When Social Security was enacted in 1935, the nation was in the midst of the Great Depression. About half of the elderly depended on others for their livelihood, and roughly one-sixth received public charity. Many had lost their savings. Social Security was created to help ensure that in the future the elderly would have adequate incomes in retirement and would not have to depend on welfare. Instead, the new program would provide benefits based on the payroll tax contributions of workers and their employers. Today Social Security is much more than a retirement program. In 1939 Social Security coverage was extended to the dependents of retired and deceased workers and in 1956 to the disabled. Over one- third of beneficiaries receive benefits for reasons other than old age. Our work on Social Security reform has emphasized the need for change not only because future program revenues are expected to fall short of what is needed to pay currently scheduled benefits in full but because Social Security, Medicare, and Medicaid taken together will consume an increasing share of the budget and the economy. To move into the future with no changes in federal health and retirement programs is to envision a very different role for the federal government. Little room would be left for other federal spending priorities such as national defense, education, and law enforcement. Absent changes in the structure of Social Security and Medicare, some time during the 2040s government would do nothing but pay interest on the debt and mail checks to retirees. Accordingly, substantive reform of Social Security and health programs remains critical to recapturing our future fiscal flexibility. Overall, the federal budget is facing unsustainable deficits and debt. Our most recent long-term budget simulations provide a compelling illustration of how unsustainable the long-term fiscal outlook is under current policies. As shown in figure 2, the long-term outlook under plausible assumptions is bleak. A demographic shift will begin to affect the federal budget in 2008 as the first baby boomers become eligible for Social Security benefits. Over time, this shift will cause spending for federal health and retirement programs including Social Security to swell. Long-term commitments for these and other federal programs will drive a massive imbalance between spending and revenues that cannot be eliminated without difficult policy choices and ultimately significant policy changes. As figure 2 shows, contrary to popular perception, although Social Security grows in size, it is not the major driver of the long-term fiscal challenge. Spending for Medicare and Medicaid is expected to grow much faster. Many specific solutions have been proposed for Social Security, but approaches to reducing health care cost growth remain elusive. Moreover, addressing federal programs such as Medicare and the federal-state Medicaid program will need to involve changes in the health care system of which they are a part. This will be a societal challenge affecting all age groups. While Social Security reform alone cannot eliminate the long-term fiscal challenge, the likely effects of reform on the nation’s fiscal future should be clearly understood and taken into account. Social Security’s benefit payments and program receipts are tracked in federal budget accounts that are known as trust funds. Trust funds are one type of mechanism created to account for receipts that are dedicated to a specific fund for a specific purpose. Social Security has two trust funds, the Old-Age Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. The combined OASDI trust fund comprises the financial resources of the Social Security system. Social Security has a permanent appropriation that permits the payment of benefits as long as the relevant trust fund account has a sufficient balance. Social Security’s outlays are limited to trust fund balances, but the program’s outlays and revenues are also part of the federal unified budget. Today, Social Security payroll tax revenues exceed benefits. In 2005, the Social Security trust fund paid $530 billion in benefit payments and administrative costs and took in $608 billion in cash revenues, leaving a cash surplus of about $78 billion. By law, the Social Security trust fund must invest any cash surpluses in interest-bearing federal government securities. Throughout its history, Social Security has invested mostly in a special type of nonmarketable securities that, like debt held by the public, are guaranteed by the full faith and credit of the U.S. government. Treasury borrows the cash from Social Security’s surplus to pay for other government expenses, and this use of Social Security’s excess cash revenues reduces the amount Treasury would otherwise need to borrow from the public to finance other federal programs. (See fig. 3). These excess cash revenues, however, will begin to diminish in 2009, one year after the oldest members of the baby boom generation first become eligible for Social Security old age benefits. This downturn in the Social Security cash surplus—the difference between payroll taxes and benefits paid—will begin a squeeze on the rest of the budget that will worsen in the coming years, making less cash revenue available for other federal priorities. By 2017 trust fund cash revenues will be inadequate to pay currently scheduled benefits in full, and the Social Security trust fund will need to redeem trust fund assets from the Treasury. To pay the trust fund, Treasury will need to provide cash from general revenues in exchange for those trust fund securities. This can come only through increased revenue, increased borrowing from the public, reduced spending in the rest of the government, or some combination of these. While the trust fund is redeeming its securities, it will continue to pay full benefits, but the redemptions will reduce overall federal budgetary flexibility. As we have said previously, Social Security reform proposals will need to be evaluated on a number of criteria. Our work on various aspects of this important program has emphasized that Social Security reform is about more than solvency. To evaluate reform proposals, we have suggested that policy makers should consider three basic criteria: 1. the extent to which the proposal achieves sustainable solvency and how the proposal would affect the economy and the federal budget; 2. the balance struck between the twin goals of individual equity (rates of return on individual contributions) and income adequacy (level and certainty of benefits); and 3. how readily such changes could be implemented, administered, and explained to the public. Our first criterion of sustainable solvency reflects the need to look at Social Security reform both in terms of its trust fund and in the larger context of the federal budget as a whole. It is different from OCACT’s definition, which is focused solely on the trust fund, for which they are responsible. From a micro perspective, projected trust fund balances can provide a vital though imperfect signaling function for policymakers about underlying fiscal imbalances in covered programs. Tracking the estimated future balances makes it possible in turn to estimate how much more funding is needed to pay for the benefits scheduled in current law. A shortfall between the long-term projected fund balance and projected costs can signal that the fund, either by design or because of changes, is collecting insufficient monies to finance currently scheduled future payments. This signaling device can eventually prompt policymakers to action. From a macro perspective, however, program solvency measures such as the trust fund exhaustion date and the actuarial balance calculation provide no information about the broader question of program sustainability—that is, the capacity of the future economy and the federal unified budget to pay program benefits over the long run. When a program is not fully self-financed, as is the case with Social Security, projected accumulated trust fund balances do not necessarily reflect the full future cost of existing government commitments. Accordingly, trust fund balances are not an adequate measure of Social Security’s sustainability. The critical question is whether the Nation and the government as a whole can afford the benefits in the future and at what cost in terms of other claims on scarce resources. Extending a trust fund’s solvency without reforms to make the underlying program more sustainable over the long term can obscure the warning signals that trust fund balances provide, thereby creating a false sense of security and delaying needed program reform. Evaluating proposals is a complex task involving trade-offs between competing goals. Reform proposals should be evaluated as packages that strike a balance among individual reform elements and important interactive effects between these elements. The overall evaluation of any particular reform proposal depends on the weight individual policy makers place on each criterion. Since its establishment in 1935 Social Security has been financed primarily by payroll taxes contributed equally by employers and employees. Both tax rates and benefits have changed over time, but Congress has generally rejected proposals for including general revenue in financing Social Security benefits. Payroll tax rates have increased, from a total of 2 percent of taxable payroll in 1937—when payroll taxes were first collected—to 12.4 percent today. Benefits have also been expanded to include workers’ families and the disabled. The question of whether some general revenue should be used to minimize the burden of payroll taxes has been debated since the program’s inception. The Committee on Economic Security (CES), tasked by President Roosevelt with designing the program, believed that expected benefit payments would exceed expected payroll tax revenues beginning about 1965 and at that time general revenue should be used to fill the gap. Under this financing arrangement, the general revenue share was ultimately expected to reach about one-third of total revenues. President Roosevelt rejected the idea of using general revenue in program financing. He endorsed payroll tax financing on the grounds that it would ensure the new program would be “self-supporting.” A perceived link between benefits and payroll tax contributions would, he believed, serve to preserve the program in the future. Using general revenue would make the program welfare—in President Roosevelt’s words, “the dole by another name.” President Roosevelt’s financing approach envisioned the buildup of a reserve fund that would serve to fund benefits in the long term, but objections were made to this approach. Some believed that the existence of a large reserve fund would lead to higher benefit levels or other increased government spending; others objected to the underlying concept of prefunding benefits which they believed would lock in specific levels of support for aged beneficiaries in the future.