GAO

United States General Accounting Office

Testimony

Before the Committee on Ways and Means, House of 

Representatives

For Release on Delivery

Expected at

3 p.m.

Tuesday,

February 23, 1999

SOCIAL SECURITY AND 

SURPLUSES

GAOs Perspective on the 

Presidents Proposals

Statement of David M. Walker

Comptroller General of the United States

GAO/T-AIMD/HEHS-99-96

Page 1 GAO/T-AIMD/HEHS-99-96

Mr. Chairman and Members of the Committee:

It is a pleasure to be here today to discuss the Presidents recent proposal

for addressing Social Security and use of the budget surplus. These

proposals address some of the most important issues facing the nation,

both now and over the longer term. As you know, both GAO as an

institution and I as an individual have a long-standing interest in these

issues.

The Presidents proposal is complex, which makes it all the more important

for us to focus our attention on what it doesand what it does not dofor

our long-term future. In summary, the Presidents proposal:

 Reduces debt held by the public from current levels, thereby also

reducing net interest costs, raising national saving, and contributing to

future economic growth.

 Fundamentally changes Social Security financing in two ways:

 It promises general funds in the future by, in effect, trading publicly

held debt for debt held by the Social Security Trust Fund (SSTF).

 It invests some of the trust fund in equities with the goal of capturing

higher returns over the long term.

 Does not have any effect on the projected cash flow imbalance in the

Social Security programs taxes and benefits, which begins in 2013.

 Does not represent a Social Security reform plan and does not come

close to saving Social Security.

Context: Long-Term 

Outlook Is Important

It is important to look at the Presidents proposal in the context of the fiscal

situation in which we find ourselves. After nearly 30 years of unified

budget deficits, we look ahead to projections for surpluses as far as the

eye can see. At the same time, we know that we face a demographic

tsunami in the future that poses significant challenges for the Social

Security system, Medicare, and our economy as a whole. In this context,

we should recognize that the President uses a longer-term framework for

resource allocation than has been customary in federal budgeting.

Although all projections are uncertainand they get more uncertain the

farther out they gowe have long held that a long-term perspective is

important in formulating fiscal policy for the nation. Each generation is in

part the custodian for the economy it hands the next and the nations longterm economic future depends in large part on todays budget decisions.
Page 2 GAO/T-AIMD/HEHS-99-96

This perspective is particularly important because our model and that of

the Congressional Budget Office (CBO) continue to show that absent a

change in policy, the changing demographics to which I referred above will

lead to renewed deficits. This longer-term problem provides the critical

backdrop for making decisions about todays surpluses.

Surpluses are the result of a good economy and difficult policy decisions.

They also provide a unique opportunity to put our nation on a more

sustainable path for the long term, both for fiscal policy and the Social

Security program itself. Current decisions can help in several important

respects: (1) current fiscal policy decisions can help expand the future

capacity of our economy by increasing national savings and investment,

(2) engaging in substantive reforms of retirement and health programs can

reduce future claims, (3) by acting now, we have the opportunity of

phasing in changes to Social Security and health programs over a sufficient

period of time to enable our citizens to adjust, and (4) failure to achieve

needed reforms in the Social Security and Medicare programs will drive

future spending to unsustainable levels and eventually squeeze out most

or all discretionary spending. If we let the achievement of a budget surplus

lull us into complacency about the budget, then in the middle of the 21 st

century, we could face daunting demographic challenges without having

built the economic capacity or program/policy reforms to handle them.

The Proposal Before turning to the context for and analysis of the Presidents proposal,

let me briefly describe it. The President proposes to use approximately

15 years to reduce debt held by the public and to address Social Securitys

financing problem. His approach to this, however, is extremely complex

and confusing. The President proposes to transfer an amount equal to a

portion of the projected surplus to the Social Security and Medicare trust

funds.1 This transfer is projected to extend the solvency of Social Security

from 2032 to 2049. His proposal to permit the trust fund to invest in

equities is expected to further extend trust fund solvency to 2055. He calls

on the Congress to work with him on program changes to get to 2075.

To understand and evaluate this proposal, it is important to understand the

nature of the federal budget, how trust funds fit into that budget, and the

challenges of saving within the federal budget.

1In this testimony, I will address only the Social Security portion of this transfer. The issues are similar

but not identical for the Medicare trust fund transfer.
Page 3 GAO/T-AIMD/HEHS-99-96

Can We Save for the Future 

in the Federal Budget?

The federal budget is a vehicle for making choices about the allocation of

scarce resources. It is different from state budgets in ways important to

this discussion. Most states use fund budgeting in which pension funds

that are separate and distinct legal entities, build up surpluses that are

routinely invested in assets outside the government (e.g., readily

marketable securities held in separate funds). In contrast, the federal

governments unified budget shows all governmental transactions and all

funds are available for current activities, including current-year activities of

all trust funds. We cannot park our surplus in a cookie jar. The only way to

save in the federal budget is to run a surplus or purchase a financial asset.

When there is a cash surplus it is used to reduce debt held by the public.

Therefore, to the extent that there is an actual cash surplus, debt held by

the public falls.

This presents a problem for any attempt to advance fund all or part of

future Social Security benefits. Advance funding within the current

program would mean increasing the flows to the SSTF. Although it is

officially off budget, the fact remains that the SSTF is a governmental

fund. In the federal budget, trust funds are not like private trust funds.

They are simply budget accounts used to record receipts and expenditures

earmarked for specific purposes. A private trust fund can set aside money

for the future by increasing its assets. However, under current law, when

the SSTFs receipts exceed costs, they are invested in Treasury securities

and used to meet current cash needs of the government. These securities

are an asset to the trust fund, but they are a claim on the Treasury. Any

increase in assets to the SSTF is an equal increase in claims on the

Treasury. One government fund is lending to another. The transactions net

out on the governments books. Given this investment policy, any increase

in the trust fund balances would only become an increase in saving if this

increment were to add to the unified budget surplus (or decrease the

unified budget deficit) and thereby reduce the debt held by the public.

This is also the only way in which an increase in the SSTF balance could be

a form of advance funding.

How do these transactions affect the governments debt? Gross federal

debt is the sum of debt held by the public and debt held by governmental

accountslargely trust funds. This means that increases in the trust fund

surplus will increase gross debt unless debt held by the public declines by

at least the same amount. Any reform of Social Security that increases the

annual SSTF surplus would increase debt held by government accounts

since, under current law, any excess of revenues over benefit payments is

loaned to Treasury for current needs. As a result, total government debt
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would go up unless these surpluses were used to reduce debt held by the

public by an equivalent amount.

For most people, the different types of debt in the federal budget may be

confusingespecially since what is good news for a trust fund may be

bad news for total debt and vice versa. This is so because total debt (or

gross debt) is the sum of two very different types of debtdebt owed to the

public and debt owed by one part of the government (general fund) to

another part of the government (trust funds). Therefore, if a trust fund

surplus grows faster than debt held by the public falls, total debt grows

even if the trust fund surplus is created as an attempt to save or to prefund some of the future benefit payments. These contradictory

movements emphasize the need to differentiate between different types of

debt and what they mean. Both debt held by the public and debt held by

trust funds are important--but for different reasons. Analytically, therefore,

what is most important is not whether total debt increases but rather the

reasons behind the increase--does it represent an attempt to advance

fund through substantive reform or merely the promise of future

resources?

Debt held by the public and debt held by trust funds represent very

different concepts. Debt held by the public approximates the federal

governments competition with other sectors in the credit markets. This

affects interest rates and private capital accumulation. Further, interest on

debt held by the public is a current burden on taxpayers. Reducing this

burden frees up capacity to meet future needs .

In contrast, debt held by trust funds performs an accounting function and

currently represents the cumulative annual surpluses of these funds (i.e.,

excess of receipts over disbursements plus accrued interest). Importantly,

debt held by the SSTF does not represent the actuarial present value of

expected future benefits for either current or future participants. Nor does

this debt have any of the economic effects of borrowing from the public. It

is not a current transaction of the government with the public; it does not

compete with the private sector for available funds in the credit market. It

reduces the need to borrow from the public and so may hold down interest

rates. Unlike debt held by the public, debt held by trust funds does not

represent an immediate burden on current taxpayers. Rather, it is a claim

on future resources. The surplus is held in Treasury securities that give the

SSTF a claim on the Treasury equal to the value of those securities. When

the securities have to be redeemed, the Treasury must come up with the
Page 5 GAO/T-AIMD/HEHS-99-96

cash. At that time, taxpayers will see some combination of a lower surplus,

lower spending, higher taxes, and/or greater borrowing from the public.

If borrowing from the public is increased to cover this cash need, there

could be upward pressure on interest rates. In addition, because debt held

by the trust fund is not equal to future benefit payments--it is not a measure

of the unfunded liability of the current system--it cannot be seen as a

measure of this future burden. Nevertheless, it provides an important

signal of the existence of this burden. Whether the debt constitutes a new

economic burden for the future or merely recognizes an existing one

depends on whether these currently promised benefits would be paid even

in the absence of the securities.

How Does the Presidents 

Proposal Work?

This information is important to understand the Presidents proposal

because, in large part, he proposes a set of transactions that, in effect, trade

debt held by the public for debt held by the SSTF. 2 By running a cash

surplus over the next 15 years, debt held by the public falls. To save this

surplus, the President proposes to transfer it to the trust fund in the form

of increased Treasury securities. Under his proposal, debt held by the

public falls, but debt held by the trust funds increases. Because he shows

the transfer as a subtraction from the surplusa new budgetary concept

he shows no surplus. As a result, he attempts to save some of the projected

surplus by hiding it.

The mechanics of the proposed transfer of surpluses to the SSTF are

complex and difficult to follow. Few details have been made available, and

there is conflicting information on exactly how it would work. Figures 1

and 2 are flowcharts representing our best understanding of the Social

Security portion of this transfer. Since it is impossible to understand the

changes proposed by the President without understanding the present

system, figure 1 shows the flows under the current system. Under current

law, annual cash flow surpluses (largely attributable to excess payroll taxes

over benefits payments and program expenses) are invested in Treasury

2Paying down publicly held debt and issuing new special securities to the SSTF are two different

transactions. Nevertheless, the effect is as if the securities are exchanged.
Page 6 GAO/T-AIMD/HEHS-99-96

securities.3 This excess cash is commingled with other revenues and

used to finance other governmental activities. In this way, SSTF surpluses

have helped and continue to help finance the rest of the government. This

year, the SSTF surplus is expected to exceed the general fund deficit so

there is also a surplus in the unified budget. Over the entire 15-year period,

more than half of the projected unified surplus is composed of Social

Security surpluses. Absent any change in policy, these unified surpluses

will be used to reduce the debt held by the public.

Figure 1: Current Social Security Flows

*Unified surplus = FICA surplus + general fund surplus

Source: GAO Analysis.

3This presentation is somewhat simplified. In reality, FICA taxes are collected with income and

corporate taxes by the Treasury and then allocated by the Treasury to Social Security, Medicare, or the

general fund. In addition, a portion of income taxes paid on Social Security benefits flow into the SSTF.

The expenditure side of the SSTF transactions is also simplified since administrative expenses also

flow from the trust fund. These elements are unchanged by the Presidents proposal and do not change

the flows critical to understanding it.

Unified Budget

FICA Surplus

Special Treasuries

FICA Taxes

*Unified surplus would

pay down the debt held

by the public

Social Security

Trust Fund General Fund

 Discretionary

Spending

Mandatory

Spending

Other Taxes

Benefits
Page 7 GAO/T-AIMD/HEHS-99-96

Under the Presidents proposal, this would continue. However, as shown in

figure 2, at the point where total tax receipts are allocated to pay for

government activities, a new financing step would be added to transfer a

portion of the unified budget surpluses to the Social Security and Medicare

trust funds. The unified budget would do this by providing a new set of

securities for these trust funds. However, the excess cash would still be

used to reduce the debt held by the public.

Figure 2: Social Security Flows Under President’s Proposal

Source: GAO Analysis.

In essence, this exchanges debt held by the public for debt held by the trust

funds. While there are many benefits to reducing publicly held debt, it is

important to recognize that under the current law baselinei.e., with no

changes in tax or spending policythis would happen without crediting

additional securities to the trust funds.

FICA Surplus

Special Treasuries

Transfer for

Trust Fund

Special treasuries and

authority to purchase

equities

Unified surplus would pay down

the debt held by the public

Social Security

Trust Fund General Fund

Discretionary

Spending

Mandatory

Spending

Purchase of

equities

Other Taxes

Benefits

Unified Budget

FICA Taxes
Page 8 GAO/T-AIMD/HEHS-99-96

The administration has defended this approach as a way of assuring both a

reduction in debt held by the public and giving Social Security first claim

on what they call the debt-reduction dividend to pay future benefits.

However, issuing these additional securities to the SSTF is a discretionary

act with major legal and economic consequences for the future. Some

could view this as double countingor double-crediting. Importantly, to

the extent it appears that way to the public, it could undermine confidence

in a system that is already difficult to explain. However, the debate over

double counting focuses on the form of the proposal rather than its

substance. Although form is important when it interferes with our ability

to understand the substanceand I think this proposal falls into that

trapthe important debate must be on the substance of the proposal.

This proposal represents a fundamental shift in the way the Social Security

program is financed. It moves it away from payroll financing toward a

formal commitment of future general fund resources for the program. This

is unprecedented. Later in my statement, I will discuss the implications of

this proposal for overall fiscal policy and for the Social Security program.

Government Financing 

and Debt

The Presidents proposals would have the effect of reducing debt held by

the public from the current level of 44 percent of Gross Domestic Product

(GDP) to 7 percent over the 15-year period. The President notes that this

would be the lowest level since 1917. Nearly two-thirds of the projected

unified budget surplus would be used to reduce debt held by the public.

Because the surplus is also to be used for other governmental activities, the

amount of debt reduction achieved would be less than the baseline (i.e., a

situation in which none of the surplus was used), but nonetheless the

outcome would confer significant benefits to the budget and the economy.

Our previous work on the long-term effects of federal fiscal policy has

shown the substantial benefits of debt reduction. 4 One is lowering the

burden of interest payments in the budget. Today, net interest represents

the third-largest program in the budget, after Social Security and Defense.

Interest payments, of course, are a function of both the amount of debt on

which interest is charged and the interest rate . At any given interest rate,

reducing publicly held debt reduces net interest payments within the

4Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, October 22, 1997).
Page 9 GAO/T-AIMD/HEHS-99-96

budget. For example, CBO estimates that the difference between spending

the surplus and saving the surplus is $123 billion in annual interest

payments by 2009--or almost $500 billion cumulatively between now and

then. Compared to spending the entire surplus, the Presidents proposal

would also substantially reduce projected interest payments . Lower

interest payments lead to larger surpluses; these in turn lead to lower debt

which leads to lower interest payments and so on: the miracle of

compound interest produces a virtuous circle. The result would be to

provide increased budgetary flexibility for future decisionmakers who will

be faced with enormous and growing spending pressures from the aging

population.

For the economy, lowering debt levels increases national saving and frees

up resources for private investment. This in turn leads to increased

productivity and stronger economic growth over the long term. Over the

last several years, we and CBO have both simulated the long-term

economic results from various fiscal policy paths. These projections

consistently show that reducing debt held by the public increases national

income over the next 50 years, thereby making it easier for the nation to

meet future needs and commitments. Our latest simulations done for the

Senate Budget Committee, as shown in figure 3, illustrate that any path that

saves all or a significant share of the surplus in the near term would

produce demonstrable gains in per capita GDP over the long run. 5 This

higher GDP in turn would increase the nations economic capacity to

handle all its commitments in the future.

5The on-budget balance path assumes that any surplus in the non-Social Security part of the budget is

spent on either a tax cut or spending increases or some combination but assumes the current law path

for the Social Security trust fund. Thus, the surplus in the Social Security trust fund remains untouched

until it disappears in 2013 after which the unified budget runs a deficit equal to the SSTF deficit. The

Save the Surplus path assumes no changes in current policies and that budget surpluses through 2024

are used to reduce debt held by the public. The No Surplus path assumes that permanent increases in

discretionary spending and tax cuts deplete the surpluses but keep the budget in balance through 2009.

Thereafter, deficits reemerge as spending pressures grow.
Page 10 GAO/T-AIMD/HEHS-99-96

Figure 3: GDP Per Capita Under Alternate Fiscal Policy Simulations

Source: GAO Analysis.

Under the Presidents proposal, debt held by trust funds goes up more

rapidly than debt held by the public falls, largely due to these additional

securities transferred to the trust funds. Gross debt, therefore, increases.

It is gross debtwith minor exceptionsthat is the measure that is subject

to the debt limit. The current limit is $5.95 trillion. Under the Presidents

plan, the limit would need to be raised sometime during 2001. Under either

the CBO or the Office of Management and Budget baseline (i.e., save the

entire surplus), the limit would not need to be raised during at least the

next 10 years. Since other proposals to use the surplus would also bring

forward the time when the debt limit would have to be raised, the impact of

the Presidents proposal on debt is in part a compared to what? question.

In figure 4, we show the debt subject to limit under the baseline, the

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046 2050

On-budget balance Save the surplus No surplus

1998 level

Per capita 1998 dollars
Page 11 GAO/T-AIMD/HEHS-99-96

Presidents proposal, and a hypothetical path we have labeled on-budget

balance.6

Figure 4: Debt Subject to Limit Under Baseline and President’s Proposal

Source: OMB, CBO, Senate Budget Committee, and GAO Analysis.

6The baseline is the CBO baseline. It assumes that none of the surplus is used for tax cuts or spending

increases. On-budget balance assumes that any surplus in the non-Social Security part of the budget

is spent on either a tax cut or spending increases or some combination but that the surplus in the

Social Security trust fund remains untouched. There is no on-budget surplus until 2001.

$4,000

$4,500

$5,000

$5,500

$6,000

$6,500

$7,000

$7,500

$8,000

$8,500

$9,000

President's Budgetwith Social Security Proposal On-Budget Balance CBOBaseline

Debt Limit $5,950

Dollars in billions
Page 12 GAO/T-AIMD/HEHS-99-96

Figures 5 and 6 below compare the composition of debt under the same

three paths: the baseline (save the entire surplus), the Presidents proposal

(including both the Social Security proposal and the other spending), and

on-budget balance. Figure 5 shows debt held by the public under all

three scenarios, and figure 6 shows debt held by governmental accounts.

As figure 5 shows, debt held by the public falls under all three scenarios.

Since the baseline assumes the entire surplus is devoted to reducing debt

held by the public, it shows the greatest drop. Under the on-budget

balance path there are no tax cuts or spending increases until there is an

on-budget balance in 2001 while under the Presidents proposal spending

increases and tax cuts are front-loaded. As a result, the Presidents

proposal is projected to reduce debt held by the public less than the onbudget balance path during these 10 years.

Figure 6 shows the impact of the Presidents proposal to transfer securities

to the SSTF. The projections for debt held by government accounts are the

same for the baseline and the on-budget balance paths since neither

changes current law. Under the Presidents proposal, however, debt held

by the SSTF increases as securities are transferred to it. This leads to the

increase shown in figure 6.
Page 13 GAO/T-AIMD/HEHS-99-96

Figure 5: Composition of Federal Debt: Debt Held by the Public 

Source: OMB, CBO, Senate Budget Committee, and GAO Analysis. 

$ 0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

P re s id e nt's Bu d g et w ith So cia l Se c u rity P ro p o s a l O n -Budg et Balance CBO Ba se lin e

Dollars in billions
Page 14 GAO/T-AIMD/HEHS-99-96

Figure 6: Composition of Debt: Debt Held by Government Accounts

Note: Debt held by government accounts is the same under CBO baseline and the on-budget balance 

path.

Source: OMB, CBO, Senate Budget, and GAO Analysis.

While reducing debt held by the public appears to be a centerpiece of the

proposaland has significant benefitsas I noted above, the transfer of

unified surpluses to Social Security is a separate issue. The transfer is not

technically necessary: whenever revenue exceeds outlays and the cash

needs of the Treasurywhenever there is an actual surplusdebt held by

the public falls. The Presidents proposal appears to be premised on the

belief that the only the way to sustain surpluses is to tie them to Social

Security. He has merged two separate questions: (1) how much of the

surplus should be devoted to reducing debt held by the public and (2) how

should the nation finance the Social Security program in the future.

Let me turn now to the question of Social Security financing.

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

President's Budget with Social Security Proposal On -Budget Balance CBO Baseline

Dollars in billions
Page 15 GAO/T-AIMD/HEHS-99-96

Social Security 

Financing

The President proposes two changes in the financing of Social Security: a

pledge of general funds in the future and a modest amount of investment in

equities. Both of these represent major shifts in approach to financing the

program.

General Fund Financing By, in effect, trading debt held by the public for debt held by the trust funds,

the President is committing future general revenues to the Social Security

program. This is true because the newly transferred securities would be in

addition to any buildup of payroll tax surpluses. Securities held by the

SSTF have always represented annual cash flows in excess of benefits and

expenses, plus interest. 7 Under the Presidents proposal, this would no

longer continue to be true. The value of the securities held by the SSTF

would be greater than the amount by which annual revenues plus interest

exceed annual benefits and expenditures.

This means that for the first time there is an explicit general fund subsidy.

This is a major change in the underlying theoretical design of this program.

Whether you believe it is a major change in reality depends on what you

assume about the likely future use of general revenues under the current

circumstances. For example, current projections are that in 2032 the fund

will lack sufficient resources to pay the full promised benefits. If you

believe that this shortfall wouldwhen the time camebe made up with

general fund moneys, then the shift embedded in the Presidents proposal

merely makes that explicit. If, however, you believe that there would be

changes in the benefit or tax structure of the fund instead, then the

Presidents proposal represents a very big change. In either case, the

question of bringing significant general revenues into the financing of

Social Security is a question that deserves full and open debate. The debate

should not be overshadowed by the accounting complexity and budgetary

confusion of the proposal.

One disconcerting aspect of the Presidents proposal is that it appears that

the transfers to the trust fund would be made regardless of whether the

expected budget surpluses are actually realized. The amounts to be

7Cash flow into the SSTF is composed of payroll taxes and a portion of the income taxes paid on Social

Security benefits. Income taxes make up a relatively small component of the surplus. Interest paid to

Social Security is analogous to interest paid on publicly held debt. Both come from the general fund.

Interest on publicly held debt is paid in cash while interest to the trust fund is credited in the form of

additional Treasury securities.
Page 16 GAO/T-AIMD/HEHS-99-96

transferred to Social Security apparently would be written into law as

either a fixed dollar amount or as a percentage of taxable payroll rather

than as a percentage of the actual unified surplus in any given year. These

transfers would have a claim on the general fund even if the actual surplus

fell below the amount specified for transfer to Social Securityand that

does present a risk.8 However, it is important to emphasize that any

proposal to allocate surpluses is vulnerable to the risk that those projected

surpluses may not materialize. Proposals making permanent changes to

use the surplus over a long period of time are especially vulnerable to this

risk.

The history of budget forecasts should remind us not to be complacent

about the certainty of these large projected surpluses. In its most recent

outlook book, CBO compared the actual deficits or surpluses for 1988-1998

with the first projection it produced 5 years before the start of each fiscal

year. Excluding the estimated impact of legislation, CBO says its errors

averaged about 13 percent of actual outlays. Such a shift in 2004 would

mean a surplus $250 billion higher or lower; in 2009, the swing would be

about $300 billion. Accordingly, we should consider carefully any

permanent commitments that are dependent on the realization of a longterm forecast.

Investment in Equities Under current law, the SSTF is required to invest only in securities that are

issued or backed by the Treasury. The President proposes changing

current law to allow the SSTF to invest a portion of its assets in equities.

His proposal calls for the fund to gradually invest 15 percent of its total

assets in the equity market. According to the administrations estimates,

the SSTFs equity holdings would represent only a small portionabout 4

percentof the total equity market. To insulate investment decisions from

political considerations, the administration proposes investing passively in

a broad-based stock index and creating an independent board to oversee

the portfolio.

8It is worth noting that something like this happens now. Treasury does not track how much of the

revenues it collects are for Social Security and how much for income taxes. It credits the SSTF with

funds equal to the appropriate tax rate applied to the taxable wage basewhether or not those FICA

taxes were actually paid.
Page 17 GAO/T-AIMD/HEHS-99-96

Last year, we reported on the implications of allowing the SSTF to invest in

equities.9 In that report, we concluded that stock investing offers the

prospect of higher returns in exchange for greater risk. We found that, by

itself, stock investing was unlikely to solve Social Securitys long-term

financing imbalance but that it could reduce the size of other reforms

needed to restore the programs solvency. We also concluded that investing

in a broad-based index would help reduce, but not eliminate, the possibility

of political influence over stock selections. However, the issue of how to

handle stock voting rights could prove more difficult to resolve. If the

government voted its shares, it would raise concerns about potential

federal involvement in corporate affairs. If the government chose not to

vote, it would affect corporate decision-making by enhancing the voting

power of other shareholders or investment managers. The model

applicable to passive private sector investment managers under the

Employee Retirement Income Security Act may be relevant to the

resolution of this issue.

Stock investing would have approximately the same impact on national

saving as using the same amount of money to reduce debt held by the

public. Both approaches would add about the same amount of funds to

private capital markets, meaning that national saving would essentially be

unchanged. From a budget accounting standpoint, they are not the same.

Under current scoring rules the purchase of equities would be counted as

an outlay, even though it is a financial transaction, because it is a transfer of

funds from a governmental entity to a nongovernmental entity. The

proposal apparently would change that. The administration proposes to

show the entire transfer to the SSTF as a reduction in the surplus and the

equity purchases would be part of that. The purchase of equities has

another financial impact: since part of the surplus would be used to

purchase equities, debt held by the public would be reduced less in the near

term than if that amount went to reduce publicly held debt. However, in

the future, claims on the Treasury would be lower because the program

would rely in part on stock sales to pay benefits.

9Social Security Financing: Implications of Government Stock Investing for the Trust Fund, the Federal

Budget, and the Economy (GAO/AIMD/HEHS-98-74, April 22, 1998).
Page 18 GAO/T-AIMD/HEHS-99-96

Have Other Countries 

Tackled These 

Problems?

Although the dilemma we are facing of whether and how to save for the

future is a very difficult one, it is not unique. A look at other democracies

shows that surpluses are difficult to sustain. However, several nations have

succeeded in sustaining surpluses. In those nations, political leaders were

able to articulate a compelling rationale to justify the need to set aside

current resources for future needs.

For example, those countries that have come to the conclusion that the

debt burden matters make it an explicit part of their fiscal decision-making

process. Australia, New Zealand, and the United Kingdom all attempt to

define prudent debt levels as a national goal to strive for. These debt goals

can prove important in times of surplus. New Zealand, for example, used

its debt goals as justification for maintaining spending restraint and

attempting to run sustained surpluses. They promised that once they met

their initial debt target they would give a tax cut. Importantly, when they

hit that specified debt target, they delivered on their promise of tax cuts.

Other countries have saved for the future by separating their pension or

Social Security-related assets from the rest of the governments budget.

For example, the Canadian Pension Plan is completely separate from both

federal and provincial budgets. When the fund earns surplus cash, it is

invested in provincial debt securities and, starting this year, in the stock

market. Sweden also maintains a pension fund outside the governments

budget and invests assets in stocks and bonds.

Norway may be the most dramatic example of setting aside current

surpluses to address long-term fiscal and economic concerns. Norway

faces the two-edged problem of a rapidly aging population and declining oil

revenuesa significant source of current government revenue. To address

these long-term concerns, Norway started setting aside year-end budget

surpluses in 1996 to be invested in foreign stocks and bonds. Their express

intention is to draw down these assets to pay for the retirement costs for

their baby boomers.

It should be noted that other nations that have attempted to directly

address their debt and pension problems have usually done so during or

shortly after a fiscal or economic crisis. Fortunately, we do not have that

problem. Instead, we have a unique opportunity to use our current good

fortune to meet the challenges of the future.
Page 19 GAO/T-AIMD/HEHS-99-96

Social Security Reform 

Is Still Needed 

Finally, it is important to note that the President's proposal does not alter

the projected payroll tax and benefit imbalances in the Social Security

program. In addition, it does not come close to saving Social Security.

Benefit costs and revenues currently associated with the program will not

be affected by even 1 cent. Figure 7, which shows Social Security's payroll

tax receipts and benefit payments, illustrates this point. Without the

President's proposal, payroll tax receipts will fall short of benefit payments

in 201310; with the President's proposal, payroll tax receipts also fall short

of benefit payments in 2013the graph doesn't change at all. Under the

Presidents proposal, expected stock market returns would be used to fill

part of this gap, but from 2013 on the trust funds will need cash from

redeemed Treasury securities, whether or not the President's proposal is

adopted.

10Cash inflows actually consist of payroll taxes plus the income taxes paid on Social Security benefits.

Cash outflows are almost entirely made up of benefit payments, but they also include the funds

administrative expenses.
Page 20 GAO/T-AIMD/HEHS-99-96

Figure 7: SSTF Projected Cash Income and Outflow Through 2019

Source: Social Security Trustees 1998 Report, Intermediate Assumptions.

What does this mean? In 2013, inflows to the SSTF from payroll taxes and

income taxes on Social Security benefits will no longer exceed outflows for

benefits and administrative expenses. As a result, the year 2013 is the key

date from a government financing perspective. At this point, the SSTF will

have to begin drawing on its other income sourcesthe transfers from the

general fund proposed by the President and the returns on its existing

assets. Beginning in 2015, the SSTF will obtain some of the additional cash

it needs from its equity holdings. However, most of the cash needed in the

years that follow would come from tapping the SSTFs Treasury securities.

When the SSTF begins drawing on the Treasury, it means that the rest of

the government will have to come up with the cash. If there is a unified

budget surplus, it will shrink. If, however, there is no surplus, there are

only three choices: cut spending, raise taxes, and/or increase borrowing

from the public. The amount needed from the rest of the government to

help cover the SSTFs cash deficit will escalate rapidly, exceeding $100

billion annually by 2019. This has already happened to Medicares Hospital

$0.0

$0.2

$0.4

$0.6

$0.8

$1.0

$1.2

$1.4

$1.6





































Cash Income Cash Outgo

Dollars in trillions
Page 21 GAO/T-AIMD/HEHS-99-96

Insurance Trust Fund--it has been drawing on its special treasuries for

several years.

Under the Presidents proposal, the changes to the Social Security program

will be more perceived than real: although the trust funds will appear to

have more resources as a result of the proposal, in reality, nothing about

the program has changed. The proposal does not represent Social Security

program reform, but rather a different means to finance the current

program. Although the President has called for bipartisan cooperation to

make programmatic changes, one of the risks of his proposal is that the

additional years of financing it provides could very well diminish the

urgency to achieve meaningful changes in the program. This would not be

in the overall best interests of the nation.

To achieve long-term solvency and sustainability, the Social Security

program itself must be reformed. The demographic trends that are driving

the program's financial problems affect the program well into the future.

The impending retirement of the baby boom generation is the best known

of these trends, but is not the only challenge the system faces. If this were

so, perhaps a one-time financing strategy could be sufficient. But people

are retiring earlier, birth rates have fallen, and life expectancies are

increasingall these factors suggest that Social Security's financial

problems will outlive the baby boom generation and continue far into the

future. These problems cannot be addressed without changes to the Social

Security program itself.

Changes to the Social Security system should be made sooner rather than

later. The longer meaningful action is delayed, the more severe such

actions will have to be in the future. Changes made today would be

relatively minor compared to what could be necessary years from now,

with less time for the fiscal effects of those changes to build. Moreover,

acting now would allow any benefit changes to be phased in gradually so

that participants would have time to adjust their saving or retirement goals

accordingly. It would be tragic indeed if this proposal, through its

budgetary accounting complexity, masked the urgency of the Social

Security solvency problem and served to delay much-needed action.

There is another reason to take action on Social Security now. Social

Security is not the only entitlement program needing urgent attention. In

fact, the issues surrounding the Medicare program are much more urgent

and complex. Furthermore, the many variables associated with health care
Page 22 GAO/T-AIMD/HEHS-99-96

consumption and Medicare costs and the personal emotions associated

with health decisions make reform in this program particularly difficult.

To move into the future without changes in Social Security or health

programs is to envision a very different role for the federal government.

Assuming no financing or benefit changes, our long-term model (and that

of CBO) shows a world in 2050 in which Social Security and health care

absorb an increasing share of the federal budget. (See figure 8.) Budgetary

flexibility declines drastically and there is increasingly less room for

programs for national defense, the young, infrastructure, and law

enforcementi.e., essentially no discretionary programs at all. Eventually,

again assuming no program or financing changes, Social Security, health,

and interest take nearly all the revenue the federal government takes in by

2050. This is true even if we assume that the entire surplus is saved and

these continued surpluses reduce interest from current levels. As shown in

figure 9, the picture below is even more dramatic if we assume the entire

surplus is used.11 In that scenario, lower GDP and higher interest

payments lead to a world in which revenues cover only Social Security,

health, and interest in 2030. And in 2050 revenues dont even cover Social

Security and health!

11Our "No Surplus" simulation is not a forecast but rather an illustration of the implications of enacting

permanent tax cuts and/or spending increases that eliminate projected surpluses and the fiscal

pressures posed by the aging of the baby boom generation. This simulation shows ever-increasing

deficits that result in declining investment, a diminishing capital stock, and a collapsing economy. In

reality, these economic consequences would inevitably force policy changes to avert such a

catastrophic outcome.
Page 23 GAO/T-AIMD/HEHS-99-96

Figure 8: Composition of Spending as a Share of GDP Under “Save the Surplus” 

Simulation

Source: GAO Analysis.

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

1998 2030 2050

Social Security Medicare & Medicaid Net Interest All other spending

Revenue
Page 24 GAO/T-AIMD/HEHS-99-96

Figure 9: Composition of Spending as a Share of GDP Under “No Surplus” 

Simulation

Source: GAO Analysis.

Although views about the role of government differ, it seems unlikely that

many would advocate a government devoted solely to sending checks and

health care reimbursements to the elderly.

Let us address Social Security for the long term today so that the nation can

turn its attention to these other more pressing and difficult issues early in

the new millenium. Look again at figures 8 and 9: Social Security is not the

fastest growing portion of those barshealth grows faster.

Much remains to be done in reforming entitlement programs, and engaging

in meaningful Social Security reform would represent an important and

significant first step. The Congress and the administration, working

together, can find a comprehensive and sustainable solution to this

important challenge.

I recognize, though, that restoring Social Security solvency is not easy.

However, it is easy lifting compared to what faces us in connection with the

Medicare program. Ultimately, any reforms to Social Security will address

0%

10%

20%

30%

40%

50%

60%

70%

80%

1998 2030 2050

Social Security Medicare & Medicaid Net Interest All other spending

Revenue
Page 25 GAO/T-AIMD/HEHS-99-96

not only the relatively narrow question of how to restore solvency and

assure sustainability but will also go to the larger question of what role

Social Security and the federal government should play in providing

retirement income. There are many proposals being made to address these

questions; choosing among them will involve difficult and complex choices,

choices that will be critically important to nearly every Americans

retirement income.

In my view, progress is likely to be greatest if we see these choices not as

either/or decisions but rather as an array of possibilities along a

continuum. Combining elements of different approaches may offer the

best chance to produce a package that addresses the problem

comprehensively for the long term in a way that is meaningful and

acceptable to the American people. For example, such a continuum may

identify individual accounts that could serve as a voluntary or mandatory

supplement to a financially sound and sustainable base defined benefit

structure. In addition, master trust principles can be used to provide for

collective investment of base defined benefit and individual account funds

in ways that would serve to prevent political manipulation of investments.

In order to help structure these choices, I would suggest five criteria for

evaluating possible Social Security proposals.

Sustainable solvency: A proposal should eliminate the gap between trust

fund resources and expenditures over 75 years, and have the ability to

sustain a stable system beyond that time period.

Equity: A proposal should create no "big winners" or "big losers." Those

who are most reliant on Social Security for retirement and disability

income should continue to receive adequate support; those who contribute

the most would also benefit from participation in the system, and

intergenerational equity would improve.

Adequacy: Consistent with Social Securitys social insurance feature, a

proposal should provide for a certain and secure defined benefit promise

that is geared to providing higher replacement rates for lower-income

workers and reasonable minimum benefits to minimize poverty among the

elderly.

Feasibility: A proposal should be structured so that it could be

implemented within a reasonable time period, it could be readily
Page 26 GAO/T-AIMD/HEHS-99-96

administered, and the administrative costs associated with it would be

reasonable.

Transparency: A proposal should be readily understandable to the general

public and, as a result, generate broad support.

Applying such criteria will require a detailed understanding of the possible

outcomes and issues associated with the various elements of proposals.

We are working to provide the data, information, and analysis needed to

help policymakers evaluate the relative merits of various proposals and

move toward agreement on a comprehensive Social Security reform

proposal.

Conclusions Budget surpluses provide a valuable opportunity to capture significant

long-term gains to both improve the nations capacity to address the

looming fiscal challenges arising from demographic change and aid in the

transition to a more sustainable Social Security program. The Presidents

proposal may prompt a discussion and decision on both how much of our

current resources we want to save for the future and how we can best do

so. The Presidents proposal is both wide ranging and complex, and it

behooves us to clarify the consequences for both our national economy and

the Social Security program.

A substantial share of the surpluses would be used to reduce publicly held

debt, providing demonstrable gains for our economic capacity to afford our

future commitments. In this way, the proposal would help us, in effect,

prefund these commitments by using todays wealth earned by current

workers to enhance the resources for the next generations.

Saving a good portion of todays surpluses can help future generations of

workers better afford the billowing costs of these commitments, but this is

only one side of the equation. We must also reform the programs

themselves to make these commitments more affordable. Even if we save

the entire surplus over the next 50 years Social Security and health

programs will double as a share of the economy and consume nearly all

federal revenues--essentially crowding out all other spending programs.

Thus, it is vital that any proposal to expand economic growth be

accompanied by real entitlement reform.

The transfer of surplus resources to the trust fund, which the

administration argues is necessary to lock in surpluses for the future,
Page 27 GAO/T-AIMD/HEHS-99-96

would nonetheless constitute a major shift in financing for the Social

Security program, but it would not constitute real Social Security reform

because it does not modify the programs underlying commitments for the

future. Moreover, the proposed transfer may very well make it more

difficult for the public to understand and support the savings goals

articulated. Several other nations have shown how debt reduction itself

can be made to be publicly compelling, but only you can decide whether

such an approach will work here.

I am very concerned that enhancing the financial condition of the trust fund

alone without any comprehensive and substantive program reforms may, in

fact, undermine the case for fundamental program changes. In addition,

explicitly pledging federal general revenues to Social Security will limit the

options for dealing with other national issues.

The time has come for meaningful Social Security reform. Delay will only

serve to make the necessary changes more painful down the road. We must

be straight with the American people; achieving the goal of saving Social

Security will require real options to increase program revenues and/or

decrease program expenses. There is no free lunch. After all, we have

much larger and more complex challenges to tackle like the Medicare

program.

As you consider various proposals, you should consider the following

questions.

 How much of the unified budget surplus should go to debt reduction

versus other priorities?

 If we are to use some portion of the surplus to reduce publicly held debt,

is the Presidents proposed approach the way to do this?

 Should Social Security be financed in part by general revenues?

 Should the SSTF invest in the stock market?

 How can we best assure the solvency, sustainability, equity, and integrity

of the Social Security program for current and future generations of

Americans?

 How can we best increase real savings for our future?

 How can we best assure the publics understanding of and support for

any comprehensive Social Security reform proposal?

We at GAO stand ready to help you address both Social Security reform and

other critical national challenges. Working together, we can make a

positive and lasting difference for our country and the American people.

(935303) Letr
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