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House Committee on Ways and Means Statement of The Honorable Lawrence B. Lindsey, President and Chief Executive Officer, The Lindsey Group, Fairfax, Virginia Testimony Before the House Committee on Ways and Means May 12, 2005 Mr. Chairman, members of the Committee, I am honored to have been asked to testify today on the issue of Social Security reform. It is surprising that the issue of promoting national saving is not at the center of the current debate over Social Security reform, and that will be the focus of my comments today. Last year Americans spent . on consumption, investment, and government -- $1.06 for every dollar they earned. We balanced our collective checkbook only by selling assets we owned and by borrowing directly from foreigners, including institutions like the People.s Bank of China, to whom one might prefer not to be increasingly indebted. This borrowing is directly tied to an ever growing trend for us to consume foreign-produced goods at the expense of American production. Done right, the reform process offers enormous potential for improving our national saving rate and thus reducing the amount we will be borrowing from foreigners over the next century. The first part of any credible Social Security reform plan is to permanently eliminate the actuarial deficit in the system. Currently the system has promised to pay out, in present value terms, $11 trillion more than it will collect in revenue. There are a number of ways of closing this gap, but with different implications for national saving. For example, it would take a 28 percent increase in payroll taxes to make sure that the government collected all the money it needed to meet benefit promises over time. This would, if three conditions were met, temporarily increase saving. First, the government, in contrast with historical evidence, must not spend the extra revenue on non-retirement spending. Second, the adverse effects of the tax increase on the economy must not lower government revenue from non-payroll tax sources. Third, private citizens, faced with declining disposable incomes, must cover the entire shortfall from reduced consumption, not by reducing their saving. Even if these three conditions were met, the saving reduction would be temporary. Once Social Security payments caught up with the enhanced revenue, the plan would forever be moving money from one set of people who would spend the money . workers . to another set of people who would spend the money . retirees. So, even in the best case, a tax increase would do nothing to increase national saving over the long run. But, because these conditions are unlikely to be met, a tax hike would not produce the intended amount of increased national saving even in the short run, and would likely lower national saving in the longer run. The combined adverse effects on existing personal saving and the disincentive effects on working and on entrepreneurship, are likely significant. This would be particularly true of ideas to raise or eliminate the wage cap that determines both Social Security taxes and Social Security benefits. Martin Feldstein calculated that eliminating the cap would reduce net federal revenue since the behavioral response by entrepreneurs to a tax hike that took their tax rate back up to nearly 50 percent would reduce federal income tax revenue as well as produce lower than expected payroll tax receipts. Moreover, much of the entrepreneurial income that would be taxed would have funded business fixed investment. Thus, this particular tax idea would likely lower both national saving and economic growth. The second way of bringing the system into balance is to change the formula for determining benefits now, in a way that gradually reduces the current growth rate in real benefits. Currently Social Security projects a 50 percent increase in benefits, even after inflation, over the next half century. The system could be brought into balance by limiting future benefits to the level of benefits enjoyed by those retiring from the system now, while fully indexing those benefits to inflation. This could even be coupled with a generous minimum Social Security benefit, thus making the system both more progressive and providing a better safety net, with little adverse effect on national saving. The $11 trillion saving to the Social Security system of doing this could be viewed as a one-time improvement in the federal government.s balance sheet of the same amount, but with an equivalent reduction for future retirees, as benefits would not rise as fast as they might now expect. But, national saving would likely rise as a result. In order to maintain the level of consumption in retirement that the government previously promised, but could not deliver, individuals would have to gradually increase their personal saving during their working lives. This may not be easy for some folks. So, a second part of any Social Security reform that promotes national saving should include a personal account plan that helps people save and learn the benefits of saving by watching their own accounts grow. Most personal account proposals, including the President.s, would allow workers to use a portion of payroll taxes currently collected and direct them into a personal account. It has been widely noted that any shortfall to meet current benefits would be met by government borrowing, and that personal accounts that are funded by government borrowing do not raise national saving; it simply increases government borrowing to fund private saving. But it is not widely understood that for an individual to establish an account, his or her regular Social Security benefit would be adjusted prospectively by the amount of payroll tax that is diverted into a personal account plus interest. As a result, there is no added strain on Social Security resources. In fact, the system as a whole is made better off since funds are automatically transferred from years where the system has a surplus, or a relatively modest shortfall, to years when the shortfall is much bigger. Properly designed, Social Security personal accounts strengthen, and do not weaken, the solvency and safety of the Social Security system. So, long term national saving is not harmed in any way by this approach, and is likely to be increased. Still, the national saving opportunity of Social Security reform could be further enhanced. The best way is to allow workers to choose a plan where they would contribute more to their retirement in return for gaining ownership and a higher return on their existing payroll taxes. In effect, the government could match private contributions. Many companies successfully use this approach for their own 401(k) plans, but the Social Security match could easily be more generous. Consider, for illustrative purposes, a plan that asked employees to contribute 1 � percent of their wages to their own personal account, with no change in their current taxes. For only a slightly higher short run budget effect than the President.s proposal, Social Security could offer a four-for-one match on employee contributions made on the first $10,000 of earnings and a one-for-one match on contributions made on earnings above that amount. A worker making $10,000 would thus contribute $150 a year to his account and be matched $600 from existing payroll tax revenue . producing a $750 account. A worker making $50,000 would contribute $750 a year and be matched $1,200, producing a $1,950 personal account. The resulting accounts would build up much more quickly, generate more earnings, and provide far more funds for retirement. The employee.s contribution would not affect their Social Security defined benefit in any way. But as in the President.s plan, the Social Security system would be made whole for any diversion of existing payroll tax revenue. Best of all, national saving would be enhanced unambiguously. The funds being contributed by workers would largely be net contributions to national saving. They would also involve the real attributes of ownership of capital since the worker would unequivocally have some .skin in the game.. A high initial match rate would also create the right kind of incentives to change long term attitudes toward national saving, as well as being more progressive than the current Social Security system. This proposal is not a .carve out.. Nothing is carved out or removed from the Social Security system. The dollars allocated to personal accounts impose no additional strain on the Social Security system. This proposal is not an .add on.. There is no new entitlement. In fact, adding yet another entitlement to our system would be among the worst things we could do for national saving. Given the critical importance of saving to our nation.s economic future, it is important to make the most of the once-in-a-generation opportunity to promote national saving offered by Social Security reform. The combination of gradual reductions in the promised rate of real increase in future benefits and a personal account system that promotes national saving . that is neither a carve out, nor an add-on . is the best approach. _______________________________________________ http://www.mccmedia.com/mailman/listinfo/brin-l
