Social Security Reform: Early Action Would be Prudent
Published: 2005-03-09T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Social Security is the foundation of the nation's retirement income system, helping to protect the vast majority of American workers and their families from poverty in old age. However, it is much more than a retirement program, also providing millions of Americans with disability insurance and survivors' benefits. Over the long term, as the baby boom generation retires and as Americans continue to live longer and have fewer children, Social Security's financing shortfall presents a major program solvency and sustainability challenge that is widening as time passes. The House Committee on Ways and Means asked GAO to discuss the need for Social Security reform. This testimony addresses the nature of Social Security's long-term financing problem and why it would be prudent for Congress to take action sooner rather than later. This testimony also notes the broader context in which reform proposals should be considered and the criteria that GAO has recommended as a basis for analyzing any Social Security reform proposals.
section_title: What GAO Found
paragraphs: Although the Social Security system is not in crisis, it faces a serious solvency and sustainability challenge that is growing as time passes. If we do nothing until 2042, achieving actuarial balance would require a 30-percent reduction in benefits or a 43-percent increase in payroll taxes for the period 2042-2078. Furthermore, Social Security's problems are a subset of the grave fiscal challenge facing our nation. Absent changes in budget policy, the nation will ultimately have to choose among escalating federal deficits and debt, huge tax increases and/or dramatic budget cuts. As GAO's long-term budget simulations show, substantive reform of Social Security and our major federal health programs (e.g., Medicare and Medicaid) is critical to saving our nation's fiscal future. Taking action soon would serve to reduce the magnitude of changes needed to ensure that Social Security is solvent, sustainable, and secure for current and future generations. It would also allow time to phase in certain changes and time for individuals to adjust to any such changes. Acting sooner would also serve to improve the federal government's credibility with financial markets and bolster the confidence of the American people in our government's ability to address long-range financial challenges. However, financial solvency and sustainability should not be the only consideration when evaluating Social Security reform proposals. Other key objectives, such as balancing the adequacy and equity of the benefit structure and various administrative and operational issues need to be considered. Furthermore, any changes to Social Security should be considered in the context both of the whole program--including disability and survivors' benefits--and of the broader challenges facing our nation, such as the changing nature of the private pension system, long-term care needs, escalating health care costs, and the need to reform the Medicare and Medicaid programs.

section_title: Letter
paragraphs: I am pleased to be here today to discuss the underlying structural  problems and long-term challenges facing the Social Security program.  Before addressing these matters specifically, I would like to place these  challenges in the context of the larger challenges facing the federal  government today, which we discuss in our recently issued 21st Century  Challenges report.1 There is a need to bring the federal government and  its programs into line with 21st century realities. This challenge has many  related pieces: addressing our nation’s large and growing long-term fiscal  gap; deciding on the appropriate role and size of the federal government- and how to finance that government-and bringing the panoply of federal  activities into line with today’s world. Continuing on our current  unsustainable fiscal path will gradually erode, if not suddenly damage, our  economy, our standard of living, and ultimately our national security. We  therefore must fundamentally reexamine major spending and tax policies  and priorities in an effort to recapture our fiscal flexibility and ensure that  our programs and priorities respond to emerging security, social,  economic, and environmental changes and challenges.
Social Security represents the foundation of retirement income for  millions of Americans and has helped to prevent many former workers and  their families from living their retirement years in poverty. It provides  millions of Americans with disability insurance and survivors’ benefits,  thus, providing benefits that are critical to the current and future well- being of tens of millions of Americans. Fixing Social Security 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.
As I have said in congressional testimonies over the past several years, the  Social Security system faces serious solvency and sustainability challenges  in the longer term. While the Social Security program does not face an  immediate crisis, it does have a $3.7 trillion gap between promised and  funded benefits in current dollar terms over the next 75 years. This gap is  growing as time passes and, given this and other major fiscal challenges,  including expected growth in federal health spending, it would be prudent  to act sooner rather than later to reform the Social Security program.  Failure to take steps to address our large and structural long-range fiscal  imbalance, which is driven in large part by projected increases in  Medicare, Medicaid, and Social Security spending, will ultimately have  significant adverse consequences for our future economy and the quality  of life of our children, grandchildren, and future generations of Americans.
Let me begin by highlighting a number of important points concerning the  Social Security challenge and our broader fiscal and economic challenge.
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 insurance  program that affects virtually every American family. It currently pays  benefits to more than 47 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 helping to reduce 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.
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 financial  condition of the Social Security program. After all, the Social Security  Trust Fund is a subaccount of the federal government rather than a  private trust fund. Its assets are not readily marketable nor are they  convertible into cash other than through raising revenues, cutting other  government expenses, increasing debt held by the public, or some  combination of these. Furthermore, 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.
Social Security reform is part of a broader fiscal and economic  challenge. If you look ahead in the federal budget, Social Security  together with the rapidly growing health programs (Medicare and  Medicaid) dominate the federal government’s future fiscal outlook.  While this hearing is not about the complexities of Medicare, it is  important to note that Medicare presents a much greater, more  complex, and more urgent fiscal challenge than 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. Federal and state spending for  Medicaid will especially be stressed by anticipated growing demand for  long-term care services by the aging baby boom population. Taken  together, Social Security, Medicare, and Medicaid represent an  unsustainable burden on future generations. Under the 2004 Trustees’  intermediate estimates and the Congressional Budget Office’s (CBO)  long-term Medicaid estimates, spending for Social Security, Medicare,  and Medicaid combined will grow from 8.5 percent of GDP today to  15.6 percent in 2030. Absent meaningful changes to these programs, the  nation will ultimately have to choose among persistent, escalating  federal deficits, huge tax increases, and/or dramatic budget cuts.  Furthermore, any changes to Social Security should be considered in  the context of the problems currently facing our nation’s private  pension system. These include the chronically low levels of pension  coverage of the private sector workforce, the continued decline in the  number of defined benefit plans coupled with the termination of large  underfunded plans by bankrupt firms, and the shift by employers to  defined contribution plans, where workers face the potential for  greater return but also assume greater financial risk. Similarly, the  growing demand for long-term care will also likely exacerbate current  concerns regarding the provision and financing of these services. These  include the potential for families to face the financially catastrophic  costs of long-term care. In addition, the heavy reliance on unpaid care  from family members and other informal caregivers already has led, in  many cases, to severe personal burdens. This strain will likely be  exacerbated, with possibly fewer caregivers available in the coming  decades.
Acting sooner rather than later helps to ease the difficulty of  change. The challenge of facing the imminent and daunting budget  pressure from Medicare, Medicaid, and Social Security increases over  time. Social Security will begin to constrain the budget long before the  trust fund is exhausted in 2042. The Social Security cash surpluses that  are now helping to finance the rest of the government’s budgetary  needs will begin to decline in 2008, and by 2018, the cash surpluses will  turn to deficits. Beginning in 2008, Social Security’s declining cash flow  will begin to place increasing pressure on the rest of the budget. In  addition, starting in 2018, the government will have to either increase  revenues, decrease other government spending, or increase debt held  by the public to convert the bonds in the trust funds into cash in order  to pay full benefits when due. 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 a further delay of the really tough  decisions on Medicare and Medicaid. Acting sooner rather than later  would allow changes to be more modest while also being phased in so  that future and near-term retirees will have time to adjust their  retirement planning. Furthermore, acting sooner rather than later  would serve to increase our credibility with the markets and improve  the public’s confidence in the federal government’s ability to deal with  our significant long-range fiscal challenges before they reach crisis  proportions.
Reform proposals should be evaluated as packages. The elements  of any reform proposal interact; every proposal will have pluses and  minuses, and no plan will satisfy everyone on all dimensions. Reform  elements can take a variety of shapes; examples include benefit  reductions, like changing replacement rates, moving from wage to  price indexation, or increasing the retirement age, increasing payroll  taxes or the taxable wage base, and/or creating individual accounts. If  we focus on the pros and cons of each element of reform by itself, we  may find it impossible to build the bridges necessary to achieve  consensus. However, any analyses of reform proposals should reflect  the fact that the program faces a long-term actuarial deficit and that  benefit reductions and/or revenue increases will be necessary to  restore solvency. Therefore, it is important to establish the appropriate  comparisons or benchmarks against which reforms should be  measured. This requires looking at proposed reforms from at least two  benchmarks—one that raises revenue to fund currently scheduled  benefits (promised benefits) and one that adjusts benefits to a level  supported by current tax financing (funded benefits). Comparing the  benefit 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.
Failure to address the Social Security financing problem will, in  combination with other entitlement spending, lead to an unsustainable  burden on both the federal government and, ultimately, the economy. As  the Congress considers proposals to restore the long-term financial  stability and viability of the Social Security system, it will also need to  consider the impact of the potential changes on the millions of Americans  the system serves: specifically, the effects on different types of  beneficiaries and the resulting implications for the adequacy and equity of  the benefits structure. The fundamental nature of the program’s long-term  financing challenge means that timely action is needed. I believe it is  possible 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 solvent, sustainable, and secure for future generations. I also believe  that it is possible to exceed the expectations of all generations of  Americans. In addition, given our overall fiscal challenge and various  trends in the private pension and personal savings areas, I believe it would  be prudent to act sooner rather than later to address this large and  growing problem.
subsections: section_title: Social Security’s Long-term Financing Problem Is More Urgent Than It May Seem
paragraphs: Today, the Social Security program faces not an immediate crisis but  rather a long-range financing problem driven primarily by known  demographic trends. While the crisis is not immediate, the challenge is  more urgent than it may appear since the program will experience  increasing negative cash flow starting in 2018. Acting soon to address  these problems reduces the likelihood that Congress will have to choose  between imposing severe benefit cuts and unfairly burdening future  generations with the program’s rising costs. Acting soon would also allow  changes to be phased in so that 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.” On  the other hand, failure to take remedial action will, in combination with  other entitlement spending, lead to a situation unsustainable both for the  federal government and, ultimately, the economy.
The Social Security system has required changes in the past to ensure its  future solvency. Indeed, the Congress has always taken the actions  necessary to do this when faced with an immediate solvency crisis. While  such an immediate crisis will not occur for many years, waiting until it is  imminent would not be prudent. I would like to spend some time  describing the nature, timing, and extent of Social Security’s financing  problem.
subsections: section_title: The Nature of Social Security’s Long-Term Financing Problem
paragraphs: As you all know, Social Security has always been a largely pay-as-you-go  system. This means that the system’s financial condition is directly  affected by the relative size of the populations of covered workers and  beneficiaries. Historically, this relationship has been favorable to the  system’s financial condition. Now, however, people are living longer, and  spending more time in retirement.
As shown in figure 1, the U.S. elderly dependency ratio is expected to  continue to increase. The proportion of the elderly population relative to  the working-age population in the U.S. rose from 13 percent in 1950 to 19  percent in 2000. By 2050, there is projected to be almost 1 elderly  dependent for every 3 people of working age—a ratio of 32 percent.  Additionally, the average life expectancy of males at birth has increased  from 66.6 in 1960 to 74.3 in 2000, with females at birth experiencing a rise  of 6.6 years from 73.1 to 79.7 over the same period. As general life  expectancy has increased in the United States, there has also been an  increase in the number of years spent in retirement. Improvements in life  expectancy have extended the average amount of time spent by workers in  retirement from 11.5 years in 1950 to 18 years for the average male worker  as of 2003.
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, which  is the average number of children that would be born to women during  their childbearing years, 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 what it takes to maintain a stable population. Taken together, these  trends threaten the financial solvency and sustainability of Social Security.
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 fifth of what it  is today, as shown in figure 2. Relatively fewer U.S. workers will be  available to produce the goods and services that all will consume. Without  a major increase in productivity or immigration, 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.
This slowing labor force growth has important implications for the Social  Security system. 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.  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 amount of time spent in retirement could be  diminished. This could improve the finances of Social Security.
The Social Security program’s situation is one symptom of this larger  demographic trend that will have broad and profound effects on our  nation’s future in other ways as well. The aging of the labor force and the  reduced growth in the number of workers will have important implications  for the size and composition of the labor force, as well as the  characteristics of many jobs in our increasingly knowledge-based  economy, throughout the 21st century. The U.S. workforce of the 21st  century will be facing a very different set of opportunities and challenges  than that of previous generations. The slowdown in labor force growth can  have very negative effects on our nation’s economic future, as relatively  fewer workers will be producing the goods and services that everyone will  consume. If people do choose to work longer this may mitigate the  expected slowdown in labor force growth, which could strengthen the  nation’s economic prospects.
section_title: Cash Flow Turns Negative in 2018
paragraphs: Today, the Social Security Trust Funds take in more in taxes than they  spend. Largely because of the demographic trends I have described, this  situation will change. Although the trustees’ 2004 intermediate estimates  project that the combined Social Security Trust Funds will be solvent until  2042, within the next few years, Social Security spending will begin to put  pressure on the rest of the federal budget. Under the trustees’ 2004  intermediate estimates, Social Security’s cash surplus—the difference  between program tax income and the costs of paying scheduled benefits— will begin a permanent decline in 2008. By 2018, the program’s cash flow is  projected to turn negative—its tax income will fall below benefit  payments. At that time, Social Security will join Medicare’s Hospital  Insurance Trust Fund, whose outlays exceeded cash income in 2004, as a  net claimant on the rest of the federal budget. (See figure 3.)
In 2018, the combined OASDI Trust Funds will begin drawing on its  Treasury securities to cover the cash shortfall. At this point, Treasury will  need to obtain cash for these redeemed securities either through increased  taxes, spending cuts, and/or more borrowing from the public than would  have been the case had Social Security’s cash flow remained positive.  Whatever the means of financing, the shift from positive to negative cash  flow will place increased pressure on the federal budget to raise the  resources necessary to meet the program’s ongoing costs.
section_title: Different Measures but Same Challenges and Same Conclusion
paragraphs: There are different ways to describe the magnitude of Social Security’s  long-term financing challenge, but they all illustrate a need for program  reform sooner rather than later. A case can be made for a range of  different measures, as well as different time horizons. For instance, the  shortfall can be measured in present value, as a percentage of GDP, or as a  percentage of taxable payroll. The Social Security Administration (SSA)  has made projections of Social Security shortfall using different time  horizons. (See table 1.)
While the estimates vary due to different horizons, both identify the same  long-term challenge: The Social Security system is unsustainable in its  present form over the long run. Taking action soon on Social Security  would not only make the necessary action less dramatic than if we wait  but would also promote increased budgetary flexibility in the future and  stronger economic growth. Some of the benefits of early action—and the  costs of delay—can be seen in figure 4. This figure compares what it would  take to keep Social Security solvent through 2078, if action were taken at  three different points in time, by either raising payroll taxes or reducing  benefits. If we did nothing until 2042—the year SSA estimates the Trust  Funds will be exhausted—achieving actuarial balance would require  changes in benefits of 30 percent or changes in taxes of 43 percent for the  period 2042-2078. As figure 4 shows, earlier action shrinks the size of the  necessary adjustment. However, these changes do not achieve sustainable  solvency, they only achieve solvency through 2078.
section_title: Social Security Reform is Part of a Broader Fiscal and Economic Challenge
paragraphs: 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 Americans in the future. Reforming Social Security  and health programs is essential to reclaiming our future fiscal flexibility  to address other national priorities.
Changes in the composition of federal spending over the past several  decades have reduced budgetary flexibility, and our current fiscal path will  reduce it even further. During this time, spending on mandatory programs  has consumed an ever-increasing share of the federal budget. In 1964,  prior to the creation of the Medicare and Medicaid programs, spending for  mandatory programs plus net interest accounted for about 33 percent of  total federal spending. By 2004, this share had almost doubled to  approximately 61 percent of the budget.
GAO’s long-term simulations illustrate the magnitude of the fiscal  challenges associated with an aging society and the significance of the  related challenges the government will be called upon to address. Figures  5 and 6 present these simulations under two different sets of assumptions.  In figure 5, we begin with CBO’s January baseline – constructed according  to the statutory requirements for that baseline. Consistent with these  requirements, discretionary spending is assumed to grow with inflation for  the first 10 years and tax cuts scheduled to expire are assumed to expire.  After 2015, discretionary spending is assumed to grow with the economy,  and revenue is held constant as a share of GDP at the 2015 level. In figure  6 two assumptions are changed: discretionary spending is assumed to  grow with the economy after 2005 rather than merely with inflation and  the tax cuts are extended. For both simulations Social Security and  Medicare spending is based on the 2004 Trustees’ intermediate  projections, and we assume that benefits continue to be paid in full after  the trust funds are exhausted. Medicaid spending is based on CBO’s  December 2003 long-term projections under mid-range assumptions.
Both these simulations illustrate that, absent policy changes, the growth in  spending on federal retirement and health entitlements will encumber an  escalating share of the government’s resources. Indeed, when we assume  that recent tax reductions are made permanent and discretionary spending  keeps pace with the economy, our long-term simulations suggest that by  2040 federal revenues may be adequate to pay little more than interest on  the federal debt. Neither slowing the growth in discretionary spending nor  allowing the tax provisions to expire—nor both together—would eliminate  the imbalance. Although revenues will be part of the debate about our  fiscal future, the failure to reform Social Security, Medicare, Medicaid, and  other drivers of the long term fiscal gap would require at least a doubling  of taxes—and that seems implausible. Accordingly, substantive reform of  Social Security and our major health programs remains critical to  recapturing our future fiscal flexibility.
Alternatively, taking action soon on Social Security would not only  promote increased budgetary flexibility in the future and stronger  economic growth but would also make the necessary action less dramatic  than if we wait. 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. GAO has described 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 face and address 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, how it does it, and how it finances its  operations is both needed and overdue.
Also, at the same time it is important to look beyond the federal budget to  the economy as a whole. Under the 2004 Trustees’ intermediate estimates  and CBO’s long-term Medicaid estimates, spending for Social Security,  Medicare, and Medicaid combined will grow to 15.6 percent of GDP in  2030 from today’s 8.5 percent. (See figure 7.) Taken together, Social  Security, Medicare, and Medicaid represent an unsustainable burden on  future generations of Americans.
The government can help ease future fiscal burdens through spending or  revenue actions that reduce debt held by the public, thereby saving for the  future and enhancing the pool of economic resources available for private  investment and long-term growth. Economic growth can help, but given  the size of our projected fiscal gap we will not be able to simply grow our  way out of the problem. Closing the current long-term fiscal gap would  require sustained economic growth far beyond that experienced in U.S.  economic history since World War II. Tough choices are inevitable, and  the sooner we act, the better.
section_title: Considerations in Assessing Reform Options
paragraphs: 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. It is also much more than just a retirement  program; it pays benefits to disabled workers and their dependents,  spouses and children of retired workers, and survivors of deceased  workers. In 2004, Social Security paid almost $493 billion in benefits to  more than 47 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. Because the program is so deeply woven into the fabric of our  nation, any proposed reform must consider the program in its entirety,  rather than one aspect alone. To assist policymakers, GAO has developed  a broad framework for evaluating reform proposals that considers  solvency as well as other aspects of the program. Our criteria aim to  balance financial and economic considerations with benefit adequacy and  equity issues and the administrative challenges associated with various  proposals.
subsections: section_title: GAO Framework For Evaluating Reform Proposals
paragraphs: GAO developed an analytic framework to assess reform proposals using  three basic criteria:    Financing Sustainable Solvency -- the extent to which a proposal  achieves sustainable solvency and how it would affect the economy,  the federal budget, and national saving. Our sustainable solvency  standard encompasses several different ways of looking at the Social  Security program’s financing needs. While a 75-year actuarial balance  has generally been used in evaluating the long-term financial outlook of  the Social Security program and reform proposals, it is not sufficient in  gauging the program’s solvency after the 75th year. For example, under  the trustees’ intermediate assumptions, each year the 75-year actuarial  period changes, and a year with a surplus is replaced by a new 75th  year that has a significant deficit. As a result, changes made to restore  trust fund solvency only for the 75-year period can result in future  actuarial imbalances almost immediately. Reform plans that lead to  sustainable solvency would be those that consider the broader issues  of fiscal sustainability and affordability over the long term. Specifically,  a standard of sustainable solvency also involves looking at (1) the  balance between program income and costs beyond the 75th year and  (2) the share of the budget and economy consumed by Social Security  spending.
Balancing Adequacy and Equity -- the relative balance struck  between the goals of individual equity and income adequacy. The  current Social Security system’s benefit structure attempts to strike a  balance between these two goals. From the beginning, Social Security  benefits were set in a way that focused especially on replacing some  portion of workers’ preretirement 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.
Implementing and Administering Proposed Reforms -- how readily  a proposal could be implemented, administered, and explained to the  public. Program complexity makes implementation and administration  both more difficult and harder to explain. 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. While these issues may seem  technical or routine on the surface, they are important. In particular, if  these issues are not considered early enough for planning purposes,  they could potential delay—if not derail—reform. Moreover, issues  such as feasibility and cost can, and should, influence policy choices.  Continued public acceptance of 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. The  more transparent the implementation and administration of reform,  and the more carefully such reform is phased in, the more likely it will  be understood and accepted by the American people.
The weight that different policymakers 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  a comprehensive proposal, however, policymakers will ultimately have to  balance the relative importance they place on each of these criteria. As we  have noted in the past, a comprehensive evaluation is needed that  considers a range of effects together. Focusing on comprehensive  packages of reforms will enable us to foster credibility and acceptance.
This will help us avoid getting mired in the details and losing sight of  important interactive effects. It will help build the bridges necessary to  achieve consensus.
One issue that often arises within the Social Security debate concerns the  appropriate comparisons or benchmarks to be used when assessing a  particular proposal. While this issue may seem to be somewhat abstract, it  has critical implications, for depending on the comparisons chosen, a  proposal can be made more or less attractive. Some analyses compare  proposals to a single benchmark and as a result can lead to incomplete or  misleading conclusions. For that reason, GAO has used several  benchmarks in assessing reform proposals. Currently promised benefits  are not fully financed, and so any analysis that seeks to fairly evaluate  reform proposals should include comparisons to benchmarks that reflect a  policy of an adequately financed system. Similarly, it is important to have  benchmarks that are consistent with each other. Using one that relies on  action relatively soon versus one that posits no action at all are not  consistent and could also lead to misleading conclusions. Estimating  future effects on Social Security benefits should reflect the fact that the  program faces a long-term actuarial deficit and that conscious policies of  benefit reduction and/or revenue increases will be necessary to restore  solvency and sustain it over time.
section_title: Reform’s Potential Effects on the Social Security Program
paragraphs: A variety of proposals have been offered to address Social Security’s  financial problems. Some of these proposals work within the current  structure of Social Security and others would restructure the program. For  instance, many proposals contain reforms that would alter benefits or  revenues within the structure of the current defined benefits system. Also,  a number of proposals seek to restructure the program through the  creation of individual accounts. The discussion about examples of reform  in this section are meant for illustrative purposes, and are by no means  intended to be exhaustive of all the reform options proposed or the issues  related to these approaches.
Some proposals would reduce benefits relative to scheduled benefits by  modifying the benefit formula. For example, increasing the number of  years used to calculate benefits or using price-indexing instead of wage- indexing would reduce the benefits individuals receive. Since wages  generally grow faster than prices, indexing earnings to prices rather than  wages would reduce the measure of average lifetime earnings used in the  formula—reducing benefits. Changing the number of working years used  to calculate benefits to include more than the highest 35 years of earnings  would reduce the average lifetime earnings; thus, reducing benefits as  compared to current levels. Other proposals include options to reduce  cost-of-living adjustments (COLA) by lowering the COLA to less than the  CPI, limiting the COLA to a specified threshold, or delaying the COLA; to  raise the normal and/or early retirement ages or to reduce benefits more  for workers who retire before the full retirement age; and to revise  dependent benefits. Some of the proposals also include measures or  benefit changes that seek to strengthen progressivity (e.g., replacement  rates) in an effort to mitigate the effect on low-income workers.
Others have proposed options that would provide revenue increases. For  example, raising the payroll tax or expanding the Social Security taxable  wage base that finances the system would result in more revenue coming  into the system. In 2005, earnings above $90,000 are not subject to payroll  taxes. If the cap were raised and the benefit formula remained the same,  workers with earnings above the old cap would ultimately receive  somewhat higher benefits as well as pay more taxes. Other options to  increase revenues include increasing the taxation of benefits or covering  those few remaining workers not currently required to participate in  Social Security, such as some state and local government employees,  although such new participants would increase future spending  commitments as well. In addition to these proposals, Social Security can  obtain revenues from sources outside of the program, such as by  increasing the investment returns on Social Security holdings or by  earmarking revenue from estate taxes or other sources.
A number of proposals also seek to restructure the program through the  creation of individual accounts. Under a system of individual accounts,  workers would manage a portion of their own Social Security  contributions to varying degrees. This would expose workers to a greater  degree of risk in return for both greater individual choice in retirement  investments and the possibility of a higher rate of return on contributions  than available under current law. There are many different ways that an  individual account system could be set up. For example, contributions to  individual accounts could be mandatory or they could be voluntary.  Proposals also differ in the manner in which accounts would be financed,  the extent of choice and flexibility concerning investment options, the way  in which benefits are paid out, and the way the accounts would interact  with the existing Social Security program—individual accounts could  serve either as an addition to or as a replacement for part of the current  benefit structure.
In addition, the timing and impact of individual accounts on the solvency,  sustainability, adequacy, equity, net savings, and rate of return associated  with the Social Security system varies depending on the structure of the  total reform package. Individual accounts by themselves will not lead the  system to sustainable solvency—an increase in revenue, a decrease in  benefits, or both will also be necessary. Furthermore, incorporating a  system of individual accounts may involve significant transition costs.  These costs come about because the Social Security system would have to  continue paying out benefits to current and near-term retirees  concurrently with establishing new individual accounts.
Individual accounts can contribute to sustainability as they could provide  a mechanism to prefund retirement benefits that would be immune to  demographic booms and busts. However, if these accounts are financed  through borrowing, prefunding will not be achieved until the additional  debt has been repaid. An additional important consideration in adopting a  reform package that contains individual accounts would be the level of  benefit adequacy achieved by the reform. To the extent that benefits are  not adequate, it may result in the government eventually providing  additional resources to make up the difference.
Some degree of implementation and administrative complexity arises in  virtually all proposed changes to Social Security. 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. The  federal Thrift Savings Plan (TSP) could serve as a model for providing a  limited amount of options that reduce risk and administrative costs while  still providing some degree of choice. However, a system of accounts that  spans the entire national workforce and millions of employers would be  significantly larger and more complex than TSP or any other system we  have in place today.
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 through payroll deductions  to millions of workers who currently lack private pension coverage.
section_title: Social Security Reform Should be Considered in the Context of Broader Challenges
paragraphs: Other broader concerns for Social Security reform include evaluating a  proposal’s effect on national saving and a proposal’s implications for other  sources of retirement income, access to long-term care and retirement  security generally. An important economic consideration is assessing a  proposal’s effect on national saving. Individual account proposals  designed as a carve-out that finance accounts through the redirection of  payroll taxes or general revenue, do not increase national saving on a first  order basis. The redirection of payroll taxes or general revenue reduces  government saving by the same amount that the individual accounts  increase private saving. Individual accounts that are structured as “add- ons” may increase saving. However, this will depend on how the accounts  are financed and how they are structured i.e. do they target low income  workers who currently may not have high saving rates. Individual  accounts that achieve prefunding without borrowing might increase  government and individual saving. The effect of individual accounts on  national saving will also be affected by other elements, such as benefit  cuts or tax increases, that are part of the overall reform package.
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 higher deficits that result from redirecting payroll taxes  to individual accounts could prompt changes in fiscal policy that reduce  spending or increase revenue thereby resulting in lower deficits that  would otherwise have been the case and increase net national saving. On  the other hand, households may respond by reducing their other saving in  response to the creation of individual accounts. No expert consensus  exists on how Social Security reform proposals would affect the saving  behavior of private households and businesses.
Besides the effect on savings, Social Security reform proposals may also  have implications for retirement security in general. Economic security in  retirement requires both adequate retirement income—Social Security,  pensions, personal savings, and earnings from continued employment— and affordable health care—Medicare and retiree health care; and long- term care coverage. In addition to the issues I have discussed regarding  the financing challenges that Social Security, Medicare and Medicaid face,  the nation also faces serious challenges associated with the private  pension system and long-term care financing.
Only about half of the private sector workforce is covered by a pension  plan. A number of large underfunded traditional defined benefit plans— plans where the employer bears the risk of investment—have been  terminated by bankrupt firms, including household names like Bethlehem  Steel, US Airways, and Polaroid. These terminations have resulted in  thousands of workers losing promised benefits and have saddled the  Pension Benefit Guaranty Corporation, the government corporation that  partially insures certain defined benefit pension benefits, with billions of  dollars in liabilities that threaten its long-term solvency. Meanwhile, the  number of traditional defined benefit pension plans continues to decline  as employers increasingly offer workers defined contribution plans like  401(k) plans where, like individual accounts, workers face the potential of  both greater return and greater risk. These challenges serve to reinforce  the imperative to place Social Security on a sound financial footing which  provides a foundation of certain and secure retirement income.
In 2002, GAO reported that the total number of disabled elderly could be  as high as 12.1 million, by 2040. Long-term care includes an array of health,  personal care, and supportive services provided to persons with physical  or mental disabilities. It relies heavily on financing by public payers,  especially Medicaid, and has significant implications for state budgets as  well as the federal budget.
Current problems with the provision and financing of long-term care could  be exacerbated by the swelling numbers of the baby-boom generation  needing care. These problems include whether individuals with disabilities  receive adequate services, the potential for families to face financially  catastrophic long-term care costs, and the burdens that heavy reliance on  unpaid care from family members and other informal caregivers create  coupled with possibly fewer caregivers available in coming generations.
Given the broader fiscal challenges that our nation faces and the potential  future changes to Social Security, Medicare, and Medicaid, as well as the  state of private pensions and long-term care trends, it is even more  important that individuals are educated about what to expect in  retirement. In this respect, regardless of what type of Social Security  reform package is adopted, continued confidence in the Social Security  program is essential. 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. The more transparent the  implementation and administration of reform, and the more carefully such  reform is phased in, the more likely it will be understood and accepted by  the American people.
section_title: Conclusions
paragraphs: Social Security does not face an immediate crisis but it does face a large  and growing financial problem. In addition, our Social Security challenge  is only part of a much broader fiscal challenge that includes, among other  things, the need to reform Medicare, Medicaid, and our overall health care  system.
Many retirees and near retirees fear cuts that would affect them in the  immediate future while young people believe they will get little or no  Social Security benefits in the longer term. I believe that it is possible to  reform Social Security in a way that will ensure the program’s solvency,  sustainability, and security while exceeding the expectations of all  generations of Americans.
In my view, there is a window of opportunity to reform Social Security;  however, this window of opportunity will begin to close as the baby boom  generation begins to retire. We have an opportunity to address Social  Security as a first step toward improving the nation’s long-term fiscal  outlook. Furthermore, it would be prudent to move forward to address  Social Security now because we have much larger challenges confronting  us that will take years to resolve. The fact is, compared to addressing our  long-range health care financing problem, reforming Social Security  should be easy lifting. As I have said before, the future sustainability of  programs is the key issue policy makers should address—i.e., the capacity  of the economy and budget to afford the commitment over time. Absent  substantive reform, these important federal programs will not be  sustainable. Furthermore, absent reform, younger workers will face  dramatic benefit reductions or tax increases that will grow over time.
Irrespective of when Social Security reform may occur and what form it  may take, other Social Security related issues also need to be explored.  These include, but are not limited to, the current accounting/reporting and  budget treatment of Social Security and the related trust funds; its current  investment options and strategy, and the current composition of the Social  Security Board of Trustees.
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. In doing so, we will be true to our core values of accountability,  integrity, and reliability.
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