President and CEO, Barbara B. Kennelly's Statement to
the Senate Committee on Finance Hearing on
Proposals to Achieve Sustainable Solvency,
With and Without Personal Accounts

April 26, 2005

Mr. Chairman and Members of the Committee:

Earlier this month, the Senate engaged in an extended debate on an issue of great concern to millions of Americans: the privatization of Social Security. During that debate on the Senate Floor, it was stated: “this isn't a debate about Social Security's solvency ; it's a debate about Social Security's legitimacy ”.

I believe this statement accurately describes both the nature of the policy debate before us as well as its importance to the American people. For many of us, the drive toward privatizing Social Security is not, at its core, a question of the program's finances. This debate is actually about what kind of society we believe in.

The National Committee to Preserve Social Security and Medicare represents over 4 million members and supporters who are united in their opposition to the privatization of Social Security and Medicare. The members of the National Committee understand better than anyone the importance of Social Security. Every day, over 47 million Americans – one out of every four households – experience the success of Social Security firsthand. This great program is the single largest source of retirement income in the United States , and each year it keeps 12 million seniors out of poverty. Social Security, unlike virtually any other financial instrument, provides a sound, basic income that is adjusted for inflation and that lasts as long as you live.

The members of the National Committee are seniors who have long experience with the unpredictability of life. They understand the true value of Social Security not just for themselves, but for their children and grandchildren.

My members fervently believe in Social Security. They have experienced firsthand the “hazards and vicissitudes” of life, and believe in a collective societal sharing of risk to guard against them. They also truly believe carving private accounts out of Social Security will ultimately result in the dismantling of Social Security as we know it.

The problems with replacing Social Security with a system that incorporates private accounts are many. First and foremost is the issue of cost. Because any projection of the program's solvency necessarily requires uncertain predictions of economic growth, experts can disagree about the financial strength of Social Security over the long term. While there may be long-term demographic issues Congress should address to strengthen the program, it is by no means facing a financial crisis. Any system that is dependent on economic projections decades into the future will inevitably require adjustments from time to time, because no one can accurately predict that far in advance.

Completely apart from the reliability of long-term estimates, it is clear that diverting payroll taxes out of the Social Security program and into private accounts accelerates insolvency. How quickly the revenue flows go negative and the Trust Funds are unable to pay 100 percent of benefits depends on a number of factors, most significantly the amount allowed to be diverted and the number of workers who opt into the accounts. For example, allowing 4 percent of payroll taxes to be diverted into private accounts can drain the Trust Funds so quickly that today's surpluses are converted to deficits almost immediately, and the Trust Funds are unable to pay full benefits by 2030, a full decade earlier than the current Trustees' estimates.

In addition to the direct impact on Social Security, the creation of private accounts requires a massive infusion of resources spanning multiple generations. These costs are often obscured but are unavoidable in such a vast systemic change. Today, Social Security is a pay-as-you-go program, which means the payroll taxes paid by today's workers go to pay the benefits of today's retirees. Under privatization, however, today's workers must also fund their own accounts.

The result of privatization is that most workers end up paying twice – once to pay the benefits that have already been earned by current retirees, and then again to fund their own benefits, whether through borrowing, tax increases, cuts in future benefits, or some combination. A study conducted for the National Committee in 1997 concluded that every single generation living at the time of privatization would end up worse off financially than if nothing had been done to strengthen Social Security at all. More recent projections by other organizations, including the Congressional Budget Office, have reached similar conclusions.

The magnitude of the cost of privatization is evident in any private account plan. Those plans will necessarily incorporate deeper benefit cuts and/or dramatically larger borrowing to compensate for the money being diverted. These benefit cuts and the amount borrowed will be substantially larger than the amounts that would be needed to simply restore solvency to the existing program.

Plans that purport to create private accounts without benefit cuts or borrowing rely on unsubstantiated projections of economic growth that are unlikely to materialize. Minimum benefit levels guaranteed by some plans without also providing funding for these benefits cannot be relied upon to deliver these promises, particularly after the additional borrowing required to set up the private accounts. Two such examples are the plans before you today presented by Michael Tanner and Peter Ferrara. In order to achieve solvency, these plans envision massive transfers of general revenues, the sources of which Social Security's actuaries accept without question or further analysis. The Ferrara plan, for example, would require transfers of more than $68 trillion over 75 years – funds which would be generated by a combination of implausibly large cuts in federal spending and unsubstantiated increases in corporate revenues. If these revenues fail to materialize, Mr. Ferrara simply reverts to additional federal borrowing to cover the shortfall. This system of financing private accounts was labeled by a senior advisor to the Concord Coalition as “the most wondrous perpetual-motion discovery in financial history”.

The specific cost of the conversion will differ with the details of the plan, but clearly trillions of dollars will be required over time, much of it borrowed. Some proponents of private accounts describe these trillions of dollars of additional borrowing as nothing more than pre-paying a mortgage that is already owed. What they forget is what happens when you pre-pay the mortgage by borrowing money, which is what our current deficit situation will require. You end up paying a whole lot more by the time you are done.

The borrowing required to privatize Social Security is also the reason privatization is so bad for our younger generation. Proponents of privatization have spent the last decade trying to convince young people that Social Security will not be there for them when they retire, as a way of persuading them that they should not care about the dramatic benefit cuts that will necessarily be part of any plan that includes private accounts. For those who have been convinced they will not receive a benefit at all, a 50 percent cut in benefits does not seem like such a bad deal.

In reality, however, the younger generation is the one that will be hurt the most by privatizing Social Security. Because they are destined to spend the most time in the workforce under a privatized system, they will bear the brunt of the double costs. These costs are popularly described as “transition costs”. We would argue that label is misleading because transition costs imply something that lasts a short time and then is gone. In contrast, the costs of this borrowing will last for generations. My twin 3-year-old granddaughters will still be paying off this debt when they reach middle age, as will the grandchildren of millions of the National Committee's members.

The impact of trillions of dollars in additional borrowing on financial markets is also unclear, with miscalculation potentially resulting in catastrophic consequences. Acceptance of the additional borrowing requires lenders to rely on assurances by current legislators that their successors 50 years in the future will follow through on the dramatic benefit cuts privatization plans will require.

Creating private accounts is so expensive, the trillions of dollars of borrowing must also be supplemented with deep benefit cuts. This aspect of privatization is only now becoming understood by the public. Most plans, including Plan 2 proposed by the President's Social Security Commission, anticipate two different layers of benefit cuts. The first one – a change in the indexation formula from wages to prices – is mandatory for everyone eligible for a private account, whether they opt into an account or not. Over time, economists project this change alone will cut benefits by almost one-half.

Those who try to recoup some of these losses through investing in private accounts will then face a second round of cuts in addition to the first one. Though the mechanics differ from plan to plan, in effect the amounts invested in the private accounts are treated as though they were borrowed from the government in order to be invested, much like charging an IRA contribution to a credit card. When a worker retires, he is expected to pay all of that money back to the government, plus 3% interest above inflation , irrespective of his actual account balances. Even a low-inflation environment like today's still generates about 3% inflation, so in order to come out ahead, accounts today would have to earn over 6%. That is a pretty steep earning curve for accounts that are going to be limited to index funds, particularly if the Trustees' projections of dramatically lower economic growth in the future prove to be accurate. Again, economists project that over time, this so-called “clawback” or “offset”, will eliminate the remaining half of a retiree's guaranteed benefit.

To summarize the benefit cuts, the indexation change takes away about one-half of the guaranteed benefit for everyone under the age threshold, and the “clawback” takes away the remaining half of the benefit for those who opt into private accounts – leaving those retirees entirely at the mercy of the stock market in retirement. Charts used by proponents of privatization in the recent Senate Floor debate show exactly the same outcome.

The Congressional Research Service confirmed this impact in a recent report. According to their analysis, today's 41-year-old would experience a cut in benefits of about 30 percent. A child born this year with lifetime earnings of about $35,000 a year (in 2004 dollars) – which represents an average worker – would face a 91 percent cut in benefits. If that same child earned $56,000 a year or more, he or she would have his or her Social Security benefit reduced to zero.

The indexation plan proposed by Robert Pozen presents a similarly difficult set of issues. While his proposal shields the lowest income retirees from cuts, middle-income workers will see their Social Security benefits cut drastically. Over 75 percent of Social Security's funding shortfall is closed through this single indexation change, much of which will fall on workers with annual incomes under $60,000. By breaking the link between earnings and benefits, blended indexation ultimately results in a single, flat benefit for all workers that is unrelated to their earnings or contributions. And because benefit levels are compressed down to the lowest earnings levels, over time the benefit will provide little more than a poverty-level income of little value to the average worker.

An additional issue to consider is that of risk. At a time when everyone's 401(k) accounts are still recovering from the bursting of the technology bubble, those who support privatization have found it prudent to adjust their proposals in ways that minimize risk, even though such accounts necessarily provide lower rates of return. Most of these plans envision a system of accounts that mirror the Thrift Savings Plan available to federal employees. There are a number of points that need to be made in this context. First, it must be mentioned that the Thrift Savings Plan does not replace Social Security for federal workers; it is a supplement to a full Social Security benefit, in addition to a modest defined benefit plan. The result, a reasonable balance of Social Security, employer-sponsored pension, and individual savings, mirrors the traditional “three-legged stool” that makes up the ideal retirement funding mix.

It is my experience that most Americans do not understand this important distinction. Federal workers are not required to give up a single penny of their Social Security benefit as a trade-off to money in their Thrift Savings Plan account when they retire. This allows Members of Congress and other federal employees to receive both a full Social Security benefit as well as the full amounts accumulated in their Thrift Savings accounts when they retire. Most privatization plans do not operate in this way. Non-federal workers who opt into TSP-like private accounts will be required to “offset” their contributions into the private accounts by accepting dramatically lower Social Security benefits.

In effect, they will be subject to a tax on retirement collected from their Social Security benefit – a tax that is imposed simply because they have retired. Instead of being given the opportunity to fully participate in both retirement plans like Members of Congress and other federal employees, average Americans will only receive half a loaf – they will be allowed to take on the risks of a private account without the same backstop of full Social Security that protects the federal workforce.

The second point to remember is that the Thrift Savings Plan is essentially a collection of index funds in which workers can invest. While investing in index funds can be less risky than investing in the stock of a single company, there is nothing magical that shields them from risk entirely. When the market goes down, by definition so do index funds, and any federal worker who was relying on a specific balance in their Thrift Savings Plan account in order to retire 5 years ago has yet to reach their target.

Any system based on private accounts will necessarily place a tremendous burden of timing on future retirees. Looking at markets averaged out over the long-term masks the dramatic fluctuations accounts experience on a daily basis, and the imposition of a requirement to annuitize adds an additional variable to an already complex calculation. As a result, workers with exactly the same salary histories will inevitably be subject to dramatically different incomes from their private accounts based entirely on their date of retirement.

A third point relating to the Thrift Savings Plan is related to the issue of costs and how much they will impact rates of return. In order to make private accounts look attractive, proponents use projected future rates of return that are completely inconsistent with the assumptions about economic growth incorporated into the Trustees Report. To further pump up that return number, they also assume extremely low administrative costs.

This question of the administrative burdens of private accounts is a “sleeper issue” that is absolutely critical to how much money workers can expect to have with which to retire. In example after example of foreign countries that have experimented with privatized retirement systems, the administrative costs ballooned out of control. Retirees in Chile and Great Britain , for example, saw costs in the 20% range decimate their account balances, leaving them without enough money to stay out of poverty. Some proponents of privatization claim they can avoid this problem by designing private accounts that mimic the Thrift Savings Plan. But Francis X. Cavanaugh, the person who designed the Thrift Savings Plan, has explained the many reasons the model will not work in the Social Security context, leaving the government, employers, or retirees with significantly higher costs.

The last issue I would bring to the Committee's attention is the impact of private accounts on current retirees. Many proponents of private accounts seem to believe that seniors are mostly motivated by self-interest and, if they can simply be convinced their own checks are not at risk, they would sit this battle out.

In my conversations with seniors, I find two schools of thought. First, there are a number of seniors who do not believe the Administration's assurances that they will not be impacted by private accounts. These seniors look at the long-term impact of the required borrowing and reach the conclusion that even if they are “held harmless” initially, carrying that amount of debt simply is not sustainable over time. They believe once budgetary pressures build high enough, budget cutters will necessarily look for deeper cuts in programs such as Social Security, Medicare and Medicaid. The current budget debate in Congress only serves to confirm their suspicions. Few seniors have other sources of income, so any reductions in these programs would have a dramatic impact on them.

But even those who believe they will be protected are not heading for the sidelines. That is because they truly believe in this program – in its guaranteed benefits, in its progressivity, in its insurance elements. And they believe in the program so passionately, they want to preserve it for their children and grandchildren. I have seen this passion to protect Social Security at every town hall meeting in which I have participated. Senior's opposition to privatization is not dissipating – if anything, it is growing stronger.

Private accounts that replace Social Security's guaranteed benefits do not supplement Social Security, they undermine it. The more people realize the trade-offs required to restructure Social Security, the more their support for privatization drops. Through their opposition, the American people are stating loud and clear they prefer strengthening the current system to entrusting their retirement security to the uncertainties of the investment markets. Because of this, Congress should renounce private accounts and focus instead on strengthening the current program for future generations.

Thank you, Mr. Chairman.

The National Committee is a nonprofit, nonpartisan organization that acts in the interests of its membership through advocacy, education, services, grassroots efforts and the leadership of the board of directors and professional staff. The work of the National Committee is directed toward developing a secure retirement for all Americans.