First I think it is not correct, Senator, to state that it is just a fiction and not actuarially sound.

You see, actuarially soundness in private insurance means that if the board of directors of the insurance company decide to go out of business by not accepting any new policies, they must have sufficient reserves to pay off their contracts.

This concept has no place in a Government-funded program because you start with a different assumption; namely, that the Government is not going to go out of business. If the Government does go out of business there is no sense talking about actuarial soundness anyway.

So, the test of actuarial soundness in a Government program is, "Will the projected income plus the reserves take care of the projected outflow?" By that test, the social security system to date may be said to be financially and actuarially sound.

When we say the money that comes in is put into a reserve and it is just a paper transaction, so are all transactions in the financial world of the United States.

When the insurance companies get my premium, what do they do? They put it in the same kind of paper. They buy Government bonds, too, and there is no difference in the social security trust fund buying securities and the Prudential Life Insurance Co. buying Government securities.

So, we live in a paper economy. I have some green-back paper in my pocket, I wish I had more. It is just paper, but it has a value. I think that this is the only way we can work it out. There is no need to have a reserve fund which is sufficient to take care of all of the obligations if the program stops, because you start with the assumption that it will not stop.

Senator SAXBE. Don't you have a difference over the private insurance where their portfolio consists of a smaller percentage of costs and then they own interest in this corporation or that corporation, their portfolio expands to privately held producing companies that own property and make money and pay dividends and have an ever-increasing response to inflationary pressures?

Dean SCHOTTLAND. This has been thoroughly discussed by various committees of Congress. Alternatives have been explored. Congress has always felt over the years that social security funds should not engage in private business or speculation.

In some countries, the Latin American countries, for example, the social security funds are used to finance public housing, hospitals, and they take mortgages on them. The workmen's compensation fund in Italy has made a tremendous amount of money by speculation in land around Rome.

But in this country it has been felt by the Congress that social security funds ought to invest only in government securities.

Senator SAXBE. Isn't the reason for that everyone has felt basically this is an obligation of the Federal Government?

Dean SCHOTTLAND. I think so, yes.

Senator SAXBE. That is where I say I can't help but feel we have progressed far enough down the road that we can cut out the fiction and especially when we expand this to all older people. Now, you are bringing in there a lot of workers who never contributed or a lot of people, a housewife, and so on, that never contributed.

STRENGTHS OF WAGE PAYROLL TAX

Dean SCHOTTLAND. I guess I have a feeling that psychologically there is some strength in a wage payroll tax. I illustrate it by two incidents.

The State Department many years ago sent a team to the Soviet Union to study social security. I was the chairman of that team. One of the things I noticed particularly was every time we talked to a worker he would say, "I am grateful to my government for giving me social security."

No worker in America says he is grateful to his Government. He says I paid for this and I want it. The fact that he may not have paid it completely doesn't make any difference. He feels he is contributing. I think this is important.

I recall George Meany testifying before the House Ways and Means Committee when one of the Congressmen asked him how can labor be for such a tax, social security tax, which is a regressive tax.

He said, yes, but it is a regressive tax we like. We like it because we feel that as workers we are contributing. I think there is something important about that.

Senator SAXBE. That is true. But I wonder how long that is going to continue when the man sees the man who didn't contribute, never hit a lick all his life, drawing the same benefit he does.

Today he must demean himself under old-age assistance and he may draw his money but the other man who goes to the post office and gets his check says, I earned this, this is mine. I think once you expand social security to bring everybody in and give them the same benefits, the same minimum benefits, I realize there would be a difference in maximum benefits, I think you are going to lose a lot of this, shall we say, personal pride in their contribution.

Thank you.

Dr. SCHULZ. Dean Schottland, I would like to ask you about the early retirement problem. You recommend that serious consideration be given to the early retirement provision in social security with respect to the reduction of benefits and the possibility that this causes poverty.

The task force talked about this problem and in its report urged that consideration be given to alternatives to social security to meet the problem of people being forced to retire early, becoming disabled or unable to find jobs for other reasons.

I thought I sensed in your statement a suggestion that perhaps we should consider giving people retiring early a full benefit or close to full benefit. What I wanted to ask you, therefore, is whether you don't think that might be dangerous, dangerous in the sense that it would encourage more and more workers who might be able to work to ask for retirement at an earlier age. We might thereby be forcing the national standard of what is a normal retirement period lower and lower.

Dean SCHOTTLAND. That is why I said we need to study this area and I was not prepared to come to grips with specific recommendations. It is a very difficult area. There is no question when we reduced the age of women for retirement purposes, this had a great effect.

No organized group was in favor of reducing the age of retirement for women. They all opposed it. But Congress was deluged with thousands and thousands of telegrams and letters from individual women and although even the proponents were not too serious about it, it was inevitable that it would be approved. Then the men had to opt for equality with the women so they asked for age 62 as the retirement age.

I think the employer does not feel guilty letting out a person if he can get his social security. I think this is bad business.

Mrs. BREWSTER. Dean Schottland, you suggested that old-age assistance should be incorporated in social security. By the same token, would you incorporate Medicaid for that group into Medicare?

Dean SCHOTTLAND. Yes; I see no reason why we should not. Many of the OAA recipients are getting Medicare anyway because you have 1,100,000 of the 2,100,000 OAA cases actually receiving old-age-security benefits who are already in Medicare.

Mrs. BREWSTER. This would mean some cutting back in the kinds of services they possibly are getting under Medicaid that are not included in Medicare.

Dean SCHOTTLAND. Yes, but I would assume that Medicare will continue to expand and include more and more services. I just think it is inevitable that we are not going to get partial medical services over a long period of time.

Senator SAXBE. Thank you, Dean, for your excellent presentation. Mr. Pechman, I believe you are accompanied by Dr. Aaron and Dr. Taussig, associates of yours.

STATEMENT OF JOSEPH A. PECHMAN, DIRECTOR OF ECONOMIC STUDIES, BROOKINGS INSTITUTION; ACCOMPANIED BY HENRY AARON, SENIOR FELLOW, BROOKINGS INSTITUTION; AND MICHAEL K. TAUSSIG, ASSISTANT PROFESSOR OF ECONOMICS, RUTGERS UNIVERSITY 1

Mr. PECHMAN. Mr. Chairman and members of the task force, we appreciate the opportunity to present to you the results of our study, "Social Security: Perspectives for Reform," (Brookings Institution 1968). In the statement, we will raise briefly three major issues of social security policy. These issues are discussed more fully in the summary of our book which we submit for the record.2

First, we believe that the widespread habit of regarding social security as a form of insurance is misleading and harmful, even though we agree that the insurance analogy helped sell social security to the American people 35 years ago.

Second, we suggest a series of reforms to improve the structure of social security benefits.

Third, we propose modifications in social security financing to remove inequities and to alleviate the heavy burden of the payroll tax

1 Mr. Pechman is director of economic studies at the Brookings Institution, Mr. Aaron is senior fellow at the Brookings Institution and associate professor at the University of Maryland, and Mr. Taussig is assistant professor of economics at Rutgers University. The views in this paper are those of the authors and are not presented as the views of the trustees, officers, or other staff members of the Brookings Institution, University of Maryland or Rutgers University.

2 See app. 3, pp. 253-263.

on the poor. As will become apparent, the tendency to regard social security as insurance impedes reform of both the benefit structure and the method of financing.

THE INSURANCE ANALOGY

In practice, the social security law created a system of benefit payments based on past earnings of eligible beneficiaries and a system of payroll taxes based on current earnings of workers. Within any age group, including those persons presently retired and those still working, the values of individual benefits and taxes-appropriately discounted-vary greatly.

Present beneficiaries as a group receive far larger benefits than those to which the taxes they paid, or that were paid into a private insurance fund. Furthermore, this situation will continue indefinitely-though to a decreasing extent-as long as Congress maintains benefit levels in line with higher earning levels.

The essential difference between private insurance and social security turns on whether an individual currently in the labor force is paying for the social security benefits of current retired workers and survivors or for his own or his family's future benefits.

In individual insurance, each person's premiums are contractually tied to his own and his family's future benefits. Social security benefits are based explicitly on the beneficiary's earnings history, not his previous payroll taxes.

Moreover, the level of payroll taxation has been set approximately to defray costs of benefits for the currently retired. The social security program has been financed on a virtual cash, or pay-as-you-go basis in recent years. The accumulated reserves are sufficient to cover only approximately 1 year of benefit payments at present benefit levels. We wish to emphasize that there is nothing wrong with the idea that current taxes should pay for current benefits. Unlike a private insurance firm, social security does not require a reserve fund to meet its future financial commitments.

The financial soundness of the program depends only on the Government's effective power of taxation, and this power depends critically on the maintenance of a sound tax system in a healthy, growing economy. The faster the rate of economic growth, other things equal, the lighter the burden of taxation that will be required to finance any given level of future social security benefits.

To illustrate the artificiality of the insurance analogy, imagine a world identical to our own in all respects but one. The economy, population, incomes, government expenditures, including transfer payments, and taxation are the same as they are today.

The only difference is that no connection has been legislated in this imaginary world between any particular government expenditure and any particular tax. Instead, all revenues flow into a general fund and all expenditures are supported from it.

In particular, no one in this imaginary world has troubled to tie one of the long list of taxes, the payroll tax, to one of the long list of government expenditures, social security benefits.

You will agree, we feel sure, that if the legal connection between. payroll taxes and benefits in fact did not exist, nothing essential need

be changed because of the absence of that connection. Calculation of social security benefits in such a world could be done in the same way it is done today.

Taxes might continue to be imposed in the same patterns we know and dislike so well. However, in such a world the tendency would develop to evaluate social security benefits solely with regard to the effectiveness with which they meet the recognized problems of the aged, of survivors, and of the disabled.

Similarly, the payroll tax would come to be evaluated solely on the basis of its equity and resource allocation effects, exactly as other taxes are evaluated.

THE BENEFIT STRUCTURE

If the insurance analogy is abandoned, we feel that the following shortcomings in the present system will generally be recognized. First, although social security benefits are the major income source for most aged benefit recipients, minimum benefits are only a minor fraction of income levels used officially to define poverty-35 percent for widows, 42 percent for single retirees, and 50 percent for aged couples.

Second, some aged persons are excluded from benefits because of the industry or occupation in which they happened to spend most of their working careers, regardless of their total income or of the total amount of all taxes they paid.

Third, the aged group with less income and fewer assets than any other major subcategory of the aged, namely widows who had little work experience, receive smaller benefits than single retirees and aged couples.

Fourth, the benefit structure facilitates early retirement alike by those precluded from work by illness or lack of skills and those who voluntarily chose early retirement by making reduced benefits available to both.

Fifth, a ceiling is placed over benefits to large surviving families which provides inadequate income to the family forced to rely on social security benefits alone. The same ceiling is placed over benefits to large families headed by a disabled breadwinner.

These and other shortcomings of the benefit structure which we discussed in the attached report persist and are defended largely because, by historical accident, payroll taxes were linked to social security benefits, thereby lending superficial but misleading credence to the belief that social security benefits should be limited by previous payroll tax payments, as private insurance is limited by premiums.

May I interpose, Mr. Chairman, and submit to you a sampling of some of the letters that we received after our book was published and mentioned in newspapers in many places throughout the country.1 We received a large number of rather poignant letters illustrating the hardships that occur as a result of the sharp distinctions that are made in the social security law to define qualification for benefits.

Mr. PECHMAN. To remove questionable provisions, reforms in the structure of the present system are all that is necessary. The cost of their removal is modest, in comparison with across-the-board benefit liberalization which does virtually nothing to remove most such inequities and aggravates some.

1 Material retained in committee files.