Statement of Edward M. Gamlich, Ph.D., Dean, School of Public Policy, Universitry of Michigan

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

Hearing on the "The Future of This Generation and the Next" -
The Report of the 1994-1996 Advisory Council on Social Security

March 6, 1997

Thank you for soliciting my testimony on Social Security reform, Mr. Chairman. In trying to reform this important program that has worked so well now for sixty years, I am guided by three goals. The first is to retain the important social protections of this program that has greatly reduced aged poverty and the human costs of work disabilities. The second is to make these social protections affordable by bringing Social Security back into long term financial balance. The third is to add new national saving for retirement -- both to help individuals maintain their own standard of living in retirement and to build up the nation's capital stock in advance of the baby boom retirement crunch.

In the recently released report of the Advisory Council, I have introduced a compromise plan, called the Individual Accounts Plan (IAP), that tries to achieve all three goals. It would preserve the important social protections of Social Security and still achieve long term financial balance in the system by what might be called kind and gentle benefit cuts. Most of the cuts would be felt by high wage workers, with disabled and low wage workers being largely protected from cuts. Unlike the other two plans proposed by the Advisory Council, there would be no reliance at all on the stock market for these benefits, and no worsening of the finances of the Health Insurance Trust Fund.

The IA plan would include some technical changes such as including all state and local new hires in Social Security and applying consistent income tax treatment to Social Security benefits. These changes are also part of the Council's other plans, and go some way to eliminating Social Security's actuarial deficit.

Then, beginning in the 21st century, the changes would be supplemented with two other measures. There would be a slight increase in the normal retirement age for all workers. There would also be a slight change in the benefit formula to reduce the growth of Social Security benefits for high wage workers. Both of these changes would be phased in very gradually to avoid actual benefit cuts for present retirees and "notches" in the benefit schedule (instances when younger workers with the same earnings records get lower real benefits than older workers). The result of all changes would be a modest reduction in the overall real growth of Social Security benefits. When combined with the rising number of retirees, the share of the nation's output devoted to Social Security spending would be approximately the same as at present, eliminating this part of the impending explosion in future entitlement spending. Of the three plans suggested by our Council, my plan is clearly the best for achieving short and long term balance in the federal budget.

These benefit cuts alone would mean that high wage workers would not be experiencing rising real benefits as their real wages grow, so I would supplement these changes with another measure to raise overall retirement (and national) saving. Workers would be required to contribute an extra 1.6 percent of their pay to their individual accounts. These accounts would be owned by workers but centrally managed. Workers would be able to allocate their funds among five to ten broad mutual funds covering stocks and bonds. Central management of the funds would cut down the risk that funds would be be invested unwisely, would cut administrative costs, and would mean that Wall Street firms would not find these individual accounts a financial bonanza. The funds would be converted to real annuities on retirement, to protect against inflation and the chance that retirees would overspend in their early retirement years.

All changes together would mean that approximately the presently scheduled level of benefits would be paid to all wage classes of workers, of all ages. The difference between this outcome and present law is that under this plan these benefits would be affordable, as they are not under present law. The changes would eliminate Social Security's long term financial deficit while still holding together the important retirement safety net provided by Social Secuity. They would reduce the growth of entitlement spending and improve the federal budget outlook. They would significantly raise the return on invested contributions for younger workers. And, the changes would move beyond the present pay-as-you-go financing scheme, by building up the nation's capital stock in advance of the baby boom retirement crunch.

As the Congress debates Social Security reform, I hope it will keep all of these goals in mind. I also hope it will make these types of changes in this very important program. Thank you for hearing me.