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S. HRG. 109–401

PROPOSALS TO ACHIEVE SUSTAINABLE

SOLVENCY, WITH OR WITHOUT

PERSONAL ACCOUNTS

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

APRIL 26, 2005

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Grassley, Hon. Charles E., a U.S. Senator from Iowa, chairman, Committee

on Finance ............................................................................................................ 1

Baucus, Hon. Max, a U.S. Senator from Montana ................................................ 3

Frist, Hon. Bill, a U.S. Senator from Tennessee ................................................... 7

WITNESSES

Ferrara, Peter, senior fellow, Institute for Policy Innovation, director of the

Social Security Project, Free Enterprise Fund, Washington, DC .................... 8

Tanner, Michael, director, Project on Social Security Choice, Cato Institute,

Washington, DC ................................................................................................... 10

Pozen, Robert C., chairman, MFS Investment Management, Boston, MA ......... 12

Orszag, Peter R., Joseph A. Pechman Senior Fellow, Economic Studies, The

Brookings Institution, Washington, DC ............................................................. 15

Entmacher, Joan, vice president for Family Economic Security, National

Women’s Law Center, Washington, DC ............................................................. 17

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

Opening statement ........................................................................................... 3

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 67

Entmacher, Joan:

Testimony .......................................................................................................... 17

Prepared statement .......................................................................................... 68

Responses to questions from committee members ......................................... 79

Ferrara, Peter:

Testimony .......................................................................................................... 8

Prepared statement .......................................................................................... 84

Frist, Hon. Bill:

Opening statement ........................................................................................... 7

Grassley, Hon. Charles E.:

Opening statement ........................................................................................... 1

Lincoln, Hon. Blanche:

Prepared statement .......................................................................................... 98

Orszag, Peter R.:

Testimony .......................................................................................................... 15

Prepared statement .......................................................................................... 100

Responses to questions from committee members ......................................... 124

Pozen, Robert C.:

Testimony .......................................................................................................... 12

Prepared statement .......................................................................................... 130

Responses to questions from committee members ......................................... 140

Rockefeller, Hon John D., IV:

Prepared statement .......................................................................................... 145

Smith, Hon. Gordon:

Prepared statement .......................................................................................... 147

Tanner, Michael:

Testimony .......................................................................................................... 10

Prepared statement with attachments ........................................................... 149

Responses to questions from committee members ......................................... 213

Page

IV

COMMUNICATIONS

Bienko, Daniel Victor .............................................................................................. 217

Committee for Economic Development .................................................................. 227

Houston Young Republicans ................................................................................... 237

Humes, David C. ...................................................................................................... 242

The Money Management Institute ......................................................................... 245

National Committee to Preserve Social Security and Medicare .......................... 250

National Education Association .............................................................................. 256

Smith, Prof. John L. ................................................................................................ 262

Zimmerman, Tom .................................................................................................... 267

(1)

PROPOSALS TO ACHIEVE SUSTAINABLE

SOLVENCY, WITH AND WITHOUT

PERSONAL ACCOUNTS

TUESDAY, APRIL 26, 2005

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 10:07 a.m., in

room SH–216, Hart Senate Office Building, Hon. Charles E. Grassley (chairman of the committee) presiding.

Also present: Senators Hatch, Lott, Snowe, Kyl, Thomas,

Santorum, Frist, Smith, Bunning, Crapo, Baucus, Rockefeller,

Conrad, Bingaman, Kerry, Lincoln, Wyden, and Schumer.

OPENING STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S.

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. I would like to welcome everybody. I would like

to discuss, just for a moment, our procedure for today.

Senator Baucus and I will make opening statements. We will

then hear from our witnesses. Following their statements, Senators

will each have 5 minutes for questions. I will start, followed by

Senator Baucus. Then after Senator Baucus, we will follow the traditional early bird rule.

For Senators that have to go to other hearings, you will maintain

your place on the early bird rule, so when you come back, if we

have crossed your name, we will go back to you before following

down the list.

For the benefits of our new members, I hope that the early bird

rule has been explained to you by staff. If you have any questions

about it, I would ask that you would talk to our staff about it so

there is a clear understanding of how the early bird rule works.

Today’s hearing is the second this year that this committee has

had on the future of Social Security. Today we are going to examine specific proposals that achieve sustainable solvency for Social

Security, which is probably the most popular government program

ever created. Sustainable solvency means that there is a positive

trust fund balance throughout the traditional 75-year projection period for Social Security, and a level of rising balance at the end of

that period.

Sustainable solvency ultimately means that taxes and benefits

must be roughly equal. Achieving sustainable solvency, of course,

is important for a number of reasons. No one wants Social Security

to be unsustainable.

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Beneficiaries should not have to worry that their benefits will be

reduced. Workers should not have to worry that their payroll taxes

will go up, as they have 20 times. The longer Social Security’s future remains in doubt, the more people will worry about their own

future prospects.

A sustainable Social Security program will give everyone additional peace of mind. No one should take comfort in the fact that

Social Security has been on an unsustainable path for nearly 3 decades.

Given the programmatic linkages between workers and beneficiaries and wages and benefits, there is no plausible set of assumptions under which Social Security will be able to pay 100 percent of currently scheduled benefits.

Policymakers of the past had the luxury of time. They could afford to wait and see. After all, things might have turned out differently. We might have had birth rates not declining. Real wages

might have been higher, and inflation might have been lower.

But all those things were not to be. Their future is now our

present, and time is running out. The retirement of the baby

boomers is upon us within 3 years. It has been more than 20 years

since Congress enacted major Social Security reform.

Despite the obvious need for additional reform, policymakers

have refused to take further action. Instead, Social Security has become, as we all know, a political hot potato just tossed back and

forth, producing motion but no progress.

If this Congress is going to muster the courage, and if we are

going to accept the responsibility that we should address Social Security reform this year, we should do more than just kick the can

down the road a while.

Achieving only 75-year solvency like the 1983 reform means that

we have failed to fully address the problem. That means that we

are just doing nothing more than passing the buck to some future

Congress.

Each of the proposals presented by our witnesses today will

achieve the goal of sustainable solvency. They reach this goal in a

variety of different ways. Our job on the Finance Committee is to

evaluate the elements of each plan and determine the best approach overall.

As Chairman, I intend to work hard to engage this committee in

a sincere debate about ensuring Social Security’s future solvency.

I hope to bring members to the table to work in our usual bipartisan fashion. I feel strongly about the need to take legislative action this year.

Now, President Bush has lent the power of the White House to

the cause of saving Social Security, and it seems like this only happens when presidents do this, as under President Carter, as under

President Reagan. Under those two presidents, Congress did take

some action.

Under President Clinton, he had a great national debate on the

issue, but Congress did not take action. But it got a lot of bipartisan bills introduced that maybe would not have otherwise been

introduced except for President Clinton’s leadership. We should not

waste the opportunity provided by the leadership of President

Bush.

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This opportunity is not likely to come again for another decade.

I hope my co-sponsorship of the Bob Kerry and the John Breaux

and the Judd Gregg bill in 1999, following on the leadership of

President Clinton, indicates that I am not afraid as a Republican,

opposite the President, to take action at that particular time.

Outside of the hearing room today we have political theater and

we have dramatic attempts to polarize Social Security along partisan lines. I hope that my fellow committee members, in the tradition of the work of this committee, resist the temptation to allow

such theatrics to pervade this hearing room.

I want to thank my colleague, Senator Baucus, for being very intellectually honest in his approach to this issue, even though we

disagree to some extent about what we should be negotiating, or

when we should be negotiating. But I follow very closely what my

colleague says, and I thank you for the sincerity in how you have

addressed our differences of approach.

If there is going to be a bipartisan consensus for reform, the

process has to begin in this committee. We know from previous

Congresses, when leaders have taken things away from this committee, they have gone nowhere. I do not expect either the Republican or Democratic leadership this time to do that, so we have an

opportunity, and there is no time like the present to get started.

Senator Baucus?

OPENING STATEMENT OF HON. MAX BAUCUS,

A U.S. SENATOR FROM MONTANA

Senator BAUCUS. Thank you very much, Mr. Chairman.

I would like to begin just by thanking you for the tone in which

you are approaching this subject. We have, as you mentioned, a

tradition in this committee of working very much together, you and

I especially. It has been a wonderful experience for me, working

with you.

We almost always agree, and I think that is partly because we

both have the same approach, that is, trying to find pragmatic,

practical solutions based not in ideology, but on economics and

what makes sense and what does not make sense.

In fact, the cooperation is so great, it has turned into personal

friendship, which is quite something around here. I just want to

again tell you how much I appreciate that. This is one of the very

few times where we do not agree, and it is just unfortunate that

we do not. You favor private accounts, I do not.

At the same time, to use that old phrase around here, which is

really true, we agree to disagree agreeably. There has been absolutely no difference in the friendship between the two of us on this

issue, but we just, at this point, do have different points of view.

I know that, over time, we will probably find a way to resolve this

one as well, although it may not be in the immediate future.

When President Roosevelt signed the Social Security Act, he said

that ‘‘we have tried to frame a law which will give some measure

of protection to the average citizen and to his family against poverty-ridden old age.’’ Social Security has provided that critical

measure of protection for millions of American families.

4

I mean, these figures are really dramatic. For 1 out of 5 seniors,

Social Security is their only source of income. For 2 out of 3 seniors, Social Security provides most of their income.

People depend on Social Security and Social Security helps millions of families if a breadwinner dies or becomes disabled. Clearly,

we need to address Social Security’s long-run financing. Nobody

disputes that. That is clear. But we do not need to make drastic

changes.

The nonpartisan Congressional Budget Office, which is the official Congressional scorekeeper, one that we must go by when we

pass legislation around here, projects, under current law, Social Security can pay full benefits through the year 2052. We must abide

by CBO’s numbers. Other estimates will be made by other people,

and the administration has their own, but we in the Congress must

abide by CBO.

CBO says that Social Security can pay full benefits through the

year 2052. After that, CBO says, annual Social Security revenues

are sufficient to pay about 80 percent of benefits. That is after

2052.

Clearly, however, we need to make changes so that that result

in the year 2052 is not reached, so that full benefits are available

for all Americans, all seniors who retire past that year.

We should make these changes sooner rather than later, that is

clear, because the price for the solution will be much less today

than if we attempt to address it years down the road.

But I want to also make clear, we do not need to privatize Social

Security to save it. That is a very key point. We do not have to privatize Social Security in order to save it.

Unfortunately, the President has called for privatizing Social Security. The President proposes to allow workers to divert 4 percent

of their earnings into private savings accounts.

Now, common sense teaches us that when you want to get out

of a hole, first you stop digging. But the President’s plan would dig

Social Security into a deeper hole.

He has admitted that private accounts do not solve Social Security’s problems, but he should honestly go a little bit farther and

say not only do they not solve Social Security’s long-term financial

problems, but they also make the long-term financial problems

much worse. Not only do they not help solve the problems, they

make long-term problems much worse.

According to CBO, Social Security can pay full benefits, as I mentioned, until 2052. But under the President’s plan, the date when

full benefits can no longer be fully paid comes 11 years earlier in

2041.

Where does the money come from to put into these private accounts? Where does that money come from? Well, the Federal Government would have to borrow it, borrow more, much more, at a

time when, for the second fiscal year in a row, the Federal budget

deficit hit an all-time record of $412 billion.

Indeed, under the President’s plan, the Federal Government

would have to borrow roughly $5 trillion more during the first 20

years of its plan. Today, the entire debt held by the public is roughly $4.5 trillion. The President’s plan would more than double that,

to almost $10 trillion.

5

Now, how much is $10 trillion? What does that really mean? Well, one way to look at it, is this. That is $34,000 for every person

in the United States today. $34,000 for every man, woman and

child in the United States today, saddled with that $10 trillion

debt.

How much of that money will be borrowed from foreign investors

and foreign central banks? A lot. I think the current figure is,

about 37 percent of our debt is held by foreigners and foreign central banks.

Well, someone might ask, what difference does that make? It

makes a big difference. What effect will that have on American foreign policy when foreigners own so much of our debt? We start to

negotiate one foreign policy issue after another.

Get a little hint from China, a little hint from North Korea, from

Japan, about what their issue is and what they may or may not

do with respect to their holdings of U.S. debt.

It puts us in a very precarious position, to say nothing of the precarious financial position our country would be in if those dollars

are withdrawn or those securities are withdrawn by foreign governments.

We are not saying they will, but we do know there have been

hints in the past where Korea, I think, and another country indicated they may pursue that. We cannot put ourselves in the position of so much national debt.

Now, the President has not publicly taken the position on how

to eliminate Social Security’s long-run shortfall and how to make

up for the additional shortfall caused by his privatization plan.

But the President and his spokespeople have implied that there

is a benefit proposal that they might support. What is it? First, as

you may recall, the President, indirectly through his 2001 Social

Security Commission and a memo by a high-ranking White House

official, considered price-indexing initial benefits.

That proposal would deeply cut benefits for everyone and would,

according to the Congressional Research Service, eventually eliminate Social Security as we know it.

As you can imagine, once those details were understood, the

President and the White House stopped talking about price-indexing.

Well, more recently, the President and White House officials

have praised a proposal called Progressive Price-Indexing. In a

March 16 press conference, President Bush said some positive

things about an idea that has been suggested by one of today’s witnesses, Robert Pozen.

The President said, ‘‘One of the interesting ideas was by a fellow,

by an economist, name of Pozen. He came to visit the White House.

He didn’t see me, but came and tossed some interesting ideas out,

talking about making sure the system was progressive.’’

Well, under this proposal, low-income workers are left untouched, but everyone else has their Social Security benefits cut.

Instead of eventually eliminating Social Security, most workers

would eventually receive the same Social Security benefit, regardless of the amount of money contributed to the program.

Both of these proposals are bad policy and fundamentally alter

important features of Social Security, and would result in deep

6

benefit cuts for middle-income and upper-middle-income folks, especially middle-income Americans.

The benefit reductions under Mr. Pozen’s plan would be deep,

and they would keep getting deeper as we move further into the

future. According to the Center on Budget and Policy Priorities,

someone who earns $59,000 in 2005 and retires on down the road—

I do not have the exact date here—that person will receive a 42-

percent cut in benefits. Forty-two percent. That is for persons earning $59,000 today.

So, this plan is not a compromise. The plan is not progressive.

The Pozen price-indexing proposal would cut benefits deeply for retirees who rely on them.

Now, some may ask, what about the income that retirees would

get from their private accounts? Would the earnings in the private

account not be greater than the reductions in the benefits? The answer is no.

Even though retirees get to keep the money in their private accounts, they have to give most of it back, maybe all of it back, and

maybe even more than all of it back in the form of a second cut

in the Social Security benefits.

This second cut is on top of the benefit cut from switching to

price-indexing. The size of the President’s second cut would be

equal to the contributions that were made to the workers’ private

accounts, plus earnings on those contributions, of 3 percent plus

the rate of inflation. In effect, this second cut is a privatization tax.

Because of this privatization tax, if we adjust the projected rate

of return on stocks for risk, as required by the CBO—and again,

we must go by CBO numbers—participating in the private accounts

would do you no good. Put another way, the private accounts do not

offset any of the losses for the price-indexing plan that the President thinks is a good idea.

Well, what if stocks were not adjusted for risk? Would workers

be able to make up for the cuts? Our analysis shows that the stock

market would need to earn at least 10.9 percent over the next 40

years for workers to be able to make up for the cuts due to priceindexing and the privatization tax. That is in nominal terms. Most

people think of the stock market in nominal terms, not real terms.

But most experts agree that a 10.9 percent return on stocks over

the next 40 years is highly unlikely. Social Security actuaries assume the stocks will return 9.5 percent.

Top Wall Street economists, according to an article by the Wall

Street Journal in February, are expecting stock returns over the

next 40 years to be around 7.6 percent. Again, that is nominal.

Most people think of the stock market in terms of nominal. They

do not add in rate of inflation.

Let me also say a few words about the plans of our other witnesses. Peter Orszag, in conjunction with Peter Diamond, has produced a plan that would not privatize Social Security, it would

make Social Security solvent beyond 75 years, but with no gimmicks.

I do not favor Mr. Orszag’s plan, but I want to thank him and

Mr. Diamond for constructing their plan and putting it into the debate.

7

In contrast, Mr. Ferrara’s privatization plan sets back the debate. His plan includes enormous, but unspecified, spending cuts in

the Federal budget, as well as other gimmicks. Without these

spending cuts and gimmicks, his plan would raise Federal debt

held by the public to $26 trillion at the end of 75 years.

Mr. Tanner’s privatization plan is also extremely problematic. It

includes full price-indexing for workers who choose not to have a

private account, which would lead to benefit cuts of about 50 percent for an average earner retiring in 2075.

These privatization schemes, like the President’s plan, would undermine that ‘‘measure of protection to the average citizen’’ that

President Roosevelt signed into law nearly 70 years ago.

Mr. Chairman, to address Social Security’s long-term financing,

we need to reject this drastic privatization change. The carve-out

takes money away from Social Security. It does not add to Social

Security, but takes it away.

First, the President needs to leave privatization behind. He

needs to stop digging that hole. Then, and only then, can we move

on to strengthen that critical measure of protection that is Social

Security.

The CHAIRMAN. Thank you, Senator Baucus.

As is our practice in this committee when we have Republican

or Democratic leaders of the Senate on the committee, we give

them an opportunity to speak when they can be here.

So, I would call on Senator Frist at this time, and then we will

go to the panel.

Senator Frist?

OPENING STATEMENT OF HON. BILL FRIST,

A U.S. SENATOR FROM TENNESSEE

Senator FRIST. Thank you, Mr. Chairman. I will be very, very

brief.

I want to congratulate you and Senator Baucus for holding the

hearing today. At the end of the week, the President’s 60 days and

60 stops to discuss Social Security with the American public will

come to an end.

I believe the President has made the case that we need to modernize Social Security and that we do need to do it now. I believe

it is our responsibility. This important hearing today begins the

second phase of this dialogue with the American public. We all

know that we have a problem; now let us discuss the solutions.

This is the start of the legislative process to reform Social Security, and once again I thank the Chairman and the Ranking Member for beginning that process today. I thank all the witnesses for

their contribution to this debate.

I am convinced that, within the spectrum of proposals discussed

today, lie the seeds for a solution that the full Senate can consider

and which will preserve retirement security for future generations

to come.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator Frist.

Now, to our panel. Mr. Peter Ferrara, senior fellow, Institute for

Policy Innovation, director of the Social Security Project, Free Enterprise Fund, Washington, DC; Mr. Michael Tanner, director,

8

Project on Social Security Choice, Cato Institute, Washington, DC;

Mr. Robert C. Pozen, chairman, MFS Investment Management,

Boston, MA; Mr. Peter R. Orszag, Joseph A. Pechman Senior Fellow, Economic Studies, The Brookings Institution here in DC; and

Ms. Joan Entmacher, vice president for Family Economic Security,

National Women’s Law Center, Washington, DC.

We will go in the order in which you are seated there. So, starting with you, Mr. Ferrara.

STATEMENT OF PETER FERRARA, SENIOR FELLOW, INSTITUTE FOR POLICY INNOVATION, DIRECTOR OF THE SOCIAL

SECURITY PROJECT, FREE ENTERPRISE FUND, WASHINGTON, DC

Mr. FERRARA. Thank you, Mr. Chairman.

My goal is to make Social Security reform a major net gain for

workers, not a loss. Personal accounts give us the opportunity to

do that. In fact, if we do personal account reform right, we can

achieve all the major social goals of Social Security better than the

current system does today.

In fact, if you do it right, the personal accounts can be a historic,

major breakthrough in prosperity for average working people.

The bill that I think does this the best, the bill I worked on very

closely with members, was the bill introduced by Senator John

Sununu in the Senate, and Representative Paul Ryan in the House.

The major provisions of that bill are as follows. We try to make

the bill, first of all, progressive. We try to make the option progressive. So, out of the 12.4-percent Social Security payroll tax, we

allow workers to take 10 percentage points on the first $10,000 of

wages they earn each year, and 5 percentage points on everything

above that. So, it works out to an average of 6.4, or about the employee’s share.

Now, the reason we do that is because, under the current Social

Security system, low-income workers get a higher rate of return

than higher-income workers. So, if you just say, all right, you can

just take a flat 6 percent, for example, well, then the high-income

workers who have low returns on their Social Security, the market

returns are flat, so high-income workers—say, if you just take a

flat 6 percent—would gain an enormous amount and low-income

workers would gain little, if anything, because Social Security returns are higher for low-income workers.

So when you go to the market returns, if you do not have a progressive feature in it, you just have a flat option, then the highincome workers would gain enormously and the low-income workers would gain very little.

Under our plan that we developed for this legislation, we developed that progressive option. All workers gain roughly the same

amount. The high-income workers do gain, but low-income workers

gain at least as much in percentage terms as high-income workers.

So, we try to make this mirror the progressivity of Social Security

so all workers would gain an equal amount.

Now, when you exercise the personal accounts, benefits payable

from the tax-free accounts, it would substitute for a portion of Social Security benefits based on the degree to which workers exerVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 26642.000 SFIN1 PsN: SFIN1
9

cised the account option over their careers. This is how the system

achieves solvency.

If you exercise the option, you substitute your account benefits

for part of your retirement benefit. But this is not the Bush plan

formula. We designed the formula in this plan explicitly so workers

would gain a lot.

The whole idea behind this is, if personal accounts do achieve

what we say they can achieve, this can be designed so workers

would gain. So, the formula is designed so workers gain a lot.

Workers choose investments by picking a fund managed by a

major private investment firm from a list officially approved for

this purpose and regulated for safety and soundness, just like the

Federal Employee Thrift System.

The accounts are backed up by a safety net, guaranteeing that

workers would receive at least as much as Social Security promises

under current law. This is unique to this bill. This maintains the

social safety net of the current system. Any good plan should do

that.

We guarantee that, if you stay in the current system, you get the

promised benefits. If you choose the personal accounts, you have a

safety net that guarantees you at least will get the promised benefits under current law.

Why does that work? Well, first of all, we think that accounts are

so attractive, no one will stay in the old system. The returns that

workers can get in these personal accounts are so much higher, the

market returns are so much higher than what Social Security

promises, that we think it is very unlikely that, over a lifetime of

savings and investment, you could ever have returns that fall as

low as what Social Security promises.

So, you see the key here. This is why this is not a privatization

plan. This maintains the social safety net of the current system

and maintains the social framework for investing. It makes it easy

for unsophisticated investors to participate.

You see this safety net guarantee is really very critical because

it maintains the defined benefits of the current system within the

new structure of personal accounts. If you do not do better with the

defined contribution benefit of the personal account, you still have

all the defined benefits of the current system.

But we are so sure that workers are going to do better, much,

much better, that we think, why not, if you truly believe that, as

many personal accounts advocates say, then why not just guarantee the current benefits, which is what the system does.

The chief actuary of Social Security has scored this as achieving

full and permanent solvency, and that is because it shifts so much

of the benefit obligations to the accounts, that with the 6 percent

still going into Social Security, it is in permanent surplus.

At the same time, workers are going to get even better benefits.

Also, it was because, in this plan, there is no permanent borrowing

in this plan. There is short-term borrowing, but then the system

falls in a surplus.

When it falls in a surplus, the surpluses are specifically designated, set aside to pay off all the borrowing, so there is no net

borrowing over the lifetime of the reform plan.

10

So we achieve all these goals at the end of the day with the full

benefits of market returns. Workers will actually be better off. That

is what we should try to achieve with this reform.

The CHAIRMAN. Thank you, Mr. Ferrara.

[The prepared statement of Mr. Ferrara appears in the appendix.]

The CHAIRMAN. Now, Mr. Tanner?

STATEMENT OF MICHAEL TANNER, DIRECTOR, PROJECT ON

SOCIAL SECURITY CHOICE, CATO INSTITUTE, WASHINGTON,

DC

Mr. TANNER. Thank you, Mr. Chairman and members of the committee. I very much appreciate the opportunity to appear before

you today. I congratulate the committee on holding this hearing,

not the least because I hope it is an indication that we have moved

beyond the sort of sterile and unproductive debate about whether

or not Social Security is facing a crisis or just a big problem.

Because, as frightening as Social Security’s financial problems

are—and they truly are frightening—the program begins running

a deficit in just 12 years. Overall, it is facing unfunded obligations

of something like $12.8 trillion.

I believe that Social Security reform must be about more than

just achieving technical solvency. Now, that is not to downplay the

importance of solvency. Any responsible Social Security reform will

restore the program to sustainable solvency.

But, while necessary, solvency is not sufficient. We should seize

this opportunity to build a better program and one that is based

on fundamental American values like ownership, inheritability,

and choice.

The fact is, under the current Social Security system, you have

no legal, contractual, or property rights to your benefits. What you

get from Social Security at retirement is entirely up to 535 members of Congress.

But personal retirement accounts would give workers ownership

and control over their retirement funds. The money in their accounts would belong to the workers, money that the politicians,

with all due respect, could never take away. In short, workers

would own their retirement.

And because you do not own your Social Security benefits, they

are not inheritable. Millions of workers who die prematurely are

not able to pass anything on to their loved ones. But personal retirement accounts would enable workers to build a nest egg of real

inheritable wealth.

Finally, I believe that choice is part of the essence of America.

Yet, when it comes to retirement, we are forced into a one-size-fitsall cookie-cutter retirement program, a system that cannot pay the

benefits of this promise and under which we have no right to the

money we paid in.

With personal retirement accounts, workers who want to remain

in traditional Social Security would be free to do so. Those who do

not believe that private accounts can provide better returns or better benefits could stay in the current Social Security system, but

those workers who want a choice to save and invest for their retirement would have that option.

11

With this goal in mind, not just to restore Social Security to solvency, but to do that while building a better retirement program

that gives workers ownership and control over their money, scholars at the Cato Institute have developed a comprehensive proposal

for creating privately invested, personally owned accounts as part

of an overall Social Security reform.

This proposal is the basis for legislation, H.R. 530, that has been

introduced by Representative Sam Johnson of Texas, Representative Jeff Flake of Arizona, and at this point, I believe, about 10 cosponsors in the House.

Under this proposal, workers under the age of 55 would have the

option of diverting their half of the Social Security payroll tax, 6.2

percent of wages, to an individual account.

The employer’s portion of the payroll tax would continue to be

paid into the Social Security system to provide survivor’s and disability benefits, which would remain unchanged from the existing

system, as well as to partially fund continued benefits for those already retired or nearing retirement.

Workers choosing the individual account option would forego any

future accrual of retirement benefits under Social Security, the retirement portion only. However, those workers would have already

paid into the existing Social Security system and their already accrued benefits would be recognized in the form of a recognition

bond which they would receive which would be their property and

which would jump-start their individual account.

Workers who do not choose individual accounts would be free to

remain in the current Social Security system. However, these workers’ benefits would be adjusted for prices, rather than as currently

adjusted for wages.

This is not a benefit cut. No worker in the future would receive

lower benefits on an inflation-adjusted basis than workers retiring

today.

In fact, we know that the promised level of benefits in the future

simply cannot be paid, so to compare any reformed Social Security

plan to the promised benefits under Social Security is to compare

reality to a fantasy. Those benefits cannot be paid. In fact, if Congress does nothing, those benefits, by law, will be reduced by some

26 percent.

This plan calls for establishing a new minimum benefit under Social Security equal to 100 percent of the poverty level, which is

higher than the current minimum benefit under Social Security

today and which would ensure that no senior ever ends up in poverty.

This plan has been scored by the Social Security Administration’s

Office of the Actuary as obtaining solvency, and I have included not

only the actuarial memo, but also an analysis that we have released today on that scoring.

Summarizing it, however, it shows that our proposal, as embodied by the Johnson-Flake legislation, can provide large individual accounts, restore Social Security to permanent, sustainable

solvency, and do so in a fiscally responsible manner.

We acknowledge that there are up-front costs to doing this, and

we can discuss those in more detail. However, those costs not only

12

are less than for other large account plans, but they are more than

offset eventually by the savings to the system.

If our goal in creating Social Security reform is not just solvency,

but to give workers something that is really theirs, to allow ownership, control, inheritability, and choice, then I would suggest that

that must be a crucial part of any Social Security reform.

Thank you very much.

The CHAIRMAN. Thank you very much.

[The prepared statement of Mr. Tanner appears in the appendix.]

The CHAIRMAN. Now, Mr. Pozen?

STATEMENT OF ROBERT C. POZEN, CHAIRMAN,

MFS INVESTMENT MANAGEMENT, BOSTON, MA

Mr. POZEN. Thank you, Mr. Chairman, for inviting me, and

thank you for holding this hearing. I believe that this hearing can

be the beginning of a refocusing of the Social Security debate on

solvency, which must be the main agenda.

So far, we have been talking a lot about the desserts, the personal accounts, and we have not been wanting to talk much about

the spinach, the solvency, and I think it is great that we are going

to get to the spinach.

Progressive indexing, in my view, is an approach to solvency,

first and foremost, and I would like to explain that. Second of all,

I would like to talk about some of the issues that Senator Baucus

raised, some criticisms which I think could be dealt with.

Then, third of all, and probably most importantly, I’ll explain

how progressive indexing could be combined with a number of different approaches. It is not necessarily locked into a carve-out personal account.

So, first, progressive indexing is pretty simple. We divide the world into low-wage workers, defined as $25,000 per year or lower

in average career earnings, high-wage defined as $113,000 per year

and higher, and middle-wage, in between $25,000 and $113,000 per

year.

We preserve the current benefits and the future benefits for all

low-wage workers, all workers who are in retirement, and all workers who have not yet retired but will retire before 2012.

For the high-wage workers, we grow their benefits by price-indexing rather than wage-indexing their initial benefits, and then

we have a proportional formula for the middle-wage worker in between.

What is the justification for this differential indexing? We are

trying to protect low-wage workers because they need Social Security, as Senator Baucus said. For many of them, that is the only

retirement income that they have. Most importantly, they do not

have IRAs and 401(k)s, which obviously were not contemplated at

the time Social Security was enacted.

IRAs and 401(k)s are held primarily by high-wage and middlewage workers. These are tax-subsidized. In 2004, the tax subsidy

for those accounts was roughly $55 billion.

So if we look at overall government support for retirement programs, we need to treat low-wage workers a little better in Social

Security because they are more dependent on it and they do not

have these other retirement programs.

13

From a solvency point of view, progressive indexing has been

scored a variety of different ways. But I think it is fair to say that,

roughly, progressive indexing alone cures about 70 percent of the

long-term deficit of Social Security. It brings that deficit down from

a present value of about $3.8 trillion to $1.1 trillion, and most importantly, at the end of the 75-year period, it is financially self-sustaining.

Now, second of all, let me deal with the criticisms of progressive

indexing. I think some of them are well thought out, but can be

dealt with.

First is the criticism that if you continue progressive indexing to

the next century, you would ultimately get to a flat benefit. I think

that is correct. However, I never contemplated going that long; I

stopped progressive indexing at 2079, the end of the period for

measuring system solvency. At that point, there is a 20-percent difference in the benefits between high- and low-wage workers.

But if you think that is not enough differential, you could stop

progressive indexing at 2055, you can stop it at 2061, so you can

calibrate it to maintain more of a difference between low-wage and

high-wage workers. Progressive indexing already has a difference,

but you can increase that difference.

A second criticism has been made about the relationship between

wage and price growth over 75-year periods. If wage growth grows

faster than anticipated by the Social Security actuaries, then we

probably would not have to do as much in terms of price-indexing.

Again, that is probably true. If we could exactly figure out what

wage growth was going to be over the next 75 years, it would be

a lot easier. But we could, through legislative draftsmanship, say

something like wage-indexing minus 1 percent a year for the highwage workers. Thus, if wages went up a lot faster than prices, you

would not have to have as much benefit slowdown for the highwage workers because you would not need it.

The third criticism, and this I think is probably the most important one, is that progressive indexing allegedly involves ‘‘benefit

cuts.’’ I would agree with Michael Tanner in saying we can only

have a benefit cut if someone is entitled to something which we can

afford to pay. The future generations are not legally entitled to the

schedule of Social Security benefits in the future, and we cannot

afford to pay for this schedule.

I give as an example a median-wage worker who would get

$14,400 in annual benefits if he or she retired today at 65. In 2055,

under progressive indexing, in constant dollars, that worker would

get $17,400.

So in terms of purchasing power, the purchasing power of the Social Security benefits of the median worker would go up. Yes, that

median worker would get less than scheduled benefits, but the reality is, we do not have enough money to pay the scheduled benefits.

Finally, I want to discuss progressive indexing in combination

with other approaches. If you do not want to have as much benefit

slow-down (which is a more accurate term than benefit cut) as you

have in progressive indexing, then you are going to have to take

other measures like raising payroll taxes if you want to reach solvency. Peter Orszag has a very honest proposal, and he has exVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 26642.000 SFIN1 PsN: SFIN1
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plained what increases in payroll taxes would be needed to reach

solvency. The question is, are we prepared to increase payroll

taxes?

I am personally against the proposals that raise the base from

$90,000 to $150,000 and apply to all those earnings a 12.4-percent

tax rate. That is a tremendous hit on those people, and I think it

is unfair because somebody making $800,000 would not bear the

brunt of raising the base.

I think if we have an increase in payroll taxes, it ought to look

more like the Medicare model of 2.9 percent on all earnings above

the $90,000 base, and all the way up.

But then Congress and this committee will have to come to grips

with what Social Security benefits would be associated with that

payroll tax increase, because those people will want benefits.

One idea that I have discussed with some Senators is: if we had

a payroll tax increase of 2.9 percent above the $90,000 base, we

could create a personal account out of that 2.9 percent, say 2 percent, while the rest would go towards solvency. That would be a

way in which you would avoid taking any existing monies out of

the system; you would be taking out only new monies.

I included in my testimony how progressive indexing could work

with the President’s type of carve-out account. Yet there are some

people who complain about the borrowing involved with carve-out

accounts.

It is true: if all you do is create a carve-out personal account, you

will increase government borrowing. But I think that the numbers—illustrated by a graph, Appendix B in my testimony—show

that if you adopted progressive indexing along with a 2-percent

carve-out account, you actually reduce long-term borrowing by

about $2 trillion over the 75-year period.

My last point is that Peter Orszag has suggested a number of

very good proposals for add-on accounts. This can be another approach to Social Security reform. If you adopt progressive indexing

to address the solvency issue, then you could take some of the savings from this approach and put them into add-on accounts.

But again, if all we do is create or enlarge add-on accounts, if all

we do is create a new ‘‘kitty’’ account or create a new type of IRA,

these will just cost money; they will not help the solvency of the

Social Security system.

The key here is to address solvency, first and foremost. I think

progressive indexing is a fair and reasonable way to do that. While

there are criticisms, they can be dealt with by legislative drafting.

After we address solvency, then we can figure out what should be

the sweeteners, what the package should look like—that is where

you would get to personal accounts.

Thank you very much.

The CHAIRMAN. He got more time than the rest of you, if any of

you have a minute or two and you want to add on something if we

get done here.

[The prepared statement of Mr. Pozen appears in the appendix.]

The CHAIRMAN. Mr. Orszag?

15

STATEMENT OF PETER R. ORSZAG, JOSEPH A. PECHMAN SENIOR FELLOW, ECONOMIC STUDIES, THE BROOKINGS INSTITUTION, WASHINGTON, DC

Mr. ORSZAG. Thank you very much, Mr. Chairman.

Financial planners suggest that people need about 70 percent of

what they had been living on before retirement in order to enjoy

a reasonable retirement after they leave the labor force. For average workers, Social Security provides about 35 percent of previous

wages, which means you need about another 35 percent on top of

Social Security.

It is very important to think in terms of tiers: a core tier provided by the Social Security system which provides benefits that

are protected against inflation, against financial market collapses,

and that last as long as you are alive; and then a secondary tier—

which, by the way, is where accounts belong, and we already have

them—401(k)s and IRAs.

My first point is, I think we can make 401(k)s and IRAs work

a lot better. This is something that both sides of the Social Security

debate should agree on. We should come together immediately to

take the common-sense steps that would make our 401(k) and IRA

accounts work a lot better.

For example, evidence shows that if you are in a 401(k), unless

you opt out, as opposed to having to affirmatively sign up for the

plan, participation rates skyrocket, even among very low earners.

For new employees with under $20,000 in earnings, you go from

under 15-percent participation rates to 80 percent.

The same thing with regard to tax refunds. Tax refunds amount to more than $200 billion a year. We currently make it very difficult to get part of a tax refund into an IRA.

That should be the easiest thing in the world. You should be able

to check a box on your tax return and have part of your tax refund

going into an IRA. There is a lot that we can be doing. This committee can come together and get those reforms done and substantially bolster retirement security for millions and millions of Americans.

Now, although we can do a lot to bolster accounts on top of Social

Security, introducing accounts within Social Security does not

make any sense. First, it does not help to restore solvency, and if

anything, as Senator Baucus has already pointed out, would likely

harm solvency.

The way that these plans work is that you get a dollar into your

account today, but then have to pay back the dollar, plus interest,

at retirement through reduction in your Social Security benefit.

That is effectively like a loan from the Federal Government to a

worker.

In fact, in the Wall Street Journal this morning, Arthur Leavitt,

the former SEC chairman, wrote, ‘‘Every dollar you take out of traditional Social Security and put into a PSA must be paid back out

of your Social Security benefit, plus interest.

‘‘If this sounds a lot like margin investing, it should not be a surprise, since the PSA plan is modeled on that concept. . . . To come

out ahead then, an investor would have to earn a rate of return

that exceeds the interest on the loan, plus expenses.’’ The interest

rate on the loan would be 3 percent, real.

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Professor Robert Shiller at Yale, one of the Nation’s leading financial economists, suggests that under his central projections, 70

percent of the time you would wind up worse off as a result of participating in these accounts.

Again, I want to emphasize, at best, they are actuarially neutral.

Even if they were actuarially neutral over the very, very long term,

furthermore, they create a huge cash flow problem, because the

money goes out to a worker today and would not be repaid, for

young workers, for 30, 40, or 50 years. Meanwhile, the government

is out the cash. That is what creates this massive increase in debt

that is associated with these plans.

Now, you could assume that cash-flow problem away, which

many proponents want to do, but it is still there. Furthermore, the

account proposal does not make any sense even apart from that

cash-flow problem. If it were combined with progressive price-indexing, it would take the core tier of retirement income for an average earner from about 35 percent of previous wages down to below

15 percent of previous wages, and that is a bottom-layer foundation

of retirement security that is just too small, in my view, to make

any sense.

Now, some people have said that the accounts are a sweetener,

they help the pain of restoring solvency go down. But I do not actually think that this argument is correct.

Goldman Sachs recently wrote that, ‘‘In essence, the 3 percent

real rate offset on the accounts represents a loan from the Federal

Government to the account holder to fund the personal account.

This is not an attractive proposition.’’

From what I can tell, the American public agrees with Goldman

Sachs. A sweetener only works if it actually helps to make the

medicine go down. The accounts are not sugar. They are like trying

to convince your kid to eat the spinach by offering a turnip for dessert. It is not proving to be the sweetener that everyone is suggesting that it would be.

A final point. Since accounts do not help to restore solvency, and

if anything, make it worse, there are truly only two options: benefit

reductions and revenue increases. Every single plan that fails to

dedicate any additional revenue to Social Security necessarily

means larger benefit reductions.

In that context, I want to bring up an issue that is under consideration by the Senate now, which is the estate tax. If we reformed

the estate tax and froze it at its 2009 thresholds, in which $7 million per couple would be tax-free, took that revenue and dedicated

it to Social Security, you would eliminate one-quarter of the longterm problem facing Social Security.

You would obviate the need for $1 trillion in benefit reductions

that would otherwise be necessary. For an average 20-year-old

worker today, that is $1,500 a year in benefit reductions that would

no longer be necessary.

So the choice is very simple. Do you want to take that $1 trillion

and increase the after-tax inheritances received by very wealthy

children, or do you want to attenuate the need for benefit reductions or payroll tax increases within Social Security? Every dollar

of estate tax revenue that is not dedicated to restoring Social SecuVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 26642.000 SFIN1 PsN: SFIN1
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rity to solvency is a dollar more of benefit reductions or payroll tax

increases that are necessary.

Mr. Chairman, I see that my time is up. My written testimony

also goes through some of the shortcomings in progressive price-indexing, and I would be happy to answer questions about that.

Thank you very much.

The CHAIRMAN. Thank you.

[The prepared statement of Mr. Orszag appears in the appendix.]

The CHAIRMAN. Now, Ms. Entmacher?

STATEMENT OF JOAN ENTMACHER, VICE PRESIDENT FOR

FAMILY ECONOMIC SECURITY, NATIONAL WOMEN’S LAW

CENTER, WASHINGTON, DC

Ms. ENTMACHER. Thank you, Chairman Grassley, Senator Baucus, and members of the committee. Thank you for this opportunity

to testify on behalf of the National Women’s Law Center.

Social Security is not just for retired workers. It is a safety net

for families at all stages of their lives. Half of all Americans who

receive Social Security get benefits as disabled workers, children,

spouses, and surviving spouses.

This committee is considering proposals to achieve solvency by

cutting Social Security benefits, and to create private accounts

within Social Security by cutting Social Security some more, and

adding trillions of dollars to the national debt to do it.

Such proposals would hurt the economic security of workers

when they retire, and all Americans who would be burdened by

that debt. But those issues have received some attention, and Peter

Orszag mentioned some of them.

My testimony will focus on the impact of such proposals on the

other half of Social Security beneficiaries, who too often are overlooked in these discussions and are, overwhelmingly, women and

children.

Concerning solvency, you can achieve sustainable solvency simply by cutting benefits deeply enough, but that defeats the whole

purpose of Social Security. It does not fix a problem, it makes it

worse for the millions of Americans who rely on Social Security.

Yet, that is essentially the approach reflected in both the priceindexing and progressive price-indexing proposals. Both would cut

benefits deeper and deeper over time, both for those who choose a

private account and those who do not, for average earners, and

also—and this is a point that Mr. Pozen did not highlight in his

testimony—for disabled workers, children, spouses, and surviving

spouses. That is how his plan reduces the shortfall by 70 percent.

You may hear assurances that benefits for disabled workers and

survivors will be protected under some plan, but you need to look

carefully at the details of how that is to be done.

It takes money to provide that protection. Where is it coming

from? Are someone else’s benefits going to be cut more deeply? Social Security uses the same formula to determine all benefits, so

cutting some benefits but not others raises new issues of adequacy

and equity.

What would happen to spouses and surviving spouses, if Social

Security is shifted to a system of private accounts, is a question of

critical importance to women, yet the administration has said nothVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 26642.000 SFIN1 PsN: SFIN1
18

ing about how its plan for private accounts would affect these critical benefits.

Under the President’s private accounts proposals, workers who

shift payroll taxes from Social Security into a private account must

pay the money back with interest out of their Social Security benefits, on top of any other benefit cut to achieve solvency.

The concept is that the worker will get the account in exchange,

but Social Security benefits for spouses and widows are based on

the worker’s benefit. So when his retirement benefits are cut because he chose a private account, benefits for spouses and widows

could be cut as well.

But under the administration’s plan, it does not appear that a

spouse or widow would necessarily be guaranteed anything from

his account, although she is likely to get stuck paying off the debt

incurred to create it.

The President has said that under his plan workers could be required to purchase an annuity to make sure that they do not spend

their accounts too quickly and end up poor, but the President has

not said that his plan would require a married worker to purchase

an annuity with joint and survivor protection for the surviving

spouse. There may be a reason for the administration’s silence on

that issue.

Social Security can provide spousal benefits in addition to the

worker’s benefit, but private accounts represent a fixed pool of assets. Buying an annuity with joint and survivor protections rather

than a single life annuity would mean lower payments for the account holder, especially if the spouse is a few years younger.

And remember, these annuities would not be on top of Social Security, but a replacement for it, so there simply might not be

enough in the account—very likely would absolutely not be enough

in the account—to provide adequately for one worker, much less for

a worker, a spouse, and any surviving children.

My written testimony also talks about the impact on benefits for

young widowed mothers and spouses caring for children of disabled

or retired workers. These benefits are especially important to African American and Latina women and their children.

Their Social Security would be cut under many proposals, but the

small account of a worker who died or was disabled at a young age

would provide little assistance to such a woman, even if, as a

widow, she inherited the account, which she might not because the

President has said repeatedly that accounts could be left to anyone

that the worker chose.

It would be small even if she could access the assets in the account, which she might not be able to, because the President has

said accounts would have to be saved for retirement.

My written testimony raises other issues and also lays out some

alternative ways that Social Security could truly be strengthened.

I urge the committee not to weaken this program that is so vital

to American families.

Thank you.

[The prepared statement of Ms. Entmacher appears in the appendix.]

The CHAIRMAN. I would like to have the attention of the committee for a minute, particularly on the Republican side. Senator

19

Baucus and I have been informed, just as soon as the vote is over,

that he and I are expected to attend a meeting that the leadership

has called on the highway bill.

Because I do not want to adjourn the meeting and put our witnesses out of their valuable time, would somebody on the Republican side vote at 11:45, then come back and chair this while Senator Baucus and I are at our meeting? I would like to have somebody volunteer to do that.

We will have our first round of questions now. I will not name

everybody, but this is the order for the first few: Baucus, Hatch,

Conrad, Lott, Bingaman, Kyl, Kerry. There will be 5-minute

rounds, and they will apply to the Chairman as well.

I am going to start with Mr. Pozen. In your testimony, you

state—and everybody remembers your saying this—that solvency is

the spinach that needs to be eaten before we get to the dessert of

personal accounts.

I would like to have you further explain why you came to that

conclusion.

Mr. POZEN. I think that personal accounts are ways to supplement people’s retirement income. If you think of an add-on account,

that is a way to supplement Social Security in retirement. If you

think of a carve-out account, that is a way you are likely to get a

better return on a portion of your payroll taxes than you would get

under Social Security.

I have run 35-year numbers for a balanced account, a 60/40 account, which show actual returns between 1949 and 2004. If you

look at 35 years, the actual nominal returns were 7.43 percent to

10.48 percent. If you subtract 3 percent for inflation, they were in

the 4.5 to 6 percent range for real returns.

So in my view, you have a pretty good chance—not guaranteed—

of getting more than 3 percent real through a balanced account

over 35 years. So, these are all ways to use personal accounts to

supplement retirement income. But I think that you must deal first

with the benefit issue: we are growing benefits very quickly

through wage-indexing, and we just cannot possibly afford it. We

have to come to grips with the growth of benefits, and that has to

be our first agenda.

I have proposed progressive indexing. Other people have suggested different approaches. There is no easy solution here. But

these are not benefit cuts; these are slowdowns in the growth of

benefits.

People’s benefits will be growing in terms of real purchasing

power. I think we have to come to grips with that. We have to decide whether there is going to be new revenue that is going to be

combined with benefit reforms, and then we can figure out what

sort of personal accounts would be complementary to these

changes. If you do not figure out solvency first, you cannot even

have a good, intelligent discussion about what should be the personal accounts.

The CHAIRMAN. Again to you, Mr. Pozen. You raised a very interesting point on page 4 of your testimony about those who criticize

progressive indexing on the one hand, while advocating an increase

in taxable wage base on the other hand.

20

As you point out, the net effect is essentially the same. However,

in your opinion, if people were given a choice between paying higher taxes or receiving lower benefits, which do you think they would

choose?

Mr. POZEN. I think the high-wage worker would rather have

slower growth in benefits than face a tax increase. Some people

criticize progressive indexing by saying that the higher-wage worker will not get enough benefits, but those are many of the same

people who suggest that we should have higher payroll taxes. I

think that position is a bit inconsistent.

The CHAIRMAN. Ms. Entmacher, on the first page of your testimony you state that restoring Social Security solvency by reducing

promised benefits is like curing a stubbed toe by cutting off the

foot.

But on page 10, you state that the Social Security financing

shortfall is not a crisis because it can pay 70, 80 percent of promised benefits after the trust fund is depleted, or let us say, until

the cash flow is equal to benefits, it would be 70 or 80 percent.

I would like you to explain why a gradual reduction in promised

benefits for newly eligible beneficiaries is equivalent to an amputation, but a sudden 20 to 30 percent across-the-board reduction for

everybody is not a crisis.

Ms. ENTMACHER. Because, as Mr. Orszag explained, the purpose

of Social Security is to guarantee people a basic part of their preretirement income when they reach retirement age.

Right now, Social Security replaces about 40 percent of their preretirement income for the average earner. What progressive priceindexing, if you want to call it that, or price-indexing does is to

shrink that so that workers in the future would have a lower and

lower standard of living.

They could count on Social Security not for 35 or 40 percent of

their pre-retirement income, but for 20, or 15, or 10 percent. Their

standards of living would drop. Remember, at the same time as

their wages went up, they would be paying higher and higher

taxes. They would be getting less.

So, these benefit cuts that are proposed under the progressive

price-indexing plan are actually deeper than the cuts that would be

required if we did nothing.

And I am not suggesting that Congress do nothing. I am just saying that, to rely on cutting benefits to restore solvency to the Social

Security program, undermines its fundamental purpose.

The CHAIRMAN. That brings up a point. I appreciate the fact that

you are not suggesting doing nothing. But all I hear from members

of Congress, and from people on the outside, is no plan.

I want to talk to people about plans. I do not even care if you

do not talk to me. Those of you that are bad-mouthing every other

suggestion out there, suggest your own plans. You do not have to

talk to me. I am willing to do it, but we need to get some discussion

going. Doing nothing is not an option, because doing nothing is a

cut in benefits.

Grandpa Grassley gets Social Security, but my granddaughter,

when she retires 56 years from now, if we do nothing, is going to

get this cut that you are talking about. You can rationalize it all

21

you want to, but, by golly, she is entitled to what I got because her

dad, and younger people, are paying for it.

Senator Baucus?

Senator BAUCUS. Thank you, Mr. Chairman.

I think it is worth underlining that everyone in the Congress

wants to address the long-term financial problems facing Social Security. I mean, that is a given.

The question is how to get there. There is a kind of tone here

from some of the witnesses, at least the last three, that private accounts are a bit of a problem here.

Some called it dessert. Frankly, I do not see how it is a dessert.

It is not a dessert if it makes the problem worse. Desserts, the way

I think of the term, is something on top of a wonderful meal. You

get a little sweetener in addition. This is not a sweetener in addition.

These work in a way which make the long-term financial problem of Social Security worse. In fact, the President has even admitted that they do not help at all. The correct analysis is that this

makes it worse.

So, asking Mr. Pozen, why should we not just deal with private

accounts? Let us just start talking. You mentioned yourself, the

bigger issue is the long-term solvency. Why do you not just recommend that all of us agree to oppose carve-out accounts?

If we want to find a way to add on, Mr. Orszag suggested, I

think, some pretty creative ways, with what is done with income

tax refunds or 401(k)s, and so forth. In fact, the real problem is insufficient retirement income. We want more retirement income, not

less.

So why do we not just work to try to find a way to address the

long-term problems facing Social Security and not pursue this

question of carve-out accounts, which make the problem worse, but

rather, if we want, pursue some add-on accounts to increase retirement income?

Mr. POZEN. As I said, I am not against add-ons, but I would not

be able to agree to rule out carve-outs in all cases. I think you can

run all the numbers one way or another, but the numbers that I

have seen show that people do have a better chance of making a

higher return through a balanced account than they do under the

2- or 3-percent return they get from Social Security. I am looking

at actual returns from balanced accounts over a 35-year period.

Senator BAUCUS. But my time is short. I have to use it as best

I can.

Mr. POZEN. Sorry.

Senator BAUCUS. No problem. I have a chart here. It is maybe

hard to see. These are just estimates, in nominal terms, of the

rates of return on stocks. That is what they think, different organizations. CBO suggests it is going to be 6 percent, or 3 percent, real.

That is what CBO thinks out into the future.

Over here, a Wall Street economist. This is an article in the February Wall Street Journal. They predict that it will be 7.6 percent.

SSA actuaries say, in nominal terms, 9.5 percent of wealth in

stocks over the longer term.

This is an honest calculation. I do not in any way want to fudge

anything here, because that does not help anybody.

22

Mr. POZEN. You are looking at predictions. I am looking at what

actually happened in the last 35 years.

Senator BAUCUS. Well, I know. But most people think the stock

market is going to—you talk about bubbles, and this and that in

the past.

Mr. POZEN. I am talking about 35 years.

Senator BAUCUS. I am talking about what people, experts, predict the future to be. We have to look at the future here. We are

not going back to undo Social Security.

Mr. POZEN. I understand that.

Senator BAUCUS. We are looking at the future.

Mr. POZEN. I happen to be a person who has been very involved

with investments and——

Senator BAUCUS. I appreciate that. These people, too, are very involved in this.

Mr. POZEN. I agree. There are a lot of differences of opinion on

this question.

Senator BAUCUS. Those are pretty objective outfits right there. I

have asked the Center on Budget to calculate what rate of return

is necessary, under the President’s plan, to break even? In nominal

terms, they come out with 10.9 percent to break even in the future.

That is what they think.

And under your plan, as I understand it, because the number is

not 10.9 percent, it is actually a higher number to break even, because your privatization component is fewer percentage points, but

with a greater limit, it means that more would have to be put in

or the rate would have to be higher to offset the smaller amounts

in the President’s plan.

Mr. POZEN. By breaking even, you mean in this case that the private account would make up for the total slower growth in traditional benefits? That is not my attempt in my plan. My attempt is

to have the account generate more in returns than they would receive from Social Security.

Senator BAUCUS. Right. I understand.

Mr. POZEN. Using the Social Security actuary’s numbers, the account definitely winds up with a positive return. It earns back

some of the slower growth of benefits, but it does not earn back all

of them.

Senator BAUCUS. Let me just explain what these numbers represent. I am assuming a portfolio mix in the private account of 50/

30/20, as 50 percent stocks, 30 percent corporate bonds, and 20 percent treasuries.

Mr. POZEN. That is about what I used. Correct.

Senator BAUCUS. The calculation comes out to this for the future.

Mr. POZEN. The calculation comes out on those numbers to about

4.8 percent real annual return under the Social Security actuary’s

numbers.

Senator BAUCUS. Well, all I am saying is, there are a lot of people who have different estimates. A lot of people have different estimates.

Mr. POZEN. All right. But I am using the Social Security actuary’s estimates. If we use those estimates, they are projecting a 4.8-

percent real annual return.

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Senator BAUCUS. Mr. Orszag, could you comment on this discussion, please?

Mr. ORSZAG. Sure.

Mr. POZEN. And that does not make up the whole difference in

slower growth of benefits.

Senator BAUCUS. Maybe you can clear up something, Mr. Orszag,

here.

Mr. ORSZAG. Well, there are two points here. One, regardless of

whether you believe Mr. Pozen’s numbers or the 10 financial experts who were quoted in the Wall Street Journal showing much

lower stock returns, the key thing is, does it really make sense to

borrow against your future Social Security benefits to invest in the

stock market, when there is so much disagreement over what that

rate of return will be?

I think the answer there, clearly, is no. We should be bolstering

investments in stocks and retirement security on top of a solid

base, not by borrowing against it.

Senator BAUCUS. And you are also saying that these plans require a lot of borrowing.

Mr. ORSZAG. Trillions of dollars in debt.

Senator BAUCUS. Trillions of dollars, in addition.

Mr. ORSZAG. That is correct.

Senator BAUCUS. I might make one point clear, too, Mr. Orszag.

I have heard people say, what is wrong with a $2-trillion down payment for an $11- or $12-trillion unfunded liability?

Is it not true that that $2 trillion is an add-on, it is in addition

to the $11 trillion, and that over time the $2 trillion would get paid

back, but that leaves untouched the 75-year, the 100-year, or the

long-term unfunded liability of Social Security?

Mr. ORSZAG. That is absolutely right. This is a complete baitand-switch. People talk about the cost of the accounts and then

talk about the actuarial deficit in Social Security. The accounts do

nothing to reduce the long-term insolvency of Social Security.

Arguing that they do is like arguing that snake oil will help to

cure strep throat, because if you take snake oil along with an antibiotic, your strep throat goes away. The snake oil is not doing anything to get rid of the strep throat; the accounts are not doing anything to get rid of the $11-trillion deficit.

Senator BAUCUS. Thank you, Mr. Chairman.

The CHAIRMAN. Senator Hatch, then Senator Conrad after that.

Senator HATCH. I welcome all of you to the committee.

Mr. Pozen, is it not true that we have made promises here that

we cannot keep?

Mr. POZEN. Yes, we have definitely made a lot of promises that

we cannot possibly keep.

Senator HATCH. And if we do not do something about it, future

generations are going to suffer greatly?

Mr. POZEN. Yes. I agree with that conclusion. To avoid that suffering, you need something like progressive indexing or some variant which helps bring about solvency. The question is: can you do

that without giving people something else to complement that? I

am in favor of a number of things to complement progressive indexing.

24

In my view, personal accounts are something that a lot of people

would perceive as positive. You have to develop a package so that

the overall effect of the progressive indexing, plus carve-outs or

add-on accounts, is positive.

If you just finance add-on accounts, that would increase government borrowing, and that would also hurt the deficit. What you

want is a proposal that basically reaches solvency, and then you

take some modest measures to make the package reasonable.

Senator HATCH. To get back to Senator Baucus’s comments, it is

not really quite fair, is it, to compare all this to current law?

Mr. POZEN. I agree. If we compare what progressive indexing, or,

quite frankly, how any proposal comes out in terms of benefits

under current law, we are comparing it against a standard that we

cannot possibly meet.

Senator HATCH. And Mr. Pozen, some of the critics of progressive

indexing have indicated that it is flawed because it would eventually bring the benefits of all retirees to the same amount. Is this

true? If so, how long would it take for the lines to converge?

Mr. POZEN. If you extended progressive indexing beyond 2100, at

some point the lines would converge. But I do not think it is necessary to do that. I stopped progressive indexing in the model I

worked with in 2079, and there was still a 20 percent difference

between the high- and low-wage workers. If you do not think that

is enough of a differential, you can stop progressive indexing at

2060. You can calibrate that to whatever you feel is appropriate.

Senator HATCH. As you know, I am interested in your ideas on

progressive indexing. But could you elaborate on your comment

about possible problems in the relationship between wages and

prices, and how we may need to make an adjustment, or make adjustments, if the relationship changes over time?

Mr. POZEN. The relationship between wages and prices has been

pretty stable for the last 100 years. But again, we are projecting

in the future, so we need to hedge a little.

I think that people have pointed out that if wages go up a lot,

that will be better for Social Security, and you will not need as

much reduction. If the gap between wages and pricing were, say,

2 percent rather than 1.1 percent, you would not have to have the

high-wage workers be brought down all the way to price-indexing.

I think the way you could deal with that possibility is to peg the

initial benefits of high-wage workers to wage-indexing minus a percentage, such as 1 percent, so you could technically work that out.

If we were lucky enough to have a lot of wage productivity and to

need less benefit slow-down in Social Security, we could have a

self-correcting mechanism.

Senator HATCH. Mr. Orszag, you indicated that Americans

seemed to prefer relying on ‘‘additional revenue’’ in order to solve

the challenges facing Social Security.

Now, it appears that your assumption and the basis for your

plan, is heavy reliance on increasing taxes. Is this assumption

based on surveys? If so, do you think those who want to see higher

taxes believe they or someone else will have to pay for them?

Mr. ORSZAG. Senator, two responses. First, it does come from

public opinion surveys.

25

Senator HATCH. It is easy to see why people in the public who

believe others are going to have to pay for it might be for something like that.

Mr. ORSZAG. I do not think that it necessarily comes down to

narrow self-interest in terms of, someone else will pay the tax. I

really think it comes down to the kind of Social Security system

that people want, and what they see as fair with regard to financing.

For example, the proposals to raise the wage cap, which are apparently quite popular, I do not think come from people saying, I

am not going to pay that. I think it comes from a sense of fairness

that someone earning $9 million a year pays tax only on 1 percent

of his or her wages, where someone earning $90,000 a year pays

tax on all of her wages.

Senator HATCH. You suggest that we should consider reforming

the estate tax and dedicating the revenue to shoring up the Social

Security system. Has Social Security not always relied on the payroll tax and not general revenues? Do you not think that turning

to general revenue breaks the relationship between workers’ contributions to Social Security and the benefits that they receive?

Mr. ORSZAG. It is a good question. There is an exception in current law that income taxation of benefits, which exists under current law, is dedicated to both Social Security and Medicare, so

there is a component that is already in place.

I think the key is dedicated revenue; not unspecified general revenue transfers that may not materialize, but rather a dedicated

source of revenue. I do think that the estate tax is something that

should be looked at in terms of mitigating the required benefit reductions to restore solvency.

The CHAIRMAN. Senator Conrad?

Senator CONRAD. I thank the Chairman. I thank the witnesses.

One of the things that struck me about this debate is that nobody questions the basic assumptions. As I looked at the basic assumptions of the Social Security actuaries, I found, as they look

ahead for the next 75 years, they say the economy is only going to

grow at a rate of 1.9 percent a year for the next 75 years.

Looking back, if we look at the last 75 years, the economy grew

at 3.4 percent a year for 75 years. If we would have the same economic growth going forward that we had in the past, 90 percent

of the Social Security shortfall would evaporate. Ninety percent of

the Social Security shortfall would evaporate.

Ten years ago, the Social Security actuaries told us we had 35

years left of solvency. Now, 10 years later, they tell us, you have

35 years left of solvency. They have been wrong, and they have

been wrong because they have consistently underestimated economic growth. I believe, in all likelihood, they are wrong again.

Now, does that mean we do not have a problem? I do not think

so, because the thing that we know is going to happen is that the

baby boom generation is going to retire. That is not a projection.

They have been born. They are going to be eligible for Social Security and Medicare, and they are going to retire, and the numbers

are going to increase dramatically.

As I analyze this problem, I believe we have a serious budget

problem, a budget problem in part caused by Social Security, beVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 26642.000 SFIN1 PsN: SFIN1
26

cause those bonds that we all talk about have to be redeemed out

of current income. That is a fundamental budget problem that we

confront.

In addition, under the President’s budget proposal, he is making

it all much worse because he is taking Social Security money and

using it to pay for other things.

Senator Hatch asked the flip of this question. He asked, is it not

true, we have always used payroll taxes to support Social Security?

What he did not ask is, is it not true that under the President’s

budget plan we are using Social Security money to pay for tax cuts,

income tax cuts, and other things? That is also true. That is precisely what is being done.

Over the next 10 years, under the President’s plan, he is taking

$2.5 trillion of payroll tax money and using it to pay for income tax

cuts and for other things. He is digging the hole deeper, when he

says we have a shortfall in Social Security.

Well, it is not just there that we have a problem. We also have

a problem with his plan itself, because he has nothing in his budget for his Social Security plan.

But, over the next 10 years, we know that his plan costs $750

billion, because he is diverting money from Social Security to private accounts. So that again digs the hole deeper. That is on top

of the $2.5 trillion of payroll tax money that he is taking to use to

pay for other things. Now he says, take another $750 billion out

of payroll taxes and use it to create individual accounts.

Let me just say, I have always been somebody that thought there

was a kernel of a good idea with individual accounts, but I have

never thought it was a good idea to finance it by massive debt. Yet,

the President’s plan is precisely that. In fact, over 20 years, he

says, borrow over $4 trillion to start these private accounts. Again,

that just digs the hole deeper and deeper.

As I analyze it, what we have is a serious budget problem. We

have record budget deficits. On top of that, we have a shortfall in

Social Security, although I believe the actuaries have been overly

pessimistic with respect to the projections there.

Medicare is the real 800-pound gorilla, because the shortfall in

Medicare is nearly $30 trillion, according to the Congressional

Budget Office, compared to $4 trillion in Social Security. So, we

have a very serious budget problem that nobody seems to want to

deal with around here.

I think one of the reasons is, our friends on the other side want

more tax cuts, tax cuts that explode in cost beyond the 5-year

budget window, that dig the hole deeper and deeper, that are taking, in effect, money from Social Security in order to fund them.

If we look at the debt of the country, at a time the President told

us we would be paying down debt, instead, the debt is exploding.

This is just the publicly held debt.

For the gross debt of the United States, the picture is even

worse. So, what strikes me most of all is that we are avoiding the

real problems. It is almost a diversion here that is going on.

The real problem is a budget problem, in part caused by Social

Security, and largely caused by demographics, overwhelmingly

caused by the shortfall in Medicare and the already record budget

27

deficits we are running. But nobody wants to deal with that set of

problems, because that leads to real tough choices.

Let me just ask, I would like Mr. Orszag to answer this question.

I know you are an economist. Does this debt matter? Would adding

to the debt matter to the economic strength of the country?

Mr. ORSZAG. Absolutely. Let me, first, give you the argument to

the contrary, but then tell you why it is not the case. People look

at these loans and they say, all right, we issue another dollar of

government debt today, but we have these promises that people

will pay us back in 30, 40 or 50 years, and that will wash the additional debt out. Bob Rubin will tell you, financial markets are going

to discount that 40-, 50-, or 60-year promise down the road heavily,

in part because it relies on future Senators upholding the loan repayment.

I have very little confidence that over a 50-, 60-, 70-year period

we will actually stick to a plan that is put in place. I think it is

very important to look at how long debt remains elevated even if

you combine accounts with solvency changes, like price-indexing,

that involve deep benefit cuts.

The administration’s own analysis shows that debt does not fall

below the baseline, that is, fall below what it would have been

without the plan, for 60 years. That would be like we put in the

plan at the end of World War II, we actually stuck with it the

whole time since then, and only now would we be experiencing any

net reduction in debt.

The CHAIRMAN. Now, it is Senator Lott’s turn.

Senator LOTT. Thank you, Mr. Chairman. I want to try to put all

this in as positive language as I can this round. I will change the

tone next round. [Laughter.]

But I want to thank you, Mr. Chairman, for having this hearing

and getting us moving forward, and having some substantive discussions about the problem and potential solutions. So far, all we

have had is media analysis of what we were doing or not doing,

and political statements on both sides of the aisle, and this is a

positive step forward.

I want to thank this very thoughtful panel for coming here and

presenting your ideas in the way you have.

Let me try to state what I think we should be trying to do. I do

believe we should be trying to preserve, protect, and improve Social

Security for the future. I do not have fancy charts, but the average

man and woman out there on the street working, the farmer, the

highway worker, they understand when you say this: we are getting older as a population.

Longevity is going up dramatically from not 62.6, what I think

it was originally, but 77, or something, now, and women even a lot

longer, which I would like to think about more on a personal basis.

Why are they living so much longer than men are?

But everybody understands we are living longer. That is good.

Everybody understands that the baby boomers, people in my age

group and right behind me, they are coming, and they are big.

They are going to blow the numbers out of the water. And most

people understand when you tell them what the numbers are. We

have huge growth and unaffordable benefits that, in my opinion,

are unfair and dishonest.

28

Now, if you put it to people that way, they would say, oh, yes,

that is probably right. We need to do something. And this problem

does not begin in 2052, it begins in 2008, probably. Besides that,

I care more about 2052 than I do about 2008.

I care more about my grandchildren right now than anybody else

on this earth. I also want to put this in terms of, we come up here

with our charts, our numbers, and our political gobbledy-gook.

Every man and woman out there is saying, what are you talking

about? Well, let me explain it, because I have lived it on a personal

basis.

Number one, my dad was killed in 1969 in a car wreck. He paid

into Social Security all his working life. Not he, not my mother,

and not I, because of circumstances, ever got a nickel of it. I do not

think that is fair. My mother worked all her life, before it was cool,

as a school teacher, as a bookkeeper, as a radio announcer, worked

with senior citizen centers.

She worked until she was 75. Now she is 91. Her monthly income is one-half of what it takes for her to live. We have already

sold her house, sold her car, used all of her savings, all of her

checking, and the numbers do not add up.

Then the plot thickens. My son and my daughter think, number

one, it will not be there when they get to retirement age, and if

it is, it will not be worth having because it will be so infinitesimal,

if they do not have all kinds of other arrangements, they will not

be able to live on it anyway.

Then the worst of all, my grandchildren are going to be stuck

with the bill. They are either going to have their benefits cut or

they are going to pay a whole lot more. Now, that is wrong.

My mother, at 91, is a lot more worried about those great-grandchildren than she is about whether or not she is going to have it

a year from now. But we are going to protect her, guaranteed. I

think everybody said we cannot change the system for those who

are in it, or about to get into it. So, that is kind of the outline of

where I think we are.

And let me take some of my time, not for just statements, but

some questions.

Mr. Pozen, I think I am closer to where you are. I do think we

need to change the benefits. This huge increase over the years, we

cannot justify that. And by the way, it is not as if that was done

by Roosevelt and one of my predecessors, Senator Pat Harrison of

Mississippi, way back in the 1930s. We changed this formula in

1977.

President Clinton, Pat Moynihan, and I all had basically agreed

we should have an honest CPI, and it should be based on prices,

not on wages. This was back in the 1990s. But because we could

not get the House to go along, we did not get it done. So, we are

going to have to deal with this.

But, while I like a lot of what you propose, I am a little concerned about this progressive formula that you talk about. Would

you take just a minute to go over that again? You think we should

control explosive benefit growth, not make cuts. These are explosive growths, 40 percent.

So tell me, and so the American people understand, once again,

in as common-sense language as you can, how would that work?

29

Mr. POZEN. Taking your mother, she has a replacement ratio

now of, let us say, 40 or 50 percent, And if we move completely

from wage- to price-indexing, we are going to reduce her replacement ratio from something like 40 or 50 percent to something——

Senator LOTT. But not her, just future generations.

Mr. POZEN. The replacement ratio of a person in her situation

would decline to something like 35 or 30 percent.

Senator LOTT. Let us make that clear. I do not want her calling

me later on.

Mr. POZEN. We would definitely not reduce her benefits. We

know that.

So the question is, if somebody’s replacement ratio has to be reduced because we do not have enough money to go around in Social

Security, who in the population has other sources of retirement income?

Social Security was passed when there were no 401(k)s or IRAs.

So now, when we look at the middle- and higher-wage workers, we

can say that, if the Social Security benefits for young workers in

those wage categories declined over time from, let us say, 40 percent to 28 percent, then they could make up some of that replacement ratio from their private retirement plans.

In fact, we would encourage them, through a lot of measures that

I think most members of the committee would support, to make up

this decline through IRAs, 401(k)s, and other sources of retirement

income.

But we really do not have any reason to expect that workers at $25,000 and below in annual wages will have retirement income

from sources other than Social Security. In the financial services

industry, we have tried to incent people at those lower wage levels

to participate in 401(k)s and IRAs, but it is very difficult. If you have a family of four and you are making $25,000, the

idea that you are going to put a lot into these other retirement programs just does not seem viable.

So, therefore, in progressive indexing we preserve the scheduled

benefits for all workers at $25,000 average career earnings and

lower, and continue to let them have the same replacement ratio,

roughly 45 percent for those low-wage workers, as they do now in

the future.

But we say to middle- and high-wage workers, just looking at Social Security alone, we slow the growth of their benefits so their replacement ratios decline a little. But we are counting on them—we

are encouraging them—to make up for that decline and in fact to

increase their replacement ratios through 401(k)s and IRAs. That

is really the basic idea.

Senator LOTT. I have questions for the rest of you, and I apologize, but I will be back on the second round.

The CHAIRMAN. I would now go to Bingaman, then Kyl, then

Kerry, then Thomas. If Senator Kyl does not come back, from

Bingaman we will go to Senator Kerry.

Senator Bingaman?

Senator BINGAMAN. Thank you very much.

Let me just use one of Senator Conrad’s charts here and ask,

first, Mr. Orszag about it. If this is right, I think Social Security

trustees say the economy is going to grow at 1.8 percent, and it is

30

the CBO that says it is 1.9, so they are sort of in agreement there.

His chart says 1.9 over the next 75 years.

If that is true, should we not expect that that will reduce the

amount of return a person could expect in stocks over that period

from what we have previously obtained in stocks?

I mean, I am concerned. Mr. Pozen, you have said that over the

last 35 years you have calculated how much return was possible in

a balanced portfolio, as I understand it.

Mr. POZEN. How much return was actually achieved?

Senator BINGAMAN. Actually achieved. We could not expect that

same return going forward if we have that much less economic

growth, could we?

Mr. ORSZAG. Are you asking me?

Senator BINGAMAN. I will ask either one of you.

Mr. POZEN. I will let Peter go first.

Mr. ORSZAG. I think that is one of the reasons, again, in the Wall

Street Journal poll of financial economists and experts you saw significantly lower projected returns in the future than for the past.

Mr. POZEN. I think the Social Security actuaries have estimated,

for a balanced portfolio, a real annual return, after expenses, of

about 4.8 percent. So that is their projection for the future. That

is lower than we have seen historically.

The answer to your question, I believe, is GE now intends to get

over half its revenues from the developing world. We have a global

economy. The fact that the U.S. economy would grow at a slower

rate is only part of the picture. The real question is: how is the

global economy going to go and what will be the global returns?

Senator BINGAMAN. The idea is, we would take our Social Security and invest it elsewhere because we are not able to grow as

much as we need to.

Mr. POZEN. When we invest in GE now, we are investing half

outside the U.S., though we may not want to recognize this fact.

The same thing with IBM. Most of our large companies that are

headquartered in the United States are looking for half of their

growth in revenue from outside this country.

Mr. ORSZAG. Senator Bingaman, this is precisely why Professor

Shiller at Yale suggested that there is such a high probability of

losing. The international returns on stocks have historically—even

if you use a historical analysis—been substantially lower than in

the United States.

The United States is a huge outlier historically in terms of high

returns. Shiller and others doubt that that will continue in the future for the United States. If you go internationally and again look

backwards instead of forwards, you also wind up with lower returns.

Senator BINGAMAN. Let me ask on another issue. My understanding of these private accounts is that you would put money

into a private account, and then at some point when you retire

there is a certain amount of money in that account, and there is

a thought, to the extent we understand what the President is proposing, that some or all of that is to be annuitized to ensure that

you do not fall below poverty, or something, I gather.

Mr. ORSZAG. Correct.

31

Senator BINGAMAN. Is there not a risk if a person retires when

the market is down? I mean, if I had retired back in 2000, I would

have been in fat city because the stock market was way up. If I

had waited a year or 18 months to retire, I would have had substantially less to be putting into an annuity, as I see it.

Mr. POZEN. This is a problem we have addressed in 401(k) plans

for years. If you are worried about this problem, most people would

advise what is called a risk scale-down. That is, if you had a portfolio with 60 percent in stocks and 40 percent in bonds, as you approach retirement you reduce the equity portion so that you do not

have what is called an end-game problem.

Senator BINGAMAN. And as you reduce the equity, you have to

expect a lower return.

Mr. POZEN. Yes. But you can reduce the risk substantially that

way. Second of all, you do not have to annuitize the very day you

retire. You could give people some flexibility in the timing of

annuitization.

Senator BINGAMAN. Let me ask one other aspect of it and just

ask Mr. Orszag, all this talk about, you are going to have a nest

egg that your family inherits. I have always thought of annuities

as a commitment to pay you X number of dollars per month until

you die, and then it is over.

Mr. POZEN. To the extent we have required annuitization, there

will not be much in the way of inheritance.

Senator BINGAMAN. Yes. There is no nest egg for anybody after

you die if you bought an annuity.

Mr. Orszag?

Mr. ORSZAG. That is absolutely correct. And before retirement,

remember, if you die with a spouse, the spouse would inherit the

account, but also the debt back to Social Security. That could be

a very mixed blessing for the spouse. You had better hope you are

married to a very good investor.

If you are not married, the debt will either be extinguished,

which would mean the accounts harm solvency, they are not even

actuarially neutral, or, as Mr. Pozen has proposed, the government

will reach into the account and pull out the payment that is owed

back to Social Security, thus raising questions about the rhetoric

surrounding ‘‘it is your money, the government cannot touch it.’’

In Mr. Pozen’s proposal, the government is directly reaching into

the account and reclaiming that debt that is owed back to the Social Security system.

Mr. POZEN. In my view, you would want to have a presumptive

choice of annuities when you retire, but then you would want to

give people the chance to opt out if they did not want to annuitize.

To the extent they do annuitize, then there will not be anything

left to inherit at their death.

Mr. FERRARA. But that criticism, like all the criticisms of personal accounts that have been raised, only apply to the smaller accounts that the President’s commission talked about. None of these

criticisms apply to Ryan-Sununu.

Ms. ENTMACHER. Well, let me jump in here, because a really critical question is whether, with the purchase of that annuity, you

have to provide anything for a spouse who is likely to be paying

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off the debt that was incurred to make that account out of her reduced Social Security benefits.

This is a critical question and one that you have to get an answer to. She could be left with nothing to live on. Senator Lott

talked about a small Social Security benefit that his mother receives. It could be much, much smaller under these accounts and

she could be getting nothing to supplement her Social Security benefit.

The other issue with annuities and women is to realize that

today, in the private annuities market, annuities discriminate

against women. It is also impossible to get a fully inflation-adjusted

annuity in the private annuities market, which is especially important to women, because they live longer than men and have less

to live on. They cannot afford to have inflation erode the value of

their benefits. Social Security provides that protection.

They also do not have to worry when they purchase an annuity.

When anyone purchases an annuity now, they take the risk that

that private annuity company will not be around forever to pay

them full benefits. Social Security gives you assurance.

Now, some of the plans that involve annuitization say, well, Congress will prohibit discrimination, and Congress will provide a

guarantee that companies will not go bust, and since experts say

that private annuity companies probably will not offer a product

with full inflation protection, the Federal Government will probably

have to intervene to make sure that there are annuities available

that are protected against inflation.

But if you are going to go to all that trouble, it would be much

simpler, cheaper, and safer simply to rely on Social Security.

Mr. FERRARA. Under the Ryan-Sununu bill, the annuities are all

inflation-indexed and all spousal benefits are protected.

The CHAIRMAN. Senator Kerry?

Senator KERRY. Mr. Chairman, thank you. Mr. Chairman, thank

you for having this hearing. I appreciate the opportunity to address

it.

But I have to tell you that, frankly, I find this entire last few

months and this exercise on Social Security an exercise in frustration and avoidance. It is a conversation that lacks both candor and

common sense, and some real leadership.

I heard the Chairman, a moment ago, say, where is the plan?

The Chairman got quite excited about the notion that we need

plans and not this carping on the side. Well, where is the President’s plan? There is no plan from the President. There is an idea

about private accounts which does nothing for solvency. Solvency is

the fundamental problem of Social Security.

Now, I listened to Senator Lott say he cares more about his

grandchildren than anybody else on earth. Well, if that is true, we

could solve the problem of Social Security very quickly.

This is not complicated, and we are going to solve it. Congress

is going to solve it. But we have been wasting months, frankly,

over this issue of the private accounts without any real discussion

of solvency. Even the President himself has now admitted that private accounts do not deal with the problem of solvency.

So what is this all about? Political exercise? Strategy to separate

young people? I mean, Social Security is part of a three-legged stool

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of retirement. The three-legged stool is personal savings, employerprovided retirement and Social Security.

Well, Americans are not saving money today. The average takehome pay wages of the average worker is down. Pensions are

squeezed and are falling apart. Legacy costs of major companies

are larger than they have ever been.

And here we are talking about undoing the one component of the

stool that is reliable and guaranteed and putting it out in the marketplace, at risk. It does nothing, again, to solve the problem of solvency, Mr. Chairman.

The fact is, I heard one of the witnesses say we have made promises we cannot keep. I heard Mr. Pozen say, we do not have enough

money to pay the benefits. That is not true. We do have enough

money to pay the benefits. The fact is, the entire 75-year shortfall

is about one-fifth of making the tax cuts permanent. And we have

not made the tax cuts permanent yet.

So, we are sitting here in this completely contrived atmosphere

that Social Security is at risk, and we have to somehow fundamentally change it, when we have not yet done what we are about to

do that guarantees you do not have the money to be able to pay.

If you just did not do the tax cut for the top 1 percent of Americans who have gotten tax cuts galore over the last years, you could

pay Social Security benefits through the entire century, Mr. Chairman. It is not true to say that there is a crisis that requires this

fundamental change.

Moreover, we had a hearing not so long ago in this committee

where we had the top folks from Social Security and from Health

and Human Services here, and they all said the real crisis and the

bigger problem is Medicare and Medicaid. That is the crisis that

the President ought to be leading America on.

The Medicare Part A trust fund is exhausted in 2020. We are

here talking about Social Security that does not even go bankrupt.

If we did nothing—and we all know we are going to do something—

Social Security will still pay 80 percent of the benefits by the year

2052, and those benefits will still be more than people are getting

today.

So the fundamental issue is, what do we do about solvency? Let

me quote the President himself. On March 16, the President said,

‘‘Personal accounts do not solve the issue. I repeat, personal accounts do not permanently fix the solution.’’ I suspect he meant the

problem. [Laughter.] So even that statement is misleading, Mr.

Chairman, because it is not that it does not permanently fix it, it

weakens it.

Mr. Orszag, will you make this as clear as you can to the committee, how does this change weaken the solvency of Social Security, which is the fundamental issue that we are here to discuss?

Mr. ORSZAG. It does so in two ways, Senator Kerry. The first is

that, over the 75-year period that is traditionally used to evaluate

Social Security solvency, it takes out more money than those offsetting benefit reductions. So if more money is going out the door than

coming back in, solvency is harmed. The current Social Security

deficit over the next 75 years is 1.9 percent.

Senator KERRY. Now, the other side says, well, you have this

guarantee down the road, and we are going to guarantee it.

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Mr. ORSZAG. Yes.

Senator KERRY. Why does that not hold water?

Mr. ORSZAG. Now let us move to the so-called infinite horizon

perspective, where you move beyond 75 years. There, the accounts

could still harm solvency because there are various ways in which

you are not going to get full repayment. For example, I already

mentioned, for people who died before retirement, the debts back

to Social Security would be extinguished.

People who work for less than 10 years under Social Security

would have money going into the account and the debt repayments

would not occur. High earners, if we did it with price-indexing, if

we combined this proposal with price-indexing, would have too

small of a traditional benefit to fully repay the loan.

So, there are all sorts of situations in which repayment will not

be full, and that is even assuming that all future Senators actually

stick to the deal and there is no back-sliding.

So, I think it is just completely unsound fiscal policy to issue

debt today in exchange for benefit offsets or promises that there

will be benefit reductions in 50, 60, 70 years, in the hope that everyone, meanwhile, will fulfill those promises. It is very unlikely to

happen.

The CHAIRMAN. Senator Kerry, I have to call on Senator Thomas.

Senator KERRY. I apologize, sir.

The CHAIRMAN. And you only have 6 minutes to go vote, too, on

the floor.

Senator KERRY. Thank you.

The CHAIRMAN. Senator Thomas?

Senator THOMAS. Thank you, Mr. Chairman.

The CHAIRMAN. I am going to go vote, and Senator Lott is going

to come back and chair the hearing.

Senator THOMAS. You are going to miss what I have to say.

[Laughter.]

The CHAIRMAN. I am sure you are not going to miss a vote either,

so no hurry.

Senator THOMAS. I thank you.

I appreciate the fact that we are dealing with this, finally, to

strengthen Social Security. Many changes have taken place, and

we clearly need to do something. I am sorry some of my friends

have left, because I wanted to say I am pleased that the President

has not avoided the debate and has, in fact, brought this up.

I hope members on the other side of the aisle will stop just complaining and come up with some plans of their own, because that

is kind of what we need to do.

First of all, I do not want to talk about the details, but the broader context of it, to make sure it fits into what I think has been our

American philosophy all along, and that is the opportunity for people to fulfill their dreams.

This is not a retirement program, it is a supplement to the retirement program. I hope we can keep that in mind. I have introduced some bills to make it easier for people to be able to save for

themselves, and I hope that we can do that.

Conceptually, Mr. Orszag, it seemed to me that when this was

done initially, that President Roosevelt made it clear that the

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money that would fund this would come from payroll taxes and not

be taken out of other kinds of things.

Do you think this extends it on into sort of a welfare program,

or does it continue to keep it as Social Security?

Mr. ORSZAG. You mean, continuing to base it on payroll revenue?

Senator THOMAS. Yes.

Mr. ORSZAG. Well, I think, actually, for the mainstay, the principal component of financing should continue to be something close

to the payroll system. But that does not rule out other forms of financing.

Again, we already have it. The Congress, in 1983, and again in

1993, voted to change the system so that some portion of income

taxation is dedicated both to Social Security and to Medicare.

Senator THOMAS. Well, but that does not change the concept.

Should the concept in the future be that it relies on payroll taxes

or should we start expanding it? Now you are going to take it out

of estate taxes, as I recall.

Mr. ORSZAG. My point, Senator, is that we already rely, only in

part, on an entire——

Senator THOMAS. It does not make it right, necessarily. I am asking you if you think that the concept is fair.

Mr. ORSZAG. Oh. Conceptually, I do think it makes sense to at

least consider expanding the base of financing. The reason is, going

back to that history, in the mid- to late-1930s, we as a society decided to provide extra-normal returns, higher benefits than would

otherwise be the case, to retirees at that point. That was society’s

decision. It makes some sense that society as a whole now will help

to contribute to the program that provided those benefits.

Senator THOMAS. I think we have to sometimes think conceptually.

Madam, what do you think? There is a high percentage of these

dollars that go to disabilities, and so on. Should that be Social Security money? They should be funded, no question about that. But

is this the place to fund all those programs?

Ms. ENTMACHER. Are you asking whether we should continue to

use payroll taxes to fund the Social Security disability program?

Senator THOMAS. Some of those programs. A high percentage of

the payments now are not in retirement, they are in disabilities

and other programs.

Ms. ENTMACHER. That is true. That was precisely the point of my

testimony, that Social Security enables beneficiaries to make contributions while they are working and get protection, both for

themselves and their families, if they are disabled, if they die prematurely, that their families are protected.

I think it is a very powerful thing that those disabled workers

and their families do not have to rely on welfare, do not have to

go and spend down everything they have to qualify for our welfare

programs.

Because they paid in to Social Security when they were working,

they got the dignity of a Social Security benefit that they have

earned as a disabled worker.

Senator THOMAS. But those, in most cases, are not sufficient. I

hear, every time I go home, I am getting Social Security disability,

but it is not enough.

36

Ms. ENTMACHER. But then I would be delighted to talk with this

committee about ways to improve Social Security benefits for those

people for whom the benefits are inadequate. But it should be done

through the current system.

I think the proposals that are on the table would weaken the

protections not only for retired workers, but as I pointed out, would

cut benefits for disabled workers and survivors who are in an even

worse position to try to cope with that.

Senator THOMAS. Well, we need to look at some other programs

if that is not going to be satisfactory.

Mr. Tanner, how do you offset the cash flow when you do the private accounts?

Mr. TANNER. Sure. I would point out that it is a cash flow issue.

Because the government operates on a cash flow accounting basis,

you see the short-term costs in your 5- and 10-year budget windows.

But if this was a business and you were doing accrual accounting, you would see that moving to individual accounts actually does

not change your debt at all, you are simply taking debt in the future that is sort of off the books now, putting it on the books, and

moving it forward to pay it up front today.

We believe that, to the degree that you borrowed it, it would be

a wash, but you would not see the economic benefits that come

from reduction in overall consumption. We would like to see at

least some of that shortfall financed through reductions in government spending.

In particular, I support what Senator McCain has introduced,

what is called the Pork for Pensions bill, which would trade corporate welfare, establishing essentially a base closing style commission on corporate welfare, and would use the savings from that to

be dedicated towards helping to fund this account.

There are some other mechanisms that we talk about in detail

in our plan about, and in our paper about, how we can finance at

least some of this——

Senator THOMAS. The benefit of offsets, though, are 30 years

away or more.

Mr. TANNER. Under our plan, you would begin running surpluses

in around 2045, under this proposal, as opposed to the continuing

deficits.

Senator THOMAS. That is 40 years.

Mr. TANNER. Well, that is true. But you also have to look at,

under the current Social Security system, if you go out to the 75-

year window, the current Social Security system will be running

shortfalls in excess of 6 percent of payroll, whereas, under the

Johnson-Flake bill, it will be running surpluses in excess of 3 percent of payroll. So, you actually have to look at which way it is

moving.

Senator THOMAS. Most people generally like the idea of personal

accounts, but the question in my mind, and others’, is the offset of

cost.

Mr. FERRARA. Senator, can I address the question you just asked

him about how you would deal with the offset?

Senator THOMAS. Yes.

37

Mr. FERRARA. It is fortunate that when we sat down to do the

Ryan-Sununu bill we anticipated many of the criticisms you heard

here today, and we designed it to counter those criticisms. That is

why there are no benefit cuts in it.

We did not want to confuse the situation with reductions in future promised benefits of 40 percent when, if you believe in the

personal accounts, it is completely unnecessary.

It is why there is a guarantee of currently promised benefits so

we maintain the safety net. It is why you have inflation-indexed

annuities. It is why you have no change in people on disability, and

survivors are all completely protected.

I have to confess, when the people in the White House sat down

to write the plan, they did not anticipate all the criticism, and they

have not even proposed a specific plan yet. But their plan is not

designed to deal with these criticisms, and it is unfortunate that

these things were not anticipated and dealt with in advance.

But we did deal with them in the context of the Ryan-Sununu

bill. In the Ryan-Sununu bill, there is no permanent debt. There

is short-term borrowing, like when you have a mortgage on a

house.

Senator THOMAS. What do you mean by ‘‘short-term’’?

Mr. FERRARA. Well, when we are talking about Social Security,

everything is very big. A trillion dollars in Social Security is really

pocket change. [Laughter.]

Senator THOMAS. What do you mean by ‘‘short-term’’?

Mr. FERRARA. Short-term in Social Security is 20 years. Then

over the next 20 years, the thing is entirely paid off.

A key fact that needs to be recognized in this discussion, in

terms of a general budget, is this is a very important factor that

changes the whole perspective of what we are doing here. The Congressional Budget Office projects that, under current law, Federal

spending as a percent of GDP will grow from 20 percent today to

34 percent by 2050.

Senator THOMAS. Excuse me. I have to go vote.

Mr. FERRARA. We will put it in the record and we can read it

later. But it is growing from 20 percent today. Federal spending,

as a percent of GDP, is going to grow from 20 percent today to 34

percent by 2050.

Therefore, when we say we want to finance part of the transition,

as Mr. Tanner just said, by reducing the growth of Federal spending, we can see that there is a huge run-up of Federal spending

about to occur.

People who run on fiscal restraint are going to have to recognize

that their constituencies are not going to sit idly by and be perfectly happy if they see the Federal Government grow 70 percent

relative to GDP.

So, in fact, we do have to get serious about some spending restraint. If we use some of that, a modest amount, we can finance

the transition to accounts as large as in the Ryan-Sununu plan, or

in the Cato plan. It is the large accounts where you begin to solve

these problems that have enormous benefits for workers.

If you start with these little 2-percent accounts, then you are not

going to achieve the full long-term goals, and you are not going to

38

achieve the prosperity for workers that you could achieve with the

full accounts.

This has to be done on a positive basis that benefits working people. You cannot advance this with a blood-and-guts approach that

just says, oh, gee, we are going to raise your taxes and we are

going to cut your benefits.

That is not how we got here. We got here by talking about personal accounts. That is what people campaigned on, and we need

to make good on the campaign promises and focus on the personal

accounts. If we do those right, we can provide enormous benefits

for working people. If we get lost in the underbrush, if we go back

and say we are going to negotiate a package of tax increases and

benefit cuts, well, it is going to be all negative.

It is going to be a worse deal for workers. It is not going to solve

the problem. There are two problems here. There is not just a solvency problem. The program is not a good deal for working people

today. The average benefit paid today for single retirees is only

$920. The reason you need personal accounts is because the benefits promised today are no good. The benefits in the promised system are, in fact, too low. The rate of return is miserable compared

to market rates of return. So, that is why we need the personal accounts. I would urge you to go back and focus on where we got

started.

We got started in this debate with the personal accounts, and if

we put more effort into designing a plan that really benefits working people and anticipates some of the criticism we heard today, we

can be politically successful. We know that because we run election

after election on precisely the issue framed that way. So, I would

urge you to look in that direction.

Senator LOTT. We appreciate your energy and enthusiasm.

[Laughter.]

Mr. FERRARA. Thank you. We need energy and enthusiasm here.

Senator LOTT. That is right. Very good.

Senator Wyden?

Senator WYDEN. Thank you, Mr. Chairman. Thank all of our witnesses.

This morning, about 50 Wall Street leaders, men and women

who manage billions of investment dollars, including the head of

the world’s biggest hedge fund, sent a letter to Senator Frist opposing the administration’s personal account proposal.

These are all individuals who would benefit personally from the

President’s proposal, but they believe it is unwise because they believe that the investment business they are in involves substantial

risks, and that that is different than Social Security, which is

about insurance.

So, their argument is really that retirement finance is about a

variety of investments, but that Social Security is the one area that

ought to be insulated from a substantial amount of risk.

Now, your colleague, Mr. Pozen, talked about ‘‘minimizing risk.’’

Those were his words. But any way you cut it, to me, the President’s proposal is about a substantial reallocation of risk with respect to retirement finance. I would like to ask you, Mr. Ferrara

and Mr. Tanner, why you think Social Security funds ought to be

redirected towards riskier asset classes.

39

Mr. TANNER. Well, first of all, I would hope that that letter

would finally put an end to the rumor that I am in the pay of Wall

Street in some way, and that this is all part of a Wall Street plot.

But an answer to your larger question is, maybe you are right.

Maybe private investment is risky. I do not believe it is riskier

than Social Security, which contains a substantial political risk.

The fact is, we promise benefits, we cannot deliver them. The

fact is, we have repeatedly reduced or changed benefits in the past.

The fact is, we do not have a legal right to any benefits whatsoever,

leaving us entirely in the political system.

Senator WYDEN. My time is short. This is not about whether you

favor risk in America. I vote repeatedly to cut capital gains, for example, because I am in favor of risk-taking in investment. Tell me

why you favor redirecting Social Security funds towards more risk.

Mr. TANNER. I favor giving workers a choice. If workers agree

with you that Social Security is safer than private investments, let

them remain in the current system.

But if workers want the opportunity to earn a better rate of return, to have ownership and control, give them the choice. Do not

stand in the doorway and say that we know better, for every worker, how they should control their retirement. Let us give workers

a choice. What could be more American than that?

Senator WYDEN. The main thing we are giving them, Mr. Tanner, is the right to a lot of debt. I mean, that is essentially your

version of the choice. That is why, to me, it is so important when

50 leaders from Wall Street who manage billions of dollars worth

of funds, I mean, these are people who benefit when you tap into

the American dream. They are saying there are some bigger concerns here with respect to Social Security, and that is what I hope

we will address.

Mr. Orszag, did you want to comment on that?

Mr. ORSZAG. Again, there is a place for risk. I am all in favor of

accounts. We already have them; let us make them work better.

We could come together and get 401(k)s and IRAs to work better.

The Wall Street people who signed that letter, I am sure, are all

in favor of saving on top of a solid foundation. That is where we

should be taking risk, and it is as simple as that.

Senator WYDEN. Mr. Ferrara, just so I can get you into this, the

other reason that the Wall Street leaders are speaking out this

morning is that they think that the President’s proposal would

have no net effect on the amount of capital available to the Nation’s economy. In effect, they are saying, this just moves around

the deck chairs, and in the process reallocates risk.

What would your response be to that?

Mr. FERRARA. All right. Let me respond directly to that. The answer to the question that you asked both of us is that the current

system is a bad deal for workers today. Even if all of the promised

benefits were paid, the real rate of return would be 1 to 1.5 percent

or less for most workers; for many it would be zero or negative.

People need the freedom of choice to have a better deal.

Now, see, retirement investors have an advantage over other investors because they invest over an entire lifetime. So the stock

market does go up and down, but, over 75 years, I would submit

to you that there is no chance that the rate of return on a portfolio

40

of mixed stock and bond investments could be as low as Social Security even promises today, let alone what it can pay.

But in addition, we try to anticipate your criticism in the RyanSununu bill, because we put in there a flat-out guarantee. If you

do not get more than the current system promises through the personal account system, we will guarantee that you will get at least

what is promised today.

The reason that is in there, we think that works, is because we

believe in what we are saying, that the market will provide so

much higher returns than Social Security promises, that there is

no possibility that it will get that low, so you can go ahead and

make that guarantee and workers can get better off.

Now, I do not agree with the administration that you should finance the whole transition by borrowing. I think you can get certain benefits out of personal accounts, even with borrowing. But

one of the benefits you will not get is more savings in capital investment if you just borrow the entire amount.

Again, in the Ryan-Sununu bill, we had no permanent net borrowing. We try to achieve it all and go to a fully funded system.

The idea is rooted in the work of Martin Feldstein in the 1970s,

who argued that we should shift from a pay-as-you-go system like

Social Security today where there is no savings and investment to

a fully funded system where the money is saved and invested.

So, we did it on a different model than the administration did.

We did it on a fully funded model, so there is no permanent net

debt out of it as a result. Again, we anticipated these sort of criticisms. Unfortunately, the White House has not fully anticipated

them.

Senator WYDEN. My time has expired. I would just note, what

you are suggesting is sort of like the idea that somebody can have

three hot fudge sundaes a day and lose weight.

Mr. FERRARA. No. No, I am not.

Senator WYDEN. The idea that you do it without any borrowing,

without any benefit cuts, I just think is pretty bizarre.

Thank you, Mr. Chairman.

Senator LOTT. Thank you, Senator Wyden.

Senator Snowe?

Senator SNOWE. Thank you, Mr. Chairman.

I want to thank all of you for being here today and for taking

the time, obviously, to come up with various initiatives, whether we

agree or disagree. I think the point is, it affords us the opportunity

to explore some of the issues and to evaluate the implications of

a variety of proposals.

Frankly, I think that we are sort of at a philosophical juncture

about the Social Security program as to whether or not you really

do believe in preserving the underpinning of the Social Security

program, which is a defined guaranteed benefit.

Seniors have come to trust Social Security, certainly in my State,

that has the Nation’s oldest average population. Fifty-six percent

of my population is prevented from falling into poverty as a result

of Social Security.

So, it has become a bedrock of support in their retirement years,

precisely because it is defined and because it is guaranteed. I think

that is really the issue today and what we confront in Congress as

41

to whether or not we want to tamper and incorporate an element

of risk into the program by introducing and carving out and diverting from the payroll tax to support a personal retirement account.

I think, at what cost and at what risk is it worth it to erode the

basic traditional guaranteed benefit? So I ask you, Mr. Ferrara and

Mr. Tanner, to begin with you, as to why would you think it would

be worth incorporating that risk in a system that has worked exceptionally well?

Because obviously I think that with what I have seen in your

proposal, I think ultimately you do not guarantee that individuals

are going to meet a specific income by the time they reach retirement. There is a potential. There is an up side. But the question

is, how much risk do you have to take on the down side in order

to achieve what might be a net gain of 1 percent?

Mr. FERRARA. Well, in the Ryan-Sununu plan we are the ones

who do have a guarantee. We put in a guarantee that you will get

at least the benefits promised under current law.

We do that because of the real reason why we want to have these

personal accounts, because even the returns that are promised by

Social Security under current law are very low and they are a poor

deal for workers.

For many workers, even if you get all the promised benefits, you

get a negative real rate of return. That is like taking your money

to the bank. Instead of getting interest from them, you pay the

bank to hold your money.

Now, if we do some of the things that have been talked about,

raise taxes or cut benefits to deal with the solvency problem, then

that rate of return is going to get even lower and it is going to be

negative for even more people. So, I think we clearly need to give

people freedom of choice to get a better deal.

Now, I would add that the Social Security benefit is not guaranteed. The Supreme Court held in 1960 that it is not backed up by

a government guarantee and that the benefits can be cut at any

time.

So you can structure the system to minimize any new risks on

workers and to take advantage of the market returns so that workers can get a better deal, and that is how we began, how we got

into this whole personal accounting in the first place.

Senator SNOWE. But I think the Congress has a pretty good track

record over 70 years in support of the program and the defined

guaranteed benefit. I think the issue is, there are few and far between options when it comes to defined guaranteed benefits in the

retirement world today. I think that is a fact.

There are many options for diversifying your portfolio from

401(k)s and IRAs, and so on, and so forth. The question is, do you

want to maintain that foundation for our seniors today with respect

to a defined and a guaranteed benefit income? That is the issue,

because we have many ways in which to enhance retirement income where people can take the risk. But why incorporate that risk

into a program——

Mr. FERRARA. Because the returns are so low.

Senator SNOWE. Because the returns are low. But how are you

guaranteeing a return under your plan?

42

Mr. FERRARA. We are not guaranteeing a higher return. What we

are saying is, if you look at the standard long-term market returns,

they are so much higher, the margin for error is so enormous, that

workers really need to have that freedom of choice, and I think

workers agree with that.

Senator SNOWE. I would like to have Mr. Orszag respond. But in

your plan, as I understand it, the government pays for any shortfall between the account and Social Security benefits scheduled

under current law. Do you have a funding stream for that?

Mr. FERRARA. I think that is Mr. Tanner’s.

Mr. TANNER. No, you guarantee.

Senator SNOWE. Do you have a guarantee?

Mr. FERRARA. We have the guarantee in the Ryan-Sununu bill.

He has some kind of much more limited guarantee.

Senator SNOWE. Right. You both have a guarantee.

Mr. FERRARA. Well, you see, the thing is, the guarantee is not

going to be employed because the market returns are so much

higher than what Social Security promises, that you are not going

to fall under that safety net.

Senator SNOWE. Mr. Orszag, can I just have you respond?

Mr. ORSZAG. Yes. Just quickly. I mean, we have heard a lot

about this plan. The key thing to this plan, is it contains the mother of all magic asterisks. The slow-down in spending growth that

is assumed amounts to more than $7 trillion in assumed savings

from, presumably, Medicare and other programs without any specificity about how you are going to get it.

I think it would be great if you guys could come up with $7 trillion in savings somewhere, but frankly, so far there has not been

a lot of evidence that you are able to. I do not think it is at all responsible to just assume that that money will be forthcoming.

Without that money, the whole house of cards falls apart.

Mr. TANNER. Senator?

Senator SNOWE. Mr. Tanner?

Mr. TANNER. If I could just say, first, in terms of it being a guaranteed benefit now, as Peter pointed out, it is not legally guaranteed. It is also not financially guaranteed. By law, Social Security

benefits will be reduced by 26 percent in the future when Social Security cannot pay benefits.

Actually, since that is an across-the-board benefit including people who would already be receiving benefits at that time, the reality for new workers is that they would receive an even bigger

benefit cut than that 26 percent, because you are not going to cut

grandma’s check by 26 percent, where 1 week she is getting one

check, the next week it is 26 percent lower.

What you are going to do is phase it in for new workers, and

those benefit cuts are going to be reduced. Repeatedly in the past,

Congress has reduced and changed benefits.

When I started work, they told me I could retire with full retirement benefits at age 65. Then they came along in 1983 and

changed that, and now I have to work to age 67 before I can retire.

So, there is no guarantee with the current benefits.

I would also suggest the reason why I want to make these

changes is because, while I want to preserve what is good about SoVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 26642.000 SFIN1 PsN: SFIN1
43

cial Security, I do not want to preserve the problems with Social

Security.

That includes the fact that workers have no ownership under the

current program, that Social Security benefits are not inheritable

under the Social Security program, and that there is no choice

about how much risk individuals want to achieve under the program, so we can make Social Security better while we make it solvent.

Senator LOTT. Senator Lincoln?

Senator LINCOLN. Thank you, Mr. Chairman.

I would like to ask unanimous consent. I was about 5 minutes

late arriving for the nomination of Congressman Portman, and I

would like to have my comments included in the record, please.

Senator LOTT. Without objection, it will be included.

Senator LINCOLN. Thank you.

Well, thanks to all of you panelists for your patience, and as Senator Snowe said, for your ingenuity in looking for what the solutions might be. We know we have some long-term concerns and

challenges that face Social Security.

We want to make sure that we address those in a thoughtful way

and a fair and balanced way for everybody that is concerned. I

think we know in life there are winners and losers in almost every

situation, and that would include probably some of the changes

that are being proposed in Social Security, whether it is a small

business owner, whether it is somebody that lives in a rural area,

or what have you.

But I guess it is my job to make sure that Arkansans are not left

with a disproportionate burden for any changes made to the program that has meant so much to so many of them in my home

State.

With that, I would like to touch on just a couple of the areas.

One, we know that workers living in rural areas, such as in my

State, are more likely to be poor and they are less likely to be able

to contribute to personal savings accounts.

Thirty percent of Arkansans do not even have bank accounts. So,

we are talking about people who live paycheck to paycheck. I would

note that the majority of the top 10 States in that category are represented on this committee here, so we share a lot of those demographics.

In addition, because of the physical nature of their jobs, it is

more likely that they will need either disability benefits or early retirement benefits, which are key components to not being left out

as we look at the changes.

I guess my question would be, how will private accounts impact

rural Americans? I mean, Americans who are most likely not to

have enough savings to make up for any reductions in their Social

Security benefits and those who are least likely to be capable of

paying the debt off that is going to be created from these private

accounts that the President is proposing.

Mr. FERRARA. Senator, your comments show exactly why add-on

accounts would not work for the people of Arkansas, because they

do not have extra money on top of what they are paying. Many people do not, in your State, have extra money to pay on top of what

44

they are paying in Social Security payroll taxes for some other account.

What they need is the opportunity to take some of the money

that is already being paid by them and their employers through the

system and put that into a nest egg for themselves and their families where they would have a chance to get a better deal.

Senator LINCOLN. But the problem is, their children are going to

be saddled with the debt that you create. We clearly indicated that

there is no asterisk out there that is going to pay for what you

want to do.

So whenever we increase debt, we are increasing taxes on someone, which is more than likely the children in the future that are

going to have to be saddled with the lack of capital, the increase

in inflation, interest rates, and the problems that they are going to

have dealing with the debt that is created.

Mr. FERRARA. Social Security already has an $11 trillion debt. So

even if you finance the transition by debt, you are just recognizing

part of that debt we already owe. But in the Ryan-Sununu bill, we

attempt to do the whole thing without any net new debt over the

entire life of the plan, like a mortgage.

Senator LINCOLN. I have to say, in terms of personal savings, I

have no problem, that as a part of the debate in Social Security,

we have to be very serious about being innovative in how we encourage personal savings. But I have not heard anybody mention

IDAs, which is what low-income people use.

Mr. ORSZAG. Senator, I think it is very important. The way to

build savings and wealth is not by borrowing against the core tier

of retirement income for those folks. It is not by leveraging or taking out a line of credit on your future Social Security benefits. We

must make it easier for them to save and increase incentives for

them to do so. The evidence very strongly shows that people do

save, as long as it is simple and as long as there is an incentive

for them to do so.

I am very confident that with some common sense reforms that

this committee could do now, both sides of the Social Security debate could come together, we could boost wealth and saving for

your constituents, not at the cost of borrowing against your future

Social Security benefits and running up debt, but simply by adding

on top of the Social Security system as it already exists.

Senator LINCOLN. With an opt-out as opposed to opting in.

Mr. ORSZAG. That is one of the very good ideas. That is right.

Senator LINCOLN. That is what you mentioned. Yes.

Yes?

Mr. TANNER. Senator, just one other point on the individual accounts in terms of low-income people that I think was neglected,

and that is the fact that, under the current system, the benefits

that low-income people have are not inheritable.

For millions of low-income people who died prematurely and

their children are over survivors’ age, they are not able to pass

along any sort of wealth to their children, and that means their

children will likely be poor as well. What we need to do is be able

to give low-income workers a chance to build a nest egg of real

wealth that they can pass down.

45

Senator LINCOLN. But the problem is, we have already pointed

out in the President’s plan, that when you get to a certain point

as a low-income individual, you are going to be forced to purchase

this annuity, which does not give you that.

Mr. TANNER. Under the President’s plan, that may or may not

be the case. Still, 1 out of 4 Americans will die before they reach

retirement age. That money would be inheritable. Under our proposal, and I believe under Peter’s as well, it is not required that

you annuitize fully at retirement.

Senator LINCOLN. Right now they get survivors’ benefits.

Mr. TANNER. We would only require that you either annuitize or

take a guaranteed income stream, preserving the principal up to

the poverty level, and over and above that you could take it as a

lump sum, or do whatever you want.

Mr. ORSZAG. May I add?

Ms. ENTMACHER. Senator, if I could.

Senator LINCOLN. Is that all my time?

Senator LOTT. Yes. I am sorry, it is gone. Does somebody want

to respond, though?

Ms. ENTMACHER. Yes. I just wanted to point out what the nature

of these benefits for children, if a worker is disabled or dies prematurely, is. Because a spouse of that deceased or disabled worker

can get a benefit while the children are under age 16, the children

get benefits until they turn 18, 19 if they are in school, and those

benefits are adjusted for inflation.

If a worker died and had a private account, you are not going to

be able to equal those benefits. Even if they could inherit the account and have access to it, it is not going to protect them. It is

those young children who really need the protection.

Leaving your adult children an inheritance is nice, but children

really need the protection when they are young, and that is what

Social Security does. It is particularly important when there is a

high risk of disability.

Mr. ORSZAG. May I answer?

Senator LOTT. Senator Lincoln, we need to move along because

we are getting well into the noon hour and we have a meeting we

have to go to.

Senator LINCOLN. I would just like to make sure my questions,

particularly regarding women, are included, so I will send those in.

[The questions appear in the appendix.]

Senator LOTT. Senator Crapo?

Senator CRAPO. Thank you very much, Mr. Chairman.

Mr. Ferrara and Mr. Tanner, I guess I would ask this question

to you. We have had a lot of discussion today about the issue of

disability benefits and survivorship benefits.

The discussion seems to be based, at least in large part, on the

premise that they would be changed by any personal account proposal in the sense that, whatever was done with regard to personal

accounts and the overall Social Security benefit, would then carry

over into survivorship benefits or disability benefits.

But my understanding is that that is simply not the case. It can

or cannot be done that way, depending on who puts the plan together. It is also my understanding that the President has made

46

it clear that he does not intend to do that. Could either of you comment on that?

Mr. FERRARA. Senator, you are exactly right. There is a lot of discussion that goes on about these additional benefits that is, frankly, disingenuous. The statements have been made over and over

again that these plans would not affect disability benefits, would

not affect pre-age 65 survivors’ benefits, would not affect non-retirement survivors’ benefits.

The Ryan-Sununu bill, for example, was introduced last year,

was introduced this year. There is no change in any of those benefits. They continue to be financed, as under their current system.

I believe that is true of the Johnson-Flake bill as well.

Mr. TANNER. Yes, that is correct. The Johnson-Flake bill leaves

survivors and disability benefits intact. It has a funding stream of

3.3 percent of payroll that is permanently dedicated to that, so

there is no change in survivors or disability benefits.

Senator CRAPO. And if that were the case, it seems to me I recall

either a CBO, or some other study, that indicated, frankly, that the

survivors were one of those in the categories that benefitted most

from those who benefit from personal accounts.

It seems to me the reason would be that the proposals that are

on the table protect their current benefits under the system and

give them an inheritability factor that accounts provide with them.

Is that not also correct?

Mr. FERRARA. That is exactly correct.

Mr. TANNER. Survivors’ benefits, plus.

Senator CRAPO. Yes. Mr. Orszag, do you have a comment on

that?

Mr. ORSZAG. Yes, I would like to. I think one of the reasons there

has been some confusion about this point is, let us look, for example, at the plans that have been specified by the administration or

Mr. Pozen, who has served on the President’s commission.

Those plans, the President’s commission plan and Mr. Pozen’s

plan, as scored by the Social Security actuaries, do assume a significant reduction in disability benefits and survivor benefits in the

financial analyses.

So, it is natural that people think that these benefits could be

under pressure. Now, the administration has, since that time,

made a statement to the contrary, but again we have not seen a

solvency plan.

Senator CRAPO. But you do not want to accept that statement.

Mr. ORSZAG. Given that the only plans that have been put forward by people associated with the administration assume those

reductions, I want to wait and see the details, yes.

Senator CRAPO. Well, as you know, there has been a lot of discussion about whether the President should or should not, will or will

not, give the details before the Congress has studied this enough

to come up with alternative proposals.

But it seems to me interesting that the President not only has

made it clear that he is not going to propose these changes, but

that the plans that we have on the table in front of us here, at

least at this hearing—I do not know about Mr. Pozen’s plan, but

the two plans that Mr. Tanner and Mr. Ferrara are proposing—

47

make it clear that they are not going to change that, yet it continues to be an issue that is thrown up.

Mr. ORSZAG. Let me give you one example of why. You can retain

full disability benefits, but when people reach the so-called normal

retirement age, they transfer from disability benefit to retirement

benefit.

The question is, are you going to protect their higher level of benefit even after they transferred to retirement benefits? Many of the

plans that ostensibly protect disability benefits do not, which

means a disabled worker will have benefits protected for perhaps

10 or 15 years, then suffer a decline at the transfer.

It is that kind of detail that I think is raising a lot of the concerns around this.

Senator CRAPO. Mr. Ferrara?

Mr. FERRARA. We sat down and designed the Ryan-Sununu bill.

Mr. Orszag picks up on a very important point that was raised by

the Chief Actuary of Social Security when we sat down with him.

We designed the bill to protect those disabled workers at that point

so that they are fully protected. Again, I go back to this, we did

a lot of effort in designing that bill to anticipate all these criticisms.

The point he raised just now is a very sophisticated criticism, but

we anticipated it and we took care of it in the bill. But the general

answer is, you are absolutely correct, disability benefits changes

are off the table, in general.

Now, I urge you to be cautious about these price-indexing proposals, because he is right when he said some of the price-indexing

proposals affected disability benefits. What I want to emphasize is,

taxes under the payroll tax grow with wages. Taxes under the payroll tax grow with wages.

So if you are going to have the benefits grow with prices while

the taxes are growing with wages, under the price-indexing

scheme, what does that mean? It means the rate of return goes

down every year under these price-indexing schemes.

It means the replacement rate under Social Security, the percent

in pre-retirement income that you replace with Social Security,

goes down every year because if your income is growing, benefits

are only growing with prices but your income is growing with

wages, the replacement rate declines every year. The rate of return

declines every year under these price-indexing plans.

I do not want to see people get blind-sided by that during election time when it is characterized that way, because frankly a lot

of things Senator Baucus said about the price-indexing, you will

not be able to say, no, that is flat-out not true. You will not be able

to say that, because with price-indexing, again, the taxes grow with

wages.

If benefits are only going to grow with prices, that means that

all these indefensible things are going to happen. That is why I

urge you to focus on the personal accounts and stay away from

these things like price-indexing.

Senator CRAPO. I appreciate that. I see my time is up. I just

wanted to make the point clear that there is a lot of discussion

going on here about disability benefits, survivorship benefits, and

48

so forth. Frankly, it is fair to do so because there are a lot of plans

on the table, and some plans do it and some plans do not.

But I just wanted to make it clear that, at least as far as I understand the President to have said, is that he is encouraging us

not to do it, which takes the issue off the table.

There are at least two plans on the table here in front of us

which do exactly that, and which still work out. So, I just want to

be sure we understand what it is we are attacking and defending

as we discuss these issues today.

Thank you, Mr. Chairman.

Senator LOTT. Senator Santorum or Senator Bunning?

Senator SANTORUM. Go ahead, Senator Bunning.

Senator LOTT. Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

Senator SANTORUM. And Senator Santorum.

Senator BUNNING. And Senator Santorum. [Laughter.] Thank

you. There is a question of who got here first.

Let me emphasize the fact that, in every respect, any type of personal account was always going to be considered on a voluntary

basis, period.

Let me give you another for instance. How about if we started

an account at birth. My child is born, $1,000 goes in. For the first

5 years from that child’s birth, an additional $1,000 per year. The

cost of that plan for the first 5 years is $25 billion.

The money coming for that would be new entries into the retirement plan. In other words, at 18 I would become eligible. I would

put new money in, so there would not be a net loss for that account.

Can anybody here tell me what you could do with $5,000 over 60

years in an investment account?

Mr. FERRARA. I could calculate that for you, but that is going to

grow to a large amount of money, much more than Social Security

promises, let alone what it can pay. It is going to grow to a very

large amount.

Senator BUNNING. Let me tell you what happened. This is personal, so I know this, cold turkey. In 1961, the major league baseball pension program, a defined benefit program. I do not want to

think about the current salaries. The minimum salary at the major

league level at that time was $5,000 per year—per year—so the

benefit plan was very important.

We had a defined benefit program that was guaranteed, just like

Social Security. Two players, myself and Richie Ashburn, were

members of the Pension Committee. We decided we would like to

put a variable annuity on top of the fixed benefit. We had owners’

cooperation. We had money coming in and we had this guaranteed.

Guess what? In 2005, 20 percent of our benefit is from the fixed,

80 percent of our benefit is from the variable. That is what we are

trying to talk about today for Social Security.

If you talk about 2 years down the road or 3 years down the

road, yes, there are fluctuations in the market. I was in the stock

market for 25 years as an account executive, so I understand the

market and what is going on.

We have to be innovative. The kiddie corps thing that I talked

about for $1,000 for the first 5 years, that could be incorporated

49

into any kind of plan we had. I just would like you to know that

the amount of money on that $5,000 investment would be paid off

by new initial people, and when that person became eligible to

work, they would also subtract the $5,000 from their first $5,000

in taxes that they collect from that person so there would not be

a big, overall $2 trillion loss to the account.

I want you to know that volunteering to do that is in the best

interests of every Social Security recipient in the world. The President of the United States has made it perfectly clear that no one

is going to lose any benefits if they are 55 and over. He has said

it over and over. I do not know if anybody is listening or if they

are not.

I think we could even go back to 50 and do the same thing. All

I can tell you is, the market return over a 60-year period, or a 40-

year period, is so much larger than the Social Security return, it

is unbelievable.

So when we talk about doing and maintaining the solvency of the

Social Security trust funds and adding benefits, additional benefits—not separate benefits, but additional—we create an ownership

society, where they own part of the rock, and a better increase, particularly for women and for the poor. That is where it hits the

most, not for somebody who is making $150,000.

Actually, it is just like the players today in baseball. They do not

need their pension program. I mean, if you cannot save enough out

of $4 million a year, shame on you. What I am saying is, this is

something, when we get a final bill, that will retain solvency and

add benefits.

Thank you.

The CHAIRMAN. Senator Santorum?

Senator SANTORUM. Thank you, Mr. Chairman.

I apologize for not being here for much of the testimony. I just

want to review. Does anybody on the panel believe that we should

wait to change the system, that it would be a good idea for us to

wait longer before we make any changes to the Social Security system? Does everybody believe we should act sooner, rather than

later?

Mr. TANNER. Yes.

Mr. FERRARA. Yes.

Ms. ENTMACHER. I would say, Senator, that the most important

thing is to not make the problem worse. Acting for acting’s sake is

not a good thing if the wrong steps are taken.

Senator SANTORUM. Obviously, I would never recommend acting

for acting’s sake, or to act to make the problem worse. I would

agree with that.

So we should act. So, everyone believes there is a problem that

needs to be addressed. Does everybody agree that there is a problem that needs to be addressed, and that the problem is in the relatively short term, not 40 or 50 years from now? Does everybody

agree with that?

Mr. ORSZAG. Yes. The way I would phrase it is, the problem just

gradually grows worse and worse over time.

Senator SANTORUM. And so there is a problem, and we should act

sooner rather than later.

50

Ms. ENTMACHER. But, Senator, there is not a problem in Social

Security over the short term. For the last 20 years since 1983,

workers have been paying more payroll taxes than were needed to

fund the program.

Senator SANTORUM. I accept that. I am on short time. You have

answered my question. I understand. I did not say that there is a

problem today, I said that there is a problem and we should act

now to avoid that.

Second, does anybody on the panel believe that repealing the

Bush tax cuts would directly help the solvency of the Social Security system?

Mr. TANNER. No, I do not.

Mr. ORSZAG. Yes, if the revenue were dedicated to the program.

Senator SANTORUM. But I did not say that. Just simply repealing

the Bush tax cuts, would that directly help the Social Security system?

Mr. ORSZAG. No.

Mr. TANNER. No, because it presumes you could save the money

today, which Congress has already proven it cannot.

Mr. FERRARA. He is not even putting it in the system.

Ms. ENTMACHER. Senator?

Senator SANTORUM. Yes?

Ms. ENTMACHER. It would make it easier on the rest of the Federal budget to make good and pay the interest on the bonds in the

trust fund and to redeem the bonds in the trust fund.

Senator SANTORUM. We would still be able to pay the interest,

would we not?

Ms. ENTMACHER. But for the rest of the budget, it would make

it much easier to finance Social Security.

Senator SANTORUM. So repealing the Bush tax cuts or reducing

spending, or anything to reduce the budget deficit would be good,

not necessarily repealing the Bush tax cuts. So the overall budget

picture needs to be improved.

I think we would all stipulate to that. But whether we are increasing taxes or reducing spending, both would have the same

general benefit on the Social Security system simply because of our

ability to be able to pay benefits.

Mr. FERRARA. No, I would not agree with that, because I think

increasing taxes would harm the economy, so it would not necessarily improve the budget situation, or would not improve it as

much as reducing spending would.

Ms. ENTMACHER. And I would disagree. If you focus not on the

Social Security system’s books but on the beneficiaries of Social Security, those 55 and older people that everyone talks about protecting, would be hurt if we cut Medicare, would be hurt if we cut

Medicaid, would be hurt if we cut the other services that are important to them in order to finance the borrowing that is needed

for these accounts.

Senator SANTORUM. Obviously, if we increase taxes or reduce

benefits, someone is going to be hurt. I think we can also stipulate

to that.

Let me sort of step back again. We should do something now,

there is a problem, and we should do something, I think all of you

51

have suggested, within Social Security to solve the problem for the

long term. Does everybody agree with that?

[Chorus of ayes].

Senator SANTORUM. All right. So the next question I have is, obviously, what to do. The what to do is, obviously, where we sort of

part company at this point. So we all agree there is a problem, we

have to solve it, do it now, and try to do it within the Social Security system. The question is, how do we do that?

Let us sort of step back again and look at the issue of debt. What

Mr. Orszag said which struck me as sort of interesting, was that

personal accounts exacerbate the debt problem. Yet, Mr. Ferrara

and Mr. Tanner say that is not the case, that this is a debt that

we are simply just realizing sooner rather than later.

You disagree with that, though, Mr. Orszag.

Mr. ORSZAG. I do.

Senator SANTORUM. Can you explain to me why you disagree

that an unfunded liability out there, if moved up, is not just recognizing that debt that we owe, that we will recognize at some point

sooner rather than later?

Mr. ORSZAG. The reason is, implicit debt does not need to be

rolled over. Those future benefit promises do not need to be rolled

over and refinanced in financial markets. Explicit debt does.

I know of no country in the world that has gotten into trouble

because it has a large implicit debt with benefit promises out in the

future. Lots of countries have gotten into trouble rolling over their

explicit debt. There is a very significant difference.

Senator SANTORUM. Can I ask this question? What if the case

can be made—and I think this is the case each of them would

make—that by making the debt explicit, you actually lower the

overall debt burden for the country.

Mr. ORSZAG. Well, again, the analysis becomes more complicated

there. But let us look at the administration’s proposal. I do not

think that that is actually what would occur.

Again, even for it to be neutral, you need to believe these benefit

offsets that are 40, 50, 60 years out. Just to repeat what I said earlier, people like Bob Rubin think that financial markets just simply

will not believe that the future Senator from Pennsylvania in 30

or 40 years will uphold those full benefit offsets.

Mr. FERRARA. May I address that?

Senator SANTORUM. Please.

Mr. FERRARA. What this criticism he raises overlooks is, first of

all, there is a huge amount of money going into the markets from

these personal accounts.

When the Chief Actuary of Social Security scored Ryan-Sununu,

he estimated that 15 years down the road the workers would have

$7.8 trillion in today’s dollars in those accounts.

So when he talks about, well, they are going to borrow $2 trillion

or they are going to borrow, God knows what, $7 trillion, well, they

are going to have $7.8 trillion after 15 years in those accounts. It

is $16 trillion after 25 years.

So even if you borrow all the money, on net, that borrowing is

being offset by the increased savings and investment.

52

Then the other point that he has raised repeatedly here that is

a very important point to address is, he is saying, well, will they

really have these benefit offsets in the future?

In other words, you are substituting the personal accounts for

some of your future Social Security benefits, and he is trying to

raise the fear that, well, that substitution ultimately will not take

place.

That is why you need large accounts, like in the Ryan-Sununu

bill, or like the Cato Institute has proposed. People are getting better benefits through their accounts than Social Security, and you

are not going to have a problem with that offset in the future.

Mr. TANNER. The other thing to point out is what Mr. Orszag is

actually arguing, that that $12.8 trillion in unfunded obligations

that the Social Security faces in the future is not really real, because you can always default on the benefits.

Mr. ORSZAG. That is not what I am arguing.

Mr. TANNER. So, in essence, he is arguing that you are going to

cut those benefits in the future and not make good on every penny

that is promised in future benefits, which is probably true.

It is certainly true under our plan. It has been true under his

proposal. It is true under most of the proposals that are up there,

that the promised level of benefits probably cannot be paid in the

future.

However, it is incorrect to say that that is something that has

to do with individual accounts. That has to do with, we have overpromised in terms of benefits. It has nothing whatsoever to do with

the creation of individual accounts.

The CHAIRMAN. Senator Schumer is next.

Senator SCHUMER. Thank you, Mr. Chairman. I thank the witnesses as well. First, I want to thank you, Chairman Grassley, for

holding this hearing and for, generally, your approach here, which

has always been bipartisan and to try to bring people together.

The reason why bipartisanship is having more trouble on this

issue than just about any other is because this goes not just to how

to fix Social Security, I think, but to deeply held views about what

government is all about and what our country is all about. It is

much harder to bridge a partisan divide when things are that deep.

Nonetheless, I appreciate your efforts to do it.

Now, to me, at least, there is someone missing at today’s witness

table, and that is the President or his representative.

Again, I appreciate the Chairman holding this hearing and the

general bipartisan approach he takes, but it was the President who

called Social Security a crisis, and then gummed up the works by

insisting on privatization.

The only way we are going to be able to move forward in a bipartisan way is for the President to take privatization off the table,

or alternatively present a detailed plan with privatization so this

body can either pass it, or more likely reject it, and then move on.

Everyone should understand here what the President is proposing. Under the President’s plan, someone born this year would

have no guaranteed benefit when he or she reaches retirement.

The President’s plan is not partial privatization, it is ultimately

a phase-out of Social Security. Obviously, that takes a scenario

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where the stock market does not do well at all, but that is where

it could lead. That is the fundamental difference.

Mr. Ferrara keeps talking about rate of return. Well, this is an

insurance program, not an investment. If you want to fundamentally change it and say it ought to become an investment as opposed to an insurance program, that is fine. But I do not buy it,

and I think most of the American people do not buy it.

So there are a lot of problems here. Debt is one of them. The

President wants to eliminate the death tax, but with his plan, in

my judgment, creates a much larger birth tax owed by every single

American.

People like Alan Greenspan have said, yes, he prefers private accounts, but with this level of debt we have, you would have to do

something to deal with that before you could do it.

That will lead to my first question, which is, Mr. Ferrara, you

referenced Martin Feldstein. He is a conservative, prominent Harvard economist—Harvard and conservative not being an oxymoron,

I guess, in this situation—and he served as President Reagan’s

Chief Political Advisor.

He wrote in 2002, he recommended that President Reagan not

support private accounts. His reason was, ‘‘The trust fund was

empty and the overall budget was in substantial deficit. So starting

to fund investment-based tax accounts would have required a tax

increase, or even a larger overall budget deficit.’’

In other words, the early 1980s, which saw a greater crisis than

we face today with Social Security—they were closer to running out

of money, in any case—yet, Ronald Reagan’s economist was opposed to private accounts.

Today we have financially strapped wartime expenses and large

budgets. Why is it a better idea today than it was 20 years ago?

Mr. FERRARA. Well, you know, I, too went to Harvard Law School

and I studied under Professor Feldstein. That is where my whole

enterprise with Social Security began. I actually spoke to him just

3 or 4 weeks ago, and he said, ‘‘I very much support what the

President is trying to do with personal accounts.’’

Now, the reason I brought him up is because the reasoning behind the Ryan-Sununu bill and what I have been trying to accomplish, what I have been advancing for many years, comes out of his

original reasoning. Social Security is a pay-as-you-go system. There

is no savings and investment in it. They take the money from you

and they give it to him.

What he argued is, it would benefit workers, it would benefit the

economy, if we changed it to a savings and investment system

where you had real savings and investment, and then when you

reach retirement, that supports you. That is what I am trying to

accomplish with this kind of bill.

Senator SCHUMER. I understand.

Mr. FERRARA. Not everyone is trying to do that.

Senator SCHUMER. Let me ask you—and I see my time is about

to go out—it is an insurance plan. Here, you do not look at rate

of return, which you keep talking about, for an insurance program.

In other words, I save for my kid’s college.

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My wife and I put money away for my kid’s college education. We

went to a couple of financial advisors, friends of ours, and they

said, put it in bonds because you need the money there.

In other words, the down side of not having the money for something very important, whether it be insurance or college tuition, far

exceeds the up side of making more money.

That is the fundamental difference that we see here. It is not,

when you are 2 percent below or 2 percent above, they are even.

They are not if you do not have the money for necessities. How do

you address that fundamental question?

Mr. FERRARA. Let me address this. Insurance has a value if you

look at the benefit that they promise you times the probability of

getting the benefit. By doing that calculation, you can determine

what the value of the insurance is.

Now, Social Security has a lot of insurance-type promises. When

we did the first study of this when I was at Harvard, what we did

is, we calculated the value of all the promises times the probability

of them having to be paid, and compared that to the value of what

would be paid into the system.

That is how we calculated the rates of return that are promised

by the system. We found out that, for most workers, the real rate

of return would be 1 to 1.5 percent or less; for many, it is zero or

negative.

Now, you can cover the same things through a system of private

savings and insurance. What we are doing today in the RyanSununu bill is, we are focusing on the retirement part. The other,

more insurance-oriented pieces like the pre-age 65 retirement benefit and the disability benefit, those are left entirely in the current

system as it is.

But you can calculate a value for insurance and then determine

the rate of return that way. You can design a system that takes

advantage of what is good in Social Security and provides a better

deal for workers. That is what we are trying to do with the whole

design of the Ryan-Sununu plan from the beginning, is to do that.

Senator SCHUMER. I see Mr. Orszag shaking his head. I would

just like him to respond.

Mr. FERRARA. He is always shaking his head.

Mr. ORSZAG. Only when there are incorrect statements made.

The CHAIRMAN. Senator Lott?

Senator LOTT. We are going to get second, and I guess third,

rounds here.

Senator SCHUMER. Mr. Chairman, could Mr. Orszag just answer

what Mr. Ferrara said?

The CHAIRMAN. Yes. Please, briefly.

Mr. ORSZAG. I think that even people who support individual accounts on the conservative side, people like Greg Mankiw and others, argue correctly that there is a way to analyze the problem and

it is not the way that Mr. Ferrara is presenting things, the free

lunch that solves everything, and instead actually makes the argument that the administration has made, which is that there is a

trade-off.

You get the account, but you then lose something. That then

speaks to what Senator Schumer was really talking about. There

are a whole variety of different aspects of the program that provide

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insurance, including one that is not well-appreciated, that it provides a form of lifetime earnings insurance.

Young workers today whose lives do not turn out quite as well

as they expect partially make up the difference through Social Security. That is very hard to do through private markets, and it is

not done in most private account plans. That is just one example.

The CHAIRMAN. Senator Lott?

Senator LOTT. Thank you, Mr. Chairman, again, for having the

hearing and giving us a second round.

There are so many things that have been said today that need

to be corrected, I do not hardly know where to begin, but I will just

pick two to make sure the record is correct.

Senator Baucus, in his opening statement, and now just a moment ago Senator Schumer referred to these personal savings accounts as privatization, or inferred that President Bush favors privatization. He does not. The publicly run Social Security system

would still be there. The President has endorsed personal savings

accounts managed like the thrift savings plan, which is not privatization.

Senator Kerry argued that repealing the Bush tax cuts would

solve the Social Security trust fund solvency problem. Obviously,

that is inaccurate for a variety of reasons. First of all, this was not

just for wealthy people, it was for a lot of working people, for families with children, middle-income people. It would have a huge negative impact on the economy.

But CBO, for instance, the non-partisan CBO—which a lot of

times I disagree with—said that in 2050, the cost of extending tax

cuts will be 0.7 percent of the GDP, the Social Security trust fund

deficit will be 1.4 percent GDP, and that is assuming it does not

cause huge problems in the growth of the economy.

Now, Mr. Orszag, first of all, thank you for being here and for

the thought you have given to this. Unlike the Democrats, at least

you have a plan. But I suspect yours is their plan. Now, we all

know what they are against.

They are against my grandchildren being able to have more than

what my mother has when they reach retirement age because they

do not like personal savings accounts. They do not want people to

be able to take their own money and get more from it. But let us

talk about the reform side of it. Let me make sure I understand

what you are suggesting.

Number one, do you propose to do anything with the age problem

or situation in view of increasing longevity? Would you index it?

Would you raise it? Would you do anything about age?

Mr. ORSZAG. We would not directly change the normal retirement

age. We would, however, index benefits to life expectancy.

Senator LOTT. Would you do anything about controlling the rate

of growth of benefits?

Mr. ORSZAG. Well, that, in part, would control the rate of growth

of benefits.

Senator LOTT. So how would you do that, now? Say it again.

Mr. ORSZAG. What would happen is, the goal would be to keep

lifetime benefits roughly constant as life expectancy goes up, so because people would be receiving their benefits over a longer and

longer number of months——

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Senator LOTT. Even though they may not have paid into it, or

you can justify it, they would get these increasing benefits based

on age?

Mr. ORSZAG. Benefits would still increase from one generation to

the next. What we would be trying to do is insulate the system

from the effect of increases in life expectancy.

Senator LOTT. What you would do, though, would be to raise

more revenue for Social Security. Is that correct?

Mr. ORSZAG. That is correct.

Senator LOTT. How would you do that, now? Are you doing it in

two different areas?

Mr. ORSZAG. Yes, in a few different areas. Let me give you two

examples.

Senator LOTT. All right.

Mr. ORSZAG. Mr. Pozen mentioned this, and I think it is also

something worth exploring. One idea is to impose something like

the Medicare payroll tax, 2, 3 or 4 percent on all wages, rather

than just going up to the current $90,000 a year limit.

The reason for doing that is, there is now more than $800 billion

in wages above that cap that go untaxed. That more than $800 billion represents about 15 percent of total wages, which is up from

about 10 percent in 1983.

In my view, it makes sense to try to walk that back. But an alternative, again, as I mentioned in my oral testimony, you could

use part of an estate tax revenue dedicated to Social Security and

use that to help to restore solvency.

Senator LOTT. But if we did that, of course, we would not be able

to use that savings to deal with the overall government deficit,

which we are being told we should do. You suggested that we have

not been able to come up with a plan. Yes, we can come up with

a plan, we just have not had the courage to do what is necessary

to control Federal Government spending.

But again, is it fair to say that the main part of your plan is to

get more revenue by raising taxes in several different ways into Social Security? Is that correct?

Mr. ORSZAG. Well, we have both some additional revenue dedicated to Social Security and then some changes on the benefit side.

The reason we have additional revenue is precisely to mitigate the

reductions that would otherwise be required. It is a very simple

trade-off. If you are going to restore solvency, the less that you

dedicate in additional revenue, the more you have to cut on the

benefits side.

Senator LOTT. My impression is, your plan is a tax increase. I

think that is a Democrat plan.

Mr. Ferrara, just so I can get under the wire here.

Mr. FERRARA. Yes, sir. I will wait.

Senator LOTT. Now people are already paying, both the employee

and employer, 12.6 percent.

Mr. FERRARA. 12.4.

Senator LOTT. 12.4 into this program.

Mr. FERRARA. Right.

Senator LOTT. Which is very significant. The people I know,

small business men and women, farmers, working people, they do

not want to pay more into this. They do not want to pay more

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taxes. They already think they are paying too much in taxes, from

gasoline taxes, right up and down the line. So, I think it is really

the most unfair tax of all, the payroll tax.

Mr. FERRARA. Mr. Orszag would both raise taxes and cut benefits, and no Democrat has introduced this plan. That cannot solve

the problems of Social Security, but would make them worse because it would make it a worse deal.

It would reduce the rate of return of Social Security even more.

If you raised taxes and cut benefits, more people would have a negative rate of return on the program. I think that is why you see

nobody introduce that.

Mr. ORSZAG. Instead, we should cut Medicare benefits and use

that money.

Mr. FERRARA. Well, whose proposal is that?

Mr. ORSZAG. Yours.

Mr. FERRARA. No. Come on. Tell the truth now.

Senator LOTT. I am for that. We should do that. In fact, we made

a huge mistake in what we did 2 years ago.

The CHAIRMAN. The Senator from Oregon.

Senator WYDEN. Thank you, Mr. Chairman. Thank you for the

second round, Mr. Chairman.

Mr. Ferrara, I said earlier when I looked at your proposal, no

benefit cuts, no substantial risks, no major debts in terms of financing. I said it is a little like telling somebody they can have

three hot fudge sundaes a day and lose weight. Throughout the

course of the morning, you just keep adding to the sundae, more

nuts, more cherries. It just keeps going on and on.

I want to see if I can sort some of this out. Now, I have seen one

report indicating that you would pay for your program with a $6.9

trillion general revenue transfer for which unspecified cuts would

be made in Federal spending.

The reason I ask about this, and you correct me if I am missing

something, if the cuts are not made, then we have debt. So, I want

to be clear, my reading of your proposal is that it involves a substantial amount of debt. If the cuts are made, I would be very interested, at least, in knowing where you would like to have the cuts

made.

But you have made the very substantial proposal that it looks

like it is all gain and no pain, and perhaps you could just walk me

through this question of the financing, particularly, what happens

if there are not these cuts, because by my calculus, that becomes

debt at that point.

Mr. FERRARA. If there are not those cuts, then the Federal Government becomes an unbearable burden on the country. The Congressional Budget Office projects that Federal spending, as a percent of GDP, under current law will increase from 20 percent today

to 34 percent by 2050.

Now, what we have under the Ryan-Sununu bill is a very modest

spending restraint that would reduce that growth just 1.6 percentage points below the baseline. So in other words, Federal spending

could still grow, under the spending limitation of Ryan-Sununu,

from 20 percent today to 32.4 percent by 2050. That is still far too

much.

58

What it does is, the spending restraint reduces the rate of growth

of Federal spending over 8 years by 1 percentage point, for GDP

minus 1 percent. You achieved more spending restraint than that

during the 8 Clinton years, when Federal spending grew at GDP

minus 1.8 percent.

So my point is, it is a very modest down-payment on restraining

what is overwhelming growth in Federal spending. Obviously, we

cannot sit here and watch Federal spending grow from 20 percent

to 32.4 percent of GDP, but the spending limitation under RyanSununu would still allow even that much. It is just a small downpayment on the amount of spending restraint you would need.

Senator WYDEN. Mr. Chairman, I appreciate Mr. Ferrara saying

now that his notion of what would be a modest step involves $6.9

trillion. I want to just wrap up by saying, Mr. Chairman, there is

no question in my mind—and I think you and I agree on this—that

this is a program that needs to be modernized. The demographics

are obvious. There are going to be many more older people retiring,

fewer younger people.

I was one of the 10 Democrats who joined you in voting for the

prescription drug bill because I thought that was a program that

needed to be modernized, and I still have the welts on my back to

show for that particular vote.

My concern is it is going to be very hard to modernize this program when the first step that is taken would, as the Wall Street

leaders told me yesterday, be reallocating risk and threatening the

safety net.

I just want to wrap up by way of saying, I am interested in working with you. I would like to see if we could find common ground,

like was done with Ronald Reagan and Tip O’Neill in 1983. I am

not talking about raising payroll taxes. I am not in favor of doing

that. I am in favor of trying to find common ground the way Ronald

Reagan and Tip O’Neill did.

My concern is, we are not going to be able to do it if the first

step unravels the Social Security safety net. But I just wanted to

say to you, as I said to Senator Santorum, I am interested in working with both of you, and I thank you.

The CHAIRMAN. Well, I want to say thank you. You may be one

of those forward-looking Democrats I have not paid enough attention to on this issue, and I need to sit down and talk to you.

You just may be in the mold of a Judd Gregg or a Chuck Grassley when Clinton was suggesting that we needed to save Social Security first, who worked with then-Democrats who wanted to follow

on with President Clinton’s suggestion of saving Social Security

first by working out a plan that included personal accounts.

We need to have that same bipartisanship under a Republican

President Bush that follows on some examples set by Democrats

and Republicans working together when President Clinton suggested saving Social Security first.

Senator WYDEN. Mr. Chairman, I think I had a minute left on

my time. I just want it understood that I am concerned that personal accounts—at least everything I have heard—unravels the Social Security safety net in a way that I think is going to make it

hard for us to find common ground.

59

But I still want to work with you, because I think we showed

with the prescription drug legislation that we could modernize a

program and bring it in line with the times. That was what my

comment was alluding to.

The CHAIRMAN. Well, I welcome that opportunity.

Senator Santorum?

Senator SANTORUM. I would add my name to that list of folks

who worked with, at that time, Larry Summers and Gene Speurle,

who were advising President Clinton on Social Security.

The CHAIRMAN. I am glad. I should not have overlooked you.

Senator SANTORUM. That is all right. That is not the first time.

[Laughter.] Just kidding, Mr. Chairman.

But it would be great to see some bipartisanship. I appreciate the

Senator from Oregon and his willingness to offer those comments.

I am hopeful. I know the Senator from New York, Senator Schumer, criticized the President for not being here, not presenting a

plan. People in glass houses. The fact is, not one person, certainly

in the Democratic leadership, has presented any plan.

I find it remarkable that Senator Schumer would criticize the

President for not putting forth a plan, and then proceed to attack

his plan and tell us how much benefits will be cut, which is, again,

a remarkable sleight of hand to accuse someone of not having a

plan, and then tearing a plan apart.

Senator Lott said the idea that this is privatization, which of

course it is not, that is not the President’s plan, I know the Senator

from New York knows that.

I found it also interesting that he used the term, this is an insurance program, not an investment program. I do not know that

much about insurance, but I would suggest that most insurance

companies finance their benefits through investment.

I do not know of too many insurance companies who would be

in business if they had a pay-as-you-go system for providing their

benefits. They finance insurance through investment. Why? Because they would be in jail if they did not. So, I just wanted to

throw that part out.

I want to make a couple of comments on comments that were

made, and then I have a couple of questions.

First, Mr. Orszag, you said an interesting point. You said younger workers whose lives do not turn out so well end up supporting

the system.

Mr. ORSZAG. No, no. Benefitting from the system. They get lifetime earnings insurance from the system.

Senator SANTORUM. No, you just said recently that younger

workers who do not turn out so well, their lives who were ended

prematurely, end up contributing to the system.

Mr. ORSZAG. Sorry. There are two different questions. One is,

under the President’s proposal, what happens to workers who die

before retirement.

Senator SANTORUM. Yes.

Mr. ORSZAG. By not turning out so well, I meant that their wages

were not as high as they had hoped that they would be, or that

they would become disabled. Those workers benefit from the current Social Security program disproportionately.

Senator SANTORUM. All right.

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Mr. ORSZAG. I am sorry if I misspoke.

Senator SANTORUM. I was not quite sure I understand that.

Mr. FERRARA. Right. He meant, they contribute to the system if

they die younger, then their money goes to——

Senator SANTORUM. That is how I took it.

Mr. ORSZAG. I did not mean to say that.

Mr. FERRARA. He did say that at one point in this long and extended session.

Senator SANTORUM. You did, like about 10 minutes ago.

Mr. FERRARA. He did say that at one point

Senator SANTORUM. I clearly took that you said, well, they die

younger, and therefore their money gets contributed to the system.

Mr. ORSZAG. We can make this very clear with the written

record.

Senator SANTORUM. All right. Great. That is fine. I just wanted

to make sure.

Mr. ORSZAG. Thank you.

Senator SANTORUM. I did not know what point you were making.

Mr. TANNER. It would be true if he had said that.

Senator SANTORUM. It would be true, but it would not be one

that I would think he would make. That is why I was somewhat

surprised he made it.

Ms. ENTMACHER. Yes. Well, certainly it is true that women who

tend to earn less over their working lives, because of the wage gap

and because they take more time out of the workforce for

caregiving, do better under Social Security because it has a progressive benefit formula, and the spousal benefits. So working

women, who tend to earn less over their lives, definitely benefit

from the current system.

Senator SANTORUM. And I suspect that a personal retirement account system could be structured so as to structure the accounts to

make sure that those who are lower income, as well as those who

are in and out of the workforce, would make sure that they would

have a better benefit contribution when they are in the workforce.

Mr. FERRARA. That is what we do in the Ryan-Sununu.

Senator SANTORUM. Another thing. Mr. Orszag, you said that

personal retirement accounts will add to total costs because eventual savings will never be realized. Then you said that personal retirement accounts were bad because they were just loans against

future benefits. Now, I do not know how you can say both of those

things and be consistent intellectually.

Mr. ORSZAG. Sure. Because not all the loans will be fully repaid.

That means that it is both a loan, and that the Federal Government will be out some money as a result of the loans not being

fully repaid.

So for example, take a higher earner. Let us assume that we

have progressive price-indexing. Take a high earner. The worker

will owe—and let us just make up some numbers—back $10,000 a

year.

If his or her traditional benefit is only $9,000 a year, the government is not going to reach into the worker’s pocket and pull out

extra money. That is a case in which the government loses money

as a result of the worker participating in the accounts.

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Mr. TANNER. Senator, could we lose this loan analogy once and

for all? Because it is not a loan, it is simply an opportunity cost.

What you have is a chance to put the money in traditional Social

Security and earn that rate of return or put the money into your

individual account and earn that rate of return, and you choose one

or the other.

If you choose the individual account, you do not get the benefit

from the traditional Social Security for that portion. If you choose

the traditional Social Security for that portion, you do not get the

money from the individual account. This is sort of like saying, if you had $20,000 and you were going

to go out to buy a car, and you were trying to choose between a

Ford and a Chevy, if you chose the Chevy, then somehow the Ford

has lent you the money, because you do not get to have both the

Ford and the Chevy. The reality is, you are simply picking one set

of benefits or another.

Mr. ORSZAG. Senator, Goldman Sachs has called it a loan. Actually, interestingly, the terminology surrounding the accounts is almost exactly identical to the terminology used for margin investing

in financial markets. Just like investing on margin is a loan, this

is effectively a loan. We can debate the semantics, but I think it

provides insight.

Mr. FERRARA. The term ‘‘loan’’ is an academic construct that he

has created. The people who analogize this to margin investing,

that is only if you borrow the whole thing. But again, in the RyanSununu plan, we do this without permanent net borrowing.

Senator SANTORUM. The other point I want to make, Mr. Orszag,

you talked about increasing the cap because the percentage of payroll, and you picked out, I think, 1981.

Mr. ORSZAG. 1983.

Senator SANTORUM. 1983. And said it was 90 percent or 91 percent of payroll.

Mr. ORSZAG. Ninety.

Senator SANTORUM. Yes. But I think, if you look back over the

history, that was the highest level it had ever been. So you picked

the highest point to pick as your model of what percentage of payroll we should be covering.

As you know, back in 1968, it was 73 percent of payroll. So, I

do not think it is quite forthright for you to have gone back and

said, well, we can just pick this arbitrary number, 91 or 90 percent,

as the top, and say that that is what it has been.

In fact, it is averaged. If you take the average percentage of payroll since 1937, has it not averaged pretty much exactly where we

are today, around 85 percent of payroll?

Mr. ORSZAG. I do not have that number.

Senator SANTORUM. I do.

Mr. ORSZAG. All right. Eighty-five. But two points are worth noting. First, the reason that we picked 1983 was simply that that

was the time of the last reform. Second, our plan does not actually

go all the way back to 90, it only goes back to 87 percent. So, I was

just holding that out as something that, implicitly, was behind the

1983 reforms, and we do not actually go all the way back there,

anyway.

Senator SANTORUM. All right.

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Two other points, Mr. Chairman, if you will indulge me. I appreciate it, thank you.

A question on budget deficits. Really, what we are talking about

here with personal accounts, what you insist on calling a loan, is

really just looking at, what is the best way to finance this system

in the future? We are going to pay these benefits.

I think everyone here believes, while there is not a guarantee

under the U.S. Supreme Court case that everybody insists, I understand that, but there is an implicit guarantee that the Congress is

not going to reduce benefits or dramatically reduce benefits certainly of people at or near retirement in the future.

So we are going to have this obligation out there, and this obligation is not funded. I think everyone accepts that future obligations

to Social Security are not funded at this point.

So the question is, how do we fund them? Do we fund them

through tax increases? Do we fund them through benefit cuts? Do

we fund them some way using investment as a way to pre-fund the

liability?

When you do that, then you take money that you would be,

under the current scenario, starting in 2017, borrowing to pay benefits. Does everyone agree, if we do not make any changes, in 2017

we are going to have to borrow to pay benefits?

So instead of borrowing 12 or 13 years from now to pay benefits,

what about borrowing now to finance those benefits? You say, well,

the difference is, we have an actual cost of borrowing, 15 years of

borrowing costs in this case, that we would not have if we just

waited a few years to borrow. True.

Can we look at it, maybe stepping back a little further, saying,

what is going to be the position of the Federal Government 15, 20,

30, 40 years from now in its ability to borrow versus today in its

ability to borrow?

I think what we would suggest, is that demographics—the fact

that we are aging, having fewer children, and that the boomers are

going to begin to retire—show that given that three of the four biggest programs in the Federal Government, Medicare, Medicaid and

Social Security, that demographics are going to drive budget deficits to levels heretofore unseen.

So the question is, is it perhaps wise to have additional borrowing now, when although deficits are high, not nearly as high as

they will be in the future, to finance a reduction in the deficit when

deficits become problematic?

Ms. ENTMACHER. Senator, if I might. I think the reason that we

have seen the growth in deficits that we have over the last few

years is that the revenue base has been shrinking. The tax cuts

have really diminished the amount of revenue that the Federal

Government takes in, and will continue to do so if the tax cuts are

made permanent. Mr. Ferrara has talked about——

Senator SANTORUM. What numbers are you using? Are you using

the percentage of GDP and taxes? Is that what you are using?

Ms. ENTMACHER. Yes. The tax cuts have reduced the revenue

base. As the tax cuts are made permanent, that revenue base will

shrink. We will be facing——

Senator SANTORUM. I am just trying to understand. What are

you basing that on? Are you basing that on, the percentage of

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taxes, as a percentage of GDP, is going down if we made the tax

cuts permanent?

Ms. ENTMACHER. Peter, do you have something?

Mr. ORSZAG. It is lower than it would otherwise be.

Senator SANTORUM. I understand that.

The CHAIRMAN. But do not forget, they were as high as they were

in 2001 since World War II. What we are trying to do is have a

tax policy in this country that keeps the revenue coming into the

Federal treasury where it has been for 40 years—between 17 and

19 percent of Gross National Product.

Mr. ORSZAG. I think the problem with that is precisely the one

that Mr. Ferrara has highlighted, which is, we never before in this

country have faced a demographic challenge like we face going forward.

To just look at the historical period where entitlement spending

was a tiny fraction of what it is projected to be, leaves out the point

that entitlement spending, and that is Medicare, Medicaid and Social Security——

Senator SANTORUM. I think we are agreeing on the point that we

have promised a lot of spending.

Mr. ORSZAG. Absolutely.

Senator SANTORUM. And we do not have a way to finance it.

Given traditional historic tax rates, we will not be able to finance

that.

Now, here is the question. Do you believe that global competition

20 years from now from China, India, and the rest of the world will

be less or more rigorous?

Mr. ORSZAG. I think it will probably be more rigorous.

Senator SANTORUM. So if global competition will be more rigorous, does it make sense for us, looking forward to the quality of

life that future Americans will have, that in the face of more rigorous global competition we will have much higher taxes? Would

it make more sense for future generations that we avoid making

promises we cannot keep, given that global competition?

Mr. ORSZAG. Senator, I think the best way that we can provide

for future generations is both by investing in their education, but

also by increasing our National saving rate. That is the only way

in which we are going to accumulate more capital as Americans.

Senator SANTORUM. Making a case for personal retirement accounts?

Mr. ORSZAG. No, I am not. In fact, let me now quote, since we

have now talked about Presidential Chief Economic Advisors, from

Harvey Rosen, who is the President’s Chairman of the Council of

Economic Advisors. I am quoting from his new textbook: ‘‘There is

no reason to believe that privatization by itself,’’ he uses that word,

not me, ‘‘would raise national saving. At the end of the day, all that

takes place is a swap of public and private securities between the

trust fund and private markets. No new saving is created. If you

create these accounts and issue debt to finance them, you have

done nothing to help future generations.’’

Mr. FERRARA. That is only if you borrow all the money, do you

have no net savings increase. But again, I have never been an advocate of financing the entire transition by borrowing all the

money. In the Ryan-Sununu bill, we try to eliminate all net debt

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so that you go to the fully funded system that Martin Feldstein

was originally envisioning in the 1970s.

I mean, of course if you borrow it all back, then you do not get

a net increase in savings capital. There are other advantages you

get, but you do not get that one. But if you do it the way we do

it in Ryan-Sununu, then you get that one also.

Senator SANTORUM. I just want to make the point, and I think

the point is an important point, which is, if we do not act now and

do something to help pre-fund this liability, in my opinion, and

simply go to increased taxes, particularly payroll taxes, which is

what you are suggesting, which will make our workers less competitive in an increasingly competitive global environment, and we

continue to be able to not do something about reducing spending,

which, as Mr. Ferrara has said will increase from 20 percent of

GDP to 32 percent of GDP, then we are in a situation that is simply unsustainable.

We will put our future generations in an economic vise they will

simply have to do drastic things to get out of. Simply raising taxes,

in the face of global competition, putting more burden of debt and

spending on future generations, is not—is not—a desirable alternative, given what the world is going to look like 20 years from

now.

I think most people will accept that. Now, we may disagree on

how we have solved this problem, but I think what these gentlemen are presenting, at least in my mind, is a way around these

dramatic increases in taxes, which will surely come when the

boomers retire, to finance these benefits in the face of an economy

that is becoming less and less competitive with the world.

Mr. ORSZAG. Senator, again, the key to Mr. Ferrara’s plan is this

reduction in spending that is assumed without any specificity. If

there are specific ways of cutting Medicare and Medicaid spending

by the amounts that are discussed, let us look at them.

Mr. FERRARA. But they are not focused on Medicare and Medicaid spending.

Mr. ORSZAG. In the absence of specificity, there is nothing there.

It is a magic asterisk.

Mr. FERRARA. We specified, in several papers I wrote, far more

in benefit restraint than would be necessary under Ryan-Sununu,

so you should keep up with the literature.

Senator SANTORUM. Could I ask just one final question on this?

Then I promise, Mr. Chairman, I will stop.

Are you suggesting that we do not need spending restraint, that

looking at the Federal budget spend-out, that we can maintain this

level of spending?

Mr. ORSZAG. Not at all, Senator. But what I am saying is, it is

grossly irresponsible to simply assume the savings and dedicate

those to Social Security, which is what is being done, without specificity.

Senator SANTORUM. Do you believe future Congresses will allow

spending to increase at the rate it is scheduled to increase?

Mr. ORSZAG. I think that, unfortunately, Congress will probably

not tackle this problem until a fiscal crisis is upon us, and we are

coming increasingly close to having that.

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Senator SANTORUM. So maybe having some plan that forces discipline now would be a good idea.

Mr. ORSZAG. Well, that would be like arguing that we should

gain a lot of weight in order to force ourselves to go on a diet.

Senator SANTORUM. Not at all. What we are saying is, sometimes

we need an incentive to be able to go on that diet. The incentive

would be having personal savings and investment in a better,

sounder retirement.

Mr. ORSZAG. This is an important point. The transfers that occur

from the rest of the budget to Social Security under Mr. Ferrara’s

plan occur regardless of whether the spending cuts happen or not.

Senator SANTORUM. You are arguing his plan. I am not on his

plan, I am arguing the general concept. But I understand, you get

in the box and you have to defend it.

Mr. TANNER. Senator, could I just quickly make one point on the

size of the tax increases that we are talking about here? The tax

increase would be truly enormous and truly have a devastating impact, I think, on the economy and on competitiveness.

If you were to remove the cap on the wages subject to Social Security payroll tax, which I recognize——

Senator SANTORUM. Remove the cap, meaning lifting the cap, which is now at $90,000, to tax all income at 12.4 percent.

Mr. TANNER. Right. In the first 10 years alone, that would be a $1.3 trillion tax increase. It would give the U.S. the highest marginal tax rates in the world. We would have a higher marginal tax

rate than Sweden or Germany.

In exchange for that, you would get precisely 7 additional years

of cash flow solvency under Social Security. So you would increase

taxes by $1.3 trillion and put off Social Security’s cash flow deficit

by just 7 years, so to solve Social Security just by raising taxes is

going to take an enormous tax increase of the type that this economy simply cannot suffer.

Mr. FERRARA. Let me just say one thing, quickly, to address the

mischaracterization of Mr. Orszag of the exercise I had engaged in

advancing this plan. The point of the thing was to show a mathematical result: if you engage in this amount of spending restraint,

this is the result.

The Chief Actuary of Social Security did the math. We went to

him so he would do the math, so people who say, I cannot add and

subtract, would not be able to make that criticism. It is simply a

mathematical exercise. If you engage in this amount of spending

restraint, then you get those results.

Now, if I was the President of the United States, I would have

proposed a bill with more specificity. If he wants more specificity,

well, maybe I should run. But it is an unfair criticism.

It was just a mathematical exercise to show, if you do these sorts

of things, you are going to get those results. It actually ends up as

a very modest spending restraint that you need to accomplish. In

fact, we need to do that, and more, as a country or we are going

to be in very, very deep trouble.

Ms. ENTMACHER. But Mr. Ferrara has kept saying that one of

the attractive features of his plan is that it guarantees the benefits

that people are counting on, the people who are poor, the people

who are disabled, that all these people will be protected, and that

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his plan has a guarantee. If it is only a mathematical exercise and

we do not know where the funds are coming from, where is that

guarantee?

Mr. FERRARA. It guarantees the benefits of Social Security. But

we say over and over again, we do not guarantee the rest of Federal Government spending. Are they supposed to say it is a free

lunch and it dramatically cuts government spending? Well, it cannot be both. It can only be one or the other. So, really, give me just

one criticism and let us just deal with that one.

Mr. ORSZAG. Senator, I would just add, very briefly, that it is a

mathematical exercise to note that if you cut 1,000 calories out of

your diet, you will lose a pound about every 4 days. It does not tell

you anything about how you are actually going to go about doing

that.

Mr. FERRARA. But at least it shows exactly the amount of calories you need to cut. That was the important point.

Senator SANTORUM. Thank you, Mr. Chairman.

The CHAIRMAN. Yes. And I thank all of you very much. I found

it very entertaining. [Laughter.] But more importantly than entertaining, dealing with a specific subject that I plan on this committee dealing with sometime this summer.

Now, I may be fooled and I may not get to that point, but I think

that this is an opportunity that has been given to us. As I said before, this is so politically sensitive that somehow Congress will only

talk about Social Security when forced to by presidents like Carter,

Reagan, Clinton, and Bush.

I feel I should not lose that opportunity to bring about changes

in Social Security, so that there is ownership and so that there is

preservation of this program for our children and grandchildren.

The hearing is adjourned. Thank you all.

[Whereupon, at 1:23 p.m., the hearing was concluded.]

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A P P E N D I X

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1See http://www.actuary.org/pdf/socialsecurity/tech—dec03.pdf.

RESPONSES TO QUESTIONS FROM SENATOR BAUCUS

DEEP BENEFIT CUTS

Question: An analysis of Mr. Pozen’s plan by the Office of the Chief Actuary of

the Social Security Administration was released on February 10th of this year. According to tables B1 and B2 of that analysis, a person who is born 5 years from

now, who retires at age 65, and has career earnings that are 60 percent greater

than the national average defined by the Social Security Administration—but which

is still only $59,000 this year—would have their benefits cut by about 40 percent

relative to current law. Isn’t that a deep benefit cut?

A worker who is born 5 years from now, retires at age 65 and who has career

earnings at the national average as defined by the Social Security Administration—

only $36,000 of earnings this year—would have their benefits cut by 28 percent.

Isn’t that a deep benefit cut?

These benefit cuts are not limited to those retiring in 2075. A worker who is 25

years old today with career earnings 60 percent above the national average—only

$59,000 this year—and who retires in 2045 would receive a benefit cut of 24 percent. Isn’t that a deep benefit cut?

Answer: As my written testimony notes and as your question emphasizes, progressive price-indexing imposes surprisingly large benefit reductions on average and

higher earners. The reason is that it attempts to close too much of the actuarial deficit on the benefit side. Other plans dedicate additional revenue to Social Security,

mitigating the need for benefit reductions while still achieving long-term financial

balance within the program.

PRICE-INDEXING AND WAGE-INDEXING

Question: In an article Mr. Pozen has written, he includes an example of the impact of his ‘‘progressive price-indexing’’ proposal. The example is for someone who

has earnings that are 50 percent between the maximum earnings subject to tax and

the earnings level where wage-indexing ceases. He says that this person would have

their benefits half wage-indexed and half price-indexed. Isn’t this assertion that half

the benefit would be price-indexed and half would be wage-indexed wrong? What is

the correct analysis?

Answer: Mr. Pozen’s analysis is incorrect. A 25-year-old worker who is earning $20,000 today (and whose wages increase in line with average wage growth in the

future) would experience no reduction in benefits under the progressive price-indexing proposal. A 25-year-old worker who is earning $90,000 today would experience

a benefit reduction of 29 percent. Yet a 25-year-old worker with earnings half-way

in between these two workers—with earnings of $55,000 per year—would experience

a benefit reduction of more than 23 percent. Mr. Pozen’s incorrect claim would suggest instead that the worker would experience a reduction of only 14.5 percent (the

average of 29 percent and 0).

INFINITE HORIZON

Question: For the last couple of years, the Social Security trustees have made projections over the infinite horizon. Several of the witnesses at today’s hearing have

made similar statements about their proposals over the infinite horizon. Do you

think the infinite horizon is helpful in the public policy debate about Social Security?

Answer: Infinite horizon projections may provide useful information to analysts,

but they should not play a prominent role in the policy debate. The American Academy of Actuaries has expressed particularly strong concerns about infinite horizon

projections. In particular, the Social Insurance Committee of the American Academy

of Actuaries wrote that such projections ‘‘provide little if any useful information

about the program’s long-range finances and indeed are likely to mislead anyone

lacking technical expertise in the demographic, economic and actuarial aspects of

the program’s finances into believing that the program is in far worse financial condition than is actually indicated. . . .’’ 1 As a result, such infinite-horizon projections

should not be emphasized in policy discussions.

COST OF DELAYING REFORM

Question: President Bush recently claimed that delaying action on Social Security

by ‘‘. . . just 1 year adds $600 billion to the cost of fixing Social Security.’’ Other

administration officials have used the same figure. My understanding is that this

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2 Esther Duflo, William Gale, Jeffrey Liebman, Peter Orszag, and Emmanuel Saez, ‘‘Saving

Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R

Block,’’ Retirement Security Project Policy Brief 2005–5, May 2005.

$600 billion figure is not at all what it seems to be. I thought that the latest trustees’ report, in essence, made that point. Can you comment on this issue?

Answer: The $600 billion figure, which reflects the change in the infinite-horizon

deficit from 1 year to the next, is misleading for many reasons. First, it is based

on an infinite horizon calculation, as discussed above. Second, it does not adjust for

inflation or the size of the economy. As a share of the projected economy, the projected infinite-horizon deficit has not increased. As the Social Insurance Committee

of the American Academy of Actuaries has emphasized, ‘‘The infinite-time-horizon

unfunded-obligations estimate [in dollar terms] increases each year. . . . The public,

seeing annual large increases in unfunded obligations, is likely to be misled into believing that the program’s financial situation is deteriorating and the cost of restoring actuarial balance is increasing, even if this is not the case.’’ Finally, the figure

is not put into the context of other policy choices. For example, applying the same

misleading methodology to the administration’s tax cuts as the administration applies to Social Security shows that the tax cuts ‘‘cost’’ about $1 trillion per year, because their effect on the infinite-horizon fiscal gap increases by roughly that amount

each year.

INCREASING SAVINGS

Question: Let’s focus on lower-income taxpayers. Your testimony shows that 401(k) plan participation rates skyrocket among those earning less than $20,000

when automatic enrollment is added to the program: from 13 percent to 80 percent. • Does this increase translate directly to increased personal savings? • Most low-income taxpayers don’t have access to an employer-sponsored plan.

Are any of the other options you discussed as effective as automatic enrollment

in boosting savings for low-income taxpayers?

Answer: Automatic enrollment has been shown to increase participation rates in

401(k) plans, and automatic escalation has been shown to raise contribution rates

and accumulations within 401(k)s over time. It is theoretically possible that participants respond to automatic enrollment by decreasing their savings or increasing

their borrowing outside of the plan, which would diminish or eliminate any positive

effect on personal saving. It is likely, however, that the net effects on both personal

and national savings would be positive. Workers who become contributors through

automatic enrollment tend to be younger and have lower incomes and less education

than other participants. Evidence from the pension and 401(k) literature suggests

that a significant portion of contributions by households with these characteristics

is a net addition to personal and national savings.

SAVER’S CREDIT

Question: You recommend strengthening the Saver’s Credit. We obviously need to

make this credit permanent. You suggest we also should make it refundable, and

extend the credit to more middle-income households.

• First, which of the two—refundability or extension to more middle-income

households—will be most effective in actually increasing personal savings?

• And second, do you have an opinion as to whether the credit should be refunded

to the individual, or be transformed into a matching contribution and deposited

to the saver’s IRA or 401(k) plan?

Answer: Outside of 401(k) plans, the same logic of making saving easier could be

applied—which would be especially beneficial if combined with steps to increase the

incentive to save. For example, most American households receive an income tax refund every year. For many, the refund is the largest single payment they can expect

to receive all year. Accordingly, the more than $200 billion issued annually in individual income tax refunds presents a unique opportunity to increase personal saving. If this opportunity were combined with a stronger incentive for households to

save, the benefits could prove substantial. Recent research undertaken through the

Retirement Security Project strongly suggests that the combination of a clear and

understandable match for saving, easily accessible savings vehicles, the opportunity

to use part of an income tax refund to save, and professional assistance could generate a significant increase in retirement saving participation and contributions,

even among moderate- and low-income households.2

The research referenced above suggests an effective way to increase saving would

revamp the Saver’s Credit by simplifying its structure and changing the way in

which it is presented to tax filers. In my view, simplification is more likely to arise

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3 Consider an individual who contributes $2,000 to a 401(k) plan or IRA. The saver’s credit reduces Federal income tax liability by $1,000, which is 50 percent of $2,000. The net result

is a $2,000 account balance that costs the individual only $1,000 after taxes (the $2,000 contribution minus the $1,000 tax credit). This is the same result as occurs if the net after-tax contribution of $1,000 were matched at a 100-percent rate: the individual and the government each

effectively contribute $1,000 to the account. Similarly, the 20-percent and 10-percent credit rates

are equivalent to a 25-percent and 11-percent match, respectively. 4 Catherine Eckel, and Philip J. Grossman, ‘‘Rebate versus Matching: Does How We Subsidize

Charitable Contributions Matter?’’ Journal of Public Economics, 87(3–4), 681–701, 2003.

from making the tax provision refundable than by extending it further up the income distribution. Furthermore, the evidence is suggestive that transforming the

credit into a matching contribution would make it more effective, in part by changing the way it is viewed by tax filers. This may be because of how a credit is perceived, relative to a match of the same economic value. The 50 percent credit rate

for gross contributions under the Saver’s Credit, for example, is equivalent to having

the government match after-tax contributions on a 100-percent basis.3 Experimental

work has shown that credit rates are much less effective than equivalent match

rates to induce people to contribute to charities.4 Similarly, in the context of the

Saver’s Credit, it is possible that a 100-percent match rather than a 50-percent credit could have a large effect on take-up.

RESPONSES TO QUESTIONS FROM SENATOR SMITH

Question: You each presented divergent views on how Social Security ought to be

reformed to resolve the solvency problem. For a moment, would you set aside your

preferred proposals and consider where the other panel participants are on this

issue. And taking this broader perspective, can you tell the committee where you

perceive there to be the common ground in resolving the issue?

Answer: I unfortunately found little common ground across the witnesses invited

to testify. I do, however, believe there are at least some areas of common ground

with Mr. Pozen and Ms. Entmacher. It is my understanding that we all agree that

carve-out accounts do not directly reduce the projected actuarial deficit. We also

seem to agree that some combination of benefit and revenue changes is necessary

to address the deficit, although Ms. Entmacher appears to prefer addressing the

projected deficit on the revenue side and Mr. Pozen appears to lean more heavily

on the benefit side.

Question: Mr. Orszag, you criticize the idea of progressive price-indexing. But, you

also acknowledge that we will need to increase taxes and/or constrain benefits. If

we are to protect the poor in any action we take to shore up the Social Security

system, what constraint option then would you suggest?

Answer: Progressive price-indexing is deeply flawed because the future is certain

to differ from what we currently project it to be. Policy changes should be adopted

with an eye toward how they will perform when the future turns out to be different

than we currently expect; progressive price-indexing fails this test miserably. Under

progressive price-indexing, if real wage growth is more rapid than expected, benefit

cuts are larger. But if real wage growth is more rapid, the underlying 75-year actuarial deficit (in the absence of this provision) is smaller. The larger actual real wage

growth turns out to be, the smaller the need for benefit reductions but the larger

those reductions actually are under progressive price-indexing. Therefore, under

progressive price-indexing, the severity of the benefit cuts is inversely proportional

to the need for the benefit cuts. I have put forward many other ideas for changing

the benefit formula, including many detailed proposals contained in my book with

Peter Diamond (Saving Social Security: A Balanced Approach, Brookings 2004).

RESPONSES TO QUESTIONS FROM SENATOR ROCKEFELLER

Question: How long would it take to fully transition from the current pay-as-yougo Social Security program to a universally available private accounts system?

How much would it cost to continue to pay retiree benefits during this transition

period?

Isn’t it true that young people in their 20s and 30s would pay twice? They would

be paying for the retirement of their parents and grandparents who participated in

a pay-as-you-go system, but then these young workers would also be expected to

fund their own private accounts.

Answer: Under the administration’s proposal for accounts, the cash flow from the

accounts is negative over a period of roughly 45 years. Some have termed this period the ‘‘transition’’ to individual accounts. The adverse effect on the public debt

from the accounts, however, is permanent. The reason is that, to finance a loan to

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a worker (provided in the form of revenue deposited into an individual account

under the administration’s proposal), the government borrows funds. If the worker

repays the loan, the additional government debt on that transaction is extinguished,

so public debt returns to the same level as if that worker had not opted for an account. But note that at any point in time, even if all loans were eventually repaid,

some loans would always be outstanding. As a result, public debt at any point in

time would forever remain higher with the accounts than without them. The additional, ongoing higher level of debt in the long term is substantial: the administration’s accounts involve a sustained increase in outstanding public debt of more than

30 percent of GDP; this increase is only somewhat smaller than today’s level of publicly held debt relative to GDP (38 percent).

Question: Recently, President Bush traveled to Parkersburg, WV to visit the office

that stores the paper certificates for the government bonds held by the Social Security trust fund. He made fun of these bond certificates, saying essentially that there

is ‘‘nothing’’ in the Social Security trust fund. He implied that little slips of paper

could not secure Americans’ retirement.

And yet, the President has repeatedly assured people that one of their investment

options in a private account would be government bonds. He has said that people

who are uncomfortable with the risks associated with investing in stocks would still

be able to invest in safe Federal bonds.

I would like to know if there is any real difference between the government bonds

in the Social Security trust fund that the President made fun of and the government

bonds that the President claims workers should feel confident purchasing for their

private accounts?

Answer: The Social Security trust fund currently holds more than $1.5 trillion in

Treasury securities. These assets are backed by the full faith and credit of the U.S.

Government, which is widely respected in the global financial markets as providing

the benchmark of security for any financial asset. The Treasury bonds held by the

Social Security trust fund are every bit as ‘‘real’’ as the Treasury bonds held by private investors. Indeed, if anything, the vast bulk of the bonds held by the Social

Security trust fund are more valuable than tradeable government bonds because the

‘‘special purpose’’ bonds held by the trust fund carry special features not available

on other government bonds.

The discussion of the ‘‘meaning’’ of the trust fund often conflates two issues:

whether the bonds held by the trust fund are assets to the Social Security system,

and whether they are assets for the government as a whole. The first question is

unambiguous: the bonds held by the trust fund are an asset to the Social Security

system because they earn interest income and, if necessary, can be redeemed to pay

benefits. The fact that these bonds are ‘‘paper’’ assets does not in any way reduce

their value. All pension funds hold paper IOUs; so would the individual accounts

that the commission favors. The value of all paper assets depends on the willingness

of someone to redeem them. The bonds held by the trust fund are, if anything, more

secure than other paper assets, given their U.S. Government backing. The second

issue, whether the accumulation of the trust fund assets has improved the capacity

of the U.S. government as a whole to meet future obligations, is more subtle. In my

view, the surpluses in the Social Security program have reduced the public debt

that would otherwise have been issued, contributed to national saving, and thereby

made it easier for the government to meet its future obligations.

Question: The President has suggested that retirees would be protected from mismanaging their retirement funds, because they would be required to purchase an

annuity upon their retirement. The annuity would provide a steady stream of income, at least at the poverty level. However, the annuity market is very sensitive

to market conditions.

Isn’t it true that workers with identical amounts in their accounts could receive

very different monthly benefits based on the level of the stock market on the day

they bought their annuities?

(Note: CRS examined two hypothetical workers who each had $200,000 in their

accounts and retired on different days in 2003. The worker who retired and bought

his annuity at the market peak on December 31st would get a $2,002 monthly annuity [$24,024 yearly], but the worker who bought his annuity on the lowest day of

the market, March 11, would only get $1,395 [$16,740 yearly].)

Is this fair? How would retirees know when to buy their annuities?

Answer: Yes. As the CRS report study has shown, and as has been emphasized

in research by my colleague Gary Burtless, the pricing of annuities varies signifiVerDate 11-MAY-2000 15:40 Jun 07, 2006 Jkt 095484 PO 00000 Frm 00131 Fmt 6601 Sfmt 6621 26642.000 SFIN1 PsN: SFIN1
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5See, for example, Gary Burtless, Testimony Before the Subcommittee on Social Security of

the House Committee on Ways and Means, Hearing on Social Security and Pension Reform: Lessons From Other Countries, July 31, 2001. 6 As the actuarial memorandum on a plan put forward by Mr. Pozen notes, ‘‘If there are no

survivors, and the worker dies before such benefit entitlement, their estate would receive the

balance in their IA at death minus an offset that would be paid to the Trust Funds to compensate for their earlier allocations of a portion of their payroll taxes to their IA.’’ See ‘‘Estimated Financial Effects of a Comprehensive Social Security Reform Proposal Including Progressive Price Indexing, February 10, 2005—a proposal developed by Robert Pozen, member of the

2001 President’s Commission to Strengthen Social Security,’’ available at http://www.ssa.gov/

OACT/solvency/RPozen—20050210.pdf.

cantly across generations because of fluctuations in interest rates.5 It may make

sense for workers to bear this type of risk on top of a solid foundation of retirement

income; it does not make sense for workers to face this type of risk within the core

tier of retirement income.

Question: When the United Kingdom gave workers the option of private accounts,

there was a huge problem with investors taking advantage of workers and selling

them poor long-term investments. How should consumers be protected?

Answer: The U.K. experience should be carefully studied, since it vividly illustrates the problems that can arise when workers are not equipped with enough information to make wise choices regarding individual accounts. Ensuring that workers have adequate information and financial education to manage their individual

accounts could be expensive, effectively adding to the administrative costs imposed

under such a system.

Question: Most proposals for private accounts require reductions in traditional Social Security benefits to offset the worker’s payroll taxes that were diverted to fund

the private account. Some people have called this a privatization tax.

I am interested in understanding how such a privatization tax would be collected

on the account of someone who dies young, before retirement.

In such a case, would the worker’s survivors lose some of their anticipated Social

Security benefits to pay the government back for the private account?

Answer: A married worker who dies before retirement would leave her account,

but also her debt repayment owed back to Social Security, to her surviving spouse.

In other words, the surviving spouse would indeed lose some of their anticipated Social Security benefits to pay the government back for the individual account.

If a worker dies before retirement without a living spouse, the amount in the individual asset account may be distributed to heirs, but the amount owed back to Social Security could be eliminated under the administration’s proposal. (The administration has not clarified whether the amount owed back to Social Security would be

cancelled, but the proposals from the President’s commission in 2001 made this assumption.) If these amounts owed back to Social Security were extinguished, the

system would be made financially worse off because of the accounts. A recent proposal by Robert Pozen, a member of President Bush’s Social Security commission

in 2001, would avoid the actuarial harm created by pre-retirement deaths of nonmarried workers by having the government directly reclaim part or all of the account upon the death of such a worker.6

Question: I am also interested in understanding how workers would pay back the

government if they were disabled early in their career.

President Bush often talks about a worker building up a large private account

over the course of his career and then being able to enjoy a more prosperous retirement as a result of investment growth.

However, right now, about 40 percent of West Virginians who depend on Social

Security are receiving either disability or survivors benefits.

If someone becomes severely disabled at age 30 and is never able to work again,

what kind of balance would he be expected to have in his private account?

And how would his traditional Social Security benefits be reduced to pay for this

private account?

Answer: Under the administration’s approach, disabled workers who had not yet

reached retirement would be prohibited from withdrawing any funds from whatever

accounts they had accumulated before becoming disabled. Similarly, the loan repayment associated with the account would not occur until retirement. In many cases,

the accounts accumulated by disabled workers would be very modest.

RESPONSES TO QUESTIONS FROM SENATOR LINCOLN

Question: Mr. Orszag, can you explain what would happen to the account of someone who dies young, before retirement—under the President’s plan or Mr. Pozen’s

plan?

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Answer: A married worker who dies before retirement would leave her account,

but also her debt repayment owed back to Social Security, to her surviving spouse.

In other words, the surviving spouse would indeed lose some of their anticipated Social Security benefits to pay the government back for the individual account.

If a worker dies before retirement without a living spouse, the amount in the individual asset account may be distributed to heirs, but the amount owed back to Social Security could be eliminated under the administration’s proposal. (The administration has not clarified whether the amount owed back to Social Security would be

cancelled, but the proposals from the President’s commission in 2001 made this assumption.) If these amounts owed back to Social Security were extinguished, the

system would be made financially worse off because of the accounts. A recent proposal by Robert Pozen, a member of President Bush’s Social Security commission

in 2001, would avoid the actuarial harm created by pre-retirement deaths of nonmarried workers by having the government directly reclaim part or all of the account upon the death of such a worker.

Question: I’m sure you all have heard retirement referred to as a three-legged

stool. One leg is private savings, one leg is employee benefits/pensions, and the last

leg is Social Security. American workers bear the risk for the first two legs but Social Security is supposed to be the one leg of the stool that is stable, without risk.

I believe that one of the key points in today’s discussion is who should bear the

risk when it comes to Social Security—the government or the American worker. It

is my belief that the leg of the stool representing Social Security should remain stable. It seems to me that privatization would shift the risk of retirement savings to

the American worker, leaving millions of workers no secure source of retirement income—with three shaky legs of the proverbial stool.

This is especially concerning for our Nation’s farmers. Farmers already subject

themselves to so much risk: the weather, trade pressures. This is an additional burden that will have a negative impact on them.

Do you advocate that Congress shift the risk associated with Social Security from

the Federal Government to the American worker?

Answer: As my written testimony emphasizes, I do not believe that the Federal

Government should shift additional risk to individuals within the core tier of retirement income.

Question: I believe that encouraging personal savings is a key component of this

debate. I am extremely interested in looking at ways to encourage individuals to

save more for their retirement. We are at the lowest savings rate in our Nation’s

history, and that is why financial literacy must be a part of this discussion. We

must cultivate a nation of savers, not borrowers.

Do you have recommendations on how to encourage personal savings?

Answer: My written testimony also highlights several specific steps we could take

to boost household saving for retirement. In particular, retirement security can be

significantly enhanced by improving 401(k)s and IRAs through commonsense reforms that both sides of the Social Security debate should embrace. In the face of

the difficult choices presented by the current system, many people simply procrastinate, which dramatically raises the likelihood that they will not save enough for retirement. Disarmingly simple concepts—such as changing 401(k) plans so that workers are automatically enrolled unless they opt out, and making it easy to save part

of an income tax refund—have the potential to strengthen retirement security significantly. Both sides of the Social Security debate should agree on the straightforward steps necessary to improve 401(k)s and IRAs, and should come together to

enact the changes immediately. More details on the required steps can be found at

www.retirementsecurityproject.org.

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