oversight

Social Security Reform: Demographic Trends Underlie Long-Term Financing Shortage

Published by the Government Accountability Office on 1997-11-20.

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

                              United States General Accounting Office

GAO                           Testimony
                              Before the Task Force on Social Security Reform,
                              Committee on the Budget, U.S. Senate




For Release on Delivery
Expected at 10:00 a.m.
Thursday, November 20, 1997
                              SOCIAL SECURITY
                              REFORM

                              Demographic Trends
                              Underlie Long-Term
                              Financing Shortage
                              Statement of Barbara D. Bovbjerg, Associate Director
                              Income Security Issues
                              Health, Education, and Human Services Division




GAO/T-HEHS-98-43
Social Security Reform: Demographic
Trends Underlie Long-Term Financing
Shortage
              Mr. Chairman and Members of the Task Force:

              We are pleased to be here today to speak about Social Security financing
              reform. Our aging population is placing serious pressures on Social
              Security and other forms of retirement income. In the United States, the
              population of people aged 65 and older has tripled since 1940 and is
              projected to more than double again by 2050. People 65 and older are
              expected to make up 20 percent of the U.S. population as early as 2030,
              compared with 13 percent today and just 7 percent in 1940. Moreover, the
              population aged 85 and older is projected to increase fivefold by 2050.
              These projections reflect significant increases in life expectancies. As
              people live longer, they will need more income to sustain them throughout
              retirement. Unless retirement and work patterns change, fewer workers
              will be supporting each retiree. These profound demographic trends
              underlie Social Security’s projected financing shortfalls.

              Today, I would like to discuss the demographic trends contributing to
              Social Security’s financing problem, when the problem will begin to
              confront us, the alternatives for addressing the problem, and their
              implications. My testimony is based on work we have done over the past
              few years.1

              In summary, increasing life expectancy and declining fertility rates pose
              serious challenges not just for our Social Security system but also for
              Medicare, Medicaid, the federal budget, and our economy as a whole. The
              aging of the baby-boom generation will simply accelerate this trend.

              Today, Social Security receives more from payroll taxes than it pays out in
              benefits. This excess revenue is helping build substantial trust fund
              reserves that are projected to help pay full benefits until 2029, according to
              Social Security’s intermediate projections. At the same time, this excess
              revenue helps reduce the overall federal budget deficit but will start to
              taper off after 2008. In 2012, Social Security benefit payments are
              projected to exceed cash revenues, and the federal budget will start to
              come under considerable strain as the general fund starts to repay funds
              borrowed from the trust funds.

              Although Social Security’s revenues currently exceed its expenditures,
              revenues are expected to be about 14 percent less than total projected
              expenditures over the next 75 years, according to Social Security
              Administration (SSA) projections. A variety of benefit reductions and

              1
               See the list of related GAO products at the end of this statement.



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             Social Security Reform: Demographic
             Trends Underlie Long-Term Financing
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             revenue increases within the current program structure could be
             combined to restore financial balance. However, some observers believe
             that the program structure should be reevaluated.

             Reform is necessary, and the sooner we address it, the less severe the
             necessary adjustments will be. Any economic growth and improvements in
             living standards we can achieve will also mitigate the strains that reform
             will impose. However, any course we take will substantially affect both
             workers and retirees, other sources of retirement income, the income
             distribution, the federal budget, and even the economy as a whole. Such
             effects should be well understood in making reforms.


             When Social Security was enacted in 1935, the nation was in the midst of
Background   the Great Depression. About half of the elderly depended on others for
             their livelihood; roughly one-sixth received public charity. Many had lost
             their savings in the stock market crash. Social Security was created to help
             ensure that the elderly had adequate income and did not depend on
             welfare. It would provide benefits that workers had earned with their
             contributions and the help of their employers.

             In creating Social Security, the Congress recognized an immediate need to
             bolster the income of the elderly; an individual retirement savings
             approach would not have significantly affected retirement income for
             years to come. The Social Security benefits that early beneficiaries
             received significantly exceeded their contributions, but even the very first
             beneficiaries had made some contributions. The Social Security Act of
             1935 included a companion welfare program to help the elderly who had
             not earned retired worker benefits under Social Security.

             Initially, very few of the elderly qualified for Social Security benefits;
             therefore, funding the benefits required relatively low payroll taxes.
             Increases in payroll taxes were always anticipated to keep up with the
             benefit payments as the system “matured” and more retirees received
             benefits. From the beginning, Social Security was financed on this type of
             “pay-as-you-go” basis, with any 1 year’s revenues collected primarily to
             fund benefits to be paid that year. The Congress had rejected the idea of
             “advance funding” for the program, or collecting enough revenues to cover
             future benefit rights as workers accrued them. Many feared that if the
             federal government amassed huge reserve funds, it would just find a way
             to spend them elsewhere.




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                       Trends Underlie Long-Term Financing
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                       Over the years, the size and scope of the program have changed. In 1939,
                       coverage was extended to dependents and survivors. In the 1950s, state
                       and local governments were given the option of covering their employees.
                       The Disability Insurance program was added in 1956. The Medicare
                       program was added in 1965. Beginning in 1975, benefits were
                       automatically tied to the Consumer Price Index to ensure that the
                       purchasing power of recipients’ income was not eroded by inflation. These
                       benefit expansions also contributed to higher payroll tax rates.

                       Today, Social Security has met the goal of its creators in that it provides
                       the foundation for retirement income. In 1994, about 91 percent of all
                       elderly households received Social Security benefits, compared with
                       67 percent who received some income from saved assets, just over
                       40 percent who had income from pensions, and 21 percent who had
                       earned income. Social Security contributed over 40 percent of all elderly
                       income, compared with about 18 percent each for the other sources. It
                       provided the predominant share of income for the lowest three-fifths of
                       the U.S. income distribution. On average, Social Security provided $9,200
                       to all elderly households. The other sources of retirement income
                       determine which households have the highest income.

                       Social Security has contributed substantially to reducing poverty rates for
                       the elderly, which declined dramatically from 35 percent in 1959 to under
                       11 percent in 1996. In comparison, 11.4 percent of those aged 18 to 64 and
                       20.5 percent of those under 18 were in poverty in 1996. For over half the
                       elderly, income other than Social Security amounted to less than the
                       poverty threshold in 1994. Still, pockets of poverty do remain. About
                       30 percent of elderly households are considered poor or nearly poor,
                       having incomes below 150 percent of the poverty threshold. Women,
                       unmarried people, and people aged 75 and over are much more likely to be
                       poor than are other elderly persons. In fact, unmarried women make up
                       over 70 percent of poor elderly households, compared with only
                       45 percent of all elderly households.


                       In the United States, the elderly population (those aged 65 and older) grew
Demographic Roots of   from about 9 million in 1940 to about 34 million in 1995, and it is expected
Social Security’s      to reach 80 million by 2050, according to Bureau of the Census
Financing Problem      projections. Moreover, the very old population (those aged 85 and older) is
                       expected to increase almost fivefold, from about 4 million in 1995 to nearly
                       19 million in 2050. (See fig. 1.) As a share of the total U.S. population, the




                       Page 3                                                       GAO/T-HEHS-98-43
                                         Social Security Reform: Demographic
                                         Trends Underlie Long-Term Financing
                                         Shortage




                                         elderly population grew from 7 percent in 1940 to 12 percent in 1990; this
                                         share is expected to increase to 20 percent by 2050.



Figure 1: Population Aged 65 and Older, by Age Group, 1940-2050

80   Population (Millions)




60




40




20




 0


 1940                        1960           1980                     2000                       2020                     2040
 Years

               85 and Over

              75-84

               65-74


                                         Note: Data for 2000 to 2050 are midrange Bureau of the Census projections.

                                         Source: U.S. Bureau of the Census, 65+ in the United States (Washington, D.C.: U.S. Bureau of
                                         the Census, 1996).




                                         Page 4                                                                       GAO/T-HEHS-98-43
Social Security Reform: Demographic
Trends Underlie Long-Term Financing
Shortage




Although the baby-boom generation will greatly contribute to the growth
of the elderly population, other demographic trends are also important.
Life expectancy has increased continually since the 1930s, and further
improvements are expected. In 1940, 65-year-old men could expect to live
another 12 years, and women could expect to live another 13 years. By
1995, these numbers had improved to 15 years for men and 19 for women.
By 2040, these numbers are projected to be 17 years and 21 years,
according to SSA’s intermediate actuarial assumptions. Note that these
assumptions yield a lower rate of elderly population growth than do the
Census assumptions. Some demographers project even more dramatic
growth.

A falling fertility rate is the other principal factor in the growth of the
elderly’s share of the population. The fertility rate was 3.6 children per
woman in 1960. The rate has declined to around 2.0 children per woman
today and is expected to level off at about 1.9 by 2020, according to SSA’s
intermediate assumptions.

Increasing life expectancy and falling fertility rates in combination mean
that fewer workers will be contributing to Social Security for each aged,
disabled, dependent, or surviving beneficiary. There were 3.3 workers for
each Social Security beneficiary in 1995, but by 2030, only 2.0 workers are
projected for each beneficiary (see fig. 2).




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                                           Social Security Reform: Demographic
                                           Trends Underlie Long-Term Financing
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Figure 2: Workers Contributing to Social Security Per Beneficiary, Historical and Projected, 1960-2040

6      Workers per Beneficiary




5




4




3




2




1




0

    1960             1970        1980          1990             2000              2010              2020             2030             2040
    Years


                                           Note: Projections use SSA’s intermediate actuarial assumptions.

                                           Source: Board of Trustees, 1997 Annual Report of the Board of Trustees of the Federal Old Age
                                           and Survivors Insurance and Disability Insurance Trust Funds (Washington, D.C.: SSA, 1997).




                                           These demographic trends have fundamental implications for Social
                                           Security, other forms of retirement income, and our economy as a whole.
                                           Increasing longevity means that each year more people will receive Social
                                           Security benefits. As a result, Social Security revenues must be increased,
                                           benefits must be reduced, or both. For pensions and retirement savings,
                                           increasing longevity means these income sources will have to provide
                                           income over longer periods, which will similarly require increased
                                           contributions or reduced retirement income. As already noted, there will




                                           Page 6                                                                       GAO/T-HEHS-98-43
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                        be relatively fewer workers to pay the Social Security taxes needed to
                        fund benefits. However, more fundamentally, unless retirement patterns
                        change, there will be relatively fewer workers producing the goods and
                        services that both workers’ households and elderly households will
                        consume. Yet in recent years, workers have been retiring earlier, not later,
                        and not always by choice.

                        These demographic trends also pose challenges for our long-term budget
                        outlook. They will lead to higher costs in Medicare and Medicaid as well as
                        in Social Security. In a recent report to the Chairmen of the Senate and
                        House Budget Committees,2 we discussed the results of our latest
                        simulations of the long-term budget outlook. Recent congressional action
                        to bring about a balanced budget and surplus in the next 10 years will give
                        us some breathing room, but spending pressures in these programs, if left
                        unchecked, will prompt the emergence of unsustainable deficits over the
                        longer term.


                        These demographic trends pose long-term financing challenges for both
How Social Security’s   Social Security and the federal budget. Social Security revenues are
Problem Will Develop    expected to be about 14 percent less than expenditures over the next 75
Over Time               years, and demographic trends suggest that this imbalance will grow over
                        time. In 2029, the Social Security trust funds are projected to be depleted.
                        From then on, Social Security revenues are expected to be sufficient to
                        pay only about 70 to 75 percent of currently promised benefits, given
                        currently scheduled tax rates and SSA’s intermediate assumptions about
                        demographic and economic trends. In 2031, the last members of the
                        baby-boom generation will reach age 67, when they will be eligible for full
                        retirement benefits under current law.

                        While Social Security funds are expected to be sufficient to pay full
                        benefits for more than 30 years, Social Security’s financing will begin
                        having significant implications for the federal budget in only 10 years.
                        Moreover, restoring Social Security’s long-range financial balance would
                        not necessarily address the significant challenge that its current financing
                        arrangements pose for the overall federal budget. Social Security cash
                        revenues currently exceed expenditures by roughly $30 billion each year
                        (see fig. 3). Under current law, the Department of the Treasury issues
                        interest-bearing government securities to the trust funds for these excess
                        revenues. In effect, Treasury borrows Social Security’s excess revenues
                        and uses them to help reduce the amount it must borrow from the public.

                        2
                         See Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, Oct. 22, 1997).



                        Page 7                                                                        GAO/T-HEHS-98-43
                                                     Social Security Reform: Demographic
                                                     Trends Underlie Long-Term Financing
                                                     Shortage




                                                     In other words, Social Security’s excess revenues help reduce the overall,
                                                     or unified, federal budget deficit. Moreover, the trust funds earned
                                                     $38 billion in interest last year, which Treasury pays by issuing more
                                                     securities. If Treasury could not borrow from the trust funds, it would
                                                     have to borrow more in the private capital market and pay such interest in
                                                     cash to finance current budget policy.



 Figure 3: Social Security’s Cash Revenues Exceed Expenditures Now but Fall Short Later

 50      Excess Cash Revenue (Dollars in Billions)




 25




  0




 -25




 -50




 -75




-100

  1995                                  2000                       2005                             2010                           2015
  Years


                                                     Sources: 1997 Annual Report of the Board of Trustees of the Federal Old Age and Survivors
                                                     Insurance and Disability Insurance Trust Funds and unpublished SSA data.




                                                     Page 8                                                                       GAO/T-HEHS-98-43
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                       Shortage




                       Ten years from now, these excess cash revenues are expected to start
                       diminishing, and so will their effect in helping balance the budget. In just
                       15 years, Social Security’s expenditures are expected to exceed its cash
                       revenues, and the government’s general fund will have to make up the
                       difference, in effect repaying Social Security. As a result, Social Security’s
                       cash flow will no longer help efforts to balance the budget but will start to
                       hinder them. In 2028, repayments from the general fund to Social Security
                       are expected to reach about $183 billion in 1997 dollars. In that year, this
                       amount would equal the same share of gross domestic product as the
                       deficit for the entire federal government in fiscal year 1996, or 1.4 percent,
                       according to SSA projections.


                       Restoring Social Security’s long-term financial balance will require some
Alternatives for       combination of increased revenues and reduced expenditures. A variety of
Reform                 options is available within the current structure of the program. However,
                       some proposals would go beyond restoring financial balance and
                       fundamentally alter the program structure. These more dramatic changes
                       attempt to achieve other policy objectives as well.

                       The current Social Security system attempts to balance two competing
                       policy objectives. The progressive benefit formula tries to ensure the
                       “adequacy” of retirement income by replacing a higher portion of lower
                       earners’ income than of higher earners’ income. In effect, Social Security
                       redistributes income from higher earners to lower earners. At the same
                       time, the formula attempts to maintain some degree of “equity” for higher
                       earners by providing that benefits increase somewhat with earnings.

                       Within the current program structure, a wide range of options is available
                       for reducing costs or increasing revenues. Previously enacted reforms
                       have used many of these in some form. Current reform proposals also rely,
                       at least in part, on many of these more traditional measures, regardless of
                       whether the proposals largely preserve the current program structure or
                       alter it significantly.

                       Ways to reduce program expenditures include

                   •   reducing initial benefits by changing the benefit formula for all or some
                       beneficiaries, for example, by changing the number of years of earnings
                       used in the formula;
                   •   raising the retirement age or accelerating the currently scheduled increase;
                   •   lowering the annual automatic cost-of-living adjustment; and



                       Page 9                                                        GAO/T-HEHS-98-43
    Social Security Reform: Demographic
    Trends Underlie Long-Term Financing
    Shortage




•   means-testing benefits, or limiting benefits on the basis of beneficiaries’
    other income and assets.

    Ways to increase revenues include

•   increasing Social Security payroll taxes,
•   investing trust funds in securities with potentially higher yields than the
    government bonds in which they are currently invested, and
•   increasing income taxes on Social Security benefits.

    A variety of proposals would address Social Security’s long-term funding
    problems by significantly restructuring the program, usually by privatizing
    at least a portion of it. Such proposals still essentially achieve financial
    balance by effectively raising revenues and reducing costs, but they do so
    in ways that pursue other policy objectives as well. Some of these
    proposals would reduce the role of Social Security and the federal
    government in providing retirement income and would give individuals
    greater responsibility and control over their own retirement incomes.
    These proposals often focus on trying to improve the rates of return that
    individuals earn on their retirement contributions and thus place greater
    emphasis on the equity objective. Also, some proposals focus on trying to
    increase national saving and on funding future Social Security benefits in
    advance rather than on the current pay-as-you-go basis. In this way, the
    relatively larger generation of current workers could finance some of their
    future benefits now rather than leaving a relatively smaller generation of
    workers with the entire financing responsibility. Moreover, the investment
    earnings on the saved funds would reduce the total payroll tax burden.

    Generally, privatization proposals focus on setting up individual
    retirement savings accounts and requiring workers to contribute to them.
    The accounts would usually replace a portion of Social Security, whose
    benefits would be reduced to compensate for revenues diverted to the
    savings accounts. Some privatization proposals combine new mandatory
    saving and Social Security benefit cuts, hoping to produce a potential net
    gain in retirement income. The combination of mandated savings deposits
    and revised Social Security taxes would be greater than current Social
    Security taxes, in most cases.

    Virtually all proposals addressing long-term financing issues would
    increase the proportion of retirement assets invested in the stock market
    or in other higher-risk investments. Some proposals call for the accounts
    to be managed by individuals, while others would have them managed by



    Page 10                                                      GAO/T-HEHS-98-43
Social Security Reform: Demographic
Trends Underlie Long-Term Financing
Shortage




the government. The common objective is to finance a smaller share of
retirement costs with worker contributions and a larger share of the costs
with anticipated higher investment returns.

In the case of individual savings accounts, workers would bear the risk of
economic and market performance. Individuals with identical earning
histories and retirement contributions could have notably different
retirement incomes because of market fluctuations or individual
investment choices. Some proposals would require retirees to purchase a
lifetime annuity with their retirement savings to ensure that the savings
provided income throughout their retirement.

Privatization proposals raise the issue of how to make the transition to a
new system. Social Security would still need revenues to pay benefits that
retirees and current workers have already earned, yet financing retirement
through individually owned savings accounts requires advance funding.
The revenues needed to fund both current and future liabilities would
clearly be higher than those currently collected. For example, to fund the
transition, one proposal would increase payroll taxes by 1.52 percent for
72 years and involve borrowing $2 trillion during the first 40 years of the
transition.

Privatization would also have a significant effect on the distribution of
retirement income between high and low earners. The current Social
Security benefit formula redistributes income and implicitly gives low
earners a somewhat higher rate of return on their contributions than high
earners. Privatization proponents claim that all earners would be better off
under privatization, although high earners would have relatively more to
gain from any increased rates of return that privatization might provide.
Moreover, if workers were contributing to their own retirement savings,
their contributions would not be available for redistribution as they are
now. Some privatization proposals would retain some degree of Social
Security coverage and therefore permit some redistribution to continue.

Privatization proposals also tend to separate retirement benefits from
Social Security’s survivors’ and disability benefits. In the case of death or
disability before retirement, individual savings may not have been building
long enough to sufficiently replace lost income. Some privatization
proposals, therefore, leave these social insurance programs largely as they
are now.




Page 11                                                      GAO/T-HEHS-98-43
                  Social Security Reform: Demographic
                  Trends Underlie Long-Term Financing
                  Shortage




                  Financing reforms could affect the nation’s economy in various ways. For
Implications of   example, raising the retirement age could affect the labor market for
Reform            elderly workers. Also, if reforms increased national saving, they could help
                  increase investment, which in turn could increase productivity and
                  economic growth. Economic growth could help ease the strains of
                  providing for a growing elderly population. However, reforms may not
                  produce notable increases in national saving since, to some degree, any
                  new retirement saving might simply replace other forms of individual
                  saving. Moreover, any additional Social Security savings in the federal
                  budget would add to national saving only if they were not offset by other
                  budget initiatives.

                  Reforms would affect other sources of retirement income and related
                  public policies as well. For example, raising payroll taxes could affect the
                  ability of workers to save for retirement, especially if these increases were
                  combined with tax increases enacted to help with Medicare or Medicaid
                  financing. Raising Social Security’s retirement age or cutting its benefit
                  amounts could increase costs for private pensions that adjust benefits in
                  relation to Social Security benefits. Reforms would also interact with other
                  income support programs, such as Social Security’s Disability Insurance
                  program or the Supplemental Security Income public assistance program.

                  Reforms could have effects both immediately and far into the future. For
                  example, bringing newly hired state and local government workers into
                  the Social Security system would immediately increase revenues but
                  would increase benefit payments only when the newly covered workers
                  retired. However, even changes that take effect years from now can affect
                  how workers plan now for their retirement, especially how much they
                  choose to save. Therefore, the sooner solutions are enacted, the more time
                  workers will have to adjust their retirement planning. Acting sooner rather
                  than later also would mean that the funding shortfall could be addressed
                  over a longer period at a lower annual cost.

                  Finally, any financing reforms would implicitly have distributional effects.
                  For example, increasing Social Security taxes would reduce the disposable
                  income of current workers but would help sustain retirement benefits for
                  retirees in the future. Cutting benefits instead of increasing payroll taxes
                  would have the opposite distributional effect. Also, Social Security
                  redistributes income from high to low earners to some degree; some
                  reforms would change this. In particular, reform proposals vary
                  considerably in their effects on specific subpopulations, some of which are
                  at greater risk of poverty, such as older women and unmarried women.



                  Page 12                                                     GAO/T-HEHS-98-43
               Social Security Reform: Demographic
               Trends Underlie Long-Term Financing
               Shortage




               For example, since men and women have different earnings histories, life
               expectancies, and investment behaviors, reforms could exacerbate
               differences in benefits that already exist.


               Ensuring that Americans have adequate retirement income in the 21st
Observations   century will require that the nation and the Congress make some difficult
               choices. Social Security has been effective in ensuring a reliable source of
               income in retirement and greatly reducing poverty among the elderly, and
               reforms will determine what role it will play in the future. The effect of
               reforms on other retirement income sources and on various groups within
               the aged population should be well understood when making reforms.

               Also, the demographic trends underlying Social Security’s financing
               problem are contributing significantly to increasing cost pressures for
               Medicare and Medicaid. Federal budget policy faces a profound challenge
               from the tremendous imbalance between these promised entitlements and
               the revenues currently planned to fund them. While Social Security’s
               financing is projected to pay full benefits until 2029, it will start to pose
               challenges for the federal budget much earlier—only 10 years from now.
               This fact illustrates the critical importance of examining how budget
               policy interacts with proposed reforms to Social Security and other
               entitlements. It also illustrates the need to act sooner rather than later.
               Timely policy adjustments can help us get onto a more sustainable fiscal
               path and may even help increase national saving and promote economic
               growth, which could ease the adjustments that current demographic
               trends will require.


               This concludes my testimony. I will be happy to answer any questions.




               Page 13                                                      GAO/T-HEHS-98-43
Page 14   GAO/T-HEHS-98-43
Page 15   GAO/T-HEHS-98-43
Related GAO Products


              Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19,
              Oct. 22, 1997).

              401(k) Pension Plans: Loan Provisions Enhance Participation but May
              Affect Retirement Income Security for Some (GAO/HEHS-98-5, Oct. 1, 1997).

              Retirement Income: Implications of Demographic Trends for Social
              Security and Pension Reform (GAO/HEHS-97-81, July 11, 1997).

              Social Security Reform: Implications for the Financial Well-Being of
              Women (GAO/T-HEHS-97-112, Apr. 10, 1997).

              401(k) Pension Plans: Many Take Advantage of Opportunity to Ensure
              Adequate Retirement Income (GAO/HEHS-96-176, Aug. 2, 1996).

              Social Security: Issues Involving Benefit Equity for Working Women
              (GAO/HEHS-96-55, Apr. 10, 1996).

              Federal Pensions: Thrift Savings Plan Has Key Role in Retirement Benefits
              (GAO/HEHS-96-1, Oct. 19, 1995).

              Social Security Retirement Accounts (GAO/HEHS-94-226R, Aug. 12, 1994).

              Social Security: Analysis of a Proposal to Privatize Trust Fund Reserves
              (GAO/HRD-91-22, Dec. 12, 1990).

              Social Security: The Trust Fund Reserve Accumulation, the Economy, and
              the Federal Budget (GAO/HRD-89-44, Jan. 19, 1989).




(207021)      Page 16                                                     GAO/T-HEHS-98-43
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