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the future by correcting present imbalances and by preventing the system from sliding into serious new problems.

Correction of the Dual Benefits Problem--A key problem is that of dual benefits and their attendant windfalls. Solution of this problem is crucial because it involves heavy costs and large considerations of equity, and also reflects a major structural imperfection in the system. It stems from piecemeal amendment of the railroad retirement system and the failure to coordinate it structurally with social security. Dual beneficiaries-individuals or families who receive benefits both from railroad retirement and social security-reap windfall gains. Their benefits tend to be disproportionate to their contributions and to their length of service under social security.

The excess costs of the dual benefits are charged to the Railroad Retirement Account and must be borne through higher taxes by all railroad workers, including the career railroad workers who usually do not receive dual benefits. Past attempts to solve the problem of dual benefits by offsets and other ad hoc measures have failed. Dual benefits were expected in 1950 to have a gross cost of about 1.8% of level covered payroll; the Commission's actuarial estimates now project them at 8.0% of the covered payroll, including the effect of statutory changes since 1950. About two-thirds of this cost is for windfall benefits. Unless fundamental corrective action is taken, the dual benefits problem will mount in future years.

The Commission recommends that future accrual of dual benefits be terminated and that every available measure be used to keep further windfall benefits from occurring. Its proposal for restructuring the system into two tiers would solve the problem for future service. Under these recommendations the basic tier, or OASDI, benefits will be computed on the railroad and social security-covered employment and the excess element will automatically be eliminated.

The Commission also recommends that dual benefits being received by present beneficiaries and that dual benefit rights which are now legally vested should be allowed, or "saved", by an appropriate "grandfather clause."

Some railroad workers with insufficient quarters of coverage under OASDI will not have acquired vested benefit rights, but, because they have served under two separate systems, will have paid OASDI taxes on their total covered wages (directly and via the Railroad Retirement Account) that are in excess of the annual social security maximum on combined service. For these workers the Commission recommends a one-time payment from the Railroad Retirement Account equal to this excess together with interest. This would accord in principle with the practice now followed by social security of refunding excess taxes to individuals in multiemployer cases.

Improved Benefit Formulas.-The present railroad retirement benefit formulas are extremely complex and very difficult to understand. Their complexities are increased by the various dual benefits offsets which have been necessary in the system as it is now structured. The percentage factors in the retirement formula have been compounded by successive adjustments to raise benefits for beneficiaries already on the rolls whose wage base reflects earlier years when pay rates were lower. However, the recomputed percentage factors have also been applied to new retirees whose wage base is related to more recent,

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higher wages. Workers retiring after 1966 may count more than 30 years' creditable service, which adds to the compounding effect. If the recent exponential growth in the formula factors is continued by repeated percentage increases, the wage replacement ratio will escalate and the system will become untenable. The application of a single 80% of final-average pay ceiling on benefits would not be a satisfactory solution if present formulas are kept, for more and more awards would be crowded against this ceiling in the future.

The Commission's recommendations for providing benefits which are as adequate as possible within the resources available for the second or staff tier include various significant changes. The new formulas for the restructured staff pension tier must be properly designed so they supplement the basic OASDI formulas.

As the system already faces a large deficit, the restructuring must be carried out under least-cost rules. In the changeover, the formulas for tier-two benefits must be developed so they conform closely to the present differences between (a) total railroad benefits including supplemental benefits but excluding the excess dual benefit and (b) the basic OASDI benefits based on combined railroad and social security service.

Second tier formulas should be designed to supplement social security and, in conjunction with it, to yield a relatively stable percentage of benefits in relation to final 5-year-average pay or some other measure of the living standard earned by the worker. In other words, the wage replacement ratio should be stable under dynamic economic conditions.

In an economy in which wages and prices are subject to spurts of inflation, the characteristics of different possible formulas for determining retirement benefits become important. Formulas which provide fixed dollar amounts of benefits per year of service are subject to erosion by inflation. Those which are stated as percentages of pay are better, but some yield more stable or equitable wage replacement ratios than others. One approach, used in many staff retirement systems, is a formula based on final pay or on average pay in the highest 3, 5, or 10 years. Such a formula would be a complete change from the lifetime average pay basis used by railroad retirement from its beginning. Final pay is not necessarily as representative of a worker's lifetime economic contribution as is lifetime average pay. However, the computation of average monthly compensation (AMC) based on the money amounts earned in various past years may be seriously distorted by inflation. Ideally the worker should be awarded a benefit related fairly to his relative lifetime real wage standing in relation to other workers, rather than be robbed of his benefit base by inflation. One way to do this for railroad beneficiaries might be to adjust the monthly or yearly amounts of pay entering into the AMC by the Consumer Price Index; the benefit computations based on such an adjusted AMC would reflect real wages more accurately in the lifetime average than would an average of money wages. However, such a restructuring of the wage base would necessitate reconsideration of the percentage factors now in the formulas.

The new formula and benefit structure should appropriately recognize that the basic OASDI benefits will reflect weighting for social dequacy, so the staff tier can be concentrated more on the traditional

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objective of providing supplementary benefits proportioned to years of service. The provision for dependents' and survivors' benefits in the staff tier might very well be by means of ratios applied either to the basic OASDI benefits or to the primary worker's second tier benefits, depending on the situations.

Finally, future adjustments for beneficiaries already on the rolls should be handled separately from the formula for new awards, that is, "decoupled" from the basic formula. This separation is now made successfully in the Federal civil service and military retirement sys

tems.

Correction of Anomalies.-The opportunity to design a new benefit structure will also permit redress of the many inequities and anomalies which have crept into the system during its piecemeal amendments of the last 35 years.

Among the various groups of beneficiaries, the survivors particularly aged widows-today tend to be relatively neglected. Benefits for survivors would be substantially enhanced if the Congress amends the Social Security Act along the lines of the provisions in H.R. 1 as it passed the House in 1971. If not, then this group should receive high priority attention under the restructured railroad retirement staff tier. A joint-and-survivor option should be provided in any event. As a related step, the spouse benefit might well be restructured in the future, because benefits for couples are tending to be disproportionate to those for widows in the present system.

The Restoration of Financial Solvency

The most important action the President and the Congress must take with respect to this system is immediate legislation to restore the Railroad Retirement Account to sufficient solvency to pay the statutory benefits to all who become eligible in the future. This has been a system under public law, but a system nonetheless which has been operated for the workers in the railroad industry and has been basically determined by the railway unions and the organizations of carriers on the grounds that the system was financed by employee-employer contributions.

The impending financial crisis presents a test of the validity of the premises on which the railroad retirement system has operated and of the good faith of the railway labor and management organizations which, in many instances have bargained out the successive agreements which the Congress has often accepted. A pension system is a long-range financial undertaking which must provide a sound financing program not only for 10 years, but for 30 to 50 years or more. From the standpoint of the United States Government and the general tax-paying public, the willingness of the railway labor and management organizations to adopt jointly a firm long-range plan in the near future to finance the system on a reasonably sound and fully selfsupporting basis for at least the next 30 years, can be regarded as a decisive test of whether a staff pension system for the railroad industry under its present aegis can survive.

One test of responsible action will be whether the two parties agree to taxes and other changes at least sufficient to overcome the present projected cash flow deficits, which seriously threaten the system. A second will be whether any proposals for benefit increases are matched

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by corresponding, timely increases in contributions to finance them. A third will be the acceptance of actuarial principles which will put the finances of the system on a sound basis after it gets through its present crisis and more normal financing methods become practicable.

The Commission's findings and conclusions regarding the unsound financial status of the railroad system and the action which would be necessary to finance it on an actuarially sound basis are the result of intensive study and of consultations with a group of the Nation's outstanding actuaries.

Actuarial Advisory Panel Proposals.-The general consensus of the Commission's Actuarial Advisory Panel was that the financing methods and assumptions used for the Railroad Retirement Account in the past are no longer adequate in view of the financial situation of the system and the economic trends confronting the industry. The Panel agreed with the findings of the Commission's staff studies that provision has not been made for the accumulation of sufficient reservesor for high enough tax schedules, present and future-to finance this staff pension system, which is heavily dependent on the declining employment of a single industry. The result is that the system has reached maturity without adequate reserves or sufficiently high contributions to carry it over its predictable expenditure "hump," which will be the dominant factor in the financing of this system for at least the next 30 years. Assuming the Commission's central case projections, the unfunded liability of the system is at present on the order of $14 billion.

The Panel has pointed out that an actuarially sound pension plan arranges for meeting future benefit costs through an orderly funding program which makes secure the accrued rights of pensioners and active employees when they become entitled to retire. The Railroad Retirement Account falls short of this criterion by many billions of dollars, according to the Commission's projections, and is overlydependent on gains from future entrants. Although it is a public system, its future is uncertain, for it depends for its finances on the declining employment base of the railroad industry.

The Actuarial Advisory Panel has suggested that in determining the actuarial funding requirements for the railroad retirement system, consideration be given to both long-range or traditional present value calculations and also to cash flow solvency tests. They have concluded that the traditional minimum actuarial funding level for a closed group, which is set at normal cost plus interest on the unfunded accrued liability, would not represent an actuarially sound approach for the railroad retirement system. It would result in a continually increasing percentage of payroll cost as the number of employees continues to decline. Therefore, the actuarial advisors have recommended that the funding program should provide for some long-term amortization of the unfunded liabilities. They have suggested that 30-year amortization would be a reasonable target, in view of the projected halving of railroad employment in the next 30 years. If 30-year amortization were adopted for the second or staff tier of the system, the tax rate would have to be more than doubled.

Available Options.-Historically, the railroad retirement system has been represented as a self-supporting system, financed by contributions from workers and employers and earnings from its trust fund.

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The Commission deems this to be the principle which should be followed in the future.

Representatives of both railroad labor and management have suggested the possibility of a Federal subsidy in their responses to the Commission. The Commission's analysis found no valid grounds for Federal subsidy to the system, directly or indirectly. The payment of the basic social security benefits to railroad workers can be fully assured in the future by a proper realignment: a statutory amendment providing for their direct payment by the Social Security Administration. A special Federal subsidy for the second tier would be undesirable on economic grounds and is not defensible on social grounds, given the many competing needs pressing on the Federal budget. If this system received a subsidy, many other pension plans would then want subsidies, too.

There are no easy ways to overcome the actuarial deficiency of this system. Hard decisions have to be made. The prospects of overcoming a significant portion of this deficiency from higher interest earnings or other small economies offer relatively little relief.

The Commission's projectons indicate that-in present value terms—— between 1970 and 2000 the railroad retirement system will pay an estimated $11.1 billion in gross dual benefits. Decisive action could save $3.4 billion of this sum without abridging benefits that are currently being paid or which are legally vested. On dynamic economic assumptions, the net savings would be 2% of level payroll for the 30-year period. However, the cash flow savings for the first 10 of 15 years would be modest, and over the longer run would not be enough to prevent bankruptcy.

Immediate tax increases present the only real option for restoring financial solvency to the railroad retirement system, because starting about 1975 the ratio of benefit outlays to the covered payroll will be much higher than it is now. Failing a tax increase, the system would run completely out of money by 1988 and, if it could borrow to meet its obligations, would have a debt of nearly $12 billion by the year 2000. This projection assumes continuation of the present ratio of benefits to wages, including the 1970 and 1971 temporary increases, but assumes no further liberalizations.

Maintenance of Present Reserve Ratio During Coming Crisis Period. The Commission has tried to find a middle ground which would keep the system self-supporting while going through its critical period when the number of beneficiaries exceeds the number of active railroad workers. It has concluded that it would not be practicable to try restoring the system to full actuarial solvency during this period of peak beneficiary loads. However, it believes that the system must maintain at least the degree of security for future beneficiaries which is provided by the 1972 reserve ratio-about six times net current outlays on an accrual basis, or about five times on a cash basis. The tier-two portion of the railroad retirement system requires a significantly higher reserve ratio than the social security system with its far more diversified and stronger financial base.

The Commission proposes that in the coming period of its crisis the railroad retirement system should be self-supporting, and that it should follow the criteria that the Railroad Retirement Account (a) should not at any foreseeable point-be drawn down below its pres