Statement of Robert M. Ball, Founding Chair, National Academy of Social Insurance

Testimony Before the Subcommitee on Social Secuirty
of the House Committee on Ways and Means

My name is Robert Ball. I was Commissioner of Social Security from 1962 to 1973. Prior to my appointment by President Kennedy, I had been the top civil servant at the Social Security Administration for about 10 years; my career at Social Security including my years as Commissioner spanned approximately 30 years. In 1948, I served as Staff Director of the Advisory Council on Social Security to the Senate Finance Committee which recommended the major changes that became the Amendments of 1950. Since leaving the government in 1973, I have continued to write and speak about Social Security and related programs. I was a member of the 1965, 1979 and 1991 statutory Advisory Councils on Social Security, and I served on the National Commission on Social Security Reform, the Greenspan Commission, upon whose recommendations the 1983 Amendments were based. I am testifying today as an individual member of the 1994-1996 Advisory Council on Social Security, but my views are shared in general by five other Council members. The views expressed are not necessarily those of any organization with which I am associated.

I. Introduction

Perhaps the single most important point to keep in mind about Social Security as we consider various options for the future is this:

Social Security is not in the emergency room and does not require heroic measures. Rather, it requires thoughtful attention to an eventual imbalance of income and expenses that begins to take effect in about 30 years. After that, unless the program is amended (as I am sure it will be), present financing would cover only about three-fourths of the cost.

The situation with Social Security is like that of homeowners living in a sound house that they very much like and that needs only to have its mortgage refinanced. There is no need to move out of the house or tear it down. The need is only to improve its long-term financing.

Six of us who served on the 1994-1996 Advisory Council on Social Security⁽¹⁾ propose to improve the program's long-term financing by initiating, as soon as possible, a series of common-sense measures that eliminate much of the anticipated long-term deficit. We call this approach the Maintain Benefits (MB) plan. It maintains Social Security as a defined-benefit plan, with benefits determined by law -- a key point to which I will return.

The initial measures that we propose include:

• Adjusting the Cost of Living Allowance to reflect these technical corrections to the Consumer Price Index already announced by the Bureau of Labor and Statistics;
  
  

• Taxing Social Security benefits that exceed what the worker paid in, in the same way that other public and private defined-benefit pension plans are now taxed;
  
  

• Making Social Security truly universal by gradually extending coverage to those state and local government jobs that are not now covered;
  
  

• Either reducing benefits slightly -- 3 percent on average -- by increasing, from 35 to 38 years, the wage-averaging period used to calculate benefits; or, alternatively,
  
  

• Increasing the contribution rate moderately -- 0.15 percent each for workers and employers;⁽²⁾ and
  
  

When Medicare is refinanced, correcting an anomaly in present law⁽³⁾ so that income from taxes on Social Security benefits goes entirely to Social Security rather than to both Social Security and Medicare.
These changes reduce Social Security's projected long-term deficit by nearly two-thirds, from 2.17 percent of payroll to 0.80 percent, thus extending the life of the trust fund by two decades, from 2030 to 2050.

To close the remaining deficit and maintain Social Security in long-term balance, the options available for consideration include: gradually increasing payroll taxes; gradually increasing the retirement age or otherwise lowering projected outlays; or generating a better return on Social Security trust fund investments by diversifying them to include investing in stocks as well as in government obligations. We recommend that this last option be given very careful consideration by the Congress.

This kind of public-private investment strategy -- the same strategy used by other pension systems -- would permit Social Security, while continuing to invest primarily in Treasury securities, to invest part of the accumulating trust fund surplus in a passively managed portfolio of stocks indexed to the broad market.

This investment approach has many advantages over the two proposals advanced by other members of the Advisory Council to break up Social Security into millions of individual retirement savings accounts. Most importantly, it preserves Social Security as a defined-benefit plan, in which benefits are determined by law rather than by what happens to an individual's savings account.

That is a fundamentally important safeguard for a system designed, as Social Security is, to provide a secure base on which to plan and build one's retirement. If the base itself is made less secure -- by replacing it with millions of relatively small individual accounts, all subject to the vagaries of individual investment decisions and unduly dependent on the performance of the stock market -- Americans will have lost the universal system of basic economic security that we have been building so carefully and successfully for 60 years. Instead of refinancing the mortgage, we will have undermined the house.

Whatever the President and the Congress decide to do with Social Security in the future, we should not seriously consider trading part of it for high-cost social experiments that put all Americans at risk. In our view, the Social Security Advisory Council did not produce three viable options from which to choose. The six of us could not, under any foreseeable circumstances, support either of the two private-retirement-accounts proposals, and we do not believe that most Americans will find them even remotely attractive, once the risks, costs, and trade-offs are fully understood.

II. Social Security: America's Family Protection Plan

For 60 years the United States has pursued a three-tier retirement income policy consisting of Social Security and two supplementary tiers: employer-sponsored pensions, now covering about half the work force, and voluntary individual savings. Each tier complements the others and has become a fixed feature of national policy. Social Security, covering nearly everyone, is a contributory, wage-related, defined-benefit plan administered by the Federal government and entirely supported by dedicated Federal taxes, and the two supplementary tiers are explicitly encouraged by Federal tax policy.

Social Security, the basis of this three-tier structure, has been a uniquely successful program by any measure. For more than half a century, it has been America's family protection plan, providing millions of the elderly and disabled with secure incomes, guarding them against impoverishment, and relieving their children and grandchildren of what could easily become the unmanageable burden of supporting them year in and year out throughout their old age.

No program has ever done more to alleviate and prevent poverty or to protect income against erosion by inflation. None has done more to protect children against the risk of impoverishment when a wage-earning parent dies or becomes disabled. And no program has ever enjoyed greater public support.

Several key points about Social Security need to be kept in mind, particularly when considering proposals that would have the effect of replacing or substantially altering it:

Social Security provides a basic income floor for virtually all working Americans at the time of retirement, allowing millions of the elderly to maintain their independence. It provides $12 trillion in life insurance protection, more than all private insurance combined. More than 43 million Americans are currently receiving benefits -- including 27 million retirees, 11 million family members and survivors of deceased workers (including 3 million children under 18) and 5 million disabled persons.

Social Security is self-supporting and has not added a penny to the deficit. Since 1937 the program has collected $5 trillion and paid out $4.5 trillion, leaving $500 billion in reserve.

Social Security is highly efficient and has very low administrative costs. Administrative expenses consume less than one percent of revenues, compared to 11 percent on average (not including profit) for private insurance.

With fewer than half of all U.S. workers currently covered by private pension plans, the majority of retired Americans find themselves relying on Social Security for most of their income. Without Social Security, nearly one of every two elderly Americans would fall below the poverty line.

Social Security benefits and inflation adjustments have been of crucial importance in reducing poverty among older Americans. Thirty years ago, poverty among the elderly was more than twice the national rate. Today the poverty rate among the elderly is under 12 percent, comparable to other adults.

Social Security provides substantial protection for survivors and those with disabilities. For a typical example -- a 27-year-old couple, both working at average wages, with two small children -- survivors' protection is worth $307,000. Disability protection for the same family amounts to $207,000.

Social Security is, in other words, a program of many parts: part retirement program, part disability income program, part life-insurance program, part anti-poverty program -- and all of them working together for the benefit of the nation. Even if some individuals were able to do better under an individualized retirement savings scheme, the nation as a whole would not be better off.

It is also important to understand that although Social Security does require financial strengthening to meet its full obligations over the 75-year period for which Social Security forecasting is done, the program does not face a financial crisis -- now or tomorrow.

Even with no changes in present contribution rates and benefits, Social Security can continue to pay full benefits on time for 30 years, and after that could still pay 75 percent of its obligations. Even 75 years from now, without any change in law, Social Security could still meet 70 percent of its obligations. Our task, in other words, is not to overcome a crisis but to make up a shortfall.

In 1995, the Trustees of Social Security estimated that over the long run -- that is, over the course of the 75-year estimating period -- outlays are expected to exceed revenues by 2.17 percent of total covered payrolls. In other words, if Social Security contribution rates had been increased by 2.17 percentage points in 1995, the long-term deficit would be eliminated. This is not to suggest that a contribution-rate increase in 1995 would have been a good idea, but simply to show that the shortfall on the horizon is not of such magnitude as to require radical solutions. Moderate measures, undertaken soon, can avert major problems later, in much the same way that a minor course correction can steer a ship safely past a hazard on the horizon.

The long-term imbalance of revenues and expenses can be substantially reduced by taking several common-sense steps. These options are discussed in Social Security for the 21st Century: A Strategy to Maintain Benefits and Strengthen America's Family Protection Plan, our statement in the report of the Advisory Council, and are summarized below:

Long-term deficit remaining after implementation of above changes: 0.80%⁽⁶⁾

The Advisory Council agreed that this package of relatively modest changes reduces Social Security's anticipated long-term deficit by nearly two-thirds, extending the life of the trust funds from 2030 to 2050. That being the case, there simply is no compelling argument for abandoning the traditional Social Security program, with its unique advantages, for a radical experiment with individual retirement savings accounts. Yet that is the approach proposed by various Advisory Council members.

II. 'Individual Accounts' (IA)

The Individual Accounts (IA) plan proposed by two members of the Council would:

(1) Reduce existing Social Security protection so that over the long run benefits are brought into balance with the current combined contribution rate (12.4 percent of payroll); and

(2) Establish a new compulsory individual savings plan, financed by an additional 1.6 percent deduction from workers' earnings, raising the worker's deduction from 6.2 percent of earnings to 7.8 percent beginning in 1998.

Benefits under the Social Security part of the plan would be gradually reduced, ultimately cutting benefits about 30 percent on average. This results in part from accelerating the increase in the normal retirement age (NRA) scheduled in present law and then continuing to increase it by indexing it to longevity, and in part by changing the wage-averaging and benefit formulas. The reduction in benefits would be gradual but substantial.

Proponents argue that the IA plan, on average, is designed to protect the status quo for Social Security participants by bringing the combined benefits of the reduced Social Security system and the new savings plan up to the level now provided for (but not fully funded) by the present Social Security system. However, the IA plan has many flaws:

It reduces Social Security's defined guaranteed benefit plan in the long run by 30 percent for the average worker (32 percent for higher-paid and 22 percent for lower-paid workers), with the hope that the average return on savings in individual accounts will make up for the losses in Social Security benefits. But even if this turns out to be the case on average, many will fall below average, particularly among the lower-paid.

It requires all workers to set aside more of their wages than at present -- in effect a tax increase -- with the increase required to be saved for retirement, regardless of other more immediate needs that the worker and his or her family may have for health care, emergencies, or more basic needs such as food, clothing and shelter.

It makes the challenge of solving Medicare's financial problems more difficult by pre-empting compulsory deductions from workers' earnings for retirement savings rather than for health care. If a payroll-tax increase is to be considered, there is a more immediate need to direct such income to Medicare than to Social Security.

It undermines broad public support for the residual Social Security system by producing lower and lower benefits, which in turn will create pressure from the more successful savers and investors to shift more of their payroll taxes from Social Security to private accounts.

Even on average, it is unlikely to achieve the goal of adequate retirement income because many savings accounts holders will face more immediate needs and will want access to their money before retirement, and there will be great pressure on the Congress to authorize early withdrawals. After all, the selling point for these private accounts is that the money belongs to the individual. Individuals facing emergencies or other major expenses will not take kindly to being told that they must wait for many years to gain access to their funds.

For all of these reasons (discussed at greater length in our statement in the report of the Advisory Council), the six of us strongly oppose the IA plan. Indeed, we see the IA plan as something of a Trojan horse, in effect if not in intent, because it could result in undermining support for what would remain of the traditional Social Security program, thus leading to even greater substitution of a private savings scheme for social insurance.

III. Personal Security Accounts (PSAs)

The Personal Security Accounts (PSA) plan proposed by five members of the Advisory Council would:

(1) Replace Social Security's existing benefits structure with a flat monthly government-paid retirement benefit varying only with length of time worked;

(2) Create a system of compulsory private individual "security accounts" (i.e., savings accounts) for retirement, funded by 5 percentage points of the payroll tax now going to Social Security.

The monthly benefit payable via the government system would be $205 after 10 years of coverage (in 1996 dollars, wage-indexed thereafter), rising by about $8 for each additional year of coverage until the maximum benefit -- $410 a month -- is reached for workers having 35 years of coverage. Spouses of eligible workers would receive a monthly benefit of $205, and older surviving spouses would get 75 percent of the total flat benefit payable to the couple. A disability and young survivor's program similar to the present system (but ultimately reduced by 30 percent in the case of disability) would also be part of the central government system.

The PSA plan requires increasing the payroll tax by 1.52 percentage points beginning in 1998 and continuing through 2069. In addition, the plan would borrow from the Federal government over 33 years -- at the peak owing the Treasury about $2 trillion (in 1996 dollars, $15 trillion in then-current dollars) and then repaying it over the next 35 years. The tax increase and the borrowing are necessary to enable the plan to fulfill the benefit promises of the present Social Security system for those 55 and older, and to pay for past service credits from the present system to those 25 to 54. All those now under 25 would, at retirement, receive only the flat benefit plus whatever the 5 percent of wages invested in PSAs added up to.

Individuals would be free to invest their PSAs in any generally available financial instrument, and the accumulated amounts would become available when they reached retirement age, with no requirement for annuitization and with no special provision for spouses or other dependents.

The PSA approach has all the disadvantages of the IA plan -- and more:

It requires a 1.52 percentage point increase in the payroll tax for 72 years, and, in addition, massive borrowing from the Federal government.

The residual public Social Security program becomes even more unattractive to most contributors than in the case of the IA plan, with benefits related only to the length of time under the system. Thus, regardless of wage levels or what was paid in, the maximum benefit is only $410 a month (about two-thirds of the poverty level) for someone who has paid into the program for 35 years.

Investment choices are essentially unrestricted (and thus difficult to monitor) and the payout at retirement age could be in a lump sum, with no annuity requirement to spread payments out over the retirement years -- and no inflation protection.

The more successful investors would have little reason to want to keep what is left of the public system, and without their political support it would probably be phased out or converted into a means-tested poverty program.

The plan increases the Federal budget deficit by $200 to $300 billion a year for the next three decades. Moreover, with some investors failing to get good returns, the burden on the government (read: taxpayers) would in all likelihood be greater, because many retirees facing impoverishment would be forced to turn to means-tested income-support programs such as Supplemental Security Income (SSI), thus driving up the cost of these taxpayer-supported programs.

The plan is particularly harsh on those with disabilities and on those spouses who do not have sizeable accounts of their own (as discussed in our statement in the report of the Advisory Council).

The communication and administrative tasks created by the plan, particularly during the "transition" period (more than 70 years), seem overwhelming. The government would have to explain the protection being provided under present Social Security law and the new flat benefit program as it will be for the young, while explaining the rules governing how much one gets from each source during the transition. Administratively, the government would have to keep an eye on small as well as large employers to make sure not only that deductions are made from wages each payday but that they are deposited in the employee's choice of a bank, broker, or other financial agent. Then the government must make sure that the accumulating funds are kept intact -- through all subsequent movements of the varying totals among changing fiscal agents -- until retirement. This would be a monumental task. As noted previously, the administrative costs of the present Social Security system are below one percent. In contrast, the administrative costs of Chile's privatized retirement system -- which offers fewer options than would be available under the PSA plan -- are reportedly in the range of 15 percent.

The plan violates the basic principle of pooling resources and spreading the risk that has helped Social Security to weather economic downturns and recessions and that makes it feasible to distribute retirement income equitably. Instead of sharing risks, workers would have to bear risk individually -- with the certainty that some risks would turn out very badly, and that in such cases (typically people outliving their savings accounts), retirees would have to turn to their adult children or to means-tested income-support programs for help.

The plan fails the test of cost-effectiveness. If we want to increase returns on investment of Social Security funds -- both to completely close the remaining long-term deficit discussed above and to make Social Security a more attractive 'investment' for younger workers -- it would make far more sense to centrally invest a portion of the trust funds in private equities, as is done now by virtually all other federal, state, local, and private-sector defined-benefit retirement plans. With this approach, administrative costs are much lower and net overall returns are thus higher.

The IA plan and the PSA plan have their differences, but what they have in common is that both, in the guise of rescuing Social Security, require radical and unnecessary "reforms" that would mean new risks and higher costs for workers and retirees.

They require workers to pay twice for retirement: once to keep the present system solvent enough to pay at least reduced benefits to present beneficiaries and those workers who will be retiring soon, and once to fund the new system of individual retirement accounts.

They require major new tax increases. The IA plan increases workers' deductions (workers only -- no matching increase for employers) from 6.2 percent to 7.8 percent of payroll; the PSA plan increases the combined worker-employer rate by 1.52 percentage points while simultaneously borrowing more than $2 trillion from the Treasury. These are burdens that would begin now and accumulate for decades.

They undermine public confidence in Social Security, even in its "reformed" version, by requiring substantial cuts in government-paid benefits, thus making some private investment accounts appear to be more attractive.

They assume that workers will, on average, be able to offset reduced benefits -- and come out ahead -- by earning higher returns on their private investments. But of course there are no guarantees. A skillful or lucky investor may indeed do well; an unlucky investor could end up with much less than the benefits that would have been guaranteed in law under the present system. Averages being averages, it is a certainty that many would earn below-average returns.

None of this is necessary. The six of us who propose the Maintain Benefits plan believe that our first task is to take the common-sense steps outlined above (and discussed in our statement in the Council report) and this greatly reduces Social Security's long-term deficit right away. At the same we propose exploration of the various options to bring the program into full long term balance.

There are several such options, including: enacting, in the near future, moderate tax increases or benefit cuts for future retirees; scheduling further increases in the normal retirement age (which has the same effect on Social Security's long-term deficit as reducing benefits, and which some would argue may be justified by increases in longevity); or scheduling a series of future increases in contribution rates. All of these options have disadvantages, however, including making Social Security less attractive to younger workers by lowering the ratio of benefits to contributions. This strengthens the case for exploring the pros and cons of a public-private investment strategy.

IV. A Public-Private Investment Strategy

The six of us who advocate the Maintain Benefits plan also advocate reviewing Social Security's present investment policy. Under present law, funds may be invested only in low-yield government bonds. Yet funds are accumulating in anticipation of the demands on the system that will be made when the baby-boom generation begins retiring in the second decade of the 21st century. Investing up to 40 percent of this accumulating "surplus" in stocks indexed to the broad market would yield higher returns, closing the remaining long-term deficit while also improving the benefit/contribution ratio for younger workers.⁽⁷⁾

The objective of investment neutrality can be established in law and pursued as a matter of policy by establishing an expert board (as in the case of the Federal Retirement Thrift Investment Board, which administers the Thrift Savings Plan for Federal employees) to select an appropriate passive market index, choose portfolio managers, and monitor portfolio management.

Some critics of this investment strategy argue that politicians would be tempted to tamper with the index of government investments in order to steer investments toward preferred social objectives. In reality this is unlikely to be a problem. Once the objective of investment neutrality is set, we can be reasonably confident that our competitive political system will furnish the necessary checks and balances to protect this principle. Efforts by one party to undermine neutrality would provide a major point of attack for the other party, with the result that future Congresses would be reluctant to interfere with an established investment arrangement in which nearly every American family would have a stake. (This is the same principal of political balance that has thus far protected Social Security from radical change.)

Perhaps foremost among all the advantages of this approach over the IA and PSA plans is that it preserves Social Security as a defined-benefit plan, with benefits determined by law rather than by the uncertainties of individual investment decisions. In all respects, it leaves the essential principles of the traditional Social Security system undisturbed while restoring long-term balance and offering Social Security participants the same investment benefits that are enjoyed by participants in other large retirement plans -- state, local, and private. The investment risk is kept manageable and affordable by investing as a group rather than as individuals, and the administrative costs are, of course, very low in comparison to making investments at retail and managing millions of relatively small individual accounts.

V. Conclusion

Today Social Security fulfills what Lincoln described as "the legitimate object" of government: "to do for a community of people whatever they need to have done but cannot do at all or cannot do so well for themselves in their separate and individual capacities." It is extremely important that Social Security, as the basis for all retirement planning, continue in the form of a defined-benefit plan, promising specified benefits that are not at risk of being undermined by investment decisions.

With Social Security as a base to build on, those who can afford to accumulate other retirement income are free to do so, with encouragement from the tax code and without being penalized by a means test. And, with basic Social Security protection in place, pension plans and private investors can more freely take risks in pursuit of higher investment returns.

This argues for retaining Social Security as the basic foundation of our traditional three-tier retirement system -- a foundation that is not threatened by the failure of a business or the decline of an industry, and with benefits continuing to be defined by law. Over time, of course, Social Security has adapted to change and can continue to do so, even as we are now recommending. But the system that has met every challenge for 60 years has proven sound -- and continues to merit powerful public support.

Whenever Social Security's long-term stability has been threatened by circumstances warranting a legislative response, strong public support for the program has encouraged political leaders to seek bipartisan solutions that build on Social Security's inherent strengths. That is the approach we recommend now -- to build on rather than replace the family protection plan that works so well for so many.

Notes
1. Robert M. Ball, Edith U. Fierst, Gloria T. Johnson, Thomas W. Jones, George Kourpias, and Gerald M. Shea.

2. Council Member Edith U. Fierst would prefer not to implement either of these changes; see her statement appended to the main report of the Advisory Council.

3. Some of the revenue from taxation of Social Security benefits now goes to the Medicare Hospital Insurance (HI) trust fund, not as a matter of policy but for reasons related to Senate voting procedures (see the report of the Advisory Council, p. 78), and this anomaly should be corrected when Medicare is refinanced.

4. Estimates by the Office of the Actuary, Social Security Administration.

5. This is the only one of these proposals not supported by a majority of the Advisory Council.

6. Adjusted for interaction of proposed changes (see the report of the Advisory Council, p. 80).

7. To help maintain the program in balance even beyond the traditional 75-year estimating period, a contribution-rate increase of 1.6 percent should be scheduled to go into effect in 2045, with the understanding that at that time, depending on actual experience, the increase may not be needed (see the report of the Advisory Council, p. 86, for a discussion of this issue).