[House Hearing, 109 Congress] [From the U.S. Government Publishing Office] SOCIAL SECURITY REFORM: SUCCESSES AND LESSONS LEARNED ======================================================================= HEARING BEFORE THE SUBCOMMITTEE ON DOMESTIC AND INTERNATIONAL MONETARY POLICY, TRADE AND TECHNOLOGY OF THE COMMITTEE ON FINANCIAL SERVICES U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED NINTH CONGRESS FIRST SESSION __________ MAY 5, 2005 __________ Printed for the use of the Committee on Financial Services Serial No. 109-25 U.S. GOVERNMENT PRINTING OFFICE 21-092 WASHINGTON : 2005 _____________________________________________________________________________ For Sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800 Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001 HOUSE COMMITTEE ON FINANCIAL SERVICES MICHAEL G. OXLEY, Ohio, Chairman JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania DEBORAH PRYCE, Ohio MAXINE WATERS, California SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois PETER T. KING, New York NYDIA M. VELAZQUEZ, New York EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon SUE W. KELLY, New York, Vice Chair JULIA CARSON, Indiana RON PAUL, Texas BRAD SHERMAN, California PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York JIM RYUN, Kansas BARBARA LEE, California STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas DONALD A. MANZULLO, Illinois MICHAEL E. CAPUANO, Massachusetts WALTER B. JONES, Jr., North HAROLD E. FORD, Jr., Tennessee Carolina RUBEN HINOJOSA, Texas JUDY BIGGERT, Illinois JOSEPH CROWLEY, New York CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri VITO FOSSELLA, New York STEVE ISRAEL, New York GARY G. MILLER, California CAROLYN McCARTHY, New York PATRICK J. TIBERI, Ohio JOE BACA, California MARK R. KENNEDY, Minnesota JIM MATHESON, Utah TOM FEENEY, Florida STEPHEN F. LYNCH, Massachusetts JEB HENSARLING, Texas BRAD MILLER, North Carolina SCOTT GARRETT, New Jersey DAVID SCOTT, Georgia GINNY BROWN-WAITE, Florida ARTUR DAVIS, Alabama J. GRESHAM BARRETT, South Carolina AL GREEN, Texas KATHERINE HARRIS, Florida EMANUEL CLEAVER, Missouri RICK RENZI, Arizona MELISSA L. BEAN, Illinois JIM GERLACH, Pennsylvania DEBBIE WASSERMAN SCHULTZ, Florida STEVAN PEARCE, New Mexico GWEN MOORE, Wisconsin, RANDY NEUGEBAUER, Texas TOM PRICE, Georgia BERNARD SANDERS, Vermont MICHAEL G. FITZPATRICK, Pennsylvania GEOFF DAVIS, Kentucky PATRICK T. McHENRY, North Carolina Robert U. Foster, III, Staff Director Subcommittee on Domestic and International Monetary Policy, Trade and Technology DEBORAH PRYCE, Ohio, Chair JUDY BIGGERT, Illinois, Vice Chair CAROLYN B. MALONEY, New York JAMES A. LEACH, Iowa BERNARD SANDERS, Vermont MICHAEL N. CASTLE, Delaware MELVIN L. WATT, North Carolina FRANK D. LUCAS, Oklahoma MAXINE WATERS, California RON PAUL, Texas BARBARA LEE, California STEVEN C. LaTOURETTE, Ohio PAUL E. KANJORSKI, Pennsylvania DONALD A. MANZULLO, Illinois BRAD SHERMAN, California MARK R. KENNEDY, Minnesota LUIS V. GUTIERREZ, Illinois KATHERINE HARRIS, Florida MELISSA L. BEAN, Illinois JIM GERLACH, Pennsylvania DEBBIE WASSERMAN SCHULTZ, Florida RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin TOM PRICE, Georgia JOSEPH CROWLEY, New York PATRICK T. McHENRY, North Carolina BARNEY FRANK, Massachusetts MICHAEL G. OXLEY, Ohio C O N T E N T S ---------- Page Hearing held on: May 5, 2005.................................................. 1 Appendix: May 5, 2005.................................................. 29 WITNESSES Thursday, May 5, 2005 Amelio, Gary, Executive Director, Federal Retirement Thrift Investment Board............................................... 8 Cavanaugh, Francis X., Public Finance Consulting................. 12 James, Estelle, Consultant and Professor Emeritus, Suny, Stony Brook.......................................................... 9 Purcell, Patrick, Specialist in Social Legislation, Congressional Research Service............................................... 11 APPENDIX Prepared statements: Oxley, Hon. Michael G........................................ 30 Maloney, Hon. Carolyn B...................................... 35 Pryce, Hon. Deborah.......................................... 44 Wasserman Schultz, Hon. Debbie............................... 46 Amelio, Gary................................................. 48 Cavanaugh, Francis X......................................... 67 James, Estelle (with attachments)............................ 79 Purcell, Patrick............................................. 118 Additional Material Submitted for the Record Frank, Hon. Barney: ``Why Personal Accounts and Why Now?''....................... 128 Amelio, Gary: Written response to questions from Hon. Barbara Lee.............. 131 James, Estelle: Written response to questions from Hon. Barney Frank............. 132 Written response to questions from Hon. Barbara Lee.............. 133 SOCIAL SECURITY REFORM: SUCCESSES AND LESSONS LEARNED ---------- Thursday, May 5, 2005 U.S. House of Representatives, Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Committee on Financial Services, Washington, D.C. The subcommittee met, pursuant to call, at 10:05 a.m., in Room 2128, Rayburn House Office Building, Hon. Deborah Pryce [chairman of the subcommittee] presiding. Present: Representatives Pryce, Biggert, Harris, Gerlach, Neugebauer, Price, Maloney, Waters, Moore, Frank, and Pearce. Chairman Pryce. [Presiding.] Good morning. The hearing of the Subcommittee on Domestic and International Monetary Policy, Trade and Technology will now come to order. Thank you all for being here today to discuss Social Security reform and review the successes and lessons learned from both foreign countries and our own plan for federal workers, the Thrift Savings Plan. The witnesses at this hearing have immeasurable knowledge of the structural reforms undertaken by our international counterparts, and also the importance of incorporating private accounts into any reforms we make here at home. We know that the United States is wonderfully unique in its history, its economy and its people. Therefore, the lessons learned by the systems that work well or do not work well in other countries may not be directly analogous to the United States. Differences in population, life expectancy, and savings rates are just a few examples of the fine nuances that can make the application of the same policies yield dramatically different results. Indeed, our goal should not be to mimic the retirement programs of other nations. Rather, we should aim to enact a system that is tailor-made for the people and the economy of our United States. Having said that, examining the retirement security systems of other nations can and should be done by this committee and this Congress. Other countries's experiences in implementing these retirement security policies can provide very valuable lessons for us. By reviewing the successes and shortcomings of other nations's programs, we will find areas that can be improved upon and then made applicable to the American experience. A case in point is the United Kingdom's efforts at pension reform. According to the Congressional Research Service, this mis-selling of personal pensions is said to have affected 1.5 million workers, mostly older and lower-paid, who were persuaded by overzealous sales agents to switch to risky, inappropriate plans based on unduly optimistic estimates on rates of return. The government has ordered companies to reimburse these workers at an estimated cost of $3.2 billion to date, with total costs projected to reach $20 billion. Investor choice is just as significant as investor protection in any voluntary personal accounts. We have seen the stagnant rates of return in Chile, where workers initially had no investment choice, with only one portfolio offered for over 20 years. Finally, Chile reformed its system to offer five portfolios with different degrees of risk. I was pleased to read Dr. Estelle James's quote in a recent Washington Post article saying, ``If we create personal accounts in the United States, we should also make portfolio choices simple, limited and diversified, including international securities, to protect inexperienced investors from themselves.'' As Congress moves forward in drafting legislation to reform our Social Security system, this committee must stay involved to ensure that proper protections for investors and increased financial literacy are included. In addition, any plan to reform Social Security will require a concentrated effort by Congress to craft a program that will remain solvent long after we are gone. We have an opportunity to broaden the discussion to include a range of retirement security issues and to educate Americans on the personal savings plans provided by the financial services industry today. Financial literacy empowers individuals to manage money, credit and debt and become responsible workers, heads of households, investors, entrepreneurs and business leaders. While Congress can make laws and provide savings vehicles for Americans's retirement through Social Security or personal retirement accounts, only with an overall understanding of financial services can a person truly benefit from an investment in their future. We must continue to do more to reach out to more people. Like the Thrift Savings Plan, voluntary personal accounts would provide safe investment opportunities. In addition to a no-risk option of investing in U.S. Treasury bonds, the accounts could be invested only in secure bond and stock index funds, including a life-cycle fund designed to protect workers from sudden market changes on the eve of their retirement. With more than three million investors, the TSP is the largest individual account retirement system in the country. It has been successful in keeping costs to consumers low through the use of competitive bidding. In 2003, the TSP had $129 billion in assets under management and paid just over $2.1 million in investment expenses. The introduction of personal retirement accounts to the public means that they must be designed with adequate regulation and oversight. There must be a significant investor protection effort in addition to financial literacy so that people can understand the investments that are offered and make appropriate choices. I look forward to a lively discussion today and appreciate the witnesses's sharing with us their knowledge on this issue. Without objection, all members's opening statements will be made a part of the record. At this time, I would like to recognize my friend, the gentlelady from New York, the Ranking Member of this subcommittee, Congresswoman Maloney, for her opening statement. Mrs. Maloney. Thank you so much, Madam Chair. I am glad that you are focusing on this important issue. I certainly welcome the distinguished witnesses that we have here today. One of my amendments is up in a markup in another committee. I am going to summarize my remarks and defer to the Ranking Chairman for the continuation. I just feel that this is extremely important, and that we need to look at what has happened in other countries. In many of the other countries it has not been successful. To give one example, the U.K. adopted voluntary individual accounts very similar to the plan put forth by the administration. Many workers who switched lost money and have now switched back to the traditional plan. The scandal forced the government to introduce a variety of reforms and aggressive enforcements. Currently, financial firms are now repaying $22 billion to individuals who were given unsuitable recommendations. At retirement under the plan being put forth by the Bush administration, workers would pay back the amount they contributed to private accounts, with interest, through a reduction in their guaranteed security benefit. The interest rate would be 3 percent above the rate of inflation, which is the same that they would get if they had left their money in the trust fund invested in Treasury notes. I would like permission to place into the record a research paper that was written recently by Yale economist Robert Schiller that demonstrates that if workers invest in life-cycle accounts, which President Bush has suggested as the appropriate default investment option, about 70 percent of workers would be worse under private accounts than if they had stayed in the traditional system and they would not make more than they have to pay back. Very problematic is the cost of transition. Earlier, Alan Greenspan testified that these private accounts will do nothing to help the solvency of the current Social Security system, but will add a great deal of debt. The administration's proposal includes zero funding for the President's proposal for private accounts, and thus would rely on increased government borrowing to pay the transition costs at a debt of over $7 trillion and over $450 billion deficit. This is very troubling to me. The administration estimates that the President's private accounts would add another $754 billion to the public debt in the current budget window. Because this does not start until 2009 and then phases in gradually, the true costs are truly much, much higher and Vice President Cheney has conceded that it would be trillions. The plan would add an estimated $1.4 trillion of public debt in the first 10 years, followed by another $3.5 trillion in the second decade. The increases in debt are large and longstanding. The additional debt would continue to grow relative to the size of the economy, reaching 35 percent of GDP. I mean, that is truly frightening to me. If other countries should decide that they do not want to hold much of that debt, we would be looking at a very, very serious economic situation. Another problem with privatization is the high cost of administrative and marketing that is estimated to be 30 percent from the worker's point of view, which is a great deal of money. I must say that I certainly support the Thrift Savings Plan. I would support a similar plan on top of Social Security as it exists now for federal employees, but that this system is one that has served our public well for so very long, and we should really look at the experience of other countries before dismantling a system that has served so many for so long and so well. I have quite a lengthy statement. I am going to ask to have the entire statement placed in the record. I would like to yield to the Ranking Member, and I will be right back after I offer my amendment in my markup in the other room. Mr. Frank. I assume there will be an opening statement on the other side first. Mrs. Maloney. Okay. Chairman Pryce. And then we will come back. All right. Now, I would like to recognize the Vice Chairman of the committee, Mrs. Judy Biggert. Mrs. Biggert. Thank you, Madam Chairman. I would like to thank you for holding this important hearing today. As we work to establish solvency in the current Social Security system and find additional ways to increase the savings rate, I think it is prudent to examine programs that work or do not work, both within our own country and abroad. We know that our Social Security system works now, but it will not work in the near future. We know that programs like the Thrift Savings Plan for federal workers and 401(k) retirement plans have inspired Americans to save more, to save over longer periods of time, and to gain a return on investments that trump any return that the government could give them. Today, I look forward to hearing from the witnesses about the benefits of personal account programs for individuals, things to avoid when setting up such accounts, and elements that should be included in these accounts. With that, I yield back the balance of my time. Chairman Pryce. Thank you, Ms. Biggert. The gentleman, the Ranking Member of the committee. Mr. Frank. Thank you, Madam Chair. First, on the question of Social Security, I do want to note my dismay to read in today's New York Times the headline-- let me read the first sentence: ``The Bush administration has warned the nation's biggest labor federation that union-run pension funds may be breaking the law in opposing President Bush's Social Security proposals.'' That is an outrageous effort to coerce people out of exercising their political rights. The notion that you have to be careful about advocacy is one which this administration has been very uneven in applying. Apparently, it is okay to use taxpayer money to create phony videos and pass them off as objective news reports, but if a labor union decides that it would not be in the interests of its members for this bill to go forward, they are going to be threatened. I hope that the unions will ignore this threat. It is a gross example of the wrong kind of politicization. Secondly, I am glad that we are having this hearing because I think it helps us make a couple of points. First, as I read the early rhetoric about letting people have private accounts, it had a strongly libertarian thrust. It was an individual should make the decisions, not the government; that we should free people to do what they want with their own money. I have noted with some interest that as we have progressed to specifics, the individual choice involved has gotten narrower and narrower and narrower. We ought to be clear that what we are now being told should happen with regard to Social Security accounts severely restricts what the individuals can do. That leads to a third point. President Clinton once suggested that Social Security funds could be invested in stocks to some extent, and that would increase the return for Social Security as a whole, with individuals still having their entitlements, but with more money coming into the fund. At the time, a number of people, including Chairman Greenspan of the Federal Reserve, expressed grave opposition to this, saying that it would be a terrible idea to let the federal government make these picks of what stocks should be in there. But as I read the current proposal, we are getting back to that. The current proposal is not to let individuals decide fairly freely where to put their money, but to create some limited choices for them. The federal government presumably would be the one ultimately making those limited choices. So the difference between what President Clinton proposed and what we are currently seeing is not, it seems to me, on whether or not the federal government has some influence over where the money goes, but whether or not we continue to have this guarantee to people or whether they are more at risk. I was also struck, and I am not going to be able to stay for the whole thing, but I was pleased to see in Ms. James's testimony, actually, let me just say this. I have heard a lot from some of my Republican colleagues about the inappropriateness of America looking to foreign countries to make American policy. We have certainly heard that with regard to the Supreme Court, and we have often heard that this is America and we will make our own decisions, and borrowing from foreign countries is really not what we need to do. I am glad to see that that I think somewhat silly notion has been waived in the interests of trying to get support in some ways for Social Security, since we have other systems that have done that, and the silliness of ignoring the experience of others. Now, everybody has joined into that. One of the things that struck me as I read over Ms. James's statement was at the bottom of page two and the top of page three, saying that, ``every country that has a personal account system also has a minimum pension, most commonly 20 percent to 30 percent of the average wage. This is designed to protect workers from both financial market and labor market risk.'' So far, we, America, do not have a minimum pension in our current system or in the proposed new system. I think that is a very relevant point of comparison. As I understand the President's proposal, with progressive indexation and with the private accounts taking a significant chunk, up to one-half of what you put in, it does not seem to me that we would reach that 20 percent to 30 percent minimum. The final point I want to talk about is on progressive indexation. I want to congratulate the administration on its mathematical flexibility. When we are talking about the point at which we begin to reduce people's Social Security from what they would currently be legally entitled to, the President says he wants to protect low-income people and we will begin to go to a progressive, i.e. reductive, approach to their Social Security benefits as they get into middle and upper income. Apparently for these purposes, for the purposes of reducing the benefits of Social Security below what they now are, middle income starts at about $30,000. What strikes me is when we talk about tax cuts in this climate in Washington today, middle income seems to start at about $150,000. So whether or not you are considered middle income apparently varies. If it is a question of giving you a tax cut, it is much higher. If it is a question of when we can reduce your benefits, it is much lower. The last point I would simply note again is, and I have been asked, and others, and I always want to repeat this on Social Security, what is the approach. It is clear that from now until 2018, unlike any other aspect of the federal government, the Social Security system will take in more money than it pays out. So for the near term, it seems to me we have a very easy solution: put the money back. Chairman Pryce. The Chair recognizes Mr. Neugebauer for a brief opening statement. Mr. Neugebauer. Thank you, Madam Chairwoman, for having this hearing. This is probably one of the most important things that I think that this Congress can do for the future of our children and grandchildren. I have two grandsons that are 4 and 6. I want them to have a better plan. I think we lose the debate here sometimes about Social Security. We are really talking about if we were going to start over today, would we put the same system in place today that we have? I think the answer overwhelmingly from the people in the 19th District is no, we would not. We would go to a system of ownership. I had a 75-year-old constituent call me yesterday. She said, ``Congressman, please, please, please allow our grandchildren and children to have accounts that will give them a better return on their money.'' She worked in the private sector for a while and has Social Security, but she also opened up an IRA and she said it is amazing how much money that IRA accumulated in a relatively short 10-year period. She said it is a wonderful supplement to the income we have today. The problem with Social Security today is that it yields about 2 percent to the folks. I do not think there is probably anybody in this room that would accept a 2 percent return on their money. The other problem with it is it is not a system of ownership. So today when families are trying to make retirement decisions, they cannot make retirement decisions because they are relying on the whim of Congress in the future of what those benefits are going to be. So what we do need to do is we need to come to a system that gives ownership to the American people and to our children and grandchildren in the future, and then figure out how to also at the same time reform the system that we have to ensure its solvency. But why would we perpetuate a system that we know today is giving a poor return to our citizens? Because we are afraid to address some of those important issues. I think these kinds of decisions, Madam Chairwoman, are great discussions, ones that we need to have. We are going to hear about a very successful program, the TSP program. But I also want to talk about the fact that there are examples, as Mr. Frank was talking about, looking to other countries. We can look to examples in our own country today, where teachers systems in Texas, for example, opted out of the Social Security system many years ago because they realized that it was a poor return on their investments. Now, those people that put basically the same amount of money into their retirement system in the teacher retirement system in Texas, their retirement benefits are three to four times what their counterparts that have been paying into the Social Security system for the same period of time. I think that is compelling evidence of what ownership does for families's abilities to address retirement issues in the future. Again, I thank the Chairwoman for having this very important hearing today. Chairman Pryce. Thank you. At this time, I would like to introduce our distinguished panel of witnesses, and we can get on to hearing from them. Mr. Gary Amelio is the Executive Director of the Federal Retirement Thrift Investment Board, which administers the Thrift Savings Plan. He joined TSP in 2003 with 22 years of private sector experience in private sector pensions and investment matters. Dr. Estelle James is a consultant and Professor Emeritus at the State University of New York at Stonybrook. Dr. James is recognized as a scholar on pension and retirement reform in developing countries. She has written selected papers and reports on the subject and has conducted World Bank seminars and workshops on Social Security reform in such countries as Hungary, Thailand, China and Poland. Mr. Patrick Purcell, who is a Specialist in Social Legislation for the Congressional Research Service, has written numerous reports on pension and retirement reforms for civilians and federal workers. He recently gave a well-received lecture on retirement reform at the University of Pennsylvania's Wharton School Impact Conference sponsored by the Wharton School's Pension Research Council. Mr. Francis Cavanaugh was the first Executive Director of the Federal Retirement Thrift Investment Board. He is a recognized author and scholar in the area of market financing of debt securities, having penned the book, ``The Truth About National Debt: Five Myths and One Reality,'' and other publications. We welcome all the witnesses here today and recognize them for a 5-minute summary of their testimony. Without objection, your more lengthy statements can be made part of the record. We will begin with Mr. Amelio. Thank you all for being here. STATEMENT OF GARY AMELIO, EXECUTIVE DIRECTOR, FEDERAL RETIREMENT THRIFT INVESTMENT BOARD Mr. Amelio. Good morning, Chairman Pryce and members of the subcommittee. My name is Gary Amelio and I am the Executive Director of the Federal Retirement Thrift Investment Board, an independent agency charged with administering the Thrift Savings Plan. I was appointed June 1, 2003 and serve as the managing fiduciary of the TSP. Prior to my appointment, I had 23 years of private sector experience in the employee benefits, tax and fiduciary industry. Although the board has no express position regarding proposals to change Social Security, I am pleased to discuss the successes and lessons learned by the TSP. Since 1987, the TSP has grown to 3.4 million participants with a total of $155 billion in account balances. I often comment that Congress could not have provided a better structure when it created the TSP. Congress fashioned the plan with a goal of providing retirement savings for federal employees at low administrative cost and with a limited number of funds that track broad investment markets. This simplified structure has protected the plan from political manipulation and consequently enabled the TSP to gain the confidence of federal employees and become the largest and arguably most successful defined contribution plan in the world. The TSP's participation rate significantly exceeds the industry average, primarily I believe because participants find the plan simple to grasp. The TSP participants also enjoy low administrative costs. Last year, expenses were just six basis points or 60 cents for every $1,000, which is rock bottom in the industry. I like to say that the TSP is the most inexpensive legal investment in the world. It is perhaps cheaper than illegal investments, but I do not know that. Through the years, the TSP and Congress have worked together to improve the plan. The TSP recently modernized its recordkeeping system to accommodate daily valuation and in the next couple of months life-cycle funds will be available to provide professionally designed asset allocation models appropriate for participants's investment time horizons. Last year, Congress improved the plan by approving the board's recommendation to eliminate open seasons. In 1986, the concept of allowing federal employees to invest in a retirement savings plan which included private securities was untested. By mandating a sound and simple structure protected from political manipulation, Congress created a plan which passed the test, gained the confidence of federal employees, and strengthened their retirement security. This concludes my summary comments. I ask that my extensive written statement be entered into the record. I would be pleased to respond to any questions. Thank you. [The prepared statement of Gary Amelio can be found on page 48 in the appendix.] Chairman Pryce. Dr. James? STATEMENT OF ESTELLE JAMES, CONSULTANT AND PROFESSOR EMERITUS, SUNY, STONY BROOK Ms. James. Thank you. My comments are based on work that I did while I was lead economist at the World Bank for 9 years, and continuing research that I did after leaving the Bank. I am still involved in that research. Over the past 25 years, more than 30 countries spread across Latin America, Eastern and Western Europe, Australia and Hong Kong have adopted social security reforms that include funded privately managed plans, usually based on personal accounts. Contributions to these accounts range from 2.5 percent to 12.5 percent of wages and they are projected to supply between 30 percent and 90 percent of total benefits. The accounts are basically part of the social security systems in these countries. In Latin America and Eastern and Central Europe, the accounts were created by a carve-out. In industrialized countries such as Australia, Switzerland, Netherlands and Denmark, employers have long provided employer-sponsored plans on a voluntary basis, as we do in the United States. At some point, governments decided everyone should be covered by these plans because only half of the labor force was covered on a voluntary basis. So governments made these plans mandatory and they were in effect an add-on for employers that did not provide these plans previously. It is interesting. This kind of option has not been discussed in the United States, but it is obviously one way that we could go. Now, I am going to discuss how these 30 countries handled three issues: The issue of administrative costs, which is crucial; how to control risk and protect low earners; and how to make payouts. I would like to put this in the context of two over-arching themes. First, workers do not have free rein over the funds in these accounts, as Mr. Frank said. There is a lot of control and regulation over the accounts. I think it is very important to realize that complete government control is at one end of the continuum, and complete free choice and ownership is at the other end. Most of these countries are somewhere in the middle. ``In the middle'' is where I think we should be. The important question is: Where do you position yourself in the middle? How much choice? How much control? The U.K. ran into trouble when it gave too much choice and too little regulation. On the other hand, I could cite other countries that had complete government control and wasted the funds, had low rates of return and political manipulation. So I would say being at either end of the continuum is not the place to be. The second point is that details really matter a lot. Seemingly small changes in rules, really the fine print, can determine whether you consider the outcomes good or bad. So it is really important to get down into the trenches and look at those details. I would like to just make a brief comment about each of those three issues, and then I will be glad to answer questions. Administrative costs are obviously very important because if you pay an expense ratio of 1 percent of assets per year, when you retire that will reduce your final pension by 20 percent, which is obviously a large chunk. So keeping those costs low is very important. The Chilean system has been criticized for having high costs. People are very concerned about that. In this connection, it is important to realize that costs are going to be high at the beginning. There are high startup costs. Many of the numbers quoted from Chile were their high startup costs. Currently, the expense ratio in Chile is 1.2 percent of assets per year, and it is slated to go down to .7 percent over the lifetime of a full career of a worker. This is lower than the average mutual fund and 401(k) in the United States. However, I believe we should be able to do much better in a mandatory system by exploiting economies of scale and eliminating marketing expenses. The key point here is that the most important cost is the fixed recordkeeping costs per account, which I estimate we could keep to about $20 per account if we are careful. That is based on estimates of low- cost mutual funds and the Thrift Savings Plan. If we keep to that number, then that means that once the average account size reaches $7,000, the expense ratio will be less than 30 basis points. So I would estimate that in the long run, we should be able to operate at 30 basis points or less. This will take us 8 or 10 years to get to that point. This is I think consistent with the plans that are floating around. However, if people are allowed to jump out of this basic system once their accounts reach a certain size, such as $5,000, we will never reach that $7,000 point and then the administrative costs for everyone will be higher as a percentage of assets. So this little detail that you might not even think of looking at will really determine the expense ratio and therefore the subtraction from the final pension. It is an example of how details matter a lot. In terms of controlling risk and protection of low earners, there are many techniques that we are familiar with: diversification, of course, in companies and sectors and international diversification, the life-cycle funds that have been mentioned. I can talk about them later on if you are interested. But in addition, every country, as Mr. Frank mentioned, every country that has a personal account system also has a minimum pension. The variation in size of the minimum pension is actually quite substantial, from 15 percent to 40 percent, but you could say that there is a sort of concentration between 20 percent and 30 percent of the average wage. That does set a floor and it protects workers both from financial market and labor market risk. That is something we could think about having here. We do not have it in our present system, by the way, without personal accounts. Chairman Pryce. Dr. James, I just need to remind you to be mindful of the clock. I know you have another point to get to. Ms. James. Okay, yes. I am moving on to the other point. Thank you. Payouts. Every country with personal accounts restricts payouts. Most European countries require annuitization to ensure that workers will have a life-long income. In Latin America, workers are given a choice between annuities or gradual withdrawals. In Chile where they have this choice, two- thirds of all retirees have chosen to annuitize. Lump-sum withdrawals are not permitted unless the pension meets a very high threshold, which varies across countries, but it is about 70 percent of the worker's own wage and roughly 200 percent of the poverty line, depending on country. So the threshold you choose for lump-sum withdrawals is an extremely important detail that matters. Some countries require that annuities be indexed. Many of them require that the annuity should be joint in order to cover surviving spouses. This is very important for women, obviously. In Latin America, women can keep the joint pension in addition to their own pension. Whereas in the United States, as you know, women who work in the labor market have to give up their own pension if they take the widow's pension. We have to choose. In Latin America in their personal account systems, women can keep both. As a result, women's expected lifetime benefits relative to men's have increased in the new systems. So my final point just goes back to the point that details are very important. You really have to look at them. The accounts can be good or bad depending on the details. The experience of other countries shows if we carefully structure the choice of asset managers, the investments and the payouts, and we provide a pension floor, including personal accounts as part of our Social Security system, should be able to continue to provide lifetime income security for the elderly in a cost- effective and low-risk way. Thank you. [The prepared statement of Estelle James can be found on page 79 in the appendix.] Chairman Pryce. Thank you. Your full statement will be in the record, and hopefully you can get to some of your other points. Ms. James. Thank you. I put a lot of work into all the research. I am delighted when people read it and think about it. Chairman Pryce. Mr. Purcell? STATEMENT OF PATRICK PURCELL, SPECIALIST IN SOCIAL LEGISLATION, CONGRESSIONAL RESEARCH SERVICE Mr. Purcell. Madam Chairwoman and members of the subcommittee, my name is Patrick Purcell. I am a Pension Specialist with the Congressional Research Service. Thank you for inviting me to talk to you today about the thrift plan for federal employees. We already have two distinguished other panelists who are very expert in the thrift plan, so I am going to talk a little bit very briefly about the legislative history. In the legislative history of the thrift plan, two things stand out: First, Congress chose then and has maintained to this day a system in which all of the funds that invest in the private sector are index funds. This was a carefully considered choice. As the House committee report on the legislation stated at the time, the three funds authorized as passively managed funds, not subject to political manipulation. A great deal of concern was raised about the possibility of political manipulation of large pools of thrift plan money. This legislation was designed to preclude that possibility. Likewise, the Senate committee report stated: ``Another concern the committee wrestled with was the potential for market manipulation through political pressure. The committee specifically designed the plan to avoid this problem. The legislation provides for three investment funds that are all essentially self-managed.'' The second item that stands out in the legislative history is the strong interest that Congress showed in establishing the independence and authority of the Federal Thrift Investment Board. The legislation established the Thrift Board as an independent government agency, which is required by law to operate the plan solely in the interest of plan participants. The law charges the thrift board with responsibility for developing the investment policies of the plan and overseeing the management of the plan. The law authorizes the board to appoint an executive director who runs the plan on a day-to-day basis. Three members of the board, including the Chairman, are appointed by the President. The President chooses a fourth member in consultation with the Speaker of the House and the House Minority Leader, and a fifth member in consultation with the Senate Majority and Minority Leaders. Members are subject to Senate confirmation and serve 4-year terms. All members are required by law to have substantial experience in managing financial investments and pension plans. Its independence is furthered by the fact that the federal retirement board receives no appropriations from Congress. Administrative expenses are paid through agency contributions that are forfeited by employees who leave federal service before they have vested, and by charges against participant accounts. Congress maintains oversight of the thrift plan through the House Committee on Government Reform and the Senate Committee on Homeland Security and Governmental Affairs. In summary, as we have heard and we will hear from Mr. Cavanaugh, the thrift plan is a key component of federal employees's retirement benefits. It is an efficient provider of retirement savings accounts to the federal workforce, which has achieved high participation rates and low administrative costs. I have a longer statement to be entered in the record. This concludes my opening remarks, and I would be happy to answer any questions the subcommittee might have. [The prepared statement of Patrick Purcell can be found on page 118 in the appendix.] Chairman Pryce. Thank you, Mr. Purcell. Mr. Cavanaugh, welcome. STATEMENT OF FRANCIS X. CAVANAUGH, PUBLIC FINANCE CONSULTING Mr. Cavanaugh. Thank you. Madam Chairwoman and members of the subcommittee, I welcome this opportunity to discuss the important subject of establishing individual accounts in the Social Security system. I will focus on the administration's proposal. The critical question, of course, is cost. Individual accounts are proposed to provide a higher investment return than would be realized by the Social Security trust fund. On this basis, individual accounts would not be feasible for the 68 million employees of 98 percent of the businesses in the United States. That is the 5.6 million small businesses with fewer than 100 employees. To understand the cost of individual accounts for small businesses, we must first understand why 85 percent of them do not now have retirement plans for their employees. A major reason is that the 401(k) industry has found that it cannot profitably provide services for a company for less than approximately $3,000 a year, even though they enjoy economies of scale from combining thousands of employers in their centralized computer systems. Further significant economies of scale would not be realized by a central TSP-type agency because there would still be millions of small business workplaces to be reached. Nor can we assume that a new central government agency would be more efficient than the major 401(k) providers who now serve this market. Thus, the annual cost for an employee of a company with 10 employees would be $300, or 30 percent of the President's proposed initial annual individual account contribution of $1,000, and most U.S. companies have fewer than 10 employees. These figures confirm the findings of a number of earlier studies by the Department of Labor and the Employee Benefit Research Institute. Obviously, substantial government subsidies would be necessary to make individual accounts attractive to employees of small businesses. If all Social Security taxpayers participated in the individual account program, the administrative costs would be more than $46 billion a year, which would be a subsidy to support an uneconomic function. In addition to the above costs, which are based on what the current providers are actually charging for establishing and serving 401(k) plans on the market, there are overwhelming practical obstacles to modeling individual accounts on the TSP or on private 401(k) plans. First, the TSP is administered by just one employer, the United States Government, with an extensive network of agency personnel payroll and systems staff to provide the essential employee education, retirement counseling, payroll deduction, timely funds transfers and error-correction functions. These essential employer services in 401(k) plans could not possibly be performed by small business employers or by a new TSP central agency. Second, the TSP is computerized, like all other large plans, with investments made promptly after contributions are deducted from the employee's paycheck. With individual accounts, it would be up to 22 months after payday under current Social Security Administration procedures before individual accounts could be credited. Third, the TSP is balanced to the penny every day. The Social Security system is never balanced. Each year, there are billions of dollars in unreconciled discrepancies. Fourth, the TSP and the federal employing agencies have a very effective communications system. TSP mailings consistently have reached more than 99 percent of employees, but 25 percent of Social Security Administration mailings are returned as undeliverable. Since individual accounts are certainly not feasible for employees of small businesses in particular, the only practical way to give them high returns is to invest part of the Social Security trust fund in equities. The likely increase in trust fund earnings would be an effective way to help maintain the solvency of the trust fund. Every state in the United States has authorized public retirement fund investment in stocks, which can now be done through broad-based index funds which avoid the problem of direct government control over particular companies. As shown in the chart on page eight of my prepared statement, there is even less government influence over private companies under the trust fund alternative than under the Thrift Savings Plan or the administration's plan, less government influence. In conclusion, Madam Chairman, the administration's plan for universal individual accounts is not feasible from a cost standpoint. The only practical way for the Social Security system to capture the higher returns available from investments in stocks is to diversify the Social Security trust fund investments and the trust fund alternative compared to individual accounts would be less disruptive of financial markets, would save tens of billions of dollars a year in administrative costs, and could be effective virtually immediately, rather than the 2009 starting date proposed for individual accounts. The multi-trillion transition costs of individual accounts would be avoided. The additional trust fund earnings would go a long way toward strengthening Social Security finances and would thus reduce, if not eliminate, the need for significant tax increases or benefit reductions. Thank you for your attention. I hope that my longer prepared statement will be included in the record. [The prepared statement of Francis X. Cavanaugh can be found on page 67 in the appendix.] Chairman Pryce. Certainly, without objection, it will be. Thank you very much for your abbreviated testimony. I know that there is a lot that you all could offer up, and hopefully we will get to some of that in the questions. Let me just start by saying that as a federal employee I am a participant in TSP and have enjoyed much success in that program. My own State of Ohio is one of a half-dozen states that has begun to offer a 401(k)-like retirement accounts through which eligible employees can invest in a handful of state-screened mutual funds or other portfolios. But we have not had as much success as TSP in Ohio. Along with that, I would just like to offer up that I have a very friendly mailman. I see him when I am home. He stops in and we chat, and he likes to talk about all kinds of things we do here in Washington. He informed me the other day that if President Bush wants to really sell personal accounts, he should get the postal force out, because he and his wife have just made so much money in their Thrift Savings Plan and it is the best thing that ever happened to them, and he should just get all of the postal carriers from all over the country to come and share their experience. So my question is, what are the key features of TSP that makes it so successful, and participation rates so very high, compared to, for instance, what we have in Ohio? Maybe you are not familiar with that, but I just kind of described it, so if you have any insights, that would be great. Mr. Amelio. The size of the plan helps to keep the costs so low. We have large dollar-amounts, as well as a large number of participants, which you would not get from any individual state in order to spread the cost. Secondly, the index funds that we utilize are about the lowest-cost investment that you can find. I am a very large proponent of them. We are able to minimize costs. So if you combine those two features, the large size of the plan with the index funds, I think we are well managed. We do everything internally in terms of administration. That is how we keep the costs relatively low. Chairman Pryce. Mr. Purcell, and then Dr. James? Mr. Purcell. One thing I think that contributes to the high participation rate is the generous match. The federal government, of course, makes a 1 percent contribution on behalf of all employees covered by FERS regardless of whether the employee contributes, but then there are matching contributions so that in effect if you contribute 5 percent, your employing agency contributes an additional 5 percent. So that is a very strong incentive for participation. Chairman Pryce. Yes. Doctor? Ms. James. Yes. Well, I think you also have to look at the wage-base. That is, the average wage of the employee group and the average contribution size, because ultimately that is what determines the size of the account. As I said in my remarks, if you have larger accounts, you are dividing this fixed recordkeeping cost per account by a much larger number. So you can track the TSP costs over time and you can see that that expense ratio falls directly as the average size of the account increases, given the fact that those recordkeeping costs are largely fixed per account, whether it is $1,000 or $50,000. Chairman Pryce. You mentioned a $20 amount per account. Is that over 1 year or what period of time? Ms. James. Well, $20 is my kind of benchmark number. I take that out of looking at mutual funds which have recordkeeping costs, and that is the low end of the cheesy, the lower administrative cost mutual funds operate at about $20 per account in recordkeeping. Chairman Pryce. Per year? Ms. James. It is per year. And it is my estimate of TSP, because I have been unable to get the exact numbers from TSP, but it is my estimate of the ballpark that that is. Chairman Pryce. Let's real quickly switch over to Chile. What are the downsides of their system? You mentioned the high cost. What would you recommend us to do differently if we were to model from that? During our research on reforms in other countries, what are the mistakes we want to really be careful about? Ms. James. Chile and most of the Latin American countries use the retail market, that is pension funds that met certain rules and regulations could enter. They could approach the individual worker and try to attract the individual worker. So it was a direct pension fund-to-worker relationship. Most of the countries in Latin America and Eastern and Central Europe have used that approach. I do not think that is the best approach for us because that is a costlier approach. It involves reaching a lot of little people with little accounts. It involves high marketing expenses. Marketing expenses can be half of total expenses in many of these countries. So I think the approach used in the Thrift Savings Plan, which is using the institutional market, aggregating the small accounts, using a competitive bidding process, using passive investments which Latin America could not use because they did not have indexes, they did not have markets the way we do. So we have at our disposal institutions that they did not have. These can help us keep costs low by competitive bidding, passive investment, which keeps the investment part of the account practically to zero. I mean, if you index to the S&P 500, your investment costs are virtually nothing. Chairman Pryce. My time has expired. We will allow Ms. Maloney to proceed. Thank you. Mrs. Maloney. Thank you so much. I thank all the panelists. There has been a lot of discussion about the Thrift Savings Plan, which is a great success, but this plan, of course, is in addition to Social Security. I would certainly support a similar Thrift Savings Plan for anybody in addition to Social Security. My question, and I would ask Mr. Cavanaugh to begin this, what problems might arise if the Thrift Savings Plan really becomes the substitute for Social Security? Mr. Cavanaugh. If the Thrift Savings Plan or individual accounts became a substitute for Social Security, well, that would be way beyond any of the current proposals. Mrs. Maloney. Or a portion of it, a portion. Mr. Cavanaugh. A portion, well, if you take some of the proposals, the President's portion for the individual accounts would be up to $1,000 in the first year. It would go up $100 each year thereafter, and eventually people could put in 4 percent of pay, but it would be over 30 years before the higher income people would get to that. That is relatively modest compared to total savings or the savings investment in the Social Security trust fund. I think the major question there in terms of impact is whether it is cost-effective. As I indicated in my prepared statement, it would not be. The expense ratio which the administration says would be .03 percent, according to my calculation based on the current market, it would be over 10 times that amount. So to me, it is a nonstarter. I do not see how the program could get off the ground. I would bet that if the Congress enacted anything like the President's current proposal, you would have to recall it within 6 months, once you found that there is no market there, and the costs that would be required. Mrs. Maloney. Dr. James, building on the high cost, I am also concerned about the cost of transition. The plan would increase federal debt by, most economists's estimates, by about $5 trillion in the first 20 years and by increasing amounts after that. The transition costs of pension systems in Argentina contributed really to the country's financial difficulties. Of course, the United States is not Argentina, but we certainly have a huge national debt now of over $7 trillion. How would you address the problem of the large transition costs? Shouldn't an honest proposal for private accounts include a way of paying for these costs other than simply increasing the federal debt? Ms. James. Actually, on individual accounts, I agree with you on that point. I think that how we handle the transition costs is crucial. In the case of Chile, they accumulated a fiscal surplus before starting this system. They started out with a surplus that helped cover the transition costs. We are not in that position, unfortunately. Part of the object of an individual account system is to increase national saving. We have a very low national saving rate. Individual accounts would build up personal saving, but if we finance the transition purely through debt finance, then there would be a commensurate increase in public dis-saving, which would cancel it out, and we would not get the net increase in national saving that we desire. So I do think that is a crucial issue. My own personal view is that we should do one of two things. Either we should come up with a transition-financing plan that does not rely exclusively on debt finance. There are two ways of doing that: cutting government spending or raising taxes. I think we should face that squarely. The second way of doing it would be to use an add-on, rather than a carve-out. If you use an add-on, you do not have transition costs. You also do not have those offsets, the loan that gets subtracted at the end. So there are virtues to that. I think that if you use an add-on, a voluntary add-on really would not be different from what we have now in the form of IRAs and other voluntary plans. So it would have to be a mandatory add-on, which would become part of the overall Social Security system. So I think we either need a transition financing plan, or we should go the route of at least a partial add-on approach. That is my opinion. Mrs. Maloney. Okay. My time is up, but I am also very concerned about the lower benefit because of the payback that you have to pay back into the system. Ms. James. But if there is an add-on, there is no payback. Chairman Pryce. The gentlelady's time has expired. The Chair recognizes Ms. Biggert, the Vice Chairman of the committee. Mrs. Biggert. Thank you, Madam Chairman. Dr. James, Mr. Cavanaugh in his testimony expressed some skepticism that small companies could manage the burden of administering participation in a personal accounts system. He also indicated that the economies of scale from outside management groups would not be available to them. Would you agree with that analysis? Ms. James. You mean if you required every employer to provide its own plan? It was not clear to me exactly what model Mr. Cavanaugh had in mind, because certainly the plans that we are talking about, that are being discussed now, would not be a company-by-company plan. Mrs. Biggert. I think probably it would be rather than like the Thrift Savings Plan, where there is a huge plan, that that would be a lot of little companies who would be managing the personal accounts. Ms. James. No, I do not think it would work that way. I think the idea is there would be a large pool, and under the current plan that is being discussed, as I understand it, the small company would not even be involved in what was going on because money would continue to be withheld. If you used the carve-out approach, then some portion of that would be at the aggregate level subtracted off and put into people's accounts. It would not involve company-by-company costs. Mrs. Biggert. Would it involve, though, there still has to be somebody who administers it. Ms. James. Yes, certainly that is true. I think the collection would be done through the Internal Revenue Service, just as Social Security taxes are now collected. And then there would have to be a recordkeeping mechanism, that is what I was referring to, that would keep track of how much of that money went into each person's account. This is done in Sweden, by the way. They have centralized recordkeeping through the tax collection system. They have centralized recordkeeping for all their workers. Workers then choose among 600 mutual funds. They have a lot of choice there, but the mutual funds do not even know which individuals are going with them. Rather, an aggregate pot of money goes to the mutual funds that workers have chosen. And they of course are now 70 basis points, and they expect it to be getting down to about 30 or 40 in the future. But they manage to give so much choice and keep costs low because they really have a price control system. I do not think we would want a price control system. That is why I think we would have to go the other route and use competitive bidding. Mrs. Biggert. But of course, Sweden is a lot smaller country---- Ms. James. Yes, it certainly is. Mrs. Biggert.--than we are. And so to have one agency that would manage this whole thing, don't you think that it would probably be farmed out to various companies who deal in these type of funds to manage those? Ms. James. I think it would need to be done. I think there are substantial economies of scale in the recordkeeping function. Even mutual funds outsource to two or three large companies that do all the recordkeeping because of the economies of scale. So I think you would either have one large system or you would have a small number of regional systems as we have for Medicare, for example. I do not think you would have a lot of small companies doing this. That would not be an efficient way to go. Mrs. Biggert. I think in your testimony that you agreed with Mr. Cavanaugh that startup costs could be quite high initially. You suggested that amortizing startup costs over time is a way to ensure that costs are not so crippling in the beginning, besides having a surplus, which would be probably the best, if that were possible. Ms. James. Yes, yes. Mrs. Biggert. Have other countries done amortization? Ms. James. Well, for example, the countries that have used the retail approach where pension funds have entered on a competitive basis, you see that in fact their costs in the early years were higher than their fees. They actually made a loss in the early years which they recouped later on. The estimate is that the break-even point comes somewhere after 5 or 10 years. So in a sense they have amortized in that way. If we did this in a more centralized way, we would need a policy decision about that. What they did was their own private competitive approach. We would need to make that policy decision, and I think we would amortize over a large number of years so that the costs would be spread across more cohorts. Mrs. Biggert. Okay, thank you. I yield back. Chairman Pryce. I recognize Mr. Frank. Mr. Frank. Thank you, Madam Chair. Dr. James, I have a copy of a paper that was on your Web site, ``Why Personal Accounts?,'' authored by you and Deborah James. I assume there is a connection. Ms. James. My daughter. [Laughter.] Mr. Frank. Good. It is nice to promote family. Ms. James. She is one of the baby boomers. Mr. Frank. I appreciate the balance with which you approach this, because you do advocate private accounts, but within a certain context. Ms. Maloney got at some of these, and I would like to go further. The minimum pension, one of the bullet points on page three of the paper, a minimum pension should be, you said, between 20 and 30 percent. Under the system that the President has proposed, you could put up to half of your money into private accounts ultimately, as I understand it, but we also would have that reduction in a progressive way. Do you have any sense, that if I retired, say, making about $50,000 a year and I put about half into that, when you say a private pension, would that refer to the amount of Social Security I would get from the other half? Or do you mean in addition to that? Ms. James. I do not exactly understand. Mr. Frank. You say there should be a private pension of 20 to 30 percent in your statement, in addition. Would that be met by the part of your Social Security that was not in the private account, if it was 50-50? Ms. James. You mean the minimum pension? Mr. Frank. Yes. Ms. James. You know, different countries handle the minimum pension---- Mr. Frank. Right. But what would you propose for us? A minimum pension should be added to offset labor and financial market risk. Ms. James. You are reading from the paper. Mr. Frank. From the paper, yes. Ms. James. The little thing. Right. Well, I have my own sort of complicated view of what a minimum pension is and how it might be handled. I think of the public and the private part as together encompassing Social Security. So I do not think of just the traditional part. Mr. Frank. I agree. Let me ask you this. Ms. James. And I would think the minimum would apply, in my view, the minimum would apply to the total, and I would like to see it also linked to years worked per worker, so that people who work longer get a larger return, and that is complicated. Mr. Frank. Let me just put it this way. Under our current system, if we were to do what has been proposed, allow private accounts with up to half and then do that progressive indexation, would the residual pension part be adequate in your judgment? Ms. James. I am sorry. I do not---- Mr. Frank. Let me try again. Suppose we adopted what the President had proposed. You are aware of that? Ms. James. Yes. Mr. Frank. Up to half could go into private accounts. Ms. James. I think he has 4 percentage points going in. Right? Mr. Frank. Yes, up to half of what---- Ms. James. It is a little bit less than half. Mr. Frank. Right. Ms. James. Yes. Mr. Frank. And also progressive indexation, as he calls it. Ms. James. Yes. Mr. Frank. If that is all we did, would that meet your standard for an adequate minimum pension? Ms. James. Oh, well, no. There is no minimum in there. Mr. Frank. Okay. Thank you. Ms. James. Nor is there a minimum in our current system. Mr. Frank. I understand that, but we are talking about changes. Ms. James. Yes. Mr. Frank. In fact, on that subject, you do say also in the paper, wage indexation of the traditional benefit should continue. If you switch to price indexation, the benefit would call drastically relative to the wages and contributions that rise over time. Many seniors will end up way below the average standard of living. So that you would not support the progressive indexation as it has been proposed, at least not at the level of cut-off where it now is? Ms. James. I think progressive indexation is better than pure price indexation. Mr. Frank. That is not what I asked you. Ms. James. If I were---- Mr. Frank. Dr. James, excuse me. I am trying to deal with this. Ms. James. I understand. I want to tell you what my---- Mr. Frank. I am asking you for your opinion. If you do not want to give it, just tell me. Ms. James. No, no. I want to---- Mr. Frank. All right. This is what you said. Wage indexation should continue. Ms. James. Yes. Mr. Frank. There has been a proposal that it should not continue at a fairly low level of cutoff. I am just asking for your opinion on that. Ms. James. Yes. I would like to see the current replacement rate be maintained into the future out of the two parts of social security, including the accounts. Mr. Frank. All right. I appreciate that. Ms. James. That would be my objective in structuring a new system. I would try to make sure that the relationship of the pension to the wage remained where it is today, but I would think of the two income streams as contributing to that. Chairman Pryce. Thank you. The gentleman's time has expired. Mr. Frank. Dr. James, I am kind of disappointed. I was really trying to have a straightforward conversation. I gather you are kind of reluctant to look like you might disagree with the administration. I do not think we have a good discussion if you feel constrained in that way. There are other things in the paper. Would you mind if I put some of these in the record? Ms. James. No. I am delighted to put it in the record. Mr. Frank. Thank you. Chairman Pryce. I recognize Mr. Pearce. Mr. Pearce. Thank you, Madam Chair. Mr. Amelio, when I called the TSP office and asked them the relative costs, and I know you cannot give it exact, but they tell me the cost of administering the plan is about .001, and maybe even as low as 0.006, 1/10 of 1 percent down to 60 percent of 1/10 of 1 percent. Is that about right? Mr. Amelio. The cost on a basis point level would be 0.006. That is six basis points. If you take our entire budget and divide it among the participants, it comes to approximately $26 per participant per year. That is 100 percent of the cost. Mr. Pearce. Right, 0.006. Mr. Amelio. A basis point would be 0.001. You would have to get another---- Mr. Pearce. Yes, I understand. Mr. Cavanaugh testified that the administrative costs would be at least 10 times that. If we went from three million participants, or three-and-a-half million, whatever you have now, to 40 million, because we are told that 40 million baby boomers are going to go into retirement. Let's say that only another 10 million or 15 million, so if we go from 3 to 15 million people in the plan, can you see where you administrative costs are going to go up by 10 times? Mr. Amelio. If we increase the number of participants substantially, is that your question, Congressman? Mr. Pearce. Yes. Mr. Amelio. The costs may go up marginally. They would not go up incrementally. In other words, if we doubled the number of participants in our plan, we would not necessarily double the amount of costs in our plan, no. Mr. Pearce. So the cost structure might stay the same, but not increase dramatically. Mr. Amelio. With respect to the TSP, that is correct, yes. Mr. Pearce. Mr. Cavanaugh, in your testimony you declare that the system of personal accounts would not work because private companies like my company, and I have a small company, at one point we had 50 employees. I never visualized, when I am sitting here talking about Social Security reform, I never visualized that I would do anything more as an employer than what I do right now. I simply get the employee to fill out a W- 2 for the Internal Revenue; maybe a W-4; maybe add a little bit of WD-40 to make it work well when I send it in, but I do not do much. I do collect the taxes from my employees, and I write the check for myself, and I send that to Social Security. Your whole assumption in saying that personal accounts will not work is that I am suddenly going to take the administrative function from Social Security away from Social Security and start doing it myself. I never conceived of that as we are sitting here in the broad stage of discussion. Would your opinion about the personal accounts sustain if we did not make your initial assumption that I, as an employer, was going to take over the Social Security Administration's functions? If we do not make that assumption, if we instead leave the functions with Social Security, will your evaluation stand in the same position? Mr. Cavanaugh. The problem is, and I speak in terms of the current market, the market looked at this problem years ago. They thought since they had already provided 401(k) plans successfully for large corporations---- Mr. Pearce. My question, sir, if you would address that, is will your perception stand if you do not go in with your initial assumption? The assumption of your entire argument is that I as an employer am going to take the function of Social Security Administration, which I never believed that that plan would do. You say that small companies cannot administer 401(k)s and that they do not have them. All I do right now with Social Security is I take the money from my employees; I write a check to Social Security or the government. I think that is all that we would be doing if we had personal accounts. The administration would slide over to an agency like TSP. I would not be required to find people to administer the plan. I do not have people to administer a plan right now. With four or five employees, it just does not get that far. But I do not perceive the initial assumptions that you make, and we come to a different conclusion. My question is, would your conclusion stand if you do not make your initial assumption? If we instead expect Social Security to set up a TSP plan, would your conclusions still stand in the same position they do now? Mr. Cavanaugh. Yes. My conclusion would still stand because if you do not do anything more as a small company than deduct the tax and send it in to IRS, which is what you say you are doing now, that is not what the administration or any of the individual account proponents are talking about. They are talking about a 401(k)-type plan. The industry, when they try to bring these 401(k)-type plans, such as is proposed now, to small business, they have found that if the business has less than 10 employees, they do not want to talk with them, because there is too much involved beyond what you are talking about in terms of taking money---- Mr. Pearce. My time has elapsed. In due respect, I never think that the plan that we are talking about is going to be set up that way. I think that what we are talking about is that the money will be sent to Social Security and a person can opt with Social Security to put some in a personal account, and it will be very similar to the TSP plan that we have, and that TSP plan will be administered by an administration very much like we have. Chairman Pryce. The gentleman's time has expired. Mr. Pearce. Thank you, Madam Chair. Chairman Pryce. Ms. Moore, the gentlewoman from Wisconsin. Ms. Moore. Thank you, Madam Chair. I would like to yield 3 minutes to Mr. Frank. Mr. Frank. Thank you. I want to try again, Dr. James. It says in this paper here, wage indexation of the traditional benefit should continue. Do you still believe that? Ms. James. Yes. Mr. Frank. Then even if we have private accounts, you would still want there to be wage indexation and not price indexation? Ms. James. I would want it to be wage indexed. Mr. Frank. Good. Okay. Ms. James. But could I add something to that? Because I do think we are going to need to have to figure out some way to save money on that traditional part so other changes would have to be made. Mr. Frank. Right. Ms. James. For example, raising the retirement age is one thing. Mr. Frank. I understand. But another change you mentioned, and again you mentioned it, but I think you believe that if we do not stick with wage indexation, even with private accounts there could be a reduction in the cost of living, in the standard of living of people. That is what you said, Dr. James. Ms. James. Yes. Mr. Frank. Okay, second question then. On the transition costs, you say they should not be debt-financed as the current proposal is. Ms. James. Right. Mr. Frank. Here is what you say, instead the limit could be raised on earnings subject to payroll tax. You note that recently most of the wage increase has been above the $90,000. Ms. James. That is right. Mr. Frank. Or better still, a surtax on all incomes could be imposed. Do you still prefer those methods, to debt? Ms. James. Yes, I still do. Mr. Frank. Okay. So you are for private accounts, but with wage indexation remaining and an increase in retirement age, and it being financed, the transition, by some increase in taxation. Is that correct? Ms. James. That kind of plan. You know, I was outlining something very briefly and I still stand by the---- Mr. Frank. I am not putting words in your mouth. You put this on your Web site. Ms. James. That is right. Mr. Frank. I did not have a search warrant. I really just read it. Thank you. I yield back. Ms. James. If I could just add to that. Consistent with what I said, I think that personal accounts have the propensity to improve our system, but I think how you do it and how you get there---- Mr. Frank. I understand that. What I will say is this, there are various ways to do it. I should have added also that you propose that personal accounts be partly with an additional contribution and partly out of Social Security. So yes, if you are talking about increasing taxes one way or the other, raising the retirement age, keeping wage indexation, and financing them partly by additional and partly from, that is a good proposal. Nothing that we have seen resembles it, that is all, other than yours. I yield back. Ms. Moore. Thank you. This is a very distinguished panel and I would love to ask all of you questions, but I guess I want to pursue the line of questioning that Mr. Pearce started with Mr. Cavanaugh, and indeed with Dr. James. I want a clarification on the cost of the thrift saving plan. It is my understanding, Mr. Cavanaugh, that the reason that you think that cost efficiencies could not be realized is because literally 200 million workers and all of those employers would have to have payday of the very same day as the federal government; they would all have to submit the paperwork. There are now about 13,000, thousands of telephone counselors that would be needed. Could you just explain that a little bit more? To follow up, Dr. James, can you explain to me why you believe that we could avoid the transition costs when the thrift saving plan and the federal government under Social Security enjoys not paying those costs because it buys those Treasury bills itself and does not have to pay, and it is not the retail approach. So I am very confused as to how you think we could avoid those costs. Thank you. Ms. James. Who is going to answer first? Ms. Moore. It is up to you. Mr. Cavanaugh. Go ahead, Estelle. Chairman Pryce. There are 48 seconds remaining, so divide it up appropriately. Ms. James. Are you referring to the transition costs or the startup costs? Transition costs come from a carve-out. The startup costs are the costs that you have to incur to get the IT system going and get the whole system established. Which are you referring to? Ms. Moore. Well, you are the one that is telling us that-- -- Ms. James. Well, I think the startup costs, you cannot avoid. There are going to be startup costs. My proposal for that is that it should be amortized over many years because in fact it will serve many future cohorts of workers. With respect to transition costs, that is a whole other story. There, I think you need a transition cost financing plan which would come partly out of taxes, partly out of cuts in government spending. These are the possible places it could come from. I think it should not come exclusively from debt finance. Chairman Pryce. The gentlelady's time has expired. I recognize Mr. Neugebauer. Ms. Moore. The witness will not be allowed to answer me, Madam Chair? Chairman Pryce. We are up against a series of votes and I think she completed her sentence. So we will go on. Ms. Moore. Thank you. Mr. Neugebauer. Thank you, Madam Chairman. Mr. Amelio, I have a TSP account. Do I have an account number, or do you use my Social Security number? Mr. Amelio. Your account is recognized by your name and your Social Security number. Mr. Neugebauer. So at payday, you get an electronic notification that I have withdrawn a certain amount of money, and that information from all the federal employees is sent to you electronically, is it not? Mr. Amelio. There are 130 payroll offices throughout the federal government. Each of those payroll offices transmits to us. I believe we actually receive money on a daily basis, although every other week are the heaviest transmissions. Mr. Neugebauer. But you probably receive that electronically, is that correct? Mr. Amelio. They are all electronic. Yes, sir. Mr. Neugebauer. And so when we are talking about a system where we are going to divert, and one other question, and you do not own any securities in TSP? You contract, when I give you money, you give money to a fund that is tracking the S&P, but your organization does not buy stocks every day. It just invests into the funds that you have contracted with. Is that correct? Mr. Amelio. The fund holds five investments. One of them is, of course, the G Fund or Treasury securities. The other four are index funds. They are managed by Barclay's, which has to get an award by competitive bidding. There are commingled funds, which are similar to, but not identical to mutual funds. We hold funds. We do not hold individual securities. Mr. Neugebauer. Right. So you hold the funds. So really what we are talking about, and this notion of having employers managing accounts, is not the president's proposal. The proposal on the table is, or one of the proposals that have been brought forward is basically taking Social Security, where we already have account numbers, we already have names, and so basically transitioning that money rather than into the federal treasury, a portion of that, 2 percent or 4 percent, whatever the number is, is transitioned into an account that says Randy Neugebauer now has $100 more in his retirement account this month through the new personal account system than he had last month. At the end of the month now when I get a statement, it says so much went into TSP, and then it says so much went into Social Security. But you know what the balance in my Social Security account is? It is zero. I have a balance in my TSP account. What we are talking about, we already have a very sophisticated collection system in place with the IRS. It has accounts in the Social Security numbers. That is very easily transitioned, and that information and those funds transferred to a third-party provider that we would contract for, and then everyone would have an account. So I think to just kind of scare people off that this is going to cost $200 for $1,000, you know, I think that is bad information. One of the things that I wanted to ask Dr. James about, what is your perception of the downside of going to private accounts? Some people are worried about the benefits being less, but we already have seen a track record where actually the returns are better. So if you want to put a floor on what the benefits would be, it looks like to me we are actually from an annuity standpoint, actually reducing the potential for liability, even if we looked at a minimum guarantee as staying on the current system, or are going to a system where we are investing a portion of those funds in a higher account. Ms. James. I am sorry. I do not exactly---- Mr. Neugebauer. I think the point some people were trying to say, is there a minimum retirement level that we think you would maintain. Ms. James. I think I was asked about whether there should be a minimum pension built into our system. I would favor a minimum pension that was tied to years of work so that people who work many years at low rates of pay are assured of a certain minimum relative to the average wage. I think that would also help to assuage some of the fears that with an individual account you might experience bad investment returns, and that would be particularly bad at the low end of the income scale where people would have a hard time cushioning. So a minimum pension is one way to assure people that if they invest and if there is a prolonged period of poor investment returns, people who had worked most of their lives would be assured of a certain minimum standard of living. That is what I would favor and I think it would help to overcome some of the fears of accounts. Chairman Pryce. The gentleman's time has expired. Mr. Neugebauer. My time has expired. Chairman Pryce. We will go on to recognize Ms. Waters. Ms. Waters. Thank you very much. I appreciate this hearing. I think this is very important. We still all have a lot to learn. I was interested in the discussion about the minimum account guarantee. Do you know if the President has adopted this kind of thinking of a guarantee for those who may find themselves at risk because they have invested in ways that cost them? Do you know if this concept has been included in anything that has been produced by the President and this administration? Ms. James. As far as I know, that is not in the current plan. As you know, we do not have a lot of details about the current plan. I have not seen that. It also is not in our current system, let me reiterate. So we have to put it in that perspective. Ms. Waters. Well, but it is a little bit different. The reason I like the idea, if we ended up going that way, for some kind of a minimum guarantee, is that the current system guarantees you that for as long as you live, that Social Security check will be deposited in your account. We have that guarantee. Ms. James. Right. Ms. Waters. Even out through the year 2042, it guarantees that 80 percent of it would be there. Most people agree you could do some very simple things, as you suggest doing, in the way that you have the minimum guarantee, while the transition costs I suppose of all of this, or increasing or lifting the ceiling on the payroll tax. You talk about using that for transition costs. Is that right? Ms. James. I think in the piece that Mr. Frank referred to, I talked about how that could be financed by raising the payroll tax or having a surtax on incomes is one way to finance the transition. That is right. Ms. Waters. Okay. But I suppose what I am getting it is, number one, that I like the idea of the minimum guarantee; that we do have a guarantee now. And even at 2042 where 80 percent perhaps could only be guaranteed if in fact you lifted the ceiling on the amount of payroll taxes and increased that somewhat, we could fully fund Social Security, in the same way that you describe that you could fund transitional costs. Is that correct? Ms. James. It would require a substantial increase to fund the entire Social Security benefit. Your question actually gets to a very key point. If we are going to put more revenue into the system, should it go into the traditional benefit or should it go into personal accounts. Ms. Waters. That is right. What I did not hear was, because I keep hearing this huge amount that it would take to transition and to set up these accounts, whether you are suggesting that you lift the ceiling, you lift the payroll taxes to finance that. Ms. James. If I could just respond to that, because it is really the central question and I think we ought to focus on that a little bit in the broader debate. One problem with raising taxes and putting more revenue into the traditional system, is that in the interim period, over the next 30 or 40 years, that will be building up the trust fund. You then have to ask how will the money in the trust fund be invested. Now, right now the money in the trust fund is invested exclusively in government bonds. There is some evidence that that actually increases the government's deficit; that it is not only invested in government bonds that would have existed otherwise, but it encourages additional deficit finance because here is this pot of money sitting there that only the government gets access to. Now, if this increases the government deficit, then eventually taxpayers are left with a larger set of obligations that they have to fulfill. That will simply result in a larger taxpayer burden down the road. In other words, really the question is can we effectively save in this way by simply building the trust fund. The proposal to put all that extra revenue into the trust fund would run the danger that we really would not be saving; that it would be in the trust fund, but it would become an additional government deficit. Ms. Waters. I understand that, but I would have to look closely at that deficit argument to see if really that is what happens. What worries me a bit about this discussion of the private accounts even, particularly about your take on this, that a minimum guarantee as done in other countries that you have identified, would give you some kind of safety net. What I am really concerned about is this: Over the past several years, last two years or so, even in the TSP accounts, those people that were heavily invested in one of those markets lost money. With these investment accounts, if you are in your last couple of years of retirement and you do not have a minimum guarantee, and you lose the money that you are allowed to invest, how then do you recoup it? What do you do? Because I think we have seen some evidence of that in TSP, even though it is considered pretty good. I mean, it is pretty safe. Chairman Pryce. The gentlelady's time has expired. I would be happy to allow a brief answer, and of course we can submit further questions. Ms. James. Right. I will make my answer very brief. I am sure you know the historical data. All we have is the past. We do not know for sure what the future will hold. Historically, we know that for any 20-year period in the past, you would not have lost money. You would have come out ahead with a stock market investment rather than bonds. Now, the future may be different and no one is proposing all this money should be put into the stock market. So that is part of my answer. Another part of the answer is, I think people should move out of stocks gradually as they are approaching retirement age. I think waiting until the last moment is dangerous for the very point you mentioned. The market could fall on the day that you decide to move out. So I think a gradual move-out during the 5 to 10 years prior to retirement is the way that I would recommend doing this. Finally, I think we are mostly concerned about the low end of the spectrum in this regard, and that is where I think some kind of minimum guarantee would be useful. Ms. Waters. Thank you, Madam Chair. With unanimous consent, just to raise the question of who is going to tell Ms. Mary Jones how to do that strategy. I am at retirement age and nobody told me. So where do they get this information from? Ms. James. It has to be built in. It has to be structured. You cannot depend on individuals to think it through. Ms. Waters. That is right. That is absolutely true. Thank you. Chairman Pryce. Thank you. We are at a vote now, and the Chair notes that some members may have additional questions for this panel. They are encouraged to submit them in writing. Without objection, the hearing record will remain open for 30 days for members to do so and for the witnesses to place their responses in the record. We are very, very grateful to all of you for spending time with us this morning. It was most informative, and thank you for being here. This hearing is adjourned. 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