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★ 23–926 2005

SEVENTH IN A SERIES OF SUBCOMMITTEE

HEARINGS ON PROTECTING AND STRENGTHENING

SOCIAL SECURITY

HEARING

BEFORE THE

SUBCOMMITTEE ON SOCIAL SECURITY

OF THE

COMMITTEE ON WAYS AND MEANS

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

JUNE 21, 2005

Serial No. 109–26

Printed for the use of the Committee on Ways and Means

(

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ii

COMMITTEE ON WAYS AND MEANS

BILL THOMAS, California, Chairman

E. CLAY SHAW, JR., Florida

NANCY L. JOHNSON, Connecticut

WALLY HERGER, California

JIM MCCRERY, Louisiana

DAVE CAMP, Michigan 

JIM RAMSTAD, Minnesota 

JIM NUSSLE, Iowa 

SAM JOHNSON, Texas 

PHIL ENGLISH, Pennsylvania 

J.D. HAYWORTH, Arizona 

JERRY WELLER, Illinois 

KENNY C. HULSHOF, Missouri 

RON LEWIS, Kentucky 

MARK FOLEY, Florida 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

ERIC CANTOR, Virginia 

JOHN LINDER, Georgia 

BOB BEAUPREZ, Colorado 

MELISSA A. HART, Pennsylvania 

CHRIS CHOCOLA, Indiana 

DEVIN NUNES, California 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

SANDER M. LEVIN, Michigan 

BENJAMIN L. CARDIN, Maryland 

JIM MCDERMOTT, Washington 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

MICHAEL R. MCNULTY, New York 

WILLIAM J. JEFFERSON, Louisiana 

JOHN S. TANNER, Tennessee 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

EARL POMEROY, North Dakota 

STEPHANIE TUBBS JONES, Ohio 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

RAHM EMANUEL, Illinois 

SUBCOMMITTEE ON SOCIAL SECURITY 

JIM MCCRERY, Louisiana, Chairman 

E. CLAY SHAW, JR., Florida 

SAM JOHNSON, Texas 

J.D. HAYWORTH, Arizona 

KENNY C. HULSHOF, Missouri 

RON LEWIS, Kentucky 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

SANDER M. LEVIN, Michigan 

EARL POMEROY, North Dakota 

XAVIER BECERRA, California 

STEPHANIE TUBBS JONES, Ohio 

RICHARD E. NEAL, Massachusetts 

ALLISON H. GILES, Chief of Staff 

JANICE MAYS, Minority Chief Counsel 

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

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

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

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

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

is further refined. 

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iii 

C O N T E N T S 

Page 

Advisory of June 14, 2005 announcing the hearing .............................................. 2 

WITNESSES 

Congressional Budget Office, Douglas Holtz-Eakin, Ph.D., Director .................. 6 

Baruch College, City University of New York, June O’Neill, Ph.D. .................... 18 

Institute for Research on the Economics of Taxation, Stephen J. Entin ............ 25 

The Heritage Foundation Center for Data Analysis, William W. Beach ............ 34 

Economic Policy Institute, Lee Price ...................................................................... 39 

Dartmouth College, Andrew W. Samwick, Ph.D. .................................................. 52 

The Center on Budget and Policy Priorities and New York University, Jason 

Furman, Ph.D. ...................................................................................................... 57 

CarriageOaks Partners, LLC and The Cato Institute’s Project on Social Security Choice, William G. Shipman ........................................................................ 64 

SUBMISSIONS FOR THE RECORD 

Delores Guinn, Horshoe Bay, TX, statement ........................................................ 100 

Thomas S. Marino, La Habra, CA, statement ....................................................... 100 

Bob Moore, Lawton, OK, statement ....................................................................... 101 

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(1) 

SEVENTH IN A SERIES OF SUBCOMMITTEE 

HEARINGS ON PROTECTING AND 

STRENGTHENING SOCIAL SECURITY 

TUESDAY, JUNE 21, 2005 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, SUBCOMMITTEE ON SOCIAL SECURITY, Washington, DC. 

The Subcommittee met, pursuant to notice, at 10:02 a.m., in 

room B–318, Rayburn House Office Building, Hon. Jim McCrery 

(Chairman of the Subcommittee) presiding. 

[The advisory announcing the hearing follows:] 

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2 

ADVISORY 

FROM THE COMMITTEE ON WAYS AND MEANS 

SUBCOMMITTEE ON SOCIAL SECURITY 

FOR IMMEDIATE RELEASE CONTACT: (202) 225–9263 

June 21, 2005 

No. SS–7 

McCrery Announces Seventh in a Series of 

Subcommittee Hearings on Protecting and 

Strengthening Social Security 

Congressman Jim McCrery (R–LA), Chairman, Subcommittee on Social Security 

of the Committee on Ways and Means, today announced that the Subcommittee will 

hold the seventh in a series of Subcommittee hearings on protecting and strengthening Social Security to hear the views of Members of the House. The hearing will 

take place on Tuesday, June 21, 2005, in room B–318 Rayburn House Office 

Building, beginning at 10:00 a.m. or immediately following the conclusion 

of the full Committee hearing. 

In view of the limited time available to hear witnesses, oral testimony at this 

hearing will be from invited witnesses only. However, any individual or organization 

not scheduled for an oral appearance may submit a written statement for consideration by the Subcommittee and for inclusion in the printed record of the hearing. 

BACKGROUND: 

The Trustees of the Social Security system consider both demographic and economic factors to project the future condition of the Social Security Trust Funds. The 

demographic factors, covered in a previous Subcommittee hearing, are the primary 

reason why the system is facing insolvency. However, economic factors, while subject to greater variability than demographic factors, are important, too. 

Four important economic variables required to project Social Security’s finances 

are the rate of real earnings growth, the real interest rate, the inflation rate, and 

the unemployment rate. In particular, the earnings growth and inflation rates have 

direct effects on various automatic benefit and tax base adjustments in the program. 

As a result, it is important to examine the interrelationship between Social Security 

and the economy as we look for ways to strengthen Social Security’s financing. 

While these and other economic variables help to determine Social Security spending and revenues under current law, it is also important to consider the larger impact of the Social Security program on the Nation’s economy. According to the Social 

Security Trustees, the program’s costs are growing faster than the economy and the 

tax base that supports it. Some economists have suggested that the current system 

is inefficient because it induces workers to save less andretire early and that 

strengthening Social Security could have positive economic effects. 

One way to strengthen Social Security and potentially enhance national savings 

and economic growth is to pre-fund benefits. The past two Administrations, as well 

as the 1994–1996 Social Security Advisory Council and the 2001 President’s Commission to Strengthen Social Security, proposed partially pre-funding Social Security 

through either personal accounts or the collective investment of theSocial Security 

Trust Funds. 

In announcing the hearing, Chairman McCrery stated, ‘‘Many people think of Social Security in terms of how it affects their personal retirement income and their 

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3 

take-home paychecks. However, Social Security also affects the economy, and vice 

versa. As we examine ways to strengthen Social Security, we must consider both 

the individual and the broader consequences of options under discussion.’’

FOCUS OF THE HEARING: 

The Subcommittee will examine how economic assumptions are used to project the 

future condition of the Social Security system and determine Social Security benefits, along with the merits of, and options to, achieve pre-funded benefits. 

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS: 

Please Note: Any person(s) and/or organization(s) wishing to submit for the hearing record must follow the appropriate link on the hearing page of the Committee 

website and complete the informational forms. From the Committee homepage, 

http://waysandmeans.house.gov, select ‘‘109th Congress’’ from the menu entitled, 

‘‘Hearing Archives’’ (http://waysandmeans.house.gov/Hearings.asp?congress=17). Select the hearing for which you would like to submit, and click on the link entitled, 

‘‘Click here to provide a submission for the record.’’ Once you have followed the online instructions, completing all informational forms and clicking ‘‘submit’’ on the 

final page, an email will be sent to the address which you supply confirming your 

interest in providing a submission for the record. You MUST REPLY to the email 

and ATTACH your submission as a Word or WordPerfect document, in compliance 

with the formatting requirements listed below, by close of business Tuesday, July 

5, 2005. Finally, please note that due to the change in House mail policy, the U.S. 

Capitol Police will refuse sealed-package deliveries to all House Office Buildings. 

For questions, or if you encounter technical problems, please call (202) 225–1721. 

FORMATTING REQUIREMENTS: 

The Committee relies on electronic submissions for printing the official hearing record. As always, submissions will be included in the record according to the discretion of the Committee. 

The Committee will not alter the content of your submission, but we reserve the right to format 

it according to our guidelines. Any submission provided to the Committee by a witness, any supplementary materials submitted for the printed record, and any written comments in response 

to a request for written comments must conform to the guidelines listed below. Any submission 

or supplementary item not in compliance with these guidelines will not be printed, but will be 

maintained in the Committee files for review and use by the Committee. 

1. All submissions and supplementary materials must be provided in Word or WordPerfect 

format and MUST NOT exceed a total of 10 pages, including attachments. Witnesses and submitters are advised that the Committee relies on electronic submissions for printing the official 

hearing record. 

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

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

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

by the Committee. 

3. All submissions must include a list of all clients, persons, and/or organizations 

on whose behalf the witness appears. A supplemental sheet must accompany each 

submission listing the name, company, address, telephone and fax numbers of each 

witness. 

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

Wide Web at http://waysandmeans.house.gov. 

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

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

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

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

f 

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Chairman MCCRERY. The hearing will come to order. Good 

afternoon, everyone. Welcome. This is our seventh Subcommittee 

on Social Security hearing on protecting and strengthening Social 

Security. Before we start this morning, I would like to take just a 

moment to acknowledge the work of our former Subcommittee 

Chairman, Congressman Jake Pickle. Jake died this past weekend. 

As you all know, he served a long time in the House, about 31 

years. He was a lifelong Texan, a World War II naval combat veteran, a fiscal conservative. He worked tirelessly in the early 

eighties toward finding a bipartisan solution to the Social Security 

solvency crisis of that day. So, I think it is fitting that we pause 

for a second and remember Jake Pickle this morning as we try to 

follow a path toward a solution to the Social Security problems that 

confront us today and in the near future. Social Security, of course, 

occupies a special place among government programs because it 

has a profound impact not only on an individual person’s finances, 

one’s personal economy, but also on our National economy. Today 

we will examine the larger macroeconomic issues associated with 

Social Security. 

One such issue involves the economic variables used to estimate 

Social Security’s finances. The variables include the rate of real 

earnings growth, the real interest rate, employment, and the inflation rate. The real earnings growth rate affects growth of initial 

benefits payable to individuals as well as the tax base supporting 

the program. The interest rate affects the balance of the Social Security Trust Funds. The employment rate affects current revenue 

and future benefit obligations for the program. The inflation rate 

determines adjustments to benefits after they begin. 

From an economic and an individual perspective, a key question 

we face is how best to finance Social Security benefits, whether to 

stick with the current pay-as-you-go financing structure under 

which today’s workers’ payroll taxes support today’s retirees, or 

whether we begin to save real assets to help pay benefits in the future—also known as prefunding Social Security. Through voluntary 

prefunded personal accounts, we would have the opportunity to not 

only strengthen Social Security, but encourage savings, which could 

in turn greatly expand the pool of capital available for investment, 

leading to more economic growth and jobs. I welcome our very distinguished panel this morning, and I look forward to hearing your 

views and responses to our inquiries. Now, I would ask my colleague Sandy Levin, the Ranking Member of the Subcommittee, if 

he would like to make some opening remarks. 

Mr. LEVIN. Thank you very much, and it is most appropriate 

that you started off our hearing today to remember Jake. He was 

a wonderful and, in his own way, colorful character. If he were 

with us today, I am sure he would have a story or two to enlighten 

our hearing. He had an intense dedication to the Social Security 

system, and I was relatively new when he—very new when he was 

in full bloom in 1983. He stayed that way throughout his years 

here. So, Jake, as we delve further into this, we remember you well 

and we miss you. In announcing today’s hearing, our Chairman 

suggested that one way to strengthen Social Security is to prefund, 

as you put it, benefits, and that doing so could enhance national 

savings and economic growth. This is an important discussion. I 

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am glad we are having it, and we very much welcome this very distinguished group of experts. 

This is not, however, a new discussion. In 1983, we made the decision to shift from a pure pay-as-you-go Social Security system to 

one that was partially prefunded. As a result, we currently have 

over $1.7 trillion in the Social Security Trust Fund. This year 

alone, Social Security will earn $169 billion more than is needed 

to pay this year’s benefits. Although those surpluses invested in 

U.S. Treasury bonds are enough to secure Social Security’s future 

for many years, some of their economic benefit has been muted because Congress often borrowed Social Security surpluses to pay for 

other priorities rather than using them to increase national savings 

by paying down the national debt. For example, President Bush’s 

current budget and the budget resolution passed by the House and 

Senate majorities proposed to spend every dime of this year’s surplus to finance other priorities, including over $100 billion in tax 

cuts. As we demonstrated in the late nineties, when President Clinton led us in saving the surplus for Social Security and we built 

up a $5.6 trillion projected budget surplus, fiscal discipline can 

have real economic advantages as well as ease the pain of keeping 

future obligations. Unfortunately, the current Administration 

squandered the surplus in Social Security funds on a massive tax 

cut aimed at the very wealthy, undoing progress we had made toward prefunding Social Security’s obligations. 

So, as we discuss prefunding today, we should keep in mind that 

privatization and prefunding are two different things. A guaranteed benefit pension system can be prefunded, as all State pension 

systems and private pensions in the United States are, and a 

privatized system can be essentially unfunded, as under President 

Bush’s Social Security privatization plan, by borrowing all the 

money for future accounts and passing on the cost to future generations. I hope our witnesses can help us better understand the real 

costs and benefits of prefunding, and the various ways it can be 

achieved. Social Security’s guaranteed benefits, whether prefunded 

or pay-as-you-go, are critical to millions of current and future retirees and families. I would just add, if anyone has any doubt about 

that, they should read the articles in the New York Times, especially the one on Sunday. It would be particularly disingenuous for 

those who made decisions to move off a fiscally responsible path to 

use their own poor policy choices to justify privatizing Social Security and putting guaranteed benefits at risk for millions of Americans. So, we look forward to your testimony. Thank you, Mr. Chairman. 

Chairman MCCRERY. Thank you, Mr. Levin. This morning’s 

rather large panel is quite a distinguished one. We have with us 

this morning Dr. Douglas Holtz-Eakin, who is the Director of the 

Congressional Budget Office (CBO); Dr. June O’Neill, formerly of 

the CBO and currently Wollman Distinguished Professor in Economics at the Zicklin School, Baruch College, New York; Stephen 

J. Entin, President and Executive Director, Institute for Research 

on the Economics of Taxation; William W. Beach, Director, Center 

for Data Analysis, The Heritage Foundation; Lee Price, Research 

Director, Economic Policy Institute; Dr. Andrew Samwick, Professor of Economics and Director of the Nelson A. Rockefeller Cenhsrobinson on PROD1PC72 with HEARING

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ter, Dartmouth College in New Hampshire; Dr. Jason Furman, 

Senior Fellow, Center on Budget and Policy Priorities and Visiting 

Scholar of New York University; and William G. Shipman, Chairman, CarriageOaks Partners, Manchester-by-the-Sea, Massachusetts, and Co-Chairman of The Cato Institute’s project on Social Security Choice. Welcome, all of you. Thank you very much for joining us this morning. Dr. Holtz-Eakin, we are going to begin with 

you, if you would. All of your written testimony will be included in 

the record in their entirety. If you could try to summarize that in 

about 5 minutes, we would appreciate it. Thank you. 

STATEMENT OF DOUGLAS HOLTZ-EAKIN, PH.D., DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

Mr. HOLTZ-EAKIN. Thank you, Mr. Chairman, Mr. Levin, and 

Members of the Committee. The CBO is pleased to be here today. 

The written testimony that we have submitted has four basic 

points. Point number one is to summarize the financial outlook for 

Social Security under current law and identify the financing problems. This is not news and I will leave that to written testimony. 

The second point is to document the role of economic performance 

in contributing to and solving the financing problem, the particular 

contribution of wage rates, interest rates, and the like. Point number three is to reverse the direction and look at the role of fixing 

the Social Security and larger budgetary issues that face the 

United States in providing better economic performance. Then the 

testimony closes with a bit of a discussion about the virtues of moving sooner, as opposed to later, in addressing these pressing financing problems. 

Let me take those in order. The first is the role of economic performance in the Social Security finances. As the Chairman mentioned at the outset, there are some key variables which are used 

for projecting the outlook for Social Security under either current 

law, or in a reform program. They are the earnings growth, interest rates, inflation, and the mix of unemployment and employment 

for any given labor force. 

Earnings growth is by far the most important. Earnings growth 

is driven by productivity advances in the United States. Earnings 

will rise with productivity and take a mix of taxable earnings and 

untaxed compensation. Those rises in earnings will increase both 

taxes received by the system, and also benefits due in the system. 

The rise in productivity that drives earnings will come from two 

sources. One is the continuous progress of innovation in the United 

States, which is captured in the economist’s term ‘‘total factor productivity.’’ The second is the additional productivity that comes 

with the accumulation of wealth and capital resources, the provision of workers with greater amounts and higher quality factories, 

machines, and the like, which raise productivity, and thus earnings. There is a timing difference. Increases in productivity and 

earnings first are reflected in taxes, and then later show up as 

higher benefits from the higher earnings. In any event, it is unlikely, given the historic pace of productivity growth and the likely 

variation around that historic pace, that we can grow our way out 

of the Social Security financing problem. The figure that we 

brought as a display in this regard shows, at the top, the outlays 

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under current law for Social Security. These are scheduled benefits 

as a fraction of GDP. The bottom dark line is scheduled receipts 

as a fraction of GDP in the system, and the light blue shaded area 

shows the variation in productivity that would be about 80 percent 

likely under historic growth rates of productivity. So, there is an 

80 percent chance, given what we know, that productivity will lie 

somewhere in that band and produce outlays somewhere in that 

band. 

As you can see, while it is the case that higher productivity 

growth could ameliorate the Social Security financing problem, it 

is extremely improbable that it will by itself be a solution to the 

mismatch between scheduled benefits, at the top, and revenues, at 

the bottom. That is the most central economic variable affecting the 

future of Social Security as it is currently constructed. The second 

key variable is real interest rates. While they don’t affect this picture of the current annual benefits or the current annual receipts, 

they do affect system financial measures such as trust fund exhaustion. To the extent that interest rates are higher, bonds in the 

trust fund accumulate greater interest, and the trust fund lasts 

longer. A rough rule of thumb is that in our projections raising real 

interest rates by 1 percentage point would allow the trust fund to 

last a little under a decade-and-a-half longer, a little under 15 

years. Going the other direction, if interest rates were lower by a 

full percentage point, trust funds would be exhausted about that 

much sooner. 

The second thing that interest rates are important for are measures of actuarial balance. Interest rates are used to discount the future back to the present. To the extent that interest rates are higher, future deficits count less in those computations compared to 

current surpluses, and the actuarial balance does not look as bad. 

The reverse is also true. To the extent that interest rates are lower, 

future deficits will count more heavily and the actuarial balance 

will move in the other direction. I will leave to Members and the 

staff the comments we have written on the inflation and unemployment rates in our projections. They are less central to either measured or actual performance of the system in the future. 

The second aspect is to look at achieving better performance and 

fixing the budgetary problems facing the United States. Not just 

Social Security, but fixing the larger demands in Medicare and 

Medicaid would improve the future economic performance of the 

United States. There, the key issue is that by saving more in the 

present as a nation, we can accumulate greater national wealth, 

produce greater national income, and enlarge the pie available to 

fund all of the private-sector and public-sector demands. We did 

some illustrative calculations that raising the national saving rate 

by 2 percentage points might raise the capital stock by 15 percent 

by 2050, raise GDP per person by 4 percent over that period. Even 

simply saving the current Social Security surplus, genuinely saving 

it as national saving increases, could raise GDP per capita by 1.5 

percent over the next 50 years. That prefunding could take place 

in the government, it could take place in the private sector, and the 

central issue is a design one which allows any resources devoted 

to prefunding not be offset by government or private sector actions. 

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1See Congressional Budget Office, Updated Long-Term Projections for Social Security (March 

2005). 

Then finally, the testimony closes with a short discussion that is 

intended to illustrate the benefits of moving sooner as opposed to 

later. One can think of current-law Social Security as a wait-andreform strategy. In our projections, when the trust funds exhaust 

in 2052, benefits are at that point mechanistically cut by about 22 

percent. That is a wait-and-reform strategy of a rather meat-cleaver fashion. One could imagine moving sooner. This display shows, 

simply for illustration, the difference between benefits received 

over the lifetime of beneficiaries. If one waits and reforms, that is 

the dark line that shows those cohorts born in 1950–1959 getting 

fully scheduled benefits but later cohorts getting much less. Or 

with the light blue lines, imagining a 10 percent across-the-board 

cut in benefits now, which would share the burden, providing less 

for the older cohorts but allowing younger cohorts, those who are 

15 and younger at the moment, to receive greater benefits over the 

life of their participation in the program. We are pleased to have 

the chance to both submit the written testimony, and to be here, 

and we look forward to your questions. 

[The prepared statement of Dr. Holtz-Eakin follows:] 

Statement of Douglas Holtz-Eakin, Ph.D., Director, Congressional Budget 

Office 

Mr. Chairman, Congressman Levin, and Members of the Subcommittee, I appreciate the opportunity to appear before you today to discuss Social Security and the 

economic factors that influence its financial outlook. 

As you know, Social Security is the single largest Federal program. In 2004, the 

Social Security system received $569 billion in tax revenue and paid out $493 billion 

in benefits. The program provided benefits to more than 47 million people—about 

two-thirds of them retired workers and the rest disabled workers, survivors of deceased workers, workers’ spouses, and minor children. 

Although today the program takes in more revenue than it spends, that situation 

will not continue once large numbers of baby boomers begin claiming retirement 

benefits. In coming years, the Social Security system will face mounting financial 

pressures as its outlays start to grow much faster than its revenue. The Congressional Budget Office (CBO) projects that scheduled Social Security outlays (those 

implied by the current benefit formula) will rise from 4.3 percent of gross domestic 

product (GDP) in 2004 to 6.4 percent in 2050.1 Revenue, however, is scheduled to 

average less than 5.0 percent of GDP. 

The aging of the population will place similar pressures on the government’s two 

big health care programs, Medicare and Medicaid. Without changes in spending or 

revenue policies, Federal debt could begin to grow at an unsustainable pace. Faster 

economic growth would help reduce some of that budgetary imbalance, but it is 

highly unlikely that economic growth alone could solve the problem. Conversely, 

slower growth would exacerbate the situation. Prefunding future retirement obligations by increasing national saving could noticeably reduce the burdens that an 

aging population would impose on future workers, and taking action sooner rather 

than later could lessen some of the uncertainties that future retirees face. 

The Financial Outlook for Social Security 

The next decade will see the beginning of a significant, long-lasting shift in the 

age profile of the U.S. population. Over the next 50 years, the number of people ages 

65 and older will more than double, while the number of adults under age 65 will 

grow by less than 20 percent. That shift reflects demographic trends that have been 

evident for years and that are expected to continue, such as the aging of the babyboom generation, increases in life spans, and a relatively low fertility rate. 

Those trends imply that the number of workers per Social Security beneficiary 

will decline significantly, from 3.3 in 2004 to 2.0 in 2050. Because Social Security 

depends on revenue from current workers to finance benefits, that demographic 

shift will have a profound impact on the system’s finances. 

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Social Security’s Finances 

In 2009, the Social Security surplus—the amount by which the program’s dedicated revenue in a year exceeds the benefits paid in that year—will start to diminish. In 2020, that surplus will disappear, and outlays for benefits will begin to surpass the system’s annual revenue (see Figure 1). To pay full benefits, the Social Security system will eventually have to rely on interest on the government bonds held 

in its trust funds—and ultimately, on the redemption of those bonds. In the absence 

of other changes, bonds can continue to be redeemed until the trust funds are exhausted, which will occur in 2052, CBO projects. But where will the Treasury find 

the money to pay for the bonds? Will policymakers cut back other spending in the 

budget? Will they raise taxes? Or will they borrow more? 

Figure 1. Social Security Revenue and Outlays Under Current Law 

(Percentage of GDP) 

Source: Congressional Budget Office. 

Note: The projections in this figure employ the Social Security trustees’ 2004 intermediate demographic assumptions and CBO’s January 2005 economic assumptions. Revenue includes payroll taxes and income taxes on benefits but not interest credited to the Social Security trust funds; outlays include trust-fund-financed 

Social Security benefits and administrative costs. Under current law, outlays will 

begin to exceed revenue in 2020; starting in 2053, the program will no longer be 

able to pay the full amount of scheduled benefits. 

Once the trust funds are exhausted, the Social Security Administration will no 

longer have the legal authority to pay full benefits. As a result, it will have to reduce payments to beneficiaries to match the amount of revenue coming into the system each year. Although the exact size of that reduction is uncertain, CBO estimates that benefits will have to be cut—both for current recipients and for new 

beneficiaries—by about 22 percent to match the system’s available revenue. 

The key message from those numbers is that with benefits reduced annually to 

equal revenue, as they will be under current law when the trust funds run out, 

some form of the Social Security program can be sustained forever. Of course, many 

people would not consider a sudden 22 percent cut in benefits to be desirable policy. 

In addition, the budgetary demands of bridging the gap between spending and revenue in the years before that cut could prove onerous. But Social Security is sustainable from a narrow programmatic perspective. What is not sustainable is continuing to provide the present level of scheduled benefits given the system’s present 

financing (see Figure 2). 

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Insert offset folio 23926a.001
10 

Figure 2. Social Security Revenue and Outlays with Scheduled Benefits 

Extended 

(Percentage of GDP) 

Source: Congressional Budget Office. 

Note: The projections in this figure employ the Social Security trustees’ 2004 intermediate demographic assumptions and CBO’s January 2005 economic assumptions. Revenue includes payroll taxes and income taxes on benefits but not interest credited to the Social Security trust funds; outlays include Social Security benefits and administrative costs. In this outlay projection, currently scheduled benefits are assumed to be paid in full after 2052 using funds from outside the Social 

Security system. 

Implications for the Budget and the Economy 

CBO’s projections offer some guidance about the potential impact of those developments on the budget. Under CBO’s assumptions, the Social Security surplus (excluding interest on bonds in the trust funds) will reach about $100 billion in 2007. By 

2025, however, the surplus will have turned into a deficit of roughly $100 billion 

(in 2005 dollars). That $200 billion swing will represent a significant challenge for 

the budget as a whole, especially in light of the current budget deficit. 

The demand on the budget from Social Security will take place at the same time 

as—but is projected to be eclipsed by—the demand from Medicare and Medicaid. 

Currently, outlays for Social Security benefits are slightly more than 4 percent of 

GDP, as is Federal spending on Medicare and Medicaid combined. But whereas Social Security outlays are projected to grow to 6.4 percent of GDP by 2050, spending 

on the two health programs could reach a total of 20 percent of GDP if current 

trends in health care costs continue. 

Without changes in policy, therefore, Federal spending is likely to increase sharply in coming decades. Unless taxes rise well above their historical levels, the gap 

between spending and revenue will widen, expanding the amount of Federal borrowing. The resulting increase in government debt could seriously harm the economy. It could crowd out private capital formation, and although its impact on capital 

accumulation could be muted by borrowing from abroad, foreign borrowing is no 

panacea. The debt owed to foreigners would still have to be serviced. In the end, 

Federal debt would reduce the disposable income of U.S. residents and erode future 

living standards. 

Effects of Economic Assumptions 

Projections of the future financial status of Social Security depend on a number 

of demographic and economic assumptions. In its projections, CBO uses the demographic assumptions of the Social Security trustees and its own economic assumptions. CBO’s economic assumptions for the next 10 years are described in The Budghsrobinson on PROD1PC72 with HEARING


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11 

et and Economic Outlook (January 2005); the assumptions for later years are consistent with those used in the 10th year of the projection. 

Assumptions about four economic factors affect the finances of the Social Security 

system: the growth of earnings, the interest rate used to compute the interest credited to the trust funds, employment, and inflation. Of those four, earnings growth 

has the largest impact on Social Security’s outlays and revenue. The interest rate 

affects Social Security’s finances because it determines the amount of interest paid 

to the trust funds, but that interest is an intragovernmental transfer and has no 

effect on the total budget. The other factors have important implications for overall 

economic performance, but they do not affect Social Security’s finances significantly. 

Earnings Growth 

Real (after-inflation) earnings growth—and its main underlying determinant, productivity growth—is the key economic determinant of Social Security’s finances as 

well as of the performance of the economy in general. Social Security benefits are 

based on earnings during a person’s working years. Workers with higher lifetime 

earnings receive higher benefits, as do their dependents and survivors. The benefit 

formula is also structured to ensure that as average earnings grow, benefits for new 

recipients grow at approximately the same rate. As long as the system pays scheduled benefits, Social Security benefits will replace the same portion of earnings for 

future generations as they do for today’s beneficiaries (for workers who claim benefits at the normal retirement age). However, the purchasing power of those benefits 

will be greater than that of benefits paid today. 

Although initial Social Security benefits are indexed to earnings, higher-than-expected earnings growth would improve Social Security’s financial position. Higher 

real earnings immediately result in higher payroll tax revenue, but outlays do not 

increase until the workers with higher earnings claim benefits, which can be years 

or even decades later. The benefits paid to current recipients are indexed to prices, 

not earnings, so overall outlays do not increase in lockstep with real earnings. 

In the long run, workers’ compensation grows with productivity. Productivity 

growth in turn stems from two factors: increases in the amount of capital per worker and, more important, technological advances that raise the amount of goods and 

services that can be produced with a given level of capital and labor—so-called total 

factor productivity (TFP). Workers do not receive all of their compensation in the 

form of earnings; some is received in nontaxable forms, such as health benefits. 

CBO assumes that the increasing share of compensation received as nontaxable benefits will slow the annual growth rate of taxable earnings by 0.1 percent. For its 

part, TFP is assumed to increase at an average annual rate of 1.25 percent over 

the long term. With the growth in nontaxable compensation and other technical factors that affect earnings accounted for, that assumption implies that earnings will 

grow by about 1.2 percent annually. 

Uncertainty about earnings growth results in uncertainty about the size of future 

Social Security shortfalls—but there is little, if any, uncertainty that shortfalls will 

exist. On the basis of analysis of historical variation in TFP, CBO has projected the 

range of probable outcomes for Social Security outlays that lies between the 10th 

and 90th percentiles for TFP (see Figure 3). By definition, there is a 10 percent 

chance that TFP will be above the 90th percentile and a 10 percent chance that it 

will be below the 10th percentile. CBO projects that the gap between Social Security 

spending and revenue will equal 1.39 percent of GDP in 2050. The 10th percentile 

projection for that year is a deficit of 2.1 percent of GDP, and the 90th percentile 

projection is a deficit of 0.7 percent of GDP. Moreover, even the 99th percentile projection (which implies only a 1 percent chance that TFP will be so high) shows the 

Social Security system running a deficit of 0.3 percent of GDP. 

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2Specifically, the interest rate on new special obligations equals the average market yield on 

all outstanding, marketable U.S. obligations that are due or callable more than four years in 

the future. See Jeffrey L. Kunkel, Social Security Trust Fund Investment Policies and Practices, 

Actuarial Note 142 (Social Security Administration, Office of the Chief Actuary, January 1999). 

Figure 3. Social Security Revenue and the Potential Range of Scheduled 

Outlays with Uncertainty About Productivity 

(Percentage of GDP) 

Source: Congressional Budget Office. 

Notes: The dark lines in this figure indicate CBO’s projections of expected revenue 

and outlays based on the Social Security trustees’ 2004 intermediate demographic 

assumptions and CBO’s January 2005 economic assumptions. In those projections, 

annual Social Security outlays (for benefits and administrative costs) exceed revenue (from payroll taxes and income taxes on benefits but not interest credited 

to the Social Security trust funds) starting in 2020. Currently scheduled benefits 

are assumed to be paid in full after 2052 using funds from outside the Social Security system. 

The shaded area indicates the 80 percent range of uncertainty for projected outlays, 

assuming that total factor productivity varies as it has in the past. (The 80 percent range of uncertainty means that there is a 10 percent chance that actual values will be above that range, a 10 percent chance that they will be below it, and 

an 80 percent chance that they will fall within it. The uncertainty range is based 

on a distribution of 500 simulations.) 

Interest Rate 

The real interest rate has no direct effect on annual Social Security revenue and 

outlays. However, it does affect trust fund measures and summarized measures, 

such as the 75-year summarized balance (the difference between the present values 

of projected revenue and outlays over 75 years). 

The interest rate used to calculate the interest credited to the trust funds is equal 

to an average of the rates on privately held Treasury bonds.2 A higher rate results 

in a later trust fund exhaustion date. CBO assumes that the real interest rate will 

be 3.3 percent. If that rate was 1 percentage point higher (4.3 percent), the exhaustion date would be extended from 2052 to 2066. A rate of 2.3 percent would accelerate the exhaustion date to 2045. 

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3The annual cost-of-living adjustment that applies to payments beginning in January is determined by the increase in the consumer price index for urban wage earners and clerical workers 

(CPI–W) from the third quarter of two years before to the third quarter of the previous year. 

For example, the adjustment made to payments in January 2005 was determined by the increase in the CPI–W from the third quarter of 2003 to the third quarter of 2004. 

In the computation of summary financial measures, future outlays and revenue 

are discounted using the real interest rate. A higher discount rate would weight 

past and current surpluses more heavily and would give less weight to future shortfalls. With a higher real interest rate, the summarized balance would show an improvement. 

From the perspective of the total budget, the interest rate is important because 

it determines the amount of interest that the Federal Government will owe to members of the private sector and foreign governments that hold Treasury securities. 

Employment 

Higher levels of employment increase total earnings and thus revenue from Social 

Security payroll taxes. They also lead to higher Social Security benefits in the future. On net, however, higher employment levels improve Social Security’s financial 

position because the higher revenue precedes payment of the associated benefits, 

often by many years. 

The percentage of the population working is determined by two factors: the labor 

force participation rate, which measures the portion of people working or seeking 

work, and the unemployment rate, which measures the share of people in the labor 

force who are unemployed. Over the long term, reasonable variation in either factor 

is not likely to have a large impact on the financial outlook for Social Security. In 

its most recent long-term Social Security projections, CBO assumed an average unemployment rate of 5.2 percent. If the average rate turned out to be 6.2 percent, 

the Social Security deficit in 2050 would be 1.38 percent of GDP rather than the 

projected 1.39 percent. The effects of reasonable variation in labor force participation are of the same magnitude. 

Inflation 

In general, the economy benefits from low and stable inflation. However, in a mechanical sense, high inflation actually improves Social Security’s finances. Assuming 

that real earnings growth is constant, higher inflation will immediately result in 

higher earnings and higher payroll tax revenue. But Social Security benefits will not 

be adjusted for inflation until the following year.3 Of course, higher inflation can 

also have broader negative effects on the economy that may worsen Social Security’s finances. 

In its most recent long-term Social Security projections, CBO assumed an average 

inflation rate of 2.2 percent. If the average rate turned out to be 3.2 percent, the 

Social Security deficit in 2050 would be 1.29 percent of GDP instead of 1.39 percent, 

as projected. 

Consistency of Projections 

A concern that arises among some analysts is the consistency of economic projections, including CBO’s, that envision much slower growth of GDP than was experienced over the past 50 years and projections of earnings growth that are at the 

same pace as historical experience. The projections of lower GDP growth stem from 

projections of slower labor force growth. CBO does not anticipate that the fertility 

rates experienced during the baby boom will recur. Moreover, since 1950, the labor 

force participation rate of women has risen from 40 percent of the rate for men to 

80 percent, an increase that is numerically impossible to repeat. However, the continued rise in productivity will be reflected in growing earnings per worker, and the 

flexible adjustment of a market economy will ensure sustained high rates of employment. 

Prefunding Future Obligations and Economic Growth 

Any strategy to prepare the United States for an aging population must deal with 

a key fact: the goods and services that retirees will consume in the future will have 

to be produced by the U.S. economy or imported from abroad at that time. From 

that perspective, what matters is not the financial structure of the Social Security 

program but the capacity of the economy and the distribution of economic output. 

Various options for changing Social Security will have different effects on the economy and on the division of resources between the elderly and other people. To the 

extent that those options boost the future size of the economy by increasing the nation’s accumulation of assets, they will make it easier to support a larger portion 

of the population in retirement. 

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4 Net national saving is national saving minus depreciation of the capital stock. Net national 

product is gross national product minus depreciation. 5That calculation assumes that private savers would respond to the change in government 

saving as they have in the past. 

Just as individuals prepare for their retirement by saving in advance, a nation 

can prepare for an aging population by prefunding its future obligations. That goal 

can be accomplished by increasing national saving, which is the combined saving 

of the private sector and the government. A rise in national saving increases the 

pool of funds available for investment at home and abroad, thus adding to the stock 

of productive capital and providing resources to purchase assets from other countries. As investment in businesses’ structures and equipment increases, workers become more productive, real wages rise, and the United States is able to produce 

more goods and services. Moreover, the income from additional foreign assets supplements the income produced domestically. 

Prefunding could have a noticeable effect on the future production of goods and 

services. In 2004, net national saving amounted to only 2.2 percent of net national 

product (though it averaged 6.1 percent from 1980 to 2000), and CBO projects that 

it will average 3.9 percent between 2005 and 2015.4 If net national saving was permanently increased by 2 percentage points of net national product, the nation’s capital stock would be 15 percent larger in 2050, CBO estimates. With more capital, 

workers would earn higher wages, and real GDP per capita would rise by 4.3 percent. Even a more modest goal of simply saving Social Security’s noninterest surplus 

instead of spending it could raise real GDP per capita by 1.5 percent in 2050.5

In principle, prefunding could be carried out by either the private sector, the government, or both. Households could prefund their future retirement by saving more; 

the government could prefund its future obligations by reducing the budget deficit. 

However, not all policies intended to increase private or government saving are 

equally effective in raising total national saving. For example, higher income tax 

rates might increase government saving but might also serve to reduce private saving. Similarly, tax incentives to stimulate private saving might involve revenue 

losses to the government, which reduce the amount of government saving. Conversely, curbing the growth of entitlement benefits might raise both government 

saving and private saving, as beneficiaries saved more to offset the reduced benefits. 

For example, indexing initial Social Security benefits to prices instead of to wages, 

as the President’s Commission to Strengthen Social Security proposed as part of its 

Plan 2, would raise both private and government saving initially and could boost 

the capital stock by between 41⁄2 percent and 61⁄2 percent in 2050, CBO estimates. 

In the end, what matters for the growth of the capital stock and the economy is 

the combined impact of a policy change on government saving and private saving— 

not the effect on either one alone. 

In practice, could the government actually maintain the potential budget surpluses that would be generated from a tax increase or spending cut? That question 

has provoked a great deal of controversy, particularly in the context of Social Security’s cash flow surplus. From a technical standpoint, the question is impossible to 

answer because it is impossible to know how other policies would have been changed 

if the Social Security surplus did not exist. The ultimate question of whether a surplus in the Social Security program causes policymakers to spend more on other 

programs—or tax less—is thus not one that is easy to answer. 

Some analysts point to the reduction in Federal debt in the late 1990s as evidence 

that the government could save if it tried; others argue that the experience of the 

past few years shows the enormous difficulty of maintaining budget surpluses over 

an extended period, even despite efforts to put Social Security surpluses in a ‘‘lock 

box.’’ Indeed, many proponents of personal savings accounts argue that diverting the 

Social Security surpluses to personal accounts could create a more effective ‘‘lock 

box.’’ In their view, such accounts would raise total national savings and effectively 

prefund future retirement obligations by making it more difficult for policymakers 

to spend resources. 

The effectiveness of accounts in increasing national savings, however, would depend on how the accounts were financed and on the rules governing both accumulations in and withdrawals from them. For example, if it was too easy to take money 

from an account before retirement, participants might not accumulate as much as 

they would under a more restrictive arrangement. Administrative costs could also 

reduce the amount of net savings created by the accounts. Furthermore, some individuals might respond to personal accounts by reducing other private saving. Indeed, experience with 401(k) plans suggests that although low-income people increased their saving in response to tax incentives that favor such plans, most highincome people responded by shifting their assets from other accounts into their 

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401(k) plan rather than by increasing their total saving. Combining a tax incentive 

for saving with lower future Social Security benefits, however, could limit the risk 

that people would reduce other saving dollar for dollar, because those who did could 

have less income in retirement. 

Some analysts have also suggested that private accounts might strengthen marginal incentives to work because people would see the link between their contributions to the accounts and their eventual retirement benefits more clearly than they 

do under the current system. That effect might not have a large impact on the labor 

supply, however. Although perceptions of improved marginal incentives would tend 

to boost the labor supply, perceptions of higher—and possibly more certain—retirement income would tend to reduce it (because people would not have to work as 

much to reach a given standard of living). The net effect on the labor supply would 

depend on the balance between those two factors and might not be large. 

Making Changes Now or Later: Economic and Budgetary Effects 

Uncertainty is an economic cost in its most fundamental form, and in the current 

context, there is uncertainty about the future of Social Security: what the program 

will look like and who will be affected by changes to it. The sooner that uncertainty 

is resolved or reduced, the better served will be current and future beneficiaries, 

who must make various decisions about their retirement. Phasing in changes to Social Security allows for gradual accommodation, giving people time to modify their 

expectations and to adjust their work and saving behavior. For example, younger 

workers who learned that they would receive lower-than-anticipated retirement benefits would have many years to respond. They could work or save a little more each 

year. If the same benefit cuts were announced as those workers neared retirement, 

however, workers might be forced to make dramatic changes and still might not 

have time to accumulate sufficient savings. 

One way to gauge the advantage of acting earlier is to examine potential changes 

to the current pay-as-you-go Social Security system. As noted above, CBO projects 

that the Social Security trust funds will become exhausted in 2052 under current 

law. After that, the Social Security Administration will lack the authority to pay 

benefits in excess of the system’s annual revenue, meaning that outlays will have 

to be reduced immediately by 22 percent to match that revenue, CBO estimates. Put 

another way, current law constitutes a ‘‘wait and change’’ strategy. Until 2052, 

beneficiaries would continue to receive scheduled benefits; however, those benefits 

would have to be cut by 22 percent in 2053, and larger reductions would be needed 

in later years. 

Alternatively, policymakers could reduce the benefits paid to earlier cohorts so 

that the benefits paid to later cohorts would not have to be cut as much. To illustrate that point, CBO examined a hypothetical policy that would reduce all new Social Security benefit awards by 10 percent (relative to those currently scheduled) beginning with people retiring or becoming disabled in 2012. 

In general, lifetime benefits for current workers (those born before 1980) would 

be lower under this policy than if no changes were made to the program (see Figure 

4). However, assuming other government finances were held constant, such a 

change would allow greater benefits to be paid to later generations than under current law. The reduced benefits paid to earlier generations would result in government savings, probably in the form of lower debt, that could be used to pay higher 

benefits to later generations. 

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Figure 4. Lifetime Social Security Benefits Under Current Law and with a 

10 Percent Benefit Cut Beginning in 2012 

(Percentage of scheduled benefits) 

Source: Congressional Budget Office. 

Such a policy could also substantially slow the growth of Federal debt held by the 

public over coming decades. Compared with current law, a 10 percent cut in new 

benefit awards starting in 2012 could reduce Federal debt by 25 percent of GDP by 

2050 (see Figure 5). That debt reduction could also bring economic benefits from 

more private saving, faster capital accumulation, and higher economic growth. Enacting the same policy 10 years later would also reduce Federal debt, but the effects 

would be smaller. 

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Figure 5. Change in Federal Debt Held by the Public from a 10 Percent Cut 

in Social Security Benefits 

(Percentage of GDP) 

Source: Congressional Budget Office. 

The mechanistic approach of CBO’s example is not intended as a recommendation 

or a comprehensive gauge of options. More-realistic proposals would include multiple provisions (such as tax increases, benefit reductions, or both) and would most 

likely be instituted gradually. This example is merely a convenient means of demonstrating the implications of earlier changes versus later ones. 

Such policy changes entail a variety of trade-offs about how to allocate the burden 

of bringing Social Security into long-term balance. One trade-off involves making decisions about the value of consumption today relative to the value of consumption 

tomorrow. The more that consumption is delayed, the more that resources are available for capital investment, which can boost economic growth. Another set of tradeoffs involves balancing fairness across income classes and generational cohorts. In 

some respects, those trade-offs cannot be neatly separated into decisions about income groups and generations, since the prospect of rising wages is likely to make 

future generations more affluent than current generations, on average. 

Whatever the policy—benefit reductions, tax increases, transfers of resources from 

other Federal programs, or a combination of those approaches—earlier action would 

distribute the burdens of the change over more generations. For both workers and 

beneficiaries, gradual changes are generally preferable to precipitous and disruptive 

actions, such as sudden, large reductions in benefits or sudden, large increases in 

taxes. Moreover, if changes were announced in advance and phased in gradually, 

workers and beneficiaries would have more time to prepare and to appropriately adjust their decisions about work and saving. 

f 

Chairman MCCRERY. Thank you. Dr. O’Neill? 

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STATEMENT OF JUNE O’NEILL, PH.D., WOLLMAN PROFESSOR 

OF ECONOMICS, BARUCH COLLEGE, CITY UNIVERSITY OF 

NEW YORK, NEW YORK 

Ms. O’NEILL. Mr. Chairman, Members of the Subcommittee, I 

appreciate the opportunity to appear before you today. For many 

years we have known that some time in the future the Social Security benefits currently scheduled would not be fully funded by 

scheduled tax increases. Yet the point in time when the system will 

run deficits always seemed far in the future, a distant period when 

Baby Boomers become retirees. We are now rapidly approaching 

that period. Social Security has grown to become the largest program in the national budget. Yet, despite its size, Social Security 

has seen surpluses, not deficits, for the past two decades, a fact 

that may have lulled some people into thinking: What’s the problem? The emergence of surpluses, however, is partly the result of 

a favorable but temporary demographic episode, and partly the result of legislation that raised taxes. The baby bust generation of 

the thirties has been reaching retirement age over the past decade, 

a trend that slowed the growth in retirees. At the same time, the 

Baby Boomers were still enlarging the size of the work force, and 

therefore of taxpayers. Also, on the revenue side, legislation enacted in 1983 increased Social Security taxes by an amount that 

produced surpluses for many years. 

The quandary faced by the Greenspan Commission that recommended the 1983 legislation is endemic to the problem of funding a pay-as-you-go system. Social Security is required to balance 

costs and revenues over a 75-year fiscal horizon. Benefits are 

scheduled, and automatically indexed, but legislating the taxes to 

fund these benefits depends on long-run projections based on aspects of the economy that cannot be known with any certainty. If 

tax revenues to pay for the benefits are set too low, the system will 

run deficits. If taxes are set too high, there will be surpluses. The 

Greenspan Commission erred on the side of surpluses, which 

turned out to be surpluses for the first 30 years but, after that, 

deficits for the long run. The commission may have believed that 

the surpluses would be saved to help fund the subsequent retirement of the Baby Boomers. Instead, the surpluses have been used 

routinely to fund other programs and have helped to mask deficits 

on the non-Social Security side of the budget. 

The period of Social Security surpluses is now expected to come 

to an end sometime between 2015 and 2020 as more and more 

Baby Boomers are added to the beneficiary population; at that 

point, annual deficits will replace surpluses. Expressed as a percentage of GDP, the Social Security shortfall, or gap, is estimated 

to increase rapidly, reaching 1.5 percent of GDP in 2035, and growing after that. How will we meet this shortfall? Some hold to the 

belief that we will not face a financing problem for four decades 

from now. That belief is based on the accounting practices of the 

Social Security system that treat the balances in the so-called 

‘‘trust fund’’ as though they were actually available to fund the revenue shortfall. The Social Security Trust Fund does not hold assets 

purchased in private markets that can be sold to pay benefits. The 

balances in the trust fund are bookkeeping entries showing the achsrobinson on PROD1PC72 with HEARING

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cumulated surpluses borrowed by the Treasury from the Social Security system, plus interest. 

In other words, the trust fund holds promises. The only way to 

make good on those promises is to increase general revenues or increase the publicly held debt. This will obviously entail a growing 

fiscal burden starting in another 10 to 15 years, when Social Security begins running deficits. Thus, our actual problem will begin at 

least two decades before the projected date of legal trust fund insolvency. Current projections of the trustees indicate that the trust 

fund balances will be exhausted about 2041—the CBO has it a decade later—at which point Social Security would be declared legally 

insolvent. The one practical effect of legal insolvency is that, by 

law, benefits must be held to the level of Social Security revenues 

once the balances of trust fund promises are depleted. Current estimates indicate that insolvency would trigger a precipitous reduction in benefits of 26 percent in 2041. Those are trustee estimates; 

CBO has a later-date insolvency, and somewhat lower initial decline in benefits. If Congress at that time chose to change the law 

and legislate higher taxes to close the gap, a payroll tax increase 

of 34 percent would be required, an increase in the combined payroll tax from about 13 percent to about 18 percent. 

One lesson to be learned from the financial history of Social Security is that we would not be in this fix if we had a prefunded 

system. If the Baby Boomers had started out making contributions 

into their own individually held accounts, their savings would have 

been invested in assets that eventually provide retirement income. 

Social Security, which is funded as a pay-as-you-go basis, shares 

many of the same problems faced by the defined benefit plans of 

the troubled airline and auto workers pensions. Benefits are promised, but the funding that will be needed to pay for them is not necessarily there when the time comes. 

The trust fund has no mechanism for prefunding benefits, nor 

would it be feasible or desirable for the Federal Government to 

purchase and hold assets from private markets. The only way for 

the Federal Government to prefund benefits is through individual 

accounts, in which each worker’s contribution would go directly 

into an investment that cannot be directed to pay for other government programs but would grow in value over time and eventually 

contribute to the worker’s own retirement income. For reasons such 

as these, prefunded, defined contribution plans have become the 

dominant type of pension plan in the private sector and the proportion of workers participating in defined benefit plans has sharply 

declined. 

Several concerns have been raised about the substitution of 

prefunded individual accounts for a portion of traditional Social Security benefits. Some argue that because workers cannot be certain 

of the ultimate value of the private accounts, they are better off 

with the safe benefit promised under our current system. Benefits 

under the current program are not risk-free. Today’s young workers cannot be sure what the level of taxes and benefits will be over 

the next 40 years. The state of the economy and the world situation, as well as the political inclinations of the public and of future 

lawmakers, are uncertain, yet are bound to affect the future benefits that can actually be paid. Risk is present in private market inhsrobinson on PROD1PC72 with HEARING

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vestments, but can be minimized by well-known techniques of diversification. Moreover, based on past history, the average return 

to private investment securities can be expected likely to exceed 

the return that Social Security benefits will bring relative to tax 

payments made. 

Another concern is the transition cost that arises when a portion 

of taxes is diverted to private accounts and additional funds from 

either general revenues or government-issued debt must be obtained to fund the benefits of existing retirees. However, these 

transition costs are not a dead-weight loss. When the workers who 

have contributed to individual accounts retire, no tax payments 

will be needed to pay for the portion of their benefits that was 

prefunded. The transition costs may be viewed as an economic investment that will lower government costs in the future and will 

benefit saving and encourage economic growth. 

In my view, there are two significant changes that should be 

made. One is to begin a transition to at least a partially prefunded 

system. With prefunding we can look forward to a period when a 

significant portion of Social Security benefits will not be subject to 

unfavorable demography and constant political crises. Workers 

would gain by receiving a higher return on their savings in a more 

flexible form. Society would gain from increased economic growth. 

The second change needed is to contain the costs of the pay-as-yougo portion of the system while maintaining an adequate safety net. 

Under our current wage indexed system, benefits are automatically 

set to replace about 40 percent of the average retiree’s earnings no 

matter how high the earnings get of all future retirees. In 40 years, 

the average worker at retirement is expected to receive a benefit 

that is 50 percent higher than that of the retiring worker today. 

A plan such as progressive indexing would reduce the growth of 

benefits awarded to the average retiring worker while enhancing 

the benefits of low-wage earners. 

The provision of benefits at the high levels currently scheduled 

goes far beyond Social Security’s original mission of poverty prevention. In signing the original law, President Roosevelt said, ‘‘We 

can never ensure 100 percent of the population against 100 percent 

of the hazards and vicissitudes of life. We have tried to frame a law 

which will give some measure of protection to the average citizen 

and to his family against the loss of a job and against a povertyridden old age.’’ At this point in time, doing nothing is not a sensible option. It ultimately would result in a sudden sharp decline 

in benefits when the program reaches legal insolvency. Major 

changes in retirement plans must be made enough in advance so 

that workers have time to adjust their work plans and savings. The 

time for planning and for reform is now. Thank you. 

[The prepared statement of Dr. O’Neill follows:] 

Statement of June O’Neil, Ph.D., Wollman Distinguished Professor of 

Economics, Baruch College, City University of New York, New York 

Mr. Chairman and Members of the Subcommittee: 

I appreciate the opportunity to appear before you today to discuss problems concerning the Social Security system. For many years projections of the long-term financial status of Social Security have indicated that the benefits scheduled under 

current law cannot be fully funded by scheduled tax revenues. Yet the point in time 

when the system will run deficits always seemed far in the future—a distant period 

when baby boomers become retirees. We are now rapidly approaching that period. 

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I will give a brief overview of the projected financial status of the program under 

current law and then comment on the economic issues raised by a mandatory retirement saving plan that is financed on a pay-as-you-go basis, under which the benefits 

of current retirees are funded by the taxes of current workers. Issues related to the 

financial status of Social Security and its ‘‘trust fund’’ frequently get the most attention. But fundamental questions need to be addressed concerning the economic costs 

of maintaining Social Security in its current form. 

Projected Financial Status 

Social Security currently is the largest program in the Federal budget. This year the program is estimated to spend $515 billion dollars, an amount that exceeds defense expenditures and accounts for 23% of total Federal outlays. In another five 

years Social Security will begin to grow more rapidly as the oldest wave of baby 

boomers starts retiring. By 2015, social security is projected to be 70% larger than 

it is today, accounting for 26% of the budget. Combined with Medicare, the two programs are expected to consume almost half the Federal budget in 2015. (Medicare 

is growing faster than Social Security and it is estimated that in 2015 will be about 

85% as large as Social Security and eventually will overtake it.) 

Despite its size, Social Security has not incurred funding problems for the past 

two decades. Although Social Security expenditures have been large, tax revenues 

from the payroll tax and from taxes paid on social security benefits have been even 

larger, generating substantial annual social security surpluses. The surpluses are 

partly the result of favourable economic conditions and favourable demography and 

partly the result of legislated tax increases. Regarding demography, the baby bust 

generation of the thirties has been reaching retirement age over the past decade 

while the baby boomers were still enlarging the size of the work force. In addition, 

increases in tax rates and coverage legislated in 1983 set in motion a flow of revenues that either accidentally or by design, produced surpluses for many years. Presumably the Greenspan Commission that recommended the bailout package—-Social 

Security was at that time close to default—believed that any surpluses would be 

saved to help fund the subsequent retirement of the baby boomers. But the surpluses have been used to fund other programs. At present the annual Social Security surplus is approaching $100 billion. It has significantly helped to mask the deficit in the non-Social Security side of the budget for most of the past two decades. 

Figure 1 shows the past record and current projections of scheduled benefit payments and tax revenues from 1990 to 2080, based on the Trustees 2005 projections. 

The long period of Social Security surpluses is now expected to come to an end 

around 2015 as more and more waves of baby boomers are added to the beneficiary 

population. Between 2015 and 2020 the Social Security surplus fades and turns to 

deficits. If no changes in the program are legislated, the overall Federal budget will 

experience considerable strain from the added burden of funding the growing Social 

Security shortfall. 

Expressed as a percentage of GDP, the small Social Security surplus of 0.2% in 

2015 is estimated to turn into a shortfall or gap between scheduled benefit payments and tax revenues of 0.4% in 2020 (Figure 2). The gap then climbs quickly 

to 1.5% of GDP in 2035 and increases more slowly after that, reaching 1.9% of GDP 

in 2080. 

How will we meet this shortfall? Some hold to the belief that we will not face a 

financing problem for more than three decades from now. But that belief is based 

on the accounting practices of the Social Security system that treat the balances in 

the so called ‘‘trust fund’’ as though they were actually available to fund the revenue 

shortfall. Unfortunately, the Social Security trust fund does not, and could not hold 

assets purchased in private markets that can be sold to pay benefits. The balances 

in the trust fund are bookkeeping entries showing the accumulated surpluses borrowed by the Treasury from the Social Security system plus the interest that would 

have been earned on those balances from investing in various Treasury securities. 

In other words, the trust fund holds promises. But the only way to make good on 

those promises is to raise general revenues or increase the publicly held debt. This 

will obviously entail a heavy fiscal burden starting in another 10 to 15 years, when 

social security begins running deficits. Thus our actual fiscal problem will start at 

least two decades before the projected date of legal trust fund insolvency. 

Eventually the trust fund balances are projected to be exhausted, at which point 

Social Security would be declared legally insolvent. The Social Security trustees currently estimate that insolvency will occur around 2041, a date that undoubtedly will 

be altered many times. The one practical effect of insolvency on the program is that 

by law, benefits must be held to the level of social security revenues, once the balances of trust fund promises are depleted. If the law remains unchanged, that would 

mean a precipitous reduction in benefits of 26% in 2041 and 32% in 2079 (Figure 

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3). It should be noted that a change in the law that closed the gap between benefit 

costs and revenues in 2040 with a payroll tax increase would require a 34 percent 

increase (an increase in the combined payroll tax from 13.3% to 17.8%). The size 

of that tax increase would have to continue growing after 2040 to keep pace with 

increasing costs. 

Basic Economic Issues 

One major conclusion suggested by the pessimistic Social Security outlook is that 

we would not be in this fix if we had a pre-funded system. If the baby boomers had 

started out makingcontributions into an individually held account, their savings 

would have been invested in assets that eventually provide retirement income. But 

Social Security, which in many ways is similar to the troubled airline and autoworkers’ defined benefit pension programs, is funded on a pay-as-you-go basis. The 

trust fund has no mechanism for pre-funding benefits. Nor would it be feasible or 

desirable for the Federal Government to purchase and hold assets from private markets. The only way for the Federal Government to pre-fund benefits is through individual accounts in which each worker’s contribution goes directly into an investment 

that cannot be directed to pay other government programs, but would grow in value 

over time and eventually contribute to the worker’s own retirement income. For reasons such as these, pre-funded, defined-contribution plans have become the dominant type of pension plan in the private sector as the proportion of workers participating in defined-benefit plans has dropped sharply. 

Several concerns have been raised about the substitution of pre-funded individual 

accounts for a portion of traditional Social Security benefits. Some argue that because workers cannot be certain of the ultimate value of their private accounts they 

are better off with the ‘‘safe’’ benefit promised under our current system. But benefits under the current program are not risk-free. Today’s young workers cannot be 

sure what the level of taxes and benefits will be over the next 40 years. The state 

of the economy and the world situation as well as the political inclinations of the 

public and of future lawmakers are uncertain, and are bound to affect future benefits. Risk is present in private market investments, but can be minimized by wellknown techniques of diversification. Moreover, based on past history, the average 

return to investment expected, even with conservative strategies, is likely to exceed 

the return that Social Security benefits bring relative to the tax payments made. 

Another concern involves the transition costs that arise when a portion of taxes 

is diverted to private accounts and additional funds from either general revenues 

or government issued debt must be obtained to fund the benefits of existing retirees. 

However, these transition costs are not a deadweight loss. When the workers who 

have contributed to individual accounts retire, no tax payments will be needed to 

pay for the portion of their benefits that was pre-funded. The transition costs should 

be viewed as an investment that will lower government costs in the future and will 

benefit saving and encourage economic growth. 

Decisions We Must Make 

In my view there are two significant changes that need to be made. One is to 

begin a transition to at least a partially pre-funded system. The die is cast for the 

financing problems of the near term. But with pre-funding we can look forward to 

a period when Federal retirement benefits will not be subject to unfavourable demography and constant political crises. Workers would gain by receiving a higher 

return on their savings and in a more flexible form. Society would gain from increased economic growth. 

The second change needed is to contain the costs of the pay-as-you-go portion of 

the system program while maintaining an adequate safety net. Under our current 

wage-indexed system, benefits are automatically set to replace about 40 percent of 

the average retirees earnings, no matter how high the earnings get of our future 

retirees. For example, the earnings level and benefit award of the average worker 

retiring in 40 years is expected to be 50 percent higher than that of the retiring 

worker today. A plan such as progressive indexing would reduce the growth of benefits awarded the average retiring worker while enhancing the benefits of low wage 

earners. 

Providing benefits at the high levels currently scheduled goes far beyond Social 

Security’s original mission of poverty prevention. In signing the original law, President Roosevelt said: ‘‘We can never insure one hundred percent of the population 

against one hundred percent of the hazards and vicissitudes of life, but we have 

tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.’’

At this point in time, doing nothing is not a sensible option. In fact, it ultimately 

would result in a sudden sharp decline in benefits when the program reaches legal 

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insolvency. Major changes in retirement plans must be made enough in advance so 

that workers have time to adjust their work plans and savings. 

Figure 1: Scheduled OASDI Cost and Revenue As a Percentage of GDP 

(2005 Trustees Report) 

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Insert offset folio 23926a.006
24 

Figure 2: Social Security Gap (Scheduled Benefit Costs—Tax Revenue) 

As a Percentage of GDP (2005–2080) 

Figure 3: OASDI Income and Cost Rates Under Intermediate Assumptions 

(2005 Trustees Report) 

(As a percentage of taxable payroll) 

f 

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Insert offset folio 23926a.007 Insert offset folio 23926a.008
25 

Chairman MCCRERY. Thank you, Dr. O’Neill. Mr. Entin? 

STATEMENT OF STEPHEN J. ENTIN, PRESIDENT AND EXECUTIVE DIRECTOR, INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION 

Mr. ENTIN. Thank you, Mr. Chairman, Members of the Subcommittee. I thank you for the opportunity to testify on the issue 

of Social Security reform. If your only concern is about the national 

budget and keeping the Old-Age and Survivors Insurance (OASI) 

program solvent for a few more years with minimal political fallout, then Congress must either raise taxes or cut benefit growth in 

some manner, as in 1977 and 1983. Those efforts did not improve 

the economy; they did not help your constituents on a permanent 

basis. We need to take into account not only how the economy affects Social Security, but how Social Security affects the economy, 

and how proposed solutions might impact your constituents and 

the economic performance of the Nation. 

I would suggest that if you want to deal with the economic situation as well as the technical budget situation within Social Security, then your best bet would be to treat Social Security as an insurance program and a safety net, and strengthen those aspects of 

the system, but to spin off the retirement feature. Social Security 

is not real saving. Let younger workers put some of their tax 

money into real saving vehicles that offer a much higher rate of return and that, unlike Social Security, make the economy grow. I 

would also like to ask you, quite literally, why are we making a 

Federal case out of retirement saving? The government’s interest 

in this is to keep people out of poverty in their old-age and to prevent them from needing public assistance. If this is the case, the 

mandated saving should only extend to achieving the socially acceptable minimal level of retirement saving. Any Federal retirement system should let people stop adding to the government-mandated accounts when they are big enough to provide whatever basic 

level of lifetime income Congress deems appropriate. 

Mae West once said, ‘‘Too much of a good thing is wonderful.’’

She wasn’t talking retirement saving or Federal intervention in 

personal finances. Carve-outs should be large enough and accounts 

should earn enough to allow people to replace all of their Social Security retirement benefits. They should not be so large as to displace private pensions or Individual Retirement Accounts (IRAs). 

You don’t have to do the whole thing. Some of the plans that have 

been offered are too small. They involve small carve-outs, low-yielding assets, and low-yielding retirement annuities. The personal accounts would offer only part of the Social Security retirement benefit, leaving a residual burden on the OASI system and future Congresses. The President’s Panel Plan Two and the Graham Plan 

would have that drawback. Some plans are too big. They match the 

relatively high benefits and replacement levels promised low-income workers, but they overshoot for middle-and upper-income 

workers. The Ryan-Sununu Plan has an average carve-out of 6.4 

percent; it could, if invested in stocks, yield replacement rates of 

80 to 100 percent of pre-retirement income. You don’t need to go 

that far. Perhaps something on the order of a 4-percent carve-out 

tilted a bit toward the low-income, a bit less toward the upper-inhsrobinson on PROD1PC72 with HEARING

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come, would do the job and would still induce most people to use 

the personal accounts. 

Should you trim the benefit growth? Well, if you don’t have personal accounts and just patch up Social Security, you are going to 

have to do that anyway. If you make the carve-outs and the private 

plans big enough to attract everyone into them, then it would in 

theory not be necessary to trim the promised benefits since nobody 

would be claiming them. If you don’t trim the promised benefits, 

they get very high, as Dr. O’Neill has mentioned and as the chart 

I have reproduced from the trustee’s Report in the back of my testimony shows. So, if you fail to trim the benefits it makes it harder 

for the new personal accounts to better the Social Security promises, and fewer people would switch into them. Wage indexing of 

the benefit formula and the projected 128-percent increase in real 

wages by 2080 would send benefits for some couples very, very 

high. An upper-income married couple could be getting over 

$109,000 a year from Social Security in today’s money. We can’t afford that, and the payroll tax hike that would be necessary to provide such a benefit would be outrageous. There are many ways to 

trim benefits. I have mentioned some in my testimony. 

The economic outcome depends on how you do it. Do not cap the 

carve-out; you won’t be giving any labor incentives to people above 

the limited amount of money covered by the amount of payroll tax 

diversion. The President’s Panel Two Plan and the Graham Plan 

effectively omit labor incentives for people above $25,000 and 

$32,500. The Ryan-Sununu Plan extends its carve-out all the way 

up to $90,000 and has more labor force incentives. You mustn’t neglect the labor force impact because the saving in investment impact is not so certain. The latter would depend on what you do with 

the money and how you handle the financing. The labor force effects of lowering the payroll tax are very well-known. As I mentioned, how you fund the transition is going to affect the economic 

outcome. Trimming government spending would free real resources 

and money to help the private sector expand and Gross National 

Product (GNP) would be about 2 to 3 percent higher over time. Borrowing would not do that. Raising other taxes, especially on capital 

at the margin, could cause GNP to fall by about 8 percent by the 

time the Baby Boomers is done retiring. 

Don’t assume that simply establishing personal accounts and 

prefunding will boost growth in tax revenues by increasing national 

savings and investment. Some of the saving would displace other 

saving. Businesses that borrow the saving might be fully invested 

in the United States, and expand abroad. If you couple the Social 

Security reform with better tax treatment of capital formation, you 

could ensure that the saving would occur, that it would not be borrowed back by the government if you trim government spending, 

that it would be invested in the United States, and then you might 

end up with GNP about 6 or 7 percent higher; over twice the gain 

from just having the personal accounts alone. Social Security reform and tax reform go hand in glove. Thank you. 

[The prepared statement of Mr. Entin follows:] 

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Statement of Stephen J. Entin, President and Executive Director, Institute 

for Research on the Economics of Taxation 

Congress has been asked to deal with the projected outyear deficits in the Social 

Security Old Age and Survivors Insurance program (OASI), and to help future generations better meet their retirement needs. It would be wise to take action now, 

while policy changes would have time to work, rather than wait until a crisis forces 

less benign choices on a future Congress. Before taking action, however, the Subcommittee needs to be clear about several things. What are the problems that you 

are trying to address? What policy options are available and what do they do? How 

can they be matched to the objectives? 

What are the problems that you are trying to address? 

Is your objective merely to deal with Congressional concerns about the Federal 

budget consequences of the OASI deficits? Is it merely to keep OASI solvent, more 

or less in its current form, for some period of time after the retirement of the baby 

boom generation, with minimal political fall-out? If these are the goals, Congress 

must either raise taxes dedicated to OASI, raise other taxes, trim OASI benefits, 

or trim other spending. There are an infinite number of ways to do this. Some combination of changes must be selected. In 1983, a compromise was agreed to under 

the cover of the Greenspan Commission. It merely bought time. It did not solve the 

System’s long run problems, and paid no attention to the proposal’s effects on the 

economy and the well-being of the population. 

Are there additional objectives this time around? Should the solution enhance the 

retirement income of future generations? Should it improve the functioning of the 

economy? Should it give people more freedom and responsibility for their own welfare? Should it provide a permanent fix, throughout the 75 year planning period and 

beyond, rather than a temporary one as with the 1977 and 1983 Amendments? If 

so, you must address the solvency and budget issues in certain ways and not others, 

and go beyond solvency to address these other issues. In doing so, be very careful 

how you design your program to make it effective, affordable, and devoid of unintended consequences. 

The interests of the public go beyond the narrow concerns of the Congress in these 

matters. Over the years, this Subcommittee has tried to study and address these 

more fundamental interests. Members of both parties have offered thoughtful and 

effective proposals. The Subcommittee’s recent attention to the problem is most encouraging. 

Hybrid nature of Social Security: a sound safety net, a shaky retirement 

system 

Social Security combines a social safety net program and a retirement income program. The social safety net includes insurance features, such as disability and survivors’ benefits, and income transfers to low income earners. The original purpose 

of Social Security was to prevent poverty among the elderly, a stark problem in Depression-era America. 

To attract political support for what was then a revolutionary national welfare arrangement, President Roosevelt and Congress extended retirement benefits to most 

workers, not just to the needy. The immature system, with many workers and few 

retirees, could offer middle and upper income workers a good return on their contributions to gain support for the safety net system. The retirement benefits were 

to be only one leg of a three-legged retirement income program, however. The other 

two legs were pensions and private saving. 

Today, the system is mature. A full complement of retirees is drawing benefits, 

and the recipients are living longer than ever before. The birth rate is down, and 

there are fewer workers per retiree. Today, the Social Security system remains an 

effective anti-poverty program and safety net. As a retirement program, however, 

it is now a bad deal, and getting worse. Today, the carrot for younger workers to 

support the safety net is to allow them to buy their way out of the retirement system, rather than to remain in it, and to put some of their tax money into real saving 

vehicles that offer a much higher rate of return. 

Social Security is a pay-as-you-go tax-transfer system, in both its safety net and 

retirement features. Income is payment for production. When a transfer system 

shifts income from taxpayers to beneficiaries, it is effectively taking output from 

those who produced it and giving it to others. A real retirement system, by contrast, 

involves real saving. It is funded, not pay-as-you-go. People devote some of their current earnings to saving. They consume less than they produce, and support capital 

formation, boosting productive capacity. The capital adds to future output, and when 

the savers retire, they are still producing goods and services via the capital they 

own. Their income is not a transfer from others, it is payment for additional output 

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they are currently making happen. Substituting Social Security benefits for real saving has depressed capital formation (or made it more dependent on foreign saving), 

and has retarded productivity, wages, and GDP for decades. If done correctly, 

switching back to a system of real saving would boost capital formation and Americans’ ownership of capital. It would boost productivity and wages too. 

Role of government in retirement saving decisions today 

Why are we making a federal case out of retirement saving? What reason is there 

for the Federal Government to concern itself with the saving and retirement decisions of individuals? The usual justification is a concern over moral hazard. Society 

will not stand by and let people suffer extreme poverty in old age. But society does 

not want people to take advantage of that fact, and does not want to pay for people 

who could have taken care of themselves. Thus, the government feels it has a right 

to force people to save when young to avoid needing assistance when old, and perhaps to make them buy an annuity so they won’t fritter away the money or outlive 

it when they retire. This is a rather paternalistic attitude, piling one intervention 

(mandated saving) on top of another (the safety net). If this is the case for Federal 

involvement, the mandate should only extend to achieving the socially acceptable 

minimum level of retirement income. The government should not require people to 

do more, nor should it coopt other forms of saving. 

How much saving should we mandate? 

Mae West once said, ‘‘Too much of a good thing is wonderful.’’ But she wasn’t talking about retirement saving, or federal intervention in personal finances. 

The program should let people stop adding to the government mandated accounts 

when they are big enough to provide whatever basic level of lifetime income the 

Congress chooses to set. Once an account holder is able to buy a minimum required 

annuity, or can fund a staged payout over his or her remaining life expectancy, that 

should be enough. The plan should then allow people to use the payroll tax diversion for anything they wish, i.e. an unfettered tax cut. (This feature is in the Chilean plan.) The plan should not make people contribute up to a specified retirement 

age no matter how large the accounts get. 

Most plans only require individuals to annuitize a basic level of benefits, and 

leave them free to allocate the rest of their assets as they like, and that is good. 

But there is no public purpose served by forcing people to accumulate excessive 

funds in the government program in the first place. Let people use pensions, IRAs, 

and other saving plans for such purposes. Do not nationalize the retirement savings 

industry. Give people their freedom once they have met their mandated retirement 

needs. 

How big a carve-out is needed? Should it be invested in high- or low-yielding assets? 

Carve-outs should be large enough, and accounts should earn enough, to allow 

people to replace all their Social Security benefits. They should not be so large as 

to make transition financing unnecessarily difficult or to displace private pensions 

or IRAs. 

Some plans are too small. Some plans recommend small carve-outs to minimize 

the apparent transition cost to the Federal budget. Some would make available lowyield investment options consisting mainly of government or corporate bonds. Such 

plans may be convenient for budget makers, and may satisfy people with a profound 

distrust of financial markets, but they do a disservice to the people. 

Locking people into low-yielding assets as they work and save, and into low-yielding retirement annuities, would guarantee them a heavy saving burden when young 

and a low income when old. Their personal accounts might then deliver less than 

currently promised benefits, or even the reduced benefits that a trimmed down 

OASI system might offer. Their personal accounts would offset only a part of their 

Social Security benefit, leaving a residual burden on the OASI system. For example, 

the relatively small carve-outs and the contribution caps in the President’s Panel 

plan 2 and the Graham plan, and presumed investment guidance, could keep the 

accounts from matching current benefit levels for many people. The carve-out should 

be large enough, and the investment options should be high-enough yielding, to generate a fund at retirement that can replace fully whatever retirement benefit would 

be available by remaining in Social Security. If Congress decides to trim the growth 

of future Social Security benefits for those who choose to remain dependent on the 

Social Security system, a lower carve-out would be needed to make the personal accounts more attractive than Social Security benefits. 

Some plans are too big. Some plans propose large carve-outs to match the benefits and replacement rates given to low income workers, who receive higher replacement rates than higher earners under OASI. For example, the Ryan/Sununu plan 

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has an average carve-out of 6.4%, and, in a blended stock-bond fund, could match 

low income benefits currently promised. Another plan would let people put all 12.4% 

of the OASDI tax aside, including the Disability Insurance portion. Such carve-outs 

would over-shoot benefits and replacement rates currently promised to average and 

higher income workers, and far over-shoot what Social Security can pay at current 

tax rates, unless people could stop contributing to them once enough saving to generate a socially mandated basic retirement income floor was attained. (See tables 

2, 3, and 4, below. Multiply the carve-out rates in the various plans by the potential 

replacement rates each percent of income saved could generate, and compare the results to what Social Security is promising.) 

Furthermore, the accounts are assumed to be invested in fairly conservative 

blended funds before retirement, and low-yielding bonds afterwards. Such large 

carve-outs, if invested more in stocks, and in balanced annuities, would yield much 

larger retirement benefits. Replacement rates could reach 80 percent to 100 percent 

of pre-retirement income, and could coopt pensions, IRAs, and other private saving 

arrangements. We should not be proposing to take over the bulk of retirement saving in the revised Federal program. Too large a carve-out would also increase the 

transitional borrowing requirement or the amount of spending restraint needed to 

avoid the borrowing. 

Just right? An average four percentage point carve-out, designed to be higher for 

low income workers, and lower for high income workers, should be more than sufficient to induce most people to use personal accounts, especially if benefit growth is 

trimmed to avoid payroll tax increases, and if stock investments are encouraged. 

(See Table 4, Alternative plan.) 

Should promised benefit growth be trimmed? 

If Congress makes the carve-outs and the resulting personal accounts so big that 

they will exceed everyone’s promised Social Security benefits, and everyone will opt 

for them in lieu of benefits, it does not matter whether the regular benefits are 

trimmed or not. However, failure to trim benefit growth would make it harder for 

the personal accounts to beat what Social Security is promising, and less likely that 

people will switch. Bigger carve-outs would be needed, with a bigger explicit transition cost for the federal budget. That is something of an illusion, since we are shedding a corresponding Social Security promise (cutting the current unfunded obligation by $10.5 trillion at a cost of $2 trillion to $4 trillion). Still, it is less costly to 

trim the program back to what current taxes can now pay for. Furthermore, trimming benefits would reduce government intervention in the saving decision. Smaller 

benefits would mean that more people would get all their system-related income 

from individual accounts instead of SSA. 

The attached table VI.F10 from the Social Security 2005 OASDI Trustees Report 

shows the projected growth in real retirement benefits under current law. These 

numbers are after inflation. Wage indexing of the benefit formula, coupled with a 

projected increase of 128% in real wages by 2080, will send real benefits soaring 

in line with wage growth. Add fifty percent for married couples getting a spousal 

benefit, and double the numbers for two worker couples each earning at the illustrative levels. Upper income couples could be getting over $109,000 a year, in today’s dollars. To meet these benefits, the payroll tax would have to rise by six percentage points, a major blow to low income workers. Surely, some trimming of benefit growth could be done without injuring future cohorts. 

If we are to trim benefits, how shoujld we do it? 

Price versus wage indexing. The 1972 Social Security Act Amendments included an automatic mechanism that over-adjusted benefits for inflation, and replacement rates soared. Prior to the 1976 election and the 1977 Amendments, a 

panel headed by actuary William C. Hsiao addressed the error. Unions, SSA, and 

HEW recommended wage indexing worker’s earnings histories and the ‘‘bend points’’

of a new benefit formula, keeping benefits growing with wages over time. The Hsiao 

panel and OMB recommended using a price index for those elements to keep the 

system solvent over time. The resulting benefits would still have risen in real terms, 

just not as fast as with wage indexing. (See the Report of the Consultant Panel on 

Social Security to the Congressional Research Service, Prepared for the Use of the 

Committee on Finance of the U.S. Senate and the Committee on Ways and Means 

of the U.S. House of Representatives, 94th Congress, 2nd session, August, 1976.) In 

an election year, President Ford opted for the more generous wage indexing. He lost 

the election anyway. 

This old form of price indexing the benefit formula differs from the current proposals for price indexing benefits in the President’s Panel plan 2 and the Graham 

plan. The new proposals would hold benefit growth to the rate of inflation, starting 

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in 2009. (It would keep wage indexing earnings and bend points, but lower the replacement factors in each bend point to offset inflation.) Cohort over cohort, future 

average wage workers would get the same real benefit as today’s average wage 

worker; future low wage workers would get the same real benefit as today’s low 

wage worker, and so on across all earnings levels. 

A progressive price indexing plan has been suggested by Professor Robert Pozen. 

Benefits for the bottom 30% of the earnings distribution would be calculated as 

under current wage indexing. Benefits for the highest earners would be limited to 

price increases (as in this new form of price indexing). Benefits for workers between 

the 30th percentile and the top would be gradually scaled from the wage-indexed 

level to the price indexed level. 

In 1994, Ways and Means Chairman Dan Rostenkowski and Social Security Subcommittee Chairman J. J. Pickle introduced measures to eliminate projected Social 

Security deficits. The Rostenkowski bill (H.R. 4245) slowed benefit growth for workers with average income and above by adding an additional bend point with a 10% 

replacement factor, and holding the growth of the top two bend points to a percent 

below wage growth for 50 years. The results roughly resemble the Pozen plan. The 

Pickle bill (H.R. 4275) gradually raised the normal retirement age to 70, which is 

another way to trim benefit growth. Other proposals would ‘‘index’’ normal retirement age to rising life expectancy. 

To annuitize or not to annuitize, another key question 

Too much of an annuity is a bad deal for retirees. One cannot leave an ordinary 

annuity to one’s heirs; payments die with the recipient. Annuities can be designed 

to cover more than one beneficiary, or to guarantee a minimum return if the annuitant dies early, but such arrangements are expensive and complex. People should 

have alternatives, such as a paced withdrawal in line with life expectancy. If Congress insists on annuities, once a minimal anti-poverty annuity is purchased, a person should be free to use the rest of the account’s assets as he or she wishes. But 

then, why make people accumulate that excess in the government sponsored plan 

in the first place? 

Economic benefits demand careful design 

Do not cap the carve-out. The most certain economic benefit from diverting a 

portion of the payroll tax to personal accounts will come from the added incentive 

to work and hire. For that to occur, however, the incentive must exist ‘‘at the margin,’’ i.e., extend to the next dollar one might earn by working longer or harder. To 

that end, the carve-out must not be capped. The President’s Panel plan and the 

Graham plan only reduce the effective payroll tax rate at the margin on incomes 

up to $25,000 and $32,500, and give no incentive to people with higher incomes. The 

Ryan-Sununu plan reduces the tax rate and extends the work incentives all the way 

up to the maximum covered wage of $90,000. 

How the transition is funded will affect the economic outcome 

Trimming government spending growth would free real resources to expand the 

private sector of the economy, funded by increased private saving. Borrowing would 

not free real resources, and would take back much of the saving in the personal accounts to pay for government operations. It would leave the economy slightly worse 

off over time. Raising other taxes, especially on capital, at the margin, would weaken the economy and reduce investment, employment and wages. For a more extensive discussion, see my testimony to the House Budget Committee Social Security 

Task Force, May 18, 1999. The attached Chart 1, adapted from that testimony, 

shows the impact of the various financing options on GNP. 

To maximize gains in a global market, combine with tax reform 

One cannot assume that simply establishing personal accounts will boost growth 

and tax revenues by increasing national saving and investment. Some of the saving 

will displace other saving that people are already doing. Some of the saving may 

be borrowed by the government. Some of the saving will back out some of the saving 

flowing in from abroad, or will flow abroad. Businesses that borrow the saving may 

be fully invested in the United States under current tax and regulatory regimes, 

and may expand abroad instead. 

To ensure that the personal accounts increase U.S. saving, investment, wages, 

employment, and output, Congress should: trim spending instead of borrowing to 

fund the transition; accord the accounts the same tax incentives given to pensions 

and IRAs; improve the tax treatment of investment by moving toward expensing of 

investment outlays and by extending the relief from the double taxation of corporate 

income provided by the 15% tax rates on capital gains and dividends. In short, Social Security reform and fundamental tax reform work hand in glove. Each reinhsrobinson on PROD1PC72 with HEARING

31 

forces the other. Chart 2, adapted from my Task Force testimony, shows the impact 

of adopting expensing as well as personal accounts. The resulting increase in GNP 

is substantially larger than without adding that feature. 

Some tables to guide the design of a proposal 

Table 1 lists historical rates of return on various assets that could be included 

in investment options for personal accounts. Compare these to the 2% return in 

OASI, which is the sum of population growth and productivity/real wage growth. 

Table 2 presents mixes of assets that would result in various rates of return. It also 

shows how much retirement income could be replaced, for each percent of income 

saved while working over a 45 year period, if invested in these mixed funds. Table 

3, top section, shows the replacement rates that Social Security is promising to people at various levels of income, and how much it can actually deliver at current tax 

rates. The bottom section shows how much of a carve-out would be needed to match 

the Social Security replacement rates in personal accounts, at the various rates of 

return. Table 4 shows the carve-outs contained in various Congressional proposals. 

Table 1: Average Annualized Returns on Assets, 1926–2004 

(Ibbotson Associates) 

Nominal Real 

Large company stocks 10.4% 7.2% 

Small company stocks 12.7% 9.4% 

Long term corp. bonds 5.9% 2.8% 

Long term govt. bonds 5.4% 2.3% 

Intermediate term govt. bonds 5.4% 2.3% 

U.S. Treasury bills 3.7% 0.7% 

Inflation 3.0% n.a. 

Table 2: Returns on various portfolios of assets, and replacement 

rates for each % of income saved 

Portfolio mix: Percent Stocks and Percent 

Bonds* 0/100 40/60 60/40 75/25 95/5 

Approximate real return during accumulation 2.5% 4.5% 5.5% 6.5% 7.5% 

Payout as % of pre-retirement income (replacement rate), annuity in bonds (real return of 2.5%), for each % of income saved* 4.0% 6.5% 8.6% 11.3% 15.0% 

Payout as % of pre-retirement income (replacement rate), annuity in mixed portfolio 

(real return of 4.5%), for each percent of income saved* 4.8% 7.8% 10.3% 13.5% 18.0% 

*Stocks roughly 2:1 large company: small company; Bonds roughly 2:3 corporate: government. Assumes income rise 1.1% a year in real terms. Assumes 20 years average lifespan in retirement. 

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Table 3: Social Security replacement rates for retirees with various 

earnings histories, as promised under current law and as funded 

under current tax rates 

Income categories, 2005: low wage* 

($15,820) 

average 

wage* 

($35,157) 

high wage* 

($56,251) 

max. wage* 

($90,000) 

Promised replacement rate: 55% 41% 34% 27% 

Funded replacement rate: 38% 28% 23% 18% 

Percent of income (required carve-out) that must be saved in working years in various portfolios to equal Social Security’s promised/funded replacement rates (above). Top line assumes an annuity with a 2.5% real return (all bonds) and bottom line assumes an annuity 

with a 4.5% real return (60/40 stocks/bonds)* 

0/100 2.5% 13.9%/9.6% 10.3%/7.1% 8.6%/5.8% 6.8%/4.5% 

stocks/bonds 4.5% 11.6%/8.0% 8.6%/5.9% 7.1%/4.8% 5.7%/3.8% 

40/60 2.5% 8.4%/5.8% 6.3%/4.3% 5.2%/3.5% 4.1%/2.8% 

stocks/bonds 4.5% 7.0%/4.8% 5.2%/3.6% 4.3%/2.9% 3.4%/2.3% 

60/40 2.5% 6.4%/4.4% 4.8%/3.3% 4.0%/2.7% 3.2%/2.1% 

stocks/bonds 4.5% 5.4%/3.7% 4.0%/2.7% 3.3%/2.2% 

2.6%/1.8% 

75/25 2.5% 4.9%/3.4% 3.6%/2.5% 3.0%/2.0% 2.4%/1.6% 

stocks/bonds 4.5% 4.1%/2.8% 3.0%/2.1% 2.5%/1.7% 2.0%/1.3% 

95/5 2.5% 3.7%/2.5% 2.7%/1.9% 2.3%/1.5% 1.8%/1.2% 

stocks/bonds 4.5% 3.1%/2.1% 2.3%/1.6% 1.9%/1.3% 1.5%/1.0% 

*Uniform low wage earner at 45% of average wage; high wage earner at 160% of average; maximum earner 

at covered wage cap. Figures for 2005, Social Security OASDI Trustees Report. 

Table 4: Carve-out Rates Under Various Reform Plans 

Income categories, 2004: low 

wage 

ave. 

wage 

high 

wage 

max. 

wage 

Social Security Panel Plan 2: 4% of wages up to 

$1,000 contribution (covers 1st $25,000 of wages) 4.0% 2.8% 1.8% 1.1% 

Graham: 4% of wages up to $1,300 contrib. (covers 

1st $32,500 of wages) 4.0% 3.7% 2.3% 1.4% 

Ryan/Sununu: 10% of 1st $10,000 of wages, 5% of 

remainder up to max. wage 8.2% 6.4% 5.9% 5.6% 

Alternative: 10% of 1st $10,000 of wages, 2% of remainder up to max. wage 7.1% 4.3% 3.4% 2.9% 

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f 

Chairman MCCRERY. Thank you, Mr. Entin. Mr. Beach? 

STATEMENT OF WILLIAM W. BEACH, DIRECTOR, CENTER FOR 

DATA ANALYSIS, THE HERITAGE FOUNDATION 

Mr. BEACH. Thank you very much, Mr. Chairman. My name is 

William Beach, with The Heritage Foundation. Mr. Levin, Members of the Subcommittee, it is a pleasure to be with you this morning. I am going to continue to be a footnote to Steve Entin and talk 

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about taxes. My testimony today focuses on how raising taxes to 

pay for Social Security’s expected financial shortfalls would likely 

affect major economic indicators. That is, what does the mainstream economic theory tell us about the likely effects on the general economy if Congress increases dedicated revenue flows to finance projected shortfalls between Social Security’s income and its 

outlays? Research conducted by myself and my colleagues at The 

Heritage Foundation’s Center for Data Analysis (CDA), shows that 

either raising tax rates or increasing the taxable income amounts 

comes with an economic price. Of course, so does the President’s 

plan, but the economic costs are considerably different. 

Social Security’s trustees estimate that increasing the payroll tax 

rate by 1.9 percentage points to 14.3, roughly, percent, in total 

might be sufficient to make Social Security’s Old-Age, Survivors 

and Disability Insurance (OASDI) programs solvent over the 75- 

year test period. This is the sort of small change that many opponents of reform, that is of structural reform, paint as a reasonable 

solution to Social Security’s developing crisis. Using a mainstream 

model of the U.S. economy, Mr. Chairman, we at the Center for 

Data Analysis simulated the economic effects of a 1.9 percent point 

increase of the payroll tax on the general economy. It should come 

as no surprise to this Committee that a tax increase of this magnitude would increase the cost of labor in the economy and therefore have an impact on jobs. The CDA study found that a 1.9 percentage point increase in the payroll tax would reduce potential 

employment by roughly 277,000 jobs per year, on average, over the 

next 10 years, relative to the baseline—a baseline that we adopted 

from the CBO. There are spillover effects on economic growth as 

well. Increasing the payroll tax would reduce U.S. GDP, a broad 

measure of economic activity, by roughly $35 billion per year, on 

average, over the next 10 years. 

Overall, raising the payroll tax would have a major impact on 

U.S. households. On average, every American would have roughly 

$302 less in disposable income per year for each of the next 10 

years, amounting to over $1,200 less for a family of four. Raising 

the payroll tax rate is only one variant of the revenue-enhancement 

approaches to reform. Other proponents of tax increases argue that 

the amount of wages subject to the tax should be increased. This 

increase is what is called the maximum taxable income amount. It 

would in fact increase revenues, but again, come at an economic 

cost. The cost of eliminating the cap—let’s just take that, for example—would, among other things, result in a very large increase, 

perhaps the largest tax increase in U.S. history, subjecting millions 

of Americans to a massive hike in overall payroll tax rates and, I 

fear, a very significant increase in the capital taxes. Among its effects, this would be a very large increase in taxes, as I have said—

roughly $607 billion over 5 years, and $1.4 trillion over our 10-year 

period in our model. 

It would, oddly enough, fail to save Social Security from bankruptcy. Social Security would start paying out more in benefits 

than it collects in 2025, only eight years later than under the current system. Attached to my written testimony is a graphic to that 

effect. It would increase the top effective Federal marginal tax rate 

on labor income to over 50 percent, its highest level since the sevhsrobinson on PROD1PC72 with HEARING

36 

enties. It would reduce the take-home pay of 9.8 million workers 

by an average of $4,200 in the first year alone after the cap is removed. It would weaken the U.S. economy by reducing the number 

of job opportunities and personal savings significantly. In fact, in 

fiscal year 2015 in our model, in the number of job opportunities 

lost would exceed 965,000 jobs. Personal savings, adjusted for inflation, would decline by $55 billion. 

Opponents of real or structural Social Security reform are right 

in the sense that we can make small changes to the system—there 

is certainly that. They are, in a sense, misleading because they are 

not talking about the economic consequences of those small 

changes, particularly on the tax side. The changes may indeed be 

small, or seemingly small, but the numbers involved are, in the 

last analysis, enormous. Raising the payroll tax or the maximum 

taxable income limit enough to fully fund Social Security would put 

a damper on savings, jobs, and economic growth, to the great detriment of working Americans. Raising taxes enough to take Social 

Security’s cash flow problems off the table would require even more 

sacrifice. I am happy to answer questions. 

[The prepared statement of Mr. Beach follows:] 

Statement of William W. Beach, Director, Center for Data Analysis, The 

Heritage Foundation 

The salutary news from Capitol Hill this summer is the steady movement toward 

reforming Social Security’s Old-Age Program. Despite news stories and public opinion polls, many Members of Congress in both parties have pushed forward with serious debate over Social Security financial future and analysis of ways to make that 

future more secure. Everyone who cares about Social Security’s retirement programs 

applauds that effort. 

Indeed, it appears likely that the principal bill writing committees of the House 

and Senate may complete work on reform legislation over the next few months. 

Given that increasing probability, it is important now to consider the ramifications 

of reform plans on a host of factors, not the least of which is U.S. economic activity. 

My testimony today focuses on how raising taxes to pay for Social Security’s expected financial shortfalls would likely affect major economic indicators. That is, 

what does mainstream economic theory tell us are the likely effects on the general 

economy if Congress increases dedicated revenue flows to finance projected shortfalls between Social Security’s income and its outlays? 

Why start with the question rather than with one focusing on the economic effects 

of using higher taxes to fund the transition costs to an improved Social Security retirement program? Clearly, Congress will need many answers to this question. However, I believe it should first ponder an often heard ‘‘reform’’ to the current system 

that its advocates claim would avoid any necessity for embracing Personal Retirement Accounts: raise taxes to fill in the financing shortfalls either by increasing the 

payroll tax rate or raising the maximum taxable income amount. 

Research conducted by me and my colleagues at Heritage’s Center for Data Analysis indicate that either approach to revenue enhancement comes with an economic 

price. Of course, so does the President’s plan. The economic costs, however, are significantly different. 

President Bush proposes to solve the problem of Social Security’s unfunded liabilities by enacting a reform plan that includes personal retirement accounts (PRAs). 

Proponents of PRAs argue that this sort of reform would increase national savings, 

bolster employment, and improve economic growth, all while closing Social Security’s funding gap. Opponents of the President’s approach argue that Social Security’s funding problems do not demand wholesale reform and that Social Security’s 

shortfall is only a ‘‘challenge’’ that can be addressed by making small changes to 

the current program. 

One such change that has been proposed would be to raise payroll taxes enough 

to render Social Security solvent. Opponents of real reform are right that raising 

payroll taxes could close a portion of Social Security’s funding gap, but they are 

wrong in saying that doing so would require only a small change. Raising payroll 

taxes would make Social Security a worse deal for millions of working Americans, 

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1The Trustees base this estimate on a 75-year time horizon. 

2Data taken from U.S. Department of Labor, Bureau of Labor Statistics, Consumer Expenditure Survey. 3These estimates are preliminary and subject to change. CDA used the Global Insight, Inc., 

U.S. Macroeconomic Model to conduct this analysis. The methodologies, assumptions, conclusions, and opinions in this report are entirely the work of Heritage Foundation analysts. They 

have not been endorsed by and do not necessarily reflect the views of the owners of the model. 

This analysis was conducted by Tracy Foertsch and Rea Hederman of the Center for Data Analysis. 

harm the economy, and cost thousands of jobs, and still would not fix Social Security. 

Social Security faces an unfunded liability of $3.7 trillion in today’s dollars over 

the next 75 years. This number represents the amount that the system, despite having promised the money to America’s workers, will be unable to pay. Short of major 

reforms, raising taxes or cutting benefits are the only ways to close this funding 

gap. 

Right now, workers pay a 6.2 percent tax on their wages up to $90,000 to fund 

Social Security. Employers pay an additional 6.2 percent tax. This division in the 

payroll tax is artificial, however, as employers regard their part of the payroll tax 

as an expense of hiring, just like wages and other benefits: In other words, it is 

money that the employer is willing to spend on his workers. Though workers see 

only a 6.2 percent deduction on their pay stubs for Social Security, they really pay 

the whole 12.4 percent tax in terms of foregone wages. 

Social Security’s Trustees estimate that increasing the payroll tax by 1.89 percentage points, to 14.29 percent in total, would be sufficient to make Social Security’s Old Age, Survivors, and Disability programs solvent.1 This is the sort of ‘‘small 

change’’ that opponents of reform paint as a reasonable solution to Social Security’s 

developing crisis. 

The average worker might disagree. If payroll taxes were increased by 1.89 percentage points, a worker earning $35,000 would forego an additional $662 in pay 

every year. Raising payroll taxes by 1.89 percentage points would cost this worker, 

on average: 

• As much as he spends on gasoline over three months; 

• As much as he spends in two and a half months on clothing; 

• As much as he spends in one month on food for consumption at home; or 

• As much as he spends in two months on food outside of the home.2

In other words, this ‘‘small change’’ in the payroll tax would have a major impact 

on most workers’ household budgets. 

Using the Global Insight U.S. Macroeconomic Model, economists at The Heritage 

Foundation’s Center for Data Analysis simulated a 1.89 percentage point increase 

in the payroll tax.3

It should be no surprise that a tax increase of this magnitude would increase the 

cost of labor in the economy and thereby have an impact on jobs. The CDA study 

found that a 1.89 percentage point increase in the payroll tax would reduce potential employment by 277,000 jobs per year, on average, over the next 10 years relative to the baseline. 

There are spillover effects on economic growth as well. Increasing the payroll tax 

would reduce U.S. gross domestic product (GDP), a broad measure of economic activity, by $34.6 billion per year, on average, over the next 10 years. 

Overall, raising the payroll tax would have a major impact on U.S. households. 

On average, every American would have $302 less in disposable income per year for 

each of the next 10 years, amounting to over $1,200 per year for a family of four. 

Personal savings would also decline in the aggregate by $46.9 billion per year, on 

average, over the next 10 years. Ironically, this decline in savings would make 

worse the very problem that Social Security is intended to fix—workers retiring 

with insufficient savings. 

Raising the payroll tax rate is only one variant of the revenue enhancement approach to reform. Other proponents of tax increases argue that the amount of wages 

subject to the tax should be increased. This increase in what is called the maximum 

taxable income would, indeed, increase revenues. 

However, the amount of the increase falls far short of expectations. Using SSA’s 

own projections, Heritage analysts found that eliminating the cap would generate 

only enough revenue to delay the date of the system’s insolvency by eight years, 

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4Social Security Administration, The 2005 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, March 23, 2005, 

p. 8, at www.socialsecurity.gov/OACT/TR/TR05/tr05.pdf (April 11, 2005). 5 Heritage Foundation calculation based on data from Social Security Administration, The 

2004 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance 

and Disability Insurance Trust Funds. This projection is a purely static estimate that does not 

include the shifting of income from taxable to nontaxable compensation that is likely to occur 

if the tax cap is removed. Income shifting would decrease the amount of revenue available to 

pay benefits. 6See William W. Beach and Gareth E. Davis, ‘‘Social Security’s Rate of Return,’’ Heritage 

Foundation Center for Data Analysis Report No. CDA98—01, January 15, 1998, at 

www.heritage.org/Research/SocialSecurity/CDA98-01.cfm. 7These revenue projections do not account for the negative effects of higher payroll taxes on 

economic growth and employment. They also do not account for any likely shifting of income 

from taxable wages and salaries to nontaxable fringe benefits like health insurance. As a result, 

the amounts of federal payroll taxes ultimately collected are likely to be less. 

from 2017 to 2025. Under the current law, by 2041, the OASI program would receive only enough revenue to pay 74 cents on every dollar in promised benefits.4

Yet the cost of eliminating the cap would be substantial. It would result in the 

largest tax increase in the history of the United States,5 subjecting millions of 

American families to a massive hike in their payroll taxes and further reducing the 

already dismal rate of return to Social Security.6 It would also negatively affect 

America’s economic prospects, slowing U.S. output growth and eliminating hundreds 

of thousands of employment opportunities. 

Specifically, eliminating the cap on taxable wages would: 

• Result in the largest tax increase in U.S. history, raising $607 billion (in nominal dollars) over five years and just over $1.4 trillion over 10 years.7

• Fail to save Social Security from bankruptcy. Social Security would start paying 

out more in benefits than it collects in taxes in 2025, only eight years later than 

under the current system. (See Chart 1.) 

• Increase the top effective federal marginal tax rate on labor income to over 50 

percent, its highest level since the 1970s. 

• Reduce the take-home pay of 9.8 million workers by an average of $4,206 in the 

first year alone after the cap is removed. 

• Weaken the U.S. economy by reducing the number of job opportunities and personal savings. 

By fiscal year (FY) 2015, the number of job opportunities lost would exceed 

965,000, and personal savings (adjusted for inflation) would decline by more than 

$55 billion. 

But the problem is even more fundamental: Social Security’s very structure is 

such that even all this sacrifice would not be enough to save it. Currently, the system is in a cash-flow surplus, which means that it takes in every year more money 

in taxes than it pays out. But these extra funds don’t really accumulate. Instead, 

the government spends them and issues the Social Security Trust Fund special 

bonds, which are really just IOUs to pay back the money at a later date. 

According to Social Security’s Trustees, the system is set to have a negative cash 

flow beginning in 2017. To pay out promised benefits, it will have to cash in the 

government’s IOUs, and the money to pay them will have to come from somewhere—either higher general revenue taxes (e.g., income taxes), lower government 

spending, or, ironically, more government debt. Because of the way the Trust Fund 

operates, raising payroll taxes would only delay the date when Social Security’s cash 

flow goes negative. Future tax increases or benefit cuts would still be on the table. 

Opponents of real Social Security reform are right, but also deeply misleading, 

when they say that the current system can be saved by making only small changes: 

The changes may indeed be small, but the numbers involved are enormous. Raising 

the payroll tax or the maximum taxable income limit enough to fully fund Social 

Security would put a damper on savings, jobs, and economic growth to the great detriment of working Americans. And raising taxes enough to take Social Security’s 

cash-flow problem off the table would require even more sacrifice. 

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f 

Chairman MCCRERY. Thank you, Mr. Beach. Mr. Price? 

STATEMENT OF LEE PRICE, RESEARCH DIRECTOR, ECONOMIC 

POLICY INSTITUTE 

Mr. PRICE. Thank you, Mr. Chairman and Members of the Subcommittee. I welcome the opportunity to appear before you and 

talk about this vitally important program and ways to think about 

addressing its problems. We economists generally agree on the theory, and largely agree to start the debate with the numbers coming 

out of the Social Security actuaries. We strongly disagree, I’m 

afraid, on this panel, with key interpretations of the data, and on 

the value judgments necessary for you to make in reaching policy 

decisions. So, I am going to spend my short 5 minutes on three 

major disagreements that I have with what I understand to be positions of several other panelists here and some people on this debate. 

One is, I think the general approach of focusing the Federal Government on prefunding is misguided. Number two, I think that the 

coming burden of having more elderly people is quite manageable. 

Finally, I think that the costs of private accounts far outweigh the 

benefits as they have been proposed so far. 

Let’s talk about prefunding. Here I want to make clear that I am 

not talking about prefunding within the Social Security account 

system and creating a system that people think makes sense. We 

did prefunding in 1983, and we said we would have 37 years, the 

actuaries said in 1983 we would go into cash deficit in 2020. The 

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CBO says we are going to go into cash deficit in 2020. That was 

prefunding, it was planned, there is no crisis there. We need to 

think about the next 75 years and figure out how to handle that 

program. I am talking about whether our society today should 

prefund to prepare for the generation 30 and 40 years from now. 

On that, I think thrift can be overrated. Our per capita income 

today is only 55 percent of what it will be in 40 years. Per capita 

income today in Mississippi is about 55 percent—our lowest per 

capita State—55 percent of Connecticut. Now, should we tell the 

people of Mississippi that they need to be thrifty to help the consumption of the people in Connecticut? No. I don’t think the logic 

makes any difference why people today should be sacrificing to 

raise money for the people who are going to have 80 percent higher 

income than them 40 years from now. 

I think we ought to be focusing on our fiscal policy, on what 

makes sense for us today, managing our economy well today. We 

are not doing a good job of that. It should be based on what matters for our generation, not for 30 and 40 years from now, when 

we will be much richer. So even, though thrift is overrated, so can 

recent profligacy. We should be focusing on a fiscal policy that 

keeps our external debt to GDP from rising. They are both rising 

way out of sight. I have some charts in my report that confirm 

that. To the extent that we are contributing to national savings, 

those would be sensible things to focus on. They matter to us 

today. We should be concerned about today’s generation. 

Just as a quick aside, I just find that the history of the last 25 

years, as some of the panelists here describe it, is just not the way 

I would read it. We were able to have substantial deterioration of 

our fiscal situation in the early days without a Social Security surplus. We spent most of from the mid-eighties to the early nineties 

improving our fiscal situation with the Social Security surplus, and 

I don’t think that the problems we have had in the last 4 years of 

a rapidly deteriorating fiscal situation. As the CBO charts can 

show it, when you standardize, take away cyclical effects, we have 

had a huge 3.5 percent of GDP deterioration in our fiscal situation 

from policy. Those policies were bad for us today, and they are 

not—we shouldn’t be worried about those so much because of the 

future, they are not good policy today. 

Now, I have passed out some colored charts here, I think people 

say, well, we’re going to have all these old people. I take 6 numbers 

from the actuary’s report, and the ratio of people over 65 to the 

people 20–64 is going to rise 85 percent in the next 40 years. That 

sounds terrible when you just look at it in isolation. People don’t 

often talk about, well, we are going to have productivity that is 91 

percent as much; we are going to have fewer kids. The most burdensome people using up resources in our economy are the people 

who are working. They are using up more resources. They are traveling more, buying more cars, doing more—eating at fancier restaurants. The resources that we are using for older people are fairly modest in the economy as a whole. When we look at the total 

population, which is the right way to think about it, not the blinders on just the elderly, the total population relative to working-age 

population, that is going to rise 8 percent in the next 40 years. 

That is entirely manageable with an economy that is going to have 

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productivity that is 90 percent higher. We can manage this as an 

economy. 

Now, that doesn’t say we don’t have serious fiscal problems, because you have the combination of a fiscal program in this government that is focusing on health care, primarily on elderly, and so 

when you combine having more elderly with rising health care 

costs, that is where the problem is, not in Social Security. We are 

focusing on entirely the wrong problem. It is not the demographic 

problem that presents a huge problem for us in the economy. It is 

health care. It is health care in the private sector for working people, just as much as for older people. We should be addressing 

health care and thinking about, you know, my wife is a physician. 

The technology that she is using today is totally different both in 

diagnosis and treatment from what she was taught 20 years ago. 

The technology 20 years from now has yet to be invented. We 

should be talking about how we change technology. Every other industry that has had rapid technological change—and surely medical technology is changing rapidly—has falling costs. We ought to 

be focusing our resources. We spend $30 billion a year at the National Institutes of Health (NIH) trying to find some guidance, in 

pages and pages of research guidance for NIH—that we should find 

ways to improve health but reduce the resources to do it. It is not 

there. We are improving health, but we are doing it and changing 

technology to eat up more and more resources. 

We ought to be addressing health care costs and the technology 

10, 20, and 30 years from now, and not be so focused on demography. We are going to have tremendous prosperity in the future. 

We can handle a few more old people, 8 percent more population, 

per working person. We do have to address health care for the private sector, for working people, as well as for the elderly and the 

budget. 

[The prepared statement of Mr. Price follows:] 

Statement of Lee Price, Research Director, Economic Policy Institute 

Chairman McCrery, Ranking Member Levin, and members of the subcommittee, 

thank you for this opportunity to appear before you to discuss the economic conditions used to predict the future of Social Security and the merits of pre-funded benefits. 

The late Herb Stein, who chaired the Council of Economic Advisers under Presidents Nixon and Ford, wisely recommended that we think in terms of ‘‘GDP budgeting.’’ That is, we should not look at the federal budget in isolation, but in terms 

of how it is shaping the economy as a whole. Too often, our discussion falls into the 

trap of focusing solely on changes to government inflows and outflows and we fail 

to consider either the compounding or the dampening responses in the larger economy. 

The fiscal challenge presented by Social Security represents a subset of the larger 

challenge of how our society will provide for more elderly people in the future. The 

consumption of future retirees will come almost entirely from the output of their 

working contemporaries. Retirees must finance their consumption through capital 

income, government transfers, or the generosity of their family and community. As 

we consider changes to Social Security, we should keep in mind the picture beyond 

the budget figures: How much pre-funding is realistic? Who stands to gain and who 

stands to lose? How much consumption should we sacrifice today to increase the 

consumption of more prosperous Americans in the future? 

To prepare for a higher share of elderly people in our population, government policy should not focus on pre-funding but on providing stable macroeconomic conditions to facilitate strong economic growth. That means reducing the federal deficit 

enough to prevent the debt to GDP ratio from expanding. It also means managing 

the government’s contribution to national saving in a way that keeps our foreign 

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1Technically, wage, salary, and self-employment income are all subject to Social Security taxation. For simplicity, this statement often uses the term ‘‘wages’’ as short hand for all those 

forms of income. 

debt from rising as a share of GDP. We have done a poor job on both fronts in recent years. The federal budget should keep those two debt burdens under control 

and leave private actors to decide how much saving they want to do for themselves. 

After weighing the effects on these broader questions of the proposals by the 

President and others to change Social Security, I conclude: 

• Our society can manage the increase in the population over 65 relatively easily 

as an economic matter and with relatively modest difficulty as a fiscal matter 

because of productivity gains and the benefits of a smaller population under 20. 

• Because middle—and low-income Americans rely so heavily on Social Security 

income, changes to the program should be made cautiously. 

• The President’s proposal on Social Security does not raise national saving and 

therefore does not improve the capacity of our economy to handle the coming 

increase in the population over 65. 

• To ‘‘pre-fund’’ the costs of the Baby Boom’s retirement, our society would have 

to produce more than we spend and, like the fabled ants, build up assets here 

and abroad to ease the transition to a more elderly society. Instead, we are 

worse than grasshoppers because we are eating up everything we produce and 

more. 

• The federal budget contributed significantly to national saving in 2000 and 

2001, but has subtracted from national saving in recent years. 

• The President’s proposal on Social Security requires substantial new federal 

borrowing with the goal of having middle-income retirees and survivors rely 

more on volatile capital income and less on more stable Social Security benefits. 

• Were the President’s proposal adopted, most Americans should decline the opportunity to create a personal account. Most people would come out losers most 

of the time because of the volatility of equity prices, interest rates, and inflation, plus the tendency to make bad investment decisions. 

• Revenues of the Social Security trust fund are determined by the growth of 

wages 1 below the cap. The outlook for the trust fund has deteriorated since the 

early 1980s largely because wage growth has slowed and wages have become 

more unequal. The recent drop in the share of the population employed has 

hurt revenues. 

• Future growth of trust fund revenues will depend on the growth of employment 

(for which immigration and the share of the population employed are the wild 

cards) and the growth of wages under the cap (for which productivity, the wage 

share of output, and spillover above the cap are important). 

Demography presents a manageable economic problem 

Doomsayers like to emphasize the demographic fact that the population over the 

age of 65 will soon grow much faster than the working age population. The numbers 

in this year’s Social Security trustees report indicate that the ratio of the population 

over 65 to the population 20 to 64 will rise by 85% between 2005 and 2045. That 

extra burden sounds back-breakingly heavy when taken in isolation, but relatively 

modest when put in the proper context. First, consider the fact that the trustees’

intermediate scenario projects productivity gains of 91% over that same period. That 

means that future workers will have far more income to share with the elderly. 

Next, consider the fact that the working age population is not supporting just the 

elderly. Children are far more numerous than the elderly and their population will 

fall relative to the working age population. The trustees’ intermediate numbers 

show only a 21% increase in the ‘‘dependency ratio,’’ the ratio of the total of children 

plus the elderly relative to the working age population. 

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2For further analysis, see Spriggs and Price. 2005. ‘‘Productivity growth and Social Security’s future.’’ EPI Issue Brief No. 208, Washington, D.C.: Economic Policy Institute. 

Working age people must support themselves, too. They consume more per person 

than any other age group and their share of the population is shrinking. The ratio 

of the total population to the working age population offers the best measure of the 

economic challenge posed by demography. That measure rises by only 8% over the 

next 40 years. With productivity gains of 91%, future workers will have ample room 

to support an additional 8% more people per worker and still enjoy far greater prosperity than we have today.2

Demography has more pronounced effects on the federal budget than on the wider 

economy. As currently structured, programs aimed at children and middle-age people should shrink while those for the elderly grow. From that perspective, it is the 

compounding effect of demography with rising health care costs that presents a serious budget challenge. Assuming that the elderly should continue to obtain decent 

health, we should be developing policies that slow ballooning health care costs economy wide and not just squeeze on the federal budget part of the balloon. Taking 

the longer view, we can be confident that the medical technologies of two and three 

decades from now have not yet been invented. Other industries are raising quality 

while cutting costs. So can medical care. The Federal Government should use its 

considerable influence to foster new medical technologies that decrease rather than 

increase resource use. If we could change the path of medical technologies to make 

a significant dent in resource use in the future, that would have an enormous effect 

on future standards of living. 

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3For further detail, including numbers by state, for women, for minorities, and for persons 

over 74, see Ettlinger and Chapman. 2005, ‘‘Social Security Income and the Elderly.’’ EPI Issue 

Brief No. 206, Washington, DC.: Economic Policy Institute. 4Weller, Christian and Edward Wolff. 2005. ‘‘Retirement Income: The crucial role of Social 

Security.’’ Washington, DC.: Economic Policy Institute.. 

Proceed with caution: Middle-income Americans count on Social Security 

Most people who have spent their working lives as middle-income Americans have 

come to rely on Social Security for their retirement income. One-third of Americans 

over the age of 64 receive at least 90% of their cash income from Social Security. 

For another one-third, Social Security supplies between 50% and 90% of income. 

Note that some of those people receive $20,000 from Social Security and $18,000 

from all other sources. Such people would not be in poverty without Social Security, 

but they would notice a significant cut in benefits. The share of people with over 

half of their income from federal programs would no doubt be higher if we could 

also take into account the value of their health benefits.3

The privatization plan put forward by the President would substantially cut benefits for middle-income Americans who opt out of a private account. As we explain 

later, the effective cut is probably even deeper for most of those who opt in to a 

private account. 

Middle-income Americans nearing retirement saw their retirement income prospects improve markedly between 1989 and 2001, but not for the reasons often assumed. The boom in the stock market largely passed them by. Christian Weller and 

Edward Wolff recently analyzed the Federal Reserve’s Surveys of Consumer Finances for trends in sources of wealth for those approaching retirement.4 For those 

between the ages of 56 and 64, they found median private pension wealth (including 

both defined benefit and defined contribution plans) actually declined from $54,000 

in 1989 to $48,000 in 2001. Median non-pension financial wealth went from $15,100 

to $23,200. Despite increases in home values, increases in mortgage debt caused net 

home equity to rise only modestly (from $65,700 to $70,000) for the median household. 

For the broad swath of middle-income Americans approaching retirement, Social 

Security accounted for most of their gains in wealth between 1989 and 2001. Weller 

and Wolff examined the sources of improved wealth for the middle 60% of households (those between the 20th and 80th percentile). This wider group includes some 

people who benefited modestly more from the stock market boom than those at the 

median. Yet, they found that, even for this broad group, the gains in estimated Social Security wealth dominated. Social Security wealth rose by $77,600, private pension wealth by $24,100, and all other forms of wealth by $28,500. For this group, 

the effect of the stock market was dwarfed by the effect of the strong labor market 

that caused wages to rise and, in turn, raised middle-income Americans’ prospective 

Social Security retirement income. 

It is no coincidence that Social Security is the largest program in the federal 

budget and that so many Americans rely so much on it. While the budget numbers 

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5 As discussed later, the case for public policy to impose sacrifice today on behalf of more prosperous future generations is problematic. 6For further analysis of the relative unimportance of Social Security in our larger fiscal challenges, see Sawicky, Max. 2005. ‘‘Big deficit, little deficit: The Bush budget and Social Security.’’

EPI Snapshot May 23, 2005, Washington, DC.: Economic Policy Institute and Sawicky, Max. 

2005. ‘‘Collision Course: The Bush budget and Social Security.’’ EPI Briefing Paper No. 156, 

Washington, DC.: Economic Policy Institute. 

have alarmed many politicians and economists, we cannot lose sight of what major 

changes to the program would mean to actual people who rely on it. 

Fiscal policy switched from pre-funding to de-funding future consumption 

Pre-funding requires sacrifices. Whether in the budget or in the economy as a 

whole, it entails less consumption today for the sake of more consumption in the 

future.5 Rather than sacrifice now to pre-fund part of the consumption of future retirees, we have effectively been de-funding future consumption in recent years. The 

evidence for de-funding is clear, by both the government and the overall economy. 

The deterioration of our fiscal balance since 2001 reflects decisions favoring current 

consumption over future consumption. Likewise, the collapse in our current account 

balance financed by the deterioration of our net international asset position reflects 

economy-wide decisions to consume more now and less in the future. 

The CBO has devised a measure to identify the effects of policy changes by excluding the effects of the business cycle and other transient effects. Fiscal policy is 

moving in the direction of pre-funding when this measure (the standardized-budget 

surplus or deficit) is rising and in the direction of de-funding when this measure 

is falling. 

With help from the 1983 Social Security legislation, overall fiscal policy moved in 

the direction of pre-funding from the mid-1980s through 2001. We have moved in 

the direction of de-funding since 2001. The CBO estimates that the standardized 

budget had a balance of ¥3.0% of GDP in 1983 and hit a low of ¥4.8% in 1986. 

The policies that drove the standardized balance down between 1983 and 1986 had 

largely been adopted at the time of the Social Security agreement. Over the next 

15 years, the standardized budget had an average deficit of 1.5% of GDP. While not 

a surplus the size of the Social Security surplus, that record showed an effort to 

pre-fund, or at least to stop de-funding future retirement costs. 

We should put the fiscal decisions since 2001 into the context of today’s discussion 

of pre-funding Social Security. The standardized budget fell from a 1.1% of GDP 

surplus in 2001 to a 2.6% of GDP deficit in 2004, for a decline of 3.7% of GDP. The 

entire 75-year shortfall in Social Security has been estimated to be 0.7% of GDP by 

the SSA actuaries and 0.4% by the CBO. In other words, the fiscal policy changes 

between 2001 and 2004 worsened our fiscal balance by five to nine times as much 

as it would take to fully fund Social Security for 75 years. 

In relationship to our deficit today and projected into the future, the funding 

shortfall for Social Security remains modest. If the goal is to address our long-term 

fiscal issues, we should paying more attention to health care and revenues, but not 

in the way those issues have been addressed in recent years.6 Indeed, the enactment 

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of permanent tax cuts and under-funded prescription drug benefits stand out as decisions that favor consumption earlier rather than later, and they grow in cost. Over 

the next 75 years, the tax cuts have been estimated to create a shortfall of 2.0% 

of GDP. The prescription drug bill added another hole estimated at 1.4% of GDP. 

Clearly, our government has had other priorities than to pre-fund some of the Baby 

Boom’s retirement. 

Economy-wide we’ve been de-funding for some time 

Although our fiscal policy was moving in a favorable direction for pre-funding for 

the decade and a half prior to 2001, the same cannot be said for our nation as a 

whole. Last Friday, the government reported that we ran a current account deficit 

of $780 billion at an annual rate in the first quarter, a record 6.4% of GDP. In other 

words, we are spending 6.4% more than we produce as a nation. In contrast, Japan 

and Germany justify their large surpluses as appropriate preparation for the fast 

growth of their retired population. 

Some have argued that an increased current account deficit is justified if it finances more investment in the U.S. That argument has both factual and theoretical 

flaws. As a factual matter, investment has not been particularly strong. Second, 

even if there were greater investment, it would be raising GDP (output within our 

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7The net liability position did not rise in 2003 because of the rise in the dollar against currencies (particularly the Euro) with large U.S. assets abroad. Ultimately, large current accounts 

translate into deeper net liabilities. 

borders) but would not be raising the future income of Americans. To finance our 

habit of increasing consumption faster than our output and income, we are selling 

off assets in the U.S. at a rapid rate. Those assets give persons abroad an increasing 

claim to our future output. The value of foreign-owned assets here now exceeds the 

value of U.S.-owned assets abroad by $3 trillion, a quarter of our GDP. And we are 

going into hock abroad at a rapid rate. As we sell off our assets to maintain our 

trade deficit habit, we mortgage off our future GDP to people abroad.7

No pre-funding with private accounts 

To my knowledge, no Social Security proposal under debate today provides for any 

significant pre-funding by reducing current national spending to finance higher benefits in the future. 

The President’s proposal creates private accounts with borrowing and not spending cuts. As the Administration has conceded, this proposal does not raise saving 

and therefore has no pre-funding. Because the President’s latest budget actually 

raises the deficit over the next five years, it makes no effort at pre-funding the retirement of the Baby Boom. 

Likewise, the proposal to create private accounts to the extent of the current $163 

billion Social Security surplus would involve even more borrowing initially than the 

President’s plan. A serious pre-funding plan would have an attainable sacrifice initially and grow over time. The plan to finance private accounts with the Social Security surplus starts out large and dwindles to nothing in a decade. 

Pre-funding and fairness 

Because the people who pay for pre-funding often differ from the people who benefit, we should carefully consider questions of fairness in proposals for pre-funding. 

Two fairness questions come to mind. First, what are the implications of changing 

the pre-funding arrangements of 1983? Second, how much should we sacrifice to future generations who will be far more prosperous than we are today? 

Pre-funding played an important part in the 1983 compromise on Social Security. 

To achieve 75-year actuarial balance with the Baby Boom generation’s retirement 

already looming, the 1983 agreement raised payroll tax revenues above expected 

benefit payments for the first half of the period to offset a revenue shortfall in the 

second half. To claim progressive benefits in retirement, the Baby Boom would have 

to pre-fund the system with regressive taxes. Now, after 22 years of paying regressive payroll taxes to pre-fund the system, Baby Boomers born after 1949 are being 

told that they must accept benefits cuts because of a newly found crisis: a cash 

shortfall. In fact, the actuaries projected in 1983 that program costs would first exceed revenues in 2020, the same year that CBO now projects. Despite many claims 

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to the contrary, it’s hardly a crisis when the date for the end of the cash surplus 

has been known for 22 years. 

Although thrift may always seem virtuous, the economic and moral case for prefunding is debatable. Consider this thought experiment. The Social Security trustees 

report projects that our per capita income will rise about 80% over the next 40 

years. Per capita income in Connecticut exceeds that of Mississippi by about the 

same percentage today. No one would expect the people of Mississippi to sacrifice 

today so that the people of Connecticut can consume more today. Does it make any 

more sense for people today to sacrifice to raise consumption even higher in the future? It’s one thing for us to decide to save as individuals, but it’s another thing 

for you as representatives to decide that the nation must cut today’s consumption 

for the sake of higher future consumption. 

Most would lose money with the President’s private accounts because of 

big risks 

It is unlikely that most people would come out ahead if they chose to set up a 

private account as proposed by the President. People would be asked to bear substantial risks that they would not face if they opted out of creating a private account. In simulations by Professor Robert Shiller, investors in the President’s plan 

would be expected to lose money 71% of the time. Using historical performance of 

global market indexes and projections of likely returns in a recent survey of experts 

by the Wall Street Journal, he estimated a median return of 2.6% above inflation, 

less than the 3.0% charged by the President’s plan. (Note that Shiller’s calculations 

do not reflect the decisions of actual people who, as explained below, tend to underperform a balanced portfolio of indexes.) 

Some features of the President’s proposal—and the attendant risks—have not received the attention that they deserve. Once a person opts to start contributing to 

a private account, she must do so until benefits are triggered by retirement, death 

or disability. If a 25-year-old decides to climb on board, they are strapped in to a 

roller coaster ride and cannot get off before they retire, die, or become disabled. 

Consider the multiple ways that the President’s plan exposes private account 

holders to risks of inflation. First, take the fact that people are charged interest at 

the rate of 3% plus inflation for any Social Security taxes diverted into a private 

account. Economists and accountants like to subtract inflation in making long-term 

forecasts because they don’t have confidence in forecasting inflation. But the President’s plan asks a 25-year-old who puts $1,000 into a private account to take a risk 

about the inflation charge for the 42 years until he retires. In the long term, stocks 

and bonds may adjust to higher inflation, but not in the short to medium term. For 

example, unanticipated inflation in the 1970s was accompanied by a bear market 

in stocks and a slump in bonds. 

Second, there is the risk of inflation after benefits begin. Current Social Security 

benefits are indexed for inflation, which puts the risk of higher inflation primarily 

on the government. Recognizing the risks involved, the private market has been reluctant to provide inflation-protected annuities. If they are offered in the future, 

they will come at a hefty price in terms of reduced annuity payments. 

Another risk involved with private accounts comes from the volatility of interest 

rates. When a person retires, her monthly annuity payment depends on the amount 

of money used to buy the annuity and the current interest rate. The lower the interest rate at the time of retirement and annuity purchase, the lower the annuity payment until death. A person who traded in a stock portfolio for an annuity in early 

2000 would have a much higher annuity than someone who did so in recent years 

not only because stock prices have declined but because interest rates did, too. 

Finally, in deciding whether to create private accounts with Social Security funds, 

Congress should consider the evidence that most people manage their investments 

poorly. Because they appear to buy and sell based on trends, they tend to buy high 

and sell low. This result holds not just for specific stocks but for broad mutual fund 

categories of the type proposed by the President. 

Ironically, those most eager to manage their investments seem to do the most 

poorly on average. Recent polls suggest that men are more likely to support private 

accounts than women. But note that recent research has found that men were more 

active traders and had significantly lower returns on their accounts than women. 

Private accounts have been touted as a ‘‘sweetener’’ to help the public accept sizeable benefit cuts that deepen over time. Given all the risks involved, however, people should assume that opening a private account will reduce their retirement income even further. 

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8For further analysis, see Bivens, L. Josh. 2005. ‘‘Social Security’s fixable financing issues: 

Shortfall in fund is not inevitable.’’ EPI Issue Brief No. 207, Washington, DC.: Economic Policy 

Institute. 

Average wage trends have hurt the Social Security trust fund 

Two adverse trends in the labor market have had a substantial negative effect 

on the Social Security trust fund since 1983. The Social Security actuaries have estimated a 75-year shortfall of 1.92% of payroll. The Social Security trustees have lowered their projected growth rate for real wages from 1.5% in 1983 to the current 

projection of only 1.1%. Slower wage growth causes revenues to fall more than benefits within the 75-year window. SSA actuaries project that real wage growth of 1.5% 

in the next 75 years would narrow the projected shortfall by 0.40% of payroll—about 

a fifth of the projected shortfall. 

The increased inequality of wage income has contributed even more to the shortfall. The cap on wage and salary income subject to Social Security taxes (now 

$90,000) has been rising with average annual earnings. Although the share of earners above the cap has remained about 6%, their earnings have risen much faster 

than average. As a result, the share of wage and salary income not subject to Social 

Security has risen from 10% to more than 15%. (Recent evidence for 2004 suggests 

this untaxed share has widened further.) SSA actuaries estimate that covering 90% 

of wage and salary income over the next 75 years would narrow the shortfall by 

0.75% of payroll—two-fifths of the projected shortfall. 

We would face a shortfall about 40% as large as they one projected today if, all 

else equal, real wages were still expected to rise at the rate projected in 1983 and 

wage and salary income had not become more unequal.8

Future health of the trust fund depends on a healthy labor market 

Social Security revenues are a function of how many people are employed and how 

much of their wage income is subject to Social Security taxes. The number of people 

employed is a function of the population and the share of the population employed. 

Immigration appears to present a bigger question mark for future population growth 

than domestic demography (births and deaths). The trustees projected immigration 

of 900,000 a year for each of the next 75 years in their intermediate projection and 

1.3 million a year in their low-cost projection. With the population of the U.S. and 

the rest of the world growing and global transportation and communication becoming cheaper, it seems implausible that immigration would remain fixed. If immigration grows at a modest 1% per year from recent levels, it will more than triple the 

intermediate projection and double the low cost projection within 75 years. 

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9For further analysis of this point, see Gould, Elise. 2005. ‘‘Many already lack a steady job 

before the Social Security retirement Age.’’ EPI Snapshot June 15, 2005, Washington, DC.: Economic Policy Institute 

As a matter of logic and recent experience, the employment to population ratio 

matters more to future employment than the unemployment rate. In recent years, 

the unemployment rate has gone haywire as an indicator of potential employment. 

The chart below compares the employment to population ratio for each age level for 

2000 and 2004. Note that in both years employment falls sharply well before age 

62. This belies the comfortable assumption that people hold a steady job until they 

start claiming Social Security benefits at age 62.9

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10Separate analysis shows no difference in the decline for men and for women. 

Note also that the ratio was uniformly lower in 2004 for ages up to the mid-50s 

and uniformly higher for older ages. The second chart indicates the size of the 2000– 2004 change for each age level. The decline was 2% to 4% of the population from 

the mid-20s to the mid-50s.10 That represents a decline in employment for more 

than 3 million prime working age people. If we can restore normal job growth in 

the range of 300,000 jobs a month instead of the anemic 170,000 jobs of the last 

six months to a year, it would do wonders for the trust fund coffers. If the employment to population ratio remains depressed, it bodes poorly for the trust fund. 

Wage income subject to Social Security taxes is affected by productivity, labor’s share on income, the wage share of compensation, and the share of wages below the 

cap. Fortunately, productivity has improved markedly in the last decade. Labor 

shared in productivity gains in the 1990s, but its share of the gains since 2001 has 

been extraordinarily low. Squeezed by a falling labor share of income and rising 

health benefit costs, wages have grown slowly in recent years. The continued disappointment in wage growth despite strong productivity gains was a major factor 

accounting for the trustees’ decision to advance the projected dates for the trust 

fund cash flow to turn negative and for the trust fund to be exhausted. On the other 

hand, if productivity gains of the last decade are sustained and labor’s share of 

those gains reverts to historical norms, then the trustees’ projections for taxable 

wages are too pessimistic. 

The share of taxable wage and salary income below the cap represents another 

key variable. As noted earlier, people making income above the cap have enjoyed 

faster than average wage and salary gains since 1983. That trend abated somewhat 

with the downturn in financial markets and technology companies. This year’s data 

on tax revenues and anecdotal information about a revival of bonuses and stock options suggest that the share of income above the cap is rising again. 

Unlike other economic variables, the share of wages over the cap can readily be 

fixed by legislation. The cap does not have to move at the rate of average wages 

when high income wages are growing faster. The cap could be raised to maintain 

a fixed share of income above the cap or to restore the 90% coverage of 1983. If the 

cap is removed altogether, the trust fund would no longer be hurt by greater wage 

inequality. 

Conclusion 

Most middle-income Americans have come to rely on Social Security to protect 

their families in retirement, disability, or early death. In a world of topsy-turvy 

labor and financial markets, the Social Security system provides a port in the storm. 

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Pre-funding the retirement costs of future retirees requires sacrificing current 

consumption in favor of future consumption. Policy decisions in recent years have 

turned in the opposite direction. Between 2001 and 2004, policy decisions reduced 

the federal budget balance by 3.7%, more than five times the annual average shortfall that SSA actuaries project for Social Security. Both the prescription drug legislation and the tax cuts of 2001–2003 have 75-year fiscal effects that are multiple 

times as large as the Social Security shortfall. As a nation, we are rapidly selling 

off our assets to persons abroad 

The rhetorical argument that private accounts can materially offset the cuts proposed by the President does not bear close scrutiny. Indeed, if Congress enacts the 

President’s plan for private accounts, the private accounts may have few takers because the odds are stacked against the typical investor coming out ahead of the 

‘‘clawback’’ interest charge. 

Economic variables important to the trust fund include immigration, productivity, 

the share of the population employed, the share of output received by labor, the 

share of labor compensation paid as wages, and the share of wages paid below the 

cap. The trustees were probably too pessimistic on the first two variables, but recent 

trends on the other variables are worrisome. 

Of all the variables with a significant effect on the trust fund, the one most under 

the control of Congress is the amount of wage income above the cap. Congress 

should revise the formula for the cap to prevent future erosion. Eliminating the cap 

altogether would prevent increased wage inequality from eroding trust fund revenue. Otherwise, a return to a normal pattern of gains in both employment and 

wages would do wonders both for Social Security beneficiaries and for the trust 

fund. 

f 

Chairman MCCRERY. Thank you, Mr. Price. Now, Dr. Samwick. 

STATEMENT OF ANDREW W. SAMWICK, PH.D., PROFESSOR OF 

ECONOMICS, AND DIRECTOR, THE NELSON A. ROCKEFELLER CENTER, DARTMOUTH COLLEGE, HANOVER, NEW 

HAMPSHIRE 

Mr. SAMWICK. Mr. Chairman and Members of the Subcommittee, thank you for the opportunity to testify on the economic 

factors affecting Social Security’s financing and the role of personal 

accounts in strengthening retirement security. I commend you for 

holding this series of hearings. I can imagine you must all be exhausted on your seventh out of eight. There is no better place for 

a bipartisan and comprehensive reform to start than in this Subcommittee. I would like to emphasize the following four points as 

an overview of my full written testimony. 

The first point is that, while it is true that many demographic 

and economic factors affect Social Security’s long-term finances, the 

most important drivers of the looming shortfalls are demographic—

continued improvements in life expectancy and retirement, and fertility rates that remain around two children per woman. I see very 

little in the economy and society more generally to suggest that 

this demographic pressure is overstated. The reality of this demographic shift should guide our discussions about how to reform the 

system, and in particular, I think this demographic pressure should 

strongly motivate us to consider higher target ages of retirement 

for non-disabled workers. 

Second, among the factors that are both important for Social Security’s finances and subject to considerable uncertainty in their 

projections, the real wage differential is the most critical. While it 

is true that the ultimate assumption for the real wage differential 

of about 1.1 percent seems low, particularly relative to the productivity boom that we have experienced over the last decade, when 

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this number averaged 1.6 percent, any reasonable increase in the 

assumed rate of real wage growth would still leave a large hole in 

the system’s finances. There really is no alternative to financing 

the projected retirement income of future beneficiaries other than 

preparing them to save more as a Nation and work more prior to 

retirement. 

Third, the issue of whether to bring new moneys into the system, 

and whether to do so in the form of tax increases in the current 

system or contributions to a new system of personal accounts, is 

perhaps the most polarizing in the current debate. I can only offer 

my own perspective. The default outcome if we do nothing today is 

to wait until the fiscal consequences of running the current system 

with a retired population of Baby Boomers has become unmanageable. That could happen anytime between 2017, when the current 

system is first projected to pay out more in benefits than revenues 

are collected in taxes, and 2041, when the current system is projected to lose its authorization to pay benefits as scheduled without 

new legislation. 

When that day of reckoning occurs, it will likely involve a combination of benefit cuts, tax increases, and delays in the retirement 

age, as in the 1983 amendments. However, compared to 1983, these 

changes will have to happen in greater measure and with more immediacy. We will have squandered the opportunity to envision a 

more modern retirement system that relies less heavily on pay-asyou-go financing. We will have done nothing to prepare a new generation of retirees for their lower retirement incomes. Worst of all, 

we will impose a tax burden on our children’s generation that, with 

full knowledge of its likely appearance, we will have refused to address today. I wouldn’t blame them if they refused to pay, or, in 

the face of higher taxes, they simply decided to work less. 

Fourth, if we do not intend for retirement incomes to fall, and 

if we are unwilling to move Social Security’s target retirement ages 

higher in the face of these demographic shifts, then the only option 

left is to increase saving today. There are two reasons why I believe that this additional saving should happen through personal 

accounts, whether inside or outside the Social Security system, 

rather than in the trust fund. The first is that in the last two decades the budget policies show quite clearly that the Social Security 

surpluses do not, as a rule, serve their intended purpose of lessening the burden on future generations. The availability of the Social Security surplus in the unified budget has encouraged the government to run larger deficits in the on-budget account. If new 

moneys are to be brought into the system, they have to be matched 

by an outflow to something like personal accounts to avoid this 

problem. If there is a so-called lock box, it seems that it has 536 

keys; but more importantly, it has no lid. The second reason to 

favor personal accounts is that, if we are serious about restoring 

solvency to Social Security over the long term, not just postponing 

the date that the trust fund is exhausted outside the 75-year projection period, then the scale of investments required is simply too 

large to be managed in anything but a decentralized manner. Some 

rough calculations suggest that restoring solvency on a permanent 

basis would require the accumulation of an aggregate portfolio that 

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would be equivalent to about two-thirds of all mutual funds in existence today. 

Mr. Chairman and Members of the Subcommittee, this concludes 

the overview of my written testimony, and I would be happy to answer any questions that you might have. 

[The prepared statement of Dr. Samwick follows:] 

Statement of Andrew W. Samwick, Ph.D., Professor of Economics and Director, The Nelson A. Rockefeller Center, Dartmouth College, Hanover, 

New Hampshire 

The Impact of Economic Trends on Social Security’s Financing and Retirement Security 

Mr. Chairman and Members of the Subcommittee: 

Thank you for the opportunity to testify on the economic factors affecting Social 

Security’s financing and the role of personal accounts in strengthening retirement 

security. I commend you for holding this series of hearings. There is no better place 

for bipartisan and comprehensive reform to originate than in this committee. 

As you have requested, my testimony today will focus on three topics: the economic factors that are used to project the future condition of the Social Security system; the consequences of raising taxes to meet Social Security’s obligations, and the 

advantages of pre-funding future benefits through personal accounts. 

I would like to emphasize the following four points: 

1) While it is true that many demographic and economic factors affect Social Security’s long-term finances, the most important drivers of the looming shortfalls are demographic—continued improvements in life expectancy in retirement (about 4 more years at age 65 over the next 75 years) and fertility rates 

that are about 2 children per woman. I see very little in the economy and society more generally to suggest that this demographic pressure is overstated in 

the current projections. The reality of this demographic shift should guide our 

discussions about how to reform the system. In particular, the shift strongly 

suggests the need to target higher retirement ages. 

2) Among the economic factors that are both important for Social Security’s finances and subject to uncertainty in their projection, the real wage differential 

is the most critical. While it is true that the ultimate assumption for the real 

wage differential of 1.1 percent seems low, particularly relative to the productivity boom of the last decade when it averaged 1.6 percent, any reasonable 

increase in that assumed rate of real wage growth would still leave a large 

hole in the system’s finances. There really is no alternative to financing the 

projected retirement income of future beneficiaries than preparing them to 

save more as a nation and work more before entering retirement. 

3) The issue of whether to bring new monies into the system, and whether to do 

so in the form of tax increases in the current system or contributions to a new 

system of personal accounts, is perhaps the most polarizing in the current debate. I can only offer my own perspective. The default outcome if we do nothing 

today is to wait until the fiscal consequences of running the current system 

with a retired population of Baby Boomers become unmanageable. That could 

happen anytime between 2017, when the current system is first projected to 

pay out more in benefits than the revenues that are collected in taxes, and 

2041, when the current system is projected to lose its authorization to pay benefits as scheduled without new legislation to authorize this. When that day of 

reckoning occurs, it will likely involve a combination of benefit cuts, tax increases, and delays in the retirement age, as in the 1983 amendments. However, unlike 1983, these changes will have to happen in greater measure and 

with more immediacy. We will have squandered the opportunity to envision a 

more modern system that relies less heavily on pay-as-you-go financing. We 

will have done nothing to prepare new retirees for their lower retirement incomes. And, worst of all, we will impose a tax burden on our children’s generation that, with full knowledge of its likely appearance, we will have refused 

to address ourselves today. I wouldn’t blame them if they refused to pay, or, 

if in the face of these higher taxes, they simply decided to work less. 

4) If we do not intend for retirement incomes to fall, and if we are unwilling to 

move Social Security’s target retirement ages higher in the face of the demographic shifts, then the only option left is to increase saving today. There are 

two reasons why I believe that this additional saving should happen through 

personal accounts, whether inside or outside the Social Security system, rather 

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55 

than the Trust Fund. The first is that the last two decades of budget policy 

show quite clearly that the Social Security surpluses do not as a rule serve 

their intended purpose of lessening the burden on future generations of taxpayers for financing the current generations’ retirement benefits. The availability of the Social Security surplus in the unified budget has encouraged the 

government to run larger deficits in the on-budget account. If new monies are 

to be brought into the system, they have to be matched by an outflow (to something like personal accounts) to avoid this problem. If there is a ‘‘lockbox,’’ it 

seems that there are 536 keys, but more importantly, no lid. The second reason 

to favor personal accounts is that, if we are serious about restoring solvency 

to Social Security over the long term—not just postponing the date of Trust 

Fund exhaustion outside the 75-year projection period—then the scale of investments required is simply too large to be managed in anything but a decentralized manner. Restoring solvency on a permanent basis would require the 

accumulation of an aggregate portfolio that would be equivalent to about two 

thirds of all mutual funds if it existed today. 

I would now like to discuss each of these points in more detail. In all of my calculations, I will rely on the projections based on the Intermediate assumptions of 

the 2005 Social Security Trustees’ Report. 

The Centrality of Demographic Factors 

As the committee has heard in previous hearings, the driving force behind the 

projected deterioration in Social Security’s finances is an increase in the number of 

beneficiaries relative to the number of workers. Between 2005 and 2080, the number of beneficiaries per hundred workers is projected to rise from 30 to 54, an increase of 80 percent. Over that same period, Social Security’s cost rate—the amount 

of benefits relative to the payroll tax base—is projected to increase from 11.1 percent to 19.1 percent, an increase of about 72 percent. 

Given the other assumptions underlying these projections, the demographic shift 

more than explains the worsening of Social Security’s financial picture. Over this 

75-year projection period, life expectancy after age 65 is projected to increase by 

about 4 years. (Note as well that this represents a slowing of the rate of improvement in life expectancy relative to the historical period, suggesting that the actual 

improvements could be larger.) The fertility rate is projected to be 1.95 children per 

woman, a rate that would not increase the size of the working age population in 

the absence of immigration. Even if this assumption turns out to be too low, it 

would be several decades before a higher fertility rate could meaningfully affect Social Security’s annual financial balance. 

Regardless of our individual political views or our preferred approaches to Social 

Security reform, I believe that we can all agree that this unprecedented aging of 

the population will require a substantial adjustment in the way we conceive of our 

systems of old-age support. 

The Relevance of Economic Factors 

There are several assumptions about economic factors that affect the projections 

of Social Security’s long-term solvency. The economic effects come from either of two 

main channels. First, they can alter the time-value of money, and thus the relative 

importance of the near-term annual surpluses compared to the longer-term annual 

deficits. Second, they can alter the size of the payroll tax base relative to the 

amount of benefits to be paid in a given year. For the purposes of the discussion 

in this section, I will focus on the projected long-term actuarial deficit as calculated 

over the 75-year projection period, which was 1.92 percentage points of payroll in 

the 2005 Trustees Report. Obviously, this is an incomplete measure of solvency, but 

it is sufficient to illustrate the key points about the role of economic factors. I will 

focus on longer-term measures of solvency in the next sections. 

The intermediate assumptions put the real interest rate at 3 percent. Because the 

system runs near-term surpluses and longer-term deficits, a higher interest rate 

would improve the long-term financial outlook for Social Security. However, the effects are fairly small. The sensitivity tests in the Appendix of the Trustees Report 

show that for each percentage point increase in the real interest rate, the long-term 

actuarial deficit falls by about 0.7 percent of taxable payroll. Thus, the real interest 

rate would have to nearly double to close the gap completely. Since the current assumption of 3 percent is only a bit below recent history, we would not expect substantially higher real interest rates than in this baseline. In addition, it would be 

hard to maintain the ‘‘other things equal’’ assumption in such a scenario, since an 

exogenous increase of a few percentage points in the real interest rate would 

dampen economic growth and thus Social Security’s finances. 

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It might seem like the inflation rate would have a large impact on Social Security’s long-term finances, particularly given the annual attention given to the size 

of the cost-of-living adjustments for current beneficiaries (and all of the recent discussion about the possibility of switching from wage—to price-indexing in the current benefit formula). However, higher inflation has only a mildly positive effect on 

Social Security’s projected finances, because the higher COLAs are preceded by 

higher nominal wages. The effect is not large—the Trustees Report estimates that 

a 1 percentage point increase in the CPI inflation rate improves the long-term actuarial balance by only 0.21 percent of taxable payroll. 

The key economic assumption is the growth in the average annual wage in covered employment relative to the CPI, commonly referred to as the real wage differential. The current projections are based on an ultimate real wage differential of 

1.1 percent per year. While this number is consistent with actual experience over 

the last 45 years, it is about 0.5 percentage point below the average for the past 

decade. The sensitivity analysis in the Trustees Report shows that raising the real 

wage differential by this difference would lower the long-term actuarial deficit by 

about 0.53 percent of taxable payroll. In order for higher real wage growth to close 

the gap, it would have to average about 2.9 percent per year. To get an idea of how 

infeasible this is over the long term, the real wage differential averaged 2.9 percent 

per year over the period from 1996—2000, a period that we now regard to have been 

a bubble. Nonetheless, an economic policy that focused on capital accumulation—

whether privately through enhanced retirement savings vehicles or publicly through 

a more responsible budget policy—could raise real wages and have the salutary benefit of improving Social Security’s financial outlook. 

The final economic assumption of interest is the growth of the labor force. As we 

all know, the growth of the labor force is projected to slow over the coming decades 

as the large Baby Boom cohort makes its transition from working careers to retirement. There appears to be nothing unreasonable in the way this has been projected 

in the Trustees Report, but promoting greater labor force participation is one of the 

few policy levers that we could utilize to help shore up the system’s finances. The 

natural way for this to happen would be lower the overall tax burden on working 

families (consistent with a responsible budget policy) and to encourage older workers in particular to remain in the labor force. As the committee has already devoted 

considerable attention to this issue, I can only underscore my agreement with panelists at prior hearings that it makes sense to begin a national conversation about 

how the target retirement age for most workers should increase in the face of improvements in life expectancy and the impact of demographics on the system’s finances. 

Consequences of Raising Taxes to Finance Future Benefits 

I believe that the question of whether taxes should be raised to finance future 

benefits is primarily a matter of equity and only secondarily a matter of efficiency. 

We may feel that larger tax burdens are bad, but we should also feel that larger 

deficits are surely worse, because they are your children’s taxes. If revenues coming 

into the Social Security system will ultimately have to increase, then the responsible 

course of action is to increase them now, so that the burden can be spread more 

equitably across generations. 

Consider what happens if we wait to act. In 2005, the Trustees Report tells us 

that we have unfunded obligations (over the infinite horizon, not just the next 75 

years) that are equal to about 90 percent of GDP. Those unfunded obligations could 

be eliminated by raising the payroll tax by 3.5 percentage points, immediately and 

forever (and ignoring the likely declines in economic activity associated with this tax 

increase). If we were to wait until the Trust Fund is projected to be exhausted in 

2041, then we would find ourselves (according to my own rough calculations) with 

unfunded obligations that are about 140 percent of (a much larger) GDP. Tax increases and benefit cuts would have to be commensurately higher, and all of those 

who retire in the next 35 years would evade any responsibility for sharing in the 

burden of those tax increases. 

As a matter of efficiency, it is worth reiterating points made recently to the Committee in the testimony of Tom Steinmeier and Gene Steuerle that, despite the fact 

that individuals both pay taxes and earn benefit entitlements as a result of working 

in covered employment, the link between benefits and taxes is often very weak. 

There is quite a bit of redistribution in the current system, but surprisingly little 

of it serves to make the system more progressive, largely due to the spousal benefit 

rules. In the usual way they are proposed, personal accounts do not redistribute resources as in the current system, and thus contributions to personal accounts should 

be viewed as less distortionary and less likely to reduce economic activity compared 

to raising taxes. 

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The Role of Personal Accounts in Pre-Funding Future Benefits 

Once we have decided to make greater saving an element of Social Security reform, there are institutional reasons for channeling that saving to personal accounts 

rather than the pay-as-you-go system. The first pertains to the way the Federal 

Government handles the revenues embodied in Social Security surpluses. The second pertains to the scale of investments required if reform is to actually restore solvency to the system on a permanent basis. 

The budget process in the Federal Government makes pre-funding through the 

Trust Fund completely unreliable. Over the past two decades, the government’s targeting of the unified budget deficit in its policy making has meant that the presence 

of the Social Security surplus has facilitated larger deficits in the on-budget account. 

This practice extends back to the Gramm-Rudman legislation in the 1980s and continues to this day as the Administration sets a budget target of ‘‘cutting the deficit 

in half in 5 years.’’ The ‘‘deficit’’ in question included not just the level of the Social 

Security surplus but its growth over that period. Absent a budget policy that is truly 

disciplined—like a balanced budget excluding Social Security over the business 

cycle—running larger Social Security surpluses will not have the desired effect of 

alleviating the financial burden on future taxpayers of paying for the current generation’s retirement benefits. Requiring the new revenue to immediately flow out to 

personal accounts would prevent the government from spending it on current 

projects. 

Even if the budgetary institutions could be reformed, a recognition of the scale 

of new saving that is required argues strongly for investments in personal accounts 

rather than a Trust Fund. By 2080, the annual deficit in Social Security is projected 

to grow to 5.75 percent of taxable payroll. Suppose that we wanted to save enough 

money to accumulate a portfolio so that the investment income from that portfolio 

would cover this deficit. If we could get a return of 5 percent, after inflation and 

net of administrative costs, that would require a portfolio equal to 5.75/5 = 1.15 

times taxable payroll. If that portfolio existed today, when taxable payroll is $4.73 

trillion, it would be about $5.4 trillion. To put that in perspective, it is about two 

thirds of all mutual funds in the United States today. There is simply no feasible 

way for that money to be managed in anything but a decentralized manner. Personal accounts provide a mechanism to accommodate the need for widespread ownership and decentralized money management. 

Thank you again for the opportunity to testify today. Much of what I have written 

can be found in further detail on my weblog, http://voxbaby.blogspot.com. 

f 

Chairman MCCRERY. Thank you, Dr. Samwick. Dr. Furman? 

STATEMENT OF JASON FURMAN, PH.D., SENIOR FELLOW, CENTER ON BUDGET AND POLICY PRIORITIES, AND VISITING 

SCHOLAR, NEW YORK UNIVERSITY, NEW YORK, NEW YORK 

Mr. FURMAN. Mr. Chairman, Mr. Levin, other Members of the 

Subcommittee, thank you for the invitation to address you today. 

There are many important issues in the reform of Social Security, 

some of which I had the opportunity to address at the Full Committee hearing, including the impact on benefits, debt, and the 

overall economy. Today I want to focus in particular on the issue 

of prefunding. 

In an analogy to help illustrate the choices Congress faces as it 

crafts reforms to the Social Security system, consider a family with 

a substantial mortgage on its home and daughter who is going to 

go to college in 10 years. If the parents want to help pay for the 

child’s education, they have three choices. First, they could prefund 

their daughter’s tuition by reducing their spending, saving more, 

and paying down their mortgage more quickly. Alternatively, they 

could save more and use the extra money to invest in an account. 

Finally, the parents can decide not to prefund and instead plan on 

reducing their future spending to pay for college when the bills 

come due. These are three reasonable ways to finance the daughhsrobinson on PROD1PC72 with HEARING

58 

ter’s education. Now consider more reckless parents. They take out 

a second mortgage on their home so they can invest the money 

they borrowed. That would not be prefunding. This family would 

not be any better prepared to pay their daughter’s tuition. They 

might have more money set aside, but they would also have much 

larger mortgage payments. This metaphor is, I hope, instructive as 

we consider various ways Congress might reform Social Security. 

I would like to make four specific points that build on the simple 

insights about Social Security that can be gleaned from this metaphor. 

First, partially prefunding Social Security is a sensible goal. If 

benefits for people at or near retirement are protected, prefunding 

can only be accomplished by raising Social Security contributions. 

Prefunding Social Security means making benefit reductions or 

contribution increases today that would raise net Federal savings. 

Raising savings should be a fundamental goal of any proposal to 

reform Social Security. For this reason and others, partially 

prefunding Social Security as part of an overall strategy to restore 

solvency is a good idea. President Bush and congressional leaders 

from both parties have ruled out benefit reductions for people at or 

near retirement. The Chairman and other Members of this panel 

have called for more prefunding. The only way you can possibly do 

that is to increase the contributions people are making to Social Security beyond the 12.4 percent they are making today. I interpreted 

Dr. Samwick as meaning that when he talked about bringing new 

moneys into the system. The Committee is interested in prefunding 

Social Security; this is the only way to do it. 

Second, none of the major Social Security reforms under discussion have any significant prefunding. I have reviewed every reform 

proposal that the Social Security actuaries have scored based on 

the 2003 and 2004 Social Security trustees’ assumptions, and other 

than two proposals—one by economists Peter Diamond and Peter 

Orszag and one by former Commissioner Bob Ball, both of which 

have a modest, relatively small amount of prefunding—none of the 

other proposals has any real prefunding at all. They do not do anything to benefits before 2012. Even then, the benefit reductions 

begin gradually and there are no contribution increases. If you look 

at Figure One and Figure Two in my prepared testimony, they 

show the benefit changes under two proposals. One of them is the 

President’s sliding scale benefit reductions, and the other is a combination of raising the retirement age and longevity indexing. Both 

of those do relatively little for solvency in the first decades that 

they are in effect, and only grow substantially larger much later 

on. That is not prefunding. 

Third, individual accounts by themselves do nothing to prefund 

Social Security. As I mentioned, increasing Social Security contributions—for instance, raising the total contribution to 15.4 percent and dedicating 3 percentage points of that to individual accounts—would partially prefund Social Security. It is not the accounts that are leading to the prefunding, it is the larger contributions. None of the major recent individual accounts plans that have 

been scored by the actuaries propose increasing total account contributions. As a result, any assets in the accounts are matched by 

increases in the government’s debt. Like the family that mortgages 

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1The views expressed in this testimony are mine alone. 

its house to put money in a college savings account, this process 

does nothing to prefund Social Security or increase Federal savings. 

One of the leading public finance textbooks, written by Harvey 

Rosen, the former Chairman of President Bush’s Council of Economic Advisors, explains that, ‘‘There is no reason to believe that 

privatization‘‘—and that is the only time I will use that word in 

this hearing, is in quotes—‘‘by itself would raise Federal savings. 

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 savings is created.’’ In short, the primary effect of borrowing to finance individual accounts is no change in national savings. Furthermore, accounts 

could reduce savings if individuals treat them as net wealth and 

consequently decrease their savings in 401(k) s and IRAs. This 

would leave people even less prepared for retirement. Some have 

argued that accounts could increase savings if the higher deficits 

associated with them lead to lower government spending and/or 

higher taxes outside of Social Security. Note that, even in this case 

the prefunding is a result of other budgetary policies, not the accounts. There is little reason to believe that even this development 

would occur. The Bush Administration has not claimed that if accounts were passed it would propose additional reductions in Federal programs or higher taxes to offset the increased deficit. In fact, 

Administration officials emphasize that they do not believe there is 

any need for such steps because, they contend, the accounts are fiscally neutral over the infinite future. 

Finally, and very briefly because I have more than exhausted my 

time, Social Security is a relatively small part of the long-run deficit, and I urge this Committee to focus on our overall fiscal challenges, which include health care and the level of taxes in light of 

the tax cuts in the last 5 years. Thank you. 

[The prepared statement of Dr. Furman follows:] 

Statement of Jason Furman Ph.D.,1 Non-Resident Senior Fellow, Center on 

Budget and Policy Priorities & Visiting Scholar, New York University 

Wagner Graduate School of Public Service, New York, New York 

Mr. Chairman and other members of the Committee, thank you for the invitation 

to address you today regarding an important facet of the Social Security reform debate—prefunding. Social Security is currently running a substantial surplus but in 

the coming decades the number of workers supporting each retiree will fall and the 

challenges facing Social Security will grow. Prefunding entails making larger initial 

reductions in benefits or increases in contributions in order to reduce the magnitude 

of the changes required in the future. At the same time, prefunding increases national savings, reducing consumption today but expanding the economy and thus 

consumption possibilities in the future. 

An analogy can help illustrate the choices Congress faces as it crafts reforms to 

the Social Security system. Consider a family with a substantial mortgage on its 

home and a daughter who will go off to college in a decade. If the parents wants 

to help support their daughter’s education, they have three choices: 

• The parents could ‘‘prefund’’ their daughter’s education by reducing their spending, saving more, and using the money to pay down their mortgage more quickly. 

• Alternatively, the parents could use the additional savings to prefund their 

daughter’s education by investing their new savings in an educational savings 

account. 

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• Finally, the parents could decide not to prefund their daughter’s education and 

instead plan on reducing their future spending to pay for college when the bills 

come due. 

All three of these are reasonable ways to finance the daughter’s education. But 

one method is not: the family could take out a larger mortgage on their home and 

invest the borrowed money in an educational savings account. This would not represent prefunding. The family is no more prepared for their daughter to go to college—they have more money set aside for college but they also have larger mortgage 

payments. And the family might suffer from the dangerous delusion that they have 

prefunded their daughter’s education. They will thus be unprepared for the combined burden of repaying the mortgage and sending their daughter to college. 

In my remarks today, I will make five points that build on the simple insights 

about Social Security that can be gleaned from this metaphor: 

• First, fully prefunding Social Security is neither warranted on policy grounds 

nor feasible. 

• Second, partially prefunding Social Security is a sensible goal. But, if benefits 

for people at or near retirement are protected, prefunding can only be accomplished by raising Social Security contributions. 

• Third, none of the major Social Security reform plans under discussion have 

any significant prefunding. All of the plans protect benefits for people at or near 

retirement and none contain contribution increases. 

• Fourth, individual accounts—by themselves—do not do anything to prefund Social Security. 

• Finally, I recommend—as a starting point—prefunding our future fiscal challenges by partially undoing some of the major fiscal errors of the last four and 

a half years, including the tax cuts and the prescription drug bill. 

First, fully prefunding Social Security is neither warranted on policy 

grounds nor feasible. 

Our law requires that private pension plans are fully funded. They must maintain 

sufficient assets to cover all accrued benefits—even if plan closes down and receives 

no future contributions. This rule was designed to ensure that companies retain the 

resources to pay retirees, even if they go bankrupt. 

In contrast, Social Security is largely a pay-as-you-go system. The majority of benefit payments in any given year are paid for by revenues collected in that year. If 

payroll tax contributions ceased today, the Social Security trust fund would only be 

sufficient to pay benefits for the next three and a half years. 

Social Security’s pay-as-you-go structure originated in the 1930s. President Franklin Delano Roosevelt and the Congress that created Social Security decided that the 

elderly, who fought in World War I and bore the brunt the Great Depression, should 

immediately start receiving benefits. If Social Security had been fully advance funded, no one would have gotten full benefits until the late 1970s—after a lifetime of 

contributions to the system. 

The policy logic that applies to a private company does not apply to Social Security. Unlike a private company, the United States will not cease to exist and the 

Federal Government can count on continued payroll tax collections into the indefinite future. With adjustments in Social Security benefits and taxes, Social Security 

can be made sustainably solvent. 

Even if one believes that the wrong decision was made in the 1930s and wishes 

Social Security were fully advance funded, shifting from our current system to an 

advance funded system is not feasible. Doing so would require either eliminating an 

entire generation’s benefits or doubling an entire generation’s payroll taxes. Every 

significant Social Security reform proposal, whether with or without accounts, largely maintains Social Security’s pay-as-you-go structure. 

Second, partially prefunding Social Security is a sensible goal. But, if benefits for people at or near retirement are protected, prefunding can only be 

accomplished by raising Social Security contributions. 

Partially prefunding Social Security, as part of an overall reform to restore solvency, is a good idea. America currently enjoys a more fiscally-favorable demographic structure than our country is likely to face ever again in the future. As a 

result, the Social Security Trustees project that the system will run a surplus 

through 2017 (on a cash basis) or 2027 (including interest on the trust fund). As 

the number of workers per retiree diminishes, Social Security will shift into deficit. 

Instead of waiting for deficits to emerge, acting sooner to reduce benefits or raise 

contributions to Social Security would allow for smaller future adjustments. But on 

the other hand, future generations are likely to be richer and more able to afford 

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2 Another variant of this is to establish quasi-mandatory add-on accounts by subsidizing the 

additional account contributions by those who choose to make the added contributions with even 

larger benefit reductions than would be necessary to restore solvency for those who choose not 

to establish accounts. This is the approach taken by Martin Feldstein and Andrew Samwick and 

proposed by the President’s Commission Model 3. Unless the subsidies for the additional account 

contributions are so large that most people would participate, this approach will not result in 

significant prefunding. 

adjustments. Policymakers should weigh these competing considerations. I recommend erring on the side of caution by including at least some prefunding. 

Prefunding Social Security means making benefit reductions or contribution increases today that, at a more fundamental level, would raise net national savings. 

Raising savings should be a fundamental goal of any proposal to reform Social Security. This goal was unanimously accepted by the 1994–96 Advisory Council and endorsed by the President’s Commission to Strengthen Social Security. 

This goal is particularly important today because in the last three years, net national savings has averaged 1.6 percent of GDP—the lowest level in seventy years. 

At the same time, investment was financed by an average 4.8 percent of GDP in 

capital inflows from abroad—the highest level on record. Borrowing at this level is 

unsustainable; eventually this debt will need to be repaid. Social Security and pension reform can help increase private savings and reduce government dissaving (i.e., 

by reducing budget deficits). 

Higher national savings leads to increased investment and/or reduced foreign borrowing. Either way, higher savings is the only way to increase consumption by future generations of the elderly without reducing consumption by future generations 

of the young. 

President George W. Bush and Congressional leaders from both parties have ruled 

out reducing benefits for people at or near retirement. This is a sound choice because people at or near retirement have already factored their expected benefits into 

their financial plans and it would be too late for them to make up for reductions 

by saving more. But, because policymakers have ruled out reducing benefits for people at or near retirement, the only way to meaningfully prefund Social Security is 

to increase contributions to Social Security. 

Policymakers can choose from several ways to raise contributions, including: raising Social Security tax revenues (i.e., raising the ceiling on taxable earnings, applying a smaller ‘‘legacy charge’’ above the ceiling, or raising payroll tax rates); raising 

other revenues (i.e., dedicating revenues from a reformed estate tax to Social Security); or raising the total contribution to Social Security above the current 12.4 percent FICA rate and dedicating the additional contributions to individual accounts.2

While all of these steps would partially prefund Social Security, the choice of which 

provision or combination of provisions to adopt should be guided by several goals: 

ensuring the source of revenue is progressive, respecting Social Security’s role as the 

core tier of retirement security, maintaining administrative efficiency, and being 

mindful of the interaction of prefunding with other aspects of the federal budget. 

Third, none of the major Social Security reform plans under discussion have 

any significant prefunding. All of the plans protect benefits for people at or 

near retirement and do not have any contribution increases. 

Few of the major Social Security proposals from recent years have any real 

prefunding. The proposal by economists Peter Diamond and Peter Orszag and the 

proposal by former Social Security Commissioner Bob Ball are the only plans scored 

by the Social Security actuaries that entail even modest prefunding. None of the 

other proposals increase the total contribution to Social Security. None of the proposals reduce Social Security benefits before about 2012 and even then the reductions in Social Security begin very gradually. 

For example, consider the benefit reductions in two leading approaches: the sliding scale benefit reductions (also known as ‘‘progressive price indexing’’) supported 

by the President and benefit reductions from raising the retirement age and longevity indexing (as proposed by Senator Chuck Hagel). As shown in Figure 1, it 

takes more than 20 years before either plan reduces Social Security spending by 0.5 

percent of payroll, a relatively modest contribution to overall solvency. In contrast, 

the Diamond-Orszag plan would reduce the Social Security deficit by this amount 

almost immediately and would continue to grow over time. 

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Figure 1. Reduction in Social Security Cash Flow Deficit* 

*Increase in the Social Security cash flow surplus before 2017 

Note: ‘‘Sliding scale redns’’ indicates the President’s proposal. ‘‘Longevity indexing’’

indicates Senator Hagel’s plan to raise the retirement age to 68, index benefits 

for longevity, and modify the early/delayed retirement factors. 

Figure 2 shows the percentage of the Social Security cash flow deficit closed by 

each of the three plans, excluding the individual accounts portions of the plans. 

Both the President’s plan and the longevity indexing plan close only a small fraction 

of the deficit in the early years, growing to nearly 70 percent of the deficit by 2080. 

In contrast, the Diamond-Orszag plan closes more than 100 percent of the deficit 

(or modestly increases the surplus) prior to 2020 (not shown in the Figure) and thus 

smoothes the process of restoring sustainable solvency. 

Figure 2. Percentage of Cash Flow Deficit Eliminated 

*Increase in the Social Security cash flow surplus before 2017. 

Note: ‘‘Sliding scale redns’’ indicates the President’s proposal. ‘‘Longevity indexing’’

indicates Senator Hagel’s plan to raise the retirement age to 68, index benefits 

for longevity, and modify the early/delayed retirement factors. 

Fourth, individual accounts—by themselves—do not do anything to 

prefund Social Security. 

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3 Harvey S. Rosen, Public Finance, Seventh Edition, 2005, p. 208. Rosen goes on to explain 

that ‘‘sophisticated schemes’’ that include additional out-of-pocket contributions could increase 

savings. Recent carveout account proposals, including the President’s proposal, do not have any 

of the features Rosen identified as potentially leading to higher savings. 4This either occurs directly as a result of the benefit offset (as proposed by President Bush) 

or indirectly as a result of other benefit reductions necessary to make up for the cost of subsidies 

for individual accounts. 5Douglas Elmendorf and Jeffrey Liebman provide evidence suggesting that individuals reduce 

savings by about 40 percent of the value of individual accounts but only increase savings by 

25 percent for future reductions in Social Security benefits (like the benefit offset). As a result, 

they conclude that ‘‘individual accounts are likely to crowd out some other household saving.’’

Douglas W. Elmendorf and Jeffrey B. Liebman, ‘‘Social Security Reform and National Saving 

in an Era of Budget Surpluses,’’ Brookings Papers on Economic Activity, 2:2000. 

Individual accounts, by themselves, do nothing to prefund Social Security. Increasing Social Security contributions—for example raising the total contribution to 

15.4 percent and dedicating 3 percentage points of this to an individual account— would partially prefund Social Security. But it is not the accounts but the larger 

contributions that are leading to the prefunding. 

No major recent individual account proposal, however, is proposing to increase 

total account contributions. In the last few years, every major individual accounts 

proposal is funded by diverting existing payroll taxes or by borrowing from the general fund. In either case, any assets in the accounts are matched by increases in 

the government’s debt. Like the family that mortgages its house to put money in 

a college-savings account, this process does nothing to prefund Social Security or increase national savings. 

One of the leading public finance textbooks, written by the former Chairman of 

President Bush’s Council of Economic Advisers Harvey Rosen, explains that ‘‘privatization’’ by itself does not raise national savings: 

Hence, privatization can help finance future retirees’ consumption only to the extent that it allows future output to increase. And the only way it can do this is by 

increasing saving. 

However, there is no reason to believe that privatization by itself would raise national savings—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 savings is 

created.3 (emphasis added) 

In short, the primary effect of borrowing to finance individual accounts is no 

change in national savings. Furthermore, two secondary effects could be important. 

First, the accounts would reduce savings if individuals treat them as net wealth 

and consequently decrease their savings in 401(k)s and IRAs. The completely rational actor who inhabits economics textbooks should not change his or her savings as 

a result of the accounts because, in the absence of additional revenue, every dollar 

contributed to accounts is generally matched by a dollar reduction in present value 

terms in future Social Security benefits.4 The accounts do not represent net wealth 

but are instead are akin to a loan. Workers will still need to save as much of their 

own money to enjoy a dignified retirement. But, the design of the President’s ac- counts (and the way in which they are often described) could lead many people to 

overlook the benefit offset associated with the account and to incorrectly assume 

that the accounts represent new wealth. Such people could feel less need to save 

in the form of 401(k)s and IRAs.5 This would not just reduce national savings, it 

would also leave these people even less prepared for retirement. 

Second, in theory the accounts could increase savings if the higher deficits associated with them lead to lower government spending and/or higher taxes outside of 

Social Security. In this case, the government would not be completely financing the 

accounts with borrowing and national savings would increase. Note, even in this 

case, the same level of prefunding could be achieved without the account as long 

as the President and Congress have the political will to reduce the non-Social Security deficit. 

But there is little reason to believe that such developments would occur. The Bush 

administration has not claimed that if accounts were passed it would propose additional reductions in federal programs or higher taxes to offset the increased deficit. 

In fact, administration officials emphasize that they do not believe there is any need 

for such steps because, they contend, the accounts are fiscally neutral over the infinite future. In addition, the Bush administration has not included the short-run deficit impact of the accounts in its budget submissions. It would be imprudent to base 

a major policy on the hope that future government spending and/or taxes would 

change as a result. 

As a result, debt-financed accounts—including the President’s proposal—are likely 

to reduce national savings permanently. Even with the potentially offsetting effect 

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6Stephen C. Goss, ‘‘Long-range OASDI Financial Effects of the President’s Proposal for 

Strengthening Social Security—INFORMATION,’’ June 26, 2000. 7 In addition, the Clinton proposal included another provision to invest part of the trust fund 

in equities. Even using returns that are not adjusted for risk, the equity investment contributed 

only 6 years to solvency, much less than the genuine prefunding entailed by the additional debt 

reduction. 

of phased-in benefit reductions, national savings would likely be lower and America 

as a whole would be poorer for several decades. 

Finally, I recommend—as a starting point—prefunding our future fiscal 

challenges by partially undoing some of the major fiscal errors of the last 

four and a half years, including the tax cuts and the prescription drug bill. 

Social Security is only one part, and a relatively small part, of the long-run deficit. Policymakers should focus on prefunding our overall fiscal challenges by reducing the deficit and thus increasing net national savings. 

In the 1990s, policymakers put America in better fiscal shape to meet the future 

challenges of Social Security, Medicare, and Medicaid. In 2000, President Bill Clinton proposed devoting the entire Social Security surplus to debt reduction and devoting additional portions of the non-Social Security surplus to further debt reduction and Social Security solvency. The Social Security actuaries estimated that paying down the debt and dedicating the savings to Social Security would have extended the life of Social Security by 20 years.6 It is important to note that these 

contributions constituted prefunding by increasing the unified budget surplus, reducing the debt held by the public, and raising net national savings. Prefunding 

does not require equity investment or individual accounts.7

In the last five years the surplus has disappeared as a result of several rounds 

of large tax cuts and spending increases, and, to a lesser degree, adverse shocks. 

As a result, it is no longer feasible to use debt reduction to substantially prefund 

Social Security. Nevertheless, there is still substantial scope to close the overall fiscal gap. This is worth doing whether or not the steps are officially scored as extending the solvency of Social Security or not. Ultimately, what matters most is overall 

fiscal sustainability and, in this regard, the tax cuts passed from 2001 through 

2004, if made permanent without causing a large increase in the Alternative Minimum Tax (AMT), would cost more than three times as much as the 75-year Social 

Security deficit and the prescription drug benefit will cost more than twice as much 

as the 75-year Social Security deficit. 

As a starting point, I recommend repealing a portion of the tax cuts passed from 

2001 to 2004 or, at the very least, allowing them to expire in 2010 or offsetting the 

cost of extending them by broadening the tax base. In addition, I recommend exploring ways to reduce the cost of the prescription drug benefit passed in 2003. This 

would lay a foundation for more significant deficit reduction, including policies to 

restore Social Security solvency. 

Thank you, I look forward to the Committee

f 

’s questions. 

Chairman MCCRERY. Thank you, Dr. Furman. Mr. Shipman? 

STATEMENT OF WILLIAM G. SHIPMAN, CHAIRMAN, 

CARRIAGEOAKS PARTNERS, LLC, MANCHESTER-BY-THE-SEA, 

MASSACHUSETTS; CO-CHAIRMAN, THE CATO INSTITUTE’S 

PROJECT ON SOCIAL SECURITY CHOICE 

Mr. SHIPMAN. Chairman McCrery, Ranking Member Levin, and 

other Members of the Subcommittee, I thank you very much for 

giving me the opportunity to be here this morning to express my 

views on Social Security reform. To start off, if I may, I would like 

to share with you a personal story that I think is central to the debate. It was many years ago when our young teenage son came 

home very proud. He had his first paycheck. This was a real paycheck, where somebody actually wrote him a check, as opposed to 

mowing lawns and being paid by neighbors. He opened it up and 

he said, ‘‘Dad, what’s ‘‘ficka‘‘?’’ And I said, ‘‘I have no idea. I have 

never heard that term before. Where did you get it?’’ And he 

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showed me the paycheck and I looked at it and I said, ‘‘Oh, that’s 

the Federal Insurance Contributions Act (FICA).’’ And ‘‘ficka’’—FICA—doesn’t mean that much to a young teenage 

boy. He said, ‘‘Well, what’s that?’’ And I said, ‘‘Well, that’s the Federal Insurance Contributions Act.’’ That went directly over his 

head, and I thought I lost him. He said, ‘‘Well, well, what’s that?’’ I said, ‘‘Well, that’s Social Security.’’ He said, ‘‘You know something 

about that. What does it really mean?’’ And I said, ‘‘Well, do you 

see what was taken out of your check?’’ He said yes. I said, ‘‘Double 

that, because you’re employer takes the same amount out of your 

wages and that is sent to the government as long as you work. 

Then when you get old and retire, the government will send you 

some money.’’ He pondered that. He said, ‘‘Oh, is it a good deal?’’ And I said, ‘‘Frankly, no, it’s not.’’ And then the real question: ‘‘Do 

you think I should do it?‘‘ [Laughter.] 

And I said to him, ‘‘You have no choice.’’ What this lack of choice 

means is that for about 10 percent of our wage income Americans 

are not free to be able to spend that on other common and available retirement options. Not having this choice is bad enough. Its 

costs are compounded by the fact that the 10 percent doesn’t really 

buy very much. An average wage worker today at 45 years of age, 

retiring in 20 years under scheduled benefits, will receive a benefit 

roughly equal to about 36 percent of that worker’s last year’s wage. 

If that individual were to save half of the amount of the Social Security tax, and just the retirement portion of the Social Security 

tax, that individual would receive a benefit, based on historical 

market returns, a benefit roughly double what you would receive 

from Social Security. Roughly double the benefit at roughly half the 

price. This may be one reason why Social Security is mandatory. 

Few people likely would participate if it were voluntary. This 

should give us some pause. Should our government force its citizens to buy a product they may not want? Or, to put it differently, 

shouldn’t our government encourage competition amongst product 

providers so that citizens can choose best what meets their needs? 

These questions will weigh more heavily as Social Security ages 

further, because pay-as-you-go systems become less attractive with 

time. In 1950 in the United States, when there were 16 workers 

per retiree, the highest Social Security tax any American paid was 

$90 a year. Today, just for the retirement portion of Social Security, the highest tax is $9,540 a year. Even adjusted for inflation, 

the tax has gone up by about 2000 percent. You may not have noticed this. Even if you did notice it, you may not have cared so 

much because it edges up so very slowly that it is unyielding. I 

kind of think of it as comparable to getting kicked to death by a 

rabbit. You don’t feel it. The last strike is terminal. 

As much as this tax has gone up, our friends in Europe would 

consider us lucky. As you may know Social Security started in Europe, specifically in Germany, in 1889. So, we have something to 

learn from them. Their payroll is not capped at $90,000, such as 

ours. Their Social Security tax is on all of their wage income. The 

payroll tax rate in France today is 51 percent of payroll. In Germany, Italy, and Spain, it is about 38 to 42 percent of payroll. 

These prohibitive taxes have led to almost zero economic growth in 

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Western Europe, high unemployment—10 percent in France, over 

12 percent now in Germany. There is civil unrest, and they are 

talking now, as we are, about raising taxes further. 

The alternative is a market based system where individuals are 

free to save and invest in markets highly diversified across asset 

classes, across national borders, and across time. Much of this from 

other testimonies that have been given. These systems—and by the 

way, they are common in the private sector, defined benefit plans, 

defined contribution plans and the like—these are quite common 

and they could work extremely well as a national system. In my 

view, it is almost certain that we will adopt a market based system. In my view, it is almost uncertain as to when we will do it—

now, when we have time to prepare, or later, when we don’t. 

You as Members of Congress hold a hope for America because 

you have a unique opportunity to provide workers the freedom to 

choose, to accumulate wealth, to pass it along to their kids if they 

so choose, and for Americans to no longer be tethered to the government for their retirement. You should grasp this opportunity. 

Should you do that, all Americans will be forever thankful. Thank 

you very much. 

[The prepared statement of Mr. Shipman follows:] 

Statement of William G. Shipman, Chairman, CarriageOaks Partners, LLC, 

Manchester-by-the-Sea, Massachusetts, and Co-Chairman, The Cato Institute’s Project on Social Security Choice 

Chairman McCrery, Ranking Member Levin and members of the subcommittee, 

I thank you for giving me the opportunity to express my views on the reform of our 

Social Security system. Eleven years ago, on October 4, 1994, I had the opportunity 

to speak before this same Committee and in my written testimony I offered: 

As both a son and a father, I am interested that the elderly are well cared for, 

and that the young have the opportunity to build sufficient assets so that they, too, 

can retire in dignity. Social Security, as presently structured, ultimately will achieve 

neither objective. Although compassionate in its original intent, it is flawed in design. 

The system’s financial structure is fundamentally unsound. Legislation of 1977 

and 1983 attempted to address this by raising taxes and cutting benefits; Social Security was to be on sound financial footing well in to the 21st century. And now, 

just a few years later, The 1994 Board of Trustees’ report suggests that the system 

will run out of money seven years earlier than it projected just one year ago. Legislative initiatives to reduce benefits further and raise taxes are again on the drawing 

board. This did not work in 1977 or 1983; it will not work now. Social Security’s 

financial integrity requires an entirely different approach. I offer this testimony in 

the spirit of the starting point for an alternative: a concept of privatization wherein 

Americans benefit from the engine of a free economy and free choice. With privatization properly structured, today’s elderly will be protected, the young will retire with 

higher incomes, and our political leaders will have offered, once and for all, a lasting 

solution for which all voters will be thankful. 

Since that testimony our nation has had a vigorous and open discussion. Many 

new ideas have been offered, ideas not developed prior to 1994. The climate of opinion has changed; more Americans are now aware of the issue, more Americans want 

the option to save and invest for their own future. We are getting closer to the point 

where the ‘‘rubber meets the road,’’ when you, as Members of Congress, will have 

to vote. Your decision is more important than perhaps you know. 

It has been eleven years since my first testimony on this issue and in many ways, 

but certainly not all, little has changed politically; we’re still talking about raising 

taxes and reducing benefits. We have wasted precious time. 

A Collision Course 

Like other nations we face an unprecedented challenge of how to deal with a reality that mankind has never confronted before and one that most people are unaware of. How we and other governments respond will affect each American citizen, 

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our families, businesses across the land, indeed our very way of life. The reality is 

not only unprecedented, it is unyielding. 

Dr. Karl Otto Pohl, former president of the German central bank, the 

Bundesbank, stated it this way: ‘‘In a relatively short period, we must adapt our 

domestic institutions, international relationships, and even our individual life plans 

to a new, and powerful reality.’’

What he was speaking of, and what confronts each of us here, is the fact that 

there are two powerful forces on a collision course. The first is the aging of society, 

the reality that the elderly population is increasing more rapidly then the population as a whole. In America, but even more so in other countries, the elderly rely 

on Social Security to survive financially. Should Social Security falter, many elderly 

will be destitute. 

The second force is that most Social Security systems, including ours, are, in fact, 

failing. They are financially unstable, and not sustainable as they are presently 

structured. 

The challenge is to avoid the collision of these two forces. In my view, the risks 

are high that we will not. But should we prevail by structuring a lasting solution, 

the rewards will be as unprecedented as the challenge itself. 

The Early Years: Social Security’s Roots 

Social Security was enacted in 1935 during the Great Depression. During the first 

half of the 1930s real GDP fell by about 25 percent, unemployment jumped to 22 

percent and the stock market virtually imploded and fell about 70 percent. Our nation was on her economic knees. President Roosevelt had to do something, something big, but large government programs were anathema to the frontier spirit of 

our young nation. In order to achieve his goals he needed unprecedented authority. 

To grasp that authority he went before the nation on March 4, 1933 in his first Inaugural Address and asked for authority ‘‘. . . as great as the power that would be 

given me if we were in fact invaded by a foreign foe.’’ He achieved his goal and ushered in Social Security, the flagship program of the New Deal. 

Much like other Social Security programs that preceded ours, the first being Germany’s in 1889, benefits paid to the elderly were financed by payroll taxes. In our 

case, during the Great Depression, people who had jobs were considered the 

wealthy. It wasn’t like today wherein Americans have portfolios of stock and bonds, 

real estate, defined benefit and contribution plans and the like; you were considered 

wealthy if you had a job. And needs were so urgent that the ‘‘payroll wealth’’ was 

taxed. A saving and investment structure would not have worked at that time because it takes time to compound investment returns to accumulate wealth, and time 

was short. 

Today: A Fundamentally Flawed Program 

Over the decades, however, this sort of urgent safety net has turned into the 

rough equivalent of a defined benefit plan. Yet its financial structure has not advanced. The Old-Age and Survivors Insurance part of Social Security, as its finances 

are presently structured, is inefficient, financially unsound and fundamentally 

flawed. 

Because benefits are paid by taxing payroll, benefits can increase by no more than 

payroll increases, assuming that the tax rate on payroll is held constant. Over the 

last four decades or so, payroll has increased by about 1.5 percent per annum in 

real terms. That is roughly equivalent to saving and investing and receiving a rate 

of return of 1.5 percent. To put this into perspective, if one were to save $1,000 each 

year for a 45-year working career and earn 1.5 percent, the saving would accumulate to about $64,000. During the last 79 years a mixed portfolio of 90/10 percent 

large/small company stocks earned an inflation-adjusted average annual return of 

9.7 percent. One thousand dollars invested annually for 45 years earning that return would accumulate to about $650,000. And a conservative portfolio of 60/40 percent stocks and bonds, respectively, would accumulate to about $288,000. These different values give a glimpse of the lost opportunity that our citizens incur by being 

required to finance their retirement through payroll taxes. 

But it is worse. For any particular age group it matters how many workers pay 

taxes relative to the number of retirees who receive benefits. The change in this 

ratio is largely determined by the change in national wealth, or GDP per capita. 

As national wealth rises, life spans also rise. We observe this not only here but 

across all parts of the globe. When Social Security was enacted life expectancy at 

birth was 61 years of age; it is now about 78. In the post-war period global life expectancy has increased from 45 to 65 years of age, a greater increase in the last 

50 years or so than in the previous 5,000 years. This is all new. We didn’t expect 

it. But now we think it will continue. 

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Also, as nations become more wealthy birth rates fall. In many countries they 

have fallen below the population replacement rate of 2.1. The combination of rising 

life expectancy and falling birth rates causes havoc with pay-as-you-go financed Social Security systems. In the United States there were 16 workers per beneficiary 

in 1950; today there are about 3.3. It is expected that there will be only two in just 

35 years. Therein lies an interesting paradox: as countries become more wealthy 

their Social Security systems become more poor. The oddity is driven by the causal 

relationship between increasing wealth—and increasing life expectancy as well as 

decreasing birth rates—all wrapped around pay-as-you-go financing. 

Birth rates have fallen to such low levels in Europe—France-1.9, Germany-1.4, 

Italy-1.3, Spain-1.3—that ‘‘there is now no longer a single country in Europe where 

people are having enough children to replace themselves when they die.’’

The Global Political Response: Raise Taxes 

The political responses to the changing demographics that squeeze Social Security’s finances are frequently the same across the world. Governments and politicians tend to see the problem in the narrowest of lights: merely a solvency issue— too many benefits paid, too few taxes received. This near-sighted analysis is further 

compounded by the focus on just today’s solvency and not tomorrow’s. But from this myopic perspective the options are clear; raise taxes, cut benefits. 

Of the two, governments tend toward raising taxes first. This makes sense for at 

least a couple of reasons. There are more workers to tax than there are retirees 

from whom to cut benefits. Therefore, if the choice were only one or the other, raising taxes inflicts a lesser per capita burden. The second reason is that workers are 

younger than retirees, therefore, they have more time to adjust to a tax increase 

than retirees have to adjust to a benefit cut. 

The short-sighted strategy of raising taxes has been employed world-wide. In the 

United States, for example, in 1950 when there were 16 workers per beneficiary, 

the maximum Social Security tax any American worker paid was $90 a year. At 

that time the tax rate was 3 percent on only $3,000 of wage income. As the glacial 

force of demographics slowly and unrelentingly squeezed the system, the $90 tax 

rose and squeezed the worker. Now, the tax, just for the retirement portion of Social 

Security, is 10.6 percent of $90,000, or $9,540. After adjusting for inflation over the 

last 55 years, that tax has increased almost 2,000 percent. In all likelihood, the reason that we stood for this is that the tax rose slowly; the increase was never really 

noticeable in any one year, but over time it has become more of a burden than the 

income tax for about three quarters of American workers. 

Our friends in Europe, however, would consider us lucky. The payroll tax in 

France is about 50 percent and in Germany, Italy and Spain it ranges roughly between 38 and 42 percent. It is true that these countries’ systems provide more services than ours, but this is not a plus. Europeans are dependent on more of their 

needs from government programs that are not sustainable. 

As many European nations have raised their payroll taxes to prohibitive levels 

they have choked individual economic freedom and incentive. Economic growth is 

stagnant, and unemployment rates hover around 10 percent, even 12 percent in 

Germany. Civil unrest is now more common in Germany and France as governments tell their people that benefits are no longer affordable and will have to be 

cut, while at the same time they extol the virtues of the welfare state. We are on 

the same path, but for the moment we trail far behind. 

Then, Cut Benefits 

At some point, the strategy of raising taxes approaches a political wall. People 

sense that maybe, just maybe, they could achieve more with their hard-earned 

wages than they get from Social Security. Politicians sense this and move to the 

lesser desirable option of cutting benefits. Such blunt language, however, is not commonly uttered. Code is employed: progressive price indexing, longevity indexing, 

adding a third bend point, reducing bend point factors, increasing the NRA, decreasing the PIA, and it goes on and on. It’s all code for cutting benefits. 

Fundamental Reform: Retarded by the Claim of Insurance 

Eventually, after cutting benefits hits its political wall, the thinking shifts to fundamental reform, saving and investing in wealth-producing assets for all workers. 

This idea of market-based financing for retirement income is not new, in fact it is 

old and well established in the private sector, but it is viewed with some disdain 

from advocates of the status quo. They object to the notion that Social Security 

should be an investment structure and defend their objection by claiming that it is 

insurance. This claim had some merit decades ago. Not now. In fact, Social Security’s finances are in trouble largely because they are inappropriately based on the 

insurance model. 

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Insurance works well when many people are subject to an event that has little 

chance of happening to any single individual. A good example is homeowners’ fire 

insurance. Many people buy fire insurance to protect their homes and yet few homes 

burn. Because the number of homes insured is many times the number of homes 

that burn, the annual insurance premium is very low relative to the replacement 

cost of one’s house. Insurance companies are simply the medium through which individual uncertainty of loss is transferred to, and financed by, the group. 

The insurance model does not work well when the group is subject to an event 

that the entire group experiences. For example, if it were certain that everybody’s 

house would burn down, say, when the owner reached age 65, then insurance companies would have to charge annual premiums the future value of which would be 

the cost of rebuilding all the houses. This premium would be a large multiple of the 

premium charged for the uncertain case. Central to the insurance model is that the 

ratio of the annual premium to the dollar value of what it protects is negatively correlated to the uncertainty of individual loss. 

Social Security is frequently heralded as insurance, more precisely social insurance. The ‘social’ part of the term merely means that the government plays the role 

of the insurance company. Other than that, it remains the insurance model. When 

Social Security was enacted in 1935, life expectancy was 61 but benefits weren’t 

payable until age 65. Now benefits are payable at age 62 and life expectancy is 78. 

The element of uncertainty has kind of flipped upside down. Because of this, the 

retirement component of Social Security isn’t insurance; once born, reaching age 62 

and needing retirement income is almost certain. As a result, there is very little 

risk, or uncertainty, to transfer to the group, resulting in the fact that annual premiums must be enough to accumulate to a sum, including interest, that will finance 

retirement income. 

Under these conditions, social insurance cannot provide such income at a lower 

cost than saving and investing for retirement. Unfortunately, however, it can and 

does provide it at a higher cost because it is financed through the payroll tax and 

is subject to unyielding demographic forces. In a perverse way Social Security’s finances and its adherence to the insurance model are caught in a kind of time warp; 

in the age of the iPod Social Security is a 78 RPM, wind-up phonograph. Unless 

protected by the power of the state, it can neither compete nor survive. 

The State Monopoly Faces Competition 

Being protected by the power of the state really means that for 10.6 percent of 

their wage income American workers are not free to choose among alternatives for 

their retirement. Bad as that is, the 10.6 percent doesn’t buy much relative to reasonable and available alternatives. This is why Social Security is mandatory; few 

would participate if they had the freedom not to. Competition, as always, is a threat 

to the status quo. For workers, however, competition is their hope. 

Competition would allow all workers to invest part of their payroll tax in capital 

markets around the world, in professionally managed portfolios that are highly diversified across asset classes, national borders and time. Such an opportunity would 

allow one to accumulate enough wealth to replace the pay-as-you-go benefit entirely. 

For an average wage worker retiring this year at age 65, Social Security’s scheduled benefits are projected to replace about 42 percent of his last year’s wage. But 

for workers retiring in the future full benefits won’t be paid until age 67. For those 

future retirees, should they choose to retire at age 65, benefits will replace only 36 

percent of their last wage. The worker’s cost for these scheduled benefits, which are 

in excess of what is affordable based on present law, is the 10.6 percent payroll tax. 

The Market-Based Alternative 

The market-based alternative is significantly more attractive. Over the last 79 

years a conservative portfolio of 60/40 percent stocks and bonds, respectively, earned 

a real return of just a little over 7 percent. Investing just half of the retirement payroll tax, 5.3 percent, each year for 45 years would provide a retirement benefit equal 

to 97 percent of one’s last year’s wage. This assumes that there is no interruption 

in saving each year, that the market return is as stated and falls by 2 percent during the distribution phase, and that life expectancy upon retirement is 20 years. 

Each of these assumptions can be changed. Work may be interrupted. Markets may 

do worse or better. Life expectancy may be more or less than 20 years once retired. 

To take a conservative path, if the market return were only 5.5 percent and if 

life expectancy were 30 years at the onset of retirement—about 10 years more than 

assumed by Social Security—then under these conditions the replacement rate 

would 39 percent, higher than Social Security’s scheduled benefits at age 65 and significantly higher than payable benefits. 

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Americans Understand the Tradeoffs 

Our citizens sense these tradeoffs, risks, uncertainties, and the fundamental differences in providing retirement income from a tax system versus a saving and investment system. This is why, but only part of why, they want the option, the freedom to choose. 

If they could acquire this freedom they also would have personal property rights 

over their accumulated wealth. They have no such rights to Social Security benefits. 

They also could bequeath some or all of their retirement assets. They cannot under 

Social Security. They would benefit from the direct relationship between effort, their 

saving, and reward, their accumulating wealth. They would have the dignity that 

comes with being personally responsible for their future. They would no longer be 

tethered to the government. They would no longer be subject to politicians’ preferences over when they can retire, how much they can get, how their spouses are 

treated, how much they’re going to pay, and all of the rules and regulations that 

have evolved to the point of being incomprehensible. They would be free. 

It’s been eleven years since I had the opportunity to speak before this Committee. 

Although much of what I am saying today is what I said then, I hope that we are 

closer to fundamental reform. If we are not, and the two powerful forces that I mentioned above in fact collide, we will edge closer to the wrenching difficulties that Europe is now facing. 

You, Congress, are the Hope 

But should we grasp the extraordinary opportunity that this challenge offers, we 

will forever strengthen our nation, our economy, our freedoms, and our ability to 

finance the many needs that the future will undoubtedly require. It is a matter of 

will and political leadership in seeing the benefits of greater personal freedom and 

acting to ensure them. You, as Members of Congress, have the unique opportunity 

to offer, once and for all, a lasting solution for which all Americans will be forever 

thankful. 

Thank you, 

f 

William G. Shipman 

Chairman MCCRERY. Thank you, Mr. Shipman. Thank all of 

you for your excellent testimony this morning. I want to emphasize 

again something Dr. O’Neill said when she said that in 2042, or in 

2052, depending on whose assumptions are correct, beneficiaries 

would experience an initial decline in benefits. Which implies that 

after that initial decline, there would be a further decline. Is that 

correct, Dr. O’Neill? 

Ms. O’NEILL. That is correct, according to what we believe is 

going to happen with the economy. 

Chairman MCCRERY. So, whether it is a 22-percent decline or 

a 27 percent initial decline, the benefits are going to get worse 

after that. Is that right? 

Ms. O’NEILL. Yes, because the gap between revenues and benefits grows. 

Chairman MCCRERY. Thank you. Obviously, we have some disagreements about the definition of prefunding and the merits of 

prefunding. Dr. Furman, I was interested in your comment that 

the only way to prefund Social Security is to increase Social Security taxes. I assume if we were to increase Social Security taxes 

and then put those into personal accounts or make a direct government investment in the markets, that that would satisfy your definition of prefunding. Is that right? 

Mr. FURMAN. I was giving, I think, a generally accepted definition in the economics profession. You could immediately cut benefits. That has been ruled out, and I think wisely so. Alternatively, 

I used the word ‘‘contributions’’ because that could come from payroll taxes, raising the cap, a mandatory individual account on top 

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of the 12.4. I am not saying that I recommend any of those, just 

giving you that if you want to satisfy the definition—— Chairman MCCRERY. No, I am not calling you an advocate for 

prefunding. I am trying to get our definitions straight here. Why 

wouldn’t it satisfy your definition of prefunding if we raised, say, 

personal income taxes and dedicated that to personal accounts in 

Social Security? 

Mr. FURMAN. Oh, no, that would satisfy it. I used the word ‘‘contributions’’ to mean anything that—— Chairman MCCRERY. Broadly speaking. Not contributions—— Mr. FURMAN. At the fundamental economic level, the most important thing is that we are raising savings, which is equivalent to 

reducing consumption. 

Chairman MCCRERY. Right. We could do that either by raising 

taxes within the Social Security system, you know, raise the cap 

on income subject to taxes or raise the tax rate itself, or we could 

satisfy that by raising general taxes and applying them to the Social Security system. 

Mr. FURMAN. But again, that wouldn’t make the policy good or 

bad, but that would make it prefunding. 

Chairman MCCRERY. Okay, well, that is good. At least we, I 

think, can agree on that definition of prefunding with respect to 

funding personal accounts. I don’t think it is at issue that—or perhaps some of my colleagues would disagree, maybe some on the 

panel would disagree—but is it at issue that absent some new 

source of revenue or some reduction in spending elsewhere to come 

up with the cash to fund personal accounts, there is no increase in 

Federal savings? Is that correct? Anybody disagree with that? 

Mr. ENTIN. In a static sense, yes, unless the changes you made 

triggered some additional behavior changes by the public. If you 

trimmed benefit growth and trimmed the tax rate equally and you, 

in static terms, got no change in the net budget situation, but if 

the reduced payroll tax encouraged some additional employment 

and the people would earn more and save more, you would have 

a change in Federal saving. So, the mechanisms you choose can 

have an effect on these static estimates. 

Chairman MCCRERY. Sure. I don’t want to get into this right 

now, maybe others will, but Mr. Price’s comment that we are not 

managing the economy very well now. We can certainly agree or 

disagree on that, but Mr. Shipman—I think it was Mr. Shipman 

that pointed out that other economies are not doing nearly as well 

as ours. 

Mrs. TUBBS JONES. Mr. Chairman, I am having a hard time 

hearing you. I don’t know if I am the only one, but could you raise 

your level just a little bit? 

Chairman MCCRERY. I will certainly try to do that. Other Nations’ economies don’t seem to be doing quite as well as ours, so 

evidently we are doing something right in comparison to those nations that are most similar to us from an economic standpoint in 

Western Europe and Eastern Europe. So, I think that certainly is 

something that people could disagree on. That is an example of 

what Mr. Entin is talking about, making changes in policy that affect other things in our economy which make the economy better. 

Many of my colleagues in the Minority are disparaging of the tax 

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cuts that have been made. Most of us, I guess all of us on our side 

believe that those tax cuts are responsible for, in some part, the 

difference in economic growth in the United States and those countries in Western Europe, and the difference in the unemployment 

rate here, which is much better than the unemployment rate in 

Western Europe. 

So, those are things we can discuss. That is a good point Mr. 

Entin made. I certainly wouldn’t discount increases in national saving that are kind of a spinoff of other policies. I am talking about 

static, direct, what we can identify through the establishment of 

personal accounts in Social Security. Clearly, if we funded those 

with some new revenue or by an identified cut in other spending 

dedicated to the personal accounts, then you would automatically 

have an increase in national savings. 

Dr. Furman. 

Mr. FURMAN. Thank you. I am only aware of one study that examines the impact of carve-out accounts on national savings. It was 

performed by Doug Elmendorf, who is an economist at the Fed, and 

Jeffrey Liebman, who is an economist at the Kennedy School of 

government. They found that carve-out accounts financed by debt 

would, over the long term, reduce national savings and reduce economic output. They found that people would look at the assets in 

their individual accounts and treat some of that as net wealth, say, 

oh, I have $100,000 in my account, I don’t need to put as much into 

my IRAs, 401(k), and not realize that that $100,000 they had in the 

account was matched by $100,000 worth of benefit reductions that 

were coming 20, 30 years in the future. If people overlook the benefit offset, that is what will happen. That is, as I said, the only 

study I am aware of, and it finds that the interactions are negative. 

Chairman MCCRERY. Yes, Mr. Price? 

Mr. PRICE. If I could clarify. I don’t want to get into—this is not 

the place to debate the wisdom of fiscal policy, but simply to point 

out that as to prefunding, whether we are contributing to more 

saving today on behalf of future generations, we have gone in the 

other direction. The policy decisions that we have made have done 

the opposite of what you had said was the definition of prefunding; 

we have done the opposite. As a statistical matter, I don’t think 

there can be any question that that is what we have done. 

Chairman MCCRERY. I agree. 

Mr. PRICE. It may have been the right thing to do to manage 

the economy. I don’t think so; other people think so. The fact is, 

it was the opposite direction of prefunding. 

Chairman MCCRERY. Oh, absolutely. No question about that. 

Which brings up another question, and that is the 1983 reforms. 

Some—maybe it was my good friend Sandy Levin, who said in his 

opening remarks that that was a form of prefunding, when we increased the payroll tax and increased the surplus coming in and we 

dedicated that surplus to future generations of beneficiaries, that 

was a way to prefund. I suppose technically it is a way to prefund, 

and maybe in the macro picture it is a way to prefund, but with 

respect to the Social Security program itself, as Dr. O’Neill said, it 

was merely putting promises to pay in the Social Security box. 

Would any of you like to comment on whether the 1983 reforms, 

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the increase in the surplus, is prefunding? Is that the kind of 

prefunding we should do? Dr. Samwick? 

Mr. SAMWICK. I would like to draw a distinction between 

prefunding future benefits and pre-authorizing them. All that the 

1983 amendments have done, based on the conduct of our other 

budget policy, is to pre-authorize those payments. If we, instead, 

had a fiscal policy which was, say, over the course of a business 

cycle to balance the on-budget account, then that would be 

prefunding because it would have engendered no additional government spending outside of Social Security. I think Mr. Price described another scenario, which would be there is no drift in debtto-GDP ratio, presumably, exclusive of the Social Security Trust 

Fund. That would make that pre-authorizing of those benefit payments actual prefunding. I don’t believe—— Chairman MCCRERY. Had we done that, had we followed a fiscal policy that balanced the operating budget and left aside the 

surplus—that is what you are suggesting—well, what would we 

have done with that surplus? 

Mr. SAMWICK. Well, you would have bought back existing debt 

held by the public. 

Chairman MCCRERY. Bought back debt. How long would it have 

taken us if we had started in 1984, when this big surplus began 

to accumulate, to extinguish all the debt if we had immediately 

gone to a balanced budget in the operating side of the budget? 

Mr. SAMWICK. I don’t have the direct answer. 

Chairman MCCRERY. It wouldn’t have taken very long. 

Mr. SAMWICK. Right. In my—— Chairman MCCRERY. In my recollection, it would have taken 

only a few years to totally extinguish the debt of the United States, 

the external debt of the United States. So, then what do we do with 

it? 

Mr. SAMWICK. I believe, and my written testimony makes this 

clear, that if you are to run—if you are to increase contributions 

to the system, you would like to do so in a decentralized manner 

of personal accounts for a variety of reasons, not just the availability of suitable credit market instruments for the government to 

be able to hold. 

Chairman MCCRERY. Thank you very much. 

Mr. FURMAN. Mr. Chairman, if——

Chairman MCCRERY. I am going to let Mr. Levin have his turn, 

but maybe he will let you say something. Mr. Levin? 

Mr. LEVIN. Thank you for giving me a chance. I will save a 

minute to do that. I am glad, Mr. Shipman, you are here, because 

I think your presentation is the most frank discussion of what is 

behind private accounts. I think everybody should take note of it. 

That is really what the President’s private proposals do. They move 

toward elimination of what you call tethering of people to a Social 

Security system, or government system. That is exactly what the 

President’s proposals would do over time, with the clawback and 

with the change in indexing—and adding annuitization, by the 

way, which doesn’t allow people to pass it on to their heirs. But 

anyway, your presentation here, Cato has been very direct, and essentially it means the end of our Social Security system over time. 

That is what you are after. That is what the President is after. 

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Let me just say—and then we will come back to you if there is 

time. No one is saying do nothing. That is number one. No one is 

saying that. Second, I think it is a mistake to read Social Security 

as an anti-poverty program. It has helped to bring seniors out of 

poverty, it has reduced the poverty rate from 30 percent at the 

time of Social Security down to less than 10. It is not only or basically an anti-poverty program. It was structured, originally, and 

certainly after that to provide a level of retirement benefits so people, as my mother would have put it, could continue to live independently. She wasn’t in poverty, she wasn’t wealthy, she was allowed to continue to live her own life. So, when we say, we talk 

about poverty, Social Security and the replacement rate of 39 percent or 40 was an effort to allow people to live in dignity, to live 

with independence, and not fall back into poverty in many, many 

cases. 

Dr. Furman, let me give you a chance to answer the question, 

because it raises—and Dr. Samwick. In the Clinton years we projected a deficit that was a form of prefunding, it seems to me. The 

Chairman asked the question what you do after you pay off the 

debt. We are a long ways from that today. I think the policies of 

recent years have shown that fiscal irresponsibility is the opposite 

of prefunding. Dr. Furman, go ahead. You were going to answer. 

Mr. FURMAN. I remember in 2001 one of the problems people 

in Washington were preoccupied with was paying off the debt too 

quickly. I think we can all agree that President Bush has decisively 

solved that economic problem. 

[Laughter.] 

Mr. FURMAN. But the debate over the 1983 and whether it constituted prefunding or not, in this context, I view as somewhat academic. Which is to say interesting to me, but not very relevant. 

None of the major Social Security proposals I am aware of—and 

the Chairman may have one that I am not yet aware of—involve 

any significant degree of prefunding. So, to debate whether you 

should prefund through the trust fund or prefund through accounts, when the plan isn’t doing any prefunding at all, strikes me 

as not the most relevant debate to be having. That being said, first 

of all, the debt is high enough now that we do have substantial 

scope to prefund the system—but not proposal does that—through 

debt reduction. 

Second of all, the question 1983 and whether it prefunded or not 

is not, did we raid the Social Security surplus, which we did do and 

we didn’t do in the nineties when President Clinton was President; 

the question is would the deficit have been even higher if we hadn’t 

had the Social Security reforms in 1983. In that case, the debt 

would be lower than it otherwise would have been in the absence 

of those reforms, and we would genuinely have prefunded. That is 

my reading of the evidence. 

Mr. LEVIN. Actually, my time is going to be up, Mr. Chairman. 

Again, I want to thank you for painting what I think is the basic 

issue. I think the American public basically disagrees with you. I 

don’t think they think they are tethered to Social Security. It provides, in addition to retirement, disability protection and also survivor benefits, which are hard to purchase in the private market. 

I think more and more people think they are tethered to their prihsrobinson on PROD1PC72 with HEARING

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vate plan. If you ask people who are employed and who are covered 

by private pension plans, whether they work for United or whatever, I think they feel Social Security is something they worked for, 

they earned, and is guaranteed. They want it to continue. The 

problem that President Bush is having is that people understand 

that inside of his proposals is essentially the essence of what you 

are proposing, and that is the replacement of Social Security with 

private accounts. They don’t want that. 

Mr. SHIPMAN. May I respond? 

Mr. LEVIN. You may—you think 50 years from now the decision 

will be different, but it is not today. Go ahead. 

Mr. SHIPMAN. First of all, I believe that you mentioned that my 

preference is to end this over time. I am speaking only about the 

retirement portion of Social Security, not disability insurance. Of 

course disability insurance is part of Social Security, so that——

Mr. LEVIN. And survivors? 

Mr. SHIPMAN. Well, that is really—85 percent of survivors are 

aged widows and widowers, which really come under the retirement portion. Fifteen percent are the tragic cases of children whose 

parents have died early. Even in a market based system, if those 

parents die early, from my point of view those children should not 

be disadvantaged whatsoever because of moving to a market based 

system. I believe that the amount that is paid is roughly between 

$3 billion and $5 billion a year to these children, and that should 

not be interrupted whatsoever even if you were to move to a market based system. 

As to whether Americans are tethered or not, as to whether 

Americans want to continue with Social Security as it is structured 

now or a market based alternative which we could structure, we 

will only know the answer to that question if they are given the 

choice. You may think that they will stay with Social Security. 

Somebody else may think that they would go to the market based 

alternative. If you are correct, giving them the option to have a 

market based alternative will not alter whatsoever the fact that 

they think that Social Security is a better deal. They will stay with 

it. 

Mr. LEVIN. No, because what it means is massive debt and 

major benefit cuts for everybody on Social Security. That is what 

the President——

Mr. SHIPMAN. If they think it is a better deal, they won’t move 

from it. 

Mr. LEVIN. I know, but for those who move, it means massive 

debt for the Nation and major benefit cuts for everybody else. Essentially, what the American people are saying to the President of 

the United States and to this Congress is that they want to maintain the guaranteed benefit of Social Security. That is what they 

are saying. Thirty, 40 years from now, you may be right. At this 

point, I think the American people are saying that you are wrong. 

Thank you. 

Chairman MCCRERY. Mr. Johnson? 

Mr. JOHNSON OF TEXAS. Thank you, Mr. Chairman. Mr. 

Levin, you and I don’t agree at all. I mean, you got a couple of people out there that are saying no to everything, and Dr. Furman, his 

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no-net savings would reduce the input, and the only answer is tax 

increase. I don’t believe that. 

Mr. FURMAN. Well, I was thinking if you want to prefund and 

you don’t want to cut benefits for people now, you have to—— Mr. JOHNSON OF TEXAS. I will ask you a question when I get 

ready to. I believe that Mr. Shipman made a statement some years 

ago, actually the Board of trustees Report in 1994 suggested the 

system is going to run out of money, and it didn’t work in 1977, 

it didn’t work in 1983, it will not work now. I appreciate that statement because I think that is correct. I think Mr. Shipman is absolutely correct that people need the choice. The choice doesn’t include benefits for disability, widows, and orphans. Nobody wants to 

mess with that. I think those funds are going to be there under any 

plan that is proposed today. So, I wonder if you would discuss personal accounts with a different vision, maybe, Mr. Shipman. 

Mr. SHIPMAN. Yes, thank you, sir. From my perspective, speaking only for myself, all Americans should be free to stay in Social 

Security as it is structured or move to an alternative, a market 

based alternative. The efficacy of market based alternatives have 

been spoken of in extent in this hearing, as well as at others. The 

way that I would design it would be if you choose to go into the 

market based alternative, then some portion of your existing FICA 

tax, the OASI tax, which is 10.6 percent of $90,000 of wage income 

this year, some portion of that would go into a private account, 

sent by the employer to Treasury just as it presently is in the FICA 

tax. Treasury receives the wire transfer and immediately sends it 

over to a private custodian bank, held in trust for each American 

that made that choice. 

Now, when that amount is reconciled to the individual’s name, 

which takes about a year or so under existing Social Security structure, then each individual would be allowed to put that amount 

into one of three highly diversified balanced funds—U.S. stocks, 

U.S. bonds; foreign stocks, foreign bonds; and cash. Very common 

as structures in defined benefit plans as well as defined contribution plans. One of three funds. One of three funds. After a period 

of roughly three to 5 years, after the system reaches a steady state, 

each individual could go down to another level and, through other 

providers such as mutual funds, registered investment advisors, 

certified financial planners, and the like, all constrained by the 

trustees of this system as to what the portfolio would be, they could 

move down into that level. I refer to this as a retail level. This 

would be more expensive than the first three balanced funds. I 

move down to that retail level, let’s say go to Fidelity; I could move 

from Fidelity, to T. Rowe Price, to Vanguard to various other providers, and they would charge me whatever they wished. I don’t 

have to be there because I could move back up into this institutional platform, which would be the three balanced funds. 

I testified to the House Budget Committee Social Security Task 

force, I believe it was called, in 1999 on this structure and shared 

with the Committee that this had been costed out, including asset 

management, recordkeeping, custody, an annual statement, 175 to 

350 million phone calls per year to a customer service center, 85 

percent of which are answered by a computer, 15 percent answered 

by a customer service representative—very much like a 401(k) 

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structure. Including all of those costs, assuming just a 2 percentage 

point savings rate, steady state costs 19 to 34 basis points of assets. That is less than the 401(k) model, that is less than the mutual fund model, and it is very, very cost effective. To Mr. Levin’s 

point, nobody has to do it. It would all be by freedom of choice. 

Thank you, sir. 

Mr. JOHNSON OF TEXAS. Thank you. I might add, Mr. Levin, 

that all—100 percent—of the young people in our district want that 

type of voluntary way to put their money into an account. 

Mr. LEVIN. Would you yield? 

Mr. JOHNSON OF TEXAS. Sure. 

Mr. LEVIN. The surveys show the more young people hear about 

the President’s plan, the less they like it. That is what the surveys 

show. You need to, Mr. Shipman, talk about the impact of diverting 

those kinds of moneys from Social Security into private accounts on 

the benefits structure and on the debt of this country. It doesn’t 

come, the diversion isn’t cost-free, sir. 

Mr. JOHNSON OF TEXAS. No, but it does—— Mr. LEVIN. It is trillions of dollars. 

Mr. JOHNSON OF TEXAS. Solvency occurs downstream and you 

don’t have to worry. 

Mr. LEVIN. It doesn’t touch solvency. It doesn’t touch solvency. 

Mr. JOHNSON OF TEXAS. Thank you, Mr. Chairman. 

Chairman MCCRERY. Actually, it does touch solvency under Mr. 

Johnson’s plan as scored by the Social Security actuaries. Mr. 

Neal? 

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

McCrery mentioned the debate that we have had here over tax 

cuts, which is in some measure, I think, a reflection of the major 

differences that we hold about the condition of the Social Security 

Trust Fund today. Dr. Holtz-Eakin, is it fair to say that in some 

measure the Social Security Trust Fund surpluses have been used 

to fund the tax cuts? 

Mr. HOLTZ-EAKIN. It is fair to say that the dollars entirely 

intermingle in the Federal budget and that we have run deficits in 

recent years, despite the fact that there are Social Security surpluses. 

Mr. NEAL. But that is fair to say that the surplus has been used 

to fund the tax cuts? 

Mr. HOLTZ-EAKIN. Not in any dollar-for-dollar matching sense, 

but on net. 

Mr. NEAL. No, no. The general statement, it is accurate, and the 

other aspects of the budget as well. Given your previous position 

here, Dr. O’Neill, would you agree with that statement? 

Ms. O’NEILL. Well, you can’t identify which——

Mr. NEAL. No, you can’t identify which dollar, but is it a fair 

statement to offer? 

Ms. O’NEILL. The entire—all of the expenditures——

Mr. NEAL. We have great regard for the role that you have 

played here, Doctor. One of the things about the positions that you 

have held here is that you tend to be above the fray. Is that an 

accurate statement or not, that the tax cuts have been in some 

measure funded by the Social Security surplus? 

Ms. O’NEILL. Well, I—of course it is——

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Mr. NEAL. Thank you very much. That is why we have such regard for you folks that hold those positions here, because we do respect you in an academic sense. 

Ms. O’NEILL. But I pause—— Mr. NEAL. Let me go to you, Dr. Furman, for a moment here. 

If we were to establish private accounts, how would we guarantee 

that they were actually prefunded? Wouldn’t we have to fully offset 

the cost of those accounts by either raising taxes or cutting benefits? I think a moment ago you were headed there? 

Mr. FURMAN. Right. My comments today, contrary to Mr. Johnson, I actually didn’t view as negative or positive about accounts. 

I was trying to stick to the topic of prefunding, and not some of 

the broader issues I have addressed previously. Accounts by themselves don’t constitute prefunding. You need to pay for the money 

that goes into the accounts for prefunding, and you need to pay for 

that by raising contributions in one way or another. 

Mr. NEAL. Is that sustainable? 

Mr. FURMAN. It depends on the way in which it is done. I think 

one would have concerns that some of the prefunding that you 

think you are getting on paper that way unravels, because people 

end up saving less in their 401(k)’s and IRAs. 

Mr. NEAL. What kind of policy changes would occur, or would 

lead, if we were to go in the direction of private accounts being retained without prefunding? 

Mr. FURMAN. You would need dramatic reductions in future defined Social Security benefits to pay off the debt associated with 

those accounts. You would not have any up-front increases in national savings to help smooth that transition. 

Mr. NEAL. Mr. Price, would you agree with that? 

Mr. PRICE. Yes. 

Mr. NEAL. You would? Dr. Eakin? 

Mr. HOLTZ-EAKIN. I think it is important to recognize that you 

cannot evaluate the long-run consequences of any of these without 

a fully specified plan. Just saying ‘‘accounts’’ in isolation really 

doesn’t give you enough information. 

Mr. NEAL. What would happen—I mean, the dot-com phenomenon is fresh in all of our minds here for those who would say 

we would only put these trust fund accounts in certain-to-grow private initiatives. I am certain that if we were sitting here, though, 

five, six, 7 years ago, the same forces that will be saying these will 

all be safe investments would have been pressuring this Congress 

to open up those opportunities for the dot-com industry. What happens to the families that would come here asking their elected officials for ability to access the accounts for purposes other than retirement? Mr. Price, would you like to——

Mr. PRICE. I am sorry, could you repeat the question? 

Mr. NEAL. If there were requests from the general public asking 

for access to those accounts for purposes other than retirement. We 

have talked about using the IRAs, which I agree with, by the way, 

for first-time home purchases and things of that magnitude. What 

do you think would happen? 

Mr. PRICE. Well, surely people face big crises in their lives. We 

have created—you guys have passed laws that allow people to get 

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ment. I think that those same kinds of political pressures would 

apply to these new accounts. Whether you would relent and allow 

people to do with those, you would know better than I. I think 

there would be a lot of pressure from people who face medical crises or education finance crises, that they would get access to 

their—they have been told it is their account, and they think they 

know better than anybody else when they are 45 or 50 that it 

should be spent now rather than later. 

Mr. NEAL. As we pursue this discussion, it has really healthy, 

and Mr. McCrery has done a very good job with the panels that 

have been assembled. Many of us have a fresh memory of the S&L 

issue and how that played out here, when we allowed people to get 

into the S&L industry and to do things that they had not been 

properly chartered, or the issue had not been vetted for. The bill 

was enormous to the American taxpayer. Do you want to offer your 

comments on that, Mr. Price? 

Mr. PRICE. I would like to comment on that because I think a 

lot of people have a tendency to exaggerate their ability to make 

decisions. Some of the most interesting research is that even if you 

have broad measures, a bond account versus a stock account, that 

people buy—they read the newspapers that stocks are going up and 

so they go buy the stocks. Or that stocks are going down and they 

sell the stocks and buy the bonds. When you look at actual research, when people had access to confidential private accounts, 

what people were buying and selling, they were doing it—they 

were buying high and selling low. You look at inflows into mutual 

funds. They go in at the wrong time. Actual, real people know that 

they make bad decisions. That these measures, like Robert Schiller 

shows, the average return using indexes is a median return using 

historical performance of actual stock markets, and you apply those 

to—and take what a recent Wall Street Journal Survey projects are 

going to be the returns, with a median return of 2.6 percent. The 

President has a clawback charge of 3 percent. That means that 71 

percent of the time, people will lose money. That is using an index. 

That is using steady performance. That is not taking real people, 

who in real time, evidence clearly shows, make the wrong decisions. They buy high and sell low. They tend to do worse than the 

averages, because they have confidence. 

The evidence is that men are much more active traders than 

women, they have more confidence. Higher-income people have 

more confidence than—they do more trading, and they don’t do it 

better. People are not patient to just let things stand. They move 

into stocks when they have read that they have been going up. 

They buy high. 

Mr. NEAL. Thank you. 

Thank you, Mr. Chairman. 

Chairman MCCRERY. Thank you, Mr. Neal. 

Mr. PRICE. We did the same thing in the S&L situation. We 

thought that if we just turned the market loose and let people invest, they would make good decisions in housing and whatever else 

we let them do, and they made a lot of bad decisions. 

Chairman MCCRERY. Mr. Shaw? 

Mr. SHAW. Mr. Shipman, do you agree with what Mr. Price just 

said? 

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Mr. SHIPMAN. No, I don’t. And——

Mr. SHAW. Thank you. Dr. O’Neill, I saw you were frustrated 

at being cut off by Mr. Neal with regard to the answer to his question as to whether the tax cuts that this Congress put in place, or 

has put in place over the last several years, what effect they have 

had on the shortfall, the coming shortfall on Social Security. Would 

you like to expand on that answer? 

Ms. O’NEILL. The overall budget deficit—are you referring about 

the budget deficit that we now face? 

Mr. SHAW. Well, he was trying to blame that on the problem 

with the Social Security. Let me ask you another question. If we 

had——

Mr. NEAL. Would the gentleman yield? 

Mr. SHAW. No, I will not. You didn’t yield to her when she was 

trying to answer your question fully. The question is, would we 

have put real money, put actual money into the Social Security 

Trust Fund, or would it have been converted into Treasury 

bills——

Ms. O’NEILL. But we don’t have any way of putting money into 

the Social Security——

Mr. SHAW. Right. 

Ms. O’NEILL. To take money from now and put it into the future 

in Social Security is the whole problem of a pay-as-you-go system. 

Various speakers have sort of endorsed the lock-box idea, that if 

you can, having budget savings, that that will reduce the publicly 

held debt below what it would have been, and therefore, in the future we will have more money for Social Security. But, that 

arguement has two problems with it. One is during the days when 

we did have a large surplus, I think the proof was really shown 

that it is impossible to have a surplus dangling there and not be 

touched. The surplus, in part, evaporated because it was there. It 

meant that after all those years of restraint during much of the 

nineties, suddenly there was money. It is Members of Congress; it 

wasn’t just the Bush Administration who decided to increase 

spending of all kinds during that period. It was everybody. It is 

just difficult to run a surplus. That plus the recession, plus 9/11, 

contributed to the deficit. 

Okay. Suppose we hadn’t done that and the surplus—suppose 

somehow there had been restraint and much of the surplus had 

been saved. What then? There is no guarantee that if we lowered 

the debt now that in the future that money would go to Social Security. There is nothing to tie it to Social Security. 

Mr. SHAW. That is right. 

Ms. O’NEILL. There could be another thing that we would rather 

spend the money on at the time. 

Mr. SHAW. There is no mechanism——

Ms. O’NEILL. There is no direct link. 

Mr. SHAW. That is right. There is no mechanism in order to 

hold money in the Social Security Trust Fund. 

Ms. O’NEILL. There is not any lock box. 

Mr. SHAW. Now, the years when we had surplus, we paid down 

the national debt. We did not pay down any of the Treasury bills 

that were being held by Social Security Trust Fund, did we? 

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Ms. O’NEILL. Well, on paper there was increasing so-called balances, the promises. 

Mr. SHAW. So the Treasury bills actually inside the trust fund 

continue to grow. 

Ms. O’NEILL. They continue to grow, but in terms of——

Mr. SHAW. And they are backed by the full faith and credit of 

the U.S. government. 

Ms. O’NEILL. Yes, but that——

Mr. SHAW. They are not a real economic asset at this particular 

point if it is a Treasury bill that is owned by the government and 

held by the government, payable to the government by the government. 

Ms. O’NEILL. That is all true, but when the time comes when 

the funds would actually be needed, there is no guarantee that the 

economy would be in a position to actually honor those promises, 

and the law can be changed. It has in the past, and—we do not 

know what future Congresses and future Presidents are going to 

do. 

Mr. SHAW. This Congress has been very active, and we have 

seen it in some of the disasters that we have had in the private 

pension system. United Airlines would be one I know of very well 

because my brother is a retired United Airlines captain. This was 

not a fully funded system, and it is going down. This Congress is 

working on requiring the private sector to fully fund or at least 

fund up to 80 percent, or some percentage, of the liabilities. That 

is different—and those funds may have been backed up by the full 

faith and credit of United Airlines, but certainly they were not 

funded properly, and we are trying to apply the same standards to 

the SSA, or at least go in that direction by creating real economic 

assets. Now, these same bonds, if they were in the name of the people that are in the system of the workers, then those would be real 

economic assets, wouldn’t they? 

Ms. O’NEILL. That is their private property, right. 

Mr. SHAW. It would really be a very, very strong—make a 

strong statement as to the full faith and credit of the government 

payable to the worker. That would be a substantial asset. 

Ms. O’NEILL. Which is why I mentioned that the private sector 

has taken care of this problem by converting to defined contribution plans, which essentially are pre-funded plans. I belong to such 

a plan, TIAA-CREF. That plan has been highly successful, and I 

think that most of the participants are very happy with it. It has 

weathered the storm of the bubble collapse. Enough had already 

been accumulated. Depending on the share that you had in the 

stock portion versus the bond portion, everybody experienced some 

degree of decline. But by now, with the expansion, the rebound for 

many has more than made up for it. 

Mr. SHAW. And in your testimony, you quite correctly testified 

that some time between 2015 and 2020, there would not be enough 

cash coming in to honor the benefits in the benefit structure that 

we have today. Is that not correct? 

Ms. O’NEILL. That is correct. 

Mr. SHAW. Thank you. Thank you, Mr. Chairman. 

Chairman MCCRERY. Mr. Becerra? 

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Mr. BECERRA. Thank you, Mr. Chairman. Thank you to the 

panelists for their testimony. Again, an engaging discussion, and 

we thank you, Mr. Chairman, for the numerous hearings that we 

have had. Let me ask Dr. Furman a question. This hearing is supposed to focus on the issue of pre-funding, coming up with a system 

where we prefund the benefits that will be available into the future 

for those who retire. Yet, if I heard you correctly, what you were 

saying is that the Bush tax cuts which have benefited mostly 

America’s wealthiest people have amounted to the opposite of 

prefunding, in fact, a defunding of a system that could be available 

to help in retirement. Is that an accurate statement? 

Mr. FURMAN. That is an accurate statement. They have 

defunded our overall fiscal situation at a cost that is more than 3 

times as much as the 75-year Social Security deficit that so much 

of the policy discussion has been focused on. 

Mr. BECERRA. So, if there is a desire to try to prefund a future 

retirement system, what we have done through the Bush tax cuts 

is actually not only made it more difficult to pre-fund, but by a factor of perhaps three or so? 

Mr. FURMAN. That is correct. 

Mr. BECERRA. Now, did I hear you correctly as well that private accounts, at least those that we know proposed by President 

Bush, that those themselves, as they have been proposed by President Bush, do not lead to any prefunding as well? 

Mr. FURMAN. That is correct. There has been a lot of discussion, and I think it is an important discussion, whether to prefund 

through accounts or not through accounts. To get to that second 

stage of the discussion, you need a plan to prefund in the first 

place, and I have not seen any plans that would do that. 

Mr. BECERRA. Mr. Price, I think you are the one that had mentioned that you cannot do prefunding by having the Federal Government borrow money. Is that accurate? 

Mr. PRICE. That is accurate. 

Mr. BECERRA. As well, okay. Go ahead. 

Mr. PRICE. I think the Chairman and everybody on the panel 

would agree with that. 

Mr. BECERRA. Mr. Shipman, I listened with interest to your 

testimony when you mentioned that the Social Security benefit 

does not amount to very much for most Americans. I think to myself today there are about 10 percent of America’s seniors who are 

living in poverty. Without Social Security, that number would be 

about 50 percent. So, I think a lot of seniors, at least that 40 percent that does not live in poverty, probably looks at Social Security 

and says it does amount to quite a bit. 

You mentioned that your alternative to Social Security would be 

a market based system, if I am quoting correctly, ‘‘a market based 

system where we are free to invest where we want.’’ You also indicated that no one has to do it, no one has to participate, and that 

there is freedom of choice. Again, that makes me think of what we 

had prior to the Depression, in the twenties leading up to the Depression. That is what we had—freedom of choice. You could invest 

wherever you wanted. There was nothing that guaranteed you a 

set retirement benefit, and we saw what happened as a result of 

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the Depression. In fact, the result was President Roosevelt coming 

forward with the Social Security program. 

Then I thought to myself, I remember when I was in the State 

legislature, there was a very similar argument that was made that 

we should have freedom of choice, you can participate if you wish, 

and it had nothing to do with retirement. It had to do with motorcyclists on our freeways and whether or not they should wear helmets. Most of the motorcyclists that we had testify before us in 

Committee would say, ‘‘We want the freedom of choice. We want 

to be able to decide whether we need to wear a helmet or not.’’ The 

difficulty was we had all the evidence before us, the data that 

pointed out the number of hospital stays, the amount of costs that 

were incurred by the traumatic injury to heads and otherwise to 

motorcyclists, as a result of freeway accidents. The fact that almost 

none of these individuals had the moneys or the insurance to pay 

for the costs of their health care, in some cases long-term health 

care, needed as a result of permanent brain damage, and so forth. 

So, the State legislature in California, as I think in most States, 

had moved forward, has since moved forward with legislation requiring motorcyclist to wear helmets. Under your framework of 

freedom of choice and you do it if you wish, you are not required 

to, we probably would still have a lot of motorcyclists in this country riding around on their motorcycles, many of them very good 

motorcyclists, without helmets. I guess my question would be: 

While it is great to have freedom of choice, say we were living 

under your system framework of no Social Security, what would 

your response be to an Enron employee who yesterday had a 401(k) 

but today does not? 

Mr. SHIPMAN. Enron is a classic case, and—— Mr. BECERRA. What would you say if you had an Enron employee here today sitting before you? How would you respond to 

them in terms of their retirement benefits under the 401(k) that 

they had before? 

Mr. SHIPMAN. As far as their 401(k) plan, or as far as a market 

based system for Social Security? 

Mr. BECERRA. Well, a 401(k) is a market based plan that is 

available to those. You are free to choose to participate if you wish, 

as you have proposed. What would you say to an Enron employee 

who had a 401(k) plan principally invested in the Enron company 

itself? 

Mr. SHIPMAN. I guess I would say—and I would say to you as 

well as the rest of the panel—that from my point of view, the freedom of choice is to whether you can go into the market based system or not. Then it ends. Once you are in it, as I mentioned to Mr. 

Johnson, once you are in it, the trustees stipulate the portfolios, 

highly diversified across asset classes, borders, and time and so on. 

In each of these portfolios, there would be literally thousands of securities. One of them will be tomorrow’s Enron. There are thousands of them, and the impact upon the portfolio will be to the 

right of the decimal point. 

In a 401(k) plan, it is significantly different because not only are 

the individuals free to go into the 401(k) plan, in most cases beyond 

that they are free to invest any way that they want. That is not 

what I have argued for in the reform of Social Security. Free to go 

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into the market based system, but not free to invest any way you 

want after you have made the election to go into the market based 

system. They are fundamentally different structures. 

Mr. BECERRA. I know my time has expired, so I thank you for 

the response. Mr. Chairman, thank you. 

Chairman MCCRERY. Mr. Ryan? 

Mr. RYAN. Thank you, Mr. Chairman. I think I followed Mr. 

Becerra last week, and I have sort of a deja-vu sense. In Wisconsin 

you do not have to wear a motorcycle helmet, and we are going to 

defend that right. We make Harley Davidsons there. 

[Laughter.] 

Mr. RYAN. And bows and arrows. This whole hearing about 

prefunding, I just want to ask the panel kind of a general question. 

The younger you are under the current system, the worse you do 

as a percentage of your payroll, correct? Meaning if you are 70 

today, the payroll taxes you experienced are giving you about a 4.5 

to 5-percent rate of return based upon those payroll taxes. If you 

are 40 today, you are getting about a 1-percent rate of return. If 

you are one today, you are scheduled to get about a negative 1 percent rate of return. Correct? I think everybody—— Mr. FURMAN. Average rate of return in the system going forward is still positive, not negative. 

Mr. RYAN. I am not going to take it individually. The average 

age cohort. So—— Mr. PRICE. Let’s just keep in mind that there is no market for 

many of the products that Social Security provides. You are trying 

to focus in on the retirement product. 

Mr. RYAN. The question was directed specifically as a component of what you pay in and what you get out in the benefit. 

Mr. PRICE. Right, and what I am saying is that there is no product that provides people inflation-adjusted benefits until retirement. 

Mr. RYAN. Sure, well—— Mr. PRICE. There is no product that——

Mr. RYAN. You could buy a Treasury Inflation-Protected Securities (TIPS) bond that would provide you an inflation-protected instrument against inflation for retirement. 

Mr. PRICE. But, the plan so far——

Mr. RYAN. Absolutely. 

Mr. PRICE. You talk about—I mean, the problem with——

Mr. RYAN. I do not mean to cut you off, but we only have 5 minutes. So, my next question is—please. My next question is: Since 

we are talking about prefunding, what is more reliable for a younger worker, say aged 40 and below? The concern I have is, when you 

talk to anybody in their twenties and their thirties, and half the 

people in their forties, they almost always tell you, ‘‘I don’t believe 

it is going to be there when I retire. I am not counting on Social 

Security. My investment adviser told me not to count on Social Security for my retirement planning.’’ That is wrong. We do not want 

that kind of a system. Whether you are Democrat or Republican 

here, we want to make sure this is a program you can count on 

when you retire. 

So, my question is: What is more reliable for a person to get this 

certain level of benefits, prefunding by giving an ability for an indihsrobinson on PROD1PC72 with HEARING

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vidual to put money in their own account, to grow at a market rate 

of return, to help finance their benefits, or hoping that Congress 

will come up with a solution on this pay-as-you-go system given the 

current problems that we have today? I will just start with you, 

Mr. Shipman, and go down the row, whoever wants to comment. 

Mr. SHIPMAN. I accept the question as being rhetorical. It is 

clearly safer to save and invest in capital markets and receive the 

market rate-of-return than it is to pay taxes to the government in 

a pay-as-you-go system wherein the number of workers relative to 

retirees has, is, and will be, shrinking. 

Mr. RYAN. Mr. Furman, I’ve got to think you have an answer 

to that. 

Mr. FURMAN. I will try to think of one. First of all, I would not 

have used the word ‘‘prefunding.’’ Prefunding to me, and I think to 

most of—— Mr. RYAN. Yes, we went through that. 

Mr. FURMAN. So I will not repeat that. In terms of the answer 

to your particular question, if you look at—let’s just take the President’s proposal as an example. 

Mr. RYAN. Okay. 

Mr. FURMAN. Under that, you have either a Social Security 

benefit on the one hand, or a combination of a Social Security benefit and an account on the other hand. In terms of market risk, the 

one with the account has more market risk than the one without 

the account, in terms of pure market risk. In terms of political risk, 

those two retirement systems are, from my perspective, exactly 

identical. You can still reduce the residual defined benefit under 

the President’s plan or increase it, if you want to. There is also this 

critical factor of the offset rate, which as he sets it, 3 percent, an 

arbitrary number, could change it to 2.5, could change it to 3.5. 

That would dramatically change the value of your account. Finally, 

you could change the tax treatment of accounts. You could tax 

them as they accumulate them, tax them upon withdrawal. Any of 

those——

Mr. RYAN. So, the political——

Mr. FURMAN. The political risk of these two benefits are identical. One of them has more market risk. That means one of them 

has more overall risk. 

Mr. RYAN. Look, I want to get to these other folks, but basically 

what you are saying is it is impossible for us to tie the future 

hands of Congress, and they could do anything in the future. Given 

the fact that we have a $4 trillion 75-year shortfall, $11.1 trillion 

infinitely rising shortfall, clearly Congress is going to have to do 

something about this. So, these benefits are right now at risk. 

Mr. FURMAN. I feel like we have had this discussion before. 

They are at the same level of risk. I view that risk as very, very 

low. Historically, Congress has never made changes in benefits 

from year to year of the magnitude that Enron stock has fluctuated 

from year to year. 

Mr. RYAN. Anybody else? 

Mr. SAMWICK. If you are going to prefund, there are two reasons why you have to do it through personal accounts: one, you 

want to be able to invest in risky securities, not just riskless bonds; 

second, there really is no mechanism to make sure that prefunding 

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actually serves to reduce the tax burden on future generations. 

That is why it has to be personal accounts. 

Mr. PRICE. Personal accounts create tremendous risk for the 

government. One of the things that is misunderstood about the 

United plan, most defined benefit plans were in great shape in 

2000. The change in the stock market has a big effect. If you had 

an individual who had all his money in stocks in 2000 and wanted 

to retire then, and could get the higher interest rate, they could get 

a great annuity. Three years later, their stock portfolio would have 

been down. Their interest rate that they can convert to annuity 

would have been down. They would have had more than—the 

monthly annuity they could get in 2003 would be cut in half when 

compared to what they got in 2000. What would be the political response to that if that happened? It is a huge political risk—— Mr. RYAN. Okay, because there are four more hands up, I want 

to let them go. Mr. Beach? 

Mr. BEACH. Well, I would just briefly say, Congressman Ryan, 

that the creation of the fiscal deficit which we have in Social Security right now—and it is growing—is evidence of the political risk 

that surrounds the current system. The Congress has not been able 

to contain its willingness to increase those benefits, and as a consequence, there is now the problem which is before this Committee. 

I think I would join Mr. Shipman in saying that one of the ways 

to reduce that risk is embrace a highly diversified personal retirement account system. 

Mr. ENTIN. Highly diversified stocks beat bonds over a lifetime 

of work. Bonds beat the pay-as-you-go potential from the demographic situation. You are going to be better off in that. They have 

to be diversified. Of course, if you put money into your own account, you have funded it. If the national situation is not funded, 

that is Congress’s fault. You do have to get the government to 

wean itself from the Social Security revenue if you are going to do 

that, and it should. As for the annuitization, it is like the savings 

and loan crisis. Congress passed a bad provision, and people took 

advantage of it. That was the Congress’s fault. If you mandate that 

people annuitize their account the moment they retire, regardless 

of the state of the market, somebody could get injured relative to 

somebody else who did it a year earlier or 2 years later. Let people 

wait a couple of years and annuitize it in stages. For goodness 

sakes don’t make people annuitize everything, beyond what is necessary for a basic retirement level. Give them the freedom to leave 

some of the account to their children later. 

Ms. O’NEILL. The political risk of private accounts I think would 

be as close to zero as possible. We do believe in private property 

in this country and would not abscond the private accounts of individuals. So, the political risk, I think is minimal. On the other 

hand, the political risk of Social Security can be great because 

there are too many factors that can affect it that we have no control over now. Given that, the monetary return is obviously better 

from a market account, even by the most conservative strategy; 

and, as the other speakers have mentioned, there would likely be 

control—one could not become a day trader, for example, with your 

Social Security account. Any prudent plan—I have not really seen 

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thing. Prudent plans would follow the general rule of don’t put all 

your eggs in one basket. 

Mr. PRICE. You don’t think United diversified its assets? 

Mr. RYAN. Dr. Holtz-Eakin? 

Ms. O’NEILL. That is not the only—— Mr. RYAN. Please. Typically it is Member to witness instead of 

witness to witness. Dr. Holtz-Eakin? 

Mr. HOLTZ-EAKIN. The systems have different risk and return 

characteristics. Prefunded plans offer higher rates of return than 

can any pay-as-you-go system going forward. Risks around those 

kinds of returns, in a pay-as-you-go system you have got all the 

risks we talked about in our testimony—productivity, inflation, unemployment, the kinds of things that affect that system. Then you 

have market risk in individual accounts, and how people manage 

that is an important issue, the tools that are available for risk 

management. Finally, both face legislative risk. The system is currently out of balance and will have to be brought into balance at 

some point, somehow, and to get to a prefunded system we have 

to somehow get from here to there, and that involves sacrifice by 

somebody to put the resources away. How that would be done is 

also unknown. So, there is a competitive set of risks on both sides. 

Mr. RYAN. Thank you. 

Chairman MCCRERY. Just to follow up real quickly, if we were 

to make an effort to take as much risk out of personal accounts as 

possible, Mr. Entin, would it make sense—and be careful how you 

answer this because this is a suggestion that Dr. Holtz-Eakin gave 

me some time ago. Would it make sense to require when a person’s 

personal account achieved a level sufficient to an annuity effective 

on the date of his retirement, which would guarantee him income 

equal to the poverty rate or poverty plus 10 percent or whatever 

we want to make it, and then allow him to continue to accumulate 

in his account without annuitization required at that point? 

Mr. ENTIN. I think, in fact, some foreign countries do that to get 

that added degree of security, but also to get an added degree of 

freedom, because once you have achieved the basic social objective 

of preventing yourself from going onto the public dole later in life, 

you should be free to either add to the account or not add to the 

account. In Chile, for example, once you have been able to do that 

and purchase that annuity—and it might take a different form, not 

necessarily an annuity but some guaranteed set-aside—you can 

stop contributing. You can take the money out of the system and 

put it in some other investment, or spend it. 

Chairman MCCRERY. So, you would not have any objection to 

our building in some safeguard like that. 

Mr. ENTIN. I would have no objection to building in some sort 

of safeguard. Why are you going to make people—as some plans 

do—contribute all the way up until the time they retire, even if 

their saving has gone way beyond that annuity? You might as well 

let them out of the system, and let them put their money in some 

other sort of program at that point. Remember, you have this 

moral hazard you are trying to guard against, and indeed you may 

make the protection level more than the poverty level so that independence can be achieved. Beyond some reasonable amount, you 

don’t need to go any further. If you look at the table as to where 

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benefits are going over time in the Trustees’ Report or in my testimony, you might ask yourself: Why do we need to go up to 

$109,000 a year for an upper-income couple? Let them be free after 

some reasonable point. 

Chairman MCCRERY. I understand. Thank you. Mr. Pomeroy? 

Mr. POMEROY. Thank you, Mr. Chairman. You know, there is 

the story about Strom Thurmond who set all kinds of records for 

lengthy service in the Senate, and there were some chuckles when 

he voted for the term limits bill in the Senate. It is like, ‘‘Stop me 

before I run again.’’ I kind of have the same reaction to Members 

of the majority who presided over the largest swing in our Nation’s 

fiscal standing in the history of the country, largely driven by the 

2001 and 2003 tax cuts. Now they are talking about prefunding. It 

is kind of like, ‘‘Stop me before we take some more.’’ I really think 

that the lock box agreement between the parties represented that 

brief hour when there was this virtuous competition in terms of 

who would not spend those dollars the best. Really, it was a wonderful but brief period of time. The notion that we ought to borrow 

more money to somehow prefund to me defies rationale. 

Now, in a visit that the Chairman and I were having with another Member, it helped me understand some of the drive toward 

this concept, basically saying, look, an unfunded liability is the 

same as a debt owed by the country. So, if we borrow $2 trillion 

the first decade, $4 trillion the second decade, and add it to the balance sheet, it is just the same as the unfunded liability for Social 

Security. Now, I am wondering if the fiscal markets—or is there 

any recognized treatment in fiscal policy for actually reducing the 

hard borrowed obligation of the U.S. Government versus an unfunded liability, if those stand an equal treatment at all. Dr. 

Furman? 

Mr. FURMAN. Yes, that is a very good question, and I know of 

no Nation that has undergone a crisis because its implicit debt was 

too large. A lot of Nations have undergone crises because their explicit debt was too large, because they had to service that and pay 

that on an annual basis. There is not a one-for-one economic substitution between explicit debt and implicit debt. Explicit debt is more 

immediate, more tangible, and implicit debt is less certain and 

more subject to change and does not carry the same full faith and 

credit. 

Mr. PRICE. There have been researchers looking at the Argentinean experience that claim that added debt for their privatization, and borrowing to do that contributed to their fiscal crisis and 

their economic problems. 

Mr. POMEROY. Dr. Holtz-Eakin, you said a statement that did 

not surprise me, and I would not think you would have it in one 

of your scoring models. You indicated that, basically, offsetting 

risks of the private account theory, markets go up, markets go 

down, some risk there. On the Social Security side of the equation, 

you always have political risk. Dr. O’Neill, you have alluded to the 

political risk of making this system insecure. Basically, the benefits 

are established in the national code. It is a matter of national law. 

So, the political risk you are talking about involves Congress strolling over to the House and Senate floor and voting to slash benefits 

to retirees and having that law signed by the President. That is the 

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essence of the political risk that Social Security benefits face. Is 

that correct from an individual recipient’s perspective? 

Mr. HOLTZ-EAKIN. From an individual recipient’s perspective, 

the question is, will the benefits be changed by law, or will the 

taxes be changed by law. There are two sides of the equation, and 

both are up in the air because the current system is 

unsustainable—— Mr. POMEROY. In seven decades, you have not had that march 

to the House floor to slash benefits, and I would say that if there 

is one thing the aging demographic of our country probably makes 

likely, it is that that it is not a risk that needs to keep people 

awake in the years ahead. You know, there is something—Mr. 

Entin, you said a statement that I really like. Government should 

wean itself off of Social Security revenue. Instead, this fiscal turn 

that we have had has made us completely dependent upon Social 

Security revenue. I am wondering if your institute, the—— Mr. ENTIN. The Institute for Research on the Economics of Taxation. 

Mr. POMEROY. The Institute for Research on the Economics of 

Taxation. Did you take a position on the 2001 tax cut? 

Mr. ENTIN. Yes. 

Mr. POMEROY. Were you for it? 

Mr. ENTIN. I was critical of some elements of it. I came down 

for it. I would have preferred that it be restructured. 

Mr. POMEROY. How about the 2003 tax cut? 

Mr. ENTIN. Yes. 

Mr. POMEROY. I have seen an analysis that while there are 

many features that may have driven this deficit, the tax cuts were 

the single biggest component of us being in the fiscal straits that 

we are, certainly recognizing the economic slowdown, recognizing 9/ 

11, and the costs of the war as all the other contributors, but the 

tax cut, number one of those causes.Mr. ENTIN. I think the recession was number one, and I think that you are looking at static 

revenue estimates and taking it out of the economic context. If you 

let the economy go downhill, you are in trouble. Remember the perfect golden years of harmony in the Congress and the real push for 

fiscal discipline that occurred between 1930 and 1933? Everyone 

said, ‘‘we have got to balance this budget, we are in a recession,’’

and it turned into a depression. That really threw us in a financial 

hole. You have to make sure the economy is strong for any of this 

to work, and if the economy goes south, then the returns in the private accounts will not be so high. Capital formation will be in the 

tank, wages will not be growing, and payroll tax receipts will slow 

to a crawl. 

Mr. POMEROY. The reference to the pre-Roosevelt period and 

our Federal Government reminds me of the budget——

Mr. ENTIN. Mr. Roosevelt also raised taxes. 

Mr. POMEROY. Committee testimony that blamed the depression on the economic activism of Herbert Hoover. I think that that 

is an extreme and highly contentious——

Mr. ENTIN. Mr. Hoover recommended balancing the budget in 

the recession, and Mr. Roosevelt tried by raising taxes to balance 

the budget in the recession, until he changed later, quite wisely. He 

started down the wrong road, too. Remember——

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Mr. POMEROY. The essence of the question—look, this is interesting—— Mr. ENTIN. In 1983—— Mr. POMEROY. The essence of my question was for someone 

that just said the government should wean itself off of Social Security revenue, you are with an institute that has supported two tax 

cuts that have substantially driven the deficit deeper and thereby 

made our reliance upon Social Security revenue for funding government programs—— Mr. ENTIN. We have also urged a great deal more spending restraint. 

Mr. POMEROY. I yield back, Mr. Chairman. 

Chairman MCCRERY. Thank you, Mr. Pomeroy. Mr. Brady is 

next, but just before he begins, I just want to pose a question for 

you to think about and answer when all of my colleagues have 

questioned the panel; that is, I think Mr. Pomeroy and Dr. Furman 

really posed the wrong question when they were talking about debt 

and the impact of that increased debt, that is, if you use debt to 

finance personal accounts, there is no market that would accept the 

proposition that over 75 years it will all even out and actually be 

better. While that may be true, I don’t know that it is exactly relevant. What I think probably is relevant, however, is what level of 

additional debt would actually impose an economic burden on our 

society. I think that is the question on which, I suspect, we have 

different opinions. The weight of the evidence, I believe, is that 

with what the President has proposed, it would not affect the economy one whit. Mr. Brady? 

Mr. FURMAN. Could I briefly respond to that? 

Chairman MCCRERY. No. Be thinking about it so that you can 

respond more than briefly at the appropriate time. 

Mr. FURMAN. Thank you. 

Chairman MCCRERY. Mr. Brady? 

Mr. BRADY. Thanks, Mr. Chairman. Obviously, Members of the 

panel see different sources for our defecits. I think the economy—

the triple hit of the attacks of 9/11, the recession, and the dotcom 

bust all contributed to the economy in a big way. I think all those 

press releases we sent out about projects we have delivered back 

home have contributed greatly to our deficit. Yes, I think the tax 

cuts have, but to the extent that they have been an economic stimulus have been a price I have been willing to pay. I also think as 

we look at pre-funding we can look at, rather than raise this ‘‘scare 

our seniors’’ type approach, we can look at models like the Thrift 

Savings Plan (TSP), decades old, tens of billions of dollars, averaging 7.5 percent return, Galveston Plan, 24-years-old, interestbearing accounts only averaging 6.5 percent, Texas Teachers half 

a century old, averaging now about 10 percent return a year. All 

models where those participants would not ever choose Social Security and go back to that lower income alternative. 

Let me ask this question. Dr. Holtz-Eakin made an inescapable 

point that preserving Social Security for every generation is going 

to cost a ton of money, both in the permanent deficit that we face 

in the future, as well as when we begin to pay back the Social Security Trust Fund, the first year about $16 billion. That is the size 

of the NASA budget. The second year it doubles, $35 billion. That 

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is the size of the U.S. Department of Homeland Security. As he testified, it moves very quickly to $100, $200, $300 billion. 

It raises the point that to preserve Social Security for every generation, we are going to spend a lot of money. The question I have 

for you, from an economic impact as we weigh how we are going 

to do this, whether we fund the pay-as-you-go system or prefund 

retirement accounts that, like these other models, grow slowly and 

steadily over the years. Starting, Douglas, with you, if I could, from 

an economic impact, comparing raising taxes to borrowing money, 

to reducing spending, from a number one choice as good for the economic impact of those three options, which would you prefer? How 

would you rank them? I guess that is the question. 

Mr. HOLTZ-EAKIN. The core economic question is will we accumulate sufficient assets in the form of capital and technologies and 

education to have a larger economy in the future. So, you have to 

give up something now, save for the future. That means you consume less. The next question is the mechanism by which that happens. Do you consume less because you borrow a whole bunch? Do 

you consume less because of your tax consumption? Those are all 

secondary features of the core issue, which is how will we grow the 

U.S. economy so that it will be large enough to pay for these programs in the public sector and the private sector lifestyle that we 

have come to enjoy. 

Mr. BRADY. Doctor? 

Ms. O’NEILL. We can’t predict very well, and we don’t know the 

exact recipe for stimulating productivity. We know what can have 

adverse effects on productivity—policies that have disincentives, 

and Social Security I think is among the programs that have disincentives attached to them, disincentives to save and disincentives 

to work at certain ages. It is hard to answer the question without 

introducing your personal beliefs. I don’t think it is an exact 

science that can tell you what strategy is more economically advantageous, by some precise amount, than another. You can point out 

the elements that you perceive will contribute. To some extent, it 

is a matter of the way you read the economy. In my view, I think 

that reducing expenditures would be more stimulating to growth, 

as would reducing taxes, but certain kinds of taxes, taxes that 

blunt incentives. Reducing marginal tax rates obviously gives an 

incentive boost. Raising them gives you disincentives. 

The payroll tax can have harmful effects, particularly for low-income workers. I think most economists agree that the payroll tax 

is paid for—the employer’s share is really paid for by the employee 

in the form of lower earnings. For a low earner, that bumps into 

the minimum wage for one thing, so that there is nothing to roll 

it back against, and it leads to unemployment. 

Mr. BRADY. Great. Thank you. Mr. Entin? 

Mr. ENTIN. We have so many taxes to choose from, and so many 

spending programs and regulations to choose from. You have to put 

it in the context of the broader national system. We do know certain things promote investment by lowering the cost of capital, the 

hurdle rate you have to earn in order to make the investment pay 

off. You can get that in any corporate finance book. We also know 

that certain types of taxes certainly affect the asset values of securities, so that would affect the future growth of personal accounts. 

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You can arrange a change in the fiscal budget, and in the level of 

Federal spending that would let you make tax changes that would 

help employment and work incentives, saving incentives, and 

would cause corporations to want to put more capital in place in 

the U.S. rather than overseas. You can get a lot of good growth out 

of doing the right policies. I think economists know what those are. 

I think the urge to spend a lot right now is blocking such policies, 

and I think the growth of spending over the last few years has hurt 

us in our ability to reform the tax system and reform Social Security in a way that will benefit everybody for the next hundred 

years. 

Mr. BEACH. Let me just continue that answer, and add one or 

two things to it, and also what June and Doug have said. I think 

the Congress really needs to get a grip on spending. I mean, this 

is part of the problem. We have not talked about it today. The deficit was either the economy, 9/11, or the tax cuts. It is also enormous spending growth over the last three or 4 years, which in 

some respects is unprecedented when you have got singularity of 

party control. The other thing, Congressman, that I know you are 

concerned about, and I am concerned about, too, is that history 

may not be a good guide. Implicit debt may become now a major 

discount against external debt values. We see this happening in 

Europe where implicit debt for elderly programs is growing rapidly, 

and I would become concerned with that, despite the relative absence, as Dr. Furman said, of scientific evidence, I think the anecdotal financial evidence is becoming a real factor in the way people 

see the invest ability in certain economies. 

Mr. PRICE. I am very concerned that as a nation we are borrowing, spending 6.5 percent more than we are producing and making. We should not be borrowing that much. We are not going to 

be able to borrow that much in the indefinite future, and we need 

to change our fiscal posture, so that when the turn in that comes, 

we don’t squeeze investment too much. So, we should be dealing 

with the fiscal gap that we have got. That means cutting spending 

and raising revenues. We all have candidates for cutting spending. 

I am not going to defend every spending program that is out there, 

but I think it is also the case that we do not have such an ideal 

tax system that we could not raise more revenue and still have as 

good economic performance. We have got to be able to find ways 

to raise more revenue that does not hurt our economic performance. We have a lousy tax system right now, and we can raise more 

revenue and do it in a way that does not hurt growth that much. 

I think we have got to watch spending, but we also have to be realistic that that is not going to be enough politically if we are going 

to allow enough financing in the private market to support the investment we need. 

Mr. BRADY. I am going as long as the Chairman will let me go. 

Mr. SAMWICK. I would simply say that a larger program involves more distortion to the economy via the revenue that is 

raised and the spending decisions that are made. Some of that distortion is absolutely essential if you believe that the cornerstone 

purpose of this program is to reduce elderly poverty. The demographic shift means there is not enough money to achieve all of the 

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out reducing somebody’s consumption of something at some time. 

Since consumption is going to have to go down, we ought to start 

that process sooner rather than later to smooth those reductions. 

Mr. FURMAN. I just wanted to clear up one misunderstanding. 

I am not saying that implicit debt does not matter. It does matter, 

and it would be better to have less of it than more of it, all things 

equal. As a pure hypothetical, let’s say right now we have 20 units 

of explicit debt, 80 of implicit debt, so we have a total of 100. Don’t 

worry about what the units are. What carve out accounts do is they 

take some of that implicit debt and turn it into explicit debt. Let’s 

say it makes it 50/50. What I was saying is that composition, having the same amount of debt, more of it in explicit form, leads to 

more of a danger of a financial crisis. At the very best, it is neutral 

and we are fine, it does not hurt us, it does not help us. At worst, 

it hurts us really badly. You average those two together, and it is 

not such a good idea. 

Mr. SHIPMAN. In the ranking—reducing spending, raising 

taxes, cutting benefits—number one in my view is reducing spending, absolutely. As far as raising taxes or cutting benefits—I am 

speaking about payroll taxes and cutting payroll benefits—we have 

gone over the last 55 years, we have increased the payroll tax by 

2000 percent, roughly, inflation-adjusted. We are sitting here again 

talking about how we keep this system going. Raising taxes will 

not solve the problem. Reducing benefits, by the way——

Mr. BRADY. Thank you. Mr. Chairman, Ms. Tubbs Jones has 

said that my extra time could come out of hers, so there is no problem. 

[Laughter.] 

Chairman MCCRERY. I am sure. Mrs. Tubbs Jones, feel free to 

take your time and all the rest of Mr. Brady’s. 

Ms. TUBBS JONES. In your dreams. 

[Laughter.] 

Good afternoon, panel. Thank you, Mr. Chairman. We will work 

out a relationship here. What I think it ought to be is that I get 

as much time as you got in order to make my inquiry in a bipartisan conduct of this wonderful hearing we are having here. Let me 

start with Mr. Beach. Mr. Beach, I think I heard you say something to the effect that we need to reduce our spending. 

Mr. BEACH. Yes, ma’am. 

Ms. TUBBS JONES. From my perspective, the only time this Administration really talks about reduction of spending is when we 

are outside the expenditures of dollars for Iraq and Afghanistan, 

and we are talking about domestic spending that is a particular 

concern to people who are the have-nots, like on Social Security, on 

Medicare prescription drug benefits, on a health care benefit for 

America, even on No Child Left Behind. Would you agree with me 

on that, sir? 

Mr. BEACH. The Administration is full of spending ideas and 

has given you lots of opportunities to spend additional money, and 

you have taken those and you have added to them as well. 

Ms. TUBBS JONES. Wait a minute. Go back to my question. 

There is no talk about a limit on spending when we talk about the 

war in Afghanistan or the war in Iraq. 

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Mr. BEACH. I am not an expert on the war. I understand you 

have to spend money to win them. 

Ms. TUBBS JONES. You do understand deficit spending and restraint on spending, and you never heard a discussion about restraint on spending with regard to Iraq or Afghanistan, have you, 

Mr. Beach. Come on, be nice and say yes or no. That is the truth. 

Mr. BEACH. Well, yes, I—— Ms. TUBBS JONES. You may not be an expert on war, but you 

are supposed to be an expert on spending money. 

Mr. BEACH. Congresswoman, I do believe I heard a debate on 

the spending in Iraq, yes. 

Ms. TUBBS JONES. Okay. Thanks, Mr. Beach. 

Mr. BEACH. You are welcome. 

Ms. TUBBS JONES. At least you got close to a yes or no answer. 

Mr. Price, let me ask you this: When there is a discussion about 

how young people want to have a private account in this ‘‘ownership society,’’ do you ever hear them talk about the fact that Social 

Security is the best deal for young people if they should become 

disabled or die? 

Mr. PRICE. Very rarely. The fact is that a 20-year-old has a 3 

in 10 chance in their lifetime of claiming some disability insurance. 

It is a big program. One in 10 of those or 1 of those 3 will die and 

have survivor benefits, and another, 2 in 10, 1 of whom was disabled, 2 in 10 are going to get survivor benefits for their families. 

The insurance piece of this program is vitally important. 

Ms. TUBBS JONES. Have you ever heard a dollar figure for the 

cost of a young person being able to purchase a policy that is as 

clear and broad as either the disability or survivor benefit policy? 

Mr. PRICE. I have not. I would love to see a measure, if you 

were to buy in the private market, of what it would cost for somebody to get the disability insurance, get the survivor insurance, get 

the inflation insurance, and the retirement part. I think it would 

come out to a good buy. 

Ms. TUBBS JONES. I have heard in the private market in some 

of the reports that I have read that it ranges between $323,000 to 

$400,000 for a young person to to go out into the market and purchase the coverage that the disability or survivor benefits provide. 

Mr. PRICE. No. That is the sort of face value of the insurance 

policy. 

Ms. TUBBS JONES. Right. 

Mr. PRICE. When I buy $300,000 worth of life insurance, I pay 

$1,500 a year. I am not paying $300,000. 

Ms. TUBBS JONES. Face value, you are correct. 

Mr. PRICE. Right, but the face value of the life insurance and 

the face value of the disability insurance are on the order of 

$300,000 to $400,000. 

Ms. TUBBS JONES. In some of the prior questions, Mr. Price, 

there was a whole discussion—I have lost that thought. How did 

I do that?—about private accounts and other benefits—no, it was 

about prefunding, and you got cut off in your response about 

prefunding. I wonder do you want to continue any response that 

you had given previously. If not, it is okay. I am going to go to Dr. 

Furman and see if he. 

Mr. PRICE. I apologize. I was cut off, but I have forgotten. 

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Ms. TUBBS JONES. Okay. Dr. Furman, you can use up the rest 

of my time. 

Mr. FURMAN. I will even give some back to make up. 

Ms. TUBBS JONES. No, they owe us time. I got cut off. Go 

ahead. 

Mr. FURMAN. I guess I would summarize what I have said. A 

lot of it is if you are interested in prefunding, I would be more than 

happy to work with you, but—— Ms. TUBBS JONES. Oh, I know what the question was, Dr. 

Furman—— Mr. FURMAN. Have to figure out ways to get additional contributions. 

Ms. TUBBS JONES. Excuse me. My father—and I say this in 

every hearing. My father, my sister, my brother-in-law, and my 

niece are all United Airlines employees. The question was with regard to United Airlines and the problems that they are facing, and 

I want to get a response. Actually, Dr. Price, I think that is where 

we were. Either of you can. 

Mr. FURMAN. I think it is an important reminder that we have 

a three-legged stool for retirement. One is Social Security, which 

has no market risk associated with it; one is private pensions; and 

one is your personal savings. We need to be focused on strengthening all three of those legs, not chopping one off and using it to 

replace another leg. 

Ms. TUBBS JONES. Do you remember what you wanted to say 

about United Airlines, Mr. Price? If you do not, it is okay. I will 

get you on another occasion. Ladies and gentlemen, Mr. Chairman, 

I am returning the time I did not get on these questions back to 

you, and I thank you for the opportunity. 

Chairman MCCRERY. Yes, ma’am, thank you very much. Mr. 

Hulshof? 

Mr. HULSHOF. Mr. Chairman, thank you. Let me start by saying how much I appreciate the evenhanded manner that you have 

conducted this hearing, especially as we have heard some interesting questions, some speeches, and other things, and just how 

much I appreciate that you do not get ruffled, because when you 

come on the tail end of this and you have heard the questions, the 

advantage is you have heard all of the testimony that you provided. 

One of the disadvantages is that I feel compelled to respond to 

some of those things that have been raised. Mr. Pomeroy talked 

about the use of excess payroll taxes in our national budget, as if 

that were a recent phenomenon. I think, Dr. Holtz-Eakin, correct 

me if I am wrong, but I think even going back perhaps to the late 

sixties through 1998, excess payroll taxes were, in fact, used to 

help finance the national budget. Mr. Levin, you had made a comment that no one says to do nothing. I think I wrote that quote 

down. Yet, I respectfully disagree because other than your colleague, Mr. Wexler, Mr. Boyd, I hear little in the way of constructive dialog as far as what to do. 

Dr. Furman, I agree with you that your presence here as the 

subject matter of this hearing was on prefunding, and yet you 

seemed eager to offer gratuitous criticism of fiscal policy, and specifically that President Bush is primarily responsible for our current fiscal situation. So, let me probe that bias of yours. I was 

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tempted to let it slide, but do you acknowledge that our country experienced a recession? 

Mr. FURMAN. The recession has almost nothing to do with the 

deficit. 

Mr. HULSHOF. That is not my question. Dr. Furman, here is 

how this works. Let me ask you a question. 

Mr. FURMAN. Yes. 

Mr. HULSHOF. If I do not—if you do not understand my question, I will rephrase it. Do you acknowledge that our country experienced a recession? 

Mr. FURMAN. Yes. 

Mr. HULSHOF. Now, I take it from your expanded answer that 

you disagree with Mr. Entin that the recession is the number one 

cause for our fiscal situation. 

Mr. FURMAN. In fiscal year 2004 and fiscal year 2005, it is not 

a major cause of our fiscal situation. 

Mr. HULSHOF. Let me ask, do you agree with many mainstream or most—I hate to characterize it as ‘‘most,’’ but many 

mainstream economists that the economic slowdown began in the 

last quarter of the year 2000? 

Mr. FURMAN. The official recession began in March 2001. 

Mr. HULSHOF. That the economic slowdown began, commenced 

in the last quarter of the year 2000. Agree or disagree? 

Mr. FURMAN. There are a variety of measures of the economy 

on a month-to-month basis. I have not studied them all. I am sure 

some of them show that and some of them show other—— Mr. HULSHOF. So, you agree or disagree? 

Mr. FURMAN. Recession began March 2001. 

Mr. HULSHOF. Agree or disagree? 

Mr. FURMAN. I agree that the recession began in March 2001. 

Mr. HULSHOF. I think as—you know, this is somewhat rhetorical, because you have to admit that the direct attacks on September the 11th had some direct and indirect economic consequences, did they not? 

Mr. FURMAN. They certainly did. 

Mr. HULSHOF. And as Ms. Tubbs Jones pointed out, Federal expenditures for conflicts in Iraq and Afghanistan, those are real dollars, whether we agree or disagree with the policy, the fact is Federal expenditures have gone into those military conflicts, have they 

not? 

Mr. FURMAN. That is correct. 

Mr. HULSHOF. Now, I do want to, on a lighter note—because 

it is interesting, Mr. Chairman, in the remaining time I have, we 

each try to come up with an analogy of what prefunding is, and I 

like, Dr. Furman, your analogy of a family with a substantial mortgage on its home and a daughter who is going off to college in a 

decade, because that is basically my family’s situation, and then 

the choices that we have. We have also heard—and for those newcomers to the room, we have also heard about being kicked to 

death by a rabbit. I invite you to watch the replay of this, if you 

are wondering about this rabbit possessing murderous intent. Mr. 

Shipman, you say that regarding prefunding—and this is from your 

testimony—that in the age of the iPod, Social Security is a 78 RPM 

wind-up phonograph. Would you like to elaborate just a bit, briefly? 

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Mr. SHIPMAN. Yes, the purpose of that was to say that things 

have changed from when Social Security started, really as a reaction to the Great Depression. The OASI part has really morphed 

into a defined benefit plan, essentially. Its finances have not advanced. It is still a pay-as-you-go system. It is archaic in trying to 

pay for relatively certain future liabilities through a tax transfer 

system as opposed to saving and investing for those relatively certain future liabilities. 

Mr. HULSHOF. To conclude, again, a crude analogy. If I own, 

Mr. Chairman, a 1935 antique car that can do the speed limit, I 

would like to pass it to my kids. It sprang an oil leak, and I have 

noticed that I have had to add a quart of oil almost from—it used 

to be every month and then every week, now it is almost daily. It 

seems that I now have a choice of whether to continue to just pour 

oil into this car, or to actually drop the engine and overhaul it. Of 

course, I know that that is going to entail some cost to do that. 

Again, that is my crude analogy of this issue, but I certainly applaud you for having yet again another stellar hearing. Thanks. 

Chairman MCCRERY. Thank you, Mr. Hulshof. Mr. Thompson, 

welcome to our Subcommittee. We are glad to have you, and if you 

would like to pose any questions to the panel, you may do so. 

Mr. THOMPSON. Well, Mr. Chairman, thank you very much for 

having the hearing and for allowing me to sit in. Mr. Levin, thank 

you very much for inviting me. I, too, came at the tail end and have 

found interesting some of the analogies and some of the comments 

that were made. I am particularly concerned from a fiscal perspective, and I suspect that all of you share all or part of that concern. 

A lot of the discussion prompted, I think, by Mr. Brady when he 

asked his question—that is where I came in—about cutting programs, cutting spending versus increasing taxes, it just seems to 

me that at some point—and I do not want to suggest that this has 

not been an honest hearing, but we have to have an honest debate 

on what the American people want in regard to those services and 

how it is we are going to pay for those services. The idea that we 

can just somehow cut, I think people need to know what that 

means. You know, just the $427 billion deficit this year, you could 

cut the Environmental Protection Agency, Health Services, Housing and Urban Development, Commerce, Education, and a whole 

bunch of other programs, and not even get to the deficit number 

of $426 billion. That does not even include the $160 billion that 

was borrowed from Social Security. 

So, I think that discussion has to take place, but I think it has 

to be a transparent, honest discussion. I think the whole issue of 

borrowing money and the debt has to be part of it. You could go 

a long way to prefund this program just by diverting the billion 

dollars a day that we spend in paying the interest on our National 

debt. We could use that to front-load this prefunding. I guess that 

brings me to my first question. When David Walker was before our 

full Committee, he had an interesting chart that he put up on the 

board that showed that by the year 2040, the Federal Government 

would be taking in just a small amount of revenue more than what 

we would paying out in the interest only on our National debt. 

Now, if we borrow to prefund Social Security or we borrow to privatize Social Security, it seems to me that we are going to grow 

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that national debt. We could actually trigger a scenario that, by 

2040, our interest is actually as much of, or more than what we 

are taking in just to pay that interest. I would be interested to 

know what this panel thinks the impact of that would be on our 

overall economy. Just briefly, if you could just—whoever would like 

to take it. 

Mr. HOLTZ-EAKIN. Well, I think, Mr. Thompson, that the debt 

profile that you have characterized is the outcome of current law 

mandatory programs which will——

Mr. THOMPSON. I understand. My question is if the Walker 

scenario comes to fruition or, even worse, if we continue to borrow 

and it becomes worse, as was explained, what impact is that going 

to have on our National economy. 

Mr. HOLTZ-EAKIN. It will have, initially a corrosive, and ultimately a contractionary effect if left unattended. 

Mr. THOMPSON. Does everybody—when we are talking about 

debt-financed accounts, this is obviously in today’s situation going 

to lead to more foreign borrowing. When you have Japan and 

China and the Organization of Petroleum Exporting Countries Nation’s leading the way in regard to foreign lending to us, I think 

we are at $2 trillion now in the amount of money that we owe 

other countries. 

Mr. PRICE. Three. 

Mr. THOMPSON. Pardon me? 

Mr. PRICE. We will find out next week it is three. 

Mr. THOMPSON. Three trillion? 

Mr. PRICE. Yes. 

Mr. THOMPSON. I am going to lose even more sleep than I was 

planning on. Just since January of last year, about $500 billion in 

foreign debt, and as this continues to grow. I think that puts our 

priorities in conflict—I don’t care what side of the aisle you are 

on—what we want to see this government doing and what we want 

to see happen for our country. I would like to know—Dr. Price, we 

will start with you—what do you see as the pitfalls of us continuing to grow not only our National debt but our national foreign 

debt? 

Mr. PRICE. Well, this is a big open question. We had a foreign 

exchange crisis and went off the gold standard in 1971 when we 

were going from a trade surplus to a trade deficit. Then, you know, 

in the mid-eighties when the dollar turned and people were worried 

about the dollar being too high, we had a current account deficit 

of 2.5 percent of GDP. The international financial markets have become more generous, particularly the central banks of Asia. So, we 

now have a 6.5 percent of GDP borrowing, and we have yet to see 

a real turn that I think we need to have. 

So, the big open question is how long, how generous are the central banks of Asia going to be? Otherwise, what is going to happen 

to private markets? Because at some point, if private markets turn 

against—and it can be Americans. I mean, the big decline of the 

Mexican peso, or the British pound, or the U.S. dollar in the past 

has been as much by people inside moving their currency out, as 

people outside. We could have a run on the dollar by Americans 

that the Asian central banks cannot keep up with, and that would 

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cause serious problems for our interest-sensitive industries, like 

housing, autos, and others. 

Mr. THOMPSON. Can we differentiate between a Social Security 

strong dollar and a national strong dollar? Can you have one and 

not the other? 

Mr. PRICE. No. 

Mr. THOMPSON. Thank you. 

Thanks, Mr. Chairman. 

Chairman MCCRERY. Mr. Thompson, thank you for coming, and 

I agree with you that we ought to have an honest debate about any 

number of decisions we must make as policymakers here in the 

Congress. In the pursuit of that, I would like to clarify some of the 

numbers you used in your question. First of all, the $426 billion 

figure, was that last year’s deficit, Dr. Holtz-Eakin? 

Mr. HOLTZ-EAKIN. You are talking about 2004? The current year, 2005, our current estimate is a ball park $350 billion. Mr. THOMPSON. $350 billion. 

Mr. HOLTZ-EAKIN. For the fiscal year ending September 30th. 

Chairman MCCRERY. Okay. Mr. Thompson also said—that does 

not count the $160 billion we borrowed last year, maybe this year, 

from Social Security. In fact, have we borrowed from Social Security and spent $160 billion either last year or this year? 

Mr. HOLTZ-EAKIN. The primary surplus in Social Security is 

much smaller. I have failed to remember this number twice in front 

of you, and I will never show up again without knowing it. 

Chairman MCCRERY. Sixty-nine billion. 

Mr. HOLTZ-EAKIN. Thank you. 

[Laughter.] 

Chairman MCCRERY. That is the correct, honest number that 

we used from the Social Security Trust Fund. That was the cash 

surplus. The interest that was credited to the trust fund, of course, 

we could not spend that. It is on paper. It is interest. So, I would 

like for us to be honest in this debate and use good numbers when 

we are trying to paint the picture that we would like everyone to 

see and operate from. 

Mr. THOMPSON. Mr. Chairman, could you yield for a moment? 

Chairman MCCRERY. Sure. 

Mr. THOMPSON. If the number $427 billion or the numbers 

that you just gave us, $419 billion, the issue is those are real dollars. I think. 

Chairman MCCRERY. Those are real dollars, Mr. Thompson, but 

to exaggerate those in the pursuit of your ends I don’t think serves 

the public or the debate well, and I was just trying to make it clear 

that the correct numbers are much different from those you cited. 

Now, I agree with the point you were trying to make very much, 

and that is the point of these hearings, and that is the point of 

those of us, including the President, who want to reform Social Security. Then we would like—some of us would like to move on to 

Medicare, and yes, Mr. Price, health care, because you are right, 

that is the biggest looming problem from a fiscal standpoint, and 

perhaps from a quality-of-life standpoint. And, fortunately or unfortunately, the government plays a huge role in health care through 

Medicare and Medicaid, and other policies, including tax policy. So, 

yes, I would like very much for us to move on from Social Security, 

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which is much easier to fix, and to generate some savings from current policy in the out-years, and then address these more difficult 

and eventually bigger problems like Medicare, Medicaid, and 

health care. With that, thank you all very much for your testimony. 

It was all excellent, and we look forward to continuing to consult 

you as we move through this discussion. The hearing is adjourned. 

[Whereupon, at 12:50 p.m., the hearing was adjourned.] 

[Submissions for the record follow:] 

Statement of Dolores Guinn, Horshoe Bay, Texas 

In reference to the Social Security reform hearings, I feel strongly that the committee should consider all aspects of this issue. The cornerstone of the proposed reform is to let the future generations set aside their own savings and/or pension 

funds. This is a disturbing proposal and I ask that each of you be honest. I, for one, 

can remember what was happening in my life during the age of twenty to forty. I 

spent many hours wondering if I could survive to the next payday, being a single 

Mom with three daughters. Do you think, for one moment, that I even considered 

a savings account. 

Surely, intelligent people that you are, you have studied the living conditions of 

those at the lower end of the spectrum who cannot even afford a car for transportation or medical treatment at the hospital. Have you given any consideration to 

them? Have you looked ahead to see what will be the results if we leave every 

American in charge of their own pension? Perhaps if you did, you would see that 

there will be a lot of elderly people out on the street. You know, and I know, that 

they will not be able to survive with the reduced Social Security payment that will 

be in place at that time. 

More importantly, what plans do you have if some catastrophic decline in the 

stock market should occur? What alternative plan do you have if over half of the 

American population is ready to retire and their account is empty? I believe that 

the easiest way to reform Social Security is set it aside, untouchable and 

unmolested by the government,as it was originally planned. The other thing is to 

take the cap for Social Security off of the wealthy. There is nothing wrong with having all Americans pay on all that they earn. 

We can surely see that fairness in the system has been at the heart of all of 

Americans discontent. Remember the beginning of the American Revolution? Americans were unhappy over taxation. Taxation without representation. Unfairness in 

the system! 

The Social Security plan, drawn up by Franklin.D. Roosevelt, was good and has 

helped so many people, probably some of your own relatives. It needs to be returned 

to its roots and tweaked with the earnings cap issue, but please do not destroy this 

program. I remind you, that you are making decisions that will affect future generations and the shame and blame for its failure will be upon your head. 

Thank you for allowing me to be heard on this issue. 

f 

Statement of Thomas S. Marino, La Habra, California 

I wish to provide my personal support of HR 147, ‘‘Social Security Fairness Act’’. When I retire in 2008, at the age of 65, I will be affected by the present Government 

Pension Offset (GPO) and the Windfall Elimination Provision (WEP). 

I am employed by the County of Orange in California, with many years of government service behind me. I did, however, manage to earn my forty Social Security 

credits during the years before government service. This included fours years of 

military service to my country during my Marine Corps enlistment. 

I earned my right to collect the full benefits of Social Security, irregardless of the 

fact that I chose a career in government service. I feel that government service 

workers, as well as teachers have a right to receive full earned benefits from their 

government pension plans and Social Security if they contributed to the systems. 

I work for a County agency that provides aid to needy persons. I am personally 

aware of individuals who also receive Federal Social Security benefits who have 

never paid into this system. I don’t understand how it can be considered fair or ethical for these persons to receive benefits when our government will deny me from 

receiving the full measure of the benefits I earned because I contributed to a government pension plan. 

hsrobinson on PROD1PC72 with HEARING

101 

I personally urge the members of Congress to support passage of HR 147. 

f 

Statement of Bob Moore, Lawton, Oklahoma 

Reform Social Security and Personal Income Tax 

First item is federal income tax on interest earned on bank accounts. Why have 

income tax laws for 300 million people when the Federal Government should have 

the financial institutions (appr. 10,000) pay a monthly tax being a percentage of the 

total dollars paid as interest to clients. No tax due from the citizens, the bank pays 

the tax, SIMPLE. 

Same is true with stock dividends, have the corporations pay the government a 

percentage of the dollar amount paid to the stockholders. No tax due from the citizens, the corporations pay the tax, SIMPLE. 10% is a good rate. 

a. Second item is a 40–40 Tax on Gasoline: 

b. eliminate the.9 cent; 

c. this tax shall not be amended for forty (40) years; 

d. a total tax of forty (40) cents a gallon tax according to the following: 

e. twenty (20) cents shall go to the Federal Government and 

f. twenty (20) cents shall go to the originating State government 

g. gasoline tax to ONLY go toward roads and bridges. 

h. Third item is Truthful Tax Reform—Federal Tax Payroll Program. 

‘‘TOTALLY’’ Eliminate the Personal Income Tax ‘‘TOTALLY’’. 

1. Fact: FICA tax is over 15% of the employees’ paycheck. Federal Courts have 

ruled the FICA is a tax not a retirement fund. The Federal Government needs 

to be honest and declare that FICA tax goes to the general fund to pay for government spending programs. Re-name FICA tax to Federal Tax Payroll Program. 

2. Government taxes should be on commission, just like all private businesses 

and private business’ employees. The government spending can only grow if 

more people make more money. 

3. Payroll deduction is the most efficient way to collect taxes. The Federal Tax 

Payroll Program will be the only federal tax that wage-earning Americans will 

pay. Never a personal income tax form to file with the IRS. 

4. Keep the system simple, one rate for all taxpayers. Ten (10%) Percent is good 

enough for GOD, then Ten (10%) Percent should be good enough for the government. However the Federal Government is not as efficient as GOD so lets 

put the maximum rate at twenty (20%) percent. 

5. The Federal Tax Payroll Program shall be 20% ‘‘Maximum’’ of which Ten (10%) 

Percent to be withheld from the wage-earners’ pay to be matched by Ten (10%) 

Percent from the Employer. Rate shall not be raised ever. 

6. Earmark how the money shall be allocated, such as: 

• 1% to DOD for National Defense; 

• 4% to Citizens Retirement Fund, a 401K type program—private social security fund for each person; 

• 15% to Social Security and other spending programs. 

• A total of 20% of the wage-earners’ salary to go to the Federal Government. 

This type of system would result in no forms, no worry and a much smaller I.R.S. 

No tax forms to file each year. No tax credits to be given or taken away by the Federal Government. No increase or decrease in the tax rate. 

This would get the Federal Government out of micro-managing the daily life of 

the taxpayers. It is called FREEDOM! 

Social Security; at this point, the government should just pay everyone the same 

amount each month once the person has reached age 62 or 65. We are a rich Country and we do not want our Senior Citizens living below the poverty level so just 

increase the monthly check for all senior citizens. If Congress was really serious 

about eliminate the national debt, Congress would cut the spending program. 

An advantage given by the government to one person means an unfair dis-advantage to all other Americans. Our Founding Fathers believed that small government 

and less taxes means more freedom. 

The Oklahoma Taxpayer, Editorial by Bob Moore 

Æ 

hsrobinson on PROD1PC72 with HEARING