of the retired population than can be expected to self-annuitize.

EBRI has undertaken an annual retirement confidence survey for each of the past

six years. The findings suggest that individuals are not well prepared for the challenge. Most have lived for a working lifetime with a regular paycheck -the equivalent of an annuity. Research by others shows that most live paycheck to paycheck,

and many borrow to cover temporary shortfalls. In addition, personal bankruptcies

are higher than ever, as is personal debt. Financial literacy, according to industry

and independent surveys, is low. The Health and Retirement Survey (sponsored by

the National Institute on Aging) finds that most respondents don’t have a good understanding of their own life expectancy prospects, and have low net worth besides.
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All available evidence suggests that the majority of retirees are not effective at managing their retirement savings throughout retirement. Question 3: Of what importance are cost-of-living adjustments, and should they be preserved?

Response to Question 3: Because more than 60 percent of the elderly rely on So- cial Security benefits for over one-half their income, few dispute the importance of

preserving cost-of-living adjustments that protect the elderly from the erosion of income that is caused by inflation. EBRI has not conducted research on the accuracy

of the current consumer price index (generated by the Bureau of Labor Statistics

(BLS) and used to make cost-of-living adjustments for Social Security beneficiaries).

EBRI is not in a position to provide guidance on the extent to which the current

cost-of-living adjustment reflects economic reality for retirees. Question 4: What are your views regarding the Consumer Price Index as an option to consider as part of Social Security reform? Response to Question 4: Congress must first decide what they want Social Secu- rity to provide in the future. If the objective continues to be a floor income for the

lowest income workers on retirement, maintained throughout retirement, then an

inflation adjustment is necessary to maintain value. Different objectives would of

course lead to different answers. The Consumer Price Index per se should be an accurate measure, and BLS should be required to do the work to assure that it is.

Question 5: How do we restore younger workers’ confidence in Social Security?

Response to Question 5: We suspect that restoring the program to long-term actu- arial solvency would greatly contribute to restoring younger workers’ confidence in

the system, although we are not aware of any empirical survey data that address

this question specifically. There is strong evidence in the surveys that the young do

not understand the program, how it works, or its objectives. Much has been written

over the past 20 years about ‘‘money’s worth’’ from Social Security, concluding that

the young will ‘‘do poorly.’’ This analysis assumes that the program is intended to

function in a way that provides a ‘‘payback,’’ which cannot be the case with any insurance program for every participant. There will always be winners and losers.

Few talk about this fact. Few talk about the degree to which Social Security supports an individual’s parents or grandparents, and the money the individual would

likely have to provide to them in the absence of Social Security. Few talk about survivors benefits, or disability benefits, or the fact that if you lose everything else,

there is still the Social Security annuity for you or your surviving spouse and children. Instead, the focus is simply on the ‘‘fact’’ that the government will make good

on the promise, so don’t worry. This misses the fact that the young don’t understand

what the promises are or why they should value them. Question 6, Part A: What are your views on the Advisory Council’s recommenda- tion to study the investing of up to 40 percent of the trust funds? How would the

market be affected by such a large infusion of money?

Response to Question 6, Part A: There are few things that are not worthy of

study. Clearly any such move should occur only after full study and careful consideration of all possible consequences. A recent study by Brett Hammond and Mark

Warshawsky on this topic appears in a forthcoming Benefits Quarterly journal.

They conclude that, under most scenarios, the market would not be overwhelmed

by such an approach. We do not know of other studies on this issue, and the impact

of trust fund investment in equities is an area that economists are just beginning

to study.

Question 6, Part B: What percentage of private industry would the government

own? Shouldn’t the government stay out of private industry? How would this be

done? Wouldn’t the government wind up taking an active role in the direction of the

companies whose assets it owns? Might this role for government have a depressing

effect on stock yields and therefore on the yields for seniors? Since the government

would control the trust funds, how do you avoid the risk that the government might

influence the selection of stocks for political purposes unrelated to the best interests

of the workers contributing to the plan?

Response to Question 6, Part B: Mark Warshawsky and Brett Hammond found

that ‘‘projections based on historical trends in the growth of the stock market as

well as of the indexed portion of the mutual fund industry suggest that, in the case

of a centrally managed Social Security investment strategy, the portion of all equities owned through the Social Security program would be relatively small [between

1.1 and 27.5 percent]’’ (forthcoming, Benefits Quarterly, 1997).

The other issues you raise have been cited as reasons by organizations that are

uncomfortable with the recommendation. The history of public pension fund involvement in corporate governance is often cited, along with past discussion of ‘‘economically targeted investments,’’ as precedents for what might occur. History would suggest that movement into equities might or might not lead to such outcomes, but
80

there would be no guarantees. Whereas not moving to equities would assure that

these things did not happen. Congress will have to decide whether the move to equities is of sufficient value to the fund to merit taking on other risks, EBRI can provide background on what other nations have done, the history of ‘‘social investment’’

discussions in the pension area, and attitudes, but does not take a position for or

against the investment issue per se. Our goal is an informed decision, whatever it

is.

Question 7: Could you suggest a way that employers and employees together could

opt to replace a personal savings account or individual account with an employer

plan that would spread the risk more and yield a higher return?

Response to Question 7: This is what Social Security presently does for all workers, regardless of hours worked. Larger employers have joined with workers to sponsor plans at work that allow savings (401(k), 403(b), 457). Most small firms have

found these plans too expensive to administer and too complex-even employer payroll deduction to IRAs. There have been proposals in the past to create an account

within Social Security to which individuals would contribute that could be placed

in savings bonds. Contributions would ‘‘flow’’ with payroll tax contributions. While

we do not have a pro or con position on this proposal, it is one that Congress might

study as a means of meeting the objective implied in your question.

Question 8: In light of the fact that the Trustees’ long-range ‘‘intermediate’’ projections made in 1983 now appear to have been optimistic, if one were to ask you to

design a package of reforms today, would you use the ‘‘intermediate’’ assumptions or

the ‘‘high cost’’ assumptions? Said another way, should we build a financing cushion

in the next set of changes we make to Social Security in the event the most recent

intermediate forecast proves to be optimistic?

Response to Question 8: As noted above, given the difficulty of taking action on

Social Security, conservative assumptions are probably good to use. In fact, Congress requires private pension sponsors to use very conservative assumptions in

order to assure that promises are kept. A financial reserve is not the only way to

deal with this, however; Congress could also consider automatic adjustments in the

COLA, in retirement age or in the benefit formula, depending on which assumptions

are wrong. For example, a COLA cap would protect against being wrong on inflation. A ‘‘indexation’’ of retirement age would protect against being wrong on life expectancy. Again, EBRI does not support or oppose any of these approaches, but

study of all options would be desirable. However, such automatic adjustments that

can be communicated in advance and are known to be out of the hands of politicians, might well serve to increase confidence in Social Security

Question 9: Given that entitlement spending overall has been projected by the Congressional Budget Office and others to grow dramatically as a percentage of GDP in

the future (when the Baby Boomers are in retirement), do you think it would be wise

to build tax increases into any Social Security reform plan?

Response to Question 9: Objectives are what matter, and public understanding.

Congress must move in a way that rebuilds public confidence in the future of whatever program is put in place. This may or may not be able to be done with tax increases as part of the package. Question 10: Do you think the public wants, or is

expecting, at least some market investment to underpin the Social Security system

in the future, whether it is through personal accounts or collectively through the

trust funds?

Response to Question 10: No.

Question 11: While the Advisory Council was not able to agree on everything, they

did agree that any sacrifices in bringing the system into balance should be widely

shared and not borne exclusively by current workers and their employers. The council’s suggestion was to apply appropriate income taxation to Social Security benefits.

Do you believe the burden should be shared by all?
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Response to Question 11: EBRI is dedicated to soundly conceived and administered public and private benefit programs. A part of sound design is equity of treatment, understanding of the program by payers and beneficiaries, and a feeling of

fair treatment by those same groups. Part of maintaining support for an insurance

program is a belief by all that they are being fairly treated. This would suggest that

burden sharing would be advisable, but it may not be achievable.

ciate hearing your views, your specific recommendations, and we

Mr. JOHNSON of Texas. In closing, again, I thank you. We appref

commend you for your differing opinions. Thank you for this debate.

The Subcommittee now stands adjourned.

[Whereupon, at 11:33 a.m., the hearing was adjourned.]

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