Committee Of Correspondence

Making Social Security Secure

Herb Stein
7:46 a.m.  Wednesday  7/17/96

We have a number of issues on the floor. I will try to disentangle them and direct your attention to helping to straighten me out if I have misunderstood. Basically, I think we would make more progress if we had some specific proposals before us, which we do not have at the moment.

1. Aaron says, “Privatization of Social Security … by itself does nothing to help future generations bear the projected increased costs of pensions.” I thought Weaver was agreeing with this when she said “there are no free lunches.” But in her Tuesday submission she says that “even if the government issues debt as workers begin socking their money away in personal accounts, there are large economic gains to privatization. They result from halting the growth of new net liabilities under the old system. ” I think she should explain that a little more.

2. Weaver refers to other benefits from privatization, that might be called “incentive effects.” They include giving workers a clearer picture of the relationship between the savings they make and the retirement income they can expect. She mentions others. In this same category of beneficial effects one might mention the incentive to the “general government” to be more economical if it is deprived of a captive market for its debt issues. Others have not, I think, referred to this kind of benefit and I would like to know what weight they attach to them.

3. I believe that everyone agrees that someone must give up something, but it is not clear who or how. Aaron evidently supports reduction in benefits to new retirees. He says that “balance can be restored with no new taxes on today’s work force.” Does he mean that new taxes may be needed on tomorrow’s work force? Weaver has not given a view of who must help to finance the transition, as she put it, or how.

4. Thau expresses the concern of his generation that they may be called to support the boomers the way the boomers supported my generation. He wants to “thoroughly restructure the entitlements pyramid now.” But I don’t know what he means by that.

5. Aaron expresses concern over the effect of privatization on the lowest-income workers who, under the present system, get larger benefits relative to their contributions than upper-income workers. I had thought that the privatization plans now in circulation tried to deal with that problem by preserving a minimum benefit. Is that not correct?

Henry Aaron
7:52 a.m.  Wednesday  7/17/96

Sen. Kerrey points to a genuinely important problem in the rapid growth of Medicare costs. He might have added Medicaid as well. But it would be wrong to use rapid growth in health care costs to justify cutbacks in pension payments. The increase in the cost of Social Security, measured as a share of GDP–from now until the last baby boomer has reached retirement age–is relatively modest, less than the decline in the defense budget since 1990. Modest changes in Social Security will suffice to restore long-run financial balance.

Furthermore, simply diverting payroll taxes from Social Security to individual accounts will do exactly nothing to improve the capacity of the nation to meet added Social Security costs. If one modestly cuts benefits and thereby lowers the public deficit, national saving will rise. Higher saving will increase economic growth and help meet these costs. But that saving can occur as effectively through enhanced Social Security reserves as in individual accounts. The individual accounts will bring much higher administrative costs–and profits for financiers who are bankrolling the privatization effort–and they will increase risk for workers and the chance they may reach retirement with little to show for their saving. Perhaps some payroll tax increase will be necessary in the distant future, but, as Ms. Weaver correctly stresses, one should not put too much weight on projections of what will happen several decades hence.

Let’s fix a system that has served America well, not destroy it.

Henry Aaron
8:07 a.m.  Wednesday  7/17/96

Carolyn Weaver bewails the “enormous debt” that earlier generations have handed to today’s workers. And what is her solution? To load them up with even more debt. She doesn’t put it that way, of course. But if one cuts through the rhetoric, that is what she proposes.

She does not propose significant curtailment in benefits for current retirees. The taxes to support those benefits can come from only one source–today’s workers. In addition, she asks today’s workers to set aside funds for their own retirement. In short, under Weaver’s plan, today’s workers will pay for two retirements–those of current retirees and their own. With friends like that, today’s workers need no enemies.

But there is something even more troubling about her emphasis on the debt today’s workers have been handed. That debt arose largely because the American people decided to give, to a generation whose careers were blighted by the Great Depression, benefits worth much larger than the taxes they paid. Ms. Weaver’s comments make me wonder if she wishes Congress had limited this generation to the paltry benefits their taxes would have purchased. A compassionate nation decided to provide much more generous benefits. There is nothing anyone can do about that decision today. I think it was the right decision.

Herb Stein
8:23 a.m.  Wednesday  7/17/96

Let me try out on you some thoughts that may have been obvious to all of you but only came to me as I pondered what you have said.

I have been confused by failure to distinguish two aspects of “privatization.”

One is that all or part of the future Social Security contributions, that under present arrangements are invested in government securities, should be invested in private assets that have a higher yield. I believe that Aaron, Kerrey and Weaver agree with that. What Thau thinks I don’t know. Aaron thinks, and I am inclined to agree with him, that “by itself” does not help to solve the problem of the availability of future national income to meet the claims of retirees. But it does strengthen the claim of the retirees to their share of that income. It has some distributional consequences. It would deprive the rest of the government of the subsidy it now gets from being able to borrow from a captive market–the Social Security reserves. What the result of that would be would depend on how the rest of the government reacts–for example, if by higher taxes, then by what taxes.

The other issue is whether the investment in the private assets should be done collectively, by the Social Security Administration, with the assets forming one common pool, or whether each covered worker should make his own investments and acquire private ownership of his investments of which he would be the sole beneficiary. If I understand them, Aaron prefers the collective plan and Weaver prefers the individual plan. I don’t know where Kerrey stands on this. The collective plan would permit preservation of the present benefit formulas that involve substantial redistribution among people in the same age cohort–between low-wage and high-wage workers, and among unmarried workers, single-worker couples and two-worker couples. In the individual plan that redistribution would not occur, at least for the part of the reserves dedicated to the plan. I understand Aaron to prefer the collective method because he wants to preserve that redistribution, at least between low-wage and high-wage workers. What he thinks about the discrimination by family structure I don’t know. Weaver, I think, prefers the individual method because she wants to strengthen the incentive to work that comes from knowing that the worker’s future benefits depend strictly on his own earnings.

The argument between redistribution and incentives in public finance has gone on for a long time, and I don’t suppose we will resolve it this week. But I would like to know whether this is really an important part of the disagreement I see within our panel.

Henry Aaron
9:10 a.m.  Wednesday  7/17/96

The moderator posed a number of questions. Here are my answers.

1. There are, indeed, no free lunches. The only way to help prepare for the costs of an increased disabled and elderly population is to increase national production. To do that requires increased saving NOW. (I leave aside the important issues of how to improve worker training and promote technological advance.) To raise saving we must consume less. Simply redirecting part of the payroll tax to private accounts does nothing to raise saving. That is why privatization of Social Security does nothing by itself to raise saving and production and help us meet the costs of the disabled and retirees.

2. It does undermine the commitment to a SOCIAL insurance system that assures low earners a benefit sufficient permit them to retire and to stay off welfare. Some current privatization proposals do promise a basic benefit payable to everyone. But such programs are politically vulnerable, and their proponents know it. The drastic reductions in welfare benefits that are likely soon to pass Congress–and the even larger but less recognized past cuts in real welfare payments–eloquently testify to that vulnerability. Those basic benefits would become easy prey to an economy-minded Congress. Only low earners would have much stake in them, and their political power is slight. Meanwhile, the individual accounts would go merrily along.

Richard Thau
12:57 p.m.  Wednesday  7/17/96

I believe that it is possible to maintain the redistribution aspects of Social Security that provide the floor of protection that Henry Aaron is so concerned about, and at the same time give workers the added personal control they want by allowing them to personally redirect a portion of their current FICA contributions into private accounts.

To me, the open question is what portion of FICA, under this plan, would be most desirable/responsible to redirect. Sen. Kerrey’s bill calls for 2 percent of payroll, others argue 3 percent (Steve Forbes) or 5 percent (members of the Advisory Council, as it’s been reported).

In our 1994 poll, we found 82 percent of adults 18-34 would like the ability to invest at least a portion of their FICA contributions privately. They know that with this option their total FICA contributions (i.e. combined public and private components) would likely give them a higher return when they retire than currently projected–and poor seniors would still be protected.

A mea culpa. I accused Henry of wanting to raise FICA taxes by 1.8 percentage points. He did not advocate that. Rather, he indicated that “the total increase in the cost of Social Security from today until the last baby boomer has retired in 2035 is projected to be 1.8 percent of gross domestic product.” Of course, I should point out that according to the June 1996 trustees report, OASI is currently 4.08 percent of GDP and DI is 0.60 percent, so an increase of 1.80 percentage points in Social Security, in comparison to the size of today’s program, would be massive.

Bob Kerrey
2:27 p.m.  Wednesday  7/17/96

When Sen. Simpson and I were writing S-825, which is our comprehensive proposal to reform Social Security, we were guided by the following principles:

1. We wanted to strengthen the Social Security system by making two promises to beneficiaries. The first promise is the collective payment to beneficiaries which has been in place since the law was passed sixty years ago. The second is the Personal Investment Plan which we would fund by diverting 2 percent of the employee share of the payroll tax into an account which would be owned by the individual. The transition costs of enacting this Personal Investment Plan are fully funded by phasing in increases in the eligibility age for full benefits to 70 years of age, an additional bend point (used to calculate benefits), and a means test on COLA’s.

The combination of these two provisions gives future beneficiaries two programs which dovetail with one another. The first is a defined payment; the second is a defined contribution. The defined benefit is the current pay-as you-go government mandated program sometimes referred to as the “social safety net” of Social Security. The defined contribution, like an IRA or 401(k) plan, is owned by the beneficiary, earns a higher rate of return, and can be passed onto the beneficiaries’ heirs.

The Personal Investment Plan (PIP) could also be made more progressive, and more powerful, by making two additional changes. First, because individuals with high incomes will be able to save more money in their PIP if we used a fixed percentage of their payroll tax, we could use a fixed dollar amount. This would help low income workers to acquire more wealth. For example, 2 percent of $62,700 enables an upper middle class worker to become much wealthier than a worker who contributes 2 percent of $15,000 per year. Second, we could enact Kidsave, a proposal by Senator Lieberman and myself, which would open PIP’s for every new born in America (a thousand dollar account could be funded with as little as .1 percent of the payroll tax) and fund it with a refundable child tax credit. I will not elaborate here, but will make the point again that generating wealth for most Americans (who are not born wealthy, do not have large incomes and do not expect to hit the lottery) can only occur by saving a little bit of money over a long period of time. Kidsave adds nearly 20 years on the length of time that compounding occurs if we add this to the PIP proposal in S.825.

2. Our legislation also builds up the collective portion (defined benefit) of Social Security so that the trust fund is equal to at least three and a half times a single year’s payment and then kept there permanently. The current strategy is to build a several trillion dollar reserve (pre-funding the baby boomers which Congress immediately began to spend in 1984 producing a situation where people today who are paid by the hour are shouldering a disproportionate share of deficit reduction) and then to spend down the reserve to zero when Congress would be expected to enact higher taxes and/or cuts in payments to beneficiaries in order to keep the program operational.

The advantages of building the trust fund to a level which is sustained into perpetuity are numerous. First, whatever promises we now make to pay benefits–whether to current or future beneficiaries–we know we could actually keep. In the current system, Americans who will not retire until after 2029 (beneficiaries who are 44 years of age and under) realize that their confidence in getting the payment which is promised to them now is directly proportional to their confidence that their children will permit their payroll taxes to increase to fund the transfer. Second, a pay-as-you-go system (stabilized with ample reserves) would encourage politicians to be more honest about what we can afford. There is an understandable desire to be more concerned about current beneficiaries who vote more enthusiastically to protect current benefits than future beneficiaries do to protect future benefits.

3. We wanted the proposal to be fully funded–which it is. By keeping the PIP administered through the Social Security Administration (because investments made by beneficiaries would be managed on the outside) taxpayers get the advantage of the efficiency and security of the Social Security Administration and the use of their actuaries, while utilizing the skills of the private sector for earning higher rates of return on their investments. We used the Social Security actuaries to evaluate and price our proposal.

S-825 would phase in many of these changes over time, although individuals with higher incomes might be affected by the additional bend point and the means test on COLA when the bill is enacted. The bigger change would be for beneficiaries who will retire after 2029. These retirees would continue to have a fixed and defined benefit program which they do not own, but would also have a more flexible fixed contribution program which would be their asset.

That is enough for Wednesday.