Long Term Fiscal Issues: The Need for Social Security Reform
Published: 2005-02-09T00:00:00

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, providing millions of Americans with disability insurance and survivors' benefits. As the baby boom generation retires and given longer life spans and lower birth rates, Social Security's financing shortfall will grow. The current gap between promised and funded benefits is $3.7 trillion and is growing daily. The Chairman of the House Budget Committee 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 is preferable 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 today, it faces a serious and growing solvency and sustainability challenge that is growing as time passes. If we did nothing until 2042, achieving actuarial balance would require a 30-percent reduction in benefits or a 43-percent increase in payroll taxes. Furthermore, Social Security's problems are a subset of our nation's overall fiscal challenge. Absent reform, 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 fiscal future. Taking action soon would also serve to reduce the amount of change needed to ensure that Social Security is solvent, sustainable, and secure for current and future generations. Acting sooner would also serve to improve the federal government's credibility with the markets and the confidence of the American people in the government's ability to address long-range challenges before they reach crisis proportions. However, financial stability should not be the only consideration when evaluating reform proposals. Other important objectives, such as balancing the adequacy and equity of the benefits structure and various administrative and operational issues need to be considered. Furthermore, any changes to Social Security should be considered in the context of the broader challenges facing our nation, such as the changing nature of the private pension system, escalating health care costs, and the need to reform Medicare and Medicaid.

section_title: Letter
paragraphs: I appreciate the opportunity to talk with you about our nation’s Social  Security program and how to address the challenges presented in ensuring  the long-term viability of this important social insurance system.  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.  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 both 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.  This gap is growing daily 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  country, children, and grandchildren.
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 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.
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) will 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. Taken together, Social Security,  Medicare, and Medicaid represent an unsustainable burden on future  generations.  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 level of  coverage of the private workforce, the continued decline in 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.
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. 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, or increasing debt held by the public.  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.
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. Social Security’s cash shortfall 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 trust  fund 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  federal health programs. Acting sooner rather than later would allow  changes to be more modest while also being phased in so that future  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 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 by itself, we may find it  impossible to build the bridges necessary to achieve consensus.  Analyses of reform proposals should reflect the fact that the program  faces a long-term actuarial deficit and that benefit reduction and/or  revenue increases will be necessary to restore solvency. This requires  looking at proposed reforms from at least two perspectives or  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).
Today, the Social Security program does not face an immediate crisis, but  rather a long-range financing problem driven by 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 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.
Today we have an opportunity to address the relatively easier part of the  overall entitlement challenge before the baby boom generation begins to  retire and the challenge begins to compound.  Medicare represents a much  larger driver of the long-term fiscal outlook, but this does not mean that  Social Security reform should be postponed until after it is addressed.  On  the contrary, it argues for moving ahead on Social Security soon.  Unlike  the case in health care, potential approaches to Social Security reform have  already been articulated in various proposals in recent years.  These  approaches can serve as a starting point for deliberations.  Since health  care will be much harder to address, there is a significant danger that if we  do not move ahead on Social Security now, we could end up reforming  neither.  Successful Social Security reform could also help build both trust  and confidence and thereby facilitate consideration of the needed  structural changes in the health care system.
The Social Security system has required changes in the past to ensure its  future solvency. Congress took action to address an immediate solvency  crisis in 1983.  While such an immediate crisis will not occur for many  years, waiting until it is imminent will not be prudent.  Furthermore, 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 there for future generations. I believe that it is possible  to reform Social Security in a way that will assure the program’s solvency  and sustainability while exceeding the expectations of all generations of  Americans.
subsections: section_title: Social Security Reform Is Part of a Broader Fiscal and Economic Challenge
paragraphs: In my role as lead partner on the audit of the U.S. government’s  consolidated financial statements and the de facto Chief Accountability  Officer of the United States government, I have become increasingly  concerned about the state of our nation’s finances.  In speeches and  presentations over the past several years, I have called attention to our  large and growing long-term fiscal challenge and the risks it poses to our  nation’s future.  Simply put, our nation’s fiscal policy is on an  unsustainable course, and our long-term fiscal imbalance worsened  significantly in 2004.  GAO’s simulations—as well as those of  the  Congressional Budget Office (CBO) and others—show that over the long  term we face a large and growing structural deficit due primarily to known  demographic trends and rising health care costs.  Continuing on this  unsustainable fiscal path will gradually erode, if not suddenly damage, our  economy, our standard of living, and ultimately our national security.  Our  current path also will increasingly constrain our ability to address emerging  and unexpected budgetary needs.
Regardless of the assumptions used, all simulations indicate that the  problem is too big to be solved by economic growth alone or by making  modest changes to existing spending and tax policies.  Nothing less than a  fundamental reexamination of all major spending and tax policies and  priorities is needed.  This reexamination should also involve a national  discussion about what Americans want from their government and how  much they are willing to pay for those things.  This discussion will not be  easy, but it must take place.
In fiscal year 2004 alone, the nation’s fiscal imbalance grew dramatically,  primarily due to enactment of the new Medicare prescription drug benefit,  which added $8.1 trillion to the outstanding commitments and obligations  of the U.S. government.  The near-term deficits also reflected higher  defense, homeland security, and overall discretionary spending which  exceeded growth in the economy, as well as revenues which have fallen  below historical averages due to policy decisions and other economic and  technical factors.
While the nation’s long-term fiscal imbalance grew significantly, the  retirement of the baby boom generation has come closer to becoming a  reality.  In fact, the cost implications of the baby boom generation’s  retirement have already become a factor in CBO’s baseline projections and  will only intensify as the boomers age.  According to CBO, total federal  spending for Social Security, Medicare, and Medicaid is projected to grow  by about 25 percent over the next 10 years—from 8.4 percent of gross  domestic product (GDP) in 2004 to 10.4 percent in 2015.  Given these and  other factors, it is clear that the nation’s current fiscal path is unsustainable  and that tough choices will be necessary in order to address the growing  imbalance.
There are different ways to describe the magnitude of Social Security’s  long-term financing challenge, but they all show 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 the Social Security shortfall using different time horizons.  (See table 1.)
While estimates vary due to different horizons, both identify the same long- term challenge: The Social Security system is unsustainable in 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.
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.  (See table 2.)  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.  (See fig. 1.)  To finance the same  level of federal spending as in the previous year, additional revenues and/or  increased borrowing will be needed in each subsequent year.
By 2018, Social Security’s cash income (tax revenue) is projected to fall  below program expenses. At that time, Social Security will join Medicare’s  Hospital Insurance Trust Fund, whose outlays exceeded cash revenues in  2004, as a net claimant on the rest of the federal budget.  The combined  OASDI Trust Funds will begin drawing on the Treasury to cover the cash  shortfall.  At this point, Treasury will need to obtain cash for those  redeemed securities either through increased taxes, and/or spending cuts,  and/or more borrowing from the public than would have been the case had  Social Security’s cash flow remained positive.
Today Social Security spending exceeds federal spending for Medicare and  Medicaid, but that will change.  While Social Security is expected to grow  about 5.6 percent per year on average over the next 10 years, Medicare and  Medicaid combined are expected to grow at 8.5 percent per year.  As a  result, CBO’s baseline projects Medicare and Medicaid spending will be  about 30 percent higher than Social Security in 2015.  According to the  Social Security and Medicare trustees, Social Security will grow from 4.3  percent of GDP today to 6.6 percent in 2075, and Medicare’s burden on the  economy will quintuple—from 2.7 percent to 13.3 percent of the economy.
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  2 and 3 present these simulations under two different sets of assumptions.  In figure 2, 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 3  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.
Although considerable uncertainty surrounds long-term budget  projections, we know two things for certain: the population is aging and the  baby boom generation is approaching retirement age.  The aging  population and rising health care spending will have significant  implications not only for the budget but also for the economy as a whole.  Figure 4 shows the total future draw on the economy represented by Social  Security, Medicare, and Medicaid.  Under the 2004 Trustees’ intermediate  estimates and CBO’s long-term Medicaid estimates, spending for these  entitlement programs combined will grow to 15.6 percent of GDP in 2030  from today’s 8.5 percent.  It is clear that, taken together, Social Security,  Medicare, and Medicaid represent an unsustainable burden on future  generations.
The government can help ease future fiscal burdens through spending  reductions 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.
Some of the benefits of early action—and the costs of delay—can be  illustrated using the 2004 Social Security Trustees’ intermediate  projections. Figure 5 compares what it would take to keep Social Security  solvent through 2078 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. As figure 5 shows, earlier  action shrinks the size of the necessary adjustment.
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 begins 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.
section_title: Demographic Trends Drive Both the Long­ term Fiscal Outlook and Social Security’s Financing Challenge
paragraphs: The Social Security program’s situation is but one symptom of larger  demographic trends that will have broad and profound effects on our  nation’s future in other ways as well.  As you are aware, 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 6, 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  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 factors means that annual 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. (See fig. 7.) Relatively fewer workers will be available to  produce the goods and services that all will consume.  Without a major  increase in productivity or increases in 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.
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, 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.
Increased investment could increase the productivity of workers and spur  economic growth.  However, increasing investment depends on national  saving, which remains at historically low levels.  Historically, the most  direct way for the federal government to increase saving has been to  reduce the deficit (or run a surplus).  Although the government may try to  increase personal saving, results of these efforts have been mixed.  For  example, even with the preferential tax treatment granted since the 1970s  to encourage retirement saving, the personal saving rate has steadily  declined.  Even if economic growth increases, the structure of retirement  programs and historical experience in health care cost growth suggest that  higher economic growth results in a generally commensurate growth in  spending for these programs in the long term.
In recent years, personal saving by households has reached record lows  while at the same time the federal budget deficit has climbed.  (See fig. 8.)  Accordingly, national saving has diminished but the economy has  continued to grow in part because more and better investments were made.  That is, each dollar saved bought more investment goods and a greater  share of saving was invested in highly productive information technology.  The economy has also continued to grow because the United States was  able to invest more than it saved by borrowing abroad, that is, by running a  current account deficit.  However, a portion of the income generated by  foreign-owned assets in the United States must be paid to foreign lenders.  National saving is the only way a country can have its capital and own it  too.
Initial Social Security benefits are indexed to nominal wage growth resulting in higher  benefits over time. consequences for the living standards of future generations. The financial  burdens facing the smaller cohort of future workers in an aging society  would most certainly be lessened if the economic pie were enlarged. This is  no easy challenge, but in a very real sense, our fiscal decisions affect the  longer-term economy through their effects on national saving.
The persistent U.S. current account deficits of recent years have translated  into a rising level of indebtedness to other countries.  However, many other  nations currently financing investment in the United States also will face  aging populations and declining national saving, so relying on foreign  savings to finance a large share of U.S. domestic investment or federal  borrowing is not a viable strategy in the long run.
section_title: Health Care Is a Larger and More Difficult Challenge Than Social Security
paragraphs: As figure 4 showed, over the long term Medicare and Medicaid will  dominate the federal government’s future fiscal outlook.  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.  Health care generally presents not only a much greater but a  more complex challenge than Social Security.  The structural changes  needed to address health care cost growth will take time to develop, and  the process of reforming health care is likely to be an incremental one.
While the long-term fiscal challenge cannot be successfully addressed  without addressing Medicare and Medicaid, federal health spending trends  should not be viewed in isolation from the health care system as a whole.  For example, Medicare and Medicaid cannot grow over the long term at a  slower rate than cost in the rest of the health care system without resulting  in a two-tier health care system.  This, for example, could squeeze  providers who then in turn might seek to recoup costs from other payers  elsewhere in the health care system.  Rather, in order to address the long­ term fiscal challenge, it will be necessary to find approaches that deal with  health care cost growth in the overall health care system.
Although health care spending is the largest driver of the long-term fiscal  outlook, this does not mean that Social Security reform should be  postponed until after health is addressed.  On the contrary, it argues for  moving ahead on Social Security now.  The outlines of Social Security  reform have already been articulated in many Social Security reform  proposals.  These approaches and the specific elements of reform are well  known and have been the subject of many analyses, including GAO reports  and testimonies.  Reform approaches already put forward can serve as a  starting point for deliberations.
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. 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. To assist policymakers, GAO has developed a  broad framework for evaluating reform proposals that considers not only  solvency but other aspects of the program as well.  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: The analytic framework GAO has developed to assess proposals comprises  three basic criteria:
Financing Sustainable Solvency—the extent to which a proposal  achieves sustainable solvency and how it would affect the economy and  the federal budget.  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. Although these issues may  appear technical or routine on the surface, they are important issues  because they have the potential to delay—if not derail—reform if they  are not considered early enough for planning purposes.  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 before this committee and elsewhere, 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.
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. Many proposals contain reforms that would alter  benefits or revenues within the structure of the current defined benefits  system. Some would reduce benefits by modifying the benefit formula  (such as increasing the number of years used to calculate benefits or using  price indexing instead of wage indexing), reduce cost-of-living adjustments  (COLA), raise the normal and/or early retirement ages, or 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  revenue increases, including raising the payroll tax or expanding the Social  Security taxable wage base that finances the system; increasing the  taxation of benefits; or covering those few remaining workers not currently  required to participate in Social Security, such as older state and local  government employees.
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. Achieving sustainable solvency requires  more revenue, lower benefits, or both. 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 such accounts are funded  through borrowing, no such prefunding is achieved. 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 revenues to make up the  difference.
Also, some degree of implementation and administrative complexity arises  in virtually all proposed changes to Social Security. 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.
Another important consideration for Social Security reform is assessing a  proposal’s effect on national saving. Individual account proposals that fund  accounts through 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. 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. 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.
Finally, the effort to reform Social Security is occurring as our nation’s  private pension system is also facing serious challenges. 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.
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.
Today we have an opportunity to address Social Security as a first step  toward improving the nation’s long-term fiscal outlook.  Steps to reform  our federal health care system are likely to be much more difficult.  They  are also likely to require a series of incremental actions over an extended  period of time.  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.
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.
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