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July 27, 2000, Thursday

TYPE: COMMITTEE HEARING

LENGTH: 35119 words

COMMITTEE: HOUSE BUDGET COMMITTEE

HEADLINE: U.S. REPRESENTATIVE JOHN KASICH (R-OH) HOLDS HEARING ON SOCIAL SECURITY AND MEDICARE

LOCATION: WASHINGTON, D.C.

BODY:
HOUSE BUDGET COMMITTEE HOLDS A HEARING ON THE LONG-TERM

SOLVENCY OF SOCIAL SECURITY AND MEDICARE

JULY 27, 2000

SPEAKERS: U.S. REPRESENTATIVE JOHN KASICH (R-OH), CHAIRMAN

U.S. REPRESENTATIVE SAXBY CHAMBLISS (R-GA)

U.S. REPRESENTATIVE CHRISTOPHER SHAYS (R-CT)

U.S. REPRESENTATIVE WALLY HERGER (R-CA)

U.S. REPRESENTATIVE BOB FRANKS (R-NJ)

U.S. REPRESENTATIVE NICK SMITH (R-MI)

U.S. REPRESENTATIVE JIM NUSSLE (R-IA)

U.S. REPRESENTATIVE PETER HOEKSTRA (R-MI)

U.S. REPRESENTATIVE GEORGE P. RADANOVICH (R-CA)

U.S. REPRESENTATIVE CHARLES F. BASS (R-NH)

U.S. REPRESENTATIVE GIL GUTKNECHT (R-MN)

U.S. REPRESENTATIVE VAN HILLEARY (R-TN)

U.S. REPRESENTATIVE JOHN SUNUNU (R-NH)

U.S. REPRESENTATIVE JOSEPH R. PITTS (R-PA)

U.S. REPRESENTATIVE JOE KNOLLENBERG (R-MI)

U.S. REPRESENTATIVE WILLIAM "MAC" THORNBERRY (R-TX)

U.S. REPRESENTATIVE JIM RYUN (R-KS)

U.S. REPRESENTATIVE MICHAEL COLLINS (R-GA)

U.S. REPRESENTATIVE ZACH WAMP (R-TN)

U.S. REPRESENTATIVE MARK GREEN (R-WI)

U.S. REPRESENTATIVE ERNIE LEE FLETCHER (R-KY)

U.S. REPRESENTATIVE GARY G. MILLER (R-CA)

U.S. REPRESENTATIVE PAUL D. RYAN (R-WI)

U.S. REPRESENTATIVE PAT TOOMEY (R-PA)

U.S. REPRESENTATIVE JOHN M. SPRATT, JR. (D-SC),

RANKING MEMBER

U.S. REPRESENTATIVE JIM MCDERMOTT (D-WA)

U.S. REPRESENTATIVE LYNN N. RIVERS (D-MI)

U.S. REPRESENTATIVE BENNIE G. THOMPSON (D-MS)

U.S. REPRESENTATIVE DAVID MINGE (D-MN)

U.S. REPRESENTATIVE KEN BENTSEN (D-TX)

U.S. REPRESENTATIVE JIM DAVIS (D-FL)

U.S. REPRESENTATIVE ROBERT A. WEYGAND (D-RI)

U.S. REPRESENTATIVE EVA M. CLAYTON (D-NC)

U.S. REPRESENTATIVE DAVID E. PRICE (D-NC)

U.S. REPRESENTATIVE EDWARD J. MARKEY (D-MA)

U.S. REPRESENTATIVE GERALD KLECZKA (D-WI)

U.S. REPRESENTATIVE BOB CLEMENT (D-TN)

U.S. REPRESENTATIVE JAMES P. MORAN (D-VA)

U.S. REPRESENTATIVE DARLENE HOOLEY (D-OR)

U.S. REPRESENTATIVE KEN R. LUCAS (D-KY)

U.S. REPRESENTATIVE RUSH HOLT (D-NJ)

U.S. REPRESENTATIVE JOSEPH M. HOEFFEL III (D-PA)

U.S. REPRESENTATIVE TAMMY BALDWIN (D-WI)

DAN CRIPPEN, DIRECTOR

CONGRESSIONAL BUDGET OFFICE

FORMER GOVERNOR PETE DU PONT

NATIONAL CENTER FOR POLICY ANALYSIS

FORMER REPRESENTATIVE TIM PENNY, CO-CHAIR

COMMITTEE FOR A RESPONSIBLE FEDERAL BUDGET

HENRY AARON, SENIOR FELLOW

BROOKINGS INSTITUTE

U.S. SENATOR BOB KERREY (D-NE)

LAURENCE KOTLIKOFF, PROFESSOR OF ECONOMICS

BOSTON UNIVERSITY

ALICIA MUNNELL, PROFESSOR OF ECONOMICS

BOSTON COLLEGE

*

KASICH: Okay, first ((inaudible)). CRIPPEN: Thank you, Mr. Chairman.

Let me begin by recognizing what we've already seen here, the difficult schedule we have today and more limited time of some of the panelists. I am available all day, so please feel free to interrupt me if it proves convenient for the committee or for other witnesses.

Mr. Chairman, I take as one of CBO's roles assisting in getting the questions right. That is not to say that CBO is always right or even that we always have an answer. But I suggest, Mr. Chairman, it would be rare to obtain the right answer when positing the wrong question.

I believe there's a growing consensus among economists on the appropriate questions concerning programs that span generations, specifically federal programs that support retirees. But before I present what I believe to be the right questions, I want to state what I believe to be the wrong question, namely the status or solvency of trust funds.

This hearing was billed as considering the sustainability of government entitlement programs. Mr. Chairman, balances in trust funds by themselves have nothing to do with sustainability. We must lead and confuse ourselves and others when we cite improvements in solvency as improvements in our collective ability to pay obligations in the future.

Unfortunately, the confusion is widespread. This poster is representative...

KASICH: Mr. Crippen, would you say that in English? I don't think -- I understood what you meant, but there isn't anybody else in the room except for Kotlikoff back there that understood what you just said. Say it in plain terms, would you?

CRIPPEN: Well, as plain as I can be, trust funds don't matter for the issue of sustainability. They are an accounting mechanism, and I will cite others who believe and say other words that may make it clearer than I can, but the level of balance in the trust fund has little to do with our ability to pay future obligations.

KASICH: I think that was pretty clear.

CRIPPEN: As I said, this poster just show you the reporting after the last trustee's report. The reporters equated solvency or increased trust fund balances with a rosier future. It may turn out to be true but not for any of the reasons cited in these articles save one, and I'll get to that in a minute.

Let me give one example of a potential danger in our accounting, and then by contrast pose what I believe to be the more relevant questions.

Sometime in the not too distant future, around 2015, Social Security expenditures will exceed payroll taxes. At that point, general funds in the form of interest credited to the trust funds will be drawn down to pay benefits. Later on, U.S. government debt credited to the Social Security trust fund will be redeemed for cash to cover any shortfall. But all of that begs the question: How does the cash get generated to cover benefits in excess of payroll taxes? It must come from the rest of government and taxpayers by cutting other programs, increasing borrowing or raising taxes, the same result as if there were no bonds credited to the fund or indeed if there were no trust fund at all.

I repeat: The economic and budgetary result is the same with or without a trust fund. As the president said in his FY 2000 budget, the trust fund balances are claims on the Treasury that when redeemed will have to be financed by raising taxes, borrowing from the public or reducing benefits. The existence of large trust fund balances, therefore, does not by itself have any impact on the government's ability to pay benefits. That point, Mr. Chairman, is not well understood.

So, if the trust fund is inappropriate for questions of sustainability, what is appropriate? I would argue, as have others I will cite this morning, that the size of the economy and the amount of those resources consumed by the elderly are most relevant to the issue of sustainability. Clearly, there are other very legitimate questions, particularly about distribution of the benefits that this analysis does not address. Rather, this approach analyzes the overall funding. As such, it would apply to virtually any distribution of the benefits you choose.

In the end, Mr. Chairman, it is the economy that acts as our intergenerational trust fund, not just for Social Security but for all other transfer payments to retirees. It is largely the resources produced after we retire that we will be consuming in federal benefits, mostly resources produced by our children and transferred to us to satisfy our claims.

Before the committee supposes that I've jumped off an ideological cliff, let me assure you that this is not a fringe notion nor does it favor one kind of reform over another. It simply states that the size of the economy defines and constrains our ability to pay beneficiaries.

Dr. Alice Ruland (ph), in her speech last year on this topic, said, and I quote, "I believe, however, that focusing too narrowly on the Social Security funding question in isolation from the more fundamental economic challenge of an aging population risks muddling the problem and perhaps picking a wrong answer. In any given future year," she went on to say, "say, 2050, a larger proportion of older people will be competing with the workforce and the rest of the population for shares of GDP in that year. Whatever's produced in 2050 will have to suffice for all claimants. Societies cannot consume more than they produce for long nor can consumer goods feasibly be stockpiled."

Dr. Ruland (ph) went on to say, the most important and urgent question, I would argue, Mr. Chairman, the right question is, and I again quote, "What we can do now to increase future GDP so that there are more goods and services to be distributed among the claimants in future years?" She went on to say, "Some solutions contribute to higher growth, and some do not. It's important to choose a pro-growth solution and choose it soon."

Similarly, Alan Blinder and Frank Newman, in an op-ed in the Wall Street Journal earlier this year said, "Unlike pension funds, Social Security does not own independent assets that can be sold. Rather, retired Americans can consume more of our gross domestic product only if other segments of society, including working people and children, consume less. And the harsh reality is that the workforce of the future will have to support a larger number of retirees. Just how heavy that burden will be depends on several factors, including the level of retirement benefits and the rate of population growth. But one factor stands our particularly important: The rate of productivity growth." Again, that was Alan Blinder and Frank Newman earlier this year in the Wall Street Journal.

Thankfully, there is, I believe, one calculation that takes those factors into account: The percentage of the economy devoted to federal spending for the elderly. The numerator is obviously obligations to retirees as defined by existing law, and the denominator is the size of the economy, the result of both the size of the workforce and their productivity.

These next two charts, one, the record for the last 30 years, and one, our projections for the next 30, plots the portion of the economy dedicated to federal spending on the elderly. We've also added to both charts the actuals and projections of total federal revenues as a percent of GDP.

KASICH: I just want everybody in the room to know, particularly my colleagues on the democratic side, this is not -- I didn't want to have this hearing today for any purpose that was related to politics. I just want everybody to take a look at these numbers, and we're going to have other people that are going probably have other points of view.

But the purpose of this is really -- I think my party, in a large way, is as unable to deal with these as the other party, and in some respects, I feel like I'm back in 1989 again saying we need to balance the budget. Now, I don't think we'll say that, but I want to warn about this. Frankly, this problem is as serious or more than what we faced 10 years ago. So, I just would like everybody to be able to kind of see these charts.

Go ahead, Dan; I'm sorry.

CRIPPEN: That's fine. I couldn't even see them.

The next two charts, one, the record -- they're going to be backwards here, Wayne, but switch them around, if you would -- the one of the left, about to be on the left, is the past 30 years, and the one on the right will be our projections for the next 30 years. As I've said, we added the revenue projections as percent of GDP as well just to be illustrative.

For the past 30 years, this measure has been creeping up, largely because of increased costs of Medicare and because of growing numbers of retirees. Thus, because the ratio grew, costs were shifted from the elderly to the working population with a burden on the workforce increased.

Over the next 30 years, the portion of the economy dedicated to federal programs for the elderly will virtually double from seven percent to 14 percent. A substantial part of the increase is due, Mr. Chairman, as you already said, to the increase in the retired population -- the baby boomers -- with little growth in the underlying workforce. A large portion of the increase is also due to ever increasing Medicare costs for each retiree. The result is that the burden on the workforce and future generations will rise dramatically.

Put another way, as we talked before, to eliminate the shift of burdens to the future, my generation, essentially, needs to pay twice -- once for our parents and once for ourselves. We are currently contributing more than our parents require, hence the Social Security surpluses. In order for that surplus to contribute to future funding of these programs, it must, and I repeat must, add to national savings. Simply running a surplus in the Social Security trust funds or otherwise adding to the trust fund balances does nothing to aid future financing, does nothing to grow the economy.

That's why trust fund accounting by itself has nothing to do with the ability to meet future obligations. But saving Social Security surpluses by running total budget surpluses of the same amount or more should enhance economic growth and make future benefits more affordable.

The calculation of spending on the elderly as a percent of GDP illustrates the policy dilemma. There are only two moving parts: the level of benefits and the size of the economy. If you want to change this outlook, say, to lower future burdens, the economy needs to grow faster or benefits need to grow slower, neither of which is directly related to solvency or trust fund balances.

But assume for a moment these charts are about right. What are the implications of our projections for spending on the elderly? With revenues at a constant 20 plus percent of GDP, programs for the elderly will eventually consume much of the federal budget, leaving little room for anything else. I should note federal revenues over the past -- federal revenues have averaged under 18 percent of GDP for the last 55 years, and the current level is near the historic high of 20.9 percent reached in 1944.

How can we reduce future burdens? We need to increase productivity, and one way to do it is to save more as a nation. Like our grandparents and parents told us, foregoing consumption today and saving instead will make us better off in the future by enhancing productivity. There may be other policies that enhance productivity.

CRIPPEN: We could also expand our workforce by changing immigration policy. In short, Mr. Chairman, we need to exhibit behavior and pursue government policies that will grow the economy.

Can we grow our way out of this problem? Not within the construct of current programs. Social Security is pegged to replacing a portion of real wages, so as the economy grows, so will future Social Security obligations, although there is a significant lag that would improve this picture. Likewise, Medicare, as currently structured, will likely increase even more rapidly than the economy. But make no mistake, a growing economy will make it easier for our kids to support us in retirement, as Blinder and Newman both observed.

If we can't grow all the way with the problem, we would have to accept some reduction in our benefits, meaning my generation, to ease the burden on future generations. For example, as you have proposed, Mr. Chairman, if in calculating an individual's Social Security benefits the current indexation for real wages will change to indexation for consumer prices, the growth an average benefits would be less than the growth in the economy. That would restrain the growth of the ratio on the second chart considerably. Obviously, the policy implications of such a change is the conversion of some notion of wage replacement to one of preservation of purchasing power, and our retirees would be guaranteed some level of consumption.

Mr. Chairman, let me quickly summarize what I've tried to present here today. First, I want to note that it is my generation, my kids, my grandkids, not my parents, who would be affected by anything I've discussed today. Second, the existence of a trust fund and whatever balances might be in it are largely irrelevant to the country's ability to pay future obligations. That is not to say that financing of the program, the current excess of taxes over expenditures, is irrelevant, but those surpluses are a result of the operation of the program and the operation of the rest of the government, not the existence of a trust fund. Rather, the most important factor is economic growth, the future size of the economy. Unless we begin to recognize this, as Dr. Ruland (ph) said, we are likely to take actions that will make the outlook worse not better.

Mr. Chairman, if we don't have the right question, we aren't likely to get the right answer.

Thank you.

KASICH: Well, obviously, you say the economy would have to grow faster, but yet we -- let me ask you this question: Do you think that the economic growth we've been seeing with the higher productivity -- which was brought about by higher productivity, do you think it can be sustained, in your judgment? Have we actually seen a breakthrough in terms of productivity based on the development of all the new technology?

CRIPPEN: There seems to be an increase back to what has been closer to historic rates of productivity increases. So, in that sense, it's comforting to say this might go on. It's still not clear. Indeed, a number of weeks ago, we hosted a conference, at the request of your counterparts in the Senate, on the new economy and where is the productivity coming from, and there is no consensus exactly on what's happening. One point of view, Mr. Gordon's, is that we're getting most of the productivity increases out of making computing equipment, not in using them but in making them. If he were right, for example, then that may not be as pervasive a productive increase as would appear to be the case.

KASICH: And now that Napster's gone down, we're really in trouble.

CRIPPEN: I know. That means you got off-line, I assume, last night.

KASICH: I ain't telling.

(LAUGHTER)

CRIPPEN: I noticed that.

So, we have adopted in our forecast some increase in productivity over the last 12 to 18 months as we've changed our economic estimates as well. But we're still below what we are -- our long-term forecasts are still below what we're currently experiencing. So, we are not complete converts yet, as a matter of forecasting, to a new economy at permanently higher productivity levels. But we have included -- we've upped our productivity growth by about 0.6 over the next 10 years. So, we are hopeful that some of this is permanent and obviously have put that in some of our projections.

KASICH: Yes. It just kind of occurs to me, a lighter moment here, is I'd be interested to see on the next vice presidential questionnaire: When exactly did you stop downloading Napster?

Anyway...

CRIPPEN: It will get there eventually.

KASICH: The answers to the Social Security problem really aren't that difficult, are they, if you have -- you'll have your chance. They're really not that difficult, are they, if you can figure out a way to generate a significant boost in return on the Social Security taxes, plus over time you slow the growth in the benefits to keep pace with inflation rather than higher than inflation. Is that correct?

CRIPPEN: Well, just increasing the rate of return on Social Security contributions won't do you a lot of good in and of itself. Again, those increased returns have to be due to increased national savings. If we are simply swapping one dollar for another, debt for equity, it doesn't matter how you view it, just increasing the rate of return of the trust fund makes the trust fund look better but doesn't grow the economy. And again, that's why I'm arguing that we should remove or at least diminish our focus on the trust fund and rather look at what I think is the more relevant question: Are the actions we're taking growing the economy? Whether or not the trust fund is improved or worsened is irrelevant. The point is, is the economy made better by the proposal of reform that you're positing?

KASICH: But if the problem with Social Security is being driven by demographics, number one, the fact that more are retired, fewer working, and the problem that the benefits themselves are being funded at a level that is higher than replacement level, higher than the rate of inflation, then even if this economy were to grow -- I don't know if it could grow much -- I mean it depends who the fed chairman is -- but let's assume it grew a little bit faster, you still are going to have a rising percentage of the economy being eaten up by Social Security, for example. In other words, the point I want to make is if you do nothing about the benefits, then you can't fix this.

CRIPPEN: That's what I was saying, I think, Mr. Chairman, trying to say, at least, in my opening statement, is that if you define this as being the problem, that is an ever growing share of the economy going to the elderly and therefore probably squeezing all other things, and if your policy goal is to lower the 14 plus percent to something less, growing the economy will help that, because there is a considerably lag in the benefits as we grow the economy. But it can't solve the problem, because you're chasing your own tail. So, in order to lower that number significantly, you will have to do something with benefits.

KASICH: I wanted to just make the point to you that I think it's possible with very modest projections to not only create the private accounts, which would generate a higher rate of return, and maybe the debate gets to be who invests this money. I hope that's where it ends up, because that means you won the fundamental debate about the need to allow people to put some money in the private economy. But you don't have to slash the benefits, really. You just have to just slow the growth in those benefits. And the people would benefit more. I mean their total amount of take from Social Security would be greater than the current system even though the current system can't meet this obligation.

So, my only point, I think the problem with Medicare is a lot more severe. And the Medicare problem is more severe, isn't it? Do you want to just run 30 seconds on that?

CRIPPEN: Well, about half of the increase you see here is Social Security, and the other half is Medicare. And even then most of these long-term projections are based on assumptions about Medicare that probably, woefully are way too low.

For example, the Social Security actuaries, which most of us use for our projections, assume that at some point in the not too distant future, I think it's around 2010, that Medicare -- the cost of Medicare -- the increases in Medicare will only mirror those in the economy. Medicare can only grow as fast as the economy. But that's not been the case almost since it was instituted, so that's probably very low, and that number -- the 14 point, whatever it is, six -- out there will be higher, because Medicare spending is going to be higher than the current projections.

KASICH: So, it's likely that for every dollar we spend on children, which in a sense is if it's in an -- and I hate to get into this debate, but I think maybe democrats have some -- or the economists that argue that investing in, for example, higher education, I happen to think they're probably right on this, although the higher education programs are so screwed up from the standpoint of out-of-control costs. But certainly investments in higher education, which gives you greater skills, is going to contribute to higher productivity. But if in fact that ratio of seven to one grows to eight to one or nine to one or 10 to one, then you are feeding consumption while you are not encouraging investment. Would that be correct?

CRIPPEN: Yes.

KASICH: Mr. Smith; go ahead, Nick.

SMITH: Mr. Chairman, thank you very much.

Just a tremendously important hearing; disappointed that there aren't more members. Maybe it represents the fact that it is still somewhat a third rail. There's a reluctance when we talk about the huge challenge that faces us with both Social Security and Medicare to deal with that problem. It's easier to put it off, and that's what we've been doing.

Dan, what's included in the -- when you talk about senior spending? Is there anything in addition to Social Security, Medicare, and Medicaid?

CRIPPEN: No. And we didn't -- although there are, obviously, and we have compiled some estimates of what other programs, veterans, for example, other things that you might put under programs...

SMITH: Extra tax benefits, that isn't included.

CRIPPEN: Those are not in there.

SMITH: How about GDP? What's included in GDP? Is the inflated or -- I use that word uneconomically -- is the inflated value of equities, especially the tech stocks and NASDAQ, included as part of GDP?

CRIPPEN: It would be included in the base, which we then grow by our assumption over time. So, I think the answer is yes.

SMITH: So, you have -- in my mind, you would have an inflated evaluation of GDP then if you're including the increased the value of those stocks rather than real production in this country.

CRIPPEN: Well, there are arguments, let me say, on both sides that, yes, the equity values may be too high and therefore if they decreased precipitously would hurt economic growth. As we were talking with the chairman, we may have our productivity numbers too low as well. But what...

SMITH: Do you support Alan Greenspan's contention that we should be providing the Bureau of Economic Analysis over in the Department of Commerce more funding to deal with these more complicated problems of developing GDP?

CRIPPEN: Data is certainly a continuing problem. A number of the past administrations have recognized it and tried to increase funding without success. We rely exclusively on other folks to generate data. We don't go collect data.

SMITH: So, is that a yes?

CRIPPEN: Yes.

SMITH: Well, and Mr. Chairman, as you know, I introduced my first Social Security bill seven years ago when I first came to Congress, introduced the first bill that was five years ago that was scored by the Social Security actuaries to keep Social Security solvent, so they scored that. And then each session I've introduced a new bill. And Mr. Chairman, if we -- most of those plans that are proposed set aside two percent of taxable payroll in terms of investment. And I call for 2.5 percent; it eventually grows to eight percent. But in terms of solving the problem without reducing benefits for senior citizens or increasing taxes, it would take closer to seven percent rather than two percent of payroll with a kind of investment that's going to return someplace around eight percent in real terms to still solve the program. And if you go that high, then the transition costs are almost unsolvable.

And, so it's a huge challenge, and the good news is, is that we're more conscious of this than we've ever been. We've got two presidential candidates that are at least approaching some of the solutions. And yet we've still got a Congress that is looking at this newfound wealth of extra surplus revenues as justification to increase spending. And, so, politically, the decision continues to be very -- extremely difficult, it seems to me.

SMITH: In your evaluations of the benefits to seniors, did you include or project prescription drugs as part of that projection?

CRIPPEN: No. This is without -- this is our current baseline, if you will, which does not have prescription drugs in it.

SMITH: In terms of the economic consequences of putting this kind of burden on future workers, if we were to solve the problem like we have in '77 and again in '83 by increasing taxes and decreasing benefits, the consequences on the economy if we simply rely on increased payroll taxes that we project are going to approach 40 percent by the year 2040, 40 percent payroll taxes to solve the problem of senior benefits, what kind of effect is that going to have on the economy?

CRIPPEN: Well, those kind of payroll taxes would presumably really deter work effort and hurt economic growth, if not in the generation on which we impose them, certainly on succeeding generations. It would continue to push the burden onto the workforce and into the future.

SMITH: And when you suggest chasing our tail by an expanding economy in the short run, bringing more Social Security funding in, but in the long run resulting in higher benefits because of what the chairman suggested in terms of our benefits being indexed to wage inflation rather than straight inflation, what is the lag time? Do you have an idea of the lag time?

CRIPPEN: Well, it's cohorts, if you will, or generations. The lag, however, produces a benefit, if you will, equal to about one percent of payroll. So, the lag is a fairly significant part of the benefit increases in these out-years. So, it is significant. I don't know what time, but 30 or 40 years.

SMITH: But it still eventually catches up with us.

CRIPPEN: Yes.

SMITH: And Mr. Chairman, what we're also I don't think building into a very serious situation is the futurist projections of longevity. With our new technology and the gene technology now evolving, our future is in our Social Security Task Force. We're guessing that within the next 20 years anybody that wanted to live to be 100 years old would be able to do that, and they'd be able to live to be 120 years old within the next 40 years. And we are not even considering that kind of medical technology that's going to really add to the longevity of people. So, savings and investment and getting a real investment return of the money and some of the surpluses is just critical if we're going to solve the problem.

KASICH: Mr. Sununu.

SUNUNU: Thank you.

One of the things that strikes me in the chart on the right and in a chart we have in some of the notes prepared for this hearing is the degree to which benefit payments, in particular I believe this is a graph of Social Security payments, which is the largest transfer of benefits to the elderly, grow at a rate much higher than the rate of inflation. And I think that the general perception of members of Congress and the public, for that matter, is that the cost of living adjustment is intended to keep pace with inflation so that benefits grow, and you don't have an erosion of purchasing power for those that are dependent on Social Security.

Could you describe a bit why it is that Social Security benefits or the total payments through the Social Security System is projected grow so much dramatically higher than inflation?

KASICH: Let me -- there is a motion to instruct on the floor that has to do with military retirees, which I think you'll want to...

SUNUNU: How much time do we have left in the vote?

KASICH: We have about six minutes. I think...

SUNUNU: I'll try to finish my questioning in just three or four minutes...

KASICH: That's fine.

SUNUNU: ...and then we can let Mr. Crippen...

KASICH: We can run over. OK.

CRIPPEN: Think about it.

SUNUNU: Well, no. I'll try and finish in two minutes so you can answer, and then we can free you from your bond here.

CRIPPEN: All right. OK.

SUNUNU: Why is the benefits grow so much higher than the rate of inflation?

CRIPPEN: Well, there are two reasons, but largely in this chart the reason you see the benefits growing is because of the baby boom retirement. We're going to double the number of retirees, roughly double, from between 2010 and 2030. So, even if the per capita benefits weren't growing any more than inflation, clearly you would have an ever increasing amount going to the elderly.

SUNUNU: But do the per capita benefits grow at a rate higher than CPI as well?

CRIPPEN: No, but the initial calculations, what we're talking about in the chairman's proposal, for example, is that your initial benefit is based on your wages adjusted for wage inflation. So, it's a wage replacement concept. After that time, your benefits are then indexed to CPI or to the price increases. So, the initial benefit uses wages...

SUNUNU: That would mean that an individual's benefit would grow at inflation, but the system's per capita benefit would grow at a higher rate than inflation, correct?

CRIPPEN: Correct.

SUNUNU: Second brief question about cash balances. The projections now for surpluses on budget and off budget are very significant. CBO just increased its estimates. It seems to me that the surpluses will exceed the amount of outstanding debt coming due and force the government to start accumulating very significant cash balances. What will the federal government do with the excess cash as it's accumulated?

CRIPPEN: We don't know, and we don't make an assumption about what it is invested in, but we do make an assumption that it will earn some rate of return.

SUNUNU: Are there any statutory limits right now to what the Treasury can do with cash balances?

CRIPPEN: Not that I'm aware of.

SUNUNU: Could they purchase equities in the public markets?

CRIPPEN: I don't know the answer to that.

SUNUNU: What is the projection for cash balances right now for the -- at the end of this fiscal year, fiscal year 2000?

CRIPPEN: At the end of this fiscal year, we've been carrying over, the last couple of years, about $40 billion. That's partly a cash and debt management...

KASICH: We're about out of time, John. We'd better -- we can come back and finish this. We'll just take a few minutes. Then we'll have Pete du Pont and the next group get up.

We'll be right back.

SUNUNU: I'm happy to follow up in writing unless you have additional questions so that Mr. Crippen doesn't have to stay, and we don't have to...

KASICH: That would be fine.

SUNUNU: Thank you, Mr. Chairman.

(RECESS)

KASICH: OK, we're going to go -- this has just been the most bizarre -- you know, I swear to you, you have a hearing like this -- and the committee will come to order.

And we're going to have -- we're also going to have my longtime friend -- I think this is the first time Tim has ever testified before this committee. He is a great, great buddy of mine. And, of course, Pete du Pont, who is in really a class of his own. He's a terrific man, and I've admired him for many years.

We've got so many things going on, all these votes on the floor, committee meetings, but I'd like to get started and get this stuff on the record.

And, Pete, I think that sometimes you've got this iceberg out there, and you've got to start talking about it before the ship hits it. So, this stuff will get on the record. Some members will come, and let's just go through this stuff.

So, I think the first person we want to have testify is Mr. du Pont. Let's let Mr. du Pont go first. You're on, sir.

DU PONT: Thank you, Mr. Chairman. And It's good to be with former Congressman Penny and Henry Aaron. Henry and I have debated this issue many times over the last five years, and I was just saying to him that I think we can take credit for the fact that when we started talking about it, nobody much cared, and now it's the central issue in a presidential campaign, and I think Henry and I have done well in elevating the debate that far.

Well, Mr. Chairman, and committee members, thank you for the opportunity to say a few words this morning about how we might meet the demographic challenges of the U.S. Social Security System. I think maybe the place to start is the Organization for Economic Cooperation and Development, OECD. Their web site has a map that shows the fertility rate of the world's nations, nation by nation. The fertility rate of 2.1 children per woman is required to maintain a constant population in the long run. And of all the OECD countries, only Ireland, Mexico, and Turkey meet or exceed 2.1. In other words, the population increase is starting to decline. In the United States, the fertility rate last year was 2.06 children per woman.

At the same time, people are living longer in every developed country. U.S. life expectancy in 1940 was 61 years for a male and 66 years for a female. Last year, it was 74 years for a male and 80 years for a female. There are going to be fewer and fewer of us, and we're going to live longer and longer. And this demographic track is the problem that Social Security if facing.

There's going to be major trouble for developed nations as pay- as-you-go Social Security Systems, of which the U.S. is one, face these demographic challenges. Fewer babies are being born that grow up to be workers paying payroll taxes, and at the same time people are living and drawing retirement accounts longer and longer.

There is no question that the pay-as-you-go Social Security System is unsustainable in the long run. Fourteen years ago, in 1986, one poll found that 46 percent of Americans doubted that Social Security would be there, and 68 percent were not confident about the future of the Social Security System. So, even then it was clear that things could not go on as they are for a long while.

And I recount these events of 14 years ago to emphasize the conditions that make Social Security reform imperative, if not gone away. And we cannot put off for another 14 years what we should have been working on 14 years ago, because the cash flow in the Social Security System earns negative in about 2015.

In 1986, I actually proposed a solution to the problem of demographics in the retirement system in our country, called the Financial Security Program, and it involved giving Americans the options of contributing part of their payroll taxes to private retirement accounts. That fell pretty much on deaf ears, as I learned, in 1986, but it's certainly very much in the news today.

In short, the problems inherent in the Social Security System and their solutions are nothing new. The problems have been there for a long while; the solutions have been on the table for a long while. The only thing that's changed is that the American people now seem interested in hearing about alternative solutions to meet the challenge.

So, I'm very respective that economists have helped raise this awareness. Eugene Steuerle of the Urban Institute wrote in 1994, and I quote, "The next few years should be viewed as a crucial period of opportunity during which the nation should be readying itself for the demands of the future. We should not be lulled into inaction by the relevant retiree to worker ratios in the near-term while a potent demographic challenge looms right around the corner," closed quote.

Federal Reserve Chairman Alan Greenspan said in 1996, "It's becoming conventional wisdom the Social Security System, as currently constructed, will not be fully viable after the baby boom generation starts to retire in about 15 years."
I was looking over Professor Kotlikoff's testimony, which he's going to give later on, and he's going to present you some data in very stark terms about those numbers.

The plight of Social Security is not a partisan matter. Senator Bob Kerry of Nebraska said that each day we let -- each day we let go by means tougher tax increases or benefit cuts for future workers and retirees. Senator Moynihan: Social Security, as now constituted, is a social insurance program that will disappear before our eyes if we do not reform it now.

So, my primary message to this committee this morning is that the moment to act is here. The time to act is now. The American people are interested as they've not been interested before, and the proposals on the table give us a number of alternatives for meeting the challenge.

Seems to me that letting workers put a percentage of their Social Security payroll tax into personal retirement accounts to be invested in real assets continues to be the best approach. Indeed, five of the 13 members of President Clinton's 1994 Advisory Council on Social Security favored that approach.

A number of approaches have been made by members of Congress of both parties. You're familiar with them. The idea of personal retirement accounts is both current and bipartisan. Senator Robb has such a bill. Senator John Breaux has such a bill, and he said -- and I think this is an interesting point of which I agree -- he said, I quote, "I believed we've moved the debate past the argument of whether there should be private investment to how private investment should be done."

Now, Mr. Chairman, some witnesses may tell you today that the problem is a small one requiring a minor adjustment to the benefits paid here or the taxes levied there. They're mistaken. The demographic destiny of our current retirement system presents a massive challenge to our economy, to our families, and to the Congress. We cannot save Social Security with some makeshift fixes in an effort to get beyond the baby boom retirements.

We must make a choice; we must make it soon. Either we can make it possible for people to fund their retirement income during their working years or we can anticipate a ruinous intergenerational conflict that will vulcanize America and limit opportunity for everybody.

Thank you, Mr. Chairman.

KASICH: Thank you very much, Governor.

Mr. Penny, welcome.

PENNY: Thank you. It's good to be here.

I testify today in my role as co-chairman of the Committee for a Responsible Federal Budget. This is an organization that has now been around for 19 years. It is a bipartisan, non-profit, educational organization. My co-chairman is a fellow Minnesotan, Bill Frenzel, who served our state for two decades here in the U.S. Congress and was at one time the ranking Republican on this committee.

PENNY: Over the years, our board membership has included every former House and Senate Budget Committee chairman, every former House and Senate ranking committee member, every former CBO director and most of the former OMB directors. So, it's sort of a haven for us budget wants when we leave elective office.

My testimony today is going to be based on two initiatives that our group has been involved with over the last few years. The first is the Graying of America project. I think most members of this committee have received copies of this in your office. We concluded this project in January of this year. It's an exhaustive research project, sort of analyzing some of the various statistics that Mr. du Pont just shared with you, and I have several charts from the study that will be displayed at the front of the room, and I will discuss the information in those charts briefly.

The second aspect of my testimony today will be to discuss with you an exercise that we conducted in eight localities around the United States where we pulled together a cross section of local residents in different regions and gave them background information on the federal budget, on federal tax policy, on demographic trends, and asked them to make some hard choices and to help us sort through policy options that Congress would soon face regarding these various budget decisions.

These exercises were cosponsored by American Express Financial Advisors. We had participation from Democratic and Republican House members at virtually every stop along the way and had somewhere between -- I believe we had somewhere between 60 and 120 participants, and in one case a couple hundred participants in these sessions. We broke them into roundtable discussions and made sure that there was diversity at each table; in other words, sort of forced the kind of compromise and consensus that would be required here in Congress in order to sort through the options and come up with policy recommendations.

So, I'll conclude with an aggregate number of respondents from these groups and what sorts of recommendations they would make relating to the demographic pressures that are facing our retirement programs in the years ahead.

I want to start with the chart that's on display. It shows from 1940 through 2050, both actual and projected workforce participation rates. This gives you some sense of the segment of the population, the under 20 crowd represented in green, the over 65 cohort represented in yellow, and how that relates to the center, those between 20 and 64 who are of working age population and essentially paying the bulk of the taxes, virtually all of the taxes to support those on either side of the spectrum.

As you can see, the size of the working population as compared to the, for lack of a better term, dependent population has been increasing and will continue to increase significantly as we move into the new century.

The second chart that I would like you to review has to do with the amount of time that the average American worker stays in the workforce. This chart, as well, gives you, in the center, the number of years that men and women are likely to be working. And then at the far right, from my perspective, it demonstrates the average number of years that they will be in retirement phase. And as you can see, the number of working years is declining. This is comparing 1940 to 1995 actual statistics. Whereas the length of those retirement years has dramatically increased.

And it's a good news/bad news scenario. It's great that we are now living much longer and enjoying another phase in our lives, but it's also a phase in our lives where we are drawing on public resources to a great extent, through both Social Security and Medicare programs, and that longevity issue will continue to plague these retirement programs in the years ahead.

The third chart that I want to share with you has to do with the worker-to-retiree ratio. Flowing from the earlier charts, it should be no surprise that today we have about 3.5 workers per each retiree. But by the year 2030, we will be down to two workers for every retiree. Hard to sustain a pay-as-you-go system, which our Social Security System is, when we have that sort of a declining worker-to- retiree ratio. It suggests that we would need to do a variety of things in order to make these programs sustainable in the longer term.

Obviously, we could look for ways to increase the workforce. Expanding immigration is a possibility, although there are limits in that regard. We could, of course, reduce the number of beneficiaries by extending the retirement age. We could reduce benefit payments so that the amount paid into the system would not need to be increased, our payroll taxes would not need to be increased. However, another option would be to simply increase payroll taxes or to borrow money or we could cut other programs in the government to provide the differential.

But none of these are attractive or easy options. All of these options, however, are options that we shared with the focus groups in our exercise with hard choices, and I will get to the response of those groups at the end of my testimony.

The fourth chart has to do with the median age of the U.S. population, and as you would expect, flowing from the statistics in the earlier charts, here as well, we're seeing an aging population according to this chart.

A parallel trend is that our workforce is becoming more diverse, and that is depicted in the next chart that Wayne will place on the board. This one might be a little harder to read, but -- in fact, I can't even read it from here. But it exhibits that as we go by, a larger share of the workforce is projected to be non-White and Hispanic, and that as we approach the year 2030 and beyond, we will have essentially a retirement population that is White and a much, much larger segment of the working population that is non-White or Hispanic.

I think it raises some interesting policy implications as we continue to tax through the payroll tax system virtually every dollar earned by working Americans in order to support a largely White and less diverse retired population. And I think the implications of that could play out politically and complicate the policy debate in years ahead.

And the final chart that I want to share with you simply indicates where we're going in terms of retirement population in America. We now have about 14 percent of Americans who are retired. That will grow to over 20 percent by the year 2030. In a sense, we will be a nation of Floridas within three decades.

So, with this as background information, we challenged these groups of average citizens in eight locals around the United States to share with us their recommendations, their policy prescription. The interesting -- it was interesting to me to see the responses, because it didn't track with what you often see in opinion polls. And I think it bears out that given adequate information, that Americans are capable of coming to different judgments than they might by simply being asked would you cut Medicare; would you raise taxes? Those answers are relatively simple or less simple when you have the policy briefing as a background.

Our response to size of government found that 60 percent of our exercise groups were determined to hold the size of government at about 19 percent of GDP. This conforms with trends that you can see over the past several decades in which we've risen above 19 percent of GDP as a size of government only to see in ensuing years the size of government retract once again. It indicates that American voters, over time, are resistant to tax levels that take more than 19 percent of GDP out of their pocketbooks, and that was reaffirmed by the focus groups that we met with around the nation.

Seventy-three percent of our participant groups voted for unified budget surpluses, followed by balanced budgets as the norm for fiscal policy decisionmaking. So, there was a sense of fiscal restraint exhibited by these groups.

Seventy-six percent of the focus -- of the roundtable groups that we met with supported some form of individual account as part of Social Security reform. These audiences were well informed and did understood the tension between political risk and financial risk if partial privatization were adopted. They understood that the entire amount of payroll tax withholding is also included in the employer's share, is also part of employee compensation. They discussed and understood the financial risk associated with individual investments, and they understood the political risk that future Congresses and future presidents could modify promised benefits or raise taxes to fund current benefit promises. Knowing all of that, most groups, again, chose to balance political and economic risk and did support some degree of individual accounts as part of a Social Security reform plan.

There was no clear consensus on Medicare reform. However, interestingly, 44 percent of our exercise groups voted for incremental reforms, which is to say they favored constraining provided benefits, increasing eligibility age, and encouraging more beneficiaries to enroll in managed care. Thirty-six percent voted for some kind of defined benefit contribution program or voucher program. There were no other options discussed by these groups that commanded more than 12 percent support.

The bottom line is I think the American people are perfectly capable of understanding the crunch that government faces as our population ages and becomes more diverse. They do not want government to grow hugely to meet those challenges. They do want to be able to meet the needs of our children and others in the population, while at the same time meeting legitimate needs of our elderly. There seemed to be a strong sense of fiscal responsibility in these groups, and that debt reduction, in their view, ought to be a near-term priority. They seemed to understand the relationship between debt reduction, overall national saving rates, and the way that would play out in terms of our economic performance.

Today's surpluses, Mr. Chairman, cannot be used to pay benefits in the year 2010 when Medicare will likely spend more than its dedicated receipts. Or in 2015, when Social Security is projected to go negative on a cash flow basis. The taxes government collects in future years must be augmented by future borrowing or benefit promises must be revised or future leaders must eliminate other functions of the government to make money available for these retirement programs.

These are demographic challenges that will only grow more serious as time goes by, and delay will make solving the problem much more difficult. Frankly, in this election cycle, it may not be a bad thing to delay any far-reaching prescriptions for solutions in these programs and to allow this to be played out in the presidential and congressional debate during this election cycle. In the meantime, as we wait for this election, it might be best to do no harm and to allow current surpluses to be used for debt reduction.

We do at our committee applaud your committee for holding these hearings. There is not anything wrong with too much education on an issue like this, and so we do applaud you for trying to keep this issue on the front burner and out there in the public domain, because it's an issue that must be better understood by the American public. And our sense, after holding these eight sessions around the country, is that armed with the information that they need, Americans are willing to make rather far-reaching and significant changes in these programs so as to avoid unnecessary burdens on future taxpayers.

Thank you for your time and for your efforts to advance the education of the public on these issues.

AARON: Thank you very much, Mr. Chairman, for inviting me to appear here today, and I'm honored to appear with Governor du Pont and former Congressman Penny.

Governor du Pont referred to a comment made by Gene Steuerle in 1994, regarding the importance of moving expeditiously to deal with the obligations we're going to be facing in the future. He suggested that, I believe, that we had not done much since 1994 in that direction. I think that's not true.

AARON: In 1994, as you know better than probably anybody else in this room, budget projections, official projections of the Congressional Budget Office, foresaw deficits stretching out into the indefinite future and growing ever larger. By 2005, the projection was -- in 1995, the projection was for a deficit of $450 billion.

In July of the year 2000, CBO's projection for the budget in the year 2005 is plus $550 billion. That is $1 trillion in one year of additional national savings. Credit for that achievement goes to you and other members of this Congress and to the White House. There's enough credit here to share on a bipartisan basis.

The idea that we have not done anything in the last few years to prepare for ourselves for the obligations we're going to face in the future is not correct. We're doing the right thing by building national saving, which can increase our productive capacity and enable us to meet whatever we decide are our obligations to the elderly in the future.

Now, my testimony is divided into four parts. I'm going to refer briefly to one and at somewhat greater length to a second part and omit the other two parts altogether; I'll just name them.

The first section deals with the projections of the financial condition of Social Security and Medicare. In the service of those remarks, I have a table, table one, part of my testimony to which I would draw your attention. The purpose of this chart is to illustrate the rather considerable variability over time in the projections that we make. I'm going to focus on Medicare.

Ten years ago, we foresaw a deficit measured as a percent of payroll of over three percentage points. Three years ago, in 1997, we foresaw a deficit of over four percentage points of payroll. As a result of the strong economy and legislation enacted in 1997, the Balanced Budget Act of 1997, we currently project the long-run deficit in Medicare less than one-third as large as that we projected just three years ago. It's 1.2 percent.

The point of this is that a combination of significant but not really radical legislation and a stronger economy than we anticipated just three years ago, compounded out for 75 years, has completely transformed the character of the financial problem that we see in Medicare. Rather than having an enormous hill to climb, there remains a problem, but one that I think successive Congresses will be able to deal with.

The simple fact is when one goes out into very long-term projections, the likelihood that the numbers we are currently projecting will actually be realized diminishes sharply. We do not know how to make accurate forecasts over very long time periods. Just with respect to the budget, there is a trillion-dollar error over the last five years, and I might add that error is purged of all effects of policy change. The trillion-dollar error is exclusively a change in forecasting methods and economic assumptions.

If we can make what appear to be mistakes of that magnitude looking just a few years ahead, we should, I think, understand that the projections we make in the very distant future are highly uncertain. It doesn't mean they're wrong, and it doesn't mean they're biased, and it doesn't mean we should ignore them. But I think it does mean we should be careful about undertaking radical action that will have immediate effects on today's population based on projections of the quite distant future.

The fact of the matter is I think we could all agree Social Security and Medicare currently are running large cash flow surpluses. We could all agree significant, projected, long-term deficits. And I think we could all agree that current action to deal with those long- term deficits is in order. We probably won't agree on what the character of those actions should be.

The second section of my testimony, which when it's available to all members -- I can see some expressions indicating perhaps it's not yet -- deals with the arithmetic -- you do have it -- with the arithmetic of transferring payroll taxes from Social Security to individual accounts along the lines that Governor Bush has proposed. And I'm not going to spend any time on that. I ask that it be part of my testimony.

The next section in my testimony presents what I think is a persuasive argument for why it does indeed make sense to transfer general revenues both to Social Security and to Medicare. And, indeed, the testimony has implications for what the size of those general revenue transfers should be.

But I'd like to spend the rest of my time on a question that I gather was raised by Mr. Crippen, and I know has been of concern to many members of Congress, and that is whether the Social Security Trust Fund is real or somehow imaginary?

Many analysts have claimed that Social Security and Medicare reserves are just accounting mechanisms, that the trust funds hold only paper assets. They sometimes claim that the accumulation of large trust fund balances does not do anything to improve government's ability to meet future benefits. This view, I believe, is simply and flatly wrong, and I'd like to explain why.

One has to start, I think, by acknowledging that government accounting conventions contain many arbitrary rules, and that if different conventions had been adopted, budget accounts would look rather different from the way they do right now. Professor Larry Kotlikoff, from whom you're going to hear presently, has contributed greatly to our understanding of these anomalies by pointing out these problems in a series of articles that have appeared in government -- in economics journals, and you may hear more about that today; I'm not sure.

But the issue here is not whether government accounts are logically consistent constructs. The issue, rather, is whether a policy of collecting more in taxes earmarked for Social Security than is paid in Social Security benefits today contributes to the nation's and the government's capacity to meet future benefit obligations? And the answer to both of those questions, I believe, is yes, and the issue isn't even close.

The first step is to recognize that the direct effects on private investment of adding $1 billion to Social Security reserves or to individual accounts are identical, as shown in a chart, table six, in my testimony. Given government spending and revenues outside Social Security, a $1 billion cash flow surplus in Social Security and a $1 billion addition to private saving directly add to funds available for private investment in exactly the same way and in exactly the same amount. In each case, the return to the nation is $1 billion, multiplied by the private marginal productivity of capital.

That table in my testimony demonstrates that the answer to the first question I posed --does the accumulation of Social Security reserves increase the nation's capacity to pay pensions in the future, the nation's capacity -- the answer to that question is a clear and unambiguous yes.

The accumulation of reserves also shifts the asset position of the federal government. The accumulation of $1 billion in Social Security reserves means that future taxpayers will be spared $1 billion in taxes to pay for any given future level of benefits. Pay more taxes today, and we have to pay fewer taxes in the future.

To be sure, some form of financial transaction is going to be necessary...

KASICH: Mr. Aaron, can I ask you just a question on that point?

AARON: Yes, please.

KASICH: Does that presume that it's not then spent?

AARON: I am taking the rest of government operations as given, so that what we're doing is we're...

KASICH: In other words, if we're running the surplus in Social Security, you're presuming that money is being used to retire debt.

AARON: Correct.

KASICH: OK. Not being used to spend.

AARON: That's correct. In effect, what I'm saying is that I think the traditional...

KASICH: Whether you save here or save there, it's savings.

AARON: I'm taking the position, I think, that members in both parties in Congress and both presidential candidates have embraced, which is you should treat Social Security reserves, in effect, as a locked box. Balance the rest of the budget, do what one thinks is wise there.

KASICH: You're not betting any money on that, are you, that that's going to happen?

AARON: I think the chances are not bad. I trust you, Mr. Kasich, and I trust...

KASICH: Well, Henry, I've got to -- having a name like Henry Aaron, I just got to say if you ask me, "Say it ain't so," I couldn't tell you that. We will spend a big chunk of it. But go ahead. We already have, but go ahead.

AARON: I think what has been happening is that you have been spending a chunk of the projected surpluses in the non-Social Security budget. Whether we're going to dip into the Social Security reserves to use those to justify tax cuts or spending increases, I think there would be a very hard case that a member of Congress would have to make to get that through Congress today.

Let me turn to the paper assets point. The statement that Social Security reserves are only paper assets is true at an insignificant level and is false in substance. Neither Social Security nor private financial savers, including individuals and pension funds, hold real assets in their accounts. Both hold IOUs, paper promises of some private or public entity to pay interest or dividends. In each case, the assets are only as good as the willingness of someone to redeem the assets or to buy them before maturity. In each case, any future need to cash in reserves to meet current obligations would reduce national saving.

The only difference between the reserves of Social Security and those of private savers is that Social Security reserves consist entirely of gilled-edged federal securities, because federal law restricts Social Security trustees to invest only in those assets, guaranteed as to principal and interest by the federal government. Private savers, in contrast, can invest in assets that carry higher yields, because the companies issuing them face some risk of bankruptcy. Social Security reserves are as real as the reserves of any private pension fund, personal brokerage account or corporate reserves.

The view that the trust fund assets are not real confuses two distinct questions: Whether trust fund accumulation adds to national saving, investment, and the capacity to pay future pension benefits, and whether government budget operations on accounts other than Social Security add to national saving, investment, and capacity to pay future benefits. As noted, the additions to Social Security reserves add to national saving and the capacity of the government to meet future pension obligations in precisely the same sense that additions to private savings accounts add to national saving and the capacity of savers to meet their debts.

The concluding section of my testimony deals with some comments on the proposed repeal of 1993 legislation, which subjected an increased portion of Social Security benefits to personal income tax and makes an argument that the repeal of that legislation at this time would be unwise.

Thank you very much, Mr. Chairman.

KASICH: Mr. Aaron, let me -- I'm going to have Pete du Pont respond to you, but I would agree with you that if we took Social Security surplus and we used it to pay down debt; in fact, part of the argument now is we should not only take the off-budget surplus and use it to pay down debt, but to take as much of the on-budget surplus as we can, these dramatically improved forecasts, and use it to pay down debt, because it gets us ahead of the game.

The problem is, though, that if you have a $4.6 trillion surplus over the next 10 years and your projections are for a $337 trillion shortfall in both Social Security and Medicare combined, then the $4.6 trillion compared to the $337 trillion obviously gets dramatically overwhelmed, correct?

AARON: Actually, no, it isn't correct. And the reason it's not correct is that you're referring to periods of radically different durations of some of those numbers.

KASICH: No, that's not correct.

AARON: In fact, were you to transfer instantly, this afternoon, $2.9 trillion of general revenues to the Social Security Trust Fund, the system would be in actuarial balance over the next 75 years.

KASICH: Right, but the actuarial balance is based on the notion that somehow we are going to honor these IOUs.

AARON: I could not imagine the United States government reneging on its debt. I hope you can't either.

KASICH: Let me ask you this question: How do you think that's going to happen?

AARON: How do I think what's going to happen?

KASICH: How are you going to honor those IOUs? Where are you going to get this money from?

AARON: The same way we have always honored them. The government has never reneged on its public debt.

KASICH: We've never had the demographic challenge that we have now. I mean how would we do it?

AARON: Actually, the...

KASICH: Tell me how you'd do it.

AARON: The public debt, even if you use the gross debt, not the debt in the hands of the public, has been declining in recent years, as a share of our GDP. And debt in the hands of the public is now lower than it has been in probably two to three decades. The projections are that public debt that in the hands of -- debt in the hands of the public will continue to diminish. What that means is that by paying down the debt today and even conceivably building up positive assets, publicly held assets, we are preparing ourselves to meet the very costs that you describe in the future.

Pensions are transfers from the active population to the inactive population. The 40 years, from 2000 until 2040, the number of people that each active worker will have to feed goes up six percent, not the huge numbers that you hear thrown around. In fact, as the elderly increases the share of the population, children go down, and labor force participation is projected to increase. So, the actual burden that workers are going to be carrying to support the inactive population goes up, but it goes up relatively modestly. And if we save now and increase productive capacity, we can meet those obligations.

KASICH: Well, but Mr. Penny just testified that Medicare will not be collecting enough revenues to meet the demands in nine -- well, it would be 10 years. Social Security will not be collecting enough revenue in 14 years to meet the demands.

AARON: Not if you include interest income. The period where the cash flow surpluses are positive is a little longer than that. And in both cases, there are reserves which could be depleted, could be used to support benefits. Medicare is not -- now has a larger window of financial solvency than it has had at any time since it was enacted.

KASICH: Well, that's the issue of solvency.

AARON: Yes.

KASICH: Solvency isn't the issue. The issue is when the bills come due, how do you pay them? Do you pay them by raising taxes? Do you pay them by grading other programs? How do you pay your bills when they come due? You won't have enough money to pay them. So, where do you get the money from?

AARON: As with the purchase of a house or sending our children to college...

KASICH: Go in debt.

AARON: ... prudent planning is to start saving early. Then when the expense comes, you have the income from those assets to help you meet those costs.

KASICH: This is only 10 years away for Medicare and only 15, 14 years away for Social Security.

AARON: Oh, it's actually sooner than that. The baby boomers start retiring in 2008.

KASICH: Right. So, we won't have enough money. So, what's all this -- what's this prudent planning? You're going to have -- I mean it would be like my barber who's trying to set some money aside to pay for his daughter's education, and then she announces she's going to a school that costs $35,000 a year. He can't pay for it. I mean in other words, what's coming over the wall is so big that the kind of action we'd have to take today wouldn't be enough to keep the waves from coming over the wall. I mean we're putting up two sandbags, and we've got the Perfect Storm coming our way.

Let me ask Mr. du Pont to make a comment on this, and Mr. Penny.

DU PONT: Well, Mr. Chairman, I can't disagree with Mr. Aaron's comment that a dollar is a dollar. And a dollar surplus in Social Security helps you just as a dollar of saving in the private sector helps you. That's certainly true. But as I said in my testimony, this is not a small problem. When the baby boom generation retires, we're going to double the number of people who get Social Security benefits. We're going to double from where we are today. I don't see how $2.9 billion transferred this afternoon -- 2.9, that's what I said, yes -- trillion dollars transferred this afternoon can solve a doubling of the retirement population. I mean the arithmetic isn't there.

If you cut off how far you go out in time, you can always make it look a little bit better. I mean you can say if you cut it off at 10 years, well, we're fine. If you cut it off at 20 years, well, we're not in much trouble. But if you look at the number of people who are working, who are entitled to benefits, and if that number is going to double over time, there is a problem, and I don't think $2.9 trillion will simply wash that away.

AARON: This isn't a matter of opinion. This number comes courtesy of Steven Goss, who's the deputy chief actuary. They have a continuing calculation that is done as part of the longer-term projections. It is the direct analog of all of the projections...

KASICH: This is all about actuarial soundness. That is presumption that somehow my two young girls are going to be chained to a machine about 22 hours a day to have to pay those bonds. That's the problem with you actuarial soundness.

AARON: No, it isn't. With due respect, that's not correct.

KASICH: Sure, it is correct.

AARON: It isn't. I don't believe so.

KASICH: You have fewer workers. You have dramatically fewer workers, dramatically more beneficiaries. You have the benefits growing by faster than the rate of inflation. I mean the numbers are pretty simple. I don't know who this guy is, but I know that...

AARON: He's the guy who produces the projections we all rely on.

KASICH: Well, he makes the projections to say that somehow this program is actuarially sound. That's based on the presumption you're going to take -- that these IOUs are ultimately going to count for something.

Mr. Penny, do you want to make a comment?

PENNY: Well, I thought you were going to respond.

AARON: No, go ahead.

PENNY: The point that you keep stressing, Mr. Chairman, is to remind us that this is a pay-as-you-go proposition. And payroll tax collections will be insufficient to meet annual benefits in the Medicare Program by 2010, in the Social Security Program by 2015. Once you reach a point where we have to begin relying on reserves, you have to come up with the cash. And Mr. Aaron continues to insist that somehow because these are assets that have the full faith of the federal government behind them, that they are not any different than any other sort of investment, and therefore we can count on it. It ignores the fact that in order to honor these IOUs in the trust fund, we have to make some other adjustment in the budget at that time. It's not money in the bank that we can simply grab hold of.

There is something to be said about paying down debt in the near- term, which will ease our interest payments on an annual basis, and you could then have those interest savings in the budget, in your 2011, 2012, 2013, to honor some of our trust fund obligations. But it won't be enough. Even if you pay off the debt, those interest savings are not enough on an ongoing basis to pay all of the promised benefits in this system.

So, something else will have to give, and with the declining worker-to-retiree ratio, there are only three options available to us. One is to borrow once again and begin increasing our debt, having spent a decade or more paying down our debt. The other is to cut dramatically the other programs of government so as to make money available for a general fund transfer into the Social Security and Medicare systems. Or the third is to burden future taxpayers with higher payroll taxes.

These are explicit choices that will need to be made unless some miracle happens, whether it's higher immigration rates that expand dramatically our workforce, whether it's some other grow in the economy that just continues unabated for the next two decades. But that's betting on the common, and I don't think that's prudent public policy.

KASICH: Just one other question for Mr. Aaron: When you talk about Mr. Goss, you are talking about actuary soundness; is that correct?

AARON: He is an actuary, yes.

KASICH: That is his argument, that the bonds actually will be honored.

AARON: I am indeed...

KASICH: That is the basis...

AARON: ... but I have never heard any elected official suggest otherwise.

KASICH: Well, you're going to hear one here. I'm not convinced of it. I'm not convinced that -- the reason why they will not be able to be honored is because you're going to have a generational war if you don't deal with this problem up-front, which is the purpose of this hearing. We're not going to boost people's payroll taxes by 30 or 40 percent, and we're not going to slash -- we're going to have a problem and probably end up having to slash benefits if we don't deal with it and create private accounts and figure out how to generate more revenue.

The fact is this problem is the most vexing problem facing this country, but there's even one more problem, and that is the rest of the world is facing the same problem. And then it's going to be great difficulty being able to come up with the capital to even borrow the money to finance not only this but also the operation of our economy.

I think that those -- I can tell you that in the Transportation Trust Fund we in fact did write off bonds that were deposited. We did not honor them in the agreement we did on the transportation bill. We, in fact, canceled out IOUs to the government, and we want to avoid that. We don't want to get into that position.

But, Mr. Aaron, if the argument is because there's an IOU in there, everything's going to be hunky dory, I've been around politics 25 years. This is a tsunami coming our way, but I think some of what you say I agree with in terms of saving here means you get ahead of the program.

AARON: May I ask you a question, Mr. Chairman?

KASICH: Sure.

AARON: These are bonds -- obligations of the Treasury Department in the same sense that bond obligations of the Treasury Department are held, say, by Chase Manhattan Bank. Are you telling me that you think that the government would renege on bonds that underwrite promises to 45 million beneficiaries before they would renege on bonds to the Chase Manhattan Bank?

KASICH: I know that New York City went bankrupt, and that the government had to bail them out. And I mean I know there have been a lot of times when -- I know about the S&L crisis where people lost much, much, much money. The point is, Mr. Aaron, I don't think we can allow ourselves to get to that position. But the notion that everything is great...

AARON: I'm not suggesting that.

PENNY: If I could ask Dr. Aaron a related question. Accepting your premise that these bonds are as secure as any instrument, more so because the faith of the federal government stands behind them and we've never reneged on any debt in the past, would you also grant that in order to make good on our promise, we have basically only three options: To transfer out of the general fund monies into the Social Security System, which may then require us to dramatically reduce spending in the general fund for other purposes; to raise payroll taxes on future workers to replenish -- to make sure that the fund has enough money to honor obligations, or to borrow money in the future to make the system whole?

AARON: Currently, these bonds can be sold only to the Treasury Department. Under those circumstances, the three options you described are the only ones available. However, if the Social Security Fund held bonds that could be marketed to the public, then there would be no need for Treasury borrowing, higher payroll taxes or cuts in other spending.

KASICH: You mean if you borrow more money.

Look, I mean I think that the question here is we don't know what's going to happen. Hopefully, and I think we will -- at some point, we will deal with this. But I never know what the government is ultimately going to do or what elected officials are ultimately going to do when the crisis comes. You remember the Pepper Commission? They did a variety of things. It was involved in cutting benefits. I don't think that the debate is really ultimately going to be what do we do with these bonds? Do we honor them? I mean there will be some way to get through that period if we let this thing roll.

KASICH: But what the -- and I think Mr. Penny is on to it -- there are only two or three things that can happen. And my only point of the hearing is let's be aware of this, and let's begin to deal with this thing sooner rather than later, because I believe that if we deal with it sooner, Mr. Aaron, what we need to do is a lot simpler than if we deal with it later.

AARON: Amen.

KASICH: And that's my point.

AARON: Amen.

KASICH: The only thing I get concerned about with some of the testimony is everything is fine. I get that sense from the two sides. One side says everything's trouble, the sky is falling, and then there's the other side of this, which is, well, you know, we can grow out of this. Everything will kind of work itself out. I think that we -- both sides need to say, look, the sky isn't going to fall. And the other side needs to say, we've got a problem; we ought to get about it as soon as we possibly can.

AARON: What you have said almost exactly echoes the first bullet in my testimony, which says we've got a long run problem, and the sooner we deal with it the better.

KASICH: Thank you, Mr. Aaron.

Mr. Smith's recognized.

SMITH: Bearing out, Mr. Chairman, what you suggested, we really don't renege on the debt. But what happened in 1977, what happened again in 1983, when push came to shove on available money, we reduced benefits, and we increased taxes. And, so you don't say we're not going to pay our debt. And that's the danger that we're facing if we continue to put off this problem in the future.

And I'm disappointed, Mr. Aaron, at your suggestion, or at least the implication, that the problem isn't that big. And your suggestion of putting $2.5 trillion into the trust fund now is not consistent with the figures that we have derived from the actuaries at the Social Security Administration or Chairman Alan Greenspan who has suggested at one time $9 trillion unfunded liability and at one time $10 trillion unfunded liability. And if you add to that approximately $3.2 trillion unfunded liability for Medicare and Medicaid for seniors, then I think the problem is significant.

The words "unfunded liability" and "$9 trillion for Social Security" means to me that if you took that money now and put it in a savings account, then the problem would be solved. If you pay out the money that's needed over the next 75 years for Social Security, the shortfall, what revenues coming in from the Social Security taxes are going to be short of the benefits that are now promised, then it's $120 trillion over the next 75 years. The problem, I think, is significant.

And then there was sort of the suggestion that, look, everybody has agreed. We're now taking the extra surplus from Social Security and paying down part of the debt, the debt held by the public. That's not what's been happening for the last 40 years.

AARON: It is what's been happening.

SMITH: Pardon?

AARON: It is what's been happening.

SMITH: No, sir; no, sir. For the last 40 years, we have used that Social Security surplus for other spending. Where we came close for the first time in the last 40 years, 30-some years, close to 40, was last year at $700 million, $0.7 billion. But if you put postal the cost of the over expenditure of the Postal Service, then we still spent the Social Security -- part of the Social Security surplus last year. This is going to be the first year that we're putting the Social Security surplus in a lock box.

And if we go ahead with this railroad retirement bill that's going to cost $21 billion, if we continue with even half of the increased spending that the president has suggested in his budget that he sent to us for next year, we're going to spend part of that Social Security surplus again this year. So, I am very nervous about the suggestion that we simply might somehow be disciplined in spending. And I agree with the chairman that the tendency is to spend it.

Let me ask the three of you a question in terms of getting some real investments from some of these surplus monies, and let's see, two-thirds of you were in Congress. Mr. Aaron, you didn't serve in this chamber.

AARON: Regrettably, no.

SMITH: Well, you've looked at the Thrift Savings Account. The Thrift Savings Account is essentially a government-type board making decisions on investments. Is it possible to have the -- set a private investment account that would ultimately be in the name of the worker so that he or she would have some entitlement to that money in case they died before they were 62 it would go into their estate?

Is it possible to set the kind of parameters of limiting to some kind of safe investments -- index funds or whatever -- that we could have the kind of safe parameters for those investments or even having a government board, like the Thrift Savings Account, invested but having that money in the name of the individual worker so that they would have the entitlement to those funds like we do in the Thrift Savings Account?

Let me maybe get your reaction, starting with you, Governor, on this balance that Republicans and Democrats seem to be arguing about, where Republicans say, look, it's got to be privately owned, personal investments. A lot of the Democrats are saying, well, look, government should do the investment.

But it seems to me that a reasonable compromise there is maybe there could even be a government board investing it, but it be in the name of that individual worker so that the Supreme Court on two decisions now that says there's no entitlement for Social Security can at least start to be countered by having part of that money and part of that investment in the name of individuals.

Pete, and then...

DU PONT: Certainly, you could structure it that way. The real solution to this enormous unfunded liability that's facing us in the Social Security System is a market account that allows people to get a better return on their Social Security, which ultimately will take the pressure off the existing trust fund.

Yes, you could design an investment account in which the individual had full and complete control, and I don't know anybody who is in favor of that in terms of letting you invest in the latest dot- com or art or speculative securities. You could then move to the next step and say, well, we'll have an account that simply can go into one of 10 or 15 government-approved investment vehicles. And that's been tried in many countries around the world and works extremely well. Or you could take the next step, which you just suggested, Congressman, of letting a government board make the investment in your name.

SMITH: Well, I really -- to make the record clear, I'm not suggesting that.

DU PONT: No, no, no.

SMITH: I'm just throwing that out.

DU PONT: Exactly.

SMITH: I'm very nervous about government having that much control over that much investment.

DU PONT: Certainly, it could be done. The risk, of course, of having government oversee investments is that the investments aren't made on a market basis. There tends to be a little political investing done, and that's not often good for the beneficiaries of the investment. But, technically, it could easily be done. Any one of those alternatives could be accomplished very simply.

KASICH: Pete du Pont has to get on a plane in about -- he has to leave here to get a plane in about 10 minutes. Could we just direct a few questions to Mr. du Pont, and then we can come back.

Mr. Moran's recognized. You have a question for Mr. du Pont.

MORAN: Thank you, Mr. Chairman.

Let me bring up another alternative that is invariably part of this context, of course. And that is the fact that as we see this change in demographics, we also have to recognize that there is a change in the health, the longevity of the population. We have a much healthier population, and I think it's almost criminal that so many people are retiring so early, so healthy, and not contributing to this economy and society, and we're having to go overseas to bring in workers, which is fine with me, and I think it's essential. But, gosh, we're losing a whole lot of human resources, because people are retiring too damn early, because we're making it too damn easy.

Now, I think we ought to raise the retirement age significantly but incrementally. The big problem, though, in doing that is that that is unfair to people who work all their lives in functions that require brawn, that require the use of your back and your arms, and the human body just can't sustain that kind of work. Now, we're making a transition where far more people are relying upon their brains and automation and computer technology, so that's helping. But could we not devise a system where people could retire from those back breaking jobs earlier using some combination of disability insurance and retirement insurance so that we could relieve the burden on the trust fund and act in a rational manner with regard to the vast majority people who can certainly afford a much higher retirement age?

The work that has been done on that seems to be pretty sketchy, and yet I don't know why that it's not possible to figure something out that would enable us to use a whole lot more of the resources that you find down in Florida on the golf courses instead of contributing to our economy in productive ways.

Now, Pete can answer that, and I'd be more than happy to have some response from the rest of the panel as well.

DU PONT: My answer will be brief. I'm not familiar with any research, Congressman, that's been done on that either. One way, of course, to keep the talents of the people in your language who are in Florida, keeping those talents in the economy, is to remove the earnings limitation, which is being done.

As for, I'm not sure what your suggestion is regarding people who do physical work as opposed to mental work, but I would think that the Congress should be cautious in creating two classes of beneficiaries if that's what you're suggesting. And that begins to raise a lot of equity issues that I think would prove very difficult.

MORAN: Well, let me just respond. See, I think that you can show some physical inability to continue doing the work that you have traditionally performed. It takes a more flexible disability insurance policy, but that may be a way to be fair and also rational and fiscally responsible. I just don't know what work has been done, and it just seems to me it's not that outlandish an idea. Because we've got to raise the retirement age. But we're going to be stuck with -- we're going to be hit with all these anecdotal examples, which are absolutely true, that there's a whole lot of people out there where we just can't expect them to keep working -- loading things on trucks and so on or even working in a lot of heavy industrial manufacturing jobs much beyond 65.

Now, Henry, I think has --

AARON: The key age, really, is 62.

MORAN: You look a bit pregnant with a response there, Henry.

AARON: I agree with you, and I would frame in just the way you did. But the key age is Social Security is not 65; it's 62. That's when you become eligible first for benefits.

There is research on the effect of reducing benefits on people's willingness to work. Let's be clear: When you raise the full benefits age from 65 -- now it's heading to 67 -- we touch the age of initial entitlement. Raising the age of full benefits is a benefit cut. That's all it is. It, strictly speaking, has nothing to do with, quote, "the retirement age." Available research indicates that cutting benefits has a very small effect on labor supply. Raising the age of initial entitlement would have a much larger effect on labor supply, and that is precisely where the problem you're raising comes into play.

The people who are retiring at age 62 include, to a disproportionate degree, those people who have been doing heavy labor and just can't get out fast enough.

SMITH: And need Social Security all the more than the average.

AARON: But I must say I share Government du Pont's concern about designing this. I thought about exactly this question for a long time. I know a number of other people have. We can't come up with a good answer. How would you produce an administrable program that would provide some kind of soft condition for disability benefits, really? And unfortunately, the more you get into the disability program and look at the way it works, the less confident you are. I won't even say that they can administer it the way it is, but that they could handle this kind of additional complexity. I wish we could. I wish I had a more upbeat answer.

KASICH: Mr. Penny?

MINGE: Yes, just real briefly. First of all, I want to say that I attach myself largely to the comments of my colleague from Virginia. It just strikes me that we are living longer, we are healthier, and at some point we have to address the idea. And I think I speak as a baby boomer.

MINGE: Yes, just real briefly. First of all, I want to say that I attach myself largely to the comments of my colleague from Virginia. It just strikes me that we are living longer, we are healthier, and at some point we have to address the idea. And I think I speak as a baby boomer.

I was born in 1951, which coincidentally, I am told there were more kids born in 1951 than any other year. This is a generational fairness issue. My parents are both alive. I don't want to pull the rug out from under them. On the other hand, I don't want to saddle my kids with a burden that they won't be able to pay. I don't expect to retire when I'm 65. I really don't expect to retire when I'm 67. I'm not going to ask any personal questions about your particular ages but whether you expect to retire at 67. I think many of my generation does not expect to retire, as we know it today, at some magic age.

I do want to raise a quote, and then I'm going to go to Governor du Pont. Winston Churchill observed once that Americans always do the right thing, once we have exhausted every other alternative. It does seem that we have to be forced by some crisis to take action, and that is indeed unfortunate.

I'm interested in this issue, in fact, fascinated by it, for a variety of reasons, as I mentioned, because I was born in '51. But also, when I was in the state legislature, and I'm not sure if former Congressman Penny served on the Legislative Commission on Pensions and Retirement in the state legislature. I know that our colleague Collin Peterson did and I did. I'm curious, and the reason I get to this, Governor du Pont, when you were governor of Delaware, you clearly had to deal with pension issues in state. How did you depoliticize those?

And I guess what we had in Minnesota I think was very effective. We had a commission. It was bipartisan. It was five members of the house, five members of the senate, and we literally worked out some of these retirement issues, which sometimes could be very thorny. But those were worked out. We had our own set of actuaries. All of these things were done, and as a result, starting in 1978, when we had a pension fund problem in the state of Minnesota, which was -- we had unfunded liability all around, and they began to lay out a plan, and they stayed with the plan, and the Pension Commission I think was very effective.

And I've really felt for a long time -- I am getting to a question, I guess -- but I've felt for a long time what happens with this big issue -- and this is a huge issue, and we thank you, even though we may have slight differences in terms of where we should go and how big the problem is -- it clearly is a big problem. And it's something that Congress needs to concentrate on. But the problem is we have the Budget Committee once in a while takes a bite at this, and we have the Ways and Means Committee that once in a while takes a bite at this; we have the Government Reform Committee, which sometimes takes a bite at it.

It seems to me we need to have more of a permanent congressional commission. And I'm just curious, Governor, did you have something like that in the state of Delaware, and do you think there might be a way we could set up some kind of a permanent commission that would begin to chart a course and would somehow hold the Congress accountable for staying on that course?

DU PONT: A two-fold answer, Congressman. First, from my years not as governor but my years in this body, I was an inmate here for some time, the idea of making one committee responsible for dealing with this rather than six or seven or eight that are responsible is a good idea to get more focus. Because, as I testified, this is a massive problem. This is not a problem to be nibbled at around the edges of eight committees.

As for Delaware's experience, there was good news and bad news. The good news was that we did not have a pension crisis in my eight years in office. The bad news was we had so many other crisis that if we'd had a pension crisis, that would have made it absolutely intolerable. We had so many fiscal problems, dealing from near bankruptcy of the state, to sagging revenues, to ballooning expenditures. I mean we had the whole nine yards.

But the answer has to be to find a way to take some pressure off of the Social Security Trust Fund by increasing the amount of resources that go to beneficiaries outside that. And that is why the market-based accounts offer such a good opportunity.

MINGE: Well, I happen to agree with you, and I think whether we're talking about retirement age, whatever we're talking about, you know, the system that was created in the '30s fit the times back in the '30s. But the work force has changed, a lot of things have changed. Life expectancy has changed. And I think it really is time for us to modernize and update the retirement system.

DU PONT: There's nothing wrong -- there was nothing wrong with Social Security in 1935. It has served millions of people extremely well in the years since. But the demographics have dramatically changed since 1935, and that is what needs to be addressed by the Congress.

Mr. Chairman, I apologize for having to leave, but I trust my two colleagues will provide you enough ammunition to keep you going for some time. And I thank you for allowing me to testify.

KASICH: Thank you, Mr. du Pont.

Other questions for the panel.

AARON: May I respond to...

KASICH: You sure can.

AARON: ... a question about jurisdiction? I think it's an important issue, and it's devilishly difficult, as you well know. No committee wants to give up jurisdiction, and that's one of the sources of the problem.

In the case of tax policy, one solution that's been adopted is to have a staff that is shared jointly by the House and the Senate to do tax analytic work. I wonder whether -- and it may be foolish to suggest something without thinking through its full implications -- but I wonder whether something analogous to that in the field of social insurance might serve the Congress well?

MINGE: That's exactly what we had in Minnesota. We had this commission, and it was a joint commission between the house and the senate. They had professional staff; they had their own set of actuaries, and many of the problems that we had relative to particular pension questions were worked out, ironed out in that commission and pretty much accepted by the rest of the body.

The problem here, of course, is we've got everybody -- if everybody's in charge, nobody's in charge, and because of the political nature sometimes of these issues, and they're easily misunderstood, easily misconstrued, and easily demagogued politically, it makes it almost impossible for us to take any kind of action, and clearly, it is time.

And I did appreciate your comments, Tim, that if you give the American people the facts, they can sort this out much better than we sometimes think they can. And I think if we have a rational discussion about where we are and where we need to go, I think the American people will go with this. I think sometimes we worry far too much about this in terms of politics, but it does seem to me that we need some commission or committee that helps to work these things out and begins to chart a course.

I don't share the chairman's view that we're all headed -- I don't see this as a tsunami. I do see this as a serious problem, but I do think it is solvable if we make modest changes now. I hope we don't wait until that wall is upon us.

I yield back my time, Mr. Chairman.

KASICH: Mr. Moran?

MORAN: Well, the other question I wanted to ask, in addition to trying to find some differential and benefit structure so that we can raise the retirement age, do it both politically and it will work from a policy and a political standpoint, is means testing. We have a bill that's coming up on the floor this afternoon. And, basically, it's a means testing bill, at least the democratic substitute is. It says that a couple can earn up to $100,000 and not have to pay anymore tax on 50 percent of their income. Over $100,000 you'd pay on 85 percent of your income. And then it's $80,000 for single, up from 35 and 45, respectively, roughly.

But that's going to fail, and we're going to go back to the 50 percent that we had and of course repeal one of the elements of that '97 Balanced Budget Act that both of you were strong proponents of and in fact Henry has alluded to.

What is your point of view on the legislation before us today?

AARON: I would oppose repeal. This is a question I think of income tax policy. In the case of contributory private pensions, the pensioner is entitled to receive back, in pension, without tax, all contributions on which it came out of taxed income. All of the rest of the pension is subject to tax.

In 1979, I chaired the Advisory Council on Social Security that recommended partial taxation of benefits, and in order to that, staff estimated the lowest fraction of benefit -- pardon me, the estimated fraction of benefits to be included in income tax so that no beneficiary would be treated more unfavorably than they would under the contributory pension rule. That is to say everybody, except for the last person, got a better deal out of the recommendation that we advanced, and it was to include 85 percent of Social Security benefits without a floor and without a 50 percent range in the tax base.

It may come as no great surprise that that recommendation was not received with great enthusiasm by the Congress, but it is the correct policy if you are going to have consistent taxation of pension income.

There is a question of whether one wants to cut tax revenues now, and I realize there's a partisan divide on that issue. But if we wish to cut taxes, I think the way to do so is by cutting rates for everybody, not by adopting a rule that makes even more overly generous than the current rule is the definition of income for one class of beneficiaries. Be clear that the current rule treats Social Security under the income tax more favorably than it would be treated if it were taxed as other contributory pensions are taxed.

PENNY: I could quickly answer this by saying since I voted for the 1983 Social Security reforms and the 1993 increase in the threshold of taxation that I'd be hard pressed now to say roll those back. And I think the arguments that Dr. Aaron has laid out are valid arguments.

I would also draw to your attention two other documents that would, I think, provide some perspective on this question: One is a facts alert that was sent out by another organization, which I am involved with, the Concorde Coalition on the board of directors, and a recent facts alert, dated July 20 of this year speaks to this very issue and suggests that reduction in this tax would be inequitable, as this is a tax that essentially applies only to seniors who are relatively well off. The higher rate, the 85 percent threshold only applies to those earning $34,000 or more as an individual, $440,000 or more as a couple, and some degree of taxation of that income I think is warranted in those income categories.

There's another report by CBO that looks at the relative tax burden of young and old and the relative benefit programs for the young and the old, and I think that also suggests that especially among the better off seniors there is some reason to think that they ought to put more back into government coffers in reflection of the fact that our government programs are now tilted heavily in favor of the retirement population. So, again, those better off clearly could be expected to return some portion of their income to the government to help finance these senior programs.

MORAN: Thank you.

UNKNOWN REPRESENTATIVE: Thank you, Mr. Chairman.

Tim, we want to welcome you back. It's good to see you here today and Dr. Aaron as well. We appreciate your testimony.

Let me start, Tim, with the answer you just gave Representative Moran -- and I apologize for being in and out of this hearing today. We've just come from a memorial service which made me unable to hear all your testimony. So, I hope I'm not repeating questions others have asked.

If you move to the analysis you just gave of the proposal before us today to a political, or public opinion assessment, much like you testified, I wonder what you would say about that. Because, as you know, we were last year faced with a trillion-dollar tax cut all in one piece, and public opinion was not particularly receptive to the uncertainty of surplus projections and the trade off in terms of debt reduction and other national priorities.

Now, as you know, the majority party in the house has adopted a very different strategy which is to split that trillion-dollar tax cut into smaller morsels and to try to pass them one at a time. The total amount of the tax cuts we've had before us thus far are well over $700 billion over the decade, and future tax cuts are proposed, and of course there are interest losses and so forth. So, I gather you're not terribly sympathetic with that strategy, whether you do it in the aggregate or in pieces.

UNKNOWN REPRESENTATIVE: I want to ask you, though, specifically about public opinion, because I think the shift in strategy is dictated by an assumption that the public opinion battle is tougher when you're dealing with these more focused tax breaks. What do you find in your own discussions around the country? Have they raised this issue?

You talked a great deal about how the public is willing to make those budget tradeoffs, and those budget sacrifices. You have some pretty impressive evidence about how seriously people take our country's fiscal situation. Do you have any evidence about where the public comes down when the issue is posed, though, as the current strategy of the majority would pose it?

PENNY: The workshops that we conducted around the country have predated this legislative session, and so they are a bit dated in that respect. What I can tell you is that in the eight sessions we conducted with anywhere between 60 and a couple hundred people in attendance, we broke them into tables for discussion, made sure that there was diversity in terms of age and ethnicity and political persuasion and profession so that very much like Congress, people of differing views were forced to come to terms with one another. And, so in that sense, what we felt we got out of these sessions was sort of an informed poll.

And what we heard from the vast majority of the participants was a strong desire for fiscal responsibility, a strong inclination to use current or near-term surpluses to pay down debt, and as I recall when the question of tax cuts for any future project surplus was brought into the discussion, we had, I think, fewer than four percent of our respondents that thought that tax cuts ought to be a priority item for Congresses in the near-term.

So, again, I can only tell you what came out of these roundtable discussions that we sponsored in eight locations around the nation, but there clearly was a distant inclination to buy into any sort of tax cut scenario. And I think that was based on their understanding that while we may have some near-term good news in terms of the economy and surplus revenues in the federal coffers, that we still have these daunting challenges right out there on the horizon that require a certain caution in the near-term, and that applies to the tax cut agenda.

UNKNOWN REPRESENTATIVE: Of course, as you stress, this is an informed poll, and it assumes that people do have good information about the tradeoffs they in fact face. And that, of course, places a burden on members of Congress and others who understand these issues and have to deal with them to make certain that public interpretation is made.

PENNY: That's right. And obviously the exercise we went through, which involved half a day of presentations to give people a context for their ultimate decisions is not necessarily the way this will play out in a campaign environment.

UNKNOWN REPRESENTATIVE: Let me quickly, Dr. Aaron, ask you a question. I know we have limited time here, and again, forgive me if you've already dealt with this. Maybe this amounts to a request to slice your testimony a somewhat different way, because I'm sure you did touch on these subjects.

I know you come to this hearing on the subjects you've testified on today with a great concern to increase national savings, to help older Americans in future years avoid total dependence on the regular Social Security Program for their retirement income, to shore up other sources of retirement income. But you end up with an unfavorable comparison, I gather, between privatization or partial privatization of Social Security versus the design of a supplemental retirement savings program, perhaps much like the president has proposed.

I wonder if you could in shorthand tell us how you compare those two options -- this kind of private savings plan inside or supplementary to Social Security. What are the relative advantages and disadvantages of approaching the agreed upon need in those two ways?

AARON: Let's start with Social Security. This is not in fact a very generous system. A full-time, average wage worker retiring at age 62 will receive a pension slightly above the U.S. poverty threshold. The function of social insurance is to provide, assured basic income, income that isn't going to vary, that will be there till you die. It strikes me that a system of approximately the size of the one we now have that provides benefits roughly of this order of magnitude, perhaps starting at a later age, is one we want to keep, because it does provide assured basic income

And the simple fact is that no private account system can provide an equal degree of assurance. They're subject to financial market risk during the accumulation phase, and unless they're converted into indexed annuities at pension phase, they're subject to inflation risk and, if you will, the danger you might live too long and outlive your assets.

So, I think the starting point is that of course we have a projected long-term deficit, and I fully agree with the chairman and others that we should move expeditiously to try and close that deficit through a combination of instruments that would leave this system in a condition similar to the current system.

Having said that, there are large numbers of Americans, all too many, who don't save at all in other forms. They may own their own homes; they have their Social Security, and that is just about it, and I think that's regrettable. It is important to encourage saving for people who now don't find it the fashionable thing to do, who are bombarded by advertisements to consume now and do and even go into debt. It's important to make saving sheik. It will help them meet lifetime objectives -- sending children to college, buying houses, meeting illnesses, being ready for unemployment, being able to take care of a serious illness -- that now will lay them low financially or that they will find simply impossible to do.

And for that reason, I think using the tax system to encourage additional private saving along the lines of accounts that would be tilted toward those who now don't save enough, which means low and lower middle-income households would serve a very important public objective, and I would hope that Congress would view such savings devices sympathetically.

I would add that I think it would be a bad mistake to condition those savings -- to make those savings available only for retirement income. The motivations I've described are that if you're a low- income household, the true fact is Social Security does provide what financial advisors would characterize as an adequate replacement rate, ratio of benefits to earnings. But these folks don't have the cash on hand to deal with lifetime's wants and crises before retirement.

So, the direction I think should be to promote saving. If people want to keep it till retirement, fine; if they want to withdraw funds under the kinds of rules under which we now allow withdrawals from 401(k) plans, IRAs, SEPs, the whole alphabetical zoo of saving instruments we now have, those rules ought to carry over to this plan as well. And I think it would be a great step ahead.

UNKNOWN REPRESENTATIVE: How do you think this kind of savings for the households that you're wanting to target could best be incentivized? And, of course, in your answer, I'd appreciate your taking account of what you think at this point we can afford.

AARON: Well, I agree with the chairman that the true fact is that confronted with on-budget surpluses of the magnitudes we now confront, whether this year or next year or the year after, we're going to see some increases in spending, and we're going to see some tax cuts.

What form should they take? It seems to me that one form that the use of some tax reductions could take would be as incentives to individuals who set up savings accounts and make some contribution on their own, kind of structurally similar to 401(k) plan. I call it a tax cut with a benign string attached. The benign string attached is we're giving you a tax cut, but you can't consume it right now. You're going to have to build it up for a while, and you'll have it available when the need strikes later in your life. That seem to me to be a tax cut that would merit very serious consideration.

UNKNOWN REPRESENTATIVE: Thank you. Thank you, Mr. Chairman.

KASICH: I want to thank both of you for being here.

And, Henry, one question: Would you be for lowering or eliminating the tax on long-term held capital gains?

AARON: no, I would not. I have gone through the evidence on this question pretty carefully. The evidence that it would boost national savings isn't there; on the contrary, it's more likely to lower saving given other tax rates. And it is in fact a tax cut that is very heavily skewed toward a very small percentage of the wealthiest people in the United States, a feature, I might add gratuitously, that it shares with repeal of the estate tax.

KASICH: I understand.

I want to thank you guys for being here, both of you, very, very much. Senator Kerry's arrived, and we want to make sure he gets up and delivers his testimony. He's a very important man. He's now on the short list, they tell me. I sure hope you're not breathing heavy over that notion.

PENNY: Mr. Chairman, if I might, before we call forward the illustrious senator from Nebraska...

KASICH: Yes.

PENNY: ... in response to Congressman Smith's question, though he's no longer in the room, I would simply refer the committee to pages nine and 10 of my testimony, my written testimony, where I speak to the issue of individual accounts. And I would ask that someone bring that segment of my testimony to Mr. Smith's attention so that he can get a response to the question he posed.

KASICH: Terrific. Thank you.

Thank you, gentlemen.

Well, I want to welcome the senator from Nebraska. I had an opportunity to take a look at a little of his testimony, and we'll let him run through it. I can see him. There we go.

And Senator Kerry has a long, distinguished career, a successful businessman, senator, and now moving on to be president of a university if he is truly going to retire from politics.

So, Bob, it's all yours.

KERRY: Thank you, Mr. Chairman and members of the committee.

I appreciate the opportunity to testify. I've written this testimony, and I may not get through all of it, but I'll begin as if I am, and if not, if I feel like ad libbing, I'll ask later to be made a part of the record.

I do think this hearing provides us with an opportunity -- it certainly has provided me with an opportunity -- to reflect about how we should set our priorities for the future and what kind of legacy we want to leave to our children.

We're lucky, in many ways, to be having this discussion about spending priorities and intergenerational equity during a time of large projected surpluses. The surpluses provide legislators with a great deal more flexibility in choosing among priorities and in determining our legacy to future generations.

Until recently, we were not so lucky. For more than 30 years, the budget projection reports from the Congressional Budget Office and the Office of Management and Budget were a source of growing despair to the American people. As each year went by, CBO and OMB would present worse news -- larger deficits, larger national debt levels, larger net interest payments. And as the government's appetite for debt expanded, fewer and fewer dollars were available for private investment.

In the beginning, Mr. Chairman, as you may recall, experts were saying that the deficits were good for us, because they were stimulating economic growth and were creating jobs. But over time, the voices of experts opposed to large deficits grew louder. They argued that deficits caused inflation, increased the cost of private capital, mortgaged away our future just at the time when we needed to be preparing for the retirement of the large baby boom generation.

As the opinions of the experts shifted, so did public opinion. During the 1980s and 1990s, the federal deficit became public enemy number one. Great efforts were made to understand it, to propose solutions to reduce it, to explain how much better life would be without it.

KERRY: During election season, the airwaves were filled with promises and plans to get rid of the deficit and pay off the national debt.

Editorial page writers reached deep into their creative reservoir to coin new phrases and create new metaphors to describe the problem. Books were published, non-profit organizations were created, constitutional amendments were called for. There was even a new political party created simply on account of the deficit.

In the 1990s, at great political risk, we finally started taking action to control of the size of the deficit and control the national debt. We voted and passed three budget acts in 1990, 1993, 1997. Unfortunately, we didn't pass Penny-Kasich-Kerry-Brown, that which would have made it even better. These three acts have radically altered the fiscal condition of the federal government. And now the debate in Congress is how the public's hard-earned tax dollars should be spent.

The enactment of these three budget acts, particularly the '93 and '97 budget acts, coupled with impressive gains in private sector productivity and economic growth, led to a remarkable reversal of our deficit and debt trends.

We celebrated our first unified budget surplus of $70 billion in 1998, and over the next 10 years, if we maintain current spending and revenue policies, CBO projects an eye-popping, unified budget surplus of $4.5 trillion. I am proud that we are able to celebrate the fruits of our fiscal restraint, but today, Mr. Chairman and members of the committee, I'd like to call your attention to what I would call one of the unintended consequences of our fiscal responsibility.

Not only have we allowed total federal spending to dip below 20 percent of GDP, levels that we've not seen since the 1970s, but very -- seldom has it been commented upon that we're also on course to have spending levels drop to 15.6 percent of GDP by 2010, spending levels we haven't seen since the 1950s. At the same time as total spending is declining as a percent of GDP, Mr. Chairman, the makeup of our federal spending is continuing to shift in very significant and, in my view, troubling ways.

An increasingly larger proportion of our spending, even after net interest is reduced, is being used for mandatory spending programs compared to discretionary spending programs. These numbers have very important implications for the measurement of intergeneration equity. And now that we've constrained spending and eliminated our budget deficits, the budget debate has shifted to questions about how to spend the surplus on debt reduction, tax cuts, new discretionary spending programs, fixing Social Security, creating a new Medicare prescription drug benefit. I favor all these things to varying degrees and enjoy participating in this debate, as I suspect most of you do as well.

Mr. Chairman, members of the committee, the trick is to find the right balance among these initiatives, and in finding the right balance, I believe one of the most important criterion in determining how to use these surpluses should be measuring intergenerational equity. Not only do we need to assess the amount of money we invest on our seniors versus our children, but we also need to assess the trends of mandatory versus discretionary spending.

Let me start my own assessment of federal spending on children and seniors. Today, the federal government spends substantially more on seniors over the age of 65 than it does on children under the age of 18. In 2000, the federal government spent roughly $17,000 per person on programs for the elderly, compared with $2,500 per person on programs for children. This means at the federal level we are spending seven times as much on people over the age of 65 as on children under the age of 18.

Mr. Chairman, even when we consider that states are the primary funders of primary and secondary education, the combined level of state and federal spending still shows a dramatic and growing contrast in spending on the old versus the young. At the state and federal level, we are still spending two and a half times the amount of money on people over the age of 65 as on children under the age of 18.

Given these discomforting facts, it might seem logical that most of our current proposals for spending surplus dollars would be for investments in our children, but instead the Congress, especially the Senate, has been proposing and working to -- and voting, as well, to spend a major portion of the surplus on the most politically organized voting block in the nation -- Americans over the age of 65.

In the Senate, Mr. Chairman, we've either acted on or are expected to act on the following proposals which directly benefit seniors only. We eliminated the earnings test on Social Security, which has a price tag over the next 10 years of $23 billion. There's an offset after that, but over the next $23 billion -- next 10 years, we'll take $23 billion out of the payroll taxes of Americans to pay for that new law.

We voted to allow military retirees who do not like Medicare to opt out of Medicare and into Tricare of the Federal Employee Health Benefit Program. That has a 10-year price tag of $90 billion. We're proposing to create a new universal Medicare prescription drug benefit, which has a price tag of about $300 billion over 10. We're discussing Medicare givebacks, which has a 10-year price tag of about $40 billion. And we've voted once, and we'll probably vote again after we get back, to increase the federal income tax exemption provided to Social Security beneficiaries, which has a 10-year price tag of $125 billion.

Mr. Chairman, if Congress acts on all these popular provisions, we'll be spending for seniors over the next 10 years. We'll have an increase in spending of $578 billion, an amount that's equivalent to this year's entire discretionary spending budget. At the same time as we are proposing these things, voting in favor of and enacting legislation to improve benefits of tax cuts for seniors, we'll be lucky to get legislation passed that spends an additional $10 billion on children under the age of 18.

The principle reason, Mr. Chairman, as you know very well, is not simply because seniors are better organized voters and children are not. We also have to look at how most programs for seniors are funded versus programs for children. As the members of this committee are well aware, most programs for seniors are funded through mandatory entitlement spending, whereas spending increases in these programs are not subject to the annual appropriations process and are protected by automatic cost of living COLAs each year. Spending programs that primarily benefit our children are discretionary, and that means, as you know well, they are subject to the annual appropriations process. There's no automatic spending increases for these programs, and instead most programs for children are held victim to politics and spending caps.

As a result, the proportion of federal government spending on mandatory versus discretionary spending has undergone a dramatic and relevant shift to this debate. Back in 1965, when I graduated from the University of Nebraska, the federal government spent the equivalent of six percent of GDP on mandatory entitlement programs, like Social Security, and 12 percent of GDP on discretionary funding items, like national defense, education, and public infrastructure.

Put another way, Mr. Chairman, 35 years ago, one-third of our budget funded entitlement programs, and two-thirds of our budget funded discretionary programs. But today, the situation has completely reversed. Today, we spend about two-thirds of our budget on entitlement programs and net interest payments and only one-third of our program on discretionary spending programs.

I'm particularly troubled, Mr. Chairman, by the decline in spending on discretionary initiatives. Although our tight discretionary spending caps were a useful tool in the past for eliminating deficits and lowering debt, they are not so useful today in helping us assess the discretionary budget needs of the nation. And today appropriated spending is contained through spending caps, in my view, that are too tight for today's economic reality.

Mr. Chairman, downward pressure on discretionary spending will become worse during the retirement of the baby boom generation when the needs of programs on the mandatory spending side will increase dramatically. The coming demographic shift -- come on, it's really -- it's going to get hot here. I was going to talk about your district.

(LAUGHTER)

Don't you control this committee? Where is everybody? I'm a victim of my own success.

Mr. Chairman, the coming demographic shift, workers per retirees, is not a pig in the python problem, as described by some commentators whose economics are usually better than their metaphors. The ratio of workers needed to support each beneficiary does not increase after the baby boomers have become eligible for benefits; it remains the same.

And Mr. Chairman, here are the hard numbers. You cannot run away from these numbers. This is what we're going to face starting in 10 years. Now, the number of seniors drawing on Medicare and Social Security will double, from 39 million to 77 million. And the number of workers is projected to grow only slightly, from 137 million to 145 million. Worse, if we continue to underinvest in the education and training of our youth, we'll have no choice but to continue what I consider to be a terrible process, though I voted for it before and I probably will again, of using H1B visas to solve the problem of shortages still there.

One of the least understood concepts regarding Social Security and Medicare, Mr. Chairman, is that neither of these programs is a contributory system with dedicated accounts for each individual. Both are intergenerational contracts, and it's worth saying again: They are intergenerational contracts. The generations in the work force agree to be taxed on behalf of eligible beneficiaries in exchange for the understanding they'll receive the same benefit when eligible.

Both programs are forms of social insurance. They are not welfare, but both are also transfer payment programs. We tax one group of individual people, and transfer that money to another group. The proportion of spending on seniors and the proportion of mandatory spending will most surely increase as the baby boomers become more eligible for transfer payments. Unless we want to raise taxes substantially or accrue massive amounts of debt, much of the squeeze will be felt by our discretionary spending programs. The spiral of underinvestment in our children and in the future work force will continue. Our government will become more and more like an ATM machine.

So, what should we do about this problem? Mr. Chairman, members of the committee, I recommend a two-step approach. Step one is to honestly assess whether we can cut our way out of this problem. Do you think public opinion will permit future Congresses to vote reductions in the growth of Medicare or Social Security or the long- term care portion of Medicare? At the moment, my answer is a resounding no. Indeed, as I said earlier, we're currently heading in the opposite direction. There's no indication, Mr. Chairman, that the political will is there to do anything other than to spend more, not less, than we're currently forecast to spend.

Thus, I reached a conclusion that step two is to consider whether it is time for us to rewrite the entire social contract and to do that you have to answer the question: Do the economic and social changes that have occurred since 1935 and 1965 justify a different kind of safety net? Mr. Chairman, members of the committee, I believe they do. I believe we need to rewrite and modernize the contract between Americans and the federal government in regards to retirement income and to health care.

We should begin by transforming the Social Security Program so that annual contributions leave all American workers, regardless of their income, to accumulate wealth by participating in the growth of the American economy. Whether the investments are made in low-risk instruments such as government bonds or in higher-risk stock funds, it is a mathematical certainty, Mr. Chairman, that 50 years from now a new generation of American workers could be heading towards retirement with the security that comes from the ownership of wealth, if we rewrite now the contract to allow them to do so.

Not only should we reform Social Security to allow workers to personally invest a portion of their payroll taxes, but we'd also make sure those account contributions are progressive so that low- and moderate-income workers can save even more for their retirements. At the same time, it's important to make the traditional Social Security benefit formula even more progressive so that protections against poverty are stronger for our low-income seniors.

Finally, it's important to change the law so that we can keep the promise to all 270 million current and future beneficiaries. And that will mean reforming the program to restore its solvency over the long- term.

Mr. Chairman, in addition to reforming Social Security, we should end the idea of being uninsured in this nation by rewriting the federal law so that eligibility for health insurance occurs simply as a result of being a citizen or a legal resident. Currently, under federal law, you're eligible for subsidies if you can prove that you're 65 and you've paid in for 40 quarters. You're eligible for a subsidy if you prove that you're poor now and promise to stay poor under the Medicaid Program. If, like me, you get lucky to get blown up in a war, you're eligible for a subsidy as a consequence of being service connected disabled through the Veterans' Administration. If you work for the government at the local level, at the state level, at the federal level, you're also eligible for subsidies.

What that means is that all of us who under law are eligible have a claim on the income of all other Americans. And unfortunately, that claim also reaches out to about 40 million Americans, 20 million of whom, I would guess, simply cannot afford to buy health insurance, though their taxes are being collected to subsidize everybody else who is eligible. I left one out, Mr. Chairman: the federal income tax deduction, which is an odd formula that says that the higher your income, the greater the subsidy we're going to provide.

Mr. Chairman, I think we should end all of those programs, have a single system of eligibility if you're an American, if you're a legal resident.

KERRY: And we should provide subsidies to the purchase of health insurance only for those who need assistance.

Mr. Chairman, in 1969, I needed assistance, and thank God I live in a great country like this that would have a law written so that I had my health care needs taken care of. But today, it embarrasses me that there are Americans out there with incomes far lower than mine, subsidizing me while they have no claim on my income to provide them assistance. They're law abiding, they're in the work force; they're struggling to raise their families.

I've been with them, Mr. Chairman. I've met with mothers and fathers who have children who as the result of an accident or because of a birth defect had their legs or arms amputated. They come to me for some assistance, because I'm in a similar condition, and we have to seek charity to provide them with assistance, because they're uninsured. It is, in my view, both -- it makes not economic sense nor does it make moral sense for the richest nation on Earth to have this differentiated and fractionized system of eligibility.

Now to be clear, Mr. Chairman and members of the committee, enacting a federal law that guarantees health insurance does not mean we have to have socialized medicine. It worked for me in 1969 when I was in the Philadelphia Naval Hospital. I would not argue for it for all Americans. There will be times when only the government can deliver it. But in general, in my view, it's better for the market to be making these decisions. We can still have 80 percent of it controlled by the marketplace.

Mr. Chairman, I don't believe we'll face the problem of growing mandatory spending till we create a system on the Social Security side that says that every single American is going to have the opportunity to accumulate a sufficient amount of wealth so they don't need to be subsidized in other areas. If you look at the long-term cost, especially the health care program that we have, and you just scratch your head on whether it's acute care or long-term care, which is in many ways worse, and you say how in -- gosh, how are we going to be able to finance that? And if we finance it only with taxes, Mr. Chairman, we're going to find sooner rather than later that our budget is entirely an ATM machine.

Mr. Chairman, one last suggestion: The budget projection is showing that federal spending will fall to 15.6 percent of GDP by 2010. Given our willingness to vote additional monies for people over the age of 65, I'd urge my colleagues to consider whether or not we should set a goal of putting aside a portion of the surpluses, perhaps an amount equivalent to one-half or one percent of GDP, it isn't that large, by 2010 for additional discretionary investments, investments that will improve the lives of our children both in the near- and long-term, investments in education and research and development, science and technology, all the things that my parents did when we had a nation that was investing in its future rather than merely worrying about how to entitle the present.

Mr. Chairman, again, and members of the committee, I want to thank you for this opportunity to testify. I'm going to -- and particularly, Mr. Chairman, thank you for your leadership over the years. You've been a true seller on the budget, a real leader on the budget. I'm quite serious, if Penny-Kasich had passed over here and Kerry-Brown had passed over in the Senate, we might have eliminated the deficit an awful lot earlier. Now, that's the good news. You probably wouldn't be chairman if that would have happened. I'm not sure the election in '94 would have had the same outcome. But I appreciate very much your leadership, and I've enjoyed our friendship.

KASICH: Thanks, Bob, it's amazing testimony. It's on the record, and I think part of the problem is that people don't really want to look at these things right now. They think it's so far away. And the tragedy of is, as I know you're aware, if you don't get on it soon, the power of things like compound interest is minimized.

I'm convinced that we need to create not only private accounts for Social Security, but I think we need to create private accounts for Medicare as well. Where the government would ensure against catastrophic illness, but the private accounts could accumulate money that could be used for other kinds of medical care and perhaps an ability to have a seamless transition in the long-term care.

But, Bob, when do you think that we could actually get about doing some of these things?

KERRY: I don't know. I mean I think as to the question that you're raising with your suggestion to have private accounts both for Social Security and for Medicare, one of the problems, Mr. Chairman, is oftentimes what happens is the private accounts get debated all by themselves as if that's all I'm proposing or all that you're proposing. There's a purpose in both proposals, and the purpose is to enable somebody, whether you're making $5 an hour or $500 an hour, to accumulate wealth and become wealthy.

And one of the interesting things there is that it may take that moment when people who write and report on this thing to understand that there's a huge difference between income and wealth. I could have $500,000 worth of income every single year. If I spend it all, I don't have any wealth to show for it. At the same time, I can make $5 or $6 an hour. If I save a little bit --and my poster child over the years was Osciella McCarty (ph) from Hattiesburg, Mississippi, who was a washer woman for almost 60 years.

And when she finally quit working, she called Southern Mississippi University up to offer them a gift. They thought it was a doily or a coffee can she had decorated or something, and it turned out to be a couple hundred thousand dollars cash. When they asked her how she accumulated $200,000 cash on income that was under $10,000 a year, she said it was simple: I just used the power of compounding interest rates. Well, on that basis, I would voted for her to be chairman of the Federal Reserve.

KASICH: Like the book, "The Millionaire Who Lives Next Door."

KERRY: Well, it's -- I mean the goal here is to say I don't care how much money you make, you have value, your worth something. The market may say you're only worth $6 an hour or $7 or $8 or whatever, but we can change the law to enable you to accumulate wealth. Mr. Chairman, it may take us going and rather allowing the press to do it or our opponents to do it, it may take us going to people who are over the age of 65 and asking them so the country can hear, especially those who have only Social Security income, and say to them, "You're 70 years old now. Let me describe this program." And they'll say, "My gosh, I wish that had been in law when I was younger." Because they know what makes them secure as well. They don't feel secure as a result of getting $600 a month from Social Security.

So, it may take a real muscular public education effort, because right now, boy, I think the jaws of consent are closed. There's just too much misunderstanding and too much intentional disinformation that's put out. In our line of work, Mr. Chairman, and you have seen as well, an awful lot of money spent that is essentially lying to the American people about what Social Security is. So, if you have that on top of sort of tendency not to want to know the truth to begin with, it's not accidental that people don't understand it.

Finally, I say I do think that we have a tendency to underestimate the willingness of people over 65 to participate in this. This is the greatest generation ever. You give them the truth, in my view, they'll take the truth. They care about their kids, they care about their grandkids, they want them to have a better future. If you BS them, that's a different thing, but if you tell them the truth, in my view, and if you call out to them, I think they'll take the challenge.

KASICH: Bob, in an era where it seems as though people are isolating themselves more everyday, in a time when we have great economic prosperity but it seems as though the gated community and the high walls are the direction that we're going, the "I want to take care of me," how do we begin to -- and maybe you've touched on it, maybe the greatest generation, one more time, needs to contribute to the country -- but how do we get people to look beyond the self- interest in this country, particularly in light of everybody yelling and screaming and shouting and politicizing everything, because that's always all about me? It's about reelection, it's about whatever's good for me. How do we even begin to start this kind of a dialogue? How do we get this where people can think in a broader way? I mean you're a poet. I wouldn't ask this question of most people, but you're a poetic man.

KERRY: I think you've got to start just quietly talking straight to a person and say, look, you and I both know that our worse instinct is when all we care about is ourselves. I get in the most trouble when I'm selfish. If all I'm worried about is me, I'm unhappy. That's not how happiness is found. Happiness is found when you fall in love with something, when you care about somebody more than you do yourself, when you have children, when you do something for somebody else. And if you want to be remembered, if you want to have somebody stand on your grave as they most assuredly will, because nobody gets out of this deal alive, if you want to have somebody stand on your grave and weep because you were a hero, you've got to act like it.

We celebrate D-Day, and we celebrate those men landing on the beaches of Normandy. Well, those were not selfish kids. And by the way, they didn't ask for veterans' benefits when they went over there. They didn't say, "Wait a minute, I'm not going to go over there unless you let me have a VA hospital." We gave that to them, because we saw them as heroes. And I think you've just got to quietly, and if that doesn't work, you've got to come and try to shame people into understanding this nation didn't become great as a consequence of starting out with selfish human beings.

KASICH: Well, here you have a situation, curious situation, where both our friend, Tim Penny, went face-to-face with a race for the United States Senate, a race I personally believe he would have won. Bob Kerry comes face-to-face with whether he runs for reelection, and he says, no, I don't think I need to do that. And yet all of us look at this problem, and we know that it needs real leadership. Maybe I could ask you to reflect on your decision. Did you have a sense that you could do more to move these issues out of here? How did you reach the conclusion not to continue to fight on these kinds of issues? I know that Mr. Penny made the decision really based on family considerations, yet he's here today and going about this in another way. What was your decision process?

KERRY: Well, first, Mr. Chairman, God bless them -- the Nebraskans gave me permission to work on these issues. I campaigned on them in '94. I asked their permission and told them much of what I've said except I've learned a lot more since then about the problem. And, secondly, I believe in going back to private life. You can see things, hear things, feel things that you just can't here, not because we're -- just because in any job you get focused on what you're doing, and it's hard to get away from it. And, thirdly, I got an opportunity to do something else, and I'm excited about it, to work directly with kids and education, so I said yes to it. And I don't think, lastly, that I can be as influential. I mean there's nothing quite like being in the arena, having the platform to talk.

I would love to -- and intend to try to find something. Maybe when we're down in Texas together in George Bush's Library we can talk about doing something together, because I would love to try to create a public space where the public could understand the issue better. I thought the president was going to be doing that with Social Security, and unfortunately he didn't.

I'll never forget: I was out of Georgetown, and he was introduced out there by a young woman who understood the program. It was his first town hall meeting that he had on this year-long discussion on Social Security. And she said, I got my first paycheck, and I went home and I said to my mother, who is this FICA person and why are they taking so much money away from me? And she then went on to explain what FICA was. She understood it, and then she made a mistake, and she said, I've been contributing to that, and I don't get a very good return on my investment. And the president didn't correct and should have. What he should have said is, no, we're taxing you now at levels higher than ever before. I mean I've talked to many people who say, well, I've paid in all my life and I'm just getting -- young people are taxed today at levels that we've never taxed them before on the payroll tax side to pay for benefits that we've raised over time. And, boy, do I know this one.

My benefits from military retirement started in 1969, and I watched on in absolute sort of a combination of horror and delight as Congress in '70, '71, and '72 voted 20 percent increases and then had to put a COLA in law in 1973. I thought, Oh my gosh. I dropped back down to four percent. And then guess what? Inflation took care of that. In '78, '79, '80, 81, it was 17, 18; it was a huge increase.

So, we need some way to have a public debate so that people like Congressman Sununu who are still here have permission to talk about this and do the right thing, because, otherwise, right now, it seems to me that, like I said, the jaws of consent are closed. We need to pry them open somehow so that political representatives who are still in the game have permission to at least honestly assess what they want to do. Let the left and right have a debate at that point, and it will be a healthy debate. But it will not be a healthy debate as long as it's dominated by the political fair that currently dominates.

KASICH: Well, the seven to one statistic is just staggering to me, that for every dollar we spend on children, we spend $7 on our seniors. You know, Bob, maybe most things in life are really about experience. I have two little twin daughters, six months old now...

KERRY: Congratulations.

KASICH: ... and they're very healthy, and we've been very blessed...

KERRY: I knew you when you didn't, and you're a better man.

KASICH: You're right; I am, I am. But here's the interesting thing: I had an opportunity. You kind of sometimes think maybe the good Lord sent me to this place. But my little girl had a virus early in her life, RSV. It was sweeping Ohio and a lot of the Midwest, and she ended up in the Children's Hospital for a couple days. And I went down there, and I looked -- slept on the floor one night, and after you're sleeping there long enough, they really don't care who you are. They just -- could you just get out of my way. And I watched the nurses. And I listened to the nurses talk about the -- it wasn't about being overworked; it was about the fear of the fact that they could not properly attend to children.

Our program of reimbursing physicians is based on Medicare recipients. If you get graduate medical education based on how many Medicare recipients you have in the hospital. There are no children who are -- I'm sorry, there are no senior citizens in the stand alone Children's Hospitals. So, what a lot of the Children's Hospitals have done is to associate with the adult hospitals, which means again that the tail begins to wag the dog. There is a network of hospitals that stand alone and serve only children.

We need $285 million to make sure that these hospitals can be reimbursed for the training of physicians. And, you know, Bob, this has been a near impossibility. Out of $100 billion HHS budget, they somehow have difficulty finding $285 million for children.

I don't know how -- may your suggestion of setting aside a certain amount of dollars, we've seen fit to dramatically increase the budget of the Pentagon by $25, $30 billion in one year, but yet it seems to be so hard in this society to carve out some things for our children.

KERRY: I think if you did it in a real thoughtful fashion, I think you can come up with a package the Republicans and Democrats both would support. But I think unless you do, the problem is, John, it won't get done. Because we'll vote -- the mandatory stuff's easy to vote for.

KASICH: Or you don't vote for it and then it's automatic.

I think we're going to get the money for the Children's Hospitals, and I hope you'll help, but it's an interesting -- but it's in subtle ways that are difficult to determine, to assess.

KERRY: No, you're right. And by the way, I've been leading on the effort on the Senate side on that very issue, the Children's Hospitals. So, I hope we can succeed and get something done this year.

KASICH: But the seven to one is interesting, because when you look at all the charts, we realize that it's the children who build this economy over time, and if they are shortchanged, then this economy is hurt.

KERRY: I have no idea how you voted on the H1B issue, but I've see you talk very eloquently about what it means to be middle class in America today. That's a vote that -- I mean I will vote for it, but I heard Chairman Goodling before the Web-based Education Commission say -- he described exactly how I feel. He said, it's the worst vote I ever cast. He said, I know I'm going to have to do it again, but it's essentially a vote that says we fail, we fail.

KASICH: Maybe we'll start our own party.

Let me recognize the gentleman from New Hampshire, Mr. Sununu.

SUNUNU: Thank you, Mr. Chairman.

Thank you for being here, Mr. Kerry.

You talked a little bit about your disappointment that it's not the best environment to talk about these issues or sometimes we feel it's not the best environment, the most receptive environment, but I happen to be a bit of an optimist, and I sense that people, as you described the greatest generation, they are willing to take up their burden. They are willing to take on a tough issue.

And people really are further out in front of this issue than we give them credit for. And I think that's largely due to the groundbreaking work that you've done and my own Senator Gregg and Pat Moynihan and others in the Senate and Jim Kolbe and Charlie Stenholm here in House and Chairman Kasich. So, I think the public is ready or more ready than we give them credit for.

I guess I have a two-pronged question here. One, if you don't feel that the debate is as advanced as it ought to be, what else can or should we do as legislators other than just talk honestly and substantively about these issues to better prepare the public for legislation on this issue? And question two would be, well, why not just move -- why not just move the legislative vehicle? Why not just take up the legislation and use that as a focal point for engaging both policy makers and the public in debate?

KERRY: Well, first of all, I share your optimism about the American people's view of this thing, which leads me to say I'd love to do a markup. Senator Gregg, your distinguished senator, and I have worked together on this, and what we've tried to do is just -- we tried to resolve our own relatively small conflicts to produce a single piece of legislation. And I'd love to see a markup on it, because I think in fact it would pass the Senate. I think we could enact it on the Senate floor if we were able to get it done.

As to the second part of your statement and question having to do with what can we do, I do think that there's just an awful lot of work that needs to be done to help people understand both what Social Security is and what it isn't, and to help them understand what it could become.

And to do something -- and I was taught -- I went into the Navy, but I went to a number of Army schools, and one of them was an Army Ranger's. It was called Army Ranger School. And I led a mission one night under instruction. And the instructor said, you know, you did a good job except you were missing one thing. I said, what's that? He said, you're missing a sense of urgency, and your men know it. They know that you lack the sense of urgency, and so they're all sort of slack and taking it easy, and you're not as successful as you -- and I think we have to create that sense of urgency that says if you do it today, here's the good things that happen, and the longer you wait the harder this thing gets. And guess who pays the price for it? Guess who pays the biggest price? It's lower wage, lower income people that are going to pay the biggest price of all.

So, part of what we need to do is simultaneously educate and create a real positive urgency. This isn't about eating spinach. This is about helping people accumulate wealth that right now don't think they have any chance.

KASICH: Bob, don't you also think, though, that we talk about the Penny-Kasich bill -- by the way, I want you to know I named my dog after Tim Penny. My dog's name now is Penny Kasich.

But, Bob, it isn't interesting -- I say that that was the first shot, successful shot, fired in the war. You have to be able to go to the floor and get your brains beat out and be willing to a bunch of times before people really start to notice. I mean in 1776, I don't remember the movie all that well, but they used to say, will you sit down, John; will you shut up? And isn't that what really we need? We need votes; we need people raising Cain. And right now...

KERRY: I think you do, but I do -- John, I think you need a lot of sort of calm education simultaneously, getting people turned on to the idea that this could change their lives in a positive way, in a very positive way. I mean it can be quite exciting to think about -- we have 3.8 million babies that will be born in the United States of America in the year 2000. Think about helping them accumulate wealth. What happens if all of them hit 50 years of age and say to Henry Aaron, you're wrong about the estate tax. I want to get rid of it, because I've got an estate over $650,000, which we could do.

KASICH: There's no way you're getting picked off.

SUNUNU: Three questions about particulars, issues that have been raised in this debate that I have some concerns about, and I just wanted to get your reaction as someone who's probably thought more than I about these points.

One is the thought raised that among the reforms or changes to Social Security that might strengthen the system would be to bring those currently not covered under Social Security into the system. A lot of state and local employees, public safety employees that aren't part of the Social Security system, and people say, well, let's bring them into the system, because it would be good for them and good for Social Security.

Now, I've got real questions about the "good for them" part, because I haven't seen a lot of letters written by these employees to their state, local or federal officials saying, please, allow me to pay 12.5 percent per year and participate in Social Security. And I have questions about the "good for Social Security" part, because what that seems to mean to me would be, well, it's a way to bring more revenues into the system that is insolvent. I don't want to bias your answer -- somehow I don't think I have -- but what's your thought about that option for reform?

KERRY: Well, I've been squarely on both sides of that issue, so that you know. Moynihan and I had it in our first proposal, and I agreed to it to because we needed the money, not because I thought it was necessary.

SUNUNU: I was unaware of that.

KERRY: And we did not put it in our second bill, in part, because the mix of people who were then looking to get on the bill included people whose states didn't require it. So, I mean it is -- if I'm able to step back with the thing, it is a little difficult to make a case that I should force somebody to buy into a system that I think is so badly flawed that it needs to be -- I'm giving them a chance to pay 12.4 percent to buy into a system that I'm not particularly crazy about.

SUNUNU: In my limited discussions with public safety employees or state employees, it's my experience that most of them are covered by private or public pension systems that are solvent and well managed. And I'm not aware of any that have looked at what they have in the way of private pensions and said, we'd like to participate. Do you know of any?

KERRY: No. That's also a good measure. You're exactly right. That's another good measure. Believe me, if the state employees of California wanted to get into the Social Security System, I believe they could find a way to get it done. The last time I checked it's a pretty good congressional delegation in the house, so my guess is that if they really wanted to get into that system, they would somehow manage to get into it.

SUNUNU: One final question about modeling: In the discussion about personal retirement accounts and an evaluation of the opportunities created by such accounts, inevitably, you need to try to model those accounts. You make assumptions about the mix in your portfolio; you make an assumption about how much you're contributing; you make an assumption about rate of return, and all kinds of other things.

A number of plans that have been put out there -- and I assume yours is one -- has been structured in such a way as to use these accounts to strengthen the system. But one of the other witnesses today has put together a model that looks at these accounts and suggests that they're doomed to failure. It would seem to me that it's a little bit dangerous to try to put together these kinds of portfolio models that try to empirically prove the success or failure of these personal accounts before we even get into the crafting of legislation, one.

And, second, could you talk a little bit more about a point you made about wealth and income? And it seems to me that a good portion of the value of a personal account isn't necessarily to be found in a quantitative analysis but more in a personal or a moral analysis of empowerment of the individual and wealth creation at the individual level.

KERRY: Yes. You've touched on a number of things there in your question, so let me know if I don't answer whichever ones are your priorities.

But I believe strongly all the administrative stuff is usually -- those are usually objections raised by people that if you could solve the problem that they've got, they're still going to oppose the plan. They're basically ankle biters, looking for some reason to inflict a little bit of pain on a proposal knowing that they're going to be against it no matter what. The administrative problems are easy to solve. I mean for gosh sakes the payroll tax is very complicated system to administer, for anybody that's been in business out there that's tried to figure out how to get the forms filled out. I mean I figure that's why God allowed us to invent software. So, that's an easy problem to solve.

Arthur Levitt once wrote -- gave a speech right after -- when this thing got hot a couple years ago, the head of the SEC, he wrote that people are not educated enough, and they're not going to be able to figure it out. And I wrote him a letter back and said, look, if you can't regulate it, let's put it on the banking system. We'll just take it away from the stock market. See what your clients think about that.

And as far as being educated enough, the kid that bags my groceries at Hy-Vee got a 401(k) account, and every time I go through there, he's talking to me about stocks and bonds. He knows more about it than Arthur Levitt does. So, the American people are educated enough to be able to figure this thing out, in my view.

I think it's terribly important to just almost brush aside those administrative folks and maybe just say, look, go talk to somebody that runs annuities. We can make the administrative -- we can keep the administrative costs low. We can keep the risks at an acceptable level. We can do all that sort of stuff. But if we can solve that problem, will you join us in trying to help create wealth for everyone?

And in that regard, I say to you, Congressman, I do think it's important to recognize that people with lower incomes, if you put two percent on them, they're simply not going to be able to generate enough. I mean I don't know what -- I'm not a mathematician, so I don't know why, but for some reason you need to get somewhere north of $700 or $800 a year annual contributions in order to accumulate wealth impressively.

KERRY: Well, the way I figure it, whoever vacuumed this rug last night is worth as much as I am even though the market may say I'm worth $130,000 and he or she is worth 20. But two percent of that 20 only generates $400 bucks a year. So, I think you've got to figure out a way -- we call ours the Breaux kicker, the one that John Breaux and I and Judd Gregg have introduced -- that enables everybody to get up to that $700 or $800 level. It makes it relatively easy. And we're talking to people who have some ideological problems with it. Heritage has been working with us trying to get it better.

And we also open accounts early, because the variable that's most important is the number of years you contribute. You can jog, you can eat grapenuts, you can do high colonics, you can do whatever you want to get healthy, but you don't get those years back. And if you're 55, you cannot make this thing work. And even if you're 45, it's tough to make it work. If you're 35, you've got to contribute a lot more than you do at 25. And the best way to do it is get them open at birth.

And, again, we've been working at Heritage. I know there's ideological problems with that. I think you can make it an earned entitlement so that it's not giving money away. But you've got to get those accounts opened early, and you've got to think -- and you've got to just force the debate into helping people accumulate wealth, and just say, do you think it would be good for somebody making $7 an hour to hit age 60 and have real wealth in their hands? And if they answer the question yes, then you say, join me in figuring out how to get it done, because it's absolutely, mathematically certain that it can be done.

SUNUNU: Thank you.

Thank you, Mr. Chairman.

HOEKSTRA: The senator is also ...

SUNUNU: We've got to go take a nap. We've got three votes this week.

HOEKSTRA: The senator is also awfully good on this issue. I only had a chance to catch the tail end of your testimony and then the questioning with John here.

I'd just like to say it's very, very refreshing, and I hope that you guys reach out to the House and work in putting together some partnerships, because I think directionally you're providing some very fresh thinking to the issue, and on these kinds of issues that's exactly where you need to be. You need to step back, think about it in a fresh way, and we might be surprised with the kinds of coalitions that we could put together to actually get some things done. I'm going back and read the whole testimony, and you've piqued my interest into what you're doing over on the Senate side.

KERRY: Thank you.

HOEKSTRA: So, thank you very much.

And, John, thanks for calling over and say, hey, Pete, you got to get over here, and there's some stuff over here you can learn.

SAXBY: I don't have a question; I just want to make a comment. And that is, Senator Kerry, I'm sorry I had to be away, didn't have a chance to listen to you, but I've followed you on this issue as well as many other issues over the six years that I've been here, and I have great admiration for you. And I'm just sorry, really, in one way that guys like you and John Kasich are leaving our institution, because you bring fresh ideas and not just common sense but just plain good sense to some complicated issues, and this being one of them.

And it's unfortunate from my perspective that we don't have strong leadership coming out of the administration on this issue. I think it was a perfect opportunity over the last couple of years to have something laid on the table when guys like you and John and others were willing to pick up the ball and run with it, and I think the Congress was in the mood to maybe get something done. It's going to take longer, probably, than that period of time to really accomplish a good, positive end result, but I just want to commend you for your boldness, your thoughtfulness on this idea.

And I hope that folks like you, as well as John, will continue on the outside to keep beating up on us here on the inside until we get something done. Because I've got a couple of grandchildren that I sure want to see fall into that category that you're talking about, whether they're making $7 an hour or $700 an hour. I think it's just critical for them 60 years from now that we do something now.

Thank you for your service.

KERRY: Thank you.

KASICH: Bob, I think -- I make a prediction: I think the Social Security solution is relatively simple, because if you create the accounts and get it done quickly, most people are winners. Almost everybody wins, and the younger you are the bigger the winner you are. You're going to have to do something with benefits, but I think you can actually write them in such a way that they keep up with inflation and not more. And that's why the seven to one statistic is so important, because people are going to say you're going to hurt these people as they become seniors. And with a seven to one advantage, seniors over children, maybe it helps to put some perspective on this.

I think that the Medicare problem and the long-term care problem is very -- is so much tougher, because with Social Security there's a win. You can sell this as a winner. Like you say, there's a great wealth there. Health care is going to be trickier because the nature of our tax code, the nature of the way in which the benefits, the health benefits, are arrived. And we all, I think, know that health care has to become more market-oriented while protecting people against catastrophic. To me, that is going to be the great challenge. But I kind of look at Social Security as a very short putt. Most people know what the problem is, and maybe we can get it done in a relatively short period of time.

KERRY: And I see it as two sides of the same coin. I mean I think -- I suggested in my testimony that if you start off by saying you're going to change Social Security so it becomes a source of wealth -- and by the way, I say to my democratic friends, many of whom have spent a long time and great passion and articulate defenders and helpers of people who are poor -- that you don't make somebody not poor by increasing the minimum wage or expanding EITC or some other device like that. That doesn't make them non-poor. It gives them a little more income, but it's not the same thing.

And if you really do care about the rich getting richer and the poor getting poorer, you're not going to solve that problem by having an estate tax or by putting other barriers in between people and wealth. You're going to solve that problem by helping everybody accumulate wealth.

And if they accumulate wealth, John, I think the second problem gets fixed, if you're willing to -- but you've got to be willing to come in and tear up that contract and say, what we had in 1965 for health care was a system that was based upon the economic reality at the time, which was you worked for 45 years in the same job -- I mean I graduated from high school in '61, and three-fourths of my class went right in the work force. And they were making more money than I did for quite a while. And they did a little time in the service, they came back, they worked a job, and supported a family. Today it's six or seven years, and you're on to something else.

So, what we needed then was something to take care of you when you hit 65. That was the economic reality then. It's not the economic reality now, and if you're going to have the right trade, technology, and immigration policies, in my view, you've got to have a safety net that starts out by saying you get health care by being an American or legal resident, not by -- and then full Medicare, Medicaid, the VA, the income tax reduction, all of it into a single system of eligibility.

And say, Bob Kerry, if you need it in 1969 right after you get blown up in the war, God bless you, we're going to provide it for you. If something else happens to you and your genes say that you're going to have cancer or something else -- which happens, I mean I don't control 90 percent of the things that happen to me -- so if something bad happens to me, we'll provide a subsidy. But if your income goes up, Bob, and you have the capacity to take care of yourself, we're not going to ask somebody with lower income to pay higher taxes to take care of you.

So, I mean that's why I think Social Security fixes the second one. But the second one, you're exactly right, it is a much, much longer putt. I mean it's more like a hole in one. I'm not even sure you're on the putting surface.

KASICH: I think that's exactly right. But maybe it all kind of, in a funny sort of way, duck tails with what I think is the greatest challenge of the future, and that is whether we can get people to tear down the walls and realize that life is not just about me. And maybe it all kind of fits together.

I want to thank you for your testimony.

KERRY: Thank you. Thanks for your service.

KASICH: And look forward to spending time with you.

KERRY: You are a better man now that you've got those babies.

KASICH: You got it.

(LAUGHTER)

All right, Bob.

KERRY: I know your committee knows that.

KASICH All right. I'm going to bring Larry Kotlikoff, the father of generational accounting and Alicia Munnell, who ha a long and distinguished career in academia and with the Clinton Administration. And I welcome you both and have you -- see if we can get through the first part of your testimony.

At 2:30, I have to defend a Kosovo provision in a conference Committee. I will go to that, but Saxby will be here to hear you. I have to do that; I have no choice on that.

So, if you want to go ahead and -- maybe we ought to -- I don't know. What's the committee want to do? Do you want to start the testimony? Why don't we go ahead, and if you can -- I hate that we have to do this, but go ahead and summarize where you are.

MUNNELL: Should I start, Mr. Chairman?

Mr. Chairman and members of the committee, I'm delighted to have the opportunity to appear before you today to discuss the question of intergenerational economics.

These issues are crucial to framing the debate over Social Security and Medicare. If you say there's a huge problem out there and that the numbers are just staggering, then that forces you to find a very dramatic solution. If you say the problems out there are manageable, then you can solve the problems with moderate changes.

What I'd like to argue is that the problems are manageable and that dramatic restructuring of either Social Security or Medicare is both unnecessary and undesirable.

I'd like to make four points. First, the projected increase in Social Security spending due to the aging of the population is neither enormous nor unprecedented. The cost of the program is going to go up by 2.6 percent of GDP between now and the year 2074 -- 2.6 percent over the 75-year period. We've seen budget changes of that magnitude before. Defense spending went up by five percent of GDP when the Cold War began, and it's gone down by 2.6 percent of GDP in the last 10 years.

Social Security financing is not in crisis; rather, the current projections show a manageable long-run financing gap. If you look over the whole 75 years, revenues are equal to 84 percent of projected benefits. We have enough money to pay full benefits till the year 2037. After that, the trust funds are exhausted, but that doesn't mean the program ends. There's still enough money in place to pay 70 percent of benefits.

Of course, Social Security is not the whole story. You also have spending on Medicare, and that's projected to grow. But incomes are also projected to grow, and if you look at the growth of income and the projected growth in Social Security and Medicare, basically the increase in cost for these two programs is going to take up only 20 percent of the increase in well being and standard of living that we're going to experience in the future. Plus moderate economic growth should enable future workers both to enjoy rising standards of living and to pay the added costs necessary to sustain current benefits.

So, my first point is that we are not facing a crisis and that future costs are manageable. I am not saying there is not a problem. There is a problem in Social Security; there's a problem in Medicare. Both problems should be fixed, and fixing them sooner is much better than fixing them later.

My second point is that the old arguments that Social Security and Medicare spending will crowd out other government programs have lost their force now that both parties are committed to moving away from the unified budget. The real threat to on-budget programs is massive tax cuts, not Social Security and Medicare.

Under the new budget arrangements, the Social Security financing would be completely separate; that is, it will be kept in a lock box. With Social Security off budget, Congress will be focusing on the financing of the non-Social Security expenditures and the money to finance those programs. For the next 20 years or so, these programs are threatened far more by the prospect of massive tax cuts than by Social Security. Thus the answer to future budget pressures is to limit the size of tax cuts, not to dramatically restructure well- functioning programs.

My third point reiterates the thrust of the testimony by Dan Crippen and everyone else who has testified today. The most important economic decision is the level of national saving, because everyone in the future, the elderly and workers, will have to be supported out of future GDP. As a practical matter, we cannot stockpile food and clothing today for retirees in 2040. Their food and their clothing will come out of output produced in 2040. Therefore, the key factor determining the welfare of future workers is the size of GDP in 2040. And the key determinant of future GDP is saving and investment today, both in physical capital and in workers.

One argument used by those who support restructuring and Social Security is the desire to increase national saving. This desire happens to be one I share wholeheartedly. However, increased saving can be accomplished equally well in the existing Social Security Trust Funds or in personal accounts. The budget arrangements will make it clear that Social Security surpluses add to national saving. These surplus funds will be used to reduce federal debt held by the public, freeing up additional resources for private investment.

Since saving can occur either through government or through personal accounts, restructuring the Social Security System by itself would do nothing to increase the size of the future economy. Under a system of personal accounts, first, future retirees would have increased private claims on economic output, but these claims would simply be offset by reduced public claims. Therefore, the desire to increase national saving is not a plausible reason to restructure Social Security.

So, my first three points argue that there is no need to dramatically restructure Social Security. First, the program is not facing a financial crisis, and people can afford future costs. Second, the old arguments about programs for the aged crowding out other government programs is much less relevant in the new budget environment. Third, we can increase national saving as easily through Social Security as through personal accounts.

My last point is that replacing all or part of Social Security's current, defined benefits...

SAXBY: Ms. Munnell, I hate to interrupt you, but we have four minutes, and we need to run over and vote. If you all can be patient with us, let us vote, we'll be back.

MUNNELL: OK.

SAXBY: We do want to hear you.

MUNNELL: Go.

SAXBY: You've already raised some interesting questions.

MUNNELL: OK.

(RECESS)

SAXBY: Thank you all for your patience and for letting us interrupt your lunch there.

MUNNELL: It's all right. I'll finish.

SAXBY: No, that's quite all right. You take your time. Other members may be coming back, but we'll proceed on.

MUNNELL: Can I just summarize where I was and finish up with my last point?

SAXBY: Sure, absolutely.

MUNNELL: I think this whole issue of intergenerational economics is very important, because it determines how you frame the issues of Social Security and Medicare. And, basically, if you characterize the problems as enormous, then when you're looking for solutions you need a dramatic change. If you characterize the problems as manageable, then when you're looking for solutions you can get moderate changes.

And the arguments -- the first three arguments I tried to make is that the problems are not enormous; they're manageable. People can afford the future costs. And, second, a lot of these arguments have been around about the programs for the elderly squeezing out other programs I think have less force now that Social Security is outside the budget. The third point was that people say, well, we really need to restructure Social Security, because we need individual accounts so that we can increase national saving. I agree increasing national savings is extremely important. It will determine what the size of GDP in the year 2040 is, but I argue that you can do that under this new budget arrangement equally well through either the trust funds or through individual accounts.

And, so that brings me to my last point, and that is that, in my view, replacing all or part of Social Security's current, defined benefit plan with personal retirement accounts is risky, it's costly, and most important, it's going to hurt the vulnerable in the long run. The whole point of having a Social Security System is to provide workers with a predictable retirement benefit. As people have said, Social Security benefits are quite modest; they're about $800 a month. And all these proposals for personal accounts involve first cutting back on Social Security benefits. So, it involves reducing that $800 to $600 or $500 or $400 and then substituting an individual account that you hope makes up for the additional lost benefit.

And, so when Senator Kerry was talking about building wealth, I think building wealth is fine. But I think it's fine on top of Social Security, on top of that $800, not making part of that $800 unpredictable.

In addition to making that $800 unpredictable, personal accounts are costly, but I agree that's a secondary issue. A very important issue, though, is that they expose participants to temptations of early withdrawal. I'm convinced that if people think those are their accounts, they're going to have very legitimate means to wanting to get access before retirement. They're going to have an illness or want to buy a home. And to the extent that they get access before retirement, there will not be enough money available in retirement.

It also brings up this whole issue of the risks associated with annuitization. What do you do with these piles of money once people get to retirement?

More fundamentally, personal accounts are likely to set in motion a process that will end up separating income support from social insurance. And in the U.S., I think separating these two functions will almost certainly produce less redistribution, which will harm future generations of low-wage workers.

So, my conclusion is that while intergenerational economic issues are important, they do not suggest that we need to dramatically alter major social insurance programs. Under the new budget structure, the main threat to other programs is not Social Security but tax cuts. Moreover, while increasing national saving is important, this can be done just as easily through the trust funds as through personal accounts. In short, there's not compelling reason to replace part of Social Security with personal accounts, and doing so will make tomorrow's elderly worse off not better off.

Thank you.

SAXBY: Thank you very much.

Professor Kotlikoff.

KOTLIKOFF: Thank you, Mr. Chairman.

Mr. Chairman and distinguished members of the House Budget Committee, I'm honored by this opportunity to discuss with you U.S. fiscal policy, specifically the burden it is likely to place on our children and grandchildren.

Notwithstanding the rosy fiscal scenarios being floated today by government agencies, there is an enormous imbalance in the projected tax burden facing current and future generations. Indeed, the most recent generational accounting for the United States, which was done recently by economists at the Congressional Budget Office and the Federal Reserve Bank of Cleveland, but has so far not been published by either agency, indicates that our children will face lifetime net tax rates that are roughly 40 percent greater than those that we face.

Avoiding that outcome would, for example, require an immediate and permanent 31 percent increase in federal personal and corporate income taxes. Such a policy would mean a $375 billion larger surplus this year. Stated differently, to achieve generational balance such that our children and grandchildren would face the same tax rates as we face, we should be running a surplus this year that is almost three times larger than the one we are actually running.

Now, rather than warn us about the tidal waves of liabilities facing our children, our government is doing its level best to mislead the American people about our fiscal future. I speak primarily of the Congressional Budget Office's 10-year budget forecasts. At the Office of Management Budget, Social Security trustees and Medicare trustees, they're all deceiving the American public about what will happen once the 77 million-strong baby boomers retire. When that happens, we'll have 100 percent more old people but only 15 percent more workers on which they can lean for financial support.

Now, how can I be so grim about the government's long-term finances when the Congressional Budget Office just last week projected surpluses between now and 2010 to accumulate to $5.7 trillion? The answer is that the CBO's surplus projection is predicated on spending assumptions that no one in Congress takes seriously and upon which no responsible adult would risk his child's economic future.

Consider CBO's frozen spending projection in which federal discretionary spending remains fixed in nominal dollars through 2010. Under that scenario, federal discretionary spending falls by 35 percent as a share of GDP between now and the end of the decade.

Now, the CBO says that it's just doing what Congress tells it to do in making these projections. But that's not what I and other parents are expecting it to do. We expect the CBO and other government agencies to provide realistic budget estimates, particularly if these estimates are going to be driving the national debate that determines how we treat our children.

Now, how much of the CBO's $5.7 trillion surplus over the next 10 years will disappear if federal spending fails magically to decline as a share of GDP to a level not witnessed in the post-war period? The answer is that $2.1 trillion of the $5.7 trillion supposed surplus will disappear. Of the remaining $3.6 trillion, $2.4 trillion is off budget and supposed to be spent on Social Security and Medicare benefits. So, what's left is only $1.2 trillion, a non-trivial sum, for sure, but a far cry from the amount needed to cover all the remaining Social Security and Medicare bills, let alone those from the rest of the government's operation.

So, Mr. Chairman, this is the clear message from the generational accounting to which I referred to at the beginning of my remarks. That analysis, which assumes that federal discretionary spending stays even with the economy, takes into account all the future government receipts and expenditures, not just at the federal level but also at the state and local level. Hence, it fully incorporates this $1.2 trillion surplus that we can legitimately anticipate over the next decade.

But this short-term surplus, notwithstanding, there remains a huge imbalance in generational policy whose elimination requires not major tax cuts or major expenditure hikes, but precisely the opposite.

So, let me now, because time is short, I'm sure, summarize the remaining part of my testimony, and I hope I can submit the testimony to the record.

The generational accounting, as I said, suggests that we need 30 percent, 31 percent immediate and permanent increase in our income taxes. We need to be running three times the size of the surplus. That's one way you can solve the demographic problem. There are, of course, other ways. You could -- we have in this -- I have in this testimony a table two at the back, which show alternatives.

An alternative to raising income taxes by 31 percent would be to raise all taxes -- FICA taxes, income taxes, state income taxes, state sales taxes, all taxes at all levels of government -- by 12 percent, immediate and permanent. You could also cut all transfer payments to unemployment, to welfare, to Social Security, to Medicare, Medicaid. All those transfer payments could be cut by 22 percent. Or you could start from this time path of government discretionary spending, which stays even with the economy, and you could cut that by one-fifth at all levels of government. Or if you just focus on the federal government, you could cut it by 66 percent.

Now, each of these alternatives would be enormously painful, but the longer we wait, the worse the alternatives will get. So, when Dr. Munnell says that we have a moderate problem or a manageable problem, I couldn't disagree more. We have a horrendous problem, and that problem is revealed by generational accounting very clearly. And this generational accounting is being done by, again, the Congressional Budget Office and the Federal Reserve Bank of Cleveland based on the latest CBO projections.

Now, one of the things about the generational accounting is that it does not truncate the analysis at 75 years. It looks through time at the long-term, and it doesn't stop 75 years from now. When you stop 75 years from now, you ignore the fact that in year 76 and year 77 and so forth you have absolutely gigantic deficits in the entitlement programs and other parts of the budget. For example, in the Social Security Program, you're looking in 76 years at a deficit that's roughly $650 billion, measured in today's dollars.

So, we have gigantic liabilities in the out-years. In having the Social Security trustees and Medicare trustees look out just 75 years, they're ignoring a large part of the long-term problem. So, if you just look at those two programs and you ignore the whole rest of the government and you assume that the trust funds for those programs that currently exist and the surpluses that are scheduled to be accumulated are all spent on the benefits of those programs, you still find out that those programs are short about 40 percent of the resources they need to pay benefits on an ongoing basis. In other words, they're 40 percent broke. And that's because the long run, after 75 years, is so bad in terms of the size of the problem. And if you also factor in more realistic longevity assumptions than those that the trustees are making, you get to this 40 percent underfunding number.

So, we have a huge problem, an enormous problem in Social Security and Medicare, and this short-term surplus that we really will have after all the spending is actually increased beyond what the CBO says unrealistically will happen, that surplus is not going to be enough to cover these long-term problems. We need to begin running a surplus that's three times as large.

So, let me just conclude by saying that the government, through its various fiscal agencies, is assuming away our fiscal problems rather than disclosing and solving them. In so doing, it badly disserves both us and our children. Notwithstanding the rosy fiscal projections, our country has a huge imbalance in its generational policy. Without dramatic and immediate changes in this policy, our children are likely to face lifetime net tax rates that are two-fifths larger than those we face.

There are a variety of steps, all painful, that we can take to achieve a situation of generational balance in which our children face the same lifetime net tax rates as we face. But getting any of these steps publicly discussed an enacted into law requires providing the nation with an honest assessment of our long-term fiscal problems. For that end, Congress should establish an independent agency to do generational accounting. This agency would evaluate the generational accounting implications of all major spending and tax bills and make annual reports to Congress about the steps needed to achieve generational balance.

Thank you, Mr. Chairman.

SAXBY: Thank you, sir, and I appreciate both of you sharing your thoughts with us. And we've obviously got to continue this dialogue, because we've heard somewhat a difference of opinion there with respect to where we're going to be 70 years from now.

And Professor Munnell, I hear what you're saying with respect to tax cuts, that we've got to be careful. I don't hear you throw in the mix that we need to be careful about how much we increase government spending, but that's what I'm hearing, in effect, from Professor -- and I hope I'm saying your name right -- Kotlikoff.

And with respect to tax cuts, with respect to trying to increase savings, which I agree with you on, with respect to tax cuts and keeping the economy moving to try to triple that surplus that Professor Kotlikoff talked about that we need, don't we need some kind of balance there with respect to tax cuts to keep the economy moving, to keep it going the way it's going? Don't we need tax cuts of some sort there to provide people with more money in their pockets so they can save, so they can take that money, pay their bills off, put it in savings, whatever they're going to do with it? Don't we need those tax cuts in there if -- and we can argue over what's moderate and what's too extreme with respect to tax cuts -- but I've just got to believe that tax cuts do enhance the growth of the economy.

I mean it's -- I just went to the University of Georgia, I didn't go to school in Boston, but that's what they used to teach us, that you keep the economy churning by keeping money churning in the economy. And that's not the only thing, but obviously -- and I'm a little bit concerned about your honing in on the idea that we've got a more serious problem with trying to keep tax cuts lower than we do with the long-term problems in Social Security.

MUNNELL: I would respond quickly since we've all been at this for a long time today. There are two things that separate Larry's view of the world from mine. First of all is what is the appropriate period when you're talking about long-term planning?

MUNNELL: And all the numbers I used and all the numbers that Social Security uses are the next 75 years. That's a reasonable planning horizon. Larry says that's not long enough. You really have to look beyond 75 years. And I guess I would just argue that Henry Aaron showed you a table of how much the projections for these programs have changed over the last four years, the 75-year projections have changed after that. So, I question looking beyond 75 years.

The other thing that my colleague here does is he talks in dollar amounts, and so he talks in hundreds of billions or trillions of dollars. And I think it's very important to always put those over percent of GDP, because we're also going to have a much bigger GDP in the future.

And, so if you do those two things, if you take the 75-year planning and talk in percents of GDP, that all the problems in both Social Security and Medicare look much more manageable.

Just in terms of tax cuts, the economy is operating at full capacity now. We don't really need to have any tax cuts to stimulate it. But I would agree with you. I mean we have surpluses. I don't think it should all go for one thing or the other. I would think that some of it should go for a tax cut, some of it should go it help Social Security and Medicare, and some should go for other domestic initiatives. So, I'm not against tax cuts. I just -- I think this is a time that you need to be careful that you don't give away money you're going to need in the future.

SAXBY: Professor Kotlikoff, you talked about trying to work on increasing our surplus because of the -- well, you said for several different reasons there. And in looking at that, is not the key there that rather than thinking on the flip side of it, that in order to look where our children are going to be 50 years from now, they're going to be paying 40 percent more in income taxes, why shouldn't we be looking at ways to decrease government spending?

Now, I realize in your table you show your numbers there about what would happen with respect to government spending, but if we concentrate on not leveling off government spending but simply slowing down government spending -- I read in the Times this morning where -- when McCrabb (ph) came in 1995, we were big on trying to reduce government spending. And yet we've been growing at a faster rate than previous Congresses, and that scares me every time I see that.

And if we do put strong emphasis on trying to slow down government spending at the same time, would we look at our children not paying two-fifths more in taxes than we're paying today?

KOTLIKOFF: Well, the -- it depends exactly what you mean by government spending. If you're talking about discretionary spending at the federal level, that type of expenditure as a share of GDP is pretty much as low as it's been since 1960. In all categories -- foreign aid, defense, non-defense, non-foreign aid, domestic discretionary spending -- we've cut that quite a bit.

Now, I'm not saying that can't be cut more. To assume, as the CBO is assuming, that it's going to be cut by 35 percent over the next 10 years, I think that's not a realistic projection, and it's led to these enormous surplus projections, which has led everybody to say, well, now we can afford to cut taxes and raise spending. The reality is that if discretionary spending doesn't fall as a share of GDP, the only other place to cut expenditures is through the entitlement programs.

Now, I do believe that a privatization of Social Security could dramatically improve the situation as part...

SAXBY: Do you think at the same time you could reduce entitlement spending of Social Security?

KOTLIKOFF: Yes. Let me explain how I would do that, because the reform proposal that I would advance, and I have advanced together with Jeff Sachs, who's a professor at Harvard -- and this proposal has been endorsed by 65 academic economists, including three Nobel Prize winners -- is to take the existing system, the OAI system, the Old Age Insurance Program of Social Security, and pay off all the benefits that are obligated under that system.

So, you take the current retirees, pay them all the benefits we owe them. Take the current workers, and when they retire, you give them their accrued benefits, the benefits they would have accrued as of the time of the reform. Then you calculate that by filling zeros in their earnings records. So, when they hit retirement, their benefits are lower because of the fact that they've had zeros filled in their earnings records after the reform.

So, through time, Social Security benefits are going to fade out. This is the retirement benefits, because under our proposal, we would leave the survivor and the disability benefits in tact.

And the proposal would also take eight percentage points of the payroll of this 12.4 payroll tax that we now use to pay for Social Security, we'd take eight percentage points of that and put that into a private account, which would be divided 50/50 between husband and wife. The government would provide a matching contribution on behalf of poor people, so there would be a progressive element. The balances would be invested in a single security, which is a market way to global indexed fund of stocks and bonds.

At retirement age, you would have your account balances gradually transformed into pension -- placed in protective pensions. So, there would be an annuitization process which would be done on a cohort-by- cohort basis, and would be done collectively. So, individuals would not be having to go to individual insurance companies and try and get a deal, and they might not get a good deal from the insurance companies they ended up with. So, it would be done collectively at very low administrative costs.

So, here is a proposal which is phasing out the old system but giving everybody all the benefits they would have accrued as of the time of the reform, putting everybody into a new privatized retirement account where there's progressivity, there's protection of dependents, because non-working spouses would have an equal size account as working spouses. There's diversified investment in the world marketplace. There's the same rate of return to all Americans. There's collective annuitization so that there's no problem of getting taken by the insurance companies at the end of the day. And you get your money out in the form of pensions.

Now, the only thing I've left out of this story is how you pay the benefits of the old system, because we're taking eight percentage points of the payroll tax and putting that into private accounts. And that you could call a tax cut. So, if you want to have a tax cut, this is the way to do the tax cut -- cut the payroll tax by eight percentage points, and put it into private accounts.

But I would pay off the existing benefits through a combination of two things. One is further restraint on discretionary spending to the extent that's possible, but the main source of finance would be a federal retail sales tax, which would mean that older people, middle age people and young people would collectively be paying off the liability of the old system.

The only group that would be omitted from the obligation of paying off the benefits of the old system would be the poor elderly. They live off of Social Security, and because their benefit are indexed to the price level, if you put on a retail sales tax at the federal level, the price level will go up, and their benefits would be automatically increased. So, the poor elderly would be perfectly insulated, and we'd just be asking the rich elder and the middle class elderly, as well as everybody else in the economy, to help pay off the benefits of the old system.

That is a prognosis or a plan for ending up 30 years from now with a payroll tax for Social Security retirement benefits which is zero, as opposed to ending up with a payroll tax for Social Security retirement benefits which could well be going from eight percentage points of wages to 14 or so.

We have a huge problem. That is a radical plan. It's also a realistic plan. It's also a fair plan, and it doesn't beat about the bush in terms of being clear that somebody has to pay off the liabilities of the old system. All the plans that are being discussed by the two presidential candidates and by members of Congress and by most of the academics out there are suggesting that we can privatize Social Security with nobody bearing any pain, any burden. We can just let the capital markets take care of everything. That's hogwash. Frankly speaking, the economics are very clear. We have to pay off the liability of the old system, and this would be the way to do it. Alicia even agrees with that.

MUNNELL: If I saw the problem as large as Larry did, I would want dramatic restructuring too. But I just want to reiterate that when you look over the 75-year period, which I think, in my view, it's a generation -- it's a perfectly reasonable planning period, the cost of Social Security -- and this is what the trustee's reports say, this is what the actuaries say -- are going to go from 4.2 percent of GDP to 6.8 percent of GDP. That's up 2.6 percent. As I said, interest is going to go down from three to zero percent of GDP. Defense spending has gone down by 2.6 percent of GDP in the '90s. We've seen 2.6 percent of GDP swings, and we have been able to cope with them.

So, I think we can cope with this kind of change, and that the existing system works well. I think we should fix it immediately. I think tolerating deficits is not acceptable. I think we should get the revenues in there or the benefit reductions or whatever we need to do to close the gap to restore financial balance, both because it's cheaper if you do it early, and, two, people need to have confidence in the system.

So, I see a small problem, so I need a small fix. Larry sees a big problem; he needs a big fix.

KOTLIKOFF: I see the fact that about a third of our current Social Security problem can be traced back to 1983 and to the fact that the Greenspan Commission, which was charged with fixing Social Security once and for all, only looked out 75 years. So, here it is 17 years later, and we have in the current 75-year projection window 17 years of huge deficits that they did not take into account back in 1983, because they didn't look out far enough.

So, the demographics are quite clear. The nature of this system is quite clear. The fact is index and scale to the economy and how it works is quite clear. There's not a huge amount of uncertainty really about the kinds of liabilities that are going to be out there, given the demographic realities. And we're blindly ignoring them. And the Social Security trustees are also making what top demographers in the country think are outlandish assumptions about longevity.

The top demographers in the country, the academic demographers, appear to think that the intermediate assumptions have three more years of life, of expected life, than the trustees have assumed. And I'm not expert on demography, but I know these individuals have done a lot of research, and the technical panel that Social Security had on this issue and other issues back last year all voted to advise the trustees to increase the longevity assumption by four years. The trustees increased the longevity assumption by one year. So, if you take that into account, you see that even over the 75-year horizon, we have a much bigger problem than Alicia is describing.

SAXBY: Let me just address this to both of you. In '95, we were looking at a projection that Social Security was going to be broke in, depending on who you listened to, 2018 to 2022. The economy gets on a fast track, and all of a sudden we're looking at surpluses now both on-budget and off-budget. If we get back into a depressed economy and if all of a sudden these surpluses disappear, does the opinion of either one of you change with respect to we do or we don't have a crisis in Social Security?

KOTLIKOFF: Let me just say that the generational accounting that I was referring to uses all the latest numbers, which incorporate all the information about the surpluses. The only assumption that differs from the CBO projections is that the federal government doesn't engage in a disappearing act; rather -- in other words, the CBO is assuming that your salary is going to fall by 35 percent compared to other workers over the next 10 years.

I don't see that happening, frankly. I don't see that happening with military wages. I don't see that they're going to fill the Air Force One with 35 percent less gas in the tank of the Air Force One. I just don't see discretionary spending falling as a share of GDP by 35 percent over 10 years.

So, if you don't make that assumption, you say, well, let's assume that federal discretionary spending will stay even with the economy, you find out that, yes, we're going to be running some short- term surpluses even under that assumption, but, no, they're not anywhere near large enough to deal with the long-term problems in Medicare and Medicaid and Social Security and other aspects of our fiscal finances. And that if you leave the whole bill to the next generation, you have them facing a 40 percent higher tax bill. So, all their tax rates, at not just the federal level but also state and local, all their tax rates would be 40 percent higher.

And now you're talking about compounding the problem by having tax cuts in the short run or spending more on drug benefit to the elderly or other programs for the elderly. That will make the generational accounting situation worse. We are in a critically difficult situation here. We have agencies in this government that are systematically disguising the facts to the American people, just systematically really lying to the American public about the nature of our problems. And the situation is much more grave than has generally been described today.

Chairman Kasich got it exactly right -- this is the Perfect Storm, and it's a perfect fiscal storm.

SAXBY: Professor Munnell, we'll let you wind this up.

MUNNELL: I'll just answer your question about how if we had downturn how that would affect the outlook. Most of the improvement with Social Security Trust Fund projections have come from events that have already occurred -- the good performance of the 1990s. The actuaries have been very cautious in incorporating optimistic economic assumptions in their projections.

For instance, they assume that productivity growth will increase over the 75 years by 1.5 percent, even though in the late '90s we've been enjoying 2.5 or a little bit more. So, I don't think a downturn would have a very big effect on the projections at this point.

SAXBY: OK. Well, let me just say to both of you, thank you very much for your patience today in being here. And to both of you, let me say that your -- we wish you would submit your statement if you haven't already. And we thank you for enlightening us, and we look forward to a continuing dialogue on this question. It's fascinating, it's complicated, but it's something that's so important for literally our children and our grandchildren. We use that phrase figuratively too often, but this really does affect our children and grandchildren.

So, we appreciate very much you all's input and your being here today.

MUNNELL: Thank you, Mr. Chairman.

KOTLIKOFF: Thank you, sir.

SAXBY: And we are concluded.

END

NOTES:
Unknown - Indicates speaker unknown.
Inaudible - Could not make out what was being said.
off mike - Indicates could not make out what was being said.

PERSON: JOHN R KASICH (94%); WALLY HERGER (57%); CHRISTOPHER SHAYS (57%); SAXBY CHAMBLISS (57%); JIM NUSSLE (56%); NICK SMITH (56%); GEORGE P RADANOVICH (55%); PETER HOEKSTRA (55%); CHARLES F BASS (54%); VAN HILLEARY (54%); JOHN SUNUNU (53%); MICHAEL (MAC) COLLINS (52%); MARK GREEN (51%); RON PAUL (50%);

LOAD-DATE: August 3, 2000

Document 5 of 54.


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