Statement of Nancy Mitchell Pfotenhauer, President,
Independent Women's Forum

Before the Subcommittee on Social Security,
 House Committee on Ways and Means

Hearing on Social Security Improvements for Women, Seniors and Working Americans

February 28, 2002

Mr. Chairman and Members of the Committee, I’d like to thank you for the opportunity to testify today on this important topic. My name is Nancy Pfotenhauer and I am president of the Independent Women’s Forum. I am an economist by profession, with experience in the Senate, the White House and the private sector. My first involvement with this issue dates back to the late 1980’s, when I had responsibility for staffing Senator William Armstrong on his Finance Committee work pertaining to Social Security. The Senator had co-chaired a bipartisan task force directed at that time to make recommendations on how to improve the current system.

As you know, a strong, vibrant retirement system benefits all Americans, including women, and Social Security is an important part of our nation’s multi-pronged effort to provide a safe and comfortable income for seniors. In many ways, the Social Security system has been successful. Poverty rates among the elderly have fallen. The program has been particularly important for women, since they tend to outlive their spouses by a substantial margin.

Today’s hearing raises a critically important topic. How can Social Security be improved for Women, Seniors, and Working Americans? The simple answer, of course, is that all Americans – old and young, rich and poor, black and white, male and female – will benefit if lawmakers can strengthen and modernize Social Security so that it is both actuarially sound and capable of providing an adequate level of retirement income.

But the challenge is how to achieve this common goal. This challenge is especially daunting considering the long-run financial problems that plague the Social Security system. Nonetheless, the following principles should guide lawmakers:

• Current retirees should receive all currently promised benefits – Simply stated, the government made a contract with these people. Whether this contract was perfect is immaterial; government should not pull the rug out from under people who have fulfilled their side of the bargain.

• Lawmakers should focus more on long-term stability and less on short-term finances – Social Security will experience modest surpluses for the next decade, but will suffer enormous deficits once most baby-boomers have retired. But fiscal balances should not be the tail that wags the dog. It is far more important to create a system that is strong and stable, regardless of short-run “transition” issues.

• International evidence is an important guide – Fortunately, many nations have engaged in substantial reform to their old age retirement systems. These experiences are a road map for lawmakers. They suggest ways of protecting seniors from poverty, ways of boosting macro-economic performance, and ways of generating more retirement income.

The Challenge

Lawmakers have two important issues that require their attention. First, Social Security has a financing crisis. Cash-flow deficits will appear about 2015 and this shortfall quickly will reach enormous proportions, averaging about 2 percent of annual GDP. The total deficit between 2015 and 2075 is more than $20 trillion – and that is after adjusting for inflation.

But there is another crisis. Retirees are receiving inadequate benefits compared to the money they are paying into the system. This rate-of-return problem worsens over time. People who retired 30 years ago got a good deal from Social Security. But people who retire today are not treated nearly as well when you consider how much more they paid into the system. And younger workers clearly will get a bad deal. Some demographic groups, such as African-Americans and working women, are especially disadvantaged.

Unfortunately, lawmakers who try to solve both of these problems – the financial crisis and the rate-of-return crisis – are bedeviled by a Catch-22. In many cases, policies that would solve one problem have the effect of making the other problem worse. Higher taxes, lower benefits, increases in the retirement age, and COLA adjustments, for instance, all have the potential ability to reduce the program’s massive deficit, but each and every one of those policies will have the effect of making Social Security’s anemic rate-of-return even worse. Yet proposals to increase the program’s rate-of-return – such as cutting payroll tax rates and/or increasing benefits – will simply cause the red ink to occur even sooner.

This is why fundamental reform is the only real answer. Personal retirement accounts are a way of escaping this Catch-22. Shifting to a funded system solves the long term financing problem since workers will be able to use their nest eggs to finance the bulk of their retirement expenses. Personal accounts also solve the rate-of-return problem since the power of compounding will ensure a substantial nest egg after 40-45 years of work. And a fringe benefit of fundamental reform is that the transition costs of moving to such a system are far less than the long-term cost of bailing out the current system.

Today’s Issues

Understanding the size and scope of Social Security’s problems is critical if we are to accurately judge incremental proposals to improve the system. Today’s hearing is designed to explore three specific issues: 1) benefit increases for women; 2) benefit guarantees for seniors; and 3) better information for workers.

The first issue must be taken in the context of the unintentioned, but significant, systematic undercompensation of women inherent in the current system.  Here are three examples:

*Women who try to balance the twin stresses of work and home by taking some time out of the workforce to care for young children or an aging parent will suffer because this “time out” lowers their overall earnings upon which benefits are calculated.

*If a married woman makes more than her husband, she is disadvantaged because benefits are based on the difference between her earnings and her spouse’s earnings.

*If a woman outlives her husband – as she is likely to do – her overall household benefit will fall dramatically, despite the fact that her overall expenses may not.

As a society, we purport to care about families.  If so, we must change our retirement system so that married women who work don’t get the short end of the stick.  In short, we must change the “dual entitlement rule.”  A woman who works – by choice or by necessity -- outside the home loses her ability to qualify for both a spousal benefit and an individual benefit, despite the fact that she has earned both.  Again, this is an unintentional consequence – but a serious one that needs to be corrected.

As you know, every married woman, regardless of whether she has ever worked and paid FICA taxes, is eligible for a benefit equal to half of her husband’s benefits.  Since many working women earn less and are employed fewer years than their husbands, 50% of the spouse’s benefits are frequently larger than the benefit calculated on the basis of their own earnings.  This means the typical married working woman receives no credit or benefits based on the payroll taxes that she has paid.  In the end, this woman receives precisely the same benefit that she would have received if she never had worked outside the home or contributed financially to the Social Security system.  Not only do these women sacrifice time with their families, they get no financial recognition of the substantial contributions they’ve made to the Social Security system.

The most detrimental aspect of the dual entitlement rule, however, is bestowed upon widows who worked to support their families.  The Social Security system effectively leaves widows with up to 50% less income than the couple had before the husband died.  In fact, by its own estimates, the Social Security Administration reports that 24% of married and widowed women have their benefits slashed by the dual-entitlement rule.  By 2040, that number is projected to increase to nearly 40%.

With regards to the second issue, benefit guarantees are symbolically important. As mentioned previously, government should fulfill its contract with senior citizens. But we should be honest about benefit guarantees. No Congress can bind a future Congress. Laws that are passed today can be repealed tomorrow. The only way to create an ironclad guarantee is to actually purchase annuities for retirees that provide the promised level of benefits. But this is probably not a likely option since it would require costs to be recognized today instead of in the future, something that is not feasible because of the current budget process.

Nonetheless, benefit guarantees should be part of the Social Security debate if they are clearly linked to Social Security reform. No serious reform proposal includes any reduction of benefits to current retirees. For both moral reasons and political reasons, reformers have no desire to touch a single penny of the benefits promised to those who played by the rules and paid in to the current system. Benefit guarantee legislation is a way of expressing this intent. But to enact guarantee legislation without reform is a hollow promise.

The third issue before the committee today is critically important. The American people deserve high-quality information about the state of Social Security’s finances. The provision of such information will improve the level of public understanding and make it more difficult for demagogues to mislead and scare people. As part of their annual Social Security Statement, workers should be told:

• How much they have paid into the system, including the taxes that their employers paid on their behalf.
• Their estimated monthly benefit based on their earnings history.
• The estimated annualized return, based on a comparison of their total payroll tax burden and their estimated monthly benefit.
• The amount of general fund revenues that will be needed to redeem the bonds in the Trust Fund.
• The amount of promised benefits that can be financed once the Trust Fund is exhausted.

There is surely other important information that could be added. The key goal is making sure the American people have an honest, dispassionate presentation of Social Security’s finances. These figures should reveal the program’s overall fiscal health, and the figures also should allow workers to determine how the program affects them.

Creating a Stronger System

The issues discussed today are important, but they are no substitute for reform. The only long-run answer is a modern Social Security system with the following features:

1. Allow workers to divert the bulk of their payroll taxes (the World Bank advises at least 5 percent) to individual, defined contribution accounts.

2. The savings should be privately managed with prudential regulation but no government manipulation or direction of funds

3. All money in personal accounts should be off-limits, with all returns re-invested, until retirement.

4. Upon requirement, at least a portion of the nest egg would be converted into an income stream.

5. Maintain a safety net to ensure that all workers receive at least as much income as the current system provides.

6. To maximize retirement income and ensure no bias against savings, the system should receive IRA treatment.

The International Evidence

As lawmakers consider how best to reform and strengthen Social Security, they should review what has happened in other nations. The actions of other nations demonstrate that personal accounts work, but these experiences also demonstrate that there are several ways to design a new system. Important variables include:

• Level of Mandatory Savings – Some nations, such as Sweden, have “privatized” only a small portion of payroll tax (only 2.5 percent, though there is an additional 2 percent – 4 percent of salary that is used to fund an employer-provided pension. Other governments, by contrast, have created fully funded systems. Australia, Hong Kong, and Chile would fall in this category, with mandatory savings levels of about 10 percent.

• Defined Benefit or Defined Contribution – Some governments, such as Switzerland and Holland, utilize defined benefit systems that guarantee a pre-determined payment based on a formula. Others, such as Australia, Hong Kong, and Chile, use a defined contribution system, meaning that benefits are determined by investment performance. Some countries, such as the United Kingdom and Sweden, have a blended system.

• Individual Mandate or Employer Mandate – The decision on who sends the money to a personal account is somewhat meaningless since the money inevitably is a form of employee compensation. And whether the mandate falls on the employer (as in Australia) or the worker (as in Chile), the employer always is responsible for withholding the funds and ensuring that the money is transferred to the fund manager.

• Private Management or Public Management – With a few exceptions, such as Singapore, all nations with personal accounts rely on private fund managers to invest funds.

• Voluntary or Mandatory – Many countries, such as the UK and Chile, allowed workers to choose whether to participate in the new system of personal accounts. Others, such as Hong Kong and Australia, mandated participation.

• Add-On Accounts or Payroll Tax Diversion – Nations with payroll-tax funded retirement systems, such as Sweden, the UK, and Chile, allow workers to finance personal accounts with existing payroll taxes. Nations with no retirement system (Hong Kong) or general revenue-financed retirement systems (Australia) create “add-on” accounts.

• IRA or 401(k) Model – Some nations allow workers to choose fund managers. Chile and Sweden would be examples of this IRS-type model. Other countries rely more on a 401(k)-type approach. In Hong Kong and Australia, for instance, your fund manager is likely determined by your place of work (though workers generally have substantial control of their portfolio).

• Regulation – Most European nations rely on prudential regulation, while Latin American nations tend to impose investment limits on fund managers.

• Taxation – Most nations provide IRA treatment to personal accounts, though Sweden and Australia are exceptions.

• Safety Net – Some governments, such as Hong Kong, have no safety net. The vast majority of governments, however, have substantial safety nets. In many nations, such as Sweden and Australia, it is impossible for workers to retire with less income than they would have received from the old government-run system.

• Transition – This is not an issue for nations with add-on accounts. In nations that allow workers to finance personal accounts with payroll taxes, government borrowing and fiscal restraint are the two most common ways of bridging the transition between a pay-as-you-go and funded systems.

• Income Streams or Lump Sums – Some governments (Hong Kong) have no requirements to use income streams. Others (Australia) strongly encourage income streams through tax law, while others (Sweden) require mandatory annuitization.

Conclusion

Social Security reform is desperately needed to solve Social Security’s financial crisis and the program’s rate-of-return crisis. But there are some common criticisms of reform. Allow me to close by addressing a few of these topics: 

1. Transition –Yes, because Social Security is a pay-as-you-go system and a substantial portion of payroll taxes will be diverted to private accounts, we will have to come up with several trillion dollars to pay benefits to current and soon-to-be retirees. Yet reform will save money because this is less than the money – more than $20 trillion – needed to balance current system.

2. Administrative costs – No system is likely to have admin costs as low as SS, but no system could produce returns as low as SS. This is a design issue, not a problem. If lawmakers want to minimize admin costs, they could copy Australia’s private system, which is like a simple, low-cost, universal 401(k).

3. The stock market will fall – Yes, it will, but more often than not, it will rise. Opponents of privatization have some success scaring financial illiterates, but I assume this audience does not need to be told about long-term market returns and the power of compound interest. Suffice to say, that the average, inflation-adjusted return since 1926 is more than 7.5 percent—and that includes the great depression and the crash in October of 1987.

4. Financial illiteracy – Yes, there are many workers who do not have knowledge of markets and, yes, there are unscrupulous people who would like to prey on these folks. No one is arguing, however, that there should be no prudential regulation and unlimited ability to self-direct investments. Under every reform plan, professional fund mangers would be in charge of the money.

Thank you again for this opportunity to testify.