Social Security: Issues in Evaluating Reform Proposals
Released: 2001-12-10T00:00:00

Letter

Social Security’s Long-Term Financing Problem Is More Urgent Than It May Appear

Today the Social Security program does not face 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 changes the challenge, but it does not eliminate the need for action. Acting sooner rather than later 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.” It is also important to put the overall federal budget on a sustainable footing over the long term, thereby promoting higher economic growth and more fiscal flexibility to finance other priorities.

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’d like to spend some time describing the nature, timing, and extent of the financing problem.

Revenue

Since Social Security will constitute claims on real resources in the future when it redeems assets to pay benefits, taking action now to increase the future pool of resources is important. As Federal Reserve Chairman Greenspan has said, 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 we can raise national saving is by increasing government saving. Saving a good portion of the surpluses would allow the federal government to reduce the debt overhang from past deficit spending, provide a strong foundation for future economic growth and enhance future budgetary flexibility.

Correspondingly, taking action now on Social Security not only would promote increased budgetary flexibility in the future and stronger economic growth but would also require less dramatic action than if we wait. Perhaps the best way to show this is to compare what it would take to achieve actuarial balance at different points in time. Figure 6 shows this. If we did nothing until 2038—the year the Trust Funds are estimated to be exhausted—achieving actuarial balance would require benefit reductions of 30 percent or a tax increase of 39 percent. As figure 6 shows, earlier action shrinks the size of the necessary adjustment.

Thus both sustainability concerns and solvency considerations must drive us to act sooner rather than later. Trust Fund exhaustion may be more than 30 years away, but the squeeze on the federal budget is only 15 years in our future. 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.

Evaluating Social Security Reform Proposals

As important as financial stability may be for Social Security, it is not the only consideration. Social Security remains the foundation of the nation’s retirement system. Yet it is 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 1999, 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, GAO has developed a broad framework for evaluating reform proposals that considers not only solvency but other aspects of the program as well. Arguably, similar frameworks can also be applied to other programs like Medicare.

The analytic framework GAO has 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 would 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.

Financing Sustainable Solvency

Any reforms to Social Security must ensure that program revenues continue to exceed the cost of benefit payments if the Social Security program is to achieve sustainable solvency. Historically, the program’s solvency has generally been measured over a 75-year projection period. If projected revenues equal projected outlays over this time horizon, then the system is declared in actuarial balance. Unfortunately, this measure is itself unstable. 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. This means that changes that restore solvency only for the 75-year period will not hold. For example, if we were to raise payroll taxes by 1.86 percentage points of taxable payroll today—which, according to the 2001 Trustees Report, is the amount necessary to achieve 75-year balance—the system would be out of balance next year. Reforms that lead to sustainable solvency are those that avoid the automatic need to periodically revisit this issue.

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 health programs is essential to reclaiming our future fiscal flexibility to address other national priorities.

Balancing Adequacy and Equity

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, and 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 sub-populations, 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.

After I finish this brief overview of our evaluation framework, I would like to come back to this criterion and share some results from our recent report on income adequacy.

Implementing and Administering Proposed Reforms

Program complexity can both make implementation and administration more difficult, and make it harder to explain to the public. Some degree of implementation and administrative complexity arises in virtually all proposed reforms 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. There is also the necessary and complex task of harmonizing any system of individual accounts with the extensive existing regulatory framework governing our nation’s private pension system. In evaluating such proposals, the complexities of meshing these systems would have to be balanced against the opportunity of extending pension participation to millions of uncovered workers.

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 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. From a practical stand-point, the phase-in of any reform should reflect individual fairness and political feasibility. With regard to proposals that involve individual accounts, an essential challenge would be to help the American people understand the relationship between their individual accounts and traditional Social Security benefits, thereby ensuring that we avoid any gap in expectations about current or future benefits.

Examining Effects of Reform on Income Adequacy

Over the past few years, we have been developing a capacity at GAO to estimate the quantitative effects of Social Security reform on individuals. Such estimates speak directly to applying our adequacy/equity criterion to reform proposals. We have just issued a new report that includes such estimates to illustrate the varying effects of different policy scenarios on individuals. Today, I would like to share our findings regarding what measures can be used to examine income adequacy, defining appropriate benchmarks for assessing the future outlook for individuals’ Social Security benefits, and how varying approaches to reducing benefits could have different effects on adequacy. Our recent report did not, however, present estimates of effects on individual equity. In addition to these points, our report looked at how concern over income adequacy has shaped the Social Security program over the years and how income adequacy has changed over time, especially for different groups of beneficiaries.

No Single Measure Gives Complete Picture of Income Adequacy

Various measures help examine different aspects of income adequacy, but no single measure can provide a complete picture. Three examples illustrate the variety of approaches.

Dependency rates measure what proportion of the population depends on others for income support or, more specifically, on government income support programs such as Supplemental Security Income (SSI). Such rates reflect one of Social Security’s goals, reducing dependency on public assistance, which was articulated very early in the program’s history.

Poverty rates measure what proportion of the population have incomes below the official poverty threshold, which is just one of many adequacy standards used in similar rate calculations. The poverty threshold provides a minimal standard of adequacy; other standards reflect different outlooks on what adequacy means.

Earnings replacement rates measure the extent to which retirement income replaces pre-retirement income for particular individuals and thereby helps them maintain a pre-retirement standard of living. When applied to Social Security benefits, this measure reflects the way the benefit formula is designed to replace earnings.

For any of these measures, the meaning of a given value of the measure is not clear. For example, what value of a dependency or poverty rate is considered low enough and what replacement rate is considered high enough are quite subjective. Moreover, all of these types of measures depend significantly on what types of income are counted, such as before- or after-tax income or noncash benefits such as Medicare and Medicaid. As a result, the measures are most useful not for their estimated values in isolation but rather for making comparisons, whether over time, across different subpopulations, or across different policy scenarios.

Benchmark Policy Scenarios Illustrate Range of Possible Outcomes

In the past, we have pointed out the importance of establishing the proper benchmarks against which reforms must be measured. Often reform proposals are compared to currently promised benefits, but currently promised benefits are not fully financed. It is also necessary to use a benchmark of a fully financed system to fairly evaluate reform proposals. To illustrate a full range of possible outcomes, our recent report on income adequacy used hypothetical benchmark scenarios that would restore 75-year solvency either by only increasing payroll taxes or by only reducing benefits. Our tax-increase-only benchmark simulated benefits at currently promised levels while our benefit-reduction-only benchmarks simulated benefits funded at current tax levels. These benchmarks used the program’s current benefit structure and the 2001 OASDI Trustees’ intermediate, or best-estimate, assumptions. The benefit reductions were phased in between 2005 and 2035 to strike a balance between the size of the incremental reductions each year and the size of the ultimate reduction. At our request, SSA actuaries scored our benchmark policies and determined the parameters for each that would achieve 75-year solvency. For our benefit reduction scenarios, the actuaries determined these parameters assuming that disabled and survivor benefits would be reduced on the same basis as retired worker and dependent benefits. If disabled and survivor benefits were not reduced at all, reductions in retired worker benefits would be deeper than shown in this analysis.

Varying Approaches to Benefit Reductions Would Have Different Effects on Adequacy

Future benefit levels and income adequacy will depend considerably on how any benefit reductions are made. Figure 7 shows the percentage of retired workers with Social Security benefits that fall below the official poverty threshold for various benchmarks. Note that this graph does not show poverty rates, which would require projections of total income;instead, it focuses only on Social Security benefits. The percentage with total incomes below the poverty threshold would be lower if other forms of retirement income were included. The figure shows that the percentage with benefits below the poverty threshold would be greater under a proportional benefit reduction than under a progressive benefit reduction. The proportional benefit-reduction-only benchmark would reduce benefits by the same proportion for all beneficiaries born in the same year. The progressive benefit-reduction-only benchmark would reduce benefits by a smaller proportion for lower earners and a higher proportion for higher earners. The tax-increase-only (no benefit reduction) benchmark estimates are shown for reference.

Percent of cohort with Social Security benefits below poverty 1955 (2017)

1970 (2032)

1985 (2047)

Birth year (age 62 year)

Different approaches to reducing benefits would have different effects on income adequacy because their effects would vary with earnings levels. Smaller reductions for lower earners, who are most at risk of poverty, would decrease the chances that their benefits would fall below poverty.

Figure 8 illustrates how different approaches would have benefit reductions that would vary by benefit levels (which are directly related to earnings). The proportional benchmark would reduce benefits by an identical percentage for all earnings levels. In contrast, the two alternative, progressive benchmarks would reduce benefits less for lower earners than for higher earners. The so-called “limited-proportional” benefit-reduction benchmark would be even more progressive than the progressive benefit- reduction benchmark because a portion of benefits below a certain level are protected from any reductions while reductions above that level are proportional. Moreover, different benefit reduction approaches would have varying effects on different beneficiary groups according to the variation in the typical earnings levels of those subgroups. For example, women, minorities, and never married individuals all tend to have lower lifetime earnings than men, whites, and married individuals, respectively. Therefore, benefit reductions that favor lower earners would help minimize adequacy reductions for such groups that typically have lower earnings.

As our report also showed, the effects of some reform options parallel those of benefit reductions made through the benefit formula, and those parallels provide insights into the distributional effects of those reform options. For example, if workers were to retire at a given age, an increase in Social Security’s full retirement age results in a reduction in monthly benefits; moreover, that benefit reduction would be a proportional, not a progressive reduction. Another example would be indexing the benefit formula to prices instead of wages. Such a revision would also be a proportional reduction, in effect, because all earnings levels would be treated the same under such an approach. In addition, indexing the benefit formula to prices would implicitly affect future poverty rates. Since the official poverty threshold increases each year to reflect price increases and benefits would also be indexed to prices, poverty rates would not be expected to change notably, holding all else equal. In contrast, under the current benefit formula, initial benefit levels would grow faster on average than the poverty threshold and poverty rates would fall, assuming that wages increase faster than prices on average, as the Social Security trustees’ report assumes they will.

Conclusion

Changes to the Social Security system should be made sooner rather than later—both because earlier action yields the highest fiscal dividends for the federal budget and because it provides a longer period for future beneficiaries to make adjustments in their own planning. The events of September 11 and the need to respond to them do not change this. It remains true that the longer we wait to take action on the programs driving long-term deficits, the more painful and difficult the choices will become.

Today I have described GAO’s three basic criteria against which Social Security reform proposals may be measured: financing sustainable solvency, balancing adequacy and equity, and implementing and administering reforms. These may not be the same criteria every analyst would suggest, and certainly how policymakers weight the various elements may vary. But if comprehensive proposals are evaluated as to (1) their financing and economic effects, (2) their effects on individuals, and (3) their feasibility, we will have a good foundation for devising agreeable solutions, perhaps not in every detail, but as an overall reform package that will meet the most important of our objectives.

Our recent report on Social Security and income adequacy showed that more progressive approaches to reducing monthly benefits would have a smaller effect on poverty, for example, than less progressive approaches. Also, reductions that protect benefits for survivors, disabled workers, and the very old would help minimize reductions to income adequacy, though they would place other beneficiaries at greater risk of poverty. More broadly, the choices the Congress will make to restore Social Security’s long-term solvency and sustainability will critically determine the distributional effects of the program, both within and across generations. In turn, those distributional effects will determine how well Social Security continues to help ensure income adequacy across the population. Still, such adequacy effects then need to be balanced against an assessment of the effects on individual equity. In addition, all adequacy measures depend significantly on what types of income are counted. In particular, noncash benefits such as Medicare play a major role in sustaining standards of living for their beneficiaries. Any examination of income adequacy should acknowledge the major role of noncash benefits and the needs they help support.

In finding ways to restore Social Security’s long-term solvency and sustainability, the Congress will address a key question, whether explicitly or implicitly: What purpose does it want Social Security to serve in the future? to minimize the need for means-tested public assistance programs; to minimize poverty; using what standard of poverty; to replace pre-retirement earnings; to maintain a certain standard of living; or to preserve purchasing power?

The answer to this question will help identify which measures of income adequacy are most relevant to examine. It will also help focus how options for reform should be shaped and evaluated. Our work has illustrated how the future outlook depends on both the measures used and the shape of reform. While the Congress must ultimately define Social Security’s purpose, our work has provided tools that inform its deliberations.

Still, Social Security is only one part of a much larger picture. Reform proposals should be evaluated as packages that strike a balance among their component parts. Furthermore, Social Security is only one source of income and only one of several programs that help support the standard of living of our retired and disabled populations. All sources of income and all of these programs should be considered together in confronting the demographic challenges we face. In addition to Social Security, employer- sponsored pensions, individual savings, Medicare, employer-provided health benefits, earnings from continued employment, and means-tested programs such as SSI and Medicaid all should be considered, along with any interactions among them. In particular, compared to addressing our long-range health care financing problem, reforming Social Security is easy lifting. We at GAO look forward to continuing to work with this Committee and the Congress in addressing these important issues.

Mr. Chairman, members of the Committee, that concludes my statement. I’d be happy to answer any questions you may have.

GAO Contact and Staff Acknowledgments

For information regarding this testimony, please contact me at (202) 512-7215. Individuals making key contributions to this testimony include Ken Stockbridge, Charles Jeszeck, Alicia Cackley, Jay McTigue, Linda Baker, and Melissa Wolf.

Related GAO Products

Social Security: Program’s Role in Helping Ensure Income Adequacy (GAO-02-62, Nov. 30, 2001).

Social Security Reform: Potential Effects on SSA’s Disability Programs and Beneficiaries (GAO-01-35, Jan. 24, 2001).

Social Security Reform: Evaluation of the Nick Smith Proposal. (GAO-AIMD/HEHS-00-102R, Feb. 29, 2000).

Social Security Reform: Evaluation of the Gramm Proposal (GAO/AIMD/HEHS-00-71R, Feb. 1, 2000).

Social Security Reform: Information on the Archer-Shaw Proposal (GAO/AIMD/HEHS-00-56, Jan. 18, 2000).

Social Security: The President’s Proposal (GAO/T-HEHS/AIMD-00-43, Nov. 9, 1999).

Social Security: Evaluating Reform Proposals (GAO/AIMD/HEHS-00-29, Nov. 4, 1999).

Social Security Reform: Implications of Raising the Retirement Age (GAO/HEHS-99-112, Aug. 27, 1999).

Social Security: Issues in Comparing Rates of Return With Market Investments (GAO/HEHS-99-110, Aug. 5, 1999).

Social Security: Implications of Private Annuities for Individual Accounts (GAO/HEHS-99-160, July 30, 1999).

Social Security: Capital Markets and Educational Issues Associated with Individual Accounts (GAO/GGD-99-115, June 28, 1999).

Social Security Reform: Administrative Costs for Individual Accounts Depend on System Design (GAO/HEHS-99-131, June 18, 1999).

Social Security Reform: Implementation Issues for Individual Accounts (GAO/HEHS-99-122, June 18, 1999).

Social Security: Criteria for Evaluating Social Security Reform Proposals (GAO/T-HEHS-99-94, Mar. 25, 1999).