oversight

Social Security Reform: Analysis of Reform Models Developed by the President's Commission to Strengthen Social Security

Published by the Government Accountability Office on 2003-01-15.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to the Chairman, Senate Special
               Committee on Aging, U.S. Senate



January 2003
               SOCIAL SECURITY
               REFORM
               Analysis of Reform
               Models Developed by
               the President’s
               Commission to
               Strengthen Social
               Security




GAO-03-310
                                               January 2003


                                               SOCIAL SECURITY REFORM

                                               Analysis of Reform Models Developed by
Highlights of GAO-03-310, a report to the      the President’s Commission to
Chairman of the Special Committee on
Aging, U.S. Senate                             Strengthen Social Security



Social Security is an important                Applying GAO’s criteria to the Commission models highlights key options
social insurance program affecting             and trade-offs between efforts to achieve sustainable solvency and maintain
virtually every American family. It            adequate retirement income for current and future beneficiaries.
represents a foundation of the
nation’s retirement income system              For example, the Commission’s Model 2 proposal reduces Social Security’s
and provides millions of Americans
with disability insurance and
                                               defined benefit from currently scheduled levels through various formula
survivors’ benefits. Over the long             changes, provides enhanced benefits for low-wage workers and spousal
term, as the baby boom generation              survivors, and adds a voluntary individual account option in exchange for a
retires, Social Security’s financing           benefit reduction. Model 2 would provide for sustainable solvency and
shortfall presents a major solvency            reduce the shares of the federal budget and the economy devoted to Social
and sustainability challenge.                  Security compared to currently scheduled benefits (tax increase benchmark)
Numerous reform proposals have                 regardless of how many individuals selected accounts. However, with
been put forward in recent years,              universal account participation, general revenue funding would be needed
and in December 2001 a                         for about 3 decades.
commission appointed by the
President presented three possible             GAO’s analysis of benefit adequacy and equity issues relating to Model 2
reform models.
                                               found that
                                               · Across cohorts, median monthly benefits for those choosing accounts are
Senator Breaux, Chairman of the
Senate Special Committee on                    always higher, despite a benefit offset, than for those who do not; this gap
Aging, asked GAO to use its                    grows over time. In addition, benefits assuming universal account
analytic framework to evaluate the             participation are higher than payment of a defined benefit generally
Commission’s models. This                      corresponding to an amount payable from future Social Security trust fund
framework consists of three                    revenues (benefit reduction benchmark). However, benefits received by
criteria: (1) the extent to which a            those without accounts fall below the benchmark over time.
proposal achieves sustainable                  · For the lowest quintile, median monthly benefits with universal
solvency and how it would affect               participation in the accounts tend to be higher than GAO’s benefit reduction
the economy and the federal                    benchmark, likely due to the enhanced benefit for full-time “minimum wage”
budget; (2) the balance struck                 workers. This pattern becomes more pronounced across the cohorts
between the twin goals of income
                                               analyzed.
adequacy and individual equity; and
(3) how readily such changes could             · Regardless of whether an account is chosen, many people could receive
be implemented, administered, and              monthly benefits under Model 2 that are higher than the benefit reduction
explained to the public.                       benchmark. However, a minority could fare worse. Some people could also
                                               receive a benefit greater than under the tax increase benchmark although a
                                               majority could fare worse. Benefits for those choosing individual accounts
                                               will be sensitive to the actual rates of return earned by those accounts.

                                               Adding individual accounts would require new administrative structures,
                                               adding complexity and cost. Public education will be key to help
                                               beneficiaries make sound decisions about account participation, investment
                                               diversification, and risk. Finally, any Social Security reform proposal must
                                               also be looked at in the context of both the program and the long-term
                                               budget outlook. A funding gap exists between promised and funded Social
www.gao.gov/cgi-bin/getrpt?GAO-03-310.
                                               Security benefits which, although it will not occur for a number of years, is
To view the full report, including the scope   significant and will grow over time. In addition, GAO’s long-term budget
and methodology, click on the link above.      simulations show, difficult choices will be required to reconcile a large and
For more information, contact Barbara D.
Bovbjerg at (202) 512-7215 or
                                               growing gap between projected revenues and spending resulting primarily
bovbjergb@gao.gov.                             from known demographic trends and rising health care costs.
Contents


Letter                                                                                 1
              Achieving Sustainable Solvency                                           4
              Balancing Adequacy and Equity                                            6
              Implementing and Administering Reforms                                   7
              Concluding Observations                                                  7
              Agency Comments and Our Evaluation                                       8

Appendix I    Analysis of Reform Models                                              12



Appendix II   Comments from the Social Security Administration                      100




              Abbreviations

              OASDI        Old-Age and Survivors Insurance and Disability Insurance
              PIA          primary insurance amount
              SSA          Social Security Administration




              Page i                                   GAO-03-310 Social Security Reform
United States General Accounting Office
Washington, DC 20548




                                    January 15, 2003

                                    The Honorable John Breaux
                                    Chairman
                                    Special Committee on Aging
                                    United States Senate

                                    Dear Mr. Breaux:

                                    This report responds to your request that we apply our criteria for
                                    assessing Social Security reform proposals to the reform models
                                    developed by the President’s Commission to Strengthen Social Security.1
                                    Each of the Commission’s three reform models represents a different
                                    approach to including a voluntary individual account option to Social
                                    Security. Model 1 does not restore solvency and accordingly is not
                                    analyzed in this report. In April 2002, we provided your staff with a
                                    briefing on our preliminary results for Model 2. This report contains our
                                    final results, focusing on Model 2, with results for Model 3 presented in
                                    Appendix I.

                                    We based our interpretation of the Commission’s reform models in large
                                    part on the memorandum provided by the Office of the Chief Actuary at
                                    the Social Security Administration (SSA) dated January 31, 2002, that
                                    estimated the reform models’ effects on the Social Security program. Our
                                    interpretation also draws on the Commission’s final report. As agreed with
                                    your office, our report is based on the analytic framework we have used in
                                    past work to evaluate Social Security reform proposals.2 That framework
                                    consists of three basic criteria:

                                •   the extent to which the proposal achieves sustainable solvency and how it
                                    would affect the U.S. economy and the federal budget,




                                    1
                                     The Commission’s report, Strengthening Social Security and Creating Personal Wealth
                                    for All Americans was issued on December 21, 2001 (revised March 19, 2002).
                                    2
                                     See, for example, U.S. General Accounting Office, Social Security: Evaluating Reform
                                    Proposals, GAO/AIMD/HEHS-00-29 (Washington, D C.: Nov. 4, 1999) and Social Security
                                    Reform: Information on the Archer-Shaw Proposal, GAO/AIMD/HEHS-00-56 (Washington,
                                    D.C.: Jan. 18, 2000).



                                    Page 1                                             GAO-03-310 Social Security Reform
•   the balance struck between the twin goals of income adequacy (level and
    certainty of benefits) and individual equity (rates of return on individual
    contributions), and
•   how readily such changes could be implemented, administered, and
    explained to the public.
    In evaluating proposals against the three basic criteria, we used a set of
    detailed questions that help describe potential effects of reform models on
    important policy and operational aspects of public concern. These
    questions are displayed in the report.

    Our analysis of the Commission reform models included comparison with
    three benchmarks:3

•   The “benefit reduction benchmark” assumes a gradual reduction in the
    currently scheduled Social Security defined benefit beginning with those
    newly eligible for retirement in 2005. Current tax rates are maintained.
•   The “tax increase benchmark” assumes an increase in the OASDI payroll
    tax beginning in 2002 sufficient to achieve an actuarial balance over the
    75-year period. Currently scheduled benefits are maintained.
•   The “baseline extended” benchmark is a fiscal policy path developed in
    our earlier long-term model work that assumes payment in full of currently
    scheduled Social Security benefits and no other changes in current
    spending or tax policies.

    To show the range of possible outcomes given the voluntary nature of
    individual accounts4 in the Commission models, we simulated each model
    assuming (1) no participation (0%) in the individual account option and
    (2) universal participation (100%) in the account option. Actual experience
    would likely fall between these bounds but cannot be predicted with any
    degree of certainty.

    As you requested, we used our long-term economic model in assessing
    Commission reform models against the first criterion, that of financing




    3
     From the perspective of analyzing benefit adequacy, the tax increase and baseline
    extended benchmarks are identical because both assume payment in full of scheduled
    Social Security benefits over the 75-year simulation period.
    4
     In this report, the term “individual account” is used for the voluntary accounts, consistent
    with published GAO work. The Commission used the term “personal account” in its final
    report.




    Page 2                                                  GAO-03-310 Social Security Reform
sustainable solvency.5 Although any proposal’s ability to achieve and
sustain solvency is sensitive to economic and budgetary assumptions,
using a common framework can facilitate comparisons of alternative
reform proposals. Our sustainable solvency standard encompasses several
different ways of looking at the Social Security program’s financing needs.
While 75-year actuarial balance is generally used in evaluating the long-
term financial outlook of the Social Security program and reform
proposals, it is not sufficient in gauging the program’s solvency after the
75th year. For example, under the Trustees’ intermediate assumptions,
each year the 75-year actuarial period changes, and a year with a surplus is
replaced by a new 75th year that has a significant deficit. As a result,
changes made to restore trust fund solvency only for the 75-year period
can result in future actuarial imbalances almost immediately. Reform
plans that lead to sustainable solvency would be those that consider the
broader issues of fiscal sustainability and affordability over the long term.6

To examine how the Commission reform models balance adequacy and
equity concerns, we used the GEMINI model, a dynamic microsimulation
model for analyzing the lifetime implications of Social Security policies for
a large sample of people7 born in the same year. GEMINI can simulate
different reform features, including individual accounts with an offset, for
their effects on the level and distribution of benefits.8 To avoid having the
extremely high returns of a small portion of participants skew the average,
we present most of our statistics as medians. To assess benefit adequacy,
we display median monthly benefit levels for the 1955, 1970, and 1985 birth
cohorts to enable comparisons over time; initial benefits by earnings




5
 For this analysis, consistent with SSA’s scoring of the Commission reform models, our
long-term economic model incorporates the 2001 Trustees’ best, or intermediate,
assumptions.
6
 In addition to assessing a proposal’s likely effect on Social Security’s actuarial balance, a
standard of sustainable solvency also involves looking at (1) the balance between program
income and cost beyond the 75th year and (2) the share of the budget and economy
consumed by Social Security spending.
7
 The GEMINI cohorts consist of simulated samples of 100,000 individuals, sometimes
called synthetic samples. These samples were validated against data from the Social
Security Administration’s Annual Statistical Supplement, the SIPP, the CPS, MINT2, and the
PSID.
8
 In simulating the individual accounts, we used the same nominal rates of return used by
SSA’s Office of the Chief Actuary in January 2002, with 6.3 percent for Treasuries, 6.8
percent for corporate bonds, and 10 percent for equities.




Page 3                                                  GAO-03-310 Social Security Reform
                        quintile, comparing the lowest and highest quintiles; and the effects on the
                        distribution of initial benefits within each cohort.

                        To examine how the Commission reform models provide for reasonable
                        implementation and communication of any changes, we used qualitative
                        analysis based on GAO’s issued and ongoing body of work on Social
                        Security reform. This work addresses various issues raised by reform
                        approaches, including establishing individual accounts, raising the
                        retirement age, and the impact of reforms on minorities and women.

                        Models 2 and 3 restore solvency to the Old-Age and Survivors Insurance
                        and Disability Insurance (OASDI) Trust Funds through a combination of
                        changes in the initial benefit calculation, general revenue transfers, and/or
                        benefit offsets for those who choose to participate in the individual
                        account option. Model 3 requires an additional contribution equal to 1
                        percent of taxable payroll under the voluntary individual account option.
                        All models share a common framework for administering individual
                        accounts. As agreed with your office, this report focuses on Model 2, with
                        results for Model 3 presented in Appendix I.


                        The use of our criteria to evaluate approaches to Social Security reform
Achieving Sustainable   highlights the trade-offs that exist between efforts to achieve solvency for
Solvency                the OASDI trust funds and efforts to maintain adequate retirement income
                        for current and future beneficiaries. The models illustrate some of the
                        options and trade-offs that will need to be considered as the nation
                        debates how to reform Social Security.

                        Our analysis of sustainable solvency under Model 2 showed that

                    •   As estimated by the actuaries, Model 2, with either universal (Model 2–-
                        100%) or zero (Model 2—0%) participation in voluntary individual
                        accounts, is solvent over the 75-year projection period, and the ratio of
                        annual income to benefit payments at the end of the simulation period is
                        increasing. However, in Model 2 –100% over three decades of general
                        revenue transfers are needed to achieve trust fund solvency. Model 2—0%
                        achieves solvency with no general revenue transfers.
                    •   Model 2-100% would ultimately reduce the budgetary pressures of Social
                        Security on the unified budget relative to baseline extended. However, this
                        would not begin until the middle of this century. Relative to both GAO’s
                        benefit reduction benchmark and tax increase benchmark, unified
                        surpluses would be lower and unified deficits higher throughout the
                        simulation period under Model 2-100%. Model 2-0% would reduce



                        Page 4                                        GAO-03-310 Social Security Reform
    budgetary pressures due to Social Security beginning around 2015 relative
    to baseline extended. This fiscal outlook under Model 2-0% is very similar
    to the fiscal outlook under GAO’s benefit reduction benchmark.
•   Under Model 2-100%, the government’s cash requirement (as a share of
    GDP) to fund the individual accounts and the reduced defined benefit
    would be about 20 percent higher initially than under both the baseline
    extended and tax increase benchmarks. This differential gradually
    narrows until the 2030s, after which less cash would be required under
    model 2-100%. By 2075, Model 2-100% would require about 40 percent less
    cash than the baseline extended and tax increase benchmarks.
•   Viewed from the perspective of the economy, total payments (Social
    Security defined benefits plus benefit from individual accounts) as a share
    of GDP would gradually fall under Model 2-100% relative to the baseline
    extended and tax increase benchmarks. In 2075, the share of the economy
    absorbed by payments to retirees from the Social Security system as a
    whole under Model 2-100% would be roughly 20 percent lower than the
    baseline extended or tax increase benchmark and roughly the same as
    under the benefit reduction benchmark.
•   With regard to national saving, Model 2 increases net national saving on a
    first order basis primarily due to the proposed benefit reductions. The
    individual account provision does not increase national saving on a first
    order basis; the redirection of the payroll taxes to finance the individual
    accounts reduces government saving by the same amount that the
    individual accounts increase private saving.
    Beyond these first order effects, the actual net effect of a proposal on
    national saving is difficult to estimate due to uncertainties in predicting
    changes in future spending and revenue policies of the government as well
    as changes in the saving behavior of private households and individuals.
    For example, the lower surpluses and higher deficits that result from
    redirecting payroll taxes to individual accounts could lead to changes in
    federal fiscal policy that would increase national saving. However,
    households may respond by reducing their other saving in response to the
    creation of individual accounts.9

    Model 3 results are presented in Appendix I. Because the benefit
    reductions in Model 3 are smaller than in Model 2, long-term unified
    deficits are larger under Model 3. Model 3 requires an additional
    contribution equal to 1 percent of taxable payroll for those choosing
    individual accounts. Assuming universal account participation in both


    9
     No expert consensus exists on how Social Security reform proposals would affect the
    saving behavior of private households and businesses.




    Page 5                                               GAO-03-310 Social Security Reform
                         models, Model 3 would result in a larger share of the economy being
                         absorbed by total benefit payments to retirees—about the same share as
                         would be the case under the baseline extended and tax increase
                         benchmarks.


                         The Commission’s proposals also illustrate the difficulty reform proposals
Balancing Adequacy       face generally in balancing adequacy (level and certainty of benefits) and
and Equity               equity (rates of return on individual contributions) considerations. Each of
                         the models protects benefits for current and near-term retirees and the
                         shift to advance funding could improve intergenerational equity. However,
                         under each of the models, some future retirees also could face potentially
                         significant benefit reductions in comparison to either the tax increase or
                         the benefit reduction benchmarks because primary insurance amount
                         (PIA) formula factors that are reduced by real wage growth, uncertainty in
                         rates of return earned on accounts, changes in benefit status over time,
                         and annuity pricing.

                         Our analysis of Model 2 shows that:

                     •   Median monthly benefits (the Social Security defined benefit plus the
                         benefit from the individual account) for those choosing individual
                         accounts are always higher, despite a benefit offset, than for those who do
                         not choose the account, and this gap grows over time. In addition, median
                         monthly benefits under universal participation in the accounts are also
                         higher than the median benefits received under the benefit reduction
                         benchmark. However, median monthly benefits received by those without
                         accounts fall below those provided by the benefit reduction benchmark
                         over time.
                     •   For the lowest quintile of beneficiaries, median monthly benefits with
                         universal participation in the accounts tend to be higher than the benefits
                         received under the benefit reduction benchmark, likely due to the
                         enhanced benefit for full-time “minimum wage” workers. This pattern
                         becomes more pronounced over time.
                     •   Regardless of whether an account is chosen, under Model 2 many people
                         could receive monthly benefits that are higher than the benefit reduction
                         benchmark. However, a minority could fare worse. Some people could
                         also receive a benefit greater than under the tax increase benchmark
                         although a majority could fare worse. Monthly benefits for those choosing
                         individual accounts will be sensitive to the actual rates of return earned by
                         those accounts.
                         The cohort results for Model 3 are generally similar to Model 2. However,
                         median monthly benefits for those choosing individual accounts are higher



                         Page 6                                        GAO-03-310 Social Security Reform
                   than the benefit level under the tax increase benchmark for the 1970 and
                   1985 cohorts. This result is likely because of Model 3’s feature of a
                   mandatory extra 1 percent contribution into the individual accounts for
                   those who choose to participate. Further results on Model 3 can be found
                   in Appendix I.


                   Each of the models would establish a governing board to administer the
Implementing and   individual accounts, including the choice of available funds and providing
Administering      financial information to individuals. While the Commission had the benefit
                   of prior thinking on these issues, many implementation issues remain,
Reforms            particularly in ensuring the transparency of the new system and educating
                   the public to avoid any gaps in expectations. For example, an education
                   program would be necessary to explain the changes in the benefit
                   structure, model features like the benefit offset and how accounts would
                   be split in the event of divorce. Education and investor information is also
                   important as the system expands and increases the range of investment
                   selection. Questions about the harmonization of such features with state
                   laws regarding divorce and annuities also remain an issue.


                   The use of our criteria to evaluate approaches to Social Security reform
Concluding         highlights the trade-offs that exist between efforts to achieve sustainable
Observations       solvency and to maintain adequate retirement income for current and
                   future beneficiaries. These trade-offs can be described as differences in
                   the extent and nature of the risks for individuals and the nation as a whole.
                   For example, under certain individual account approaches, including
                   those developed by the Commission, some financial risk is shifted to
                   individuals and households to the extent that individual account income is
                   expected to provide a major source of income in retirement.

                   At the same time, the defined benefit under the current Social Security
                   system is also uncertain. The primary risk is that a significant funding gap
                   exists between currently scheduled and funded benefits which, although it
                   will not occur for a number of years, is significant and will grow over time.
                   Other risks stem from uncertainty in, for example, future levels of
                   productivity growth, real wage growth, and demographics. Congress has
                   revised Social Security many times in the past, and future Congresses
                   could decide to revise benefits in ways that leave those affected little time
                   to adjust. As Congress deliberates approaches to Social Security, the
                   national debate also needs to include discussion of the various types of
                   risk implicit in each approach and in the timing of reform.



                   Page 7                                        GAO-03-310 Social Security Reform
                     Public education and information will be key to implementing any changes
                     in Social Security and especially so if individuals must make choices that
                     affect their future benefits. Since the Commission options were published,
                     there has been limited explanatory debate. As Congress and the President
                     consider actions to be taken, it will be important as well to consider how
                     such actions can be clearly communicated to and understood by the
                     American people.

                     Finally, any Social Security reform proposal must also be looked at in the
                     context of the nation’s overall long-range fiscal imbalances. As our long-
                     term budget simulations show,10 difficult choices will be required of
                     policymakers to reconcile a large and growing gap between projected
                     revenues and spending resulting primarily from known demographic
                     trends and rising health care costs.


                     We provided SSA an opportunity to comment on the draft report. The
Agency Comments      agency provided us with written comments, which appear in Appendix II.
and Our Evaluation   SSA acknowledged the comprehensiveness of our analysis of the
                     Commission’s proposals. The agency also concurs with our reform
                     criterion of achieving sustainable solvency and with our report’s overall
                     observations and conclusions. SSA’s comments and suggestions can be
                     grouped into a few general categories.

                     GAO Benchmarks and Their Relationship to Sustainable Solvency - The
                     agency commends our use of multiple benchmarks with which to compare
                     alternative proposals. However, they note that our definition of
                     sustainable solvency differs from that used by SSA in assessing trust fund
                     financial status. In addition, although they note that our benchmarks are
                     solvent over the 75-year projection period commonly used by SSA’s Office
                     of the Chief Actuary in its preparation of the annual trustees report, they
                     do not achieve sustainable solvency11. SSA expresses a concern that unless
                     carefully annotated, the comparisons made in our report could be
                     misunderstood. Finally, SSA also suggests the use of several alternative



                     10
                      See, for example, U.S. General Accounting Office, Budget Issues: Long-Term Fiscal
                     Challenges, GAO-02-467T (Washington, D. C. : Feb, 27, 2002) and Social Security: Long-
                     Term Financing Shortfall Drives Need for Reform, GAO-02-845T (Washington, D. C.: Jun.
                     19, 2002).
                     11
                      In response to another agency suggestion, we have also clarified our definition of
                     sustainable solvency in the report.




                     Page 8                                                 GAO-03-310 Social Security Reform
benchmarks, of which one would provide additional revenue to pay for
currently scheduled benefits.

We agree with SSA that sustainable solvency is an important objective;
indeed it is one of our key criteria with which we suggest that
policymakers evaluate alternative reforms. SSA correctly points out that
GAO’s benchmarks do not achieve sustainable solvency beyond the 75-
year period. We believe our standard is a more encompassing one. SSA’s
definition relies on analyzing trends in annual balances and trust fund
ratios near the end of the simulation period. Consequently the definition
needs to be supplemented, for example, in cases where proposals use
general revenue transfers or other unspecified sources of revenue that
automatically rise and fall to maintain annual balance or a certain trust
fund ratio. In addition, SSA’s definition does not directly consider the
resources needed to fund individual accounts. Our standard includes other
measures in an effort to gain a more complete perspective of a proposal’s
likely effects on the program, the federal budget, and the economy.

We share SSA’s emphasis on the importance of careful and complete
annotation. The report explicitly addresses the issue of sustainable
solvency and states that the comparison benchmarks used, while solvent
over the 75-year projection period, are not solvent beyond that period.
Given SSA’s concerns, we have revised our report to clarify our analyses,
where appropriate, to minimize the potential for misinterpretation or
misunderstanding.

Regarding SSA’s suggestion about the use of alternative benchmarks, we
already use a benchmark that provides additional revenue to pay currently
scheduled benefits. Our other benchmark maintains current tax rates,
phasing in benefit reductions over a 20-year period. In our view, the set of
benchmarks used provide a fair and objective measuring stick with which
to compare alternative proposals, particularly the many proposals that
introduce reform elements over a number of years. Both of the
benchmarks are explicitly fully funded and in their design we worked
closely with Social Security’s Office of the Chief Actuary to calibrate them
to ensure their solvency over the 75-year period.

Additional Analysis – Many of SSA’s comments suggest additional or more
detailed analyses of some of our findings. For example, SSA suggested
additional analyses of the characteristics of those beneficiaries who fare
better or worse under each of the Commission’s models, further
distributional analyses on groups of beneficiaries who claim benefits at
ages other than 65 and that we conduct analyses on rates of participation


Page 9                                       GAO-03-310 Social Security Reform
other than the polar cases of 0 percent and 100 percent individual account
participation. The agency also suggested that substantial analysis on
implementation and administration issues is necessary, given the
complexity of administering the commission’s models. Although we tried
to address most of the critical issues given our limited time and resources,
we agree with SSA that many of their suggested analyses could provide
additional useful insights in understanding the distributional implications
of adopting the Commission’s proposals.

Distributional Analysis - SSA expressed a number of concerns about the
SSASIM-GEMINI simulation model that we use to conduct our
distributional analysis of benefits. One concern addresses future cohorts’
benefit levels reported in our draft. In this regard, we were already
reviewing the level of benefits received by the 1985 cohort and the highest
quintile of that cohort with outside experts, and our subsequent analysis
suggests findings that are more consistent with SSA’s observations: we
have made these changes to the report.

Some of SSA’s concerns also appear to result from confusion over the
structure, design and limitations of the SSASIM-GEMINI model. We have
included some additional documentation in the report that we believe will
help both the layperson as well as a more technical audience understand
the model more easily. We note that while ancillary benefits can be
calculated through the model and are included in our analysis, we utilize
the model to focus on the individual beneficiary and not the household as
the unit of analysis. The model also includes marriage and divorce rates
and their implication for earnings. These marriage and divorce rates and
other key parameters are expressed by probability rules that drive the
lifetime dynamics of the synthetic population. These rules are not
heuristically generated but are validated through a comparison with data
from the Social Security Administration and the Current Population
Survey, among others. We also note that in certain of instances, for
example in specifying the calculation of annuities as well as the
specification of rates of return used in the modeling, we consulted with
SSA’s Office of the Chief Actuary in an effort to reflect their projection
methodology to extent that it was feasible.

Measures of Debt - SSA notes that unfunded obligations may be
considered a kind of implicit debt and should be considered in the
analysis. In analyzing reform plans, however, the key fiscal and economic
point is the ability of the government and society to afford the
commitments when they come due. Our analysis addresses this key point



Page 10                                      GAO-03-310 Social Security Reform
by looking at the level and trends over 75 years in deficits, cash needs, and
GDP consumed by the program.

Technical Comments – SSA also provided technical and other clarifying
comments about the minimum benefit provision, our characterization of
stochastic simulation as well as other minor aspects of the report, which
we incorporated as appropriate.

We are sending copies of this report to the Honorable Larry E. Craig,
Ranking Minority Member, Senate Special Committee on Aging, Senator
Max S. Baucus, Chairman, Senate Committee on Finance, Senator Charles
E. Grassley, Ranking Minority Member, Senate Committee on Finance, the
Honorable William M. Thomas, Chairman, and the Honorable Charles B.
Rangel, Ranking Minority Member, House Committee on Ways and Means,
the Honorable E. Clay Shaw, Chairman, and the Honorable Bob Matsui,
Ranking Minority Member, Subcommittee on Social Security, House
Committee on Ways and Means, and the Honorable Jo Ann B. Barnhart,
Commissioner, Social Security Administration. We will also make copies
available to others on request. In addition, the report is available at no
charge on GAO’s Web site at http://www.gao.gov.

If you or your staffs have any questions about this report, please contact
Barbara D. Bovbjerg, Director, Education, Workforce, and Income
Security Issues, on (202) 512-7215, or Susan Irving, Director, Strategic
Issues, on (202) 512-9142.




David M. Walker
Comptroller General
of the United States




Page 11                                       GAO-03-310 Social Security Reform
              Appendix I: Analysis of Reform Models
Appendix I: Analysis of Reform Models




         Analysis of Reform Models
        Developed by the President’s
              Commission to
         Strengthen Social Security


                    January 2003




              Page 12                                 GAO-03-310 Social Security Reform
                 Appendix I: Analysis of Reform Models




                       Objectives

• Evaluation of reform models put forward by the President’s
  Commission to Strengthen Social Security.


• The evaluation uses the three basic criteria GAO has
  developed that provide policymakers with a framework for
  assessing reform plans:
   – Financing Sustainable Solvency
   – Balancing Adequacy and Equity in the Benefits Structure
   – Implementing and Administering Reforms




                 Page 13                                 GAO-03-310 Social Security Reform
                   Appendix I: Analysis of Reform Models




          Evaluating Social Security
              Reform Proposals

• Comprehensive proposals can be evaluated against three basic
  criteria.

• Reform proposals should be evaluated as packages that strike a
  balance among individual reform elements and important
  interactive effects.

• Some proposals will fare better or worse than other proposals
  under each criterion.

• Overall evaluation of each proposal depends on the weight
  individual policymakers place on each criterion.




                   Page 14                                 GAO-03-310 Social Security Reform
                           Appendix I: Analysis of Reform Models




    The President’s Charge to the
Commission to Strengthen Social Security

To develop reform plans that strengthen Social Security and increase its
fiscal sustainability while meeting these principles:

• No changes to benefits for retirees or near-retirees.

• Dedication of entire Social Security surplus to Social Security.

• No increase in Social Security payroll taxes.

• No government investment of Social Security funds in the stock market.

• Preservation of disability and survivor components.

• Inclusion of individually controlled voluntary individual retirement accounts.




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Overview of Commission Reform Models

• The Commission developed three reform models, each of which
  represents a different approach to including a voluntary individual
  account component in Social Security.

• Model 1 does not change the defined benefit and does not restore
  solvency; Models 2 and 3 restore solvency through a combination
  of changes in the initial benefit calculation, general revenue
  transfers, and/or benefit offsets for those who choose to
  participate in the individual account option.

• Account contribution amounts, benefit offset in exchange for
  account participation, and calculation of an individual’s initial
  benefit differ among the three models.

• All models share a common framework for administering
  accounts.




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           Individual Accounts:
Framework Common to All Commission Models

•   Voluntary individual accounts in exchange for reduction in Social
    Security defined portion of benefit. This benefit offset is linked to
    account contributions, not actual account balance.

•   Governing Board to administer individual accounts structured
    along Thrift Savings Plan (TSP) or Federal Reserve Board
    model.

•   Two-tier investment framework:
     – Initially, balance must be invested through TSP-like system
       with several fund choices; later, if balance is above a
       threshold, account may be invested in a range of qualified
       private sector funds.
     – Annual option to change allocation.




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            Individual Accounts:
 Framework Common to All Commission Models

  • Account access:
     – Account may be left to heirs if owner dies before retirement.
     – No withdrawals before retirement (for disabled, before normal
       retirement age).1
     – At retirement, conversion to phased withdrawals or annuity.
       Above a specified threshold, balance may be taken as a lump
       sum.




1TheCommission’s report stated that due to the complex and sensitive issues involved, time did not
permit the development of specific recommendations for DI. Accordingly, the Commission
recommended the President address DI through a separate policy process.




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           Individual Accounts:
Framework Common to All Commission Models

• Annuities:
      – For married workers, joint and two-thirds survivor annuity.1
      – Several types of annuities to be made available, including
        inflation-indexed annuities and annuities permitting bequest
        if owner dies before a specified time.

• Spousal protections:
      – Account balance acquired during the marriage divided
        equally at divorce.
      – Balances acquired before marriage not shared at time of
        divorce.

1Or  alternative arrangement, agreed to by both spouses, consistent with the principle that
total benefit income will be sufficient to keep both spouses above the poverty line in
retirement.




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                                    GAO’s Methodology
• Financing Sustainable Solvency
   – GAO’s long-term economic model was used to help assess the potential
     fiscal and economic impacts of Social Security reform proposals.
   – Estimates of reform models’ costs and income are those made by the
     Office of the Chief Actuary, Social Security Administration.

• Balancing Adequacy and Equity
   – The GEMINI model, a dynamic microsimulation model,1 was used to
     analyze the 1955, 1970, and 1985 birth cohorts to enable comparison of
     results over time as reform models are fully implemented.

• Implementing and Administering Reforms
   – Qualitative analysis based on GAO’s issued and ongoing body of work on
     Social Security reform was used.
     1 GEMINI  is useful for analyzing the lifetime implications of Social Security policies for a large sample of people born in the same year and can
     simulate different reform features, including individual accounts with an offset, for their effects on the level and distribution of benefits. GEMINI was
     used to analyze Models 2 and 3 both with 0 and 100 percent participation in the individual account features of the proposals.




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                                   Benchmarks
GAO’s analysis uses three benchmarks:

• Benefit reduction maintains current payroll tax rates and assumes a
  gradual reduction in Social Security benefits beginning with those
  reaching age 62 in 2005 and continuing for the next 30 years.

• Tax increase1 assumes that the combined employer-employee payroll
  tax rate is increased by 0.34 percent for DI and 1.56 percent for OASI
  beginning in 2002 in order to pay scheduled benefits.

• Baseline extended is a fiscal policy path that assumes payment in full of
  all scheduled Social Security benefits throughout the 75-year period and
  no other changes in current policies. In this analysis, it uses the 2001
  Trustees intermediate economic assumptions, consistent with SSA
  scoring of reform models.


  1
  The benefit reduction and tax increase benchmarks were developed by GAO with technical input from SSA’s Office
  of the Chief Actuary. Both use the 2001 Trustees intermediate economic assumptions. Both restore 75-year
  actuarial balance to Social Security, but are not solvent beyond this period.




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                         Benchmarks
• All three benchmarks are used in analyzing sustainable solvency.
  From the perspective of sustainable solvency, the baseline extended
  differs from the tax increase benchmark. The tax increase
  benchmark assumes payroll tax financing of all scheduled benefits
  whereas the baseline extended benchmark assumes all scheduled
  benefits will be paid but does not specify any new financing.

• There is no difference between the tax increase and baseline
  extended benchmarks in analyzing benefit levels, since only the
  financing of benefits differs, not the actual benefit levels. Therefore
  only the benefit reduction and tax increase benchmarks are used in
  analyzing benefit adequacy.

• Benchmarks are to be viewed as illustrative, polar cases or bounds
  for changes within the current system. Other benchmarks could be
  devised with different tax and/or benefit adjustments that would
  perform the same function.




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                                               Scope

• Briefing focuses on Model 2, with results for Model 3 presented in
  the appendix.1

• The Commission’s models include a voluntary individual account
  option. In our analysis we looked at the two bounds of possible
  outcomes—universal participation (100%) in the account option,
  or no participation (0%). In analyzing benefit levels, we refer to
  these outcomes as “with” and “without” accounts.




  1
  Models 2 and 3 restore Social Security solvency; Model 1 does not and accordingly is not the focus of GAO’s
  analysis.




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                                            Model 2
•   Voluntary individual account contribution of 4 percent of taxable payroll up to
    $1,000 annually in exchange for benefit reduction.1
•   For all those age 62 in 2009 or younger, defined benefits reduced from currently
    scheduled by indexing initial benefit to prices rather than wages.
•   Enhanced spousal survival benefit beginning in 2009.
      – Increase in widow(er) benefit up to 75 percent of combined spousal benefit
        (up to average benefit levels).
•   A new enhanced benefit for full-time “minimum-wage” workers who work more
    than 20 years.2
      – Accelerated growth in initial benefits from 2009 to 2018.
      – By 2018, a minimum wage worker with 30 years of program coverage would
        receive an inflation-indexed benefit equal to 120 percent of poverty level.
•   To the extent that there is participation in individual accounts, financing through
    general revenue transfers will be needed. If participation were universal,
    transfers would be needed for about three decades.


    1Maximum  contribution amount indexed annually to wage growth. Benefit reduction based on
    amount of account contributions compounded at a real interest rate of 2 percent.
    2Theminimum wage is the current Fair Labor Standards Act minimum of $5.15 an hour but is
    assumed to grow with the Social Security average wage index.




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                 Sustainable Solvency

•   While achieving solvency for the OASDI Trust Funds is important, the concept of
    sustainable solvency goes beyond 75-year actuarial balance.

•   Sustainable solvency includes reforming the Social Security program in such a
    way as to avoid the need to periodically revisit actuarial imbalances of the
    OASDI Trust Funds. For example, a rising or level trust fund ratio at the end of
    the 75-year period can be an indicator of future program solvency.

•   However, trust fund ratios can give an incomplete picture. They do not provide
    information about the effect of program spending on the federal budget or the
    economy. In addition, trust fund ratios can be affected by timing of tax and
    benefit adjustments and use of general revenues.

•   Sustainable solvency also includes assessing the effects of proposed program
    changes on the federal budget and on the economy.

•   Reforms that reduce pressures on the federal budget and reduce the size of the
    economy that will be absorbed in the future by the Social Security system can
    lead to sustainable solvency.




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        Financing Sustainable Solvency
This criterion evaluates the extent to which the proposal achieves sustainable
solvency, including how the proposal would affect the economy and the
federal budget.
To what extent does the proposal:
•   Reduce future budgetary pressures?
•   Reduce debt held by the public?
•   Reduce the cost of the Social Security system as a percentage of GDP?
•   Reduce the percentage of federal revenues consumed by the Social
    Security system?
•   Increase national saving?
•   Restore 75-year actuarial balance and create a stable system?
•   Raise payroll taxes, draw on general revenues, and/or use Social Security
    trust fund surpluses to finance changes?
•   Create contingent liabilities?
•   Include “safety valves” to control future program growth?




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                 Model 2
      Financing Sustainable Solvency
Figure 1
• Compared to the baseline extended, Model 2 with universal
   participation (Model 2 - 100%) in the individual accounts (IA) option
   results in larger unified deficits as a share of GDP through the 2040s,
   thereafter unified deficits are progressively lower.
• Model 2 with no participation (Model 2 - 0%) in IAs results in higher
   unified surpluses and lower unified deficits beginning around 2015
   through the end of the simulation period compared to baseline
   extended.
• Greater participation in IAs results in lower surpluses/higher deficits
   over the simulation period.
• Throughout the simulation period, unified surpluses are considerably
   lower and unified deficits are considerably higher under Model 2-100%
   than under the tax increase benchmark and, to a lesser extent, the
   benefit reduction benchmark.
• Through the 2060s, the fiscal outlook under Model 2-0% is quite similar
   to the outlook under the benefit reduction benchmark but compared to
   the tax increase benchmark, unified surpluses are lower and unified
   deficits are higher over the same time frame.




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               Figure 1: Model 2
Unified Surpluses and Deficits as a Share of GDP

      Percent of GDP
 5

 0

 -5                   Baseline extended
                      Benefit reduction
-10
                      Model 2 - 0%

-15                   Model 2 - 100%
                      Tax increase
-20
  2000          2010          2020        2030         2040        2050      2060            2075
                                                Fiscal year


      Source: GAO analysis.




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                 Model 2
      Financing Sustainable Solvency
Figure 2
• Compared to the baseline extended, net debt held by the public as a
   share of GDP is higher under Model 2-100% until about 2060;
   thereafter, debt held by the public is lower.
• Under Model 2-0%, net debt held by the public is lower beginning about
   2020 through the end of the simulation period.
• Greater participation in the IAs results in higher net debt held by the
   public throughout the simulation period.
• Throughout the simulation period, net debt held by the public under
   Model 2-100% is considerably higher than the tax increase benchmark
   and, to a lesser extent, the benefit reduction benchmark.
• Net debt held by the public under Model 2-0% is slightly higher than
   under the benefit reduction benchmark and much higher than under the
   tax increase benchmark until the end of the simulation period.




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             Figure 2: Model 2
  Debt Held by the Public as a Share of GDP

      Percent of GDP
200
                         Baseline extended

150                      Benefit reduction

                         Model 2 - 0%
100
                         Model 2 - 100%

                         Tax increase
50

 0

-50
  2000           2010         2020        2030        2040         2050   2060            2075
                                               Fiscal year


      Source: GAO analysis.




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                             Model 2
                  Financing Sustainable Solvency
Figure 3:

•   The government’s cash requirement includes the amount of cash required to pay defined
    benefits and redirect payroll taxes to individual accounts. Under Model 2-100%, the
    government’s cash requirement would be greater than under both the baseline extended
    and tax increase benchmarks in the near term—by about 20 percent in 2010. Beginning in
    the 2030s, less cash would be required for Model 2-100% than the baseline extended and
    tax increase benchmarks. In 2075, Model 2-100% would require about 40 percent less cash
    than the baseline extended and tax increase benchmarks.

•   The cash requirement for Model 2-0% would be the same or less than the baseline
    extended/tax increase benchmarks throughout the period. In 2075, Model 2-0% would
    require less cash—nearly 40 percent—than both the baseline extended and tax increase
    benchmarks.

•   The government’s cash requirement for Model 2 would be greater than the benefit reduction
    benchmark until the 2050s. In 2075, Model 2 cash requirements would be about 20 percent
    lower than the benefit reduction benchmark.

•   In the near term, the greater the individual account participation, the more cash required.
    Over the long term, however, greater individual account participation would reduce the
    government’s cash requirements.




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                                    Figure 3: Model 2
                              Government Cash Requirements

           Percent of GDP
10%                         Baseline extended/Tax increase
9%                          Benefit reduction
8%                          Model 2, 0 percent
                            Model 2, 100 percent
7%
6%
5%
4%
3%
2%
1%
0%
  2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075
                                                                 Calendar year
Source: GAO analysis of data from the Office of the Chief Actuary, SSA. Benefit amounts shown for the baseline extended and tax
increase benchmarks are scheduled benefits as estimated by the actuaries. All estimates are based on the Trustees' 2001 intermediate
assumptions.
Note: Includes cash for defined benefits paid out under the traditional system and redirect of payroll taxes to individual accounts.




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                 Model 2
      Financing Sustainable Solvency
Figure 4:

•   In 2015, total benefit payments (Social Security benefits plus individual account
    disbursements) as a share of GDP under Model 2 would be about the same as
    under the baseline extended or tax increase benchmark and slightly higher than
    the benefit reduction benchmark.

•   In 2030, total benefit payments as a share of GDP under model 2 would be
    somewhat (6-8 percent) lower than under the baseline extended and tax
    increase benchmark but somewhat higher (4-5 percent) compared with the
    benefit reduction benchmark.

•   In 2075, total benefit payments as a share of GDP under Model 2-100% would
    be about one fifth lower than under the baseline extended or tax increase
    benchmark but somewhat (4 percent) higher than under the benefit reduction
    benchmark. The difference in total benefit payments between Model 2-100%
    and Model 2-0% becomes pronounced over time, with payments under Model 2-
    0% more than a third lower than the baseline extended or tax increase
    benchmark by 2075.




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             Figure 4: Model 2
   Combined Social Security and Individual
  Account Disbursements as a Share of GDP
     Percent of GDP
8%
7%

6%
5%
4%

3%
2%

1%
0%
                2000                    2015
                                         2030          2050                                                      2075
                                     Calendar year
         Actual                                  Benefit reduction
         Model 2 - 0%                            Model 2 - 100%
         Baseline extended/Tax increase
Source: GAO analysis of data from the Office of the Chief Actuary, SSA. Benefit amounts shown for baseline extended and tax increase
benchmarks are scheduled benefits as estimated by the actuaries. All estimates are based on the Trustees' 2001 intermediate
assumptions.




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                         Model 2
              Financing Sustainable Solvency
•   Under Model 2, national saving would increase primarily due to the
    improved fiscal position of the government resulting from the proposed
    benefit reductions. The redirection of payroll taxes under the IA option,
    would increase private saving and decrease government saving with no
    net effect on national saving.1
•   Model 2 restores 75-year actuarial balance with either no participation or
    universal participation in the IA option. The trust fund ratio would be rising
    at the end of the 75-year period under both Model 2-0% and Model 2-
    100%.
•   Model 2-0% requires no additional revenue. IAs are financed as a
    redirection of payroll taxes. General revenue transfers would be used to
    keep the OASDI trust funds solvent under Model 2-100%.
•   Model 2 does not create any new contingent liabilities. Individuals bear
    the risk of IA investment performance.
•   Model 2 contains no new “safety valves” to control future program growth.
    1
      Analysis limited to first order effects on saving. Effects on saving behavior in response to specific
    reform provisions are not considered given the lack of expert consensus.




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     Balancing Adequacy and Equity
This criterion evaluates the balance struck between the twin goals of
income adequacy (level and certainty of benefits) and individual
equity (rates of return on individual contributions).
To what extent does the proposal:
• Change scheduled benefits for current and future retirees?
• Maintain benefits for low-income workers who are most reliant on Social
  Security?
• Maintain benefits for the disabled, dependents, and survivors?
• Ensure that those who contribute receive benefits?
• Provide higher replacement rates for lower income earners?
• Expand individual choice and control over program contributions?
• Increase returns on investment?
• Improve intergenerational equity?




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Balancing Adequacy and Equity:
        GAO Analysis

• We evaluate the adequacy and equity
  criterion for Model 2 in comparison with GAO
  benchmarks through analyses of

  – Median monthly benefits for the 1955, 1970 and
    1985 birth cohorts.
  – Median monthly benefits by benefit quintile.
  – Distribution of benefits within each cohort.




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                Balancing Adequacy and Equity-
               Specific Provisions Affecting Benefits

Model 2
•   Maintains current benefit structure for current and near retirees.
•   Reduces OASDI defined benefits for new retirees, survivors, dependents, and
    disabled workers starting in 2009 by altering the benefit formula.
     – Slows growth in benefits by reducing PIA formula factors by real wage
        growth. This essentially increases benefits levels across generations
        according to price growth (absolute terms) rather than wage growth (relative
        terms).
     – For those who participate in the individual accounts, there is a further offset
        based on the hypothetical account accumulation, where contributions
        accrue at a real rate of 2 percent.
•   Increases benefits for certain widow(er)s and low-income earners.
•   PIA formula factor reductions and the benefit offset disproportionately
    decreases replacement rates. However, minimum benefit guarantees increase
    replacement rates for workers who qualify. Therefore, overall progressivity of
    the system is unclear given these provisions and the uncertainty of market
    returns, the magnitude of participation, and the characteristics of future
    participants.




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        Overview of Model 2 Cohort Results


• Across cohorts, median monthly benefits are higher
  than the benefit reduction benchmark for persons who
  participate in an individual account (see Figure 6).
• However, benefit levels received without accounts fall
  below the benefit reduction benchmark over time. This
  is due to the timing and structure of the benefit
  reductions under both the without accounts scenario
  and the benefit reduction benchmark (see Figure 6).
• The gap in benefits between the without accounts
  scenario and the tax increase benchmark and with
  accounts scenario grows across cohorts (see Figure
  6).




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          Figure 6: Model 2 Cohort Analysis – Median Monthly
                           Benefits by Cohort

                                        3000


                                        2500
                Constant 2001 Dollars




                                        2000


                                        1500


                                        1000


                                         500


                                           0
                                                           1955                                  1970                             1985

                                        Benefit Reduction Benchmark   Model 2 without Accounts     Model 2 with Accounts   Tax Increas e Benchmark



Source: GAO’s analysis using the GEMINI model.
Note: Median monthly benefits at age 67 for all beneficiaries. Estimates based on 1955, 1970, and 1985 birth cohorts assuming
retired workers retire at age 65, uncertain asset returns and inflation, and full annuitization of account balance at retirement age.
“With accounts” implies all individuals in the cohort participate in the individual accounts.




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Overview of Model 2 Quintile Analysis: Lowest and
          Highest Quintiles by Cohort

  •   Median monthly benefits for the 1955 and 1970 cohorts are
      maintained above the benefit reduction benchmark for the
      lowest quintile regardless of participation in individual accounts,
      likely due to the enhanced benefit for full-time “minimum wage”
      workers (see Figure 7).
  •   However, participation in the individual accounts may provide a
      benefit level even higher than the enhanced benefit for the
      lowest quintile since, over time, fewer workers will receive this
      enhanced benefit as wages are assumed to outpace inflation in
      the future.
  •   Comparing median monthly benefits across cohorts in the lowest
      and highest quintiles indicates that the enhanced benefit for full-
      time “minimum wage” workers and individual accounts maintain
      benefits above the tax increase benchmark only for those in the
      lowest quintile in the 1955 and 1985 birth cohorts (see Figures 7
      and 8).




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          Figure 7: Model 2 Quintile Analysis – Median Monthly
               Benefits by Cohort for the Lowest Quintile

                                     3000


                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500


                                     1000


                                     500


                                        0
                                                        1955                                      1970                             1985

                                      Benefit Reduction Benchmark     Mode l 2 without Accounts     Model 2 with Accounts   Tax Increase Benchmark

Source: GAO’s analysis using the GEMINI model.
Note: Estimates based on the 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, uncertain asset returns and
inflation, and full annuitization of account balance at retirement age. “With accounts” implies all individuals in the cohort participate
in the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax increase benchmark.




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          Figure 8: Model 2 Quintile Analysis – Median Monthly
               Benefits by Cohort for the Highest Quintile

                                     3000


                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500


                                     1000


                                      500


                                        0
                                                         1955                                     1970                              1985

                                      Benefit Reduction Benchmark     Mode l 2 without Accounts     M odel 2 with Accounts   Tax Increase Benchmark


Source: GAO’s analysis using the GEMINI model.
Note: Estimates based on the 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, uncertain asset returns and
inflation, and full annuitization of account balance at retirement age. “With accounts” implies all individuals in the cohort participate
in the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax increase benchmark.




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    Balancing Adequacy and Equity: Effects of Models
          on Total Distribution of Initial Benefits
•     Each model has individuals who “gain” and “lose”. Those who gain are either
       – those who participated in a individual account and received a benefit above
          the reduced defined benefit, or
       – those whose change in benefits exceed the relevant benchmarks.
•     Other factors which may have an effect on benefit outcomes:
       – Effect of minimum benefit provision
       – Uncertainty (variation) in rates of return earned on accounts1
       – Changes in benefit status over time2
       – Annuity pricing3
•     How people fare under Model 2 is a function of their
       – cohort
       – quintile
       – choice of participation in private account
       – risk and rate of return on individual account, and
       – benchmark comparison.

1Account yields must be greater than the level specified for the benefit offset to generate larger benefits.
2OASDI  eligible beneficiaries such as those who become disabled before retirement age, divorced spouses, or a disabled dependent may be
     especially affected since account availability may be hindered and length of time spent contributing to the account may be reduced.
3Upon annuitization, the price of the annuity, which fluctuates with interest rates, would reduce the monthly benefit amount received from the
     individual account. In general, the higher the annuity price the greater the benefit reduction.




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Model 2 Distributional Analysis: Distributional Effects
 Comparing 100 Percent Participation Against Zero
                Percent Participation

    • The risk of participating decreases across cohorts
      when comparing scenarios with accounts and without
      accounts, primarily because of the lengthening of the
      investment horizon. For example, 71 percent of the
      1955 cohort would gain by choosing an individual
      account, as did 83 and 90 percent of the 1970 and
      1985 cohorts (see Figure 9).
    • Of those who gained, the median gain was $32 per
      month in 2001 dollars for the 1955 cohort, while the
      median loss was about $11 per month among those
      who did not gain. For the 1970 and 1985 cohorts, the
      median gain was $147 and $397 per month in 2001
      dollars, while the median loss was $33 and $57,
      respectively.




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        Figure 9: Model 2 Distributional Analysis – Performance
        of Individual Accounts Under 100 Percent Participation
                          Scenario by Cohort
                                              100%

                                              80%

                                              60%
                Percentage of Beneficiaries




                                                                                        83                                90
                                              40%
                                                       71

                                              20%

                                               0%
                                                                                        -17                              -10
                                                      -29
                                              -20%
                                                      1955                              1970                              1985
                                              -40%

                                              -60%

                                                     Percent of Benef ic iaries Who Did Worse by Choos ing an Indiv idual Acc ount
                                                     Percent of Benef ic iaries Who Did Better by Choosing an Individual Ac count

Source: GAO’s analysis using the GEMINI model.
Note: For example, in 1955 if 100 percent of beneficiaries participated in individual accounts, 71 percent did better by choosing the accounts
and 29 percent would have done better by not choosing the accounts. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired
workers retire at age 65, full annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where
the mean nominal rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.




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    Model 2 Distributional Analysis: Distributional
    Effects of Model 2 in Comparison with Benefit
                Reduction Benchmark

•   Regardless of whether an account is chosen, a number of
    people fare better when compared to the benefit reduction
    benchmark. This is primarily because the benefit reduction
    benchmark’s PIA formula reductions are initially deeper than
    Model 2 PIA reductions (see Figure 10).
•   A majority of persons with accounts fare better than the benefit
    reduction benchmark and this majority decreases from 87 to 80
    percent across cohorts. In contrast, the number of people
    without accounts who fare better than the benefit reduction
    benchmark declines from 87 to 15 percent across cohorts.
•   A minority of persons (13 to 20 percent) with accounts fare
    worse than the benefit reduction benchmark, as do 13 to 85
    percent of persons without individual accounts (see figure 10).




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                       Figure 10: Model 2 Distributional Analysis – Distribution
                           of Benefits by Cohort and Account Participation
                           Compared to the Benefit Reduction Benchmark
      Percent of All Benficiaries Below or Above the Benchmark




                                                                 100%

                                                                 80%

                                                                 60%

                                                                 40%    86               87                  80                87
                                                                                                                                                62
                                                                 20%
                                                                                                                                                                     15
                                                                  0%
                                                                        -14              -13                 -20              -13
                                                                 -20%                                                                           -38

                                                                 -40%                                                                                                -85
                                                                 -60%

                                                                 -80%
                                                                        1955            1970                1985              1955             1970                  1985

                                                                               With Individual Accounts                                Without Individual Accounts

Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above
or below the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full
annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean nominal
rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities. “With
accounts” implies all individuals in the cohort participate in the individual accounts.




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 Model 2 Distributional Analysis: Distributional Effects
of Model 2 in Comparison with Tax Increase Benchmark


 •   Across cohorts:
      – A number of people with accounts fare better than the tax
        increase benchmark and this number increases (19 to 40
        percent) across cohorts (see Figure 11).
      – A minority of people without accounts fare better than the tax
        increase benchmark and this minority declines over time (9
        to 1 percent).




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      Figure 11: Model 2 Distributional Analysis – Distribution
          of Benefits by Cohort and Account Participation
             Compared to the Tax Increase Benchmark
               Percent of All Benficiaries with Benefits Below or Above the Benchmark




                                                                                         40%



                                                                                         20%                                      40
                                                                                                                  28
                                                                                                19
                                                                                                                                                 9                   5
                                                                                          0%                                                                                           1



                                                                                        -20%

                                                                                                                                  -60
                                                                                                                 -72
                                                                                        -40%    -81
                                                                                                                                                -91                 -95
                                                                                                                                                                                      -99

                                                                                        -60%



                                                                                        -80%



                                                                                        -100%
                                                                                                1955             1970             1985          1955                1970              1985

                                                                                                       With Individual Accounts                         Without Individual Accounts


Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above
or below the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full
annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean
nominal rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.
“With accounts” implies all individuals in the cohort participate in the individual accounts.




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 Model 2 Sensitivity Analysis, Varying the Real Rate
 of Return – Account Participation vs. Benchmarks
                      by Cohort


• Although varying the rates of return does not alter the findings
  substantially for older cohorts, the effects of varying the real rate
  of return by plus or minus 1 percent increases over time.
   – Compared to the benefit reduction benchmark, the 1955 cohort has
     a ±2% change in its distribution from a ±1% change in the real rate
     of return, whereas the 1985 cohort has about a ±11% change in its
     distribution (see Figure 12).
   – Compared to the tax increase benchmark, the 1955 cohort has
     approximately a ±3% change in its distribution from a ±1% change
     in the real rate of return, whereas the 1985 cohort has about a ±15%
     change in its distribution (see Figure 13).




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  Figure 12: Model 2 Sensitivity Analysis - Distribution of Benefits
  by Cohort Compared to Benefit Reduction Benchmark, Varying
        Real Rates of Return by Plus 1 and Minus 1 Percent
      Percent of All Beneficiaries Above or Below the Benchmark




                                                                  10 0%



                                                                  8 0%



                                                                  6 0%


                                                                                       86            88                     87          91                             89
                                                                  4 0%    84                                   81                                         80
                                                                                                                                             68

                                                                  2 0%



                                                                    0%
                                                                                       -14          -12                     -13         -9                             -11
                                                                          -16                                 -19                                         -20
                                                                                                                                             -32
                                                                  -2 0%



                                                                  -4 0%
                                                                          -1                        +1         -1                       +1    -1                       +1
                                                                                1955 Birth Cohort                   1970 Birth Cohort              1985 Birth Cohort
                                                                  -6 0%




Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above or
below the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full
annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean nominal
rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.




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                                     Figure 13: Model 2 Sensitivity Analysis - Distribution of
                                    Benefits by Cohort Compared to Tax Increase Benchmark,
                                   Varying Real Rates of Return by Plus 1 and Minus 1 Percent
       Percent of All Beneficiaries Above or Below the Benchmark




                                                                    60 %



                                                                    40 %

                                                                                                                                                                     55
                                                                    20 %
                                                                                                                                    37                  40
                                                                                                   22                    28                26
                                                                            17          19                    20
                                                                     0%



                                                                   -20 %
                                                                                                                                                                     -45
                                                                                                                                    -63                 -60
                                                                                                   -78                  -72                -74
                                                                   -40 %
                                                                            -83         -81                  -80


                                                                   -60 %



                                                                   -80 %

                                                                            -1 1955 Birth Cohort   +1        -1 1970 Birth Cohort   +1     -1                        +1
                                                                                                                                                 1985 Birth Cohort
                                                                   -100 %




Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above
or below the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full
annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean
nominal rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.




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Overview of Model 2 Disabled Worker Quintile Analysis –
        Lowest and Highest Quintile by Cohort

  •   Median monthly benefits are maintained above the benefit reduction
      benchmark for the lowest quintile regardless of participation in individual
      accounts, likely due to the enhanced benefit for full-time “minimum wage”
      workers (see Figure 14).
       – This enhanced benefit could apply to low-earning disabled workers who
          work most of their career prior to becoming disabled. In our sample the
          average age of disability onset is 55.
  •   Participation in the individual accounts is also important for disabled
      workers, especially those in the later cohorts and in the upper quintiles (see
      Figures 14 and 15). However, the earlier a disabled worker becomes
      disabled the fewer years they contribute to their account and the smaller is
      their account balance.
  •   Since disabled workers do not have access to their accounts until
      conversion to retired worker benefits at the normal retirement age (NRA),
      benefit levels before conversion would be in line with benefit levels for those
      without individual accounts.
  •   Benefit levels for disabled workers may be higher than those of retired
      workers since disabled workers are entitled to benefits at earlier ages, thus
      the reductions in their PIA factors would be smaller. This may create an
      incentive for older workers to apply for disability benefits.




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              Figure 14: Model 2 Quintile Analysis – Median
            Monthly Benefits by Cohort for Disabled Workers in
                           the Lowest Quintile
                                     3000


                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500


                                     1000


                                      500


                                        0
                                                         1955                                     1970                              1985

                                      Benefit Reduction Benchmark     Mode l 2 without Accounts     M odel 2 with Accounts   Tax Increase Benchmark

Source: GAO’s analysis using the GEMINI model.
Note: Median monthly benefits at age 67 for disabled workers. Estimates based on 1955, 1970, and 1985 birth cohorts assuming
uncertain asset returns and inflation, and full annuitization of account balance at retirement age. “With accounts” implies all
individuals in the cohort participate in the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax
increase benchmark.




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        Figure 15: Model 2 Quintile Analysis - Median Monthly
           Benefits by Cohort for Disabled Workers in the
                           Highest Quintile

                                     3000


                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500


                                     1000


                                      500


                                        0
                                                         1955                                   1970                              1985

                                      Benefit Reduction Benchmark   Mode l 2 without Accounts     M odel 2 with Accounts   Tax Increase Benchmark

Source: GAO’s analysis using the GEMINI model.
Note: Median monthly benefits at age 67 for disabled workers. Estimates based on 1955, 1970, and 1985 birth cohorts assuming
uncertain asset returns and inflation, and full annuitization of account balance at retirement age. “With accounts” implies all
individuals in the cohort participate in the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax
increase benchmark.




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    Balancing Adequacy and Equity-Overall Equity
Model 2
• Provides workers some investment choice and control, subject to
  certain limitations. This might enable individuals to earn a higher
  rate of return on their contributions with an increased measure of
  risk, primarily that the return expected may not be realized.
• May improve intergenerational equity through the move to
  advanced funding of Social Security and the inheritance feature
  of individual accounts.
• Make determining the rate of return difficult as the link between
  contributions and benefits becomes unclear due to general
  revenue transfers. Thus, we did not quantitatively assess the
  equity effects of the models.




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    Implementing and Administering
               Reforms
This criterion evaluates how readily such changes could be
implemented, administered, and explained to the public.

To what extent does the proposal:
•   Provide reasonable timing and funds for implementation and
    result in reasonable administrative costs?
•   Allow the general public to readily understand its financing
    structure and increase public confidence?
•   Allow the general public to readily understand the benefit
    structure and avoid expectation gaps?
•   Limit the potential for politically motivated investing?




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        Implementing and Administering Reforms

•   Funding for the transition from a pay-as-you-go system to a partially
    funded system would be handled by transfers from the General Fund of
    the Treasury and could be repaid when the trust funds experience cash
    flow surpluses.
•   An education program will be necessary to explain the changes in the
    benefit structure and to avoid expectation gaps.
      – Benefit offset feature, financing structure of the system may be
          difficult to explain, which increases the importance of an education
          program.
•   An education program will also be necessary to inform OASDI eligible
    workers on making sound investment decisions regarding
    diversification, risk, and participation.
•   The Commission did not explicitly address the costs of an education
    program.
•   It is unclear how the Commission’s proposed account splitting at
    divorce would fit into divorce law.




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    Implementing and Administering Reforms

•   The proposal establishes a Governing Board to administer
    the individual accounts, which is intended to limit the
    potential for politically motivated investing. The board’s
    duties include the choice of available funds and providing
    financial information to individuals.
•   The design of the voluntary individual account feature places
    an additional administrative burden on the SSA. Specifically,
    the hypothetical account, benefit offset, inheritance feature,
    and account splitting at divorce would create additional
    responsibilities for SSA.
•   There is not enough information to estimate administrative
    costs. Such costs are affected by the level of participation in
    the individual accounts. However, the Commission believes
    that individual accounts can be administered at a low cost
    since they envision the system being structured similar to the
    TSP.
•   There is not enough information to address how annuities
    and annuity pricing will be handled; therefore, we used the
    same assumptions as the SSA Actuaries and did not
    quantitatively analyze their effect on benefit levels.




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         Appendix I:

Analysis of Model 3 and
     Methodology




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             Financing Sustainable Solvency
           Interpreting Long-term Simulations
•   Long-term simulations provide illustrations--not precise forecasts--of the
    relative fiscal and economic outcomes associated with alternative policy
    paths.

•   Long-term simulations are useful for comparing the potential outcomes of
    alternative policies within a common economic framework over the long term.
     – Recognizing the inherent uncertainties of long-term simulations, we have
        generally chosen conservative assumptions, such as holding interest
        rates and total factor productivity growth constant. Variations in these
        assumptions generally would not affect the relative outcomes of
        alternative policies.
     – The model simulates the interrelationships between the budget and the
        economy over the long term and does not reflect their interaction during
        short-term business cycles.

•   Long-term simulations are not predictions of what will happen in the future.
    In reality, policymakers likely would take action before the occurrence of the
    negative out-year fiscal and economic consequences reflected in some
    simulated fiscal policy paths.




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       Financing Sustainable Solvency
Social Security Reform Proposals in the Model

•   Reform proposal cost and income estimates are from SSA’s Office of
    the Chief Actuary.
    – For each proposal, the OASDI cost estimate reflects all proposed
      reforms affecting benefits. These include changes in the index used
      to adjust initial benefit levels, benefit reductions meant to offset
      individual accounts, and other proposed changes.
    – For each proposal, the OASDI income estimate reflects such
      elements as transfers from the general fund to the trust funds and
      amounts redirected from the payroll tax used to establish individual
      accounts.




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      Fiscal Model Assumption Summary
Model inputs                                         Assumptions
Social Security spending (OASDI)                     2001 Social Security Trustees’ intermediate projections
Medicare spending (HI and SMI)                       2001 Medicare Trustees’ intermediate assumption that per enrollee
                                                     Medicare spending grows with GDP per capita plus 1 percentage point
Medicaid spending                                    CBO’s July 2002 long-term assumption that per enrollee Medicaid
                                                     spending grows with GDP per capita plus 1 percentage point
Other mandatory spending                             CBO’s August 2002 baseline through 2012; thereafter increases at the
                                                     rate of economic growth (i.e., remains constant as a share of GDP)
Discretionary spending                               CBO’s August 2002 baseline through 2012, adjusted for the 2001
                                                     Social Security Trustees’ inflation assumptions; thereafter increases at
                                                     the rate of economic growth
Revenue                                              CBO’s August 2002 baseline through 2012; thereafter remains
                                                     constant at 20.5 percent of GDP (CBO’s projection in 2012)
Nonfederal saving (percent of GDP): gross saving     Increases gradually over the first 10 years to 17.5 percent of GDP (the
of the private sector and state and local government average nonfederal saving rate from 1992-2001)
sector
Net foreign investment (percent of GDP)              Increases (or decreases) from 2002 share of GDP by one-third of any
                                                     increase (or decrease) in gross national saving through 2012;
                                                     thereafter increases (or decreases) from 2012 nominal dollar level by
                                                     one-third of any increase (or decrease) in gross national saving
Labor: growth in hours worked                        2001 Social Security Trustees’ intermediate projections
Total factor productivity growth                     Consistent with labor productivity growth in 2001 Social Security
                                                     Trustees’ intermediate projections
Inflation (GDP price index and CPI)                  2001 Social Security Trustees’ intermediate projections
Interest rate (average on the national debt)         CBO’s August 2002 implied real average interest rate through 2011
                                                     adjusted for the 2001 Social Security Trustees’ intermediate inflation
                                                     assumptions; 6.3% thereafter




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       Balancing Adequacy and Equity - Benchmarks
•       Initial benefits from both models are compared with several
        benchmarks1:
          – The tax increase (maintain benefits) benchmark – increases the
              payroll tax once and immediately by the amount of the OASDI
              actuarial deficit as a percent of payroll so that benefits received
              under the current system can continue to be paid throughout the
              projection period. This spreads the tax burden evenly across
              generations. This can also be accomplished by general revenue
              transfers. For our analysis, we assumed that this would be
              implemented as a tax increase to maintain the relationship
              between contributions and benefits.
          – The benefit reduction (maintain taxes) benchmark reduces the
              formula factors by equal percentage point reductions (by 0.319
              each year for 30 years) for those newly eligible in 2005,
              subjecting earnings across all segments of the PIA formula to
              the same reduction.
•       It is expected that Model 3 should, on average, provide higher initial
        benefits than model 2 when compared to the benchmarks due to the
        required additional 1% contributions to the individual accounts for
        those who choose to participate.
1For   additional information regarding the benchmarks, see U.S. General Accounting Office, Social Security: Program’s Role in
        Helping Ensure Income Adequacy, GAO-02-62 (Washington, D.C.: Nov. 30, 2001).




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               Balancing Adequacy and Equity-
                     Model Assumptions
•   Our unit of analysis for this report is individuals. Depending upon how
    households split account distributions, our results may over/understate
    some individuals’ benefit levels. Since we were interested in the effect that
    reform has on certain birth cohorts, we chose to focus on individuals
    because household composition can vary across birth cohorts.
•   Analysis was performed using microsimulation with stochastic elements,
    which included uncertain asset returns, inflation, wage growth, etc. These
    variables varied across time and individuals.
•   The nominal mean rates of return used in the model for the individual
    accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for
    equities. These assumptions are consistent with those used in the SSA
    Actuaries’ scoring.
•   All individuals are assumed to annuitize their entire account balance at
    retirement by purchasing a fixed annuity. Our procedure for annuitization is
    consistent with that utilized by the SSA Actuaries.
•   Each individual in each of the cohorts retires at age 65. This can have
    implications for model 3 results since model 3 modifies the actuarial
    reduction and increment factors.
•   Since access to accounts for disabled workers occurs at the NRA, benefit
    levels for all beneficiaries are reported at age 67.




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                                        Model 3

•    Voluntary individual accounts in exchange for benefit reduction.

      – An additional contribution equal to 1 percent of an individual’s
        taxable payroll is required to participate, with partial subsidy for
        lower wage workers as a refundable tax credit.

      – Account contribution equal to 2.5 percent of payroll tax up to an
        annual maximum of $1,0001 redirected from payroll tax.

      – At retirement, reduction to defined benefit based on the amount of
        account contributions (not including the additional 1 percent
        contribution) compounded at a real interest rate of 2 ½ percent.



    1Maximum   contribution amount indexed annually to wage growth.




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                               Model 3


•   Changes to defined benefits beginning in 2009:
     – Initial benefit reduced from currently scheduled by indexing
       to expected gains in life expectancy.
     – Initial benefits for upper income earners reduced: from 2009-
       2028, third highest bend point factor gradually reduced from
       15 to 10 percent.
     – Initial benefits reduced for those who retire early and
       increased for those who delay retirement.




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                                     Model 3

•   A new enhanced benefit for full-time minimum wage1 workers with more
    than 20 years of work
     – Accelerated growth in initial benefits from 2009-2018.
     – By 2018, a minimum wage worker with 30 years of program
       coverage would receive a benefit equal to 100 percent of poverty
       level; thereafter, benefits would be expected to increase about 0.5
       percent per year faster than growth in the CPI and the poverty level.

•   Enhanced spousal survival benefit
     – Increase in widow(er) benefit up to 75 percent of combined spousal
       benefit (up to average benefit levels).

•   Additional financing from permanent dedicated revenue sources and
    general revenue transfers.



1Theminimum wage is the current Fair Labor Standards Act minimum of $5.15 an hour but is
assumed to be grow with the Social Security average wage index.




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                 Model 3
      Financing Sustainable Solvency
Figure A-1
• Compared to baseline extended, as a share of GDP unified surpluses are
   smaller and unified deficits are larger under Model 3-100% until the 2050s;
   thereafter, unified deficits are smaller.
• Under Model 3-0%, beginning around 2015, projected unified surpluses
   are higher and projected unified deficits are lower than under baseline
   extended throughout the simulation period.
• Greater participation in IAs results in lower surpluses/higher deficits over
   the simulation period.
• Throughout the simulation period, unified surpluses are considerably lower
   and unified deficits are considerably higher under Model 3-100% than
   under the tax increase benchmark and, to a lesser extent, the benefit
   reduction benchmark.
• Under Model 3-0%, unified surpluses are lower and unified deficits are
   higher than under the tax increase benchmark throughout the simulation
   period and beginning around 2010, unified surpluses are lower and unified
   deficits are higher than under the benefit reduction benchmark.




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              Figure A-1: Model 3
Unified Surpluses and Deficits as a Share of GDP

       Percent of GDP
  5

  0

  -5
                    Baseline extended
 -10                Benefit reduction
                    Model 3 - 0%
 -15                Model 3 -100%
                    Tax increase
 -20
   2000          2010           2020     2030        2040         2050     2060            2075
                                              Fiscal year


        Source: GAO analysis.




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                 Model 3
      Financing Sustainable Solvency
Figure A-2
• Compared to baseline extended, net debt held by the public as a share
   of GDP is higher under Model 3-100% until about 2060; thereafter, debt
   held by the public is lower.
• Under Model 3-0% net debt held by the public would be reduced
   compared to the baseline extended beginning about 2015 through the
   end of the simulation period.
• Greater participation in the IAs results in higher net debt held by the
   public throughout the simulation period.
• Throughout the simulation period, net debt held by the public under
   Model 3-100% is considerably higher than the tax increase benchmark
   and the benefit reduction benchmark.
• Net debt held by the public under Model 3-0% is higher than under the
   benefit reduction benchmark and much higher than under the tax
   increase benchmark through the end of the simulation period.




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                 Figure A-2: Model 3
      Debt held by the Public as a Share of GDP

       Percent of GDP
200
                   Baseline extended
                       Benefit reduction
150
                       Model 3 - 0%
                       Model 3 - 100%
100
                       Tax increase

50

 0

-50
  2000           2010         2020        2030       2040         2050   2060            2075
                                               Fiscal year


      Source: GAO analysis.




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                   Model 3
        Financing Sustainable Solvency
Figure A-3:

•   The government’s cash requirement includes the amount of cash required to pay defined
    benefits and redirect payroll taxes to individual accounts. Under Model 3-100%, the
    government’s cash requirement would be greater than both the baseline extended and tax
    increase benchmarks in the near term—by more than 15 percent in 2010. Beginning in the
    2030s, less cash would be required for Model 3-100% than the baseline extended and tax
    increase benchmarks. In 2075, Model 3-100% would require about 30 percent less cash
    than the baseline extended and tax increase benchmarks.

•   The cash requirement for Model 3-0% would be slightly greater than both the baseline
    extended and tax increase benchmarks until after 2010. Thereafter, Model 3-0% would
    require less cash than both the baseline extended and tax increase benchmarks; in 2075,
    about 25 percent less cash would be required for Model 3-0%.

•   The government’s cash requirement for Model 3 would be greater than the benefit reduction
    benchmark for most of the simulation. In 2075, Model 3-0% would require about the same
    amount of cash as the benefit reduction benchmark and Model 3-100% would require over 5
    percent less cash than the benefit reduction benchmark.

•   In the near term, the greater the individual account participation, the more cash required.
    Over the long term, however, greater individual account participation would reduce the
    government’s cash requirements.




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                                    Figure A-3: Model 3
                               Government Cash Requirements

            Percent of GDP
10%
                      Baseline extended/Tax increase
9%                    Benefit reduction
8%                    Model 3, 0 percent
7%                    Model 3, 100 percent

6%
5%
4%
3%
2%
1%
0%
  2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075
                                                                Calendar year

 Source: GAO analysis of data from the Office of the Chief Actuary, SSA. Benefit amounts shown for baseline extended and tax increase
 benchmarks are scheduled benefits as estimated by the actuaries. All estimates are based on the Trustees' 2001 intermediate
 assumptions.
 Note: Includes cash for defined benefits paid out under the traditional system and redirect of payroll taxes to individual accounts.




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                  Model 3
       Financing Sustainable Solvency
Figure A-4:
•   In 2015, total benefit payments (Social Security benefits plus individual account
    disbursements) as a share of GDP under Model 3 would be slightly (1 percent)
    lower than under the baseline extended or tax increase benchmark and about 3
    percent higher than the benefit reduction benchmark.
•   In 2030, total benefit payments as a share of GDP under model 3-100% would be
    nearly 4 percent lower than under the baseline extended or tax increase
    benchmark but 8 percent higher compared to the benefit reduction benchmark.
    Under Model 3-0%, benefit payments would be about 7 percent lower than the
    baseline extended or tax increase benchmark but nearly 5 percent higher than the
    benefit reduction benchmark.
•   In 2075, total benefit payments as a share of GDP under Model 3-100% would be
    the same as under the baseline extended or tax increase benchmark and nearly
    one-third higher than under the benefit reduction benchmark. By 2075, the
    difference in total benefit payments between Model 3-100% and Model 3-0%
    becomes pronounced with payments under Model 3-0% about the same as the
    benefit reduction benchmark but only three-fourths the level as under Model 3-
    100% or the baseline extended or tax increase benchmark.




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                 Figure A-4: Model 3
        Combined Social Security and Individual
       Account Disbursements as a Share of GDP
  Percent of GDP
8%
7%
6%
5%
4%
3%
2%
1%
0%
             2000                       2015
                                           2030             2050                                                           2075
                                       Calendar year
            Actual                                 Benefit reduction
            Model 3 - 0%                           Model 3 - 100%
            Baseline extended/Tax increase
     Source: GAO analysis of data from the Office of the Chief Actuary, SSA. Benefit amounts shown for baseline extended and tax
     increase benchmarks are scheduled benefits as estimated by the actuaries. All estimates are based on the Trustees' 2001
     intermediate assumptions.




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                      Model 3
           Financing Sustainable Solvency
•   National saving would increase primarily due to the improved fiscal position of the
    government resulting from the proposed benefit reductions. The redirection of payroll
    taxes under the IA option would increase private saving and decrease government
    saving with no net effect on national saving. The required 1 percent additional
    contribution would result in an increase in personal saving, although the progressive
    subsidy would reduce government saving and reduce any net increase in national
    saving.1
•   Restores 75-year actuarial balance with either no participation or universal participation
    in the IA option. Trust fund ratio at the end of the 75-year period is declining by about 3
    percent a year under Model 3-0% but rising under Model 3-100% by about 8 percent a
    year.
•   Requires new dedicated revenue from an unspecified source. The IAs are financed as a
    redirect of payroll taxes. In addition to the new dedicated revenue, Model 3-100%
    requires general revenue transfers to keep the OASDI trust fund solvent.
•   Does not create any new contingent liability. Individual bears risk of personal account
    investment performance.
•   Indexing initial benefits to increases in life expectancy and updating the indexation every
    10 years to reflect actual increases could help guard against unanticipated growth in
    lifetime benefits.
    1
     Analysis limited to first order effects on saving. Effects on saving behavior in response to specific
    reform provisions are not considered given the lack of expert consensus.




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                        Appendix I: Analysis of Reform Models




              Balancing Adequacy and Equity-
         Distributional Effect of Specific Provisions
Model 3
• Maintain current benefit structure for current and near retirees.
• Reduces OASDI defined benefits for new retirees, survivors, dependents,
  and disabled workers starting in 2009.
   – Benefits are reduced due to indexing initial benefit calculations to
      longevity rather than wages.
   – Gradually reduces the third PIA formula factor.
   – For those who participate in the individual accounts, there is a further
      offset based on the hypothetical account accumulation , where
      contributions accrue at a real rate of 2.5 percent.
   – Increases the actuarial reduction for early retirement.
• Increases benefits for certain beneficiaries: some widow(er)s, low-income
  earners, and increases the delayed retirement credit starting in 2010.
• PIA formula factor reductions and the benefit offset disproportionately
  decreases replacement rates. However, minimum benefit guarantees
  increase replacement rates for workers who qualify. Therefore, overall
  progressivity of the system is unclear given these provisions and the
  uncertainty of market returns, the magnitude of participation, and the
  characteristics of future participants.




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         Overview of Model 3 Cohort Results


• Across cohorts, median monthly benefits are higher
  than the benefit reduction benchmark regardless of
  participation in individual accounts (see Figure A-5).
• The gap in benefits between the without accounts
  scenario and the tax increase benchmark and with
  accounts scenario grows across cohorts (see Figure
  A-5).




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                                 Figure A-5: Model 3 Cohort Analysis – Median
                                          Monthly Benefits by Cohort

                                       3000


                                       2500
               Constant 2001 Dollars




                                       2000


                                       1500


                                       1000


                                        500


                                          0
                                                          1955                              1970                               1985

                                       Benefit Reduction Benchmark    Model 3 without Accounts     Model 3 with Accounts    Tax Increase Be nchmark



Source: GAO’s analysis using the GEMINI model.
Note: Median monthly benefits at age 67 for all beneficiaries. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired
workers retire at age 65, uncertain asset returns and inflation, and full annuitization of account balance at retirement age. “With
accounts” implies all individuals in the cohort participate in the individual accounts.




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Overview of Model 3 Quintile Analysis: Lowest and
          Highest Quintiles by Cohort

  •   Median monthly benefits are maintained above the benefit
      reduction benchmark for the lowest quintile regardless of
      participation in individual accounts, likely due to the
      enhanced benefit for full-time “minimum wage” workers (see
      Figure A-6).
  •   However, participation in the individual accounts may
      provide a benefit level even higher than the enhanced
      benefit for the lowest quintile since, over time, fewer workers
      will receive this enhanced benefit as wages are assumed to
      outpace inflation in the future (see figure A-6).
  •   Comparing median monthly benefits across cohorts in the
      lowest and highest quintiles indicates that the enhanced
      benefit for full-time “minimum wage” workers and individual
      accounts maintain benefits above the tax increase
      benchmark only for those in the lowest quintile and the later
      cohorts in the highest quintile (see Figures A-6 and A-7).




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       Figure A-6: Model 3 Quintile Analysis – Median Monthly
             Benefits by Cohort for the Lowest Quintile

                                     3000


                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500


                                     1000


                                      500


                                        0
                                                         1955                                     1970                              1985

                                      Benefit Reduction Benchmark     Mode l 3 without Accounts     M odel 3 with Accounts   Tax Increase Benchmark


Source: GAO’s analysis using the GEMINI model.
Note: Estimates based on the 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, uncertain asset returns and
inflation, and full annuitization of account balance at retirement age. “With accounts” implies all individuals in the cohort participate in
the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax increase benchmark.




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             Figure A-7: Model 3 Quintile Analysis – Median
            Monthly Benefits by Cohort for the Highest Quintile


                                     3000


                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500


                                     1000


                                      500


                                        0
                                                         1955                                     1970                              1985

                                      Benefit Reduction Benchmark     Mode l 3 without Accounts     M odel 3 with Accounts   Tax Increase Benchmark



Source: GAO’s analysis using the GEMINI model.
Note: Estimates based on the 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, uncertain asset returns and
inflation, and full annuitization of account balance at retirement age. “With accounts” implies all individuals in the cohort participate in
the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax increase benchmark.




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                   Appendix I: Analysis of Reform Models




Model 3 Distributional Analysis: Distributional Effects
 Comparing 100 Percent Participation Against Zero
                Percent Participation

    • The risk of participating decreases across cohorts
      when comparing scenarios with accounts and without
      accounts, primarily because of the lengthening of the
      investment horizon. For example, 86 percent of the
      1955 cohort would gain by choosing an individual
      account, as did 93 and 95 percent of the 1970 and
      1985 cohorts (see Figure A-8).
    • Of those who gained, the median gain was $50 per
      month in 2001 dollars for the 1955 cohort, while the
      median loss was about $4 per month among those
      who did not gain. For the 1970 and 1985 cohorts, the
      median gain was $223 and $540 per month in 2001
      dollars, while the median loss was $25 and $51,
      respectively.




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             Figure A-8: Model 3 Distributional Analysis -
        Performance of Individual Accounts Under 100 Percent
                  Participation Scenario by Cohort

                                       100%

                                       80%
         Percentage of Beneficiaries




                                       60%
                                                 86                                     93                                       95
                                       40%
                                       20%

                                        0%                                              -7                                       -5
                                                 -14
                                       -20%
                                                1955                                   1970                                      1985
                                       -40%
                                       -60%

                                              Percent of Beneficiaries Who Did Worse by Choosing an Individual Account
                                              Percent of Beneficiaries Who Did Better by Choosing an Individual Account



Source: GAO’s analysis using the GEMINI model.
Note: For example, in 1955 if 100 percent of beneficiaries participated in individual accounts, 86 percent did better by choosing the accounts
and 14 percent would have done better by not choosing the accounts. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired
workers retire at age 65, full annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where
the mean nominal rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.




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                     Appendix I: Analysis of Reform Models




      Model 3 Distributional Analysis: Distributional
      Effects of Model 3 in Comparison with Benefit
                  Reduction Benchmark

• Regardless of whether an account is chosen, a number of people
  fare better when compared to the benefit reduction benchmark. This
  is primarily because the benchmark’s PIA formula reductions are
  initially deeper than Model 3 PIA reductions and the additional 1%
  contribution (see Figure A-9).
• A majority of persons with accounts fare better than the benefit
  reduction benchmark and this majority ranges from 95 to 99 percent
  across cohorts. In contrast, the number of people without accounts
  who fare better than the benefit reduction benchmark ranges from 93
  to 97 percent across cohorts.
• A minority of persons (1 to 5 percent) with accounts fare worse than
  the benefit reduction benchmark, as do 3 to 7 percent of persons
  without individual accounts (see figure A-9).




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      Figure A-9: Model 3 Distributional Analysis – Distribution
          of Benefits by Cohort and Account Participation
          Compared to the Benefit Reduction Benchmark
                                                                                  100%
        Percent of All Benficiaries with Benefits Below and Above the Benchmark




                                                                                  80%




                                                                                  60%


                                                                                                            99                   97                                  97
                                                                                         95                                                        93                                   94
                                                                                  40%




                                                                                  20%




                                                                                   0%                       -1
                                                                                         -5                                       -3                                  -3                -6
                                                                                                                                                    -7



                                                                                  -20%
                                                                                         1955              1970                  1985              1955              1970               1985

                                                                                                With Individual Accounts                                  Without Individual Accounts


Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above or below
the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full annuitization of
account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean nominal rates of return used for
the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities. “With accounts” implies all individuals
in the cohort participate in the individual accounts.




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   Model 3 Distributional Analysis: Distributional
    Effects of Model 3 in Comparison with Tax
                Increase Benchmark

• Across cohorts:
   – Except for the 1955 cohort, a majority of people with
     accounts fare better than the tax increase benchmark and
     this number increases (41 to 67 percent) across cohorts
     (see Figure A-10).
   – A minority of people without accounts fare better than the
     tax increase benchmark and this minority declines (9 to 1
     percent) over time (see Figure A-10).




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                                                               Figure A-10: Model 3 Distributional Analysis –
                                                              Distribution of Benefits by Cohort and Account
                                                          Participation Compared to the Tax Increase Benchmark
                                                                                80%
     Percent of All Benficiaries with Benefits Below and Above the Benchmark




                                                                                60%



                                                                                40%
                                                                                                                              67
                                                                                                         55
                                                                                20%    41


                                                                                                                                                 9
                                                                                 0%                                                                                 2                 1


                                                                                                                              -33
                                                                                -20%
                                                                                                         -45
                                                                                       -59

                                                                                -40%
                                                                                                                                                -91
                                                                                                                                                                    -98               -99

                                                                                -60%



                                                                                -80%



                                                                               -100%
                                                                                       1955             1970                 1985               1955               1970              1985

                                                                                              With Individual Accounts                                 Without Individual Accounts


Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above or below
the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full annuitization of
account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean nominal rates of return used for
the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities. “With accounts” implies all individuals
in the cohort participate in the individual accounts.




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                  Appendix I: Analysis of Reform Models




Model 3 Sensitivity Analysis, Varying the Real Rate
of Return – Account Participation vs. Benchmarks
                     by Cohort

   • Although varying the rates of return does not alter the
     findings considerably for older cohorts, the effects of
     varying the real rate of return by plus or minus 1
     percent increases over time. The increased volatility is
     likely due to the additional 1% contribution.
      – Compared to the benefit reduction benchmark, the 1955
        cohort has about a ±1% change in its distribution,
        whereas the 1985 cohort has about a ±2% change in its
        distribution (see figure A-11).
      – Compared to the tax increase benchmark, the 1955
        cohort has approximately a ±5% change in its
        distribution, whereas the 1985 cohort has approximately
        a ±14% change in its distribution (see Figure A-12).




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       Figure A-11: Model 3 Sensitivity Analysis - Distribution of Benefits
      by Cohort Compared to Benefit Reduction Benchmark, Varying Real
                 Rates of Return by Plus 1 and Minus 1 Percent
                                                                   10 0%




                                                                    8 0%
       Percent of All Beneficiaries Above or Below the Benchmark




                                                                    6 0%



                                                                                                     96          98            99           99                 97            99
                                                                           95          95                                                         95

                                                                    4 0%




                                                                    2 0%




                                                                     0%                                           -2           -1           -1                               -1
                                                                           -5          -5            -4                                           -5           -3


                                                                           -1                        +1          -1                         +1   -1                         +1
                                                                                1955 Birth Cohort                      1970 Birth Cohort                1985 Birth Cohort
                                                                   -2 0%


Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above
or below the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full
annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean
nominal rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.




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                                                                        Figure A-12: Model 3 Sensitivity Analysis - Distribution of
                                                                        Benefits by Cohort Compared to Tax Increase Benchmark,
                                                                       Varying Real Rates of Return by Plus 1 and Minus 1 Percent

                                                                       80%




                                                                       60%
         Perce nt of All Beneficiaries Above or Below the Benc hmark




                                                                       40%                                                                                                      80
                                                                                                                                              66                   67
                                                                                                                                 55                 53
                                                                                                           46       44
                                                                       20%                   41
                                                                               36



                                                                         0%

                                                                                                                                                                                -20
                                                                                                                                              -34                  - 33
                                                                       - 20%
                                                                                                                                 -45                - 47
                                                                                                          -5 4     - 56
                                                                                             -59
                                                                               - 64

                                                                       - 40%




                                                                       - 60%

                                                                               -1                         +1        -1                        +1     -1                         +1
                                                                       - 80%
                                                                                      1955 Birth Cohort                   1970 Birth Cohort                 1985 Birth Cohort

Source: GAO’s analysis using the GEMINI model.
Note: Monthly benefit level at age 67 is compared to the benefit level under the benchmark to determine if individuals are above
or below the benchmark. Estimates based on 1955, 1970, and 1985 birth cohorts assuming retired workers retire at age 65, full
annuitization of account balance at retirement age. Uncertain asset returns and inflation are also assumed, where the mean
nominal rates of return used for the individual accounts are 6.3% for Treasuries, 6.8% for corporate bonds, and 10% for equities.




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                     Appendix I: Analysis of Reform Models




 Overview of Model 3 Disabled Worker Quintile
Analysis – Lowest and Highest Quintile by Cohort

• Median monthly benefits are maintained above the benefit reduction
  benchmark for the lowest quintile regardless of participation in individual
  accounts likely due to the enhanced benefit for full-time “minimum wage”
  workers (see Figure A-13).
   – This enhanced benefit could apply to low-earning disabled workers
      who work most of their career prior to becoming disabled. In our
      sample the average age of disability onset is 55.
• Participation in the individual accounts is also important for disabled
  workers, especially those in the later cohorts and in the upper quintiles.
  However, the earlier a disabled worker becomes disabled the fewer years
  they contribute to their account and the smaller is their account balance
  (see Figures A-13 and A-14).
• Since disabled workers do not have access to their accounts until
  conversion to retired worker benefits at the NRA, benefit levels before
  conversion would be in line with benefit levels for those without individual
  accounts.
• Benefit levels for disabled workers may be higher than those of retired
  workers since disabled workers are entitled to benefits at earlier ages,
  thus the reductions in their PIA factors would be smaller. This may create
  an incentive for older workers to apply for disability benefits.




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                                                                    Appendix I: Analysis of Reform Models




             Figure A-13: Model 3 Quintile Analysis – Median
            Monthly Benefits by Cohort for Disabled Workers in
                           the Lowest Quintile
                                     3500

                                     3000

                                     2500
             Constant 2001 Dollars




                                     2000


                                     1500

                                     1000

                                      500

                                        0
                                                         1955                                     1970                              1985

                                      Benefit Reduction Benchmark     Mode l 3 without Accounts     M odel 3 with Accounts   Tax Increase Benchmark

Source: GAO’s analysis using the GEMINI model.
Note: Median monthly benefits at age 67 for disabled workers. Estimates based on 1955, 1970, and 1985 birth cohorts assuming
uncertain asset returns and inflation, and full annuitization of account balance at retirement age. “With accounts” implies all
individuals in the cohort participate in the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax
increase benchmark.




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                                                                    Appendix I: Analysis of Reform Models




             Figure A-14: Model 3 Quintile Analysis – Median
            Monthly Benefits by Cohort for Disabled Workers in
                           the Highest Quintile
                                     3500

                                     3000

                                     2500
             Constant 2001 Dollars




                                     2000

                                     1500

                                     1000

                                      500

                                        0
                                                        1955                                     1970                             1985

                                      Benefit Reduction Benchmark     Model 3 without Accounts     Model 3 with Accounts   Tax Increase Benchmark

Source: GAO’s analysis using the GEMINI model.
Note: Median monthly benefits at age 67 for disabled workers. Estimates based on 1955, 1970, and 1985 birth cohorts assuming
uncertain asset returns and inflation, and full annuitization of account balance at retirement age. “With accounts” implies all
individuals in the cohort participate in the individual accounts. Quintiles are based on the distribution of benefits at age 67 under tax
increase benchmark.




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                    Appendix I: Analysis of Reform Models




    Balancing Adequacy and Equity-Overall Equity


Model 3
• Provide workers some investment choice and control, subject to
  certain limitations. This might enable individuals to earn a higher
  rate of return on their contributions with an increased measure of
  risk, primarily that the return expected may not be realized.
• May improve intergenerational equity through the move to
  advanced funding of Social Security and the inheritance feature
  of individual accounts.
• Make determining the rate of return difficult as the link between
  contributions and benefits becomes unclear due to general
  revenue transfers. Thus, we did not quantitatively assess the
  equity effects of the models.




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                    Appendix I: Analysis of Reform Models




     Implementing and Administering Reforms

• Funding for the transition from a pay-as-you-go system to a partially
  funded system would be handled by transfers from the General Fund of
  the Treasury and could be repaid when the trust funds experience cash
  flow surpluses.
• An education program will be necessary to explain the changes in the
  benefit structure and to avoid expectation gaps.
    – Benefit offset feature, financing structure of the system may be
       difficult to explain, which increases the importance of an education
       program.
• An education program will also be necessary to inform OASDI eligible
  workers on making sound investment decisions regarding
  diversification, risk, and participation.
• The Commission did not explicitly address the costs of an education
  program.
• It is unclear how the Commission’s proposed account splitting at divorce
  would fit into divorce law.




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     Implementing and Administering Reforms

• The proposal establishes a Governing Board to administer the individual
  accounts, which is intended to limit the potential for politically motivated
  investing. The board’s duties include the choice of available funds and
  providing financial information to individuals.
• The design of the voluntary individual account feature places an
  additional administrative burden on the SSA. Specifically, the
  hypothetical account, benefit offset, inheritance feature, and account
  splitting at divorce would create additional responsibilities for SSA.
• There is not enough information to estimate administrative costs. Such
  costs are affected by the level of participation in the individual accounts.
  However, the Commission believes that individual accounts can be
  administered at a low cost since they envision the system being
  structured similar to the TSP.
• There is not enough information to address how annuities and annuity
  pricing will be handled; therefore, we used the same assumptions as
  the SSA Actuaries and did not quantitatively analyze their effect on
  benefit levels.




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Appendix II: Comments from the Social
              Security Administration



Security Administration




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Security Administration




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Security Administration




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Security Administration




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Security Administration




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           Security Administration




(130108)
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