Social Security: Analysis of Issues and Selected Reform Proposals
Published: 2003-01-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Social Security not only represents the foundation of our retirement income system; it also provides millions of Americans with disability insurance and survivors' benefits. As a result, Social Security provides benefits that are critical to the current and future well-being of tens of millions of Americans. However, the system faces both solvency and sustainability challenges in the longer term. In their 2002 report, the Trustees emphasized that while the program's near-term financial condition has improved slightly, Social Security faces a substantial financial challenge in the not-too-distant future that needs to be addressed soon. In essence, the program's long-term outlook remains unchanged. Without reform, Social Security, Medicare, and Medicaid are unsustainable, and the long-term impact of these entitlement programs on the federal budget and the economy will be dramatic. Over the past few years, a wide array of proposals has been put forth to restore Social Security's long-term solvency, and a commission established by the President has presented three models for modifying the current program. The Commission's final report called for a period of discussion lasting at least a year before legislative action is taken to strengthen and restore sustainability to Social Security. We have also done a qualitative review of three other proposals introduced in the 107th Congress.
section_title: What GAO Found
paragraphs: Our Social Security challenge is more urgent than it may appear. Failure to take remedial action will, in combination with other entitlement spending, lead to a situation unsustainable both for the federal government and, ultimately, the economy. This problem is about more than finances. It is also about maintaining an adequate safety net for American workers against loss of income from retirement, disability, or death; Social Security provides a foundation of retirement income for millions of Americans and has prevented many former workers and their families from living their retirement years in poverty. As the Congress considers proposals to restore the long-term financial stability and viability of the Social Security system, it also needs to consider the impact of the potential changes on different types of beneficiaries. Moreover, while addressing Social Security reform is important and will not be easy, Medicare presents a much greater, more complex, and even more urgent fiscal challenge.

section_title: Letter
paragraphs: Thank you for inviting me here to talk about our nation’s Social Security  program and how to address the challenges presented in ensuring the  long-term viability of this system. Social Security not only represents the  foundation of our retirement income system; it also provides millions of  Americans with disability insurance and survivors’ benefits. As a result,  Social Security provides benefits that are critical to the current and future  well-being of tens of millions of Americans. However, as I have said in  congressional testimonies over the past several years, the system faces  both solvency and sustainability challenges in the longer term. In their  2002 report, the Trustees emphasized that while the program’s near-term  financial condition has improved slightly, Social Security faces a  substantial financial challenge in the not-too-distant future that needs to  be addressed soon. In essence, the program’s long-term outlook remains  unchanged. Without reform, Social Security, Medicare, and Medicaid are  unsustainable, and the long-term impact of these entitlement programs on  the federal budget and the economy will be dramatic.
Over the past few years, a wide array of proposals has been put forth to  restore Social Security’s long-term solvency, and a commission established  by the President has presented three models for modifying the current  program. The Commission’s final report called for a period of discussion  lasting at least a year before legislative action is taken to strengthen and  restore sustainability to Social Security. Today we are issuing the GAO  report you requested on the Commission’s options. At your request, we  have also done a qualitative review of three other proposals introduced in  the 107th Congress. In my testimony today I will discuss not only our  report but also the broader issue of Social Security. I hope my testimony  will help clarify some of the key issues in the debate about how to  restructure this critically important program.
First, let me highlight a number of important points in connection with the  Social Security challenge.
Social Security reform is part of a broader fiscal and economic  challenge. If you look ahead in the federal budget, the combined Social  Security or Old-Age and Survivors Insurance and Disability Insurance  (OASDI) program together with the rapidly growing health programs  (Medicare and Medicaid) will dominate the federal government’s future  fiscal outlook. Under our long-term simulations, it continues to be the case  that these programs increasingly constrain federal budgetary flexibility  over the next few decades. Absent reform, the nation will ultimately have  to choose between persistent, escalating federal deficits, significant tax  increases, and/or dramatic budget cuts.
Focusing on trust fund solvency alone is not sufficient. We need to  put the program on a path toward sustainable solvency. Trust fund  solvency is an important concept, but focusing on trust fund solvency  alone can lead to a false sense of security about the overall condition of  the Social Security program. The size of the trust fund does not tell us  whether the program is sustainable—that is, whether the government will  have the capacity to pay future claims or what else will have to be  squeezed to pay those claims. Aiming for sustainable solvency would  increase the chance that future policymakers would not have to face these  difficult questions on a recurring basis. Estimates of what it would take to  achieve 75-year trust fund solvency understate the extent of the problem  because the program’s financial imbalance gets worse in the 76th and  subsequent years.
Solving Social Security’s long-term financing problem is more  important and complex than simply making the numbers add up.  Social Security is an important and successful social program that affects  virtually every American family. It currently pays benefits to more than 45  million people, including retired workers, disabled workers, the spouses  and children of retired and disabled workers, and the survivors of  deceased workers. The number of individuals receiving benefits is  expected to grow to almost 69 million by 2020. The program has been  highly effective at reducing the incidence of poverty among the elderly,  and the disability and survivor benefits have been critical to the financial  well-being of millions of others.
Given the current projected financial shortfall of the program, it is  important to compare proposals to at least two funded  benchmarks—one that funds currently scheduled benefits and one  that adjusts to current tax financing. Comparing the beneficiary  impact of reform proposals solely to currently scheduled Social Security  benefits is inappropriate since all current scheduled benefits are not  funded over the longer term. As a result, comparisons to currently  scheduled benefits after the point of trust fund insolvency assume a  payroll tax increase or general revenue infusion that have not been  enacted and may not occur. Likewise, comparisons of reform proposals  solely to funded benefits after the point of trust fund insolvency are  inappropriate since that assumes a future sudden and sharp reduction in  benefits that is not likely to occur. The key point is that there is a  significant gap between scheduled benefits and projected revenues. In  fact, a primary purpose of most Social Security reform proposals is to  close or eliminate this gap.
Reform proposals should be evaluated as packages. The elements of  any package interact; every package will have pluses and minuses, and no  plan will satisfy everyone on all dimensions. If we focus on the pros and  cons of each element of reform, it may prove impossible to build the  bridges necessary to achieve consensus.
Acting sooner rather than later helps to ease the difficulty of  change. As I noted previously, the challenge of facing the imminent and  daunting budget pressure from Medicare, Medicaid, and OASDI increases  over time. Social Security will begin to constrain the budget long before  the trust funds are exhausted in 2041. The program’s annual cash flow is  projected to be negative beginning in 2017. Social Security’s annual cash  deficit will place increasing pressure on the rest of the budget to raise the  resources necessary to meet the program’s costs. Waiting until Social  Security faces an immediate solvency crisis will limit the scope of feasible  solutions and could reduce the options to only those choices that are the  most difficult. It could also contribute to further delay the really tough  decisions on health programs (e.g., Medicare and Medicaid). Acting sooner  rather than later would allow changes to be phased in so that future and  near retirees have time to adjust their retirement planning. It would also  help to ensure that the “miracle of compounding” works for us rather than  against us.
Our Social Security challenge is more urgent than it may appear. Failure to  take remedial action will, in combination with other entitlement spending,  lead to a situation unsustainable both for the federal government and,  ultimately, the economy. This problem is about more than finances. It is  also about maintaining an adequate safety net for American workers  against loss of income from retirement, disability, or death; Social Security  provides a foundation of retirement income for millions of Americans and  has prevented many former workers and their families from living their  retirement years in poverty. As the Congress considers proposals to  restore the long-term financial stability and viability of the Social Security  system, it also needs to consider the impact of the potential changes on  different types of beneficiaries. Moreover, while addressing Social  Security reform is important and will not be easy, Medicare presents a  much greater, more complex, and even more urgent fiscal challenge.
To assist the Congress in its deliberations, we have developed criteria for  evaluating Social Security reform proposals. These criteria aim to balance  financial and economic considerations with benefit adequacy and equity  issues and the administrative challenges associated with various  proposals. The use of these criteria can help facilitate fair consideration  and informed debate of Social Security reform proposals.
subsections: section_title: Social Security’s Long-Term Financing Problem Is More Urgent Than It May Appear
paragraphs: Today the Social Security program faces not an immediate crisis but rather  a long-range and more fundamental financing problem driven largely by  known demographic trends. The lack of an immediate solvency crisis  affects the nature of the challenge, but it does not eliminate the need for  action. Acting soon reduces the likelihood that the Congress will have to  choose between imposing severe benefit cuts and unfairly burdening  future generations with the program’s rising costs. Acting soon would  allow changes to be phased in so the individuals who are most likely to be  affected, namely younger and future workers, will have time to adjust their  retirement planning while helping to avoid related “expectation gaps.”  Since there is a great deal of confusion about Social Security’s current  financing arrangements and the nature of its long-term financing problem,  I would like to spend some time describing the nature, timing, and extent  of the financing problem.
subsections: section_title: Demographic Trends Drive Social Security’s Long- Term Financing Problem
paragraphs: As you all know, Social Security has always been largely a pay-as-you-go  system. This means that current workers’ taxes pay current retirees’  benefits. As a result, the relative numbers of workers and beneficiaries has  a major impact on the program’s financial condition. This ratio, however,  is changing. In 1950, before the Social Security system was mature, the  ratio was 16.5. In the 1960s, the ratio averaged 4.2:1. Today it is 3.4:1 and it  is expected to drop to around 2:1 by 2030. The retirement of the baby  boom generation is not the only demographic challenge facing the system.  People are retiring early and living longer. A falling fertility rate is the  other principal factor underlying the growth in the elderly’s share of the  population. In the 1960s, the fertility rate was an average of 3 children per  woman. Today it is a little over 2, and by 2030 it is expected to fall to  1.95—a rate that is below replacement. Taken together, these trends  threaten the financial solvency and sustainability of this important  program. (See fig. 1.)
The combination of these trends means that labor force growth will begin  to slow after 2010 and by 2025 is expected to be less than a third of what it  is today. (See fig. 2.) Relatively fewer workers will be available to produce  the goods and services that all will consume. Without a major increase in  productivity, low labor force growth will lead to slower growth in the  economy and to slower growth of federal revenues. This in turn will only  accentuate the overall pressure on the federal budget.
This slowing labor force growth is not always recognized as part of the  Social Security debate. Social Security’s retirement eligibility dates are  often the subject of discussion and debate and can have a direct effect on  both labor force growth and the condition of the Social Security  retirement program. However, it is also appropriate to consider whether  and how changes in pension and/or other government policies could  encourage longer workforce participation. To the extent that people  choose to work longer as they live longer, the increase in the share of life  spent in retirement would be slowed. This could improve the finances of  Social Security and mitigate the expected slowdown in labor force growth.
section_title: Social Security’s Cash Flow Is Expected to Turn Negative in 2017
paragraphs: Today, the Social Security Trust Funds take in more in taxes than they  spend. Largely because of the known demographic trends I have  described, this situation will change. Under the Trustees’ intermediate  assumptions, combined program outlays begin to exceed dedicated tax  receipts in 2017 (see fig. 3), a year after Medicare’s Hospital Insurance (HI)  Trust Fund  outlays are first expected to exceed program tax revenues. At  that time, both programs will become net claimants on the rest of the  federal budget.
Although the Trustees’ intermediate estimates show that the combined  Social Security Trust Funds will be solvent until 2041, program spending  will constitute a rapidly growing share of the budget and the economy well  before that date. Ultimately, the critical question is not how much a trust  fund has in assets, but whether the government as a whole can afford the  benefits in the future and at what cost to other claims on scarce resources.
As I have said before, the future sustainability of programs is the key issue  policymakers should address—i.e., the capacity of the economy and  budget to afford the commitment. Fund solvency can help, but only if  promoting solvency improves the future sustainability of the program.
Beginning in 2017, the Trust Funds will begin drawing on the Treasury to  cover the cash shortfall, first relying on interest income and eventually  drawing down accumulated trust fund assets. The Treasury will need to  obtain cash for those redeemed securities either through increased taxes,  spending cuts, increased borrowing from the public, or correspondingly  less debt reduction than would have been the case had Social Security’s  cash flow remained positive. Neither the decline in the cash surpluses nor  the cash deficit will affect the payment of benefits. The shift will, however,  affect the rest of the budget. The negative cash flow will place increased  pressure on the federal budget to raise the resources necessary to meet  the program’s ongoing costs.
section_title: Decline in Budgetary Flexibility Disappears Absent Entitlement Reform
paragraphs: From the perspective of the federal budget and the economy, the  challenge posed by the growth in Social Security spending becomes even  more significant in combination with the more rapid expected growth in  Medicare and Medicaid spending. This growth in spending on federal  entitlements for retirees will become increasingly unsustainable over the  longer term, compounding an ongoing decline in budgetary flexibility.  Over the past few decades, spending on mandatory programs has  consumed an ever-increasing share of the federal budget. In 1962, prior to  the creation of the Medicare and Medicaid programs, spending for  mandatory programs plus net interest accounted for about 32 percent of  total federal spending. By 2002, this share had almost doubled to  approximately 63 percent of the budget. (See fig. 4.)
In much of the last decade, reductions in defense spending helped  accommodate the growth in these entitlement programs. Even before the  events of September 11, 2001, however, this ceased to be a viable option.  Indeed, spending on defense and homeland security will grow as we seek  to combat new threats to our nation’s security.
We prepared long-term budget simulations that seek to illustrate the likely  fiscal consequences of the coming demographic tidal wave and rising  health care costs. These simulations continue to show that to move into  the future with no changes in federal retirement and health programs is to  envision a very different role for the federal government. Assuming, for  example, that the tax reductions enacted in 2001 do not sunset and  discretionary spending keeps pace with the economy, by mid-century  federal revenues may only be adequate to pay Social Security and interest  on the federal debt.  Spending for the current Medicare program—without  the addition of a drug benefit—is projected to account for more than one- quarter of all federal revenues. To obtain balance, massive spending cuts,  tax increases, or some combination of the two would be necessary. (See  fig. 5.) Neither slowing the growth of discretionary spending nor allowing  the tax reductions to sunset eliminates the imbalance.
Although this figure assumes payment of currently scheduled Social  Security benefits, the long-term fiscal imbalance would not be eliminated  even if Social Security benefits were to be limited to currently projected  trust fund revenues. This is because Medicare (and Medicaid)—spending  for which is driven by both demographics and rising health care costs— present an even greater problem. Absent a change in design, these two  health programs together are projected to nearly triple as a share of gross  domestic product (GDP) over the next half-century.
This testimony is not about the complexities of Medicare, but it is  important to note that Medicare presents a much greater, more complex,  and more urgent fiscal challenge than does Social Security. Unlike Social  Security, Medicare growth rates reflect not only a burgeoning beneficiary  population, but also the escalation of health care costs at rates well  exceeding general rates of inflation. Increases in the number and quality of  health care services have been fueled by the explosive growth of medical  technology. Moreover, the actual costs of health care consumption are not  transparent. Third-party payers generally insulate consumers from the cost  of health care decisions. These factors and others contribute to making  Medicare a much greater and more complex fiscal challenge than even  Social Security. We are developing a health care framework to help focus  additional attention on this important area and to help educate key  policymakers on the current system and related challenges.
Indeed, long-term budget flexibility is about more than Social Security and  Medicare. While these programs dominate the long-term outlook, they are  not the only federal programs or activities that bind the future. The federal  government undertakes a wide range of programs, responsibilities, and  activities that obligate it to future spending or create an expectation for  spending. We have work underway regarding how to describe the range  and measurement of such fiscal exposures—from explicit liabilities such  as environmental cleanup requirements to the more implicit obligations  presented by life-cycle costs of capital acquisition or disaster assistance.  Making government fit the challenges of the future will require not only  dealing with the drivers—entitlements for the elderly—but also looking at  the range of federal activities. A fundamental review of what the federal  government does and how it does it will be needed.
At the same time it is important to look beyond the federal budget to the  economy as a whole. Figure 6 shows the total future draw on the economy  represented by Social Security, Medicare, and Medicaid. Under the 2002  Trustees’ intermediate estimates and the Congressional Budget Office’s  most recent long-term Medicaid estimates, spending for these entitlement  programs combined will grow to 13.9 percent of GDP in 2030 from today’s  8.3 percent. Taken together, Social Security, Medicare, and Medicaid  represent an unsustainable burden on future generations.
When Social Security redeems assets to pay benefits, the program will  constitute a claim on real resources in the future. As a result, taking action  now to increase the future pool of resources is important. To echo Federal  Reserve Chairman Alan Greenspan, the crucial issue of saving in our  economy relates to our ability to build an adequate capital stock to  produce enough goods and services in the future to accommodate both  retirees and workers in the future. The most direct way the federal  government can raise national saving is by increasing government saving,  that is, as the economy returns to a higher growth path, a balanced fiscal  policy that recognizes our long-term challenges can help provide a strong  foundation for future economic growth and can enhance future budgetary  flexibility.
Taking action now on Social Security would not only promote increased  budgetary flexibility in the future and stronger economic growth but  would also make less dramatic action necessary than if we wait. Some of  the benefits of early action—and the costs of delay—can be seen in figure  7. This compares what it would take to achieve actuarial balance at  different points in time by either raising payroll taxes or reducing  benefits. Figure 7 shows this. If we did nothing until 2041—the year the  Trust Funds are estimated to be exhausted—achieving actuarial balance  would require changes in benefits of 31 percent or changes in taxes of 45  percent. As figure 7 shows, earlier action shrinks the size of the necessary  adjustment.
Thus, both sustainability concerns and solvency considerations drive us to  act sooner rather than later. Trust Fund exhaustion may be nearly 40 years  away, but the squeeze on the federal budget will begin as the baby boom  generation starts to retire. Actions taken today can ease both these  pressures and the pain of future actions. Acting sooner rather than later  also provides a more reasonable planning horizon for future retirees.
section_title: Evaluating Social Security Reform Proposals
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. Social Security is also much more than just  a retirement program; it also pays benefits to disabled workers and their  dependents, spouses and children of retired workers, and survivors of  deceased workers. Last year, Social Security paid almost $408 billion in  benefits to more than 45 million people. Since its inception, the program  has successfully reduced poverty among the elderly. In 1959, 35 percent of  the elderly were poor. In 2000, about 8 percent of beneficiaries aged 65 or  older were poor, and 48 percent would have been poor without Social  Security. It is precisely because the program is so deeply woven into the  fabric of our nation that any proposed reform must consider the program  in its entirety, rather than one aspect alone. Thus, we have developed a  broad framework for evaluating reform proposals that considers not only  solvency but other aspects of the program as well.
The analytic framework we have developed to assess proposals comprises  three basic criteria:  the extent to which a proposal achieves sustainable solvency and how it  would affect the economy and the federal budget; the relative balance struck between the goals of individual equity and  income adequacy; and   how readily a proposal could be implemented, administered, and  explained to the public.
The weight that different policymakers may place on different criteria will  vary, depending on how they value different attributes. For example, if  offering individual choice and control is less important than maintaining  replacement rates for low-income workers, then a reform proposal  emphasizing adequacy considerations might be preferred. As they fashion  a comprehensive proposal, however, policymakers will ultimately have to  balance the relative importance they place on each of these criteria.
subsections: section_title: Financing Sustainable Solvency
paragraphs: Our sustainable solvency standard encompasses several different ways of  looking at the Social Security program’s financing needs. While 75-year  actuarial balance is generally used in evaluating the long-term financial  outlook of the Social Security program and reform proposals, it is not  sufficient in gauging the program’s solvency after the 75th year. For  example, under the Trustees’ intermediate assumptions, each year the 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 cost beyond the 75th year and (2) the share  of the budget and economy consumed by Social Security spending.
As I have already discussed, reducing the relative future burdens of Social  Security and health programs is essential to a sustainable budget policy for  the longer term. It is also critical if we are to avoid putting unsupportable  financial pressures on future workers. Reforming Social Security and  federal health programs is essential to reclaiming our future fiscal  flexibility to address other national priorities.
section_title: Balancing Adequacy and Equity
paragraphs: The current Social Security system’s benefit structure strikes a balance  between the goals of retirement income adequacy and individual equity.  From the beginning, benefits were set in a way that focused especially on  replacing some portion of workers’ pre-retirement earnings. Over time  other changes were made that were intended to enhance the program’s  role in helping ensure adequate incomes. Retirement income adequacy,  therefore, is addressed in part through the program’s progressive benefit  structure, providing proportionately larger benefits to lower earners and  certain household types, such as those with dependents. Individual equity  refers to the relationship between contributions made and benefits  received. This can be thought of as the rate of return on individual  contributions. Balancing these seemingly conflicting objectives through  the political process has resulted in the design of the current Social  Security program and should still be taken into account in any proposed  reforms.
Policymakers could assess income adequacy, for example, by considering  the extent to which proposals ensure benefit levels that are adequate to  protect beneficiaries from poverty and ensure higher replacement rates for  low-income workers. In addition, policymakers could consider the impact  of proposed changes on various subpopulations, such as low-income  workers, women, minorities, and people with disabilities. Policymakers  could assess equity by considering the extent to which there are  reasonable returns on contributions at a reasonable level of risk to the  individual, improved intergenerational equity, and increased individual  choice and control. Differences in how various proposals balance each of  these goals will help determine which proposals will be acceptable to  policymakers and the public.
section_title: Implementing and Administering Proposed Reforms
paragraphs: Program complexity makes implementation and administration both more  difficult and harder to explain to the public. Some degree of  implementation and administrative complexity arises in virtually all  proposed changes to Social Security, even those that make incremental  changes in the already existing structure. However, the greatest potential  implementation and administrative challenges are associated with  proposals that would create individual accounts. These include, for  example, issues concerning the management of the information and  money flow needed to maintain such a system, the degree of choice and  flexibility individuals would have over investment options and access to  their accounts, investment education and transitional efforts, and the  mechanisms that would be used to pay out benefits upon retirement.  Harmonizing a system that includes individual accounts with the  regulatory framework that governs our nation’s private pension system  would also be a complicated endeavor. However, the complexity of  meshing these systems should be weighed against the potential benefits of  extending participation in individual accounts to millions of workers who  currently lack private pension coverage.
Continued public acceptance and confidence in the Social Security  program require that any reforms and their implications for benefits be  well understood. This means that the American people must understand  why change is necessary, what the reforms are, why they are needed, how  they are to be implemented and administered, and how they will affect  their own retirement income. All reform proposals will require some  additional outreach to the public so that future beneficiaries can adjust  their retirement planning accordingly. Yet the more transparent the  implementation and administration of reform, and the more carefully such  reform is phased in, the more likely it will be understood and accepted by  the American people.
section_title: Range of Proposals Illustrates Options for Reform and Choices to be Made
paragraphs: Over the course of the last several years, various reform proposals have  been crafted. Many proposals involve restructuring the Social Security  program to include individual retirement accounts. These individual  accounts are similar to defined contribution pension plans in that benefits  are based on contributions to and investment returns (gains and losses) on  the accounts. This approach offers the potential for increased investment  returns, but, depending on the design of the reform, may expose retirees  and/or the government to investment risk. Increasing rates of return  through investment in private securities, whether through individual  accounts or collective government investment, cannot achieve sustainable  solvency without additional changes to the current system.
There has been considerable variation in the individual account proposals  introduced in the past couple of years. For example, some earlier  proposals required that individuals participate in the accounts while more  recent proposals provide individuals with the choice of whether or not to  participate. As you know, Mr. Chairman, we are currently working on a  report to be released next month that examines the unique issues  surrounding voluntary individual accounts. Individual account proposals  also differ in other areas, such as the manner in which accounts are  financed, how the accounts interact with the existing Social Security  program, the extent of choice and flexibility concerning investment  options, and the way in which benefits are paid from the account balances.
A number of Social Security reform proposals were introduced in the  107th Congress. At your request, we have done a qualitative review of the  proposals introduced last year by Representatives Shaw, De Mint, and  DeFazio. These three proposals illustrate different approaches to reform.  Representative Shaw introduced a new reform proposal last week—which  we have not had a chance to look at—and we realize that other proposals  may undergo some revisions as well. Like the Commission models, the  proposals by Representatives DeMint and Shaw included voluntary  individual accounts. All three proposals included significant revenue  enhancements, and two of them (Rep. DeMint and Rep. Shaw) included a  guarantee of future benefits at least as large as currently scheduled levels.  Some of these plans include general revenue transfers, collective  investment of some portion of trust fund assets in private securities, and  eliminating the cap on the maximum amount of earnings subject to the  payroll tax. In addition, some include provisions that would reduce future  expenditures, such as an individual account offset against Social Security  retirement and aged survivor benefits and an increase in the number of  benefit computation years in the benefit formula.
As I noted previously, last year the President’s Commission to Strengthen   Social Security issued a report containing three reform models. At your  request, we looked at the Commission’s proposals and is today issuing a  report on our findings. Each of the Commission’s three reform models  represents a different approach to including a voluntary individual account  option to Social Security. Model 1 adds individual accounts to the current  system but does not restore solvency. Models 2 and 3 restore solvency to  the Old-Age and Survivors Insurance and Disability Insurance Trust Funds  through a combination of changes in the initial benefit calculation, general  revenue transfers, and/or benefit offsets for those who choose to  participate in the individual account option. Model 3 also requires an  additional contribution equal to 1 percent of taxable payroll under the  voluntary individual account option. All models share a common  framework for administering individual accounts.
section_title: Examining the Effects of Reform Using the Commission’s Proposals
paragraphs: Applying our criteria to the Commission models highlights trade-offs  between efforts to achieve sustainable solvency and maintain adequate  retirement income for current and future beneficiaries. The models  illustrate some of the options and trade-offs that will need to be  considered as the nation debates how to reform Social Security.
We used our long-term economic model in assessing the Commission  reform models against the first criterion, that of financing sustainable  solvency. Over the past few years, we have been developing a capacity to  estimate the quantitative effects of Social Security reform on individuals.  Such estimates are useful in applying our adequacy/equity criterion to  reform proposals. To examine how the Commission reform models  balance adequacy and equity concerns, we used the GEMINI model, a  dynamic microsimulation model for analyzing the lifetime implications of  Social Security policies for a large sample of people born in the same year.  Our analysis examined the effects of the reform models for the 1955, 1970,  and 1985 birth cohorts. To show the range of possible outcomes given the  voluntary nature of individual accounts in the Commission models, we  simulated each model assuming (1) no participation in the individual  account option and (2) universal participation in the account option.
Our analysis of the Commission reform models included comparison with  three benchmarks:    The “benefit reduction benchmark” assumes a gradual reduction in the  currently scheduled Social Security defined benefit beginning with those  newly eligible for retirement in 2005. Current tax rates are maintained.
The “tax increase benchmark” assumes an increase in the OASDI payroll  tax beginning in 2002 sufficient to achieve an actuarial balance over the  75-year period. Currently scheduled benefits are maintained.
The “baseline extended” benchmark is a fiscal policy path developed in  our earlier long-term model work that assumes payment in full of currently  scheduled Social Security benefits and no other changes in current  spending or tax policies.
subsections: section_title: Financing Sustainable Solvency
paragraphs: The use of these criteria to evaluate approaches to Social Security reform  highlights the trade-offs that exist between efforts to achieve solvency for  the OASDI trust funds and efforts to maintain adequate retirement income  for current and future beneficiaries.
Overall, Model 2 would provide for sustainable solvency and reduce the  shares of the federal budget and the economy devoted to Social Security  compared to currently scheduled benefits (tax increase benchmark)  regardless of how many individuals selected accounts. With universal  account participation, general revenue funding would be needed for about  3 decades. Specifically, our analysis of sustainable solvency under Model 2  showed that:    As estimated by the actuaries, Model 2, with either universal or zero  participation in voluntary individual accounts, is solvent over the 75-year  projection period, and the ratio of annual income to benefit payments at  the end of the simulation period is increasing. However, in Model 2 with  universal account participation, over 3 decades of general revenue  transfers are needed to achieve trust fund solvency. Model 2 with zero  account participation achieves solvency with no general revenue transfers.
Model 2 with universal account participation would ultimately reduce the  budgetary pressures of Social Security on the unified budget relative to the  baseline extended benchmark. However, this would not begin until the  middle of this century. Relative to both our benefit reduction benchmark  and tax increase benchmark, unified surpluses would be lower and unified  deficits higher throughout the simulation period under Model 2 with  universal account participation. Model 2 with zero account participation  would reduce budgetary pressures due to Social Security beginning  around 2015 relative to the baseline extended benchmark. This fiscal  outlook under Model 2 with zero account participation is very similar to  the fiscal outlook under our benefit reduction benchmark.
Under Model 2 with universal account participation, the government’s  cash requirement (as a share of GDP) to fund the individual accounts and  the reduced defined benefit would be about 20 percent higher initially than  under both the baseline extended and tax increase benchmarks. This  differential gradually narrows until the 2030s, after which less cash would  be required under Model 2 with universal account participation. By 2075,  Model 2 with universal account participation would require about 40  percent less cash than the baseline extended and tax increase  benchmarks.
Viewed from the perspective of the economy, total payments (Social  Security defined benefits plus income from individual accounts) as a share  of GDP would gradually fall under Model 2 with universal account  participation relative to the baseline extended and tax increase  benchmarks. In 2075, the share of the economy absorbed by payments to  retirees from the Social Security system as a whole under Model 2 with  universal account participation would be roughly 20 percent lower than  the baseline extended or tax increase benchmark and roughly the same as  under the benefit reduction benchmark.
With regard to national saving, Model 2 increases net national saving on a  first order basis primarily due to the proposed benefit reductions. The  individual account provision does not increase national saving on a first  order basis; the redirection of the payroll taxes to finance the accounts  reduces government saving by the same amount that the individual  accounts increase private saving.
Beyond these first order effects, the actual net effect of a proposal on  national saving is difficult to estimate due to uncertainties in predicting  changes in future spending and revenue policies of the government as well  as changes in the saving behavior of private households and individuals.  For example, the lower surpluses and higher deficits that result from  redirecting payroll taxes to individual accounts could lead to changes in  federal fiscal policy that would increase national saving. However,  households may respond by reducing their other saving in response to the  creation of individual accounts.
Because the benefit reductions in Model 3 are smaller than in Model 2,  long-term unified deficits are larger under Model 3. Model 3 requires an  additional contribution equal to 1 percent of taxable payroll for those  choosing individual accounts. Assuming universal account participation in  both models, Model 3 would result in a larger share of the economy being  absorbed by total benefit payments to retirees—about the same share as  would be the case under the baseline extended and tax increase  benchmarks.
section_title: Balancing Adequacy and Equity
paragraphs: The Commission’s proposals also illustrate the trade-offs reform proposals  face generally in balancing adequacy and equity considerations. Both of  the models protect benefits for current and near retirees, and the shift to  advance funding could improve intergenerational equity. However, under  each of the models, some future retirees also could face potentially  significant benefit reductions in comparison to either the tax increase or  the benefit reduction benchmarks. This is because primary insurance  amount formula factors are reduced by real wage growth, uncertainty in  rates of return earned on accounts, changes in benefit status over time,  and annuity pricing.
Our analysis of Model 2 shows that:    Median monthly benefits (the individual account annuity plus the defined  benefit reduced by an offset) for those choosing individual accounts are  always higher than for those who do not choose the account, and this gap  grows over time. In addition, median monthly benefits under universal  participation in the accounts are also higher than the median benefits  received under the benefit reduction benchmark. However, median  monthly benefits received by those without accounts fall below those  provided by the benefit reduction benchmark over time.
For the lowest quintile of beneficiaries, median monthly benefits with  universal participation in the accounts tend to be higher than the benefits  received under the benefit reduction benchmark, likely due to the  enhanced benefit for full-time “minimum wage” workers. This pattern  becomes more pronounced over time.
Regardless of whether an account is chosen, under Model 2 many people  could receive monthly benefits that are higher than the benefit reduction  benchmark. However, a minority could fare worse. Some people could  also receive a benefit greater than under the tax increase benchmark  although a majority could fare worse. Monthly benefits for those choosing  individual accounts will be sensitive to the actual rates of return earned by  those accounts.
The cohort results for Model 3 are generally similar to Model 2. However,  median monthly benefits for those choosing individual accounts are higher  than the benefit level under the tax increase benchmark for the 1970 and  1985 cohorts. This result is likely because of Model 3’s feature of a  mandatory extra 1 percent contribution into the individual accounts for  those who choose to participate.
section_title: Implementing and Administering Reforms
paragraphs: Each of the models would establish a governing board to administer the  individual accounts, including the choice of available funds and providing  financial information to individuals. While the Commission had the benefit  of prior thinking on these issues, many implementation issues remain,  particularly in ensuring the transparency of the new system and educating  the public to avoid any gaps in expectations. For example, an education  program would be necessary to explain the changes in the benefit  structure, model features like the benefit offset and how accounts would  be split in the event of divorce. Education and investor information is also  important as the system expands and increases the range of investment  selection. Questions about the harmonization of such features with state  laws regarding divorce and annuities also remain an issue.
section_title: Conclusion: Choices and Trade-Offs Will Be Part of Any Social Security Reform— Acting Soon Would Help
paragraphs: It is likely that the structural changes required to restore Social Security’s  long-term viability generally will require some combination of reductions  from currently scheduled benefits, revenue increases, and may include the  use of some general revenues. The proposals we have examined, both in  2002 and earlier, generally reflect this. Proposals employ possible benefit  reductions within the current program structure, including modifying the  benefit formula, raising the retirement age, and reducing cost-of-living  adjustments. Revenue increases might take the form of increases in the  payroll tax rate, expanding coverage to include the relatively few workers  who are still not covered under Social Security, or allowing the trust funds  to be invested in potentially higher-yielding securities such as stocks.  Similarly, some proposals rely on general revenue transfers to increase the  amount of money going towards the Social Security program. Reforms that  include individual accounts would also involve Social Security benefit  reductions and/or revenue increases, and the use of general revenues.
The Commission report highlights the trade-offs and challenges in reform.  Model 2 uses a combination of benefit reductions and revenue increases to  restore long-term solvency. For example, we found that the model reduces  Social Security’s defined benefit from currently scheduled levels through  formula changes, provides enhanced benefits for low-wage workers and  spousal survivors, and adds a voluntary individual account option. Model 2  would both restore trust fund solvency and reduce the shares of the  federal budget and the economy devoted to Social Security compared with  currently scheduled benefits regardless of how many individuals selected  accounts. With universal account participation, general revenues would be  needed for about 3 decades. The other three proposals we examined take  somewhat different approaches, relying heavily on additional sources of  revenue. For example, Representative DeFazio’s proposal would restore  solvency primarily on the revenue side, allowing a portion of trust fund  assets to be invested in marketable securities and eliminating the cap on  taxable payroll earnings.
In evaluating Social Security reform proposals, the choice among various  benefit reductions and revenue increases will affect the balance between  income adequacy and individual equity. Benefit reductions could pose the  risk of diminishing adequacy, especially for specific subpopulations. Both  benefit reductions and tax increases that have been proposed could  diminish individual equity by reducing the implicit rates of return the  workers earn on their contributions to the system. In contrast, increasing  revenues by investing retirement funds in the stock market could improve  rates of return but potentially expose individuals to investment risk and  losses.
Similarly, the choice among various benefit reductions and revenue  increases—for example, raising the retirement age—will ultimately  determine not just how much income retirees will have but also how long  they will be expected to continue working and how long their retirements  will be. Reforms will determine how much consumption workers will give  up during their working years to provide for more consumption during  retirement.
Early action to change these programs would yield the highest fiscal  dividends for the federal budget and would provide a longer period for  prospective beneficiaries to make adjustments in their own planning.  Waiting to build economic resources and reform future claims entails  risks. First, we lose an important window where today’s relatively large  workforce can increase saving and enhance productivity, two elements  critical to growing the future economy. We lose the opportunity to reduce  the burden of interest payments, thereby creating a legacy of higher debt  as well as elderly entitlement spending for the relatively smaller workforce  of the future. Most critically, we risk losing the opportunity to phase in  changes gradually so that all can make the adjustments needed in private  and public plans to accommodate this historic shift. Unfortunately, the  long-range challenge has become more difficult, and the window of  opportunity to address the entitlement challenge is narrowing. As the baby  boom generation retires and the numbers of those entitled to these  retirement benefits grow, the difficulties of reform will be compounded.  Accordingly, it remains more important than ever to deal with these issues  over the next several years.