1994-1996 Advisory Council on Social Security

Report of March 10 and 11, 1995 Meetings of the 1994 Advisory Council on Social Security

Report of the Assumptions and Methods Technical Panel

The panel's report was divided into two parts--methods and assumptions. On the issue of methods, two panel members, Martin Holmer and Michael Sze, explained to the Council that they had developed stylized (highly simplified) models to illustrate more sophisticated methods for predicting the probable range of future outcomes of program income and outgo. They had prepared graphs based on their models using existing data but cautioned that the graphs were not intended to be strictly accurate but to show that the models could, in fact, be used. Mr. Sze added that the models were not intended to replace the current system for modeling outcomes but to supplement it. Howard Young, the panel chair, also warned that a change to new models would take considerable work and resources.

The panel next addressed the issue of assumptions about variables that affect the program. Panel member Sam Preston began by focusing on the question of mortality. SSA projections are based on an assumption that mortality rates will not decline as much in the future as they have in the past because, for example, medical breakthroughs and behavioral changes that occurred earlier in this century will not be repeated. The panel disputed this conclusion. Their tentative decision was not to recommend a change in assumptions for the next 20 years but, beyond that time, to recommend an annual rate of mortality improvement in line with the faster rate which has characterized the twentieth century. Mr. Preston noted that other countries with better data are showing an improvement in mortality rates.

Next, panel member Diane Macunovich presented her conclusions on the subjects of fertility and labor force participation of women. Ms. Macunovich had translated existing data to apply to "cohorts" (i.e., groups of individuals born in particular years). Cohorts vary as to the number of children women have as well as the age at which they start having children. In the 1950's, women had children at earlier ages; the "baby boomers", in contrast, are having their children at a later age. There is some indication that younger cohorts may be starting families earlier. Accordingly, the panel recommended a slightly higher fertility rate over the next decade before a stable level is reached.

With respect to labor force participation of women, Ms. Macunovich noted a steady increase for cohorts born in 1921 and later. However, labor force participation rates dropped off for those born after 1961. Further, those cohorts which started off with high labor force participation rates continued to have high labor force participation rates. Based on these findings, Ms. Macunovich predicted a higher rate of labor force participation for women than did the Social Security actuaries. She mentioned that this work was very recently completed and had not been discussed by members of the panel.

The panel was split on the issues of real wage growth and real interest rates. Some felt that the Social Security estimates were reasonable; others felt that lower wage growth and higher interest rates would be more realistic because of recent developments concerning savings on the part of the government, businesses, and individuals. Advisory Council chair Ned Gramlich suggested that the panel "split the difference" in these rates, but Mr. Young stated that the panel had discussed this option but decided against it.

In addition to the presentations, several members of the panel submitted papers they had written. (These papers did not, however, constitute official panel documents). Of the assumptions discussed, the panel's recommendations on fertility and labor force participation rates for women were more favorable to the program than the current ones but the recommended mortality rates were less favorable.

The Advisory Council discussed how the information presented by the panel should be handled, i.e., whether to comment, adopt the recommendations, recommend the inclusion of new models in the trustees' report, etc.. Some felt that new models would be valuable (Schieber, Lindeman); others (Jones) disagreed and thought they would alarm or confuse the public. Carolyn Weaver suggested that Council accept the panel's report but not depart from current practices at this time. Bob Ball agreed.

Taxing Social Security Benefits

Following the Technical Panel presentations, Executive Director David Lindeman briefed the Council on the taxation of Social Security and pension benefits, the points at which tax might be assessed (e.g., when the contributions are paid in or when the benefits are paid out), the rate of tax that might be applied, and the amount of benefits on which tax might be assessed. Three Council members (Ball, Bok, and Fierst) argued in favor of taxing only the amount of benefits that exceed contributions.

Raising Retirement Age and Changing the Benefit Formula

David Lindeman presented the Council members with a set of graphs on options for increasing the retirement age and/or changing the benefit formula. The options included raising the normal retirement age (NRA) to 68 or 70, with varying phase-in schedules. Some of the options would also increase the earliest eligibility age to three years before the increased NRA. The suggested changes to the benefit formula would reduce benefits for above-average earners.

Funding

Ned Gramlich initiated discussion about how the Social Security trust funds should be funded (e.g., advanced funding, partially advanced funding, or pay-as-you-go funding) and how the trust funds should be invested. Syl Schieber and Carolyn Weaver favored advanced funding. Bob Ball recalled early arguments against building up large reserves. Some people had blamed the trust fund buildup for the 1937 recession. Fidel Vargus was concerned that large buildups could lead to pressure for social investing (investment of trust fund assets in instruments other than U.S. bonds to achieve socially desirable results). On the other hand, a pay-as-you-go system could create a situation in which benefits were constantly in danger of being slashed or taxes were constantly being raised. Ann Combs suggested individual accounts, like the Thrift Savings Plan, as a way to prevent political or social investing. Tom Jones weighed the current risk of low returns against the potential risk of collapsing markets resulting from more adventurous investments. Edith Fierst thought one approach to reducing market risk would be to limit the extent of investment in private markets. Bob Ball mentioned the unease in the early days of the program at the prospect of the government's investing in private firms. David Lindeman brought up experiences in some other countries: in Japan, there was political pressure to invest in low-yield bonds, and in Sweden, an attempt had been made to raid the system.

Report of Technical Panel on Trends and Issues in Retirement Savings

Private Pension Policy

John Haley, member, Technical Panel, presented the first report, regarding private employer pension policy and how to augment private pensions in view of possible reductions in future levels of Social Security benefits. His report focused on three issues: increase pension coverage and participation, increase pension accumulation, and reduce pension losses.

To achieve these goals, he emphasized the need to simplify the current system through defined contribution plans with increased portability. To reduce pension losses, pensions should be fully funded and some inflation protection should be offered. Inflation protection could best be offered through the availability of indexed bonds; government bonds whose principal is indexed to the rate of inflation--i.e., bonds that, in effect, offer an interest rate of inflation plus a fixed percentage.

Indexed Bonds

John Shoven, next reported on the concept of the Federal government issuing indexed bonds to provide protection against inflation. The primary benefit of indexed bonds is that, with more people directing their own pension contributions, indexed bonds provide a safe and easily understood investment. He also stated that indexed bonds are desirable for a pension requiring phased payouts and hold out the possibility that insurance companies would be willing to offer inflation-adjusted life annuities, similar to Social Security payments (that receive COLAs), if they could invest in government-issued indexed bonds.

According to Mr. Shoven, indexed bonds could help reduce the interest cost of the national debt and would encourage the government to keep inflation low. However, some people view indexed bonds as an acknowledgement that the government accepts inflation. While indexed bonds have been successful in the United Kingdom, many U.S. government officials oppose them. Also, there is little support on Wall Street for these bonds because demand is unproven and the secondary market for them may be very weak. In a response to a question from Gary Burtless regarding who could purchase these bonds, Mr. Shoven repled that they would be offered only to pension plans.

Interrelationship of Retirement Ages

Peter Diamond, member, Technical Panel, reported on the interaction of the various rules regarding retirement age. For example, in examining changes in the retirement age for workers, the Council will have to examine how this will impact on the retirement age for widows. In examining changes in the retirement age, the Council must also examine the reasons people decide to retire such as loss of job, short life expectancy, and poor health. He stated that raising the early retirement age for workers may have many adverse social affects. Also, changes in the retirement age will impact on the disability program and considerations must be given to the area of overlap between disability and early retirement.

Richard Burkhauser, member, Technical Panel, then presented a report on the research he has begun regarding workforce participation, health, and pension participation rates for male workers in the year they elect to receive Social Security retirement benefits, and in the years both preceding and following their entitlement. He is also examining income levels for workers, couples, and widows, while looking at poverty rates and pension adequacy.

Investment of Trust Funds

Olivia Mitchell, co-chair, Technical Panel and Steve Zeldes, member, Technical Panel, reported on alternative methods of investing the trust fund surplus. They stated that it would be easier to remedy the long-range balance of the trust fund if action is taken now. However, in doing this, the surplus in the trust fund will grow even larger. Two alternatives they examined involved investing some of the trust fund surplus in the stock market and channeling some of the surplus into individual accounts.

Investment in the stock market would involve a tradeoff of risk versus return. The extent of the risk and who would bear the risk would have to be determined. They stated that investment in the stock market would not be the "magic bullet" that many advocates of such investment contend.

Alternatively, some of the surplus could be converted into mandatory individual defined contribution accounts. Such accounts would:

• Afford people the opportunity to allocate their own investments.
• Appeal to many middle-aged and younger workers who may be willing trade what they believe is an uncertain promise of future benefits for the certainty of their own investment account.
• Reduce long-term Social Security liabilities.
• Create a new source of investment funds.

However the creation of individual accounts would have some potential negative aspects such as:

• The contributions may not be sufficient to replace the difference from any reduction in Social Security benefits.
• People may not manage their investments properly. The government could offer a safe investment fund but a very conservative investment strategy may not provide sufficient income.
• Cash outs, if allowed, could lead to the removal of money before retirement.
• Private holdings do not provide inflation protection.
• Tax collection costs may rise. It would be advisable to continue to have the IRS collect the full payroll tax.
• Mandatory individual accounts may crowd-out employer sponsored pensions.

After the presentations by the Technical Panel, the members of the Advisory Council discussed some of their concerns. One issue discussed was administrative costs. Since the present Social Security program has a very low administrative cost, any change in the system will probably lead to higher administrative costs. Gerald Shea believes that administrative costs will rise proportionally with the complexity of the system. He cited the current healthcare system as an example of this problem. Tom Jones stated that a complex system of unlimited choices may not be needed.

Robert Ball stated that the Advisory Council should discuss the political problems. He believes that if the Social Security system becomes just a means-tested system with individual mandated plans, there would be political pressure from people who will want to leave the system.

Sylvester Schreiber commented that while it appears that Social Security remains committed to addressing the problem of adequacy, it is becoming harder to maintain equity. Robert Ball stated that Social Security may have to reduce the emphasis on rate of return. Robert Ball indicated support for the investment of a portion of the trust fund surplus in the private sector, but not through individual accounts.

Tom Jones also indicated support for changing the investment policy for the trust funds and wanted the technical panel to do more research into this matter. He stated that the issue of risk needs to be examined as well as the political effects of investing the trust funds in the private sector.