Social Security: Analysis of Issues and Selected Reform Proposals

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                           Testimony
                              Before the Special Committee on Aging,
                              U.S. Senate

For Release on Delivery
Expected at 9:30 a.m. EST
Wednesday, January 15, 2003   SOCIAL SECURITY
                              Analysis of Issues and
                              Selected Reform Proposals
                              Statement of David M. Walker
                              Comptroller General of the United States

Mr. Chairman and Members of the Committee:

Thank you for inviting me here to talk about our nation’s Social Security
program and how to address the challenges presented in ensuring the
long-term viability of this system. Social Security not only represents the
foundation of our retirement income system; it also provides millions of
Americans with disability insurance and survivors’ benefits. As a result,
Social Security provides benefits that are critical to the current and future
well-being of tens of millions of Americans. However, as I have said in
congressional testimonies over the past several years,1 the system faces
both solvency and sustainability challenges in the longer term. In their
2002 report, the Trustees emphasized that while the program’s near-term
financial condition has improved slightly, Social Security faces a
substantial financial challenge in the not-too-distant future that needs to
be addressed soon. In essence, the program’s long-term outlook remains
unchanged. Without reform, Social Security, Medicare, and Medicaid are
unsustainable, and the long-term impact of these entitlement programs on
the federal budget and the economy will be dramatic.

Over the past few years, a wide array of proposals has been put forth to
restore Social Security’s long-term solvency, and a commission established
by the President has presented three models for modifying the current
program. The Commission’s final report2 called for a period of discussion
lasting at least a year before legislative action is taken to strengthen and
restore sustainability to Social Security. Today we are issuing the GAO
report you requested on the Commission’s options.3 At your request, we
have also done a qualitative review of three other proposals introduced in
the 107th Congress. In my testimony today I will discuss not only our
report but also the broader issue of Social Security. I hope my testimony
will help clarify some of the key issues in the debate about how to
restructure this critically important program.

 U. S. General Accounting Office, Social Security: Criteria for Evaluating Social Security
Reform Proposals, GAO/T-HEHS-99-94 (Washington, D.C.: Mar. 25, 1999); Social Security:
The President’s Proposal, GAO/T-HEHS/AIMD-00-43 (Washington, D.C.: Nov. 9, 1999);
Budget Issues: Long-Term Fiscal Challenges, GAO-02-467T (Washington, D.C.: Feb. 27,
2002); Social Security: Long-Term Financing Shortfall Drives Need for Reform
GAO-02-845T (Washington, D.C.: June 19, 2002).
 Strengthening Social Security and Creating Personal Wealth for All Americans (Dec. 21,
2001; rev. Mar. 19, 2002).
 Social Security: Analysis of the Commission to Strengthen Social Security (GAO-03-310,
Jan. 15, 2003).

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    First, let me highlight a number of important points in connection with the
    Social Security challenge.

•   Social Security reform is part of a broader fiscal and economic
    challenge. If you look ahead in the federal budget, the combined Social
    Security or Old-Age and Survivors Insurance and Disability Insurance
    (OASDI) program together with the rapidly growing health programs
    (Medicare and Medicaid) will dominate the federal government’s future
    fiscal outlook. Under our long-term simulations, it continues to be the case
    that these programs increasingly constrain federal budgetary flexibility
    over the next few decades. Absent reform, the nation will ultimately have
    to choose between persistent, escalating federal deficits, significant tax
    increases, and/or dramatic budget cuts.

•   Focusing on trust fund solvency alone is not sufficient. We need to
    put the program on a path toward sustainable solvency. Trust fund
    solvency is an important concept, but focusing on trust fund solvency
    alone can lead to a false sense of security about the overall condition of
    the Social Security program. The size of the trust fund does not tell us
    whether the program is sustainable—that is, whether the government will
    have the capacity to pay future claims or what else will have to be
    squeezed to pay those claims. Aiming for sustainable solvency would
    increase the chance that future policymakers would not have to face these
    difficult questions on a recurring basis. Estimates of what it would take to
    achieve 75-year trust fund solvency understate the extent of the problem
    because the program’s financial imbalance gets worse in the 76th and
    subsequent years.

•   Solving Social Security’s long-term financing problem is more
    important and complex than simply making the numbers add up.
    Social Security is an important and successful social program that affects
    virtually every American family. It currently pays benefits to more than 45
    million people, including retired workers, disabled workers, the spouses
    and children of retired and disabled workers, and the survivors of
    deceased workers. The number of individuals receiving benefits is
    expected to grow to almost 69 million by 2020. The program has been
    highly effective at reducing the incidence of poverty among the elderly,
    and the disability and survivor benefits have been critical to the financial
    well-being of millions of others.

•   Given the current projected financial shortfall of the program, it is
    important to compare proposals to at least two funded
    benchmarks—one that funds currently scheduled benefits and one
    that adjusts to current tax financing. Comparing the beneficiary

    Page 2                                                           GAO-03-376T
    impact of reform proposals solely to currently scheduled Social Security
    benefits is inappropriate since all current scheduled benefits are not
    funded over the longer term. As a result, comparisons to currently
    scheduled benefits after the point of trust fund insolvency assume a
    payroll tax increase or general revenue infusion that have not been
    enacted and may not occur. Likewise, comparisons of reform proposals
    solely to funded benefits after the point of trust fund insolvency are
    inappropriate since that assumes a future sudden and sharp reduction in
    benefits that is not likely to occur. The key point is that there is a
    significant gap between scheduled benefits and projected revenues. In
    fact, a primary purpose of most Social Security reform proposals is to
    close or eliminate this gap.

•   Reform proposals should be evaluated as packages. The elements of
    any package interact; every package will have pluses and minuses, and no
    plan will satisfy everyone on all dimensions. If we focus on the pros and
    cons of each element of reform, it may prove impossible to build the
    bridges necessary to achieve consensus.

•   Acting sooner rather than later helps to ease the difficulty of
    change. As I noted previously, the challenge of facing the imminent and
    daunting budget pressure from Medicare, Medicaid, and OASDI increases
    over time. Social Security will begin to constrain the budget long before
    the trust funds4 are exhausted in 2041. The program’s annual cash flow is
    projected to be negative beginning in 2017. Social Security’s annual cash
    deficit will place increasing pressure on the rest of the budget to raise the
    resources necessary to meet the program’s costs. Waiting until Social
    Security faces an immediate solvency crisis will limit the scope of feasible
    solutions and could reduce the options to only those choices that are the
    most difficult. It could also contribute to further delay the really tough
    decisions on health programs (e.g., Medicare and Medicaid). Acting sooner
    rather than later would allow changes to be phased in so that future and
    near retirees have time to adjust their retirement planning. It would also
    help to ensure that the “miracle of compounding” works for us rather than
    against us.

    Our Social Security challenge is more urgent than it may appear. Failure to
    take remedial action will, in combination with other entitlement spending,
    lead to a situation unsustainable both for the federal government and,

     In this testimony, the term “Trust Funds” refers to the Old-Age and Survivors Insurance
    and Disability Insurance Trust Funds.

    Page 3                                                                       GAO-03-376T
                           ultimately, the economy. This problem is about more than finances. It is
                           also about maintaining an adequate safety net for American workers
                           against loss of income from retirement, disability, or death; Social Security
                           provides a foundation of retirement income for millions of Americans and
                           has prevented many former workers and their families from living their
                           retirement years in poverty. As the Congress considers proposals to
                           restore the long-term financial stability and viability of the Social Security
                           system, it also needs to consider the impact of the potential changes on
                           different types of beneficiaries. Moreover, while addressing Social
                           Security reform is important and will not be easy, Medicare presents a
                           much greater, more complex, and even more urgent fiscal challenge.

                           To assist the Congress in its deliberations, we have developed criteria for
                           evaluating Social Security reform proposals. These criteria aim to balance
                           financial and economic considerations with benefit adequacy and equity
                           issues and the administrative challenges associated with various
                           proposals. The use of these criteria can help facilitate fair consideration
                           and informed debate of Social Security reform proposals.

                           Today the Social Security program faces not an immediate crisis but rather
Social Security’s          a long-range and more fundamental financing problem driven largely by
Long-Term Financing        known demographic trends. The lack of an immediate solvency crisis
                           affects the nature of the challenge, but it does not eliminate the need for
Problem Is More            action. Acting soon reduces the likelihood that the Congress will have to
Urgent Than It May         choose between imposing severe benefit cuts and unfairly burdening
                           future generations with the program’s rising costs. Acting soon would
Appear                     allow changes to be phased in so the individuals who are most likely to be
                           affected, namely younger and future workers, will have time to adjust their
                           retirement planning while helping to avoid related “expectation gaps.”
                           Since there is a great deal of confusion about Social Security’s current
                           financing arrangements and the nature of its long-term financing problem,
                           I would like to spend some time describing the nature, timing, and extent
                           of the financing problem.

Demographic Trends Drive   As you all know, Social Security has always been largely a pay-as-you-go
Social Security’s Long-    system. This means that current workers’ taxes pay current retirees’
Term Financing Problem     benefits. As a result, the relative numbers of workers and beneficiaries has
                           a major impact on the program’s financial condition. This ratio, however,
                           is changing. In 1950, before the Social Security system was mature, the
                           ratio was 16.5. In the 1960s, the ratio averaged 4.2:1. Today it is 3.4:1 and it
                           is expected to drop to around 2:1 by 2030. The retirement of the baby

                           Page 4                                                             GAO-03-376T
boom generation is not the only demographic challenge facing the system.
People are retiring early and living longer. A falling fertility rate is the
other principal factor underlying the growth in the elderly’s share of the
population. In the 1960s, the fertility rate was an average of 3 children per
woman. Today it is a little over 2, and by 2030 it is expected to fall to
1.95—a rate that is below replacement. Taken together, these trends
threaten the financial solvency and sustainability of this important
program. (See fig. 1.)

Figure 1: Social Security Workers per Beneficiary

6 Covered workers per OASDI beneficiary






1960            1980            2000           2020            2040           2060             2080

Source: The 2002 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds.

Note: Projections based on intermediate assumptions of the 2002 Trustees’ Report.

The combination of these trends means that labor force growth will begin
to slow after 2010 and by 2025 is expected to be less than a third of what it
is today. (See fig. 2.) Relatively fewer workers will be available to produce
the goods and services that all will consume. Without a major increase in
productivity, low labor force growth will lead to slower growth in the
economy and to slower growth of federal revenues. This in turn will only
accentuate the overall pressure on the federal budget.

Page 5                                                                               GAO-03-376T
Figure 2: Labor Force Growth Is Expected to be Negligible by 2050

3 Percent change (5-year moving average)



1975                    2000                    2025                    2050                    2075

Source: GAO analysis of data from the Office of the Chief Actuary, Social Security Administration.

Note: Projections based on intermediate assumptions of the 2002 Trustees’ Report.

This slowing labor force growth is not always recognized as part of the
Social Security debate. Social Security’s retirement eligibility dates are
often the subject of discussion and debate and can have a direct effect on
both labor force growth and the condition of the Social Security
retirement program. However, it is also appropriate to consider whether
and how changes in pension and/or other government policies could
encourage longer workforce participation. To the extent that people
choose to work longer as they live longer, the increase in the share of life
spent in retirement would be slowed. This could improve the finances of
Social Security and mitigate the expected slowdown in labor force growth.

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Social Security’s Cash     Today, the Social Security Trust Funds take in more in taxes than they
Flow Is Expected to Turn   spend. Largely because of the known demographic trends I have
Negative in 2017           described, this situation will change. Under the Trustees’ intermediate
                           assumptions, combined program outlays begin to exceed dedicated tax
                           receipts in 2017 (see fig. 3), a year after Medicare’s Hospital Insurance (HI)
                           Trust Fund outlays are first expected to exceed program tax revenues. At
                           that time, both programs will become net claimants on the rest of the
                           federal budget.

                           Figure 3: Social Security’s Trust Funds Face Cash Deficits as Baby Boomers Retire

                               200 Billions of 2002 dollars

                               100                                           OASDI cash deficit





                                     2002    2006       2010   2014   2018      2022      2026      2030      2034     2038

                                             Cash surplus

                                             Cash deficit

                           Source: GAO analysis of data from the Office of the Chief Actuary, Social Security Administration,
                           based on the intermediate assumptions of the 2002 Annual Report of the Board of Trustees of the
                           Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.

                           Although the Trustees’ intermediate estimates show that the combined
                           Social Security Trust Funds will be solvent until 2041,5 program spending
                           will constitute a rapidly growing share of the budget and the economy well
                           before that date. Ultimately, the critical question is not how much a trust
                           fund has in assets, but whether the government as a whole can afford the
                           benefits in the future and at what cost to other claims on scarce resources.

                           Separately, the Disability Insurance Fund is projected to be exhausted in 2028 and the Old-
                           Age and Survivors Insurance Fund in 2043.

                           Page 7                                                                                GAO-03-376T
                         As I have said before, the future sustainability of programs is the key issue
                         policymakers should address—i.e., the capacity of the economy and
                         budget to afford the commitment. Fund solvency can help, but only if
                         promoting solvency improves the future sustainability of the program.

                         Beginning in 2017, the Trust Funds will begin drawing on the Treasury to
                         cover the cash shortfall, first relying on interest income and eventually
                         drawing down accumulated trust fund assets. The Treasury will need to
                         obtain cash for those redeemed securities either through increased taxes,
                         spending cuts, increased borrowing from the public, or correspondingly
                         less debt reduction than would have been the case had Social Security’s
                         cash flow remained positive.6 Neither the decline in the cash surpluses nor
                         the cash deficit will affect the payment of benefits. The shift will, however,
                         affect the rest of the budget. The negative cash flow will place increased
                         pressure on the federal budget to raise the resources necessary to meet
                         the program’s ongoing costs.

Decline in Budgetary     From the perspective of the federal budget and the economy, the
Flexibility Disappears   challenge posed by the growth in Social Security spending becomes even
Absent Entitlement       more significant in combination with the more rapid expected growth in
                         Medicare and Medicaid spending. This growth in spending on federal
Reform                   entitlements for retirees will become increasingly unsustainable over the
                         longer term, compounding an ongoing decline in budgetary flexibility.
                         Over the past few decades, spending on mandatory programs has
                         consumed an ever-increasing share of the federal budget. In 1962, prior to
                         the creation of the Medicare and Medicaid programs, spending for
                         mandatory programs plus net interest accounted for about 32 percent of
                         total federal spending. By 2002, this share had almost doubled to
                         approximately 63 percent of the budget. (See fig. 4.)

                          If the unified budget is in surplus at this point, then financing the excess benefits will
                         require less debt redemption rather than increased borrowing.

                         Page 8                                                                            GAO-03-376T
Figure 4: Federal Spending for Mandatory and Discretionary Programs, Fiscal Years 1962, 1982, and 2002

FY 1962                                     FY 1982                                         FY 2002 a

                                                        11%                                                   9%

      26%                                                                                                              37%
                          68%                         45%



          Net interest

                                        Source: GAO analysis of data from the Office of Management and Budget.
                                         Office of Management and Budget current services estimate.

                                        In much of the last decade, reductions in defense spending helped
                                        accommodate the growth in these entitlement programs. Even before the
                                        events of September 11, 2001, however, this ceased to be a viable option.
                                        Indeed, spending on defense and homeland security will grow as we seek
                                        to combat new threats to our nation’s security.

                                        We prepared long-term budget simulations that seek to illustrate the likely
                                        fiscal consequences of the coming demographic tidal wave and rising
                                        health care costs. These simulations continue to show that to move into
                                        the future with no changes in federal retirement and health programs is to
                                        envision a very different role for the federal government. Assuming, for
                                        example, that the tax reductions enacted in 2001 do not sunset and
                                        discretionary spending keeps pace with the economy, by mid-century
                                        federal revenues may only be adequate to pay Social Security and interest
                                        on the federal debt. 7 Spending for the current Medicare program—without

                                         This simulation assumes that all currently scheduled benefits would be paid in full
                                        throughout the 75-year projection period.

                                        Page 9                                                                        GAO-03-376T
the addition of a drug benefit—is projected to account for more than one-
quarter of all federal revenues. To obtain balance, massive spending cuts,
tax increases, or some combination of the two would be necessary. (See
fig. 5.) Neither slowing the growth of discretionary spending nor allowing
the tax reductions to sunset eliminates the imbalance.

Figure 5: Composition of Spending as a Share of Gross Domestic Product
Assuming Discretionary Spending Grows with GDP, the Tax Cuts Do Not Sunset,
and Currently Scheduled Social Security Benefits

   40 Percent of GDP





        2000        2015         2030   2050

                  All other spending

                  Medicare & Medicaid

                  Social Security

                  Net interest

Source: GAO’s August 2002 analysis.

Although this figure assumes payment of currently scheduled Social
Security benefits, the long-term fiscal imbalance would not be eliminated
even if Social Security benefits were to be limited to currently projected
trust fund revenues. This is because Medicare (and Medicaid)—spending
for which is driven by both demographics and rising health care costs—
present an even greater problem. Absent a change in design, these two
health programs together are projected to nearly triple as a share of gross
domestic product (GDP) over the next half-century.

Page 10                                                          GAO-03-376T
This testimony is not about the complexities of Medicare, but it is
important to note that Medicare presents a much greater, more complex,
and more urgent fiscal challenge than does Social Security. Unlike Social
Security, Medicare growth rates reflect not only a burgeoning beneficiary
population, but also the escalation of health care costs at rates well
exceeding general rates of inflation. Increases in the number and quality of
health care services have been fueled by the explosive growth of medical
technology. Moreover, the actual costs of health care consumption are not
transparent. Third-party payers generally insulate consumers from the cost
of health care decisions. These factors and others contribute to making
Medicare a much greater and more complex fiscal challenge than even
Social Security. We are developing a health care framework to help focus
additional attention on this important area and to help educate key
policymakers on the current system and related challenges.

Indeed, long-term budget flexibility is about more than Social Security and
Medicare. While these programs dominate the long-term outlook, they are
not the only federal programs or activities that bind the future. The federal
government undertakes a wide range of programs, responsibilities, and
activities that obligate it to future spending or create an expectation for
spending. We have work underway regarding how to describe the range
and measurement of such fiscal exposures—from explicit liabilities such
as environmental cleanup requirements to the more implicit obligations
presented by life-cycle costs of capital acquisition or disaster assistance.
Making government fit the challenges of the future will require not only
dealing with the drivers—entitlements for the elderly—but also looking at
the range of federal activities. A fundamental review of what the federal
government does and how it does it will be needed.

At the same time it is important to look beyond the federal budget to the
economy as a whole. Figure 6 shows the total future draw on the economy
represented by Social Security, Medicare, and Medicaid. Under the 2002
Trustees’ intermediate estimates and the Congressional Budget Office’s
most recent long-term Medicaid estimates, spending for these entitlement
programs combined will grow to 13.9 percent of GDP in 2030 from today’s
8.3 percent. Taken together, Social Security, Medicare, and Medicaid
represent an unsustainable burden on future generations.

Page 11                                                          GAO-03-376T
Figure 6: Social Security, Medicare, and Medicaid Spending as a Percent of GDP

25 Percent of GDP





     2000     2010            2020      2030         2040         2050         2060                2075



            Social Security

Source: Office of the Chief Actuary, Social Security Administration; Office of the Actuary, Centers for
Medicare and Medicaid Services; and CBO.

Note: Projections based on intermediate assumptions of the 2002 Trustees’ Reports and CBO’s June
2002 long-term projections under mid-range assumptions.

When Social Security redeems assets to pay benefits, the program will
constitute a claim on real resources in the future. As a result, taking action
now to increase the future pool of resources is important. To echo Federal
Reserve Chairman Alan Greenspan, the crucial issue of saving in our
economy relates to our ability to build an adequate capital stock to
produce enough goods and services in the future to accommodate both
retirees and workers in the future.8 The most direct way the federal
government can raise national saving is by increasing government saving,
that is, as the economy returns to a higher growth path, a balanced fiscal
policy that recognizes our long-term challenges can help provide a strong
foundation for future economic growth and can enhance future budgetary

 Testimony before the Senate Committee on Banking, Housing, and Urban Affairs, July 24,

Page 12                                                                                 GAO-03-376T
Taking action now on Social Security would not only promote increased
budgetary flexibility in the future and stronger economic growth but
would also make less dramatic action necessary than if we wait. Some of
the benefits of early action—and the costs of delay—can be seen in figure
7. This compares what it would take to achieve actuarial balance at
different points in time by either raising payroll taxes or reducing
benefits.9 Figure 7 shows this. If we did nothing until 2041—the year the
Trust Funds are estimated to be exhausted—achieving actuarial balance
would require changes in benefits of 31 percent or changes in taxes of 45
percent. As figure 7 shows, earlier action shrinks the size of the necessary

Figure 7: Size of Action Needed to Achieve Social Security Solvency

50 Percent





        2002-2076      2017-2076     2041-2076           D

              Benefit adjustment

              Tax adjustment

Source: GAO analysis of data from the Office of the Chief Actuary, Social Security Administration.

Note: The benefit adjustments in this graph represent a one-time, permanent change to all existing
and future benefits beginning in the first year indicated.

Solvency could also be achieved through a combination of tax and benefit actions. This
would reduce the magnitude of the required change in taxes or benefits compared with
making changes exclusively to taxes or benefits as shown in figure 7.

Page 13                                                                               GAO-03-376T
                        Thus, both sustainability concerns and solvency considerations drive us to
                        act sooner rather than later. Trust Fund exhaustion may be nearly 40 years
                        away, but the squeeze on the federal budget will begin as the baby boom
                        generation starts to retire. Actions taken today can ease both these
                        pressures and the pain of future actions. Acting sooner rather than later
                        also provides a more reasonable planning horizon for future retirees.

                        As important as financial stability may be for Social Security, it cannot be
Evaluating Social       the only consideration. As a former public trustee of Social Security and
Security Reform         Medicare, I am well aware of the central role these programs play in the
                        lives of millions of Americans. Social Security remains the foundation of
Proposals               the nation’s retirement system. Social Security is also much more than just
                        a retirement program; it also pays benefits to disabled workers and their
                        dependents, spouses and children of retired workers, and survivors of
                        deceased workers. Last year, Social Security paid almost $408 billion in
                        benefits to more than 45 million people. Since its inception, the program
                        has successfully reduced poverty among the elderly. In 1959, 35 percent of
                        the elderly were poor. In 2000, about 8 percent of beneficiaries aged 65 or
                        older were poor, and 48 percent would have been poor without Social
                        Security. It is precisely because the program is so deeply woven into the
                        fabric of our nation that any proposed reform must consider the program
                        in its entirety, rather than one aspect alone. Thus, we have developed a
                        broad framework for evaluating reform proposals that considers not only
                        solvency but other aspects of the program as well.

                        The analytic framework we have developed to assess proposals comprises
                        three basic criteria:

                    •   the extent to which a proposal achieves sustainable solvency and how it
                        would affect the economy and the federal budget;

                    •   the relative balance struck between the goals of individual equity and
                        income adequacy; and

                    •   how readily a proposal could be implemented, administered, and
                        explained to the public.

                        The weight that different policymakers may place on different criteria will
                        vary, depending on how they value different attributes. For example, if
                        offering individual choice and control is less important than maintaining
                        replacement rates for low-income workers, then a reform proposal
                        emphasizing adequacy considerations might be preferred. As they fashion

                        Page 14                                                         GAO-03-376T
                         a comprehensive proposal, however, policymakers will ultimately have to
                         balance the relative importance they place on each of these criteria.

Financing Sustainable    Our sustainable solvency standard encompasses several different ways of
Solvency                 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. Specifically, 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.

                         As I have already discussed, reducing the relative future burdens of Social
                         Security and health programs is essential to a sustainable budget policy for
                         the longer term. It is also critical if we are to avoid putting unsupportable
                         financial pressures on future workers. Reforming Social Security and
                         federal health programs is essential to reclaiming our future fiscal
                         flexibility to address other national priorities.

Balancing Adequacy and   The current Social Security system’s benefit structure strikes a balance
Equity                   between the goals of retirement income adequacy and individual equity.
                         From the beginning, benefits were set in a way that focused especially on
                         replacing some portion of workers’ pre-retirement earnings. Over time
                         other changes were made that were intended to enhance the program’s
                         role in helping ensure adequate incomes. Retirement income adequacy,
                         therefore, is addressed in part through the program’s progressive benefit
                         structure, providing proportionately larger benefits to lower earners and
                         certain household types, such as those with dependents. Individual equity
                         refers to the relationship between contributions made and benefits
                         received. This can be thought of as the rate of return on individual
                         contributions. Balancing these seemingly conflicting objectives through
                         the political process has resulted in the design of the current Social
                         Security program and should still be taken into account in any proposed

                         Page 15                                                          GAO-03-376T
                         Policymakers could assess income adequacy, for example, by considering
                         the extent to which proposals ensure benefit levels that are adequate to
                         protect beneficiaries from poverty and ensure higher replacement rates for
                         low-income workers. In addition, policymakers could consider the impact
                         of proposed changes on various subpopulations, such as low-income
                         workers, women, minorities, and people with disabilities. Policymakers
                         could assess equity by considering the extent to which there are
                         reasonable returns on contributions at a reasonable level of risk to the
                         individual, improved intergenerational equity, and increased individual
                         choice and control. Differences in how various proposals balance each of
                         these goals will help determine which proposals will be acceptable to
                         policymakers and the public.

Implementing and         Program complexity makes implementation and administration both more
Administering Proposed   difficult and harder to explain to the public. Some degree of
Reforms                  implementation and administrative complexity arises in virtually all
                         proposed changes to Social Security, even those that make incremental
                         changes in the already existing structure. However, the greatest potential
                         implementation and administrative challenges are associated with
                         proposals that would create individual accounts. These include, for
                         example, issues concerning the management of the information and
                         money flow needed to maintain such a system, the degree of choice and
                         flexibility individuals would have over investment options and access to
                         their accounts, investment education and transitional efforts, and the
                         mechanisms that would be used to pay out benefits upon retirement.
                         Harmonizing a system that includes individual accounts with the
                         regulatory framework that governs our nation’s private pension system
                         would also be a complicated endeavor. However, the complexity of
                         meshing these systems should be weighed against the potential benefits of
                         extending participation in individual accounts to millions of workers who
                         currently lack private pension coverage.

                         Continued public acceptance and confidence in the Social Security
                         program require that any reforms and their implications for benefits be
                         well understood. This means that the American people must understand
                         why change is necessary, what the reforms are, why they are needed, how
                         they are to be implemented and administered, and how they will affect
                         their own retirement income. All reform proposals will require some
                         additional outreach to the public so that future beneficiaries can adjust
                         their retirement planning accordingly. Yet the more transparent the
                         implementation and administration of reform, and the more carefully such

                         Page 16                                                       GAO-03-376T
                          reform is phased in, the more likely it will be understood and accepted by
                          the American people.

Range of Proposals        Over the course of the last several years, various reform proposals have
Illustrates Options for   been crafted. Many proposals involve restructuring the Social Security
Reform and Choices to     program to include individual retirement accounts. These individual
                          accounts are similar to defined contribution pension plans in that benefits
be Made                   are based on contributions to and investment returns (gains and losses) on
                          the accounts. This approach offers the potential for increased investment
                          returns, but, depending on the design of the reform, may expose retirees
                          and/or the government to investment risk. Increasing rates of return
                          through investment in private securities, whether through individual
                          accounts or collective government investment, cannot achieve sustainable
                          solvency without additional changes to the current system.

                          There has been considerable variation in the individual account proposals
                          introduced in the past couple of years. For example, some earlier
                          proposals required that individuals participate in the accounts while more
                          recent proposals provide individuals with the choice of whether or not to
                          participate. As you know, Mr. Chairman, we are currently working on a
                          report to be released next month that examines the unique issues
                          surrounding voluntary individual accounts. Individual account proposals
                          also differ in other areas, such as the manner in which accounts are
                          financed, how the accounts interact with the existing Social Security
                          program, the extent of choice and flexibility concerning investment
                          options, and the way in which benefits are paid from the account balances.

                          A number of Social Security reform proposals were introduced in the
                          107th Congress. At your request, we have done a qualitative review of the
                          proposals introduced last year by Representatives Shaw, De Mint, and
                          DeFazio. These three proposals illustrate different approaches to reform.
                          Representative Shaw introduced a new reform proposal last week—which
                          we have not had a chance to look at—and we realize that other proposals
                          may undergo some revisions as well. Like the Commission models, the
                          proposals by Representatives DeMint and Shaw included voluntary
                          individual accounts. All three proposals included significant revenue
                          enhancements, and two of them (Rep. DeMint and Rep. Shaw) included a
                          guarantee of future benefits at least as large as currently scheduled levels.
                          Some of these plans include general revenue transfers, collective
                          investment of some portion of trust fund assets in private securities, and
                          eliminating the cap on the maximum amount of earnings subject to the
                          payroll tax. In addition, some include provisions that would reduce future

                          Page 17                                                          GAO-03-376T
                           expenditures, such as an individual account offset against Social Security
                           retirement and aged survivor benefits and an increase in the number of
                           benefit computation years in the benefit formula.

                           As I noted previously, last year the President’s Commission to Strengthen
                           Social Security issued a report containing three reform models. At your
                           request, we looked at the Commission’s proposals and is today issuing a
                           report on our findings. Each of the Commission’s three reform models
                           represents a different approach to including a voluntary individual account
                           option to Social Security. Model 1 adds individual accounts to the current
                           system but does not restore solvency. Models 2 and 3 restore solvency to
                           the Old-Age and Survivors Insurance and Disability Insurance 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 also 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.

Examining the Effects of   Applying our criteria to the Commission models highlights trade-offs
Reform Using the           between efforts to achieve sustainable solvency and maintain adequate
Commission’s Proposals     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.

                           We used our long-term economic model in assessing the Commission
                           reform models against the first criterion, that of financing sustainable
                           solvency.10 Over the past few years, we have been developing a capacity to
                           estimate the quantitative effects of Social Security reform on individuals.
                           Such estimates are useful in applying our adequacy/equity criterion to
                           reform proposals. 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 people born in the same year.
                           Our analysis examined the effects of the reform models for the 1955, 1970,
                           and 1985 birth cohorts. To show the range of possible outcomes given the

                             For this analysis, consistent with SSA’s scoring of the Commission reform models, our
                           long-term economic model incorporates the 2001 Trustees’ intermediate assumptions.

                           Page 18                                                                     GAO-03-376T
                                 voluntary nature of individual accounts in the Commission models,11 we
                                 simulated each model assuming (1) no participation in the individual
                                 account option and (2) universal participation in the account option.

                                 Our analysis of the Commission reform models included comparison with
                                 three benchmarks:12

                             •   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. 13

                             •   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.

Financing Sustainable Solvency   The use of these criteria to evaluate approaches to Social Security reform
                                 highlights the trade-offs that exist between efforts to achieve solvency for
                                 the OASDI trust funds and efforts to maintain adequate retirement income
                                 for current and future beneficiaries.

                                 Overall, Model 2 would provide for sustainable solvency and reduce the
                                 shares of the federal budget and the economy devoted to Social Security
                                 compared to currently scheduled benefits (tax increase benchmark)
                                 regardless of how many individuals selected accounts. With universal
                                 account participation, general revenue funding would be needed for about

                                   In this testimony, 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.
                                  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.
                                  Our benchmarks are solvent for the 75-year projection period commonly used by SSA’s
                                 Office of the Chief Actuary, but they do not achieve sustainable solvency. Both the benefit
                                 reduction and tax increase benchmarks are explicitly fully funded and we worked closely
                                 with Social Security’s Office of the Chief Actuary in their design.

                                 Page 19                                                                       GAO-03-376T
    3 decades. Specifically, our analysis of sustainable solvency under Model 2
    showed that:

•   As estimated by the actuaries, Model 2, with either universal or zero
    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 with
    universal account participation, over 3 decades of general revenue
    transfers are needed to achieve trust fund solvency. Model 2 with zero
    account participation achieves solvency with no general revenue transfers.

•   Model 2 with universal account participation would ultimately reduce the
    budgetary pressures of Social Security on the unified budget relative to the
    baseline extended benchmark. However, this would not begin until the
    middle of this century. Relative to both our benefit reduction benchmark
    and tax increase benchmark, unified surpluses would be lower and unified
    deficits higher throughout the simulation period under Model 2 with
    universal account participation. Model 2 with zero account participation
    would reduce budgetary pressures due to Social Security beginning
    around 2015 relative to the baseline extended benchmark. This fiscal
    outlook under Model 2 with zero account participation is very similar to
    the fiscal outlook under our benefit reduction benchmark.

•   Under Model 2 with universal account participation, 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 with universal account participation. By 2075,
    Model 2 with universal account participation would require about 40
    percent less cash than the baseline extended and tax increase

•   Viewed from the perspective of the economy, total payments (Social
    Security defined benefits plus income from individual accounts) as a share
    of GDP would gradually fall under Model 2 with universal account
    participation 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 with
    universal account participation would be roughly 20 percent lower than
    the baseline extended or tax increase benchmark and roughly the same as
    under the benefit reduction benchmark.

    Page 20                                                         GAO-03-376T
                            •   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 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.14

                                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 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

Balancing Adequacy and Equity   The Commission’s proposals also illustrate the trade-offs reform proposals
                                face generally in balancing adequacy and equity considerations. Both of
                                the models protect benefits for current and near 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. This is because primary insurance
                                amount formula factors 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:

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

                                Page 21                                                                   GAO-03-376T
                        •   Median monthly benefits (the individual account annuity plus the defined
                            benefit reduced by an offset) for those choosing individual accounts are
                            always higher 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
                            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.

Implementing and            Each of the models would establish a governing board to administer the
Administering Reforms       individual accounts, including the choice of available funds and providing
                            financial information to individuals. While the Commission had the benefit
                            of prior thinking on these issues, many implementation issues remain,
                            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.

                            Page 22                                                          GAO-03-376T
                         It is likely that the structural changes required to restore Social Security’s
Conclusion: Choices      long-term viability generally will require some combination of reductions
and Trade-Offs Will Be   from currently scheduled benefits, revenue increases, and may include the
                         use of some general revenues. The proposals we have examined, both in
Part of Any Social       2002 and earlier, generally reflect this. Proposals employ possible benefit
Security Reform—         reductions within the current program structure, including modifying the
                         benefit formula, raising the retirement age, and reducing cost-of-living
Acting Soon Would        adjustments. Revenue increases might take the form of increases in the
Help                     payroll tax rate, expanding coverage to include the relatively few workers
                         who are still not covered under Social Security, or allowing the trust funds
                         to be invested in potentially higher-yielding securities such as stocks.15
                         Similarly, some proposals rely on general revenue transfers to increase the
                         amount of money going towards the Social Security program. Reforms that
                         include individual accounts would also involve Social Security benefit
                         reductions and/or revenue increases, and the use of general revenues.

                         The Commission report highlights the trade-offs and challenges in reform.
                         Model 2 uses a combination of benefit reductions and revenue increases to
                         restore long-term solvency. For example, we found that the model reduces
                         Social Security’s defined benefit from currently scheduled levels through
                         formula changes, provides enhanced benefits for low-wage workers and
                         spousal survivors, and adds a voluntary individual account option. Model 2
                         would both restore trust fund solvency and reduce the shares of the
                         federal budget and the economy devoted to Social Security compared with
                         currently scheduled benefits regardless of how many individuals selected
                         accounts. With universal account participation, general revenues would be
                         needed for about 3 decades. The other three proposals we examined take
                         somewhat different approaches, relying heavily on additional sources of
                         revenue. For example, Representative DeFazio’s proposal would restore
                         solvency primarily on the revenue side, allowing a portion of trust fund
                         assets to be invested in marketable securities and eliminating the cap on
                         taxable payroll earnings.

                         In evaluating Social Security reform proposals, the choice among various
                         benefit reductions and revenue increases will affect the balance between
                         income adequacy and individual equity. Benefit reductions could pose the
                         risk of diminishing adequacy, especially for specific subpopulations. Both
                         benefit reductions and tax increases that have been proposed could

                          About 4 percent of the workforce remains uncovered, which mostly includes some state
                         and local government employees and federal employees hired before 1984.

                         Page 23                                                                  GAO-03-376T
diminish individual equity by reducing the implicit rates of return the
workers earn on their contributions to the system. In contrast, increasing
revenues by investing retirement funds in the stock market could improve
rates of return but potentially expose individuals to investment risk and

Similarly, the choice among various benefit reductions and revenue
increases—for example, raising the retirement age—will ultimately
determine not just how much income retirees will have but also how long
they will be expected to continue working and how long their retirements
will be. Reforms will determine how much consumption workers will give
up during their working years to provide for more consumption during

Early action to change these programs would yield the highest fiscal
dividends for the federal budget and would provide a longer period for
prospective beneficiaries to make adjustments in their own planning.
Waiting to build economic resources and reform future claims entails
risks. First, we lose an important window where today’s relatively large
workforce can increase saving and enhance productivity, two elements
critical to growing the future economy. We lose the opportunity to reduce
the burden of interest payments, thereby creating a legacy of higher debt
as well as elderly entitlement spending for the relatively smaller workforce
of the future. Most critically, we risk losing the opportunity to phase in
changes gradually so that all can make the adjustments needed in private
and public plans to accommodate this historic shift. Unfortunately, the
long-range challenge has become more difficult, and the window of
opportunity to address the entitlement challenge is narrowing. As the baby
boom generation retires and the numbers of those entitled to these
retirement benefits grow, the difficulties of reform will be compounded.
Accordingly, it remains more important than ever to deal with these issues
over the next several years.

Today, many retirees and near-retirees fear cuts that will affect them while
young people believe they will get little or no Social Security benefits. As I
have said before, I believe it is possible to structure a Social Security
reform proposal that will exceed the expectations of all generations of
Americans. In my view, there is a window of opportunity to craft a
solution that will protect Social Security benefits for the nation’s current
and near-term retirees, while ensuring that the system will be there for
future generations. However, this window of opportunity will close as the
baby boom generation begins to retire. As a result, we must move forward
to address Social Security because we have other major challenges

Page 24                                                          GAO-03-376T
           confronting us. The fact is, compared to addressing our long-range health
           care financing problem, reforming Social Security will be easy lifting.

           It is my hope that we will think about the unprecedented challenge facing
           future generations in our aging society. Relieving them of some of the
           burden of today’s financing commitments would help fulfill this
           generation’s stewardship responsibility to future generations. It would also
           preserve some capacity for them to make their own choices by
           strengthening both the budget and the economy they inherit. We need to
           act now to address the structural imbalances in Social Security, Medicare,
           and other entitlement programs before the approaching demographic tidal
           wave makes the imbalances more difficult, dramatic, and disruptive.

           We at GAO look forward to continuing to work with this Committee and
           the Congress in addressing this and other important issues facing our

           Mr. Chairman, Mr. Craig, members of the Committee, that concludes my
           statement. I’d be happy to answer any questions you may have.

           Page 25                                                         GAO-03-376T