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95–604 PDF 2004

S. HRG. 108–641

STRENGTHENING SOCIAL SECURITY:

WHAT CAN PERSONAL RETIREMENT ACCOUNTS

DO FOR LOW-INCOME WORKERS?

HEARING

BEFORE THE

SPECIAL COMMITTEE ON AGING 

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

WASHINGTON, DC

JUNE 15, 2004

Serial No. 108–37

Printed for the use of the Special Committee on Aging

(

SPECIAL COMMITTEE ON AGING 

LARRY CRAIG, Idaho, Chairman 

RICHARD SHELBY, Alabama 

SUSAN COLLINS, Maine 

MIKE ENZI, Wyoming 

GORDON SMITH, Oregon 

JAMES M. TALENT, Missouri 

PETER G. FITZGERALD, Illinois 

ORRIN G. HATCH, Utah 

ELIZABETH DOLE, North Carolina 

TED STEVENS, Alaska 

RICK SANTORUM, Pennsylvania 

JOHN B. BREAUX, Louisiana, Ranking 

Member 

HARRY REID, Nevada 

HERB KOHL, Wisconsin 

JAMES M. JEFFORDS, Vermont 

RUSSELL D. FEINGOLD, Wisconsin 

RON WYDEN, Oregon 

BLANCHE L. LINCOLN, Arkansas 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

DEBBIE STABENOW, Michigan 

LUPE WISSEL, Staff Director 

MICHELLE EASTON, Ranking Member Staff Director 

(II) 

C O N T E N T S 

Page 

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

PANEL I 

Hon. David M. Walker, Comptroller General, General Accounting Office, 

Washington, DC ................................................................................................... 2

PANEL II 

Peter Ferrara, Institute for Policy Innovation and the Club for Growth, Washington, DC ............................................................................................................. 43

Jeff Brown, Ph.D., University of Illinois at Urbana-Champaign, Champaign, 

IL ........................................................................................................................... 58

Jeff Lemieux, Centrists.org, Washington, DC ....................................................... 70

Christian Weller, Ph.D., Center for American Progress, Washington, DC ......... 86

(III) 

(1)

STRENGTHENING SOCIAL SECURITY: WHAT 

CAN PERSONAL RETIREMENT ACCOUNTS 

DO FOR LOW-INCOME WORKERS? 

TUESDAY, JUNE 15, 2004 

U.S. SENATE, 

SPECIAL COMMITTEE ON AGING, 

Washington, DC. 

The committee met, pursuant to notice, at 10:32 a.m., in room 

SD–628, Dirksen Senate Office Building, Hon. Larry E. Craig 

(chairman of the committee) presiding. 

Present: Senators Craig and Kohl. 

STATEMENT OF SENATOR LARRY CRAIG, CHAIRMAN 

The CHAIRMAN. Good morning, everyone. The U.S. Senate Special 

Committee on Aging will convene. 

Thank you all very much for being with us this morning and allowing us to adjust schedules a little bit for the joint session earlier 

this morning. 

Last year, my good friend and Ranking Member of the Committee John Breaux and I asked the GAO to use its analytical expertise to evaluate how the Social Security status quo or do-nothing plan would redistribute benefits for workers. We also asked 

how well personal retirement account models and other proposals 

might affect redistribution of Social Security benefits for our children and grandchildren. I was especially interested in this report 

as on objective and nonpartisan analysis. It is important for us to 

understand how reform would impact those in most need, the lowincome workers. 

Today’s GAO on study on Social Security redistribution builds on 

previous reports requested by myself and Senator Breaux and represented before this Committee by the Comptroller General. This 

Committee has been very active on issues of income security in retirement. The GAO continues to strongly support the research interests of this Committee, and we thank you, Mr. Walker, and all 

of your staff for the high of the quality of the work products that 

you present. 

As the United States considers personal retirement accounts as 

one potential option for strengthening Social Security, it is important that we understand how different proposals impact low-, middle-, and high-income workers. I want to emphasize that the topic 

of this hearing is really about America’s youth. Those currently on 

Social Security and about to retire will not be affected by any reforms discussed here today. 

2

Finally, I would also like to comment on the Congressional Budget Office study released yesterday with different projections on the 

issue of solvency compared to Social Security’s Office of Actuary. 

Those who advocate we do nothing suggests the CBO supports 

their position because insolvency is pushed forward by another decade. On the contrary, the problem of insolvency is still there, 

though we have a little more breathing room on the front, but the 

cash-flow deficit is still projected to occur prior to 2020. 

As many of us know, insolvency isn’t the only reason reform is 

necessary. We must also be concerned about long-run sustainability 

of the system and adequacy of benefits and a fair return for 

middle- and high-income workers. It appears the CBO projects that 

many low- and middle-income retirees will receive lower benefits 

than the actuaries were projects. As a result and contrary to the 

do-nothing crowd’s response to the CBO study, today’s hearing on 

benefits levels takes on an even greater importance in light of the 

CBO’s findings. 

With that, I am pleased to welcome our distinguished witnesses 

to the Aging Committee. On panel one, we have a single witness, 

one who is very familiar to this committee, David Walker, the 

Comptroller General of the General Accounting Office. 

On our second panel, we will hear from Peter Ferrara of the Institute for Policy Innovation and the Club for Growth; Dr. Jeff 

Brown, professor of Finance for the University of Illinois at Urbana 

Champaign Campus; Jeff Lemieux, executive director for the Centrist.Org of Washington DC., a think tank; along with Dr. Christian Weller, a senior economist mist from the Center for American 

Progress here in Washington. 

So I look forward to all of their testimony, and, David, let us 

begin this morning with you, and again, thank you for allowing us 

to be a little flexible in our schedule. 

STATEMENT OF HON. DAVID M. WALKER, COMPTROLLER 

GENERAL, GENERAL ACCOUNTING OFFICE, WASHINGTON, DC 

Mr. WALKER. Thank you, Mr. Chairman. I also appreciate your 

understanding in recognizing that I need to try to get out of here 

by eleven because I have a hearing on the House side. 

The CHAIRMAN. We will keep you on schedule. 

Mr. WALKER. Thank you, Mr. Chairman. 

I appreciate you inviting me here today to continue our dialog on 

a range of issues of mutual interests concerning the Social Security 

system and potential reform proposals. As I have stated before on 

numerous occasions, without substantive reforms, both of Social Security and the Medicare programs are unsustainable in their 

present form, and their long term impact on the Federal budget 

and the economy will be dramatic. 

Today, we are issuing a report at your request and the Ranking 

Minority Member, dealing with the issue of distribution of benefits 

and taxes relative to earnings levels. We believe this is an important contribution to the continuing discussion and debate about 

various Social Security reform proposals, and before I summarize 

the results of that report, I think it is important to make a few 

overview comments. 

3

First, Social Security reform is a part of a broader fiscal and economic challenge. In fact, it is a subset of a major fiscal imbalance 

that we face. The biggest part of it is Medicare. Second, focusing 

on trust fund solvency alone, as you noted in your opening comments, is not sufficient. We need to put the program on a path toward sustainable solvency and to consider cash-flow, to consider its 

percentage of the federal budget, its percentage of the economy, etc. 

Third, solving Social Security’s long-term financing problem is 

more than important and complex and simply making the numbers 

add up. It is not just about sustainable solvency. It also involves 

adequacy, equity, and administrative feasibility considerations. 

Last, but certainly not least, acting sooner rather than later would 

help to ease the transition difficulty and help facilitate the need for 

us to move on to much more difficult complex and controversial reforms, namely health care reform in general, and Medicare, in particular. 

As you know, Mr. Chairman, under Social Security, retired workers can receive benefits at age 65 that equal about 50 percent of 

their pre-retirement earnings for an illustrative worker with relatively low earnings, but only about 30 percent for individuals with 

relatively higher earnings. To ensure that beneficiaries have adequate incomes, Social Security’s current benefit formula is designed 

to be progressive, that is to provide disproportionately larger Social 

Security benefits as a percentage of pre-retirement earnings to 

lower earners than to higher earners. 

However, the benefit formula is just one of several program features that influence the way benefits are distributed. One such program feature includes provisions for disabled workers, spouses, 

children, and survivors. Changes in the program over time will affect the distribution of benefits across generations. So the distribution of Social Security benefits can vary by eligibility, household 

type, and birth year, as well as by earnings level. 

As you know, over the last several years, we have been developing increased capacity to use micro-simulation models and other 

types of tools to help quantify the effects of possible Social Security 

reform proposals, and in doing that, I would like to move on to the 

requested study. There are two distinct perspectives, in our view, 

relating to Social Security’s goals that suggest different approaches 

to measuring progressivity. Both perspectives provide valuable insights, in our opinion. First, an adequacy perspective focuses on 

benefit levels and how well they help to ensure a minimal subsistence or maintain pre-retirement-level living standards. Second, an 

equity perspective focuses on rates of return and other measures 

relating to lifetime benefits and relative individual contributions. 

This perspective also gauges whether the system gives people a, 

quote-unquote, fair deal for their contributions. These measures 

themselves describe the adequacy and equity, but the distribution 

with respect to earnings level describes progressivity. 

It is important to note that equity measures cannot accurately 

assess the distributional effects of reform proposals that rely upon 

general revenue transfers, because they don’t specify who is going 

to end up paying for those general revenue transfers, namely what 

the relative tax burden is going to be with regard to those general 

revenue transfers. In our view, estimating future effects on Social 

4

Security benefits should reflect the fact that the program faces a 

long-term actuarial deficit and benefit reductions and/or revenue 

increases will be necessary in order to restore program solvency. 

Social Security’s current distributional effects reflect program 

features and demographic patterns among its various recipients. 

The retired worker benefit formula favors low earners by design. 

In addition, the disability benefit formula also favors low earners 

since disability recipients are disproportionately low earners. Alternatively, individual Social Security reform proposals would have 

different distributional effects, reflecting various provisions that 

make up the proposed reform proposal. 

In particular, for example, Model 2 of the President’s Commission to Strengthen Social Security proposes a new system of voluntary individual accounts along with a combination of certain benefit reductions for all beneficiaries and selected benefit enhancements for selected low earners and survivors. One of its provisions 

would reduce Social Security defined benefits proportionately for 

all workers by modifying the current benefit formula. At the same 

point in time, benefits would be enhanced for certain lower earners 

and surviving spouses, and 4 percentage points of an individual’s 

payroll taxes up to a thousand dollar annual limit could be diverted 

an individual investment accounts. 

To illustrate the distributional effects of this proposal, we used 

our micro-simulation model to estimate the benefits under it and 

under our various benchmark scenarios. We did not examine the 

distributional effect of the equity measures because it presumes 

significant general revenue transfers and it is difficult to ascertain 

who will bear the burden of those general revenue transfers. Since 

the account participation is voluntary—by that, I mean the individual account participation—we use two simulations to show the 

bounds, one simulation that assumed that there is one hundred 

percent participation in individual accounts and another one that 

assumed there would be zero. From a practical standpoint, we 

know it is going to be somewhat in between. 

We also assumed that account participants would have the same 

asset allocation, that they would invest in the same type of portfolios, if have you will, divided between equities, fixed income, investments etc. 

Based on our simulations, the distribution effects under Model 2 

of the President’s Commission could favor lower earners more than 

the distribution of benefits under either the currently promised or 

currently funded benefits/services. Stated differently, the distribution of benefits or the progressivity under Model 2 would be better 

than under the current Social Security program. It is important, 

however, to note that while the simulation suggests that the distribution of benefits under Model 2 is more progressive than the 

benchmarks under the current program, that does not mean that 

benefit levels are always higher. 

Progressivity is about how the pie is divided up. It is not about 

how big the pie is, and, therefore, something can be more progressive, but the benefit may not be more adequate. According to our 

simulation, median household lifetime benefits for the bottom fifth 

of the population under Model 2–0, would be 3 percent higher than 

under the funded benefits scenario, but 21 percent lower than 

5

under the promised benefits scenario. Medium household lifetime 

benefits for the bottom fifth under Model 2–100 percent would be 

26 percent higher than under the funded benefits scenario, but 4 

percent lower than under the promised benefits scenario. 

I think it is important, last, to note that we used individuals 

born in 1985 as a basis to do our simulation because you were concerned about the longer-term effects on our children and grandchildren, appropriately so. Importantly, the results could differ depending upon the age of the individual and nature of the reform 

proposals going forward. 

So in conclusion, Mr. Chairman, we are happy to provide this 

study. We believe it represents an additional contribution to the 

very important ongoing discussion and debate about the need for 

Social Security reform. My personal opinion, having been a former 

trustee of Social Security and Medicare, having consulted in the 

private sector for many years in the pension and health areas, is 

that we have an opportunity to reform Social Security in a way 

that will exceed the expectations of every generation of Americans 

if we put our mind to it. The sooner we act, the better. We look 

forward to working with this Committee and other interested parties in the Congress to try to achieve this desirable outcome. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Walker follows:]

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The CHAIRMAN. David, thank you very much for that presentation and, more importantly, the study that you have just completed. I think this goes along with where we are going in this 

Committee, and that is to build a solid base of information, analytical information, as Congress moves ultimately toward reform of 

the Social Security system. 

Before I do questions, David, we have been joined by Senator 

Kohl. 

Herb, do you wish to make any comment beforehand? 

Senator KOHL. No. 

The CHAIRMAN. Then let me start with questions, and you might 

have questions yourself, Herb. 

Mr. Walker, after doing all this research on redistribution issues 

for Social Security and personal retirement accounts, what are 

probably the most important things we should walk away with 

looking at this study? 

Mr. WALKER. Well, first, there is a difference between progressivity and adequacy. I think that is an important point. Second, 

when you are looking at progressivity, you need to consider it not 

just from the benefit-level standpoint, but also tax burdens; and, 

third, that individual account plans can, depending upon what 

their design is, improve progressivity, but you also need to consider 

the effect from the other dimensions; and last, I would say, there 

can be differences between individuals and households. 

The CHAIRMAN. Yes. That was going to be my next question. 

Elaborate on that just a little bit if you would, the analysis and the 

redistribution effects. 

Mr. WALKER. Progressivity tends to be a little bit less from a 

household standpoint than on an individual basis, and the reason 

being is because of family patterns. You can have low-income individuals join a household that has higher-income workers, and 

therefore it tends to moderate the distributional effects. Marriage 

is probably the best example of how that can have an effect, and 

having been married 33 years, I understand how this can happen. 

The CHAIRMAN. That is exactly the effect that happens as a result of that, OK. 

If the funds used to transition to a personal retirement account 

proposal such as in Model 2 are temporary, would it be reasonable 

to consider the funds as an investment in a sustainable system? 

How do we look at that? 

Mr. WALKER. I would not look at it as an investment. I do think 

it is, however, appropriate to look at the discounted present value 

cost of various reform proposals. One of the challenges that we 

have in the United States is the way we keep score. The way we 

currently keep score provides a misleading view of really where we 

stand and what the real economic cost is of various reform proposals. So I think that you need to look not only as to the budgetary commitment, but what is the discounted present value cost 

of various reform proposals in current dollar terms. 

For example, right now, assuming that you want to end up delivering on all the benefits that have been promised under Social Security today, and I am not saying that is true, but if that is true, 

it is going to take an additional $4.9 trillion to be able to deliver 

on that for the next 75 years. Now, that number is gross, not net 

40

of the bonds in the trust fund. Each of those other reform proposals 

will require different amounts of money as well, and so I think we 

need to think about the discounted present value cost, which is 

typically how economists would look at it and typically also how 

you would look at it from an accounting standpoint. 

The CHAIRMAN. Yes. That is a point well made. 

Your report briefly discusses general revenue transfers and the 

problem of assigning distributional effects. Can you elaborate on 

the general distribution effect if income taxes are used to finance 

the transfers? 

Mr. WALKER. Well, in general, as you know, Mr. Chairman, income taxes tend to be more progressive in nature. Payroll taxes 

tend to be very regressive in nature, and so you would have to say 

that in general terms, if you are going to use an incomes tax versus 

a payroll tax, the income tax would be a more progressive approach. I think it is, however, important to note that based upon 

GAO’s long-range budget simulations, we face a large and growing 

structural deficit, and we are going to have to address how we are 

going to close the gap whether through spending cuts, whether 

through the tax side, and, if so, whether or not it is going to be 

income taxes, payroll taxes, consumption taxes. The Congress will 

ultimately have to decide. 

The CHAIRMAN. OK. GAO talks about the twin goals of adequacy 

as equity as important considerations in any reform to strengthen 

Social Security. There are some who suggest that we shouldn’t ask 

one system to achieve both goals. What is your thinking on that 

issue? 

Mr. WALKER. I think it is important to look at four dimensions: 

Sustainable solvency, adequacy, equity, and administrative feasibility. Yes, there are challenges and tradeoffs between looking at 

those, but I think it is important to look at all four dimensions. 

The CHAIRMAN. What you are saying is, as we reform, we have 

got to look through all four of those lenses, if you will, to get the 

right one. 

Mr. WALKER. I agree, Mr. Chairman. I think we have to look at 

all four. I think others will evaluate your proposals either for the 

positive or the negative, looking at all four, and failure to look at 

all four, I think exposes any potential reform to potential criticism 

and could slow needed reforms. 

The CHAIRMAN. OK. Thank you very much. 

Let me turn to Senator Kohl. Any questions? 

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

Mr. Walker, did you put a number of transition costs? 

Mr. WALKER. Yes, sir, we did, based upon our assumptions. Right 

now, if you look at, for example, the three proposals, under the 

Model 2 of the President’s Commission, it is my understanding that 

the discounted present value cost for the transition obligation over 

the next 75 years would be $2.3 trillion. Now, that is gross. That 

is not considering the bonds that are in the trust fund, but it is 

also important to note that the other two proposals we looked at 

would also require some general revenue funding. The most would 

be the Ferrara approach. We estimated that it would take about 

$6.9 trillion in discounted present dollar terms. 

41

Senator KOHL. So we are talking about, no matter how you want 

to apportion it out, it is a tremendous amount of money to get to 

where it is we would like to go. This is not cost-free in any way. 

Mr. WALKER. You are exactly right, Senator, but I also think it is important to know that right now, we have about a $4.9 trillion 

shortfall. Now, that is gross. Net of the bonds in the trust fund, it 

is 3.7 trillion, but as you both know, the bonds in the trust fund 

are going to require additional revenues. We have already spent 

the money. 

Senator KOHL. No question. 

Mr. WALKER. So we are going to have to somehow come up with 

the revenues to deal with it. 

Senator KOHL. No question about it. When you look at the 

present formulas that are used with respect to Social Security, 

while I am not advocating it, I heard people talk about the fix that 

we could attach to Social Security by raising the threshold. Are you 

familiar with how much we could help Social Security in terms of 

its solvency by raising the threshold from where it is, which I think 

is about 86 or 87 thousand dollars? 

Mr. WALKER. You mean the taxable wage base? I don’t have the 

numbers in front of me, Senator Kohl. I would be happy to provide 

that for the record, what we have. 

Senator KOHL. Yes. I am assuming, perhaps incorrectly, that you 

have done some examination of what would happen if we decided 

to bite the bullet and raise the threshold, let us say, from 87 to 

150. 

Mr. WALKER. There is work that has been done on that by us 

and by others, and I would be happy to provide something for the 

record. I mean, there are various reform proposals, whether it is 

raising the retirement age, whether it is increasing the taxable 

wage base, whether it is modifying the benefit formula that can 

help to show you how far you get under the different proposals, and 

I do think it is important to keep in mind that from a funding 

standpoint and from a degree of imbalance, Social Security is a 

much easier problem to deal with than some of the other ones you 

are going to have to deal with, especially Medicare. 

Senator KOHL. I agree. 

Mr. WALKER. For example, if you look at the discounted present value underfunded liability for Social Security, it is about $3.7 trillion, net of the bonds in the trust fund. If you look at Medicare, 

it is about $27.8 trillion, net of the bonds in the trust fund. So I 

think one of the things that we need to consider is not just what 

needs to be done to assure solvency and sustainability of Social Security for current and future generations, but to the extent that 

you do things for Social Security, for example on the revenue side, 

then how is that going to affect what you are going to be able to 

do for Medicare? The gap is much greater in Medicare. 

I do believe and I think it is important to look at some other dimensions, such as the normal retirement age, such as the replacement rates, such as the indexing. Having been a trustee of Social 

Security and Medicare before, I spent a fair amount of time looking 

at reform proposals, and the good news is I really do believe you 

can reform this Social Security and exceed the expectations of 

every generation. I really do believe that. 

42

Senator KOHL. I think that is a good point, and I think it is a 

point well worth making and repeating, because the public is not 

aware that the Social Security problems are not nearly as serious 

as the Medicare problems in terms of funding. I think if you took 

a survey out there, most people would think Social Security problems are the biggest problems we face looking forward. Medicare 

problems are by far much bigger. 

Mr. WALKER. Medicare is seven times greater on relative terms, 

based on the numbers that I gave you. 

Senator KOHL. Thank you, Mr. Chairman. 

The CHAIRMAN. Herb, thank you for those questions. 

David, you are obviously not the first to tell us of the reality of 

the problems, and that is obviously why we continue to hold these 

hearings and build this informational base, because you are right. 

When you are dealing with a dynamic environment versus a relatively static or fixed environment where you can lock in numbers 

and they work in relation to Social Security versus Medicare, the 

world changes significantly, and we are sitting here as we attempt 

to tackle health care; we are also dealing with a phenomenally 

moving target that is dynamic in its character, and we can make 

projections, but we all know that one new discovery out there, one 

new application significantly changes costs, positive or negative, as 

we deal with health care. 

Mr. WALKER. It is a lot easier to get a handle on the estimated 

cost of Social Security than it is for health care for the reasons that 

you mention and others. I agree. 

The CHAIRMAN. But I am pleased with your optimism about the 

reality of reform in Social Security, because I am very frustrated 

and have been for some years that we are going to tell our grandchildren that if we don’t reform it, it is really going to be a significantly bad investment for them as it relates to the amount of 

money coming in versus the reality of money that would come out 

to them. I am saying that in a comparative way to my parents that 

are in their eighties and still alive where Social Security was just 

a phenomenal investment for them, and somehow Herb and I are 

going to try to fix that. 

Mr. WALKER. One of the reasons I say that is because myself, 

having two children and two grandchildren and also having done 

an extensive amount of outreach on this issue outside of Washington, I find that the people that are most fearful about Social Security reform are current retirees and people that are approaching 

retirement. From a practical standpoint, they are really not going 

to be affected by the reform. 

The CHAIRMAN. That is right. 

Mr. WALKER. It is really going to be the children and the grandchildren, our children and grandchildren and future generations, 

and for them, they are discounting Social Security to a greater extent than they should. Therefore, that means there is an opportunity to structure reforms, with or without individual accounts, in 

a way that everybody gets more than they think they are going to 

get. I would call that a win and a desirable outcome, and the sooner, the better. 

The CHAIRMAN. I think you are right. 

43

Well, thank you very much for your time, your participation, and 

the work that has been done. I think that this report, again, builds 

on that base of knowledge that we need to have as we move forward on Social Security reform. 

Mr. WALKER. Thank you, Mr. Chairman and Senator Kohl. It 

was a pleasure to be with you. 

The CHAIRMAN. Now let me call our second panel forward, 

please. 

Again, for the record and the listener, we have on our second 

panel Peter Ferrara of the Institute for Policy Innovation and the 

Club for Growth; Dr. Jeffrey Brown, professor of Finance from the 

University of Illinois at Urbana-Champaign; Jeff Lemieux, executive director for Centrists.Org, Washington DC, think tank; and Dr. 

Christian Weller, senior economist for the Center for American 

Progress here in Washington, DC. 

Gentlemen, thank you all for being with us this morning. Peter, 

let us start with you. 

STATEMENT OF PETER FERRARA, INSTITUTE FOR POLICY 

INNOVATION AND THE CLUB FOR GROWTH, WASHINGTON, DC 

Mr. FERRARA. Thank you very much, Senator, for inviting me 

this morning. 

I am here to discuss a proposal, a progressive proposal providing 

a progressive option for personal retirement accounts as a choice as 

compared to Social Security. The option provides for a large personal retirement account, and the option is designed to be progressive, which means that lower-income workers can contribute a 

higher percentage of their taxes to the account than higher-income 

workers. So the option provides specifically that out of the 12.4 percent current Social Security payroll tax, workers could take 10 percentage points of that 12.4 on the first $10,000 of their wage income each year and 5 percentage points on their taxable wage income after that. That comes out to an average of 6.4 percentage 

points of the 12.4 that would go into the personal accounts, a much 

larger account than has been proposed before, with lower-income 

workers contributing a higher percentage above that and higher-income workers being able to transfer a lower percentage. 

The proposal makes no change in disability and survivors benefits at all, and there is no change in Social Security benefits otherwise for anybody at any point now or in the future. Because the 

advantages of a large personal account are so great, no other 

changes are necessary. I discuss in detail in my written testimony 

how this structure mirrors the progressivity of social security. It 

preserves within the personal account the progressivity of Social 

Security so that workers across the board would gain roughly the 

same percentage depending on their investment portfolio, and I 

will go into that in more detail. 

There are five ways I think in which this proposal in addition enhances progressivity for low- and moderate-income workers. First 

of all, it sharply increases future retirement benefits for low- and 

moderate-income workers. Large accounts do that much more than 

any other alternative. Because of the bigger accounts, they are able 

to take more advantage of the better return in the private sector, 

and so they provide very sharp increases. Again, I detail that in my 

44

written testimony, but for a worker where they invest over a lifetime half and half in stocks and bonds at standard market investment returns, I calculate that they would gain a benefit increase 

of two-thirds compared to currently promised Social Security benefits. In other words, at standard market investment returns, investing half in stock and half in bonds, workers across the board, 

and low- and moderate-income workers in particular, would gain a 

benefit increase of two-thirds as compared to what Social Security 

promises, let alone what it can pay. If they invested two-thirds in 

stocks and one-third in bonds, the benefits they would gain would 

double what Social Security promises but cannot pay. 

So you see potentially very large increases and a large, large 

margin for error. So then in addition to that, in terms of rates of 

return analysis, you would get far higher rates of return through 

the large personal accounts than you would through the current 

Social Security system. Again, based on a number of studies that 

I have done in the past and others, I estimate for most workers 

today, the real rate of return promised by Social Security, let alone 

what it could pay, is one to 1.5 percent; the long-term return on 

corporate bonds, real return, three to three and a half percent; on 

stocks, I think the record will bear out seven to seven and a half 

percent. 

So much higher returns, and you see what we have done here is 

a vast improvement both on the basis of adequacy and of equity, 

because the returns are much higher and the future benefits are 

much higher. Also under the reform plan, low-and moderate-income 

workers would gain much greater accumulations of personal wealth 

than under Social Security. The chief actuary of Social Security has 

already officially scored this plan. He estimates that by 15 years 

after the reform plan is adopted, working people would have gained 

$7 trillion in today’s dollars in their own personal accounts. Again, 

that is the chief actuary’s number. You see, this is the greatest advantage and break for working people that we could possibly adopt 

today, $7 trillion accumulated in just the first 15 years in the personal accounts of working people. 

I detail in the written testimony of some of the gains you could 

expect: average workers, 300 to $400,000; lower income workers, 

270,000 to 350,000, depending on what portfolios they invest in, 

how much in stocks, how much in bonds. So again, it is more progressive because it lets workers accumulate much more money. It 

is more progressive because it lets worker get better benefits. It is 

more progressive because it lets low- and moderate-income workers 

get higher returns . 

Also, these much larger accumulations of personal wealth by lowand moderate-income workers would greatly broaden wealth ownership in our nation and sharply reduce the concentration of 

wealth. That $7 trillion is relatively equally distributed across the 

board, especially as compared to our current distribution of wealth. 

If you add wealth to the current wealth, it greatly reduces the concentration of wealth, again, one of the most progressive reforms 

that we could possibly have on that score. Nothing else in prospect 

would so greatly reduce the concentration of wealth. 

In addition, the reform plan addresses another problem that 

harms low-income workers, which is lower life expectancies. If they 

45

die before they reach retirement or just after, they lose everything, 

but with the personal accounts, they would have that money and 

they would accumulate. 

Finally, I would submit that on these five measures, the large 

personal accounts do much more, are much more progressive, than 

either the Diamond-Orszag plan, which achieves virtually none of 

these, or the smaller accounts proposed in Commission Option 2. 

Because the accounts are smaller, the net gains in these areas are 

not nearly as large. 

Thank you very much. 

[The prepared statement of Mr. Ferrara follows:]

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The CHAIRMAN. Peter, thank you. 

Now let me turn to Dr. Brown. 

STATEMENT OF JEFF BROWN, Ph.D., UNIVERSITY OF ILLINOIS 

AT URBANA-CHAMPAIGN, CHAMPAIGN, IL 

Mr. BROWN. Chairman Craig, Members of the Committee, I 

thank you for the opportunity to appear before you today. 

I would like to begin by summarizing quickly the three main 

points of my testimony. First, as we heard from Comptroller General Walker this morning, Social Security’s poor long-term fiscal 

health virtually requires that the system be reformed in some manner. Virtually any proposal to restore fiscal sustainability is going 

to have an effect on the distribution of costs and benefits across the 

population. 

Second, any reform, whether it includes personal accounts or 

whether it relies solely on tax increases or changes to benefits can 

be structured to be less progressive, equally progressive, or more 

progressive than the current system. An important implication of 

this is that it is possible to design a system that includes personal 

accounts which is actually more progressive than the system we 

have today. 

Third, Model 2 of the President’s Commission to Strengthen Social Security is a specific example of a plan that can restore fiscal 

sustainability and still provide a strong safety net for low-income 

individuals and families. 

As we heard earlier today, ever since Social Security’s inception, 

policymakers have had to balance sometimes competing goals. Two 

of these goals which are quite relevant for today are, first, the desire to reduce poverty among low-income elderly, and second, is the 

desire to make Social Security fair for all participants. Social Security is not and was never designed to be a welfare program. It was 

designed to provide all participants with benefits that increase as 

their lifetime contributions increase. 

Meeting multiple objectives with a single program is always difficult and it is made all the more so when the resources available 

to finance the system are insufficient. Indeed, it is actually somewhat meaningless to talk about progressivity without first discussing how the system will be brought back into long-term fiscal 

balance. Given the well-known fact that Social Security faces these 

long-run deficits, it is both economically and mathematically obvious that something must change. Either we need more resources 

flowing into the system or we must decrease expenditures from it. 

The GAO testimony this morning underscores a very important 

point, which is that it is possible to design both a sustainable and 

a redistributive Social Security system that includes personal accounts. 

Indeed, the President’s Commission made a very conscious effort 

to do this. There were several features of that plan that I believe 

are worth highlighting. The first is that the personal accounts in 

Model 2 are themselves progressive. Low income workers could expect to benefit the most because they were able to contribute a 

higher fraction of their earnings. Also, within the defined benefit 

portion of the reformed plan, benefits for low-wage workers were 

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tion. It is also the case that Model 2 was designed to increase the 

benefit that was paid to widows and widowers upon the death of 

a spouse, and in addition, those widows or widowers would be able 

to receive an inheritance from the account upon the death of their 

spouse. Both of these features have an important redistributive effect. 

The net result, as we saw from the GAO report released today, 

is that Model 2 actually compares quite favorably to current law 

in terms of overall progressivity. Yet it does this while achieving 

fiscal sustainability without relying on a permanent increase in 

payroll taxes or a permanent infusion of general revenue. There 

are other reform plans out there that take a very different approach, relying on permanent increases in the tax burden to support a larger program. I simply want to point out that in many of 

the more expensive reform plans, the incremental dollars are being 

used to increase the generosity of the program for everyone, not 

just for low-income workers. So this certainly serves to make the 

program and more expensive, but it doesn’t necessarily do anything 

to increase progressivity. 

In short, just because a reform plan is more expensive does not 

necessarily mean it is more progressive. Indeed, if Congress wishes 

to reform Social Security in a way that protects the poor, it still 

has a choice of whether to do this with a very large expensive system that requires higher tax burdens in the future or whether to 

do so within a system that actually lives within the existing payroll 

tax while still providing a strong safety net for low-income individuals. I believe that Model 2 of the President’s Commission provides 

a very useful blueprint on how to do just that, how to design a system that allows Social Security to live within its means over the 

long term, to be sustainable, and yet still serve the redistributive 

purpose for which the program was intended. 

Thank you. 

[The prepared statement of Mr. Brown follows:]

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The CHAIRMAN. Jeff, thank you very much. 

Now let us turn to Jeff Lemieux of Centrists.Org. Welcome to the 

committee. 

STATEMENT OF JEFF LEMIEUX, CENTRISTS.ORG, 

WASHINGTON, DC 

Mr. LEMIEUX. Thank you, senator. Thank you, Senator Kohl as 

well. 

We view our role in this particular debate as providing data to 

help evaluate the various different types of proposals rather than 

pitching any one particular proposal or explaining its merits. We 

also have tried to foster some bipartisanship on this issue, which 

has been very hard. There is one particularly good example of bipartisanship in the House. Representatives Kolbe and Stenholm 

have a new bipartisan bill that we have analyzed, and we also had 

an event recently where Representative Harold Ford discussed 

with Senator Lindsey Graham some approaches and some possible 

areas for common ground. I thought that was very helpful. In addition, as has already been mentioned, the economists Peter Orszag 

and Peter Diamond have put forward a proposal that is very responsible in its financing. 

Unfortunately, these constructive approaches and efforts seem to 

be the exception rather than the rule. Most of the political discussion on Social Security is very shrill and simplistic, and as a result, 

the most popular proposal is probably the do-nothing option. At the 

other extreme are these very large account proposals which have 

been characterized as free-lunch plans. If we pour lots of money 

into Social Security accounts, they will, in fact, provide a lot of 

money for people, but financing them is very difficult. I am particularly concerned that legislators might not have a clear picture of 

either the budgetary or the distributional consequences of some of 

these more extreme proposals. 

I have a chart packet that was included with the testimony. All 

of the charts in the testimony are also in the written statement, 

but if you have this packet, I will go through a couple of the charts 

as examples. The first chart is called ‘‘Four Big Entitlements’’, and 

as you can see at the bottom is Social Security, which doesn’t look 

bad by comparison with Medicare and with another entitlement 

that is often not mentioned in the debate, which is interest on the 

National debt. If we continue to accumulate deficits and debt and 

interest rates go back up, then after 2030 we will have to pay even 

more in interest, conceivably, than Medicare or Social Security. 

The second chart, Figure 2, just goes through Social Security 

costs and revenues. The blue line shows that we expect Social Security benefit costs to grow from about 4.2 or 4.3 percent of GDP 

up to about 6.3 percent of GDP and then remain flat thereafter 

once the baby-boomers have retired, while dedicated tax revenues 

are about 5 percent of GDP and roughly flat. This is the nature of 

the Social Security financing problem. 

Figure three shows the difference between those two lines, revenues and costs. We are currently in a position of surplus where the 

Social Security revenues raise more than we pay in benefits, but 

that will switch over to a deficit in about 10 or 15 years and then 

71

become a long-term deficit ranging between one and 2 percent of 

GDP, which is a substantial amount. 

The next figure shows roughly how the Kolbe-Stenholm approach 

would attempt to solve that deficit problem. It would bring the surplus down to zero immediately, spending money to build private accounts, but reducing the deficit to a much lower rate in the long 

run. 

Chart 4 shows Senator Graham’s proposal, which is similar to 

Kolbe-Stenholm in its effect, and the Ferrara proposal, considering 

the cost of Social Security where the baseline goes up from a little 

over 4 percent to over 6 percent. The Graham proposal would increase Social Security costs for the time being and then reduce 

them in the long run. The Ferrara proposal would increase them 

by a considerably larger amount, but then also reduce them in the 

long run. To be fair to Senator Graham, the final version of his proposal is opening a wide variety of financing mechanisms that would 

help reduce that increase in Social Security costs in the short run. 

The Diamond-Orszag plan essentially is the best performing proposal on the metric of how much it costs to implement. Dr. Walker 

talked about the long-term present value of these plans and how 

the current law is between four and five trillion. The Ferrara plan 

is over seven trillion. Some of the other account proposals, like the 

Graham and the Kolbe-Stenholm plans are in the neighborhood of 

two to three trillion. The Diamond-Orszag plan is under one trillion. In that sense, it is the best performer. The down side of the 

Diamond-Orszag plan is that it incorporates a permanent increase 

in taxation. 

Finally, I would like to mention the new Social Security numbers 

that came out yesterday. These are in Figures 7 and 8 and came 

out from the Congressional Budget Office. They differ slightly from 

the numbers that I have been using, which come from the Social 

Security trustees. CBO sees slightly lower outlays, especially between about 2020 and 2060 and slightly higher revenues after 

about 2040. They also have some differing economic assumptions; 

for example they assume higher interest rates on the debt that Social Security—the Treasury debt that Social Security holds and the 

Government pays Social Security interest on which has the effect 

of extending the life span of the Social Security fund, but I think 

most economists discount that measure. 

The final chart shows the graphic of the deficit. CBO assumes 

that it is between one and 1.5 percent of GDP. The trustees are a 

little higher between 1.5 and 2 percent of GDP. 

Finally, Mr. Chairman, just in response to an earlier question, 

the final figures from Dr. Walker will probably be more authoritative, but raising the tax cap to about 140 or $150,000 a year 

probably saves between .2 and .3 percent of GDP. In other words, 

it would raise Social Security financing by .2 or .3 percent of GDP, 

depending on whether or not you allow those extra taxes to accrue 

benefits when people eventually become retirees. So that would 

help close the gap a little bit, but it wouldn’t close the gap completely or anything even close to that. 

Thank you. 

[The prepared statement of Mr. Lemieux follows:]

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The CHAIRMAN. Jeff, thank you very much. 

Now let us turn to Christian Weller, Center for American 

Progress. Christian, welcome. 

STATEMENT OF CHRISTIAN WELLER, Ph.D., CENTER FOR 

AMERICAN PROGRESS, WASHINGTON, DC 

Dr. WELLER. Thank you very much, Chairman Craig. Thank you 

very much, Senator Kohl, for inviting me here today to talk about 

individual accounts and Social Security. 

I would like to make the following three points on my testimony 

today: Social Security is a necessary and increasingly important 

component to providing retirement income adequacy; second, any 

expected shortfalls under Social Security can be addressed without 

radically changing the system; and third, privatization as an alternative to fixing Social Security within the parameters of the system 

is too risky and too costly, especially for low-income families. 

Usually, 80 percent of pre-retirement income is considered adequate for a decent standard of living. A substantial minority of 

households, typically one-third, fall short of the standard. The 

shortfalls are especially large for minorities, single women, workers 

with less education, and lower-wage workers. To make ends meet 

in retirement, these households will have to curtail their consumption, often severely, and rely on public assistance in retirement. Retirement income adequacy has also worsened for the typical household over the past 2 years. 

Underlying this trend are three factors: first, pension coverage 

has remained low and declined in recent years; second, retirement 

wealth has become increasing unequally distributed; and third, 

with the proliferation of defined contribution plans, such as 401(K) 

plans, risk has shifted onto workers. Against this backdrop, Social 

Security gains in relative importance. Its coverage is almost universal. Its benefits favor low lifetime earners and has guaranteed 

lifetime inflation-adjusted benefits. 

Part of Social Security’s importance also results, as was mentioned before, from its other benefits, in particular disability and 

survivorship benefits. These benefits are often at stake when Social 

Security benefits are reduced to pay for privatization, but we have 

got to keep in mind that Social Security benefits are bare bones. 

The average replacement ratio in the U.S. is about half of that in 

Germany or Italy, and the average monthly benefit was about $850 

in 2002, yet Social Security benefits were 80 percent of income for 

households—retirement income for households in the bottom 40 

percent of the income distribution in 2000, meaning that the private sector is still not doing its job to help low-income workers. Yet, 

Social Security trustees predict a financial shortfall in the long run. 

It is anticipated that by 2042, Social Security will have exhausted 

its trust funds and the tax revenue will cover only more than twothirds of promised benefits. An immediate and permanent increase 

of the payroll tax by 1.9 percent would allow Social Security to 

cover all its shortfall. 

Social Security expenditures, however, are expected to stabilize 

around 6.5 percent of GDP in the long run, but payroll taxes will 

grow as the tax base of the system shrinks at the same time; thus, 

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dressed within the parameters of the system. One example would 

be the Diamond-Orszag plan, and other examples come from the 

1994 and 1996 Advisory Council on Social Security. 

Privatization, however, as an alternative is too risky and too 

costly, and it would require a large transfer from general revenue 

and large benefit cuts to pay for benefits that workers have already 

earned. With privatization, insurance is replaced with savings accounts. That is, the risks are privatized. These risks include the 

risk of misjudging the market and investing and losing assets. Another risk is the possibly of financial markets staying low for long 

periods of time. Moreover, workers face also the risk that they will 

exhaust their savings during the retirement and, finally, a risk 

that we haven’t paid enough attention to, in my view, workers face 

the risk that they are out of work or have low earnings when asset 

prices are low, so they cannot take full advantage of dollar cost 

averaging. 

Along with the risks, the costs also rise. For one, administrative 

costs rise particularly for low income workers in small plans. Most 

estimates put these administrative costs well above 1 percentage 

point of assets per year. Other costs arise from the loss of security. 

For instance, workers could purchase lifetime annuities to minimize longevity risks, and they could purchase invest guarantees to 

reduce market risk. However, the cost of lifetime annuities average 

about 5 percent of accumulated savings with higher costs for smaller accounts. That means that their benefits are reduced by 15 to 

20 percent compared to no costs, and the cost of guaranteed minimum benefits amounts to about 16.1 percent of annual contributions during a 40-year period with a balanced portfolio, according 

to estimates of Professor Mitchell from the University of Pennsylvania. 

Some workers are more likely than others to experience unemployment and low wages during an economic downturn, thus they 

cannot take full advantage of dollar cost averaging. In recent research that I have done with Professor Wenger from the University 

of Georgia, we find that this adds costs similar to those associated 

with annuitization for women and minorities. All of these costs will 

not be offset with substantially higher rates of return. In particular, Social Security expected shortfalls are based on low growth 

assumptions, but stock market returns follow economic growth over 

the long run; hence if the trustees are correct in their assumptions, 

the real rates of return on the stock market should also fall below 

historical averages. 

Privatization also increases the cost to the Government. We already heard a lot about that. Let me just say that in addition to 

greater transfers from general revenue into Social Security, privatization would also reduce promised benefits. 

I will end my remarks here, seeing that the light is on. Thank 

you very much. 

[The prepared statement of Mr. Weller follows:]

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The CHAIRMAN. Christian, thank you for very much for those 

comments. 

Let me ask some general questions of all of you and then some 

specific ones. You have all heard Mr. Walker talk about the GAO 

study. What, in your opinion, is the most interesting or profound 

finding in that study? 

Peter. 

Mr. FERRARA. Well, I think it is actually a very fascinating study 

because the conclusions I draw from that is that if their projected 

scenario is correct, it reduces the transition costs to large personal 

accounts because the gap that has to be covered is smaller. It also 

means that personal accounts are more urgent because the implication of their analysis is that the rates of return are lower under 

Social Security than we have expected so far. So it is an even worse 

deal now today for current workers than we had expected, and so 

it increases the urgency of large accounts, and it also shows that 

because the long-term deficit is smaller, what I have been saying 

all along is that with large accounts, you don’t need any other reductions in Social Security benefits. You don’t need price indexing, 

which is a very large reduction in the future promised benefits, and 

because the large accounts shift so much of the burden to the accounts and away from Social Security, they eliminate the long-term 

deficit by itself. That is what the chief actuary’s score showed. 

Now, the CBO analysis bears me out in this, that you do not 

need price indexing if you go to the larger accounts. You don’t need 

any reductions in future Social Security benefits to close the gap, 

because if you go to the large accounts, it eliminates the gap by 

itself, because again, so much of the burden of paying for retirement benefits is shifted to the account. When you go to larger accounts, they take more of the burden. 

The CHAIRMAN. You were speaking mostly of the CBO. 

Mr. FERRARA. Right, the CBO. 

The CHAIRMAN. What about the GAO? 

Mr. FERRARA. Oh, I am sorry. I mean, I think the GAO analysis 

doesn’t really deal that much with my proposal. I think that they 

are accurate in what they say in laying out the parameters, that 

they show that, for example, adequacy and equity are two goals, 

but I think what is interesting there and the most interesting implication I draw out of that is with a large account proposal, those 

two goals are not in conflict. Those two goals are both increasingly 

satisfied, improved with the larger account. Benefit adequacy is improved. The current system does not provide benefit adequacy. The 

benefits are inadequate in the current system. 

So if you go to the large accounts, you have much bigger increases in future benefits, and you have—so it scores on the adequacy side, and you have much bigger increases in future returns 

because you can take more advantage of the higher returns in the 

private market. In this analysis, we have got to take into account 

the degree to which different proposals enhance future economic 

growth and productivity. What is missing in a lot of the analysis 

is that when you have large accounts or you have so much savings 

and investment being produced into those accounts, those contribute greatly to future economic growth. Again, this is based on 

decades of research from Professor Martin Feldstein at Harvard 

109

and others who have written about it, the CATO Institute, Heritage Foundation and others, and so to use words like a ‘‘free lunch’’, 

you are ignoring people who use those. You are ignoring the economic growth impacts of such a productive increase in savings and 

investment, and all of that becomes bigger, much bigger, when you 

go to the much bigger accounts. 

So they point out these two goals sometimes are in conflict. Here, 

they are both served by the larger accounts, both adequacy and equity. 

The CHAIRMAN. Jeff. 

Mr. BROWN. Well, I would first begin by actually commending 

the GAO on what I think is, methodologically a very well done report. The study shows that, as we have learned in the academic literature over the last several years, that an accurate measure of 

progressivity requires that one take into account the complex 

household and family interactions. I think the most important finding, and one of the points I made in my testimony, is that in any 

reform, whether it includes personal accounts or not, it is possible 

through careful construction of the policy to make the system as 

progressive or as regressive as one wants. 

It is sometimes assumed incorrectly that by moving to personal 

accounts, that one necessarily is going to do something to hurt the 

poor, and I think the GAO proves this assertion to be false. In fact, 

it is quite possible to design a personal account system that is very 

good for low-income families. 

The CHAIRMAN. Thank you. 

Jeff. 

Mr. LEMIEUX. Thank you. I have a similar reaction. Both CBO’s 

work and GAO’s work are leading toward a higher level of analysis 

for all of these proposals. For example, until now, we haven’t really 

seen from official Congressional or Administration sources lots of 

publications on the progressivity of the different plans. I included 

in our packet some tables that show, for example, that the Graham 

plan does seem to increase progressivity fairly substantially, but 

these are based on data that I have cobbled together from a variety 

of sources, some of them unpublished. With the CBO and GAO reports, I think we will have more authoritative work on how account 

proposals of varying sizes would affect the progressivity. 

The CHAIRMAN. Right. 

Christian. 

Dr. WELLER. I agree. I have the utmost respect for my colleagues 

at GAO. I think this is a study that moves at least some of the 

issues in the right direction, but I think a lot of the debate that 

we are having is actually not analyzed, and I hope that this is the 

first step in the right direction. In particular, the study only looks 

at progressivity and makes a lot of qualifying remarks and in particular on the average level of benefits, but also on the financing 

of the transition costs to approach the individual account system. 

I would also submit that I think the study is discounting somewhat 

the risks associated with the individual accounts just by using hypothetical examples rather than the full heterogeneity of the real 

word, and I hope that this study is going in the right direction in 

terms of analyzing the complexity of all these reform proposals and 

the costs associated with these reform proposals. 

110

The CHAIRMAN. Yes. Thank you. 

Before I go to you all individually, Jeff, you had mentioned in 

your analysis in the different plans the need for bipartisanship on 

this issue and the lack, at least to date, in the debate that has gone 

on. Let me only suggest that this is called warm-up rhetoric, that 

in the end, any reform of the Social Security system by its very 

character will be bipartisan. I just believe that firmly and I say 

that because of the character of this institution and the inability 

to move anything that isn’t. We just have laid to rest a President 

who recognized the need to become very partisan on the issue of 

Social Security reform back in the early eighties. I happened to be 

there and watched he and another Irishman duke it out until they 

realized they weren’t going to get anywhere and they need to reform system until they work collectively together, and they ultimately did, and I think that that refrain certainly stays with me, 

and I think it stays with most who recognize that what we are trying to do is build a base of information from which all of us can 

look, hopefully, with limited partisan or philosophical bias, look objectively at a system that is critically necessary for the American 

people in the long term and do it right so that we can all benefit. 

Mr. LEMIEUX. I hope we can achieve that level of bipartisanship 

before we come to a crisis like we did in the 1980’s. 

The CHAIRMAN. My guess is there will be a few dust-ups before 

we get there. 

Peter, let me go back to you with a question. How do you respond 

to the critics of personal retirement account proposals who argue 

that they promise reasonably higher returns and realistic revenue 

feedback? 

Mr. FERRARA. Well, the returns that we used are the historical, 

standard historical, market returns. They are returns going back a 

hundred years. They are very similar to what the chief actuary 

uses in his estimates, and most analysts use the same returns. I 

mean, the most authoritative source is Ibbotson Associates, where 

they combine stocks and bonds and Federal debt and inflation and 

report the returns going back dozens of years, debt going back several decades, and you can use other data and go back 200 years 

if you want. The returns are basically the same. 

Well grounded in the economic literature, I think an important 

fact that people overlook is revealed in the work of Martin Feldstein, because the important number here is not really the bond returns and not really the stock returns, but the before tax real rate 

of return to capital. If you are shifting from a pay-as-you-go system 

like we have today with Social Security, which is just redistribution 

and not investment, and you shift to a system that is real savings 

and investment, the net gain from that is not the corporate bond 

return and it is not the stock market return. It is the before tax 

real rate of return to capital, and that is just overlooked by too 

many people. 

Now, that is where you get the corporate revenue feedback, because you see when the accounts buy these stocks and bonds, what 

happens to the money they use to buy them? That goes to the corporation selling the stocks and bonds. Corporations use that money 

to make investments, build new plant equipment, start new businesses, hire more workers, and they earn money back on that. That 

111

money that is earned at the corporate level is taxed, and that provides the revenue feedback. 

Now, you know, Martin Feldstein, Chairman of the National Bureau of Economic Research, is one of the chief progenitors of this 

idea going back to the 1970’s, where I learned about it when I was 

a student of his at Harvard, and it is well grounded in the economic literature. Moreover, the literature shows that, you know, 

extensive writings over the years, that this shift to a large personal 

account system is going to have a very substantial economic growth 

effects, not just on terms of the corporate revenue feedback, but 

you have got increased savings and investment. You have got a 

more efficient labor market. You have got reduced taxes. So the 

total economic growth effects are going to be much larger than was 

taken into account in the chief actuary’s score when he included 

the corporate revenue feedback. So that is only a small part. 

If you did a comprehensive analysis of the full economic growth 

effects and the rate of revenue feedback that would result, the revenue feedback would be much greater than you had there, and you 

can’t take—when you go to the larger accounts, you are taking basically 20 percent of the Federal budget and now that is going into 

a savings and investment system. That is a big change, and you 

can’t discount the economic effects of that, because the economic effects are going to be huge. 

So these are, in fact, very moderate assumptions that are used 

in here. The true reality is going to be, in fact, much greater. 

The CHAIRMAN. Well, I happen to agree with you in general. 

Mr. FERRARA. Thank you. 

The CHAIRMAN. I think that is a very exciting prospect long term 

for our country if we can move in that direction. 

Jeff Brown, in your view, when the President’s Commission considered funding the transition to a system of personal retirement 

accounts, were they talking about new transition costs required by 

reform or costs that already exist? 

Mr. BROWN. That is very good question, because I think the transition cost concept is often misunderstood. These are not really new 

costs in a present value sense. What we are really talking about 

here is a re-timing of costs. The transition costs will rise because 

of the fact that we have made benefit promises to current workers 

and retirees, and if we fulfill those promises and simultaneously 

want to fund the accounts, that certainly requires that we put more 

money aside today in order to do that. 

Another name for putting more money aside today in order to reduce the burden on future generations is saving. What these transition costs, if you want to call them that, are simply way for us 

to increase our national saving. So I actually do think it is appropriate to refer to these as an investment, because while it does require that we as a Nation reduce our consumption today, it has the 

benefit of either reducing tax burdens in the future or allowing a 

higher level of benefits and consumption in the future. 

The CHAIRMAN. One of the issues raised by critics of personal retirement accounts is that of market risk. What dimensions should 

we consider when we think of risk in that, Jeff? 

Mr. BROWN. Sure. Well, I am a finance professor, and so I certainly recognize that the ability to access higher expected returns 

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in equity markets does entail an increase in financial market risk. 

However, there are a couple of additional points that are worth 

noting. First, people who make that argument often assume that 

there is no risk to the current defined benefit system, and I think 

that is incorrect when we are facing a significantly underfunded 

system. There is political risk to the current system, that benefits 

and taxes can be changed going forward, and having a mixed system like was proposed in Model 2 actually allows allowing some diversification of political and financial market risk. 

Second that in Model 2 of the Commission, the accounts were 

voluntary, and even if you chose the account, there was no requirement that you invest in equities. You could actually come out 

ahead with a very conservative investment portfolio if you wanted 

to. So there are mechanisms in place for managing that risk which 

does exist. 

Mr. FERRARA. May I make a couple of points in answer to that 

question? 

The CHAIRMAN. Let me proceed, and then I will let you all do a 

wrap-up response to any other comments that individuals, that you 

as panelists, have made, because we will run out of time, Peter, if 

we don’t move through. 

I want to get to you, Jeff Lemieux. Your testimony is supportive 

of personal accounts; however, you do have concerns with plans 

that promise, quote, a free lunch. Could you elaborate on the features most associated with what you call a free lunch? 

Mr. LEMIEUX. Yes. I think that it boils down to whether or not 

you are going to make an attempt to pay for the transition costs 

of moving to accounts, whether they are medium-sized accounts, 

small accounts, or large accounts. As Jeff was talking about just a 

second ago, it is really a matter of timing and a matter of saving. 

If we sacrifice now, then we will have a better funded system, but 

implicit in sacrifice is paying for the accounts, perhaps, with revenue increases or spending cuts or other things. If we don’t pay for 

at least a significant share of the transition costs, then we won’t 

really be increasing national savings. It will be neutral. We will be 

putting money in people’s accounts, but we would be taking away 

from the public account. I think the financial markets would view 

that as roughly neutral, and if that were the case, then you 

wouldn’t have any of these potentials for the sorts of economic improvements that Peter has talked about. So my main worry about 

the free lunch is that we haven’t figured out how to pay for at least 

a substantial share of the transition costs in any accounts. 

The CHAIRMAN. I think that puts that in context from how you 

see it. 

As a former CBO analyst, you are probably familiar with CBO’s 

new projections for Social Security or the Social Security system. 

Are there any real changes in CBO’s projections compared to the 

actuaries? 

Mr. LEMIEUX. I don’t think we have had a chance to really analyze it deeply, but I did a superficial graphic here in the testimony 

that shows the trends in costs and revenues, and they look to me 

to be substantially similar, certainly within the bounds of any sort 

of reasonable difference of opinion on a wide variety of issues. I 

don’t think it changes the story at all. We have a demographic and 

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political problem ahead of us with Social Security. It is substantial. 

It is not as big as Medicare or perhaps interest, on the national 

debt but is substantial and we should address it. 

The CHAIRMAN. OK. Thank you. 

Christian, your testimony is critical of personal retirement accounts, yet doesn’t really talk about an alternative. Do you have 

any specific ideas of how to address the challenge that is obvious 

with the Social Security system? 

Dr. WELLER. I would submit that there is a number of proposals 

out there. We don’t have, the Center for American Progress doesn’t 

have its own plan. I personally don’t have an individual plan, but 

I think there are enough options out there. I think one idea that 

is worth debating is the Orszag-Diamond plan. The alternative is 

to go back to the 94–96 Advisory Council on Social Security, and 

there are a number of options that we could address within the 

system. 

I would lean probably in the direction away from cutting benefits, because I think that the overall benefit structure is a bare 

bones system. 

The CHAIRMAN. Yes. Well, in the Diamond-Orszag plan, their 

plan raises taxes on workers and cuts benefits for them in their retirement. It is this approach. What redistribution features of their 

plan do you find most attractive or least attractive? 

Dr. WELLER. I find least attractive the idea of indexing benefits, 

benefits cuts to longevity. I think that we will ultimately see an 

erosion of retirement income adequacy for low-income workers. I 

think the literature is very clear on that, that we won’t see an adequate commensurate increase in private saving to compensate for 

that. I think the idea of raising taxes beyond the taxable limit at 

this point is an attractive feature. 

The CHAIRMAN. OK. Now let me turn to all of you, and I will 

start back with you, Peter. You can choose in this last round to critique or debate what one other of your panelists have said or make 

a point that you don’t feel has been made for the record. 

Mr. FERRARA. Well, let me address two issues. One is the risk 

issue. I want to emphasize that in the plan that I have put forth, 

there is Federal guarantee that all workers with personal accounts 

would get at least the benefits promised under current law. So in 

that sense, the risk issue is enormously mitigated, if not eliminated 

completely, for workers across the board. This is a flat-out Federal 

guarantee. 

Now, a second critical part of this risk issue and the reason that 

guarantee works is because the gulf between market investment 

returns and the returns Social Security promises is so large, and 

that is just overlooked in the risk analysis. There is virtually no 

probability that over an entire lifetime, the returns in the markets 

are going to fall below what Social Security promises today. In 

order for that to happen, the returns in the stock market over the 

last 75 years would have to fall by 80 percent and stay that low 

for the next 75 years, and that would just give you the return 

promised by Social Security. If that happens, America is going to 

be a very different and far, far less prosperous country than it is 

today. It would be a Third World nation rather than the prosperous 

nation we know. So with that very large gulf, first of all, that mitiVerDate 0ct 09 2002 10:28 Oct 14, 2004 Jkt 000000 PO 00000 Frm 00117 Fmt 6633 Sfmt 6633 H:\DOCS\95604.TXT SAGING1 PsN: JOYCE
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gates the risk enormously. Second, it means that you can offer a 

guarantee like that, and the chief actuary in his score scored the 

cost of the guarantee using the standard Federal Government’s 

methodologies for guarantees, and the cost was very small because 

that gulf is so large. 

Now, on the second issue, the transition issue, the free-lunch 

issue, people who make this point want to count only tax increases 

or cuts in future Social Security benefits as counting in financing 

the transition, and that is just too narrow. I think that what my 

plan shows and what the chief actuary’s score shows is you don’t 

need tax increases and you don’t need cuts in future benefits if you 

go to large accounts. One of the huge implications of large accounts 

which is not fully appreciated, and what I was trying to show 

through the chief actuary score, is how quickly they shift benefits 

and how massively they shift benefits to those personal accounts. 

So why argue about what Social Security benefits are going to be 

in 2050 and argue that we should be cutting them when if you go 

to a large account, people will be actually getting better benefits 

than Social Security even promises from the personal accounts. So 

it is a meaningless argument to argue about we need to cut benefits in 2050 when, in fact, if you go to the large accounts, that is 

not even an issue. 

The plan I proposed provides for full and complete financing of 

the transition through reduced personal consumption in two ways. 

One is the reduction in growth of Federal spending, which reduces 

present consumption, and the second is devoting part of the increased growth to savings rather than consumption. In conclusion——

The CHAIRMAN. My time is going to have to ask you to stop at 

that point. 

Mr. FERRARA. That is fine. 

The CHAIRMAN. Thank you very much. I find your ideas very exciting, because I look at the opportunity spread across a long period 

of time, and I can’t imagine—and yet I know we are going to be 

faced with the reality if we take the current model and simply tinker with it, we are going to try to have to look out into the future 

and project benefits in 2050, and I find that a rather impossible 

task for this mind to come up with. 

Jeff. 

Mr. BROWN. I would just like to respond to two points, one made 

by each end of the table. The first is that financial economists and 

actuaries actually think very differently about the true economic 

cost of guarantees. As a financial economists I would agree that 

guaranteeing benefits equal to current law scheduled benefits is actually extremely expensive, much more so than the actuaries analysis would suggest. 

The second point I would make is about plans which would not 

make any benefit reductions whatsoever, such as the type that Mr. 

Weller was referring to. It is really important that one not just look 

at adequacy of benefits without thinking about the lifetime tax burden that such a plan is going to impose on families. It is a simple 

mathematical fact that the only way that we could guarantee to 

pay current law scheduled benefits without personal accounts is 

through fairly enormous payroll taxes or other tax increases on 

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current and future generations, and I think that that has a strong 

redistributive effect as well. 

The final point I would like to reiterate once again is that it is 

actually quite possible to design a personal accounts reform that 

over the long run allows the system to be sustainable, but with 

careful design provide some very strong protections for low-income 

individuals. 

The CHAIRMAN. Jeff. 

Mr. LEMIEUX. I would just like to emphasize the four criteria for 

evaluating reform plans: first, the impact on the budget; second, 

the degree of progressivity. Ultimately, we would like Government 

to be small and progressive, and Social Security is no different; 

third, the opportunities for wealth creation and the use of Social 

Security as a lever to help low-income people save and accumulate 

assets; and then, fourth, the presence or absence of gimmicks. I 

think it would be sort of a false promise if we tell the next generation, Look, we are going to provide you with an attractive new account, and, Oh, by the way, we are also going to provide you with 

an awful lot more of the National debt which you ultimately have 

to pay off in one way or another. 

Then the final comment is this hyper-politicalization of Social Security has become a problem. Even the most bland or technical 

analysis can sometimes be used for partisan political propaganda 

or other, you know, ways if it is not spelled out very clearly what 

the analysis means, and I am really encouraged by the GAO work 

and the CBO work and always the great professional work by the 

Social Security actuaries to just try and spell it out very clearly so 

that your data isn’t used in the wrong way and it eventually helps 

the debate. 

The CHAIRMAN. Christian. 

Dr. WELLER. I would like to come back to the point that individual accounts carry risks with them. I think that some risks are 

understudied, in particular the labor market risks that I mentioned 

here. I think that we need to pay more attention to that. In that 

same vein, I was struck a little bit by what Jeff Brown said earlier, 

and I think we can probably find some common ground here. If we 

care and are concerned about savings, National savings, which I 

am as a macro economist, but also personal savings, I think we 

should have a debate over what is progressive savings and what 

are progressive savings policies, but I think that debate should 

happen outside of the parameters of Social Security. 

Social Security is an insurance mechanism, not a savings mechanism. Let us leave it at that. Let us talk about progressive savings 

initiatives instead. 

The CHAIRMAN. OK. Let me conclude with this brief comment: I 

have been fascinated in the debate over Social Security since I 

came to Congress 24 years ago, and I watched the politics of it then 

and I have watched the politics of it now. I guess the analysis that 

I can use, because I held a lot of hearings out in my State and 

around the country, talking about Social Security, talking about all 

aspects of it, is to watch the generational differences at work out 

there now. They are very, very significant, and I don’t think we can 

overlook those, Jeff, as your concern relates to the partisans or the 

politics of Social Security. 

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Having gone through the debates of the eighties on Social Security reform, I would call that the old politics. I think somebody not 

long ago mentioned the old Europe versus the new Europe. I would 

suggest that with the tools we have today and the understanding 

we have today and the youth and their frustration about putting 

such large sums of money into something that will return so little 

or comparatively speaking, that the new politics of today, making 

a single assumption that is critical is that those who are currently 

on or about to go on are held relatively whole or whole is going to 

be a much different debate than we have ever had before on Social 

Security and that the political transition this country is going 

through as it relates to these kinds of analysis and understanding 

are going to be considerably different. 

There is a sense of independence out there because of just the 

character of the work force today and the tools that are available 

to it for investment and analyzing its own economic concerns that 

I find at least I am much more excited about the idea of a constructive debate on a system that is allowed to alter itself into a new 

form, if you will, over a generation of time as being something that 

really is going to be an exciting thing to put this country through, 

because I have a feeling that the country will engage in it very aggressively, at least I hope they will. 

That is part of why we are here and part of why we are laying 

this informational base, so that as we move the Congress toward 

this issue in the next few years, we will have well established some 

of the parameters, I hope, for the debate and the realities of where 

we might be able to get with the kind of reform that is going to 

have to be anticipated. 

Gentlemen, thank you all very much for your time before the 

Committee and your effort. I appreciate it. 

The Committee will stand adjourned. 

[Whereupon, at 11:50 a.m., the Committee was adjourned.]

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