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MR. MATTHEWS: Between 1994 and 1996 the Social Security Advisory Commission was looking into the issue of how to reform Social Security. They came out with their findings in January. There were three factions. They were quite divided over this. The leader of the faction who wanted to go most towards privatization was Dr. Carolyn Weaver, who is with us today. She was formerly at the Hoover Institute. She has been with AEI, American Enterprise Institute for some time. She is a resident scholar and director of Social Security and Pension Studies at the American Enterprise Institute. She has been the editor of two books that AEI has published, one of which has to deal with Social Security.
From 1981 to 1984, Dr. Weaver served as the chief professional staff member on Social Security for the US Senate Finance Committee under the chairmanship of Senator Dole. She is now currently working on another book on Social Security. She is here to talk about what the Advisory Committee found and what she wanted to present in that committee. Dr. Weaver.
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Dr. Carolyn Weaver
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Thank you. You all are a dedicated group being here this late in the evening to talk about Social Security reform, but I do appreciate it.
It seems to me that if it wasn't clear before the Social Security Advisory Council reported in January, it is certainly clear now that there has been a seed change in public attitude about and the political discourse over Social Security reform in just the very recent past. It was only a few years ago, maybe three or four years ago that privatization was rejected out of hand in Washington policy circles, and was generally not even taken seriously in the academic community. And today we have people around the nation from widely different economic and political views taking a long hard look at privatization options and many of them are concluding that there are good reasons to move in this direction.
No one, I venture to say, not even me, anticipated three years ago when Secretary Shalala appointed the Social Security Advisory Council -- (audio break) -- members appointed by her would end up proposing turning half of the retirement program into a private system of basically mandatory individual retirement accounts, full privatization of half the retirements, that something.
And yet, we did it and ours was a very diverse group. Something that hasn't been very well noticed in the press, we represented -- we had a couple of Republicans, a couple of Democrats, an independent. We had the only Hispanic member on the panel, we had three out of five of the women on the panel, and we ranged in age from 20-something to 60-something. We were more diverse than the other two groups on the panel.
Obviously times have changed and privatization is on the agenda. Having said that, let me stress a couple of the points that all three of the factions on the Advisory Council agreed on, which have been alluded to by other speakers, because I think they are very important for thinking about the future of the whole reform discussion.
One was that we should have some substantial buildup in the assets, in real assets in the Social Security system. The assets we currently have, while they sound large at $500 billion, if you're spending $350 billion a year, that's a trifling trust fund. So there was serious consideration on the part of all three groups of moving toward much more substantial advanced funding rather than relying on traditional pay as you go financing.
Secondly, all three of the plans would involve private equity investment rather than relying on the traditional low yielding government bond investments.
And then, in a sharp break with tradition, most panel members agreed that we needed to move toward privately owned, privately invested accounts. There was a difference of opinion between the chairman, which had two votes, the chairman's plan and the plan that I support, the personal security accounts plan, about a number of the details, most important being that his plan, the private accounts would be held by the government. There were a number of other restrictions applied, and was an add-on to the current Social Security system. Under the PSA plan it is actually a replacement for a part of Social Security.
In any event the key point is that all three groups, and this is a sharp break in tradition for advisory councils, all rejected the old nip and tuck reforms of the past, the little tax increase here, a little benefit restraint there, and sort of brace for the next financing crisis. It was clear that something had to be done to secure Social Security on a longer term basis and to create some value for younger workers.
Obviously within this framework of agreement there was lots of room for disagreement. And one point I'd like to make, our critics often suggest that what it fundamentally came down to when push came to shove, was a very basic difference in social values about what we wanted for the country and what we valued about poor people and old people. And I just think this is just pure smokescreen.
We came down to just basic practical questions, economic, fiscal and political questions about how you structure a system to create real savings and real investment, and do so while providing a safety net for the elderly poor.
In any event, starting from the premise that we should fully fund a component of Social Security, that is actually accumulate assets against accruing liabilities, the PSA supporters, the five of us who supported the PSA plan, believed it was highly undesirable to centralize those investments, that is the management of those investments, that once having effectively centralized investments you were just one step away from politicizing the investment, and that put workers' monies at risk as well as the allocation of capital in the economy.
And it's important to realize that under any of these plans we would have quickly had a trillion dollars or more in assets being directed into private equity markets. And therefore, we sought to find a highly decentralized investment mechanism and did so with one that was based on competition, individual choice and private ownership, which were the keys for us.
Briefly, the way our plan works is that we take five percentage points of the 10 percentage points that now go to the financing retirement program and shift those into personal accounts. The balance of the tax would go to finance disability and survivor benefits, and a remaining government retirement benefit. I should say that our advisory council largely put disability insurance off limits, figuring it was way too complex and big an issue to deal with in the time we had. That was back when we thought we'd take a year to produce our report, of course, rather than two-and-a-half years.
In any event, workers would own these accounts and they would have broad discretion in the way they would invest these. They would invest them through private financial institutions directly and private financial investments. There would be a broad array of financial investments. We envisioned something like a mandatory IRA.
These accounts, as I say, would not be built on top of Social Security, like the chairman's plan, but would replace half of Social Security ultimately. They would not be held by the federal government, they would be held by private financial institutions, and workers could gain access to their funds, as they wished at age 62, and would not be forced to annuitize the full balance, as in the chairman's case. They could actually pass along to their heirs any remaining balance.
And I think here it's important to keep in mind -- several participants here have been talking about low wage workers. Low wage workers are typically low life expectancy workers, and they are particularly disadvantaged by the forced annuitization requirements. So allowing people with known short life expectancies to be able to be able to actually draw out their proceeds as they wish, and then have assets to pass along is very valuable.
Everyone in our plan under 55 would have a personal account.
We were well aware, of course, of the financial risk that workers would be taking on. We heard about them daily, but we also thought it was important to weight that against the benefits of giving workers at all income levels the opportunity to accumulate real owned wealth and to reduce their dependence on the federal government for their own retirement income security, at the same time allowing everybody to shed some of the considerable political risks attached to these long-term benefit promises. And as we've heard, looking at long-term market averages, a well diversified portfolio of stocks and bonds substantially out performs what Social Security can deliver.
Under our plan, as I say only half of the system was privatized. That's how you get five votes instead of one, and the other half of the program would be converted into a flat benefit for full career workers. Not a flat rate but an actual flat dollar amount for full career workers and this is scaled to years of work; not unlike the UK system which has a two-tiered system. The first tier, very much as in the UK, would pay young workers something equivalent to the poverty level when they retired in a lifetime annuity, fully cost of living adjusted. In addition to that, then you'd draw your proceeds from your personal account.
If there is a controversial aspect of our proposal other than the fact that it involves privatization, it's certainly the transactions cost, and I think people like to throw that up largely to keep you from getting on to talking about the benefits of privatization. But let me acknowledge that there are hefty transition costs to any plan that involves more significant advance funding, and this stems not from privatization, it stems from our existing pay as you go system. It is our existing system that has extended benefit promises of nine to $11 trillion beyond the assets we have on hand. You heard the figure earlier of about twice the national debt exists in implicit, off the books debt to the Social Security system.
Obviously a shift toward private accounts, if we're going to continue benefits for older workers and for people who are now on the rolls, involves making a portion of this implicit, off the books, IOU explicit through formal government bonds. And to say that privatization involves, as I heard yesterday while I was doing a press conference at the Brookings Institution, to hear about the massive amounts of new debt that privatization would involve, it means sort of putting your hands up and covering your eyes about that huge debt that already exists. And for those of you that are not familiar with the Social Security unfunded liability numbers, last year alone the unfunded debt in Social Security rose by $800 billion. If you want to put into perspective what Congress is trying to do in the way of balancing the budget, over the last five years alone that debt has risen by $2 trillion, which puts our $2 trillion debt accumulated over 30 to 40 years into some perspective.
Now another unpopular piece of this is the 1.5 percent payroll tax supplement that is designed to spread the cost of the transition over a 70 year period. And in the first three decades when we have to draw on that tax plus federal borrowing, then in the latter three decades the extra proceeds from the payroll tax would be designed to pay off that debt.
And I should mention that unlike the other two plans, one which involves a direct payroll tax increase, and one which involves a mandatory add on savings component with a permanent tax increase, none of the members of the PSA group would have endorsed a payroll tax for any purpose other than paying off the unfunded liability and transitioning to privatized accounts. There was no support for using the payroll tax increase to fund the cash flow deficit or to create an add on to Social Security.
Having said that, when the actuaries cranked through all the numbers and added up all our transition costs, factored in the cost of servicing the debt, the payroll tax supplement and everything else, workers generally fared better under our plan than under either of the other two, both in terms of replacement rate -- that is benefits relative to pre-retirement earnings, and in terms of rates of return -- implicit rates of return. Workers fared better.
In the interest of time I'll just stress the question we're frequently asked, which is can workers be given this kind of responsibility? And I'll reiterate basically what you've heard. Yes, we think of course they can. To the extent workers don't have a great deal of experience with these types of private investments, it's largely among lower wage workers who have never had any discretionary income to save and invest. This would quickly solve that problem and create real incentives and opportunities for savings and investment for everyone.
The big developments, of course, are with mutual funds and with in particular stock index funds, which allow people to participate in market advances without having to become stock price analysts or in any way cherry pick or play the market. These are low cost means of ordinary men and women participating in the stock market.
And I would say that we talked about it a great deal in the end, could low wage workers, unsophisticated workers, poorly educated workers, could they do it? And all of us agreed they could. And indeed, some of our executives who had been involved with 401-K plans in their companies know the great deal of interest that lower wage workers take in their 401-K plans. They have a particular stake in performance of those plans.
And in the end, we concluded, I think prudently, that if education is a problem, then investment in education ought to be the answer, and we think that that would be forthcoming readily in a market based system.
I will close by just saying that I think it's no longer a question of whether we will have private investment accounts in the years ahead for all Americans to replace a portion of Social Security, but just how quickly we'll get to that point.
It seems to me clear that our one size fits all government tax and transfer system simply doesn't meet the needs of workers retiring in the 21st century. Given that we have the most sophisticated financial markets in the world at our disposal it makes perfect sense to use them. And for all the reasons you've heard, we believe workers and the economy, and society as a whole stand to gain from a movement toward privatizing now. Thank you.
MR. MATTHEWS: Thank you, Doctor. We have just a few minutes and we're fortunate that Congressmen Sanford and Smith have rejoined us, so if you have some questions, let's take some.
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