```
                                                                 
Social Security: Analysis of Issues and Selected Reform Proposals
(15-JAN-03, GAO-03-376T).					 
                                                                 
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, 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 report called for a period of discussion	 
lasting at least a year before legislative action is taken to	 
strengthen and restore sustainability to Social Security. We have
also done a qualitative review of three other proposals 	 
introduced in the 107th Congress.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-376T					        
    ACCNO:   A05863						        
  TITLE:     Social Security: Analysis of Issues and Selected Reform  
Proposals							 
     DATE:   01/15/2003 
  SUBJECT:   Disability insurance				 
	     Economic analysis					 
	     Federal social security programs			 
	     Funds management					 
	     Future budget projections				 
	     Retirement benefits				 
	     Social security benefits				 
	     Strategic planning 				 
	     Disability Insurance Program			 
	     Hospital Insurance Trust Fund			 
	     Medicaid Program					 
	     Medicare Program					 
	     Social Security Program				 
	     Social Security Trust Fund 			 
	     Old-Age and Survivors Insurance Program		 

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GAO-03-376T

SOCIAL SECURITY Analysis of Issues and Selected Reform Proposals

Statement of David M. Walker Comptroller General of the United States

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

GAO- 03- 376T

Page 1 GAO- 03- 376T

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 report 2 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.

1 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). 2 Strengthening Social
Security and Creating Personal Wealth for All Americans (Dec. 21, 2001;
rev. Mar. 19, 2002). 3 Social Security: Analysis of the Commission to
Strengthen Social Security (GAO- 03- 310, Jan. 15, 2003).

Page 2 GAO- 03- 376T

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 3 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
funds 4 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,

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

Page 4 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
a long- range and more fundamental financing problem driven largely by
known demographic trends. The lack of an immediate solvency crisis

affects the nature of the challenge, but it does not eliminate the need
for action. Acting soon reduces the likelihood that the Congress will have
to choose between imposing severe benefit cuts and unfairly burdening
future generations with the program*s rising costs. Acting soon would
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.

As you all know, Social Security has always been largely a pay- as- you-
go system. This means that current workers* taxes pay current retirees*
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 Social Security*s Long- Term Financing

Problem Is More Urgent Than It May Appear

Demographic Trends Drive Social Security*s LongTerm Financing Problem

Page 5 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

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.

0 1

2 3

4 5

6 2080 2060 2040 2020 2000 1980 1960 Covered workers per OASDI beneficiary

Page 6 GAO- 03- 376T

Figure 2: Labor Force Growth Is Expected to be Negligible by 2050 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.

0 1

2 3 Percent change (5- year moving average)

2075 2050 2025 2000 1975

Page 7 GAO- 03- 376T

Today, the Social Security Trust Funds take in more in taxes than they
spend. Largely because of the known demographic trends I have 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

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.

5 Separately, the Disability Insurance Fund is projected to be exhausted
in 2028 and the OldAge and Survivors Insurance Fund in 2043. Social
Security*s Cash

Flow Is Expected to Turn Negative in 2017

-400 -300

-200 -100

0 100

200 2038 2034 2030 2026 2022 2018 2014 2010 2006 2002 Billions of 2002
dollars

OASDI cash deficit 2017

Cash surplus Cash deficit

Page 8 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.

From the perspective of the federal budget and the economy, the challenge
posed by the growth in Social Security spending becomes even more
significant in combination with the more rapid expected growth in Medicare
and Medicaid spending. This growth in spending on federal 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.)

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

Flexibility Disappears Absent Entitlement Reform

Page 9 GAO- 03- 376T

Figure 4: Federal Spending for Mandatory and Discretionary Programs,
Fiscal Years 1962, 1982, and 2002

Source: GAO analysis of data from the Office of Management and Budget. a
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

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

FY 1962

Discretionary Mandatory Net interest

6% 26%

68% 44%

45% 11%

37% 54%

9% FY 1982 FY 2002 a

Page 10 GAO- 03- 376T

the addition of a drug benefit* is projected to account for more than
onequarter 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

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.

0 10

20 30

40 2050 2030 2015 2000 Percent of GDP

Revenue

All other spending Medicare & Medicaid Social Security Net interest

Page 11 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 12 GAO- 03- 376T

Figure 6: Social Security, Medicare, and Medicaid Spending as a Percent of
GDP

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
flexibility.

8 Testimony before the Senate Committee on Banking, Housing, and Urban
Affairs, July 24, 2001.

Percent of GDP

Medicaid Medicare Social Security

0 5

10 15

20 25

2075 2060 2050 2040 2030 2020 2010 2000

Page 13 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 adjustment.

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

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.

9 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.

0 10

20 30

40 50

D 2041- 2076 2017- 2076 2002- 2076 Percent

13 15 16 22

31 45

Benefit adjustment Tax adjustment

Page 14 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 the only consideration. As a former public trustee of Social Security
and 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 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 Evaluating Social Security Reform Proposals

Page 15 GAO- 03- 376T

a comprehensive proposal, however, policymakers will ultimately have to
balance the relative importance they place on each of these criteria. Our
sustainable solvency standard encompasses several different ways of
looking at the Social Security program*s financing needs. While 75- year
actuarial balance is generally used in evaluating the long- term financial
outlook of the Social Security program and reform proposals, it is not

sufficient in gauging the program*s solvency after the 75th year. For
example, under the Trustees* intermediate assumptions, each year the
75year 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.

The current Social Security system*s benefit structure strikes a balance
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
reforms. Financing Sustainable

Solvency Balancing Adequacy and Equity

Page 16 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.

Program complexity makes implementation and administration both more
difficult and harder to explain to the public. Some degree of
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 Implementing and

Administering Proposed Reforms

Page 17 GAO- 03- 376T

reform is phased in, the more likely it will be understood and accepted by
the American people.

Over the course of the last several years, various reform proposals have
been crafted. Many proposals involve restructuring the Social Security
program to include individual retirement accounts. These individual
accounts are similar to defined contribution pension plans in that
benefits 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
Range of Proposals

Illustrates Options for Reform and Choices to be Made

Page 18 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.

Applying our criteria to the Commission models highlights trade- offs
between efforts to achieve sustainable solvency and maintain adequate
retirement income for current and future beneficiaries. The models
illustrate some of the options and trade- offs that will need to be
considered as the nation debates how to reform Social Security.

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

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

Reform Using the Commission*s Proposals

Page 19 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. 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

11 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. 12 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.

13 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. Financing
Sustainable Solvency

Page 20 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 benchmarks.

 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 21 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 benchmarks.

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

Page 22 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.

Each of the models would establish a governing board to administer the
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. Implementing
and

Administering Reforms

Page 23 GAO- 03- 376T

It is likely that the structural changes required to restore Social
Security*s long- term viability generally will require some combination of
reductions from currently scheduled benefits, revenue increases, and may
include the use of some general revenues. The proposals we have examined,
both in 2002 and earlier, generally reflect this. Proposals employ
possible benefit reductions within the current program structure,
including modifying the

benefit formula, raising the retirement age, and reducing cost- of- living
adjustments. Revenue increases might take the form of increases in the
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 15
About 4 percent of the workforce remains uncovered, which mostly includes
some state and local government employees and federal employees hired
before 1984. Conclusion: Choices

and Trade- Offs Will Be Part of Any Social Security Reform* Acting Soon
Would Help

Page 24 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
losses.

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
retirement.

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 25 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 nation.

Mr. Chairman, Mr. Craig, members of the Committee, that concludes my
statement. I*d be happy to answer any questions you may have. (130216)
*** End of document. ***
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