Michael Tanner’s Testimony before the House Ways and Means Committee

I would like to applaud the Chairman and the Committee for holding these hearings today, and for your determination to go forward with trying to reform our nation’s troubled retirement system. I hope that this means we are at last moving beyond the sterile and unproductive debate about whether Social Security is facing a “crisis” or just a big problem.

Because whatever we call it, we cannot deny the fundamental facts. Social Security will begin to run a deficit in just 12 years-that is, it will begin to spend more money on benefits than it brings in through taxes. At that point, in order to continue to pay promised benefits, it will have to draw on the Social Security Trust Fund. We have seen much debate about the Trust Fund recently, with some suggesting that it guarantees Social Security’s solvency until 2041, or even 2052. However, as Congressional Budget Office director Douglas Holtz-Eakin has noted “[The Trust Fund] has no real economic resources….The key moments for Social Security are in 2018. Cash-flow benefits will equal cash-flow payroll taxes, and then after that, the Social Security Administration will have to come back to the rest of the budget for additional resources to pay promised benefits.”

Or as the Clinton Administration made clear in its FY2000 budget:

This is not to say that the Federal government will default on the bonds in the Trust Fund. I am not doubting the “full faith and credit” of the U.S. government. However, that does not relieve the Federal government from the obligation to find the money with which to redeem those bonds, currently $1.6 trillion in present value terms. To put it in perspective, think of it this way. In 2018, the first year after Social Security begins running a deficit, the shortfall will be roughly as much as the Federal government spends on such programs as Head Start and the WIC program. The cost rises rapidly thereafter. By roughly 2023, the cost of redeeming enough Trust Fund bonds to pay all the promised Social Security benefits would be nearly as much as the cost of funding the Departments of Interior, Commerce, Education, and the Environmental Protection Agency. By 2038, well before the theoretical exhaustion of the Trust Fund, you can add the Departments of Veterans Affairs, Energy, Housing and Urban Development, Justice, NASA, and the National Science Foundation. Simply redeeming the Trust Fund will begin to squeeze out all other domestic spending priorities.

Beyond 2042, once the Trust Fund is exhausted, the deterioration in Social Security’s finances only increases-and never gets any better. Overall, the present value of Social Security’s unfunded obligations run to nearly $12.8 trillion (approximately $1.6 trillion to redeem the Trust Fund, and $11.1 trillion in unfunded benefits thereafter).

However, as troubling as these numbers may be, I believe that the debate over Social Security reform should not solely-or even primarily-be a discussion of solvency. Yes, solvency is important, and any responsible Social Security reform plan should restore the program to solvency, not just short-term actuarial solvency, but permanent, sustainable solvency.

Still solvency is not enough. Instead, Social Security reform should strive to build the best possible retirement system for our children and our grandchildren. Thus, Social Security’s current situation should not be seen as either a crisis or a problem, but as an opportunity to build a new and better program, based on the fundamental American values of ownership, inheritability, and choice.

Under the current Social Security system you have no legal, contractual, or property rights to your benefits. What you get receive from Social Security is entirely up to the 535 members of Congress. But personal retirement accounts would give workers ownership and control over their retirement funds. The money in your account would belong to you-money the politicians (with all due respect) could never take away. In short, they would own their retirement.

Because you don’t own you Social Security benefits, they are not inheritable. Millions of workers who die prematurely are not able to pass anything on to their loved ones. But personal retirement accounts would enable workers to build a nest egg of real, inheritable wealth.

Choice is part of the essence of America. Yet when it comes to retirement, Congress forces all Americans into a one-size-fits-all, cookie-cutter retirement program, a system that cannot pay the benefits it has promised and in which we have no right to the money we pay in. With personal retirement accounts, workers who want to remain in traditional Social Security could do so. But younger workers who want a choice to save and invest for their retirement would have that option.

With this goal in mind, not just to restore Social Security to solvency, but to build a better retirement program that would give workers more ownership and control over their money, scholars at the Cato Institute drew on our 25 years of experience studying Social Security, and developed a comprehensive proposal for creating privately invested, personally owned accounts as part of an overall reform of the Social Security system. This proposal became the basis for legislation introduced, on July 19, 2004, by your colleague Rep. Johnson along with 18 original co-sponsors.¹ Rep. Johnson, together with Rep. Jeff Flake and 11 co-sponsors, reintroduced the bill in the 109th Congress, on January 21, 2005.²

Under this proposal, workers under the age of 55 would have the option of diverting their half of the Social Security payroll tax (6.2 percent of wages) to an individual account. The employer’s portion of the payroll tax would continue to be paid into the Social Security system to provide survivors and disability benefits, as well as to partially fund continuing benefits for those already retired or nearing retirement. Workers choosing the individual account option would forgo any future accrual of Social Security retirement benefits. However, those workers who have already paid into the current Social Security system, and therefore have accrued benefits, would receive credit for those benefits in the form of a recognition bond. This fully tradable bond would be a zero coupon note maturing on the date of the recipient’s normal retirement age.

Workers who do not choose the individual account option would continue to pay into and receive benefits from the current Social Security system. However, for these workers, the initial Social Security benefit formula will be adjusted to reflect price-indexing rather than the current wage-indexing. The result will be to restore Social Security benefits to a level payable with Social Security’s available revenue, while ensuring that future retirees continue to receive the same level of benefits as those retiring today, on an inflation-adjusted basis. This change will be phased in over a 35-year period, beginning in 2014.

This should not be seen as a benefit “cut.” Indeed, benefits will be higher in the future than they are today. While it is true that future benefits would be less than what Social Security promises, such comparisons are meaningless because unless there is a substantial increase in taxes, the program cannot pay the promised level of benefits.

That is not merely a matter of conjecture, but a matter of law. The Social Security Administration is legally authorized to issue benefit checks only as long as there are sufficient funds available in the Social Security Trust Fund to pay those benefits. Once those funds are exhausted, in 2041 by current estimates, Social Security benefits will automatically be reduced to a level payable with existing tax revenues, approximately 73 percent of current benefit levels.³

This, then, is the proper baseline to use when discussing Social Security reform. Social Security must be restored to a sustainable level regardless of whether individual accounts are created.

As the Congressional Budget Office puts it:

I would also note that, although the Cato Plan and HR 350 apply the wage-index/price-index change to all income levels, if I were rewriting the proposal at this point, I would give very serious consideration to the blended approach advocated by Mr. Pozen. Doing so would refocus Social Security benefits on those who need it most, and make the system more progressive.

The plan also called for establishing a new minimum Social Security benefit equal to 100 percent of the poverty level, providing a significant increase over the current minimum benefit. I have attached the original Cato study setting out the details of the proposal and their rationale.

The plan has been scored by the Social Security Administration’s Office of the Actuary (OACT), which concluded that it would eliminate Social Security’s long-range actuarial deficit” and would restore the system to permanent “sustainable solvency.” I have attached a study that the Cato Institute released last month exploring OACT’s findings in detail, as well as a copy of OACT’s original actuarial memo. However, to summarize, OACT found that:

• The “transition cost” (in present value) would be approximately $6.5 trillion. This is roughly half the $12.8 trillion unfunded liability of the current system. That is, the “6.2% Solution” ultimately saves taxpayers $6.3 trillion.
• The legislation also compares very favorably to other Social Security reform plans. In terms of giving workers more control and ownership of their retirement funds, the “6.2% Solution” clearly provides the most “bang for the buck.”
• On a cash-flow basis, the legislation does require significant short-term transfers of General Revenue. However, by 2046, the system would begin running surpluses, allowing any short-term debt to be repaid. Indeed, by the end of the 75-year actuarial window, the system would be running surpluses in excess of $1.8 trillion (in constant $2005)
• Much of the short-term cash-flow shortfalls are due to the redemption of recognition bonds, not to the diversion of payroll taxes to the individual accounts. These recognition bonds convey many benefits in terms of ownership as well as speeding the date at which Social Security changes from deficit to surplus. They are essentially a prepayment of future Social Security benefits, and not a new expense. The Johnson-Flake bill is the only Social Security reform bill with recognition bonds. The costs of Johnson-Flake also include the cost of increasing the minimum Social Security benefit to 100% of poverty, a significant increase over the current minimum Social Security benefit.
• Individual accounts would eventually accumulate assets in excess of $38 trillion (in constant $2005). That would lead to substantial new savings, new investment, and economic growth.
• Once short-term debt is paid off, the employer portion of the payroll tax could be reduced to 3.04%. This would pay for disability and survivors’ benefits.

In short, the SSA analysis shows that Johnson-Flake can provide large individual accounts while restoring Social Security to permanent sustainable solvency, and can do so in a fiscally responsible manner. While the up front costs will be significant, they will be less than for other big account plans, and eventually those costs will be more than offset by the savings to the system.

In addition, younger workers who chose the individual account option could receive retirement resources substantially higher than what traditional Social Security can actually pay them.

Finally, Johnson-Flake gives workers ownership and control over their retirement income. It would give low- and middle-income workers the opportunity to build a nest egg of real, inheritable wealth. It provides younger workers with greater choice. In short, if we measure a Social Security program not just as a matter of dollars and cents, but as a matter of human liberty and individual dignity, Johnson-Flake provides a better way to take care of our retirement.

Thank you.

¹ HR 4895.
² HR 530.
³ In practice, rather than reduce each check sent to beneficiaries, the Social Security Administration would stop sending out checks altogether until it accumulates sufficient funds to pay “full” benefits. When those funds are exhausted, checks would again be withheld until sufficient funds accumulate, leading to checks starting and stopping several times over the course of a year. The net effect would be that total annual benefits would be reduced by the same amount as if each month’s benefits had been proportionally reduced.
⁴ David Koitz, “Measuring Changes to Social Security Benefits,” CBO Long-Range Fiscal Policy Brief no. 11, December 1, 2003.