1994-1996 Advisory Council on Social Security

Report of the August 31st and September 1st Meetings of the Social Security Advisory Council

August 31

Members Present:

Edward Gramlich (Chairman), Robert Ball, Joan Bok, Ann Combs, Edith Fierst, Tom Jones, Syl Schieber, Gerald Shea, Marc Twinney, Fidel Vargas, and Carolyn Weaver

The meeting began with a presentation from David Lindeman, Executive Director of the Advisory Council, summarizing current law and existing proposals, in terms of the cost of the program. For this purpose, the cost of the program was defined as the dependency ratio (DR) multiplied by the replacement rate. The DR is the number of beneficiaries divided by the number of workers. The increase in the DR, caused primarily by falling birth rates, was cited as the most important factor in the increase in the cost of the program.

It was noted that one way to lower the cost of the program is to reduce the DR. All the plans before the Advisory Council would lower the DR by raising retirement age (i.e., reducing the number of beneficiaries) and extending coverage to newly hired State and local employees (i.e., increasing the number of workers). However, by including a raise in the early retirement age, Chairman Gramlich's proposal would further reduce the number of beneficiaries and, thus, lower the DR more than Mr. Ball's proposal.

Without significantly lowering the DR, the other alternatives for addressing the financing issue would involve increasing taxes, as in the Ball proposal, or lowering monthly benefit levels. Otherwise, the decision could be made to move to a more capitalized system by changing the investment of the trust funds into equity funds in order to increase the income earned by the trust funds.

In discussion, Edith Fierst expressed her belief that increasing the normal retirement age would be sufficient to lower the DR without having the severe impact of raising early retirement. Carolyn Weaver expressed concern that the trust funds needed to be protected from Congress by requiring minimum trust fund reserve ratios. Mr. Lindeman stated that the reserve ratio is already implicit in that there must be sufficient reserves to allow for the flow of benefits. With respect to investment in equity funds, he expressed the concern regarding the underperformance of investment income. Tom Jones stated that if individual accounts become part of the system, there may also be pressure on Congress to allow people to withdraw their money when they desire.

Louise Fox and Dmitri Vittas of the World Bank and Michael Tanner of the Cato Institute appeared as a panel to discuss personal investment plans (PIPs). Ms. Fox said that public pension programs have failed in a number of middle-income developing nations due to rapidly aging populations and overly generous benefits with retirement ages often as low as 45. She pointed out that these programs require payroll tax rates of 30 to 60 percent and tend to be poorly managed. She said that the poor rate of national savings in such countries compounds the problem of insolvent public pensions.

Ms. Fox outlined a World Bank 3-tier proposal which incorporates PIPs as an alternative to public pensions based on defined benefits. The first tier would be mandatory and publicly managed. Financed by taxes, it would include elements of insurance and income redistribution. The second tier would be mandatory but privately managed. Financed by worker contributions (whether employers would contribute is unclear), it would consist of savings and insurance. The second tier would be fully-funded and government-regulated. The third tier, also consisting of savings and insurance would be fully funded, but voluntary.

Ms. Fox stressed heavy reliance on the second tier for retirement income, and said that, in countries which have adopted the World Bank plan, workers strongly support the new system because of the individual equity involved. She said that countries adopting the World Bank plan can meet their retirement program needs much less expensively through reduced coverage. As more workers become dependent on the defined contribution portion of the program for the bulk of their retirement income, the obligation of the government to provide comprehensive defined benefit coverage could be decreased accordingly.

Ms. Fox suggested that transition costs to the partially-advance- funded World Bank plan are minimized in many developing countries by greatly raising both retirement age and compliance with payment of taxes. These approaches are not available for lowering transition costs in the United States, where the retirement age is already over 60 and compliance is nearly universal.

Mr. Vittas said that, in developing countries, PIPs can significantly improve the economy. He pointed out that there is a much greater incentive to make retirement contributions if there is a tangible link to benefits, and noted that the contribution compliance rate has increased dramatically in countries which have reformed their pension systems according to the World Bank plan.

Mr. Vittas noted that the current system (Social Security supplemented by private savings, pensions, and investments) works well in the United States, so that radical reform of the Nation's retirement system is not needed. He said that America's capital market is already well-developed, and concluded that the impact of PIPs on the country's overall savings rate would be unclear.

Mr. Vittas stressed, however, that adopting PIPs could overcome some of the political problems associated with the current system, such as charges that the Social Security trust fund reserves are merely worthless IOUs and that they are being used to "mask" the true size of the Federal budget deficit.

Mr. Tanner expressed strong support for PIPs as part of an extensive overhaul of America's retirement system, and advocated adoption of a system similar to that of Chile. He acknowledged that some regulations would have to be developed for safety and the movement of funds. He emphasized that many young people do not have confidence in Social Security and will not be satisfied with minor changes in the program.

Mr. Tanner said that the transition from Social Security to a PIP-based system could be financed by raising the normal retirement age or otherwise reducing benefits, by increasing general revenues (which could be achieved by reducing other Federal spending), or by increasing the Nation's debt limit. He conceded that the last alternative would be the least desirable and would probably receive little support.

Dr. Weaver said that PIP proposals should not be viewed solely from the rate-of-return standpoint. Other benefits, such as personal ownership and the confidence resulting from the transparency of such accounts, must also be considered. She pointed out that PIPs could overcome future program solvency concerns because they are not sensitive to changing demographics.

Chairman Gramlich expressed reservations about the transition from Social Security to another type of retirement system, noting that one generation would be forced to contribute to both systems. He opposed using significant benefit reductions to finance the transition, and stressed his support for voluntary, Government-managed accounts along the line of the Federal Thrift Savings Plan to supplement Social Security.

Mr. Schieber said that the original Social Security Act reserved the right of the Congress to make changes necessary to preserve the solvency of the program, and stressed that the Advisory Council must consider more than minimal proposals in order to achieve long-term solvency. He said that one way to finance the transition to a PIP-based plan would be to issue recognition bonds to cover contributions under the old system. Those bonds, used successfully in Chile's transition, are issued to older workers in acknowledgement that the majority of their payroll contributions were made to the old retirement system, and provide significant credits toward benefits payable under the new system.

Mr. Vargas said that many young people do not believe that Social Security is sustainable in its current form and that PIPs have their best chance of being considered in the current political climate. He suggested that the Advisory Council move ahead to publish a report which presents a number of alternatives rather than a narrow set of recommendations.

Mr. Ball said that, although he does not support PIPs, he would like to see a detailed PIP plan published in the Advisory Council report with an opportunity for those opposed to comment. He said that one of his primary goals is to protect Social Security benefits for current beneficiaries.

Chairman Gramlich proposed that those in favor of PIPs dedicate the final hour to developing a unified plan, and volunteered to moderate and participate in the discussion. All members present agreed, and Chairman Gramlich adjourned the public meeting.

September 1

Members Present:

Chairman Gramlich, Marc Twinney, Edith Fierst, Joan Bok, Bob Ball, Ann Combs, Fidel Vargas, and Syl Schieber.

The meeting began with a discussion of administrative issues, including potential problems that could result for the Council if there is a government-wide furlough in October.

Edith Fierst raised two concerns with regard to private pensions. She pointed out that many women end up in poverty because State and local government pension plans are not required by ERISA to provide joint and survivor options, and that pension integration rules reduce the progressivity of Social Security benefits by raising total benefits (replacement rates) disproportionately for high earners. It was agreed that there was no Advisory Council consensus to recommend the extension of ERISA rules to State and local government retirement programs. Mr. Ball concluded that the effect of reduced progressivity was not necessarily a bad result.

A panel consisting of Olena Berg, Assistant Secretary of Pension Benefits, Department of Labor, Judy Schub, representing the Pension Benefits Guarantee Corporation, Liz Buchbinder, Department of the Treasury, and Ellen Seidman, White House discussed private pensions.

Olena Berg discussed the Department of Labor's Savings Campaign which was launched July 19. She noted that her agency receives 160,000 inquiries each year regarding the calculation of individual pension benefits and that there is an incongruity between people's expectations and their real benefit amounts.

Ms. Berg stressed that her agency's message was that people need to supplement their Social Security benefits, not that saving is essential because Social Security would not be there for them. In response to a question from Mr. Schieber, Ms. Berg said that her agency could not be more aggressive in getting the message out because funds were not available for a broad-scale campaign-- similar, for example, to the Government's anti-smoking initiative.

Ellen Seidman discussed the Administration's Pension Simplification Plan. She said that in recent years, maintaining a retirement plan has become more complicated and costly, particularly for small employers. She noted that while 73 percent of full-time workers in private firms with 1,000 or more workers were covered by retirement plans in 1993, only 24 percent of those in firms with fewer than 100 employees were covered.

Ms. Seidman stated that the Administration's plan would especially help small employers increase the number of workers receiving retirement benefits by giving small employers new, less costly ways to provide retirement benefits for their employees. She concluded by saying that 80 percent of the Administration's Pension Simplification proposals are included in legislation pending in the House and in the Senate.

Liz Buchbinder, discussed the pension simplification proposals in the National Employee Savings Trust (NEST). NEST is a simplified voluntary retirement savings plan for small businesses as well as tax exempt organizations and governments. In response to an issue raised by Mr. Lindeman, Ms. Buchbinder said that Treasury believed that the current law "top heavy" rules (which were designed to prevent employers from providing rich pension benefits only to upper echelons of employees) have served their purpose and should be eliminated in controlled situations (such as NEST), where there are other safeguards to protect lower-paid employees.

Judy Schub stated that the "top heavy" rules were included to curb abuses, and if they were eliminated tomorrow, that most employers would continue to provide fair pension plans, but that a few would return to unfair situations where low-paid employees were not offered coverage. In response to a question from Mr. Ball, Ms. Schub said the Pension Benefit Guarantee Corporation could track defined benefit pension plans easily, but could not track defined contribution plan benefits.

Following a short break, Ms. Fierst suggested a proposal to modify the government pension offset provision by disregarding the first $200 of the government pension. She also discussed a Robert Myers' proposal to liberalize the windfall elimination provision. Syl Scheiber seemed opposed to these changes and Mr. Gramlich said that he thought the problems that Ms. Fierst wanted to address would be fixed by universal coverage as long as careful equity rules were included.

Prior to adjournment, Chairman Gramlich asked for any concerns or comments from Advisory Council members. Mr. Ball said that, in light of the fact that no solutions have been reached regarding the Medicare Hospital Insurance (HI) trust fund's solvency difficulties, Congress would be highly unlikely to adopt any plan for Social Security reform that would decrease revenues to the HI trust fund. For that reason, he is deleting from his plan the provision which would reallocate revenues from the taxation of benefits from the HI trust fund to the Old-Age, Survivors, and Disability Insurance trust funds. In order to maintain the long- term actuarial balance in his plan, Mr. Ball is making two benefit adjustments: He would eliminate the hiatus at age 66 in the scheduled increase in the normal retirement age and would add a proposal to reduce the Social Security spouse's benefit from 50 percent of the worker's basic benefit amount to 33 percent. He said that these changes would still leave a positive balance of about 0.08 percent of taxable payroll.

Chairman Gramlich conceded that it might be necessary to modify his proposal regarding HI revenues also, but did not cite specific provisions for maintaining its long-term actuarial balance.