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; roughly one-sixth received public charity. Many had lost their savings in the stock market crash. Social Security was created to help ensure that the elderly had adequate income and did not depend on welfare. It would provide benefits that workers had earned with their contributions and the help of their employers. In creating Social Security, the Congress recognized an immediate need to bolster the income of the elderly; an individual retirement savings approach would not have significantly affected retirement income for years to come. The Social Security benefits that early beneficiaries received significantly exceeded their contributions, but even the very first beneficiaries had made some contributions. The Social Security Act of 1935 included a companion welfare program to help the elderly who had not earned retired worker benefits under Social Security. Initially, very few of the elderly qualified for Social Security benefits; therefore, funding the benefits required relatively low payroll taxes. Increases in payroll taxes were always anticipated to keep up with the benefit payments as the system “matured” and more retirees received benefits. From the beginning, Social Security was financed on this type of “pay-as-you-go” basis, with any 1 year’s revenues collected primarily to fund benefits to be paid that year. The Congress had rejected the idea of “advance funding” for the program, or collecting enough revenues to cover future benefit rights as workers accrued them. Many feared that if the federal government amassed huge reserve funds, it would just find a way to spend them elsewhere. Over the years, the size and scope of the program have changed. In 1939, coverage was extended to dependents and survivors. In the 1950s, state and local governments were given the option of covering their employees. The Disability Insurance program was added in 1956. The Medicare program was added in 1965. Beginning in 1975, benefits were automatically tied to the Consumer Price Index to ensure that the purchasing power of recipients’ income was not eroded by inflation. These benefit expansions also contributed to higher payroll tax rates. Today, Social Security has met the goal of its creators in that it provides the foundation for retirement income. In 1994, about 91 percent of all elderly households received Social Security benefits, compared with 67 percent who received some income from saved assets, just over 40 percent who had income from pensions, and 21 percent who had earned income. Social Security contributed over 40 percent of all elderly income, compared with about 18 percent each for the other sources. It provided the predominant share of income for the lowest three-fifths of the U.S. income distribution. On average, Social Security provided $9,200 to all elderly households. The other sources of retirement income determine which households have the highest income. Social Security has contributed substantially to reducing poverty rates for the elderly, which declined dramatically from 35 percent in 1959 to under 11 percent in 1996. In comparison, 11.4 percent of those aged 18 to 64 and 20.5 percent of those under 18 were in poverty in 1996. For over half the elderly, income other than Social Security amounted to less than the poverty threshold in 1994. Still, pockets of poverty do remain. About 30 percent of elderly households are considered poor or nearly poor, having incomes below 150 percent of the poverty threshold. Women, unmarried people, and people aged 75 and over are much more likely to be poor than are other elderly persons. In fact, unmarried women make up over 70 percent of poor elderly households, compared with only 45 percent of all elderly households. In the United States, the elderly population (those aged 65 and older) grew from about 9 million in 1940 to about 34 million in 1995, and it is expected to reach 80 million by 2050, according to Bureau of the Census projections. Moreover, the very old population (those aged 85 and older) is expected to increase almost fivefold, from about 4 million in 1995 to nearly 19 million in 2050. (See fig. 1.) As a share of the total U.S. population, the elderly population grew from 7 percent in 1940 to 12 percent in 1990; this share is expected to increase to 20 percent by 2050. Although the baby-boom generation will greatly contribute to the growth of the elderly population, other demographic trends are also important. Life expectancy has increased continually since the 1930s, and further improvements are expected. In 1940, 65-year-old men could expect to live another 12 years, and women could expect to live another 13 years. By 1995, these numbers had improved to 15 years for men and 19 for women. By 2040, these numbers are projected to be 17 years and 21 years, according to SSA’s intermediate actuarial assumptions. Note that these assumptions yield a lower rate of elderly population growth than do the Census assumptions. Some demographers project even more dramatic growth. A falling fertility rate is the other principal factor in the growth of the elderly’s share of the population. The fertility rate was 3.6 children per woman in 1960. The rate has declined to around 2.0 children per woman today and is expected to level off at about 1.9 by 2020, according to SSA’s intermediate assumptions. Increasing life expectancy and falling fertility rates in combination mean that fewer workers will be contributing to Social Security for each aged, disabled, dependent, or surviving beneficiary. There were 3.3 workers for each Social Security beneficiary in 1995, but by 2030, only 2.0 workers are projected for each beneficiary (see fig. 2). These demographic trends have fundamental implications for Social Security, other forms of retirement income, and our economy as a whole. Increasing longevity means that each year more people will receive Social Security benefits. As a result, Social Security revenues must be increased, benefits must be reduced, or both. For pensions and retirement savings, increasing longevity means these income sources will have to provide income over longer periods, which will similarly require increased contributions or reduced retirement income. As already noted, there will be relatively fewer workers to pay the Social Security taxes needed to fund benefits. However, more fundamentally, unless retirement patterns change, there will be relatively fewer workers producing the goods and services that both workers’ households and elderly households will consume. Yet in recent years, workers have been retiring earlier, not later, and not always by choice. These demographic trends also pose challenges for our long-term budget outlook. They will lead to higher costs in Medicare and Medicaid as well as in Social Security. In a recent report to the Chairmen of the Senate and House Budget Committees, we discussed the results of our latest simulations of the long-term budget outlook. Recent congressional action to bring about a balanced budget and surplus in the next 10 years will give us some breathing room, but spending pressures in these programs, if left unchecked, will prompt the emergence of unsustainable deficits over the longer term. These demographic trends pose long-term financing challenges for both Social Security and the federal budget. Social Security revenues are expected to be about 14 percent less than expenditures over the next 75 years, and demographic trends suggest that this imbalance will grow over time. In 2029, the Social Security trust funds are projected to be depleted. From then on, Social Security revenues are expected to be sufficient to pay only about 70 to 75 percent of currently promised benefits, given currently scheduled tax rates and SSA’s intermediate assumptions about demographic and economic trends. In 2031, the last members of the baby-boom generation will reach age 67, when they will be eligible for full retirement benefits under current law. While Social Security funds are expected to be sufficient to pay full benefits for more than 30 years, Social Security’s financing will begin having significant implications for the federal budget in only 10 years. Moreover, restoring Social Security’s long-range financial balance would not necessarily address the significant challenge that its current financing arrangements pose for the overall federal budget. Social Security cash revenues currently exceed expenditures by roughly $30 billion each year (see fig. 3). Under current law, the Department of the Treasury issues interest-bearing government securities to the trust funds for these excess revenues. In effect, Treasury borrows Social Security’s excess revenues and uses them to help reduce the amount it must borrow from the public. In other words, Social Security’s excess revenues help reduce the overall, or unified, federal budget deficit. Moreover, the trust funds earned $38 billion in interest last year, which Treasury pays by issuing more securities. If Treasury could not borrow from the trust funds, it would have to borrow more in the private capital market and pay such interest in cash to finance current budget policy. Ten years from now, these excess cash revenues are expected to start diminishing, and so will their effect in helping balance the budget. In just 15 years, Social Security’s expenditures are expected to exceed its cash revenues, and the government’s general fund will have to make up the difference, in effect repaying Social Security. As a result, Social Security’s cash flow will no longer help efforts to balance the budget but will start to hinder them. In 2028, repayments from the general fund to Social Security are expected to reach about $183 billion in 1997 dollars. In that year, this amount would equal the same share of gross domestic product as the deficit for the entire federal government in fiscal year 1996, or 1.4 percent, according to SSA projections. Restoring Social Security’s long-term financial balance will require some combination of increased revenues and reduced expenditures. A variety of options is available within the current structure of the program. However, some proposals would go beyond restoring financial balance and fundamentally alter the program structure. These more dramatic changes attempt to achieve other policy objectives as well. The current Social Security system attempts to balance two competing policy objectives. The progressive benefit formula tries to ensure the “adequacy” of retirement income by replacing a higher portion of lower earners’ income than of higher earners’ income.