[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
           SOCIAL SECURITY: THE LONG-TERM BUDGET IMPLICATIONS

=======================================================================

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

             HEARING HELD IN WASHINGTON, DC, JUNE 19, 2002

                               __________

                           Serial No. 107-32

                               __________


           Printed for the use of the Committee on the Budget


  Available on the Internet: http://www.access.gpo.gov/congress/house/
                              house04.html

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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
JOHN E. SUNUNU, New Hampshire        JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
PETER HOEKSTRA, Michigan               Ranking Minority Member
  Vice Chairman                      JIM McDERMOTT, Washington
CHARLES F. BASS, New Hampshire       BENNIE G. THOMPSON, Mississippi
GIL GUTKNECHT, Minnesota             KEN BENTSEN, Texas
VAN HILLEARY, Tennessee              JIM DAVIS, Florida
MAC THORNBERRY, Texas                EVA M. CLAYTON, North Carolina
JIM RYUN, Kansas                     DAVID E. PRICE, North Carolina
MAC COLLINS, Georgia                 GERALD D. KLECZKA, Wisconsin
GARY G. MILLER, California           BOB CLEMENT, Tennessee
PAT TOOMEY, Pennsylvania             JAMES P. MORAN, Virginia
WES WATKINS, Oklahoma                DARLENE HOOLEY, Oregon
DOC HASTINGS, Washington             TAMMY BALDWIN, Wisconsin
JOHN T. DOOLITTLE, California        CAROLYN McCARTHY, New York
ROB PORTMAN, Ohio                    DENNIS MOORE, Kansas
RAY LaHOOD, Illinois                 MICHAEL E. CAPUANO, Massachusetts
KAY GRANGER, Texas                   MICHAEL M. HONDA, California
EDWARD SCHROCK, Virginia             JOSEPH M. HOEFFEL III, 
JOHN CULBERSON, Texas                    Pennsylvania
HENRY E. BROWN, Jr., South Carolina  RUSH D. HOLT, New Jersey
ANDER CRENSHAW, Florida              JIM MATHESON, Utah
ADAM PUTNAM, Florida
MARK KIRK, Illinois
[Vacant]

                           Professional Staff

                       Rich Meade, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel
                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, June 19, 2002....................     1
Statement of:
    Hon. David M. Walker, Comptroller General, U.S. General 
      Accounting Office..........................................     3
    C. Eugene Steuerle, Senior Fellow, the Urban Institute; 
      former Chair, Social Security Technical Panel on Methods 
      and Assumptions; President, National Tax Association.......    40
    Maya C. MacGuineas, Senior Fellow, New America Foundation....    51
    Hon. Barbara B. Kennelly, President and CEO, National 
      Committee to Preserve Social Security and Medicare; former 
      Member of Congress.........................................    56
    Dan L. Crippen, Director, Congressional Budget Office........    74
Prepared statement, additional submissions of:
    Mr. Walker:
        Prepared statement.......................................     6
        GAO's calculated rate of return on trust fund assets.....    20
        Present excess value of the OASDI program................    21
    Mr. Steuerle.................................................    43
    Ms. MacGuineas...............................................    54
    Ms. Kennelly.................................................    58
    Mr. Crippen..................................................    75





           SOCIAL SECURITY: THE LONG-TERM BUDGET IMPLICATIONS

                              ----------                              


                        WEDNESDAY, JUNE 19, 2002

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:25 a.m. in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Gutknecht, Toomey, 
Hastings, Brown, Crenshaw, Spratt, Bentsen, Price, Moran, and 
Hooley.
    Chairman Nussle. Good morning, and welcome. We have a 
number of guests joining us as well. We are pleased to have you 
with us today for our committee's hearing on Social Security 
and the budget implications of long-term sustainability.
    First of all, I would like to compliment Mr. Spratt for his 
suggestion, last year now, that we hold this hearing. We have 
obviously had many things to touch on and focus on since he 
made that suggestion after the budget went through last year. 
Certainly, September changed everyone's focus and there were 
many immediate necessary issues that we had to deal with.
    That may be a good segue or threshold for this hearing 
today. The necessary and the immediate and the emergency and 
the things that focus our attention on a minute-to-minute, day-
to-day, election year to election year basis, oftentimes are 
the only things that occupy Congress' attention.
    Today, I am pleased to focus the committee's attention on 
Social Security. Social Security is our Nation's most 
successful antipoverty program. It benefits more than 44 
million Americans and its preservation is a responsibility that 
neither I nor any of my colleagues take lightly.
    Members may recall that this hearing was originally 
scheduled for last September 13; then, of course, 2 days before 
the hearing our world changed. As a result of terrorist 
attacks, we significantly altered our perceptions about our own 
personal security. Still I know that today our colleagues--and 
myself for that matter--are determined not to let the events of 
that very important and fateful day derail our obligation to 
ensure that retirement security is available not only for this 
generation, but future generations.
    Although the Budget Committee has no specific legislative 
jurisdiction over Social Security itself and the program--or, 
for that matter, any changes to the program--we must deal with 
the consequences of any reform plan or any plan to change or 
alter or deal with Social Security as well as--maybe more 
importantly--the consequences of failing to act. It is 
absolutely critical that Budget Committee members and the 
general public understand the budget implications of Social 
Security's long-term sustainability before proceeding to a 
debate on potential solutions.
    We have today a host of high caliber witnesses who have 
given us a number of good ideas in the past; and certainly, 
first and foremost in that regard is David Walker. I don't know 
if there is anyone who has more consistently sounded the alarm 
about the impending concern over a number of long-term 
obligations to our Federal Government, Social Security being 
one of them--many obligations that he has highlighted for 
coming in a siren sort of way. We appreciate his continued 
vigilance to bring that to our attention. I told him before the 
hearing today--he really gets to showcase that.
    Oftentimes in the past, he has had to deal with that along 
with 10 or 20 other issues that he has brought to our 
attention. Today we get to focus the way we wanted to last 
September 13.
    Dealing with the problem and focusing on the consequences 
does not have to be political. You know, I have heard all sorts 
of tactics used on many people's parts: privatization, scaring 
people, doing all sorts of things. It is scary, but it is not a 
matter of the reform being scary; it is a matter of the 
consequences of inaction being quite frightening, particularly 
taken in context with what Mr. Walker and others will be 
presenting today.
    So I look forward to the opportunity to somberly take a 
look at that issue. Fortunately, we don't have the 
collegialities that people can use that as a way to forward 
anybody's particular political agenda; we can just look at this 
in the careful context that I think it deserves, particularly 
given all of the priorities that Congress has to deal with.
    Again, I would like to compliment Mr. Spratt for his 
specific suggestion and all members who have chimed in on 
needing to focus on this issue. And I would recognize him for 
any comments he would like to make at this time.
    Mr. Spratt. Thank you, Mr. Chairman. It is hard to believe 
that 18 months ago we had within our reach the first phase at 
least of a plan that would have helped us save, salvage Social 
Security. That plan had bipartisan support.
    The first phase of it was that we would dedicate the 
surpluses building up in the Social Security trust fund solely 
to the repurchase of outstanding Treasury bonds and notes, and 
thereby add about $3.5 trillion to the national savings, and at 
the same time, retire most of the debt held by the public.
    We also had a projected surplus of $5.6 billion, which was 
enough, if we husbanded our resources and budgeted right, to 
allocate some share, some portion, to shore up the long-term 
liabilities of Social Security.
    Congress took another tack, preferring tax cuts. We then 
found that we were in the midst of a recession, and we then 
found ourselves challenged by terrorists. So the fiscal facts 
have changed dramatically. We hardly have the money to buy up 
any of the public debt now, much less allocate some share of 
the general fund to subsidizing and shoring up Social Security.
    But that doesn't mean that the problem has gone away. Far 
from it. As we meet, 77 million baby boomers are marching to 
their retirement. There is no way that we can change that fact; 
we have got to face it. This hearing highlights that critical 
fact and reminds us that neither we in Congress, nor the Bush 
administration, has yet to address the biggest fiscal challenge 
that faces us all. So I think it is timely and pertinent.
    Regardless of our jurisdiction I think we should be leading 
the way here, Mr. Chairman. I appreciate your calling this 
hearing.
    Chairman Nussle. I thank the gentleman.
    As I said to start with, there is no one who has in an 
objective, sober, somber, responsible way provided any better 
information to the United States Congress on this issue than 
David Walker, who is the Comptroller General for the United 
States and, of course, oversees GAO.
    We appreciate your coming today with your presentation. We 
look forward to it, and you may proceed as you see fit. 
Welcome.

STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL OF THE UNITED 
                             STATES

    Mr. Walker. Thank you, Mr. Chairman, Mr. Spratt, other 
members of this committee. It is a pleasure to be back before 
you today to talk about our Nation's Social Security program 
and the long-range challenges relating thereto.
    I should note at the outset that while I may have been 
talking about this problem for a while--not only Social 
Security and how it fits into our long-range fiscal challenge--
CBO Director Dan Crippen shares my concerns, and I know that he 
is going to be testifying later today.
    We are two lone voices in the wilderness, and I am very 
appreciative of your willingness, Mr. Chairman and Mr. Spratt, 
to conduct this hearing, because this has to be part of a 
broader public education effort in order to help the public 
understand the nature, extent and the timing of our problems 
such that Congress will then be in a position to act.
    Because Congress will eventually be required to act, as I 
will point out, the sooner the better for a variety of reasons.
    I have a few graphics that I would like to use today to be 
able to convey a number of important messages, if we can start 
with the first one.
    My first point would be that Social Security reform is part 
of a larger and very significant fiscal and economic challenge; 
and to make that point, I am going show two graphics. The first 
one is how the composition of the Federal budget has changed 
over the last 40 years. You can see that in 1962, when John F. 
Kennedy was President, 68 percent of the Federal budget was 
discretionary. The Congress was able to decide how that was 
going to be spent every year.
    By 1982, that had declined to 44 percent. And in the fiscal 
2002 budget, it was down to 37 percent. So the ratio has 
flipped during the prior 40 years.
    Specifically, Congress used to be able to decide annually 
how $2 out of every $3 were spent. Now it is only a little more 
than $1 out of $3. This is going to get worse as we go forward, 
because much of the budget is on autopilot unless Congress and 
the President take certain actions.
    In the second graphic is our famous ``haircut, scalp and 
decapitation chart.'' I realize these labels aren't pleasant, 
but one can see how you get them from here. This shows results 
of our latest long-range budget simulation for which, 
importantly, we take the Social Security and Medicare trustees' 
best estimate, or intermediate assumptions, and we take CBO's 
assumptions; we don't want to compete with our sister agency--
they come up with the economic assumptions--or with the 
trustees.
    If you start with these and the percentage of our economy 
represented by Federal taxes, and if you assume the tax cuts 
enacted last year do not sunset, that spending will end up 
increasing based upon the Social Security and Medicare 
trustees' intermediate estimates; and that discretionary 
spending grows by the rate of the economy--this is what the 
future will look like.
    If you look at the spending side by 2015, we will start 
having to haircut all other spending. By 2030, it will have to 
be cut significantly. By 2050, the entire Federal budget would 
have to be cut in half.
    Now, obviously, there are alternatives. You can raise 
taxes, cut spending, go further into debt, or some combination 
thereof. But if you look at the relative order of magnitude, 
there is a huge long-range fiscal imbalance driven primarily by 
two things. No. 1, known demographic trends--as you mentioned, 
Mr. Chairman, the retirement of the baby boom generation--and 
No. 2, rising health care costs.
    We are not going to change known demographic trends and not 
much has been done lately to help control rising health care 
costs. In fact, some steps will end up fueling these health 
care costs.
    Second key point: Focusing on trust fund solvency alone is 
not sufficient. We need to put the program on a path toward 
sustainable solvency. Next graphic, please.
    This graphic shows the cash flows for the OASDI combined 
program, Social Security, Old Age, Survivors Income and 
Disability Insurance program. This is the combined cash flow. 
Yes, we have positive cash flows now, but we are going to start 
going into negative cash flow position starting in 2017. And 
starting in about 2006, these positive cash flows start going 
down.
    Now, what does that mean? That means that to the extent 
that you have had this positive cash flow that has provided 
some additional budget flexibility in the integrated budget, 
that is going to start going down in about 2006. That is not 
far from now. By 2017, you are going to turn a negative cash 
flow, which is going to be even more of a problem, because you 
are going to have to figure out how you are going to pay those 
benefits: raise taxes, cut spending or increase debt held by 
the public. And it gets progressively worse as time goes on.
    So cash flow is key. Solvency is only one factor.
    The next key point is that solving Social Security's long-
range financing problem is more important and complex than 
simply making the numbers add up. This program, meaning OASDI, 
is critically important to the economic security of millions of 
Americans, not only in retirement but also for the disabled and 
others.
    Given the current financial shortfall in the program, it is 
important to compare proposals both to current promised and to 
funded benefits. If you can go back, please, to the last one. 
There are a lot of people that want to compare Social Security 
reform proposals just to promised benefits. That is 
fundamentally flawed and unfair, because all the promised 
benefits are not funded.
    There is a huge shortfall between what has been promised 
and what has been funded; and you have to figure out how you 
are going to close that shortfall. So any analysis, including 
the ones that were released yesterday that compare the benefit 
cuts based solely upon promised benefits, rather than to both 
funded and promised, is unfair, unbalanced--in my opinion, 
inappropriate.
    Therefore, when GAO does work, which you will see in a few 
minutes, we compare it to both funded and promised benefits. 
Both are relevant. Using only one or the other is not 
appropriate; you need to look at both. And you need to 
determine how to close that gap.
    Reform proposals should be evaluated as packages. We are 
going to have to engage in some heavy lifting. We are going to 
have to make some trade-offs. There is no free lunch. And, as a 
result, if you look at things piecemeal--retirement age, 
indexing, bend points, even individual accounts, if you look at 
elements one at a time, you are going to polarize the 
situation. Therefore, there is a need to look at packages and 
to compare them against some criteria.
    And, Mr. Chairman, as you know, GAO has come up with some 
recommended criteria, and these are the three at the highest 
level. But there are a bunch of sub-criteria that we would 
recommend Congress use to evaluate Social Security reform 
proposals as a package.
    Next, please. Acting sooner rather than later helps ease 
the difficulty of change. This graphic shows the degree of the 
imbalance for these periods of time. You can see that the 
sooner you act, then the less dramatic either the benefit 
adjustment is going to have to be, or the tax adjustment, or 
some combination is going to have to be in order to make the 
numbers work, because of the miracle of compounding.
    Therefore, we need to be able to recognize that the longer 
we wait, not only the more dramatic the changes will have to 
be, but the more difficult they will be to make because you 
will have more people who are already receiving benefits; they 
will represent a larger percentage of the population, and 
therefore, it will be more difficult to be able to make needed 
changes in some regards.
    Last point before I summarize: We believe, Mr. Chairman, 
that it is possible to structure Social Security reform such 
that you can exceed the expectations of all generations of 
Americans.
    Let me restate that: You have the ability to exceed the 
expectations of every generation of Americans.
    And why do I say that? Because from a practical standpoint, 
current retirees and people who are near retirement are afraid 
that Congress is going to cut their benefits. And they don't 
have the time or ability to make up for any such cut because 
they are already retired or they are near retirement. From a 
practical standpoint, that is not going to be politically 
possible nor would it be fair to do that.
    Secondly, baby boomers like myself are already discounting 
Social Security. They are discounting it more than they should, 
as to what they think that they are going to get. And 
generation Xers and Ys, like my kids, are discounting it even 
more.
    Therefore, if you structure a Social Security reform 
proposal that leaves retirees and people who are nearing 
retirement alone, keeps them whole, deliver on the promise, if 
you restructure Social Security reform such that you make 
gradual changes that have gradually greater effects to younger 
people, but gives them time to be able to adjust, you can 
exceed the expectations of all generations of Americans. I call 
that a win.
    What it takes is political leadership and personal 
courage--political leadership and personal courage.
    The last word that I will give you is, this is easy lifting 
compared to Medicare and health care. This is nothing compared 
to the challenges that we face in Medicare and health care. 
There is going to be a lot of pain, and the magnitude of change 
in the health care area is going to have to be much greater. So 
all of the more reason, why don't we get on with something that 
can be a win-win scenario?
    Thank you.
    [The prepared statement of Mr. Walker follows:]

   Prepared Statement of David M. Walker, Comptroller General, U.S. 
                       General Accounting Office

    Mr. Chairman and members of the committee, thank you for inviting 
me here to discuss ensuring the long-term viability of our Nation's 
Social Security program. Social Security not only represents the 
foundation of our retirement income system; it also provides millions 
of Americans with disability insurance and survivor's 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,\1\ the system faces both solvency and sustainability 
challenges in the longer term. Although the Social Security Trustees 
now project that under the intermediate or ``best estimate'' 
assumptions the combined Social Security trust funds\2\ will be 
exhausted 3 years later than in last year's estimates, the magnitude of 
the long-term funding shortfall is virtually unchanged. 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 last 
December a commission appointed by the President presented three models 
for modifying the current program. The Commission's final report\3\ 
called for a period of discussion lasting at least a year before 
legislative action is taken to strengthen and restore sustainability to 
Social Security. It is not my intention to discuss the specifics of or 
take a position for or against any individual reform proposal, element, 
or approach. Rather, I hope my testimony today, which is based on a 
body of work we have published over the past several years, will help 
clarify some of the key issues in the debate. To do that, I'm going to 
talk about the nature and timing of the Social Security problem and a 
framework you might use in addressing it.
    First, let me highlight a number of important points in connection 
with our Social Security challenge:
      Social Security reform is part of a larger and 
significant 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 GAO's 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 it is not the only 
perspective we need to have on Social Security's long-term financing. 
In fact, focusing on trust fund solvency alone is inappropriate and 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 financial shortfall of the program, it 
is important to compare proposals to both current promised and funded 
benefits. Comparing the beneficiary impact of reform proposals solely 
to current Social Security promised benefits is inappropriate since all 
current promised benefits are not funded over the longer term. As a 
result, comparisons to current promised 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 also inappropriate since that 
assumes a reduction in benefits that has not been enacted and may not 
occur. The key point is that there is a significant gap between 
promised and funded benefits that must be closed. 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. The program's annual 
cash surplus will enter a steady decline beginning in 2006,\4\ and from 
2017 on, 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 field to only those choices that are the 
most difficult and could also delay the really tough decisions on 
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.
      We believe it is possible to structure a Social Security 
reform proposal that will exceed the expectations of all generations of 
Americans. Today many retirees and near-retirees fear cuts will affect 
them while young people believe they will get little or no Social 
Security benefits. We believe the time has come to craft a solution 
that will protect Social Security benefits for the Nation's current and 
near-term retirees, while ensuring that the system will be there for 
future generations.
    Our Social Security challenge is more urgent than it may appear. 
Although the combined trust funds will not run dry until 2041, the 
Social Security program's pressure and cash demands on the rest of the 
Federal Government will begin much sooner. Failure to take remedial 
action will, in combination with other entitlement spending, place 
unsustainable pressure on the 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 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 more urgent fiscal challenge.
    To assist the Congress in its deliberations, GAO has 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. Although making policy decisions of this importance 
requires appropriate deliberation, the time to act is now. Waiting only 
makes the problem larger, the magnitude of the required changes 
greater, and the time available to phase in changes shorter. Waiting 
also may serve to further delay the really hard decisions on Medicare 
and Medicaid.

 Social Security's Long-Term Financing Problem Is More Urgent Than 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 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.'' Mr. Chairman, as 
you heard earlier this month while hosting the Second Annual OECD 
International Conference of Chairpersons of Parliamentary Budget 
Committees, we are not alone in facing long-term budget challenges due 
to an aging population. Our counterparts in many European countries are 
debating these same issues, and a number of developed and developing 
countries have already engaged in fundamental reform of their systems 
to deal with their long-range challenges.
    Acting soon will also help put the overall Federal budget on a more 
sustainable footing over the long term, thereby promoting both higher 
economic growth and more fiscal flexibility. The importance of such 
flexibility was brought dramatically home last September. The budgetary 
surpluses of recent years put us in a stronger position to respond both 
to the events of September 11 and to the economic slowdown than would 
otherwise have been the case. Going forward, the Nation's commitment to 
surpluses will truly be tested. None of the changes since September 11 
have lessened the pressures placed by Social Security, Medicare, and 
Medicaid on the long-term fiscal outlook. Indeed, the events of 
September 11 have served to increase our long-range fiscal challenges.
    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.

 Demographic Trends Drive Social Security's Long-Term Financing Problem

    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 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 three children per woman. 
Today it is a little over two, 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 become negligible by 2050 (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 considered 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.




    In addition to encouraging people to work longer, a second approach 
to addressing labor force growth would be to bring more people into the 
labor force. In domestic social policy, we have seen an increasing 
focus on encouraging those previously outside the labor force (i.e., 
welfare recipients, the disabled) into the workforce. Concern about the 
slowdown in the growth of the labor force may also lead to discussions 
about immigration and its role. Increased immigration, however, poses 
complex issues and is unlikely to be the sole solution. For example, 
according to a recent United Nations study,\5\ it would take more than 
a sustained tenfold increase in projected immigration to maintain the 
ratio of workers to retirees at recent levels. These are issues that 
the Congress may wish to explore further in the next few years.
    Because of the demographic trends discussed above, current 
estimates show that within 15 years benefit payments will begin to 
exceed program revenue, which is composed largely of payroll taxes on 
current workers\6\ (See fig. 3).


     social security trust funds, cash flow, and the federal budget
    Within the Federal budget, Social Security--more properly, the Old-
Age and Survivors Insurance and Disability Insurance programs (OASDI)--
has two trust funds that authorize Treasury to pay benefits as long as 
the applicable trust fund has a positive balance. Currently, annual tax 
revenues to Social Security exceed annual benefit payments. The trust 
funds, by law, invest the resulting cash surplus in U.S. Government 
obligations or securities that are backed by the full faith and credit 
of the U.S. Government. At present, the trust funds' assets are in the 
form of special, nonmarketable Treasury securities that are backed by 
the full faith and credit of the U.S. Government and so carry no risk 
of default.\7\ Although the trust funds cannot sell their holdings in 
the open market, the trust funds face no liquidity risk since they can 
redeem their special Treasury securities before maturity without 
penalty. These securities earn interest credits at a statutory rate 
linked to market yields, and this interest from the Treasury is 
credited to the trust funds in the form of additional Treasury 
securities.
    I think it is useful to pause for a moment here and reflect on what 
the term ``trust fund'' means in the Federal budget.\8\ Trust funds in 
the Federal budget are not like private trust funds. An individual can 
create a private trust fund using his or her own assets to benefit a 
stated individual(s). The creator, or settler of the trust, names a 
trustee who has a fiduciary responsibility to manage the designated 
assets in accordance with the stipulations of the trust. In contrast, 
Federal trust funds are budget accounts used to record receipts and 
expenditures earmarked for specific purposes. The Congress creates a 
Federal trust fund in law and designates a funding source to benefit 
stated groups or individuals. Unlike most private trustees, the Federal 
Government can raise or lower future trust fund collections and 
payments or change the purposes for which the collections are used by 
changing existing laws. Moreover, the Federal Government has custody 
and control of the funds.
    Under current law, when the Social Security trust funds' tax 
receipts exceed costs--that is, when the trust funds have an annual 
cash surplus--this surplus is invested in Treasury securities and can 
be used to meet current cash needs of the government or to reduce debt 
held by the public. In either case, the solvency of the trust funds is 
unchanged. However, while the Treasury securities are an asset to the 
trust funds, they are a liability to the Treasury. Any increase in 
assets to the trust funds creates an increase of equal size in future 
claims on the Treasury. One government fund is lending to another. As a 
result, these transactions net out on the government's consolidated 
books.\9\
    The accumulated balances in a trust fund do not in and of 
themselves increase the government's ability to meet the related 
program commitments. That is, simply increasing trust fund balances 
does not improve program sustainability. Increases in trust fund 
balances can strengthen the ability to pay future benefits if a trust 
fund's cash surpluses are used to improve the government's overall 
fiscal position. For example, when a trust fund's cash surpluses are 
used to reduce debt held by the public, this increases national saving, 
contributes to higher economic growth over the long term, and enhances 
the government's ability to raise cash in the future to pay benefits. 
It also reduces Federal interest costs below what they otherwise would 
have been, thereby promoting greater fiscal flexibility in the future.
    According to the Trustees' intermediate estimates, the combined 
Social Security trust funds will be solvent until 2041.\10\ However, 
our long-term model shows that well before that time program spending 
will constitute a rapidly growing share of the budget and the economy. 
Ultimately, the critical question is not how much a trust fund has in 
assets, but whether the government as a whole can afford the promised 
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.
    social security's cash flow is expected to turn negative in 2017
    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, annual cash surpluses begin to shrink in 2006, and 
combined program outlays begin to exceed dedicated tax receipts in 
2017, a year after Medicare's Hospital Insurance trust fund (HI) 
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 (See fig. 4).
    As I noted above, the special Treasury securities represent assets 
for the trust funds but are future claims against the Treasury. 
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. Regardless of 
whether the trust funds are drawing on interest income or principal to 
make benefit payments, 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.\11\ Neither the decline in the cash surpluses nor 
the cash deficit will affect the payment of benefits. However, the 
shift affects 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.


 decline in budgetary flexibility will be severely exacerbated absent 
                           entitlement reform
    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. Prior to 
the creation of the Medicare and Medicaid programs, in 1962 mandatory 
spending 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. 5).
    In much of the last decade, reductions in defense spending helped 
accommodate the growth in these entitlement programs. This, however, is 
no longer a viable option. Even before September 11, reductions in 
defense spending were no longer available to help fund other claims on 
the budget. Indeed, spending on defense and homeland security will grow 
as we seek to combat new threats to our Nation's security.
    Our long-term budget 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 last year do not sunset 
and discretionary spending keeps pace with the economy, by midcentury 
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.\12\ To 
obtain balance, massive spending cuts, tax increases, or some 
combination of the two would be necessary (See fig. 6). Neither slowing 
the growth of discretionary spending nor allowing the tax reductions to 
sunset eliminates the imbalance.




    It is important as well to look beyond the Federal budget to the 
economy as a whole. Figure 7 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 
(CBO) most recent long-term Medicaid estimates, spending for these 
entitlement programs combined will grow to 14.1 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.


    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.
    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 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.\13\ The 
most direct way the Federal Government can raise national saving is by 
increasing government saving. Ultimately, as this committee recommended 
last fall, we should attempt to return to a position of surplus as the 
economy returns to a higher growth path. This 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.
    Similarly, 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. Perhaps the best way to illustrate this is to compare what 
it would take to achieve actuarial balance at different points in time 
by either raising payroll taxes or reducing benefits.\14\ Figure 8 
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 8 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.

              Evaluating Social Security Reform Proposals

    As important as financial stability may be for Social Security, it 
cannot be the only consideration. As a former public trustee of Social 
Security and Medicare, I am well aware of the central role these 
programs play in the lives of millions of Americans. Social Security 
remains the foundation of the Nation's retirement system. It is also 
much more than just a retirement program; it 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, GAO has developed a broad framework 
for evaluating reform proposals that considers not only solvency but 
other aspects of the program as well.
    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 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.
                     financing sustainable solvency
    Historically, Social Security'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 
immediately by 1.87 percentage points of taxable payroll today--which, 
according to the 2002 Trustees' Report, is the amount necessary to 
achieve 75-year balance--the system would be out of balance next year. 
This is the case because actions taken to close the 75-year imbalance 
would not fully address the projected deficit in year 76 of 6.49 
percent of taxable payroll. 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 Federal 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. 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.
            implementing and administering proposed reforms
    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.
    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 any gaps in expectations about 
current or future benefits are avoided. In addition, increasing the 
public's level of sophistication and understanding of how to invest in 
the market, the relationship between risk and return, and the potential 
benefits of diversification presents an education challenge that must 
be surmounted so that the American people have the necessary tools to 
secure their future. The Enron collapse helps to illustrate the 
importance of this, as well as the need to provide clear and 
understandable information so that the public can make informed 
retirement decisions.

                               Conclusion

    Early action to address the financing problems of Social Security 
yields the highest fiscal dividends for the Federal budget and provides 
a longer period for future beneficiaries to make adjustments in their 
own planning. The events of September 11 and the challenges of 
combating terrorism do not change this. In fact, the additional 
spending that will be required to fight the war on terrorism and 
protect our homeland will serve to increase our long-range fiscal 
challenges. 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.
    Although the program does not face an immediate solvency crisis as 
it did in 1983, the fundamental nature of the program's long-term 
financing challenge means that timely action is needed. The demographic 
trends recognized in 1983 are now almost upon us. It is these 
demographic trends--and their implications for both Social Security and 
Medicare--that lead to the conclusion that the program faces both a 
solvency and a sustainability problem. For the American people to 
understand why change is necessary, a public education campaign will be 
needed that focuses not just on Social Security but also on our long-
range fiscal challenges.
    We will face many difficult choices in making Social Security 
sustainable. Focusing on comprehensive packages of reforms that protect 
the benefits of current retirees while achieving the right balance of 
equity and adequacy for future beneficiaries will help to foster 
credibility and acceptance. This will help us avoid getting mired in 
the details and losing sight of important interactive effects. It will 
help build the bridges necessary to achieve consensus.
    Today I have described the three basic criteria against which GAO 
thinks Social Security reform proposals may be measured. These may not 
be the same criteria every analyst would suggest, and certainly how 
policymakers weight the various elements may vary. However, 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.
    Today many retirees and near-retirees fear cuts that will affect 
them while young people believe they will get little or no Social 
Security benefits. As I said at the start of my testimony, we believe 
it is possible to structure a Social Security reform proposal that will 
exceed the expectations of all generations of Americans. Yes, we 
believe there is a window of opportunity to craft a solution that will 
protect Social Security benefits for the Nation's current and near-term 
retirees, while ensuring that the system will be there for future 
generations. However, this window of opportunity will close as the baby 
boom generation begins to retire. As a result, we must move forward to 
address Social Security because we have other major challenges 
confronting us. The fact is, compared to addressing our long-range 
health care financing problem, reforming Social Security will be easy 
lifting.
    It is my hope that we will think about the unprecedented challenge 
facing future generations in our aging society. Relieving them of some 
of the burden of today's financing commitments would help fulfill this 
generation's stewardship responsibility to future generations. It would 
also preserve some capacity for them to make their own choices by 
strengthening both the budget and the economy they inherit. We need to 
act now to address the structural imbalances in Social Security, 
Medicare, and other entitlement programs before the approaching 
demographic tidal wave makes the imbalances more difficult, dramatic, 
and disruptive.
    We at GAO look forward to continuing to work with this committee 
and the Congress in addressing this and other important issues facing 
our Nation.
    Mr. Chairman, Mr. Spratt, members of the committee, that concludes 
my statement. I'd be happy to answer any questions you may have.

                               End Notes

    1. U. S. General Accounting Office, Social Security: Criteria for 
Evaluating Social Security Reform Proposals, GAO/T-HEHS-99-94 
(Washington, D.C.: Mar. 25, 1999); Social Security: The President's 
Proposal , GAO/T-HEHS/AIMD-00-43 (Washington, D. C.: Nov. 9, 1999); 
Budget Issues: Long-Term Fiscal Challenges, GAO-02-467T (Washington, 
D.C.: Feb. 27, 2002).
    2. In this testimony, the term ``trust funds'' refers to the Old-
Age and Survivors Insurance and Disability Insurance Trust Funds.
    3. Strengthening Social Security and Creating Personal Wealth for 
All Americans (Dec. 21, 2001; rev. March 19, 2002).
    4. This calendar year estimate is based on projected tax receipts 
and outlays in constant 2002 dollars under the intermediate assumptions 
of the 2002 Trustees' Report.
    5. United Nations Population Division, Replacement Migration: Is it 
a Solution to Declining and Aging Populations? (March 2000).
    6. Income tax revenue resulting from taxation of up to 50 percent 
of Social Security benefits for certain higher income beneficiaries is 
credited to the OASI and DI trust funds and provided a little more than 
2 percent of total income in 2001.
    7. Under current law, the Secretary of the Treasury as trustee may 
purchase marketable Treasury and agency securities if the Secretary 
determines that such purchase is ``in the public interest.'' Such 
purchases have been rare. As of the end of calendar year 2001, about 
0.003 percent of OASDI trust fund holdings were in marketable Treasury 
securities.
    8. For a discussion of trust funds and other earmarked funds in the 
budget, see U.S. General Accounting Office, Federal Trust and Other 
Earmarked Funds: Answers to Frequently Asked Questions, GAO-01-199SP 
(Washington D.C.: Jan. 2001).
    9. Under current accounting standards, the long-term funding gap--
the difference between promised benefits and expected contributions--
for Social Security and Medicare is reported as required supplementary 
stewardship information but not treated as a liability in the 
government's financial statements. The recognized liability is the 
amount of benefits due and payable to or on behalf of beneficiaries at 
the end of the reporting period.
    10. Separately, the DI fund is projected to be exhausted in 2028 
and the OASI fund in 2043.
    11. If the unified budget is in surplus at this point, then 
financing the excess benefits will require less debt redemption rather 
than increased borrowing.
    12. This simulation assumes that all promised benefits would be 
paid in full throughout the 75-year projection period.
    13. Testimony before the Committee on Banking, Housing, and Urban 
Affairs, U.S. Senate, July 24, 2001.
    14. Solvency could also be achieved through a combination of tax 
and benefit actions. This would reduce the magnitude of the required 
change in taxes or benefits compared to making changes exclusively to 
taxes or benefits as shown in figure 8.

    Chairman Nussle. Thank you.
    As I said, this is one of the first things that Mr. Spratt 
suggested to me when I took over as chairman of the committee; 
that he wanted to focus on this and highlight this and have a 
hearing on this, and so, I would like to invite him to go first 
in the questioning.
    Mr. Spratt. General Walker, obviously one way to restore 
some solvency to Social Security for the long run is to 
increase the rate of the return on the assets in the trust 
fund.
    Have you given any thought or analysis to how we might do 
that, using the traditional structure that we have now, a trust 
fund invested in government bonds? Have you considered the 
possibility that it might be invested in equities or corporate 
bonds in order to increase the yield or return of the trust 
fund?
    Mr. Walker. Obviously, to the extent that the Congress 
decided to more actively invest these funds, then based upon 
modern portfolio theory, having a diversified portfolio of 
assets, one should be able to achieve a greater rate of return 
over time.
    At the same point in time, Mr. Spratt, as you know, that 
also has implications on the budget. Because my understanding 
is, under the current budget rules--and Director Crippen can 
verify this or correct me--that if you end up using that cash, 
and then make an investment, that is counted as an expenditure 
at the present point in time.
    So, from an economic standpoint, your point is well taken. 
In fact, one of the things I think that this committee needs to 
think about is, how do we keep score? We currently keep score 
based upon, largely, cash flow concepts and 10-year horizons, 
which ignore the economic reality and which also ignores the 
fact that most of our budget challenges are, after 10 years, 
big budget challenges.
    Mr. Spratt. Well, we can easily change that rule and simply 
stipulate by another rule that if economic assets are 
purchased, they should not be treated the same as if a 
consumable service or commodity was purchased.
    Have you calculated what we would need to realize as a rate 
of return on the trust fund, the return that we can expect 
under existing circumstances in order to keep it solvent for 
the next 70 years?
    Mr. Walker. Well, what we can do is, we can make some 
assumptions, where we would end up taking, for example, the 
number in the financial statements of the U.S. Government, 
which is the discounted present value of the unfunded liability 
that exists right now, over the next 75 years. And we could 
compare what a more likely return would be on a more 
diversified portfolio of assets versus that and come up with 
what the difference in the number would be.
    That might be helpful to you. I think it would illustrate 
your point.
    [The information referred to follows:]

          GAO's Calculated Rate of Return on Trust Fund Assets

    In response to your request, we calculated the rate of return on 
trust fund assets that would be necessary to achieve trust fund 
solvency for 75 years. Our calculations are based on the data and 
intermediate assumptions presented in the 2002 Trustees' Report. In 
order to simplify the calculation, we assumed immediate investment of 
all current and projected future assets of the combined Old-Age and 
Survivors Insurance and Disability Insurance (OASDI) trust funds. We 
found that the rate of return over the 75-year projection period would 
have to be increased 2.5 percent from the 3 percent real rate of return 
assumed by the Trustees to a real rate of 5.5 percent to achieve 
combined trust fund solvency through 2076. We discussed this estimate 
with the staff at the Office of the Chief Actuary, Social Security 
Administration, who agreed that our estimate was reasonable.
    As noted, this calculation assumes that the entire combined trust 
fund balance of more than $1 trillion is immediately invested and earns 
that rate of return over the entire 75-year period. Hypothetically, the 
trust fund could redeem its existing balance of more than $1 trillion 
in Treasury securities, but its investment could potentially be 
disruptive to financial markets. In addition, investment of trust fund 
assets in private markets would have immediate consequences for the 
Federal budget. Social Security cash surpluses would not be available 
to finance other government activities. In addition, reinvesting 
existing trust fund balances would mean that the Treasury would have to 
repay money previously borrowed from the trust fund. In 1998, GAO 
issued a report that examined issues raised by government investment of 
Social Security funds in the stock market with the intention of earning 
higher returns.* Our 1998 report stated that allowing the Social 
Security trust fund to invest in the stock market is a complex proposal 
that would have potential consequences for the trust fund, the U.S. 
economy and Federal budget policy. Additional information and analyses 
on related issues can be found in our 1998 report.
---------------------------------------------------------------------------
    *Note.--Social Security Financing: Implications of Government Stock 
Investing for the Trust Fund, the Federal Budget and the Economy. April 
22, 1998, GAO/AIMD/HEHS-98-74.

    Mr. Spratt. Well, if you can do that for the record, if you 
can demonstrate what we would need to realize as a rate of 
return on the trust fund in order for the trust fund to meet 
its obligations through the stipulated time period, I think--
what is it, 75 years?
    Mr. Walker. Yes. We will have to make some assumptions; we 
will disclose those.
    And I think the other thing, as you know, Mr. Spratt, which 
is very important is that part of the problem with Social 
Security is that even if you come into actuarial balance for 
the 75-year period today, you know you are going to be out of 
balance next year because of the way the numbers work. I mean, 
the deficit is escalating each year.
    Mr. Spratt. Well, obviously the problem with going out that 
far is a lot of things we don't know about 2075.
    Mr. Walker. That is true, although I think we have to also 
learn some lessons that it is even tough to project 10 years, 
much less 75. On the other hand, I think that we can't be 
overly optimistic, because we know that some of these trends, 
like demographics, aren't going away.
    Mr. Spratt. You mentioned the net present value of the 
shortfall in Social Security today. I have seen the number $3.3 
trillion. Is that your calculation of what the shortage is on a 
net present value basis?
    Mr. Walker. It is around $3 trillion. I will provide it for 
the record. And again that doesn't count Medicare, which is a 
big one.
    [The information referred to follows:]

               Present Excess Value of the OASDI Program

    According to the 2002 Financial Report of the United States 
Government, for the OASDI program, the present value of the excess of 
income (excluding interest) over expenditures for the 75-year period 
2001-2075, taking into account the beginning trust fund balances and 
the cost of attaining a target trust fund balance at the end of the 
period, is $3.394 trillion.

    Mr. Spratt. I understand that.
    I don't have any further questions at this time. Thank you 
very much.
    Chairman Nussle. Let me start with what may be--what may 
sound like good news, the trustees' report. I guess part of why 
I am asking this is to highlight why it may not be good news 
and why sometimes this gets confusing.
    But this year's trustees' report shows that the dates of 
cash flow deficits and insolvency for Social Security are 
gradually receding, and that is often reported as good news and 
assumed to be good news. Every time a year is added onto that, 
or a period of time is added onto the solvency date, that is 
championed or that is reported as being good news.
    Can we really afford to feel secure about the fact that 
that solvency date appears to be receding slightly?
    Mr. Walker. In my opinion, Mr. Chairman, solvency is one 
measure that you should look at. However, it is only one. And, 
in fact, if you just look at the solvency measure, it can give 
you a false sense of security and potentially a misleading 
picture as to what the condition of Social Security is.
    I think you also have to look at, when does Social Security 
turn a negative cash flow? Because once it starts, you know, 
turning a negative cash flow, that has a very real impact on 
the budget.
    In addition to that, you have to look at what percent 
Social Security is to the overall budget and the overall 
economy. Furthermore, you have to look at, how does Social 
Security fit into the overall budget picture and the ability to 
be able to deliver on not just Social Security promises, but 
other promises that have been made.
    So my personal view is that solvency is something to track, 
but by no means is it the primary measure that Congress should 
focus on.
    Chairman Nussle. Why is it the primary measure that 
Congresses focus on, or for that matter, the media? I mean, 
that is the date that is reported. Banner headlines, that is 
what is talked about. You will see it in every publication and 
rag and everything else. Why is that the date that--should we 
be tracking other dates or times or measures as primary 
factors, as opposed to, seemingly, highlighting just that one 
date or factor?
    Mr. Walker. I would argue that there are at least two dates 
that are important. One date is when you turn negative cash 
flow; another date is the insolvency date. I think those are 
two key dates as a point in time. If you look at negative cash 
flow, that is 2017, based on the most recent trustees' report.
    If you look at when the cash flows start declining--right 
now we are building positive cash flows--when they start 
declining, that is 2006, based on the latest trustees' report.
    I think this is part of the public education plan. First, 
what does solvency mean? What does that date mean? What that 
means is that if we don't do anything to Social Security by 
that date, which is, I believe 2041, which is the insolvency 
date----
    Chairman Nussle. We have got a chart on this. I am not 
trying to use--I am not trying to make you accept this chart, 
but this is a chart that may--here is the chart.
    This is, I think, what you are referring to. Just so we can 
put it in some kind of a graphic, charted way, is this what you 
are talking about?
    Mr. Walker. I think what you are talking about here is the 
blue line represents the trust fund. And the green line 
represents cash flow income. The outgo is obviously 
expenditures. And the date, as I recall, is--2041 I believe is 
the date that the combined OASDI trust fund is supposed to be 
insolvent.
    What that means is, if Congress does nothing between now 
and then, if all trustees' intermediate assumptions prove to be 
valid as of that date you would end up having to decide what 
you are going to do about the approximate 25-percent shortfall 
between the revenues that are coming in in that program every 
year and the promises that have to be paid in that year.
    That is obviously not a desirable state, to wait until you 
spend every last dime. Then, all of a sudden, you have this 
significant shortfall that has to be addressed, which shortfall 
increases year by year because of some of the demographic 
trends and other factors that we talked about.
    Mr. Spratt. Thank you, Mr. Chairman.
    When you speak of a cash deficit in 2017, are you including 
in the income to the trust funds interest payments and income 
tax transfers?
    Mr. Walker. The interest on the bonds I believe is not 
included in that, because that is not a cash item. I believe if 
you take total income, it would be about 2027.
    So it is truly just what I said; it is cash flow. As you 
know, the interest on the bonds is an accounting entry but it 
is significant because it is a government commitment to pay in 
the future.
    Mr. Spratt. But we book the interest on the bonds as income 
and use it to purchase other bonds, don't we?
    Mr. Walker. That is correct.
    Mr. Spratt. So it is treated as an asset by the trust fund?
    Mr. Walker. It is an asset, it is income, but it is not 
cash. In other words, what we do count is, we count payroll 
taxes, we count the taxation that is attributable to taxation 
of certain Social Security benefits where they are cash 
amounts, but we don't count the notational interest on the 
bonds because it is a non-cash item.
    Chairman Nussle. Two more things quickly. One is the 
Nation's gross domestic product is obviously going to be 
growing. Some would possibly predict that it would grow much 
more substantially than is being used as the basis for the 
arguments that you are making, or that others make, about the 
concern.
    I have heard those who would suggest that we could grow out 
of this, that somehow that there may be a bump for the baby 
boomers; but by and large, this could be taken care of by 
growth in the economy.
    Would you address that either in favor or against?
    Mr. Walker. Well, first, this does assume growth in the 
economy generally consistent with CBO's assumptions. So you can 
ascertain whether you believe they are reasonable or not. There 
is growth in the economy that is assumed as part of this 
analysis.
    My personal opinion is that reasonable people can differ as 
to whether or not you can grow out of part of, or all of, the 
Social Security problem. What you are not going to grow out of, 
in my opinion, is the larger fiscal problem. In other words, if 
you look at the degree of imbalance that I showed up there on 
the ``haircut, the decapitation and the disembodiment'' chart, 
there is something you are not going to grow out of in my 
opinion.
    Chairman Nussle. The last thing I would like you to just 
address is your second-to-last page of your presentation. If 
you want to put it up, that would be great. It is basically 
your criterion for evaluating Social Security reform proposals. 
You went over that very quickly.
    Would you just expand on your three points for the members, 
what you mean by those three points as we begin to possibly 
take a look at some solutions in the near future?
    Mr. Walker. Well, these are very high levels. We have a 
number of sub-elements for each one. It is available on our Web 
site. But at the highest levels, financing sustainable 
solvency, the idea that we have been talking about, solvency 
has some significance, but it is not everything. It can be 
misleading. You need to look at what has to be done not only to 
be able to make the program solvent, but to be able to make the 
program sustainable as a percentage of the budget, as a 
percentage of the economy over time.
    Secondly, balancing adequacy and equity in the benefit 
structure. Whatever changes you make, consideration has to be 
given to different income levels and different resource levels 
of the individuals involved and what likely effect that is 
going to have on them, and then equity between generations, 
equity between different classes of individuals in whatever 
changes you are considering making.
    And then thirdly, implementing and administering reforms. 
To what extent are there going to be transition challenges? To 
what extent are there going to be administrative challenges 
associated with whatever reform proposals you may consider?
    To the extent that you are talking about reforming the 
existing defined benefit structure, that is one thing. To the 
extent that you are considering individual accounts, either as 
an optional or as a mandatory element of reform, then that 
raises a whole new range of implementation issues that you need 
to think about from the standpoint of how are you going to end 
up handling the record-keeping, what are you going to do about 
the investments, what are you going to do about investment 
education?
    Those are solvable problems, but they are significant 
challenges that have to be adequately focused on both as to the 
structure and the timing of implementation of any such 
proposal.
    Chairman Nussle. Thank you.
    I would just observe before I recognize, I guess Mr. 
Bentsen, Mr. Spratt and I just had a 15-minute conversation 
with the Comptroller General, and I don't think politics was 
invoked once. I don't know if that can be sustained, but I will 
tell you, if we can't have a conversation about this in this 
country, about this challenge, and do it in a non-political 
way, we are not going to address it. I think we have proven 
that we can. Maybe that is, in part, why we don't have 
jurisdiction. I don't know.
    But I am very serious about that. I think there are ways 
that we can have conversations about this, even though people 
can have their differences of opinion.
    Mr. Walker. Can I touch on that, Mr. Chairman?
    Chairman Nussle. Please.
    Mr. Walker. In a prior life, I was a trustee of Social 
Security and Medicare. I was Assistant Secretary of Labor for 
pensions and health and head of the Pension Benefit Guaranty 
Corporation. And because I have a lot of background in pensions 
and health, as well as other areas, I was afforded the 
opportunity to participate in some of these town hall meetings 
that former President Clinton, former Vice President Gore and 
other bi-partisan leaders held around the country as part of an 
education effort to try to educate the American people on the 
nature, extent, and timing of the problem, and to try to put it 
in context. That has to happen.
    What I found is, the American people are a lot brighter 
than sometimes we give them credit for. And, if you give them 
the facts, they can understand the need for some type of 
change.
    Reasonable people can differ on what those changes should 
be. But one of the things that has to happen is, there needs to 
be a public education effort which is part of that political 
leadership and personal courage that has to happen to get a 
little bit out front, because realistically, Congress is not 
going to act until the American people have a better 
understanding of the nature and extent and magnitude of the 
problem, because you obviously have to stand for reelection.
    By the way, Mr. Spratt, the interest is included in the 
trust fund balance; it is included in that. But, it is not 
included in the cash flow analysis.
    Mr. Spratt. That is kind of a quirk of our accounting. I 
mean, if we booked interest as a real cost, even though we were 
paying it to ourselves, usually as trustee, our bottom line 
would look a lot different today.
    I think it is one of the anomalies in Federal bookkeeping 
that we really ought to give more serious attention to.
    Mr. Walker. I think you are right. One of the things that 
we need to do is, we need to take another look at the 
accounting and disclosure for Social Security and Medicare 
obligations. Right now, under generally accepted accounting 
principles for the Federal Government, the bonds that are held 
in the trust fund are not shown as a liability in the 
consolidated financial statement of the U.S. Government.
    The reason it is not shown as a liability is because the 
right hand owes the left hand. Just as in the private sector, 
you eliminate those types of transactions on consolidation.
    At the same point in time, the unfunded obligation between 
promised benefits and funded benefits, that approximate $3.4 
trillion number that we talked about before, just for Social 
Security, is not shown as a liability. It is disclosed. It is 
contained in a separate statement, which is a positive step.
    But I think one of the things that we need to do--and I 
have shared with this with my colleagues on the Joint Financial 
Management Improvement program, including the Secretary of the 
Treasury and the Director of OMB--is that we need to have a 
discussion and debate about whether or not the current 
accounting treatment should go further.
    I expect that that will end up happening within the next 
year or so.
    Mr. Spratt. Thank you, sir.
    Chairman Nussle. Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Mr. Walker, I don't want to debate what are on the margins, 
but I do think on the interest that Mr. Spratt brings up, there 
is a legal obligation for that interest.
    You are right, we don't account for it in the same way that 
we don't account for some other trust funds we have out there: 
the BIF fund, the Safe fund and other things like that. But 
there is a legal obligation that presumably Congress is going 
to honor; otherwise, it would probably have somewhat 
catastrophic effects on the Treasury market and others. So I 
think we have to count it.
    But you are right. In a $3.4 trillion present value 
deficit, we are debating on the margins here. When you talk 
about this gap, this deficit, the cash flow deficit and the 
long-term cash flow deficit, and you say we are going to have 
to have either benefit reductions or increased revenues, or 
some combination thereof; and you--but you do that based upon 
demographic projections, which I think--I think your 
assumptions--I don't know whether your assumptions are 
accurate, but I think your ingredients are accurate that you 
have to look at that.
    Is it true that regardless of whether there was a--and I am 
not trying to make it political or anything--when we had the 
Social Security task force a couple of years ago, and we had 
Alan Greenspan come and talk to us about this in an off-the-
record luncheon, he made this point. This is more of a societal 
problem, where you have a universal pension safety net program; 
and whether it was--whether it is operated through a Federal 
Government trust fund program, as it is right now, or whether 
or not it was operated through a private sector or 
privatization concept of some sort, where there was a 
guaranteed benefit level, which is the case right now, that 
deficit would exist. Is that correct?
    I mean, one way or the other, the economy has to pick it 
up? It scores against GDP, whether it is governmental or non-
governmental?
    Mr. Walker. Yes.
    But the way to really look at it is, we call this a ``trust 
fund.'' This is not a traditional trust fund in the sense that 
you and I or, frankly, the American people would normally refer 
to as a ``trust fund.''
    What ``trust fund'' means in this context is an accounting 
device. It is a sub-account within the overall financial 
statements of the U.S. Government.
    Now, don't get me wrong. The fact that this trust fund 
holds government securities backed by the full faith and credit 
of the U.S. Government, guaranteed as to principal and 
interest, has not only legal significance; it has, economic and 
moral significance as well.
    But, you know, this is not a fund that is backed by hard 
assets that are actively invested.
    So you really have several options. When you turn a 
negative cash flow to deal with the long-range problem, you 
need more income, less benefits, more debt held by the public; 
or to try to figure out a way that you can increase rate of 
return. Through actively funding, you might end up helping to 
reduce the problem on a discounted present value basis over 
time.
    Mr. Bentsen. I guess I agree with that.
    But I guess my question is this: Isn't there generally an 
unfunded liability of pension obligations, both within the 
government and outside of the government, that we are having to 
make through either--through either income-generating assets, 
or whatever, we are having to make up?
    So this is more of a societal program that other nations 
around the world, as they age, are starting to face as well. 
And whatever you end up with--with whatever proposal, the 
cost--there is a cost associated with it whether you privatize, 
or don't privatize, whatever. That cost is either in the form 
of a reduction in benefits or an increase in up-front 
contribution.
    Mr. Walker. I think your point is that it has a 
macroeconomic impact, it has a broader impact, which is true.
    There is one bit of good news here, but let's not get too 
enthusiastic. The one little bit of good news is that we are a 
lot more open and transparent about our challenges in this 
regard, and in fact, our challenges in this regard are not 
nearly as great as some other industrialized nations. That is 
the good news.
    The bad news is that some developing countries are ahead of 
us. Some developed countries are also ahead of us in trying to 
deal with this long-range problem.
    Mr. Bentsen. Thank you.
    Chairman Nussle. Mr. Gutknecht.
    Mr. Gutknecht. Thank you, Mr. Chairman.
    Mr. Walker, thank you for coming up. I am reminded, 
listening to your testimony, of something that Winston 
Churchill said almost 70 years ago. He said, Americans always 
do the right thing, once we have exhausted every other 
possibility.
    I am afraid what I see happening is, we are sort of going 
down that path again. I have asked to put this pie chart up 
that you started your remarks with. This is a troubling pie 
chart, at least it is to me, when you see how much of our total 
Federal budget has gone basically to entitlement programs. What 
troubles me is, with all due respect to friends on the Ways and 
Means Committee last night, they passed a bill claiming to 
spend roughly $350 billion over the next 10 years on a new 
entitlement called prescription drugs.
    Your colleague--or your partner in crime, sitting beside 
you there--Mr. Crippen and his people, recently did a study. 
They estimate that seniors alone will spend over $1.8 trillion 
on prescription drugs over the next 10 years. My concern is, we 
are doing almost nothing on what I think is the big issue. That 
is, affordability.
    We are allowing the pharmaceutical industries to literally 
take all of their profit, all of their research dollars, all of 
their marketing dollars from the pockets of American consumers. 
We are doing very little in terms of opening up free markets to 
allow Americans access to drugs at world prices which are 
dramatically lower than here in the United States. But that is 
for another day.
    But my issue is, when you look at these charts--first 
question: do you estimate that the net interest--and there is 
some good news/bad news in these charts--the net interest went 
from 6 percent to 11 percent. We are now down to 9 percent, 
roughly.
    As you go forward, what is your estimate? Will that 
percentage go up, stay the same, or will it come down?
    Mr. Walker. If you go to the next chart, you will see it.
    Mr. Gutknecht. OK.
    Mr. Walker. The next one, interest is the dark blue. And so 
you can see as a percentage of the economy rather than as a 
percentage of the budget--it goes down and then starts to 
escalate after about 2015. It rapidly escalates after that.
    Part of that has to do with the fact that you turn negative 
cash flow in both Social Security and Medicare. And if you 
don't end up doing something on the revenue side and/or the 
benefit side, then it assumes you are going to increase debt 
held by the public, which means that your interest expense is 
going to start going back up.
    So that is how it looks over those periods of time.
    Mr. Gutknecht. That is my concern, that as we go forward if 
we open up more and more entitlements under Medicare, which we 
are not adequately funding today--when I talk to my rural 
health care providers, they are not happy; in fact, more than a 
hundred providers in Colorado have now said that they won't 
take any new Medicare recipients.
    So we have got a whole lot of things that are converging. I 
do want to close though and come back.
    You mentioned in your testimony just recently, in response 
to the last question, there are other countries that are moving 
forward. Germany is one of them, under the leadership of what 
we would describe as a liberal government in Germany. They did 
begin the process of creating a personalized retirement system; 
and I just want to share with you and my colleagues what they 
have done.
    Originally, Germans were allowed to put up to 1 percent of 
their pay into these retirement accounts. That will rise to 4 
percent by 2008. And the amazing news--this is according to the 
German press--is that their original estimates--they are going 
to dramatically surpass their original estimates in terms of 
how much these accounts are going to be worth.
    Deutsch Bank is now estimating, by 2009, the new capital 
that will be included in these new accounts could reach 160 
billion Euros, which is roughly US$138 billion by 2009. So the 
point is that there are other governments, clearly left-of-
center governments that are moving forward with reform of their 
Social Security systems. And it may well be that there is hope 
that we in the United States will ultimately do the right 
thing.
    Mr. Walker. One of the things that we have done at GAO is 
issued reports on what some other countries have done in this 
area. I believe it is important for us to do that, not just in 
the area of Social Security, but health care, the environment 
and a number of other areas, because we live largely in a 
borderless world where we face many shared challenges.
    So, therefore, it is important to try to learn from others. 
What did they do? What worked? What didn't work? But we 
obviously have to apply that to our system and our culture and 
our values and, hopefully, we will do that in time.
    Chairman Nussle. And just to remind members that we had an 
excellent hearing and summit of budget chairmen just this last 
week, the OECD, that discussed this very topic. And another 
example of--maybe not the exact model Mr. Gutknecht approved, 
but as a political way to handle it, Sweden may be a good 
example. They held hands together in a total partisan way, in a 
total political way, and decided to make the decision.
    So there are some models out there that are worth taking a 
look at. We tried to highlight that at the committee.
    Ms. Hooley.
    Ms. Hooley. Thank you. Would you do just a little 
explaining to me about--and I apologize if this question has 
been asked. But as you look at privatization for Social 
Security, what kind of cuts are we going to have to make to 
benefits to make that happen? And when do we ever get a return 
on that? And do individuals have their own accounts, or is 
that--or are those accounts pooled where they have some choices 
within that pooling?
    Mr. Walker. Well, first, one would have to have a specific 
proposal, because obviously there are a number of different 
proposals out there for different individual accounts. In my 
personal opinion, having an individual account is not 
equivalent to privatizing Social Security.
    But the fact of matter is, to the extent that Congress 
would decide, as a part of more comprehensive Social Security 
reform, that it wanted to have individual accounts as an 
element, first it would have to decide, is it going to be 
voluntary? Is it going to be mandatory?
    Is it going to be an add-on to the defined benefit? Is it 
going to be a substitute for a portion of the defined benefit? 
If so, are you going to make other changes?
    Are you going to do something with the retirement age? Are 
you going to do something with the indexing, something with the 
bend points in calculation of the replacement ratios?
    And so there are a lot of questions that would have to be 
answered in order to be able to--for me to give any specific 
numbers or percentages in that regard.
    We have analyzed several past Social Security reform 
proposals, and we are in the process of analyzing the three 
Social Security reform proposals that the Commission came out 
with for another committee, which we expect will be available 
late in the year.
    Ms. Hooley. Do you have these?
    Mr. Walker. No. We are running them through an economic 
model.
    We have an economic model we use for Social Security 
reform. We will have the results later this year, but we don't 
have the numbers yet. But that would be helpful to you.
    Ms. Hooley. Since we spent all this surplus, what would be 
your opinion about the best things to do with Social Security 
to make sure that it is there in the future, and that we do not 
lower the benefits?
    Mr. Walker. Well, I think there are several reasons we 
don't have the surplus now.
    Ms. Hooley. I know, but let's just talk about, we don't 
have it. So what would be your solution to making sure that 
Social Security is there in the future, and that we do not 
lower the benefits?
    Mr. Walker. I think part of it is to create additional 
fiscal discipline over the budget and the spending process 
going forward. Being able to look at what the longer-term 
implications of current or proposed actions as to whether or 
not they are making our situation better or worse in the long 
term; and then obviously trying to do what can be done to fuel 
economic growth.
    And to the extent that there are surpluses generated, to 
use that in a way that starts reducing debt--in order to 
provide additional fiscal flexibility going forward.
    I have testified on behalf of GAO before as to the range of 
options that Congress has to try to help deal with the long-
range fiscal challenge and the different levels of risk; and I 
would be happy to provide that to you, which I think would be 
helpful.
    Ms. Hooley. Do you think it should be privatized?
    Mr. Walker. I don't know of anybody who is talking about, 
quote, unquote, ``privatizing the Social Security system''--I 
mean, a situation where it would not be a government program 
and where there wouldn't be any government guarantees, where 
there wouldn't be any government involvement.
    I do know a lot of people who are talking about the 
possibility of using individual accounts as an element of more 
comprehensive Social Security reform. I think that is something 
that is worth serious consideration. But I think it has got to 
be a piece of an overall package.
    I wouldn't want to make a hypothetical recommendation. I 
don't think it is appropriate for me to do.
    Ms. Hooley. Thank you.
    Chairman Nussle. Thank you.
    Mr. Toomey.
    Mr. Toomey. Thank you, Mr. Chairman. I would like to follow 
up on this line of questioning that my colleague just began, 
because specifically, I think it is important that we address 
head on this question of whether personal accounts somehow 
necessitate benefit cuts.
    If you stop and think about where we are today, the current 
system in its current form, it seems to me if we don't do 
anything to reform this system, if we leave it exactly as it 
is, then we are assured of benefit cuts, either in the form of 
absolute cuts, because the cash flow isn't there to pay the 
promised benefits or, at a minimum, dramatic cuts in the rate 
of return on the money that people put into the system, because 
it would require a dramatic tax increase in order to fund the 
benefits as currently promised.
    Is that a fair way to characterize the current system?
    Mr. Walker. I think--to be balanced, I would have to say 
that if you don't do anything, it assumes you are going to have 
to significantly increase taxes or cut benefits.
    Mr. Toomey. Which drives down returns.
    Mr. Walker. Or significantly cut benefits, or some 
combination.
    Mr. Toomey. So as I see it, the current season, unreformed, 
if we pretend that we don't have a problem here and we leave it 
unaddressed, that leads to dramatic cuts, at a minimum, in the 
return to workers or in the absolute benefits.
    I would also like to touch on this issue of whether there 
is something somehow inevitable about a major societal problem 
in any kind of retirement plan, and I would appreciate your 
comment on this. It seems to me that it, rather, depends very 
much on the structure of the plan.
    And we have a plan in which we have an unfunded defined 
benefit system, and we are relying on an ever-growing work 
force to fund it, which we know we are not going to have in 
relation to the number of retirees; and that an alternative 
system in which you have a prefunded, essentially--at least if 
a component of this were to be prefunded--invested in the 
economy, able to generate market rates of return, and then that 
that would provide some component.
    If you move in that direction, you can indeed solve the 
solvency problem permanently. Is that your view, that this can 
done?
    Mr. Walker. Not by itself.
    I think what you have to do is, if you go to an individual 
account structure, then you have to decide how you are going to 
handle the transition obligation. You are going to have to 
solve a number of administrative issues. Then you are going to 
have to decide whether or not you are going to allocate 
additional general revenues, or whether or not you are going to 
change the benefit structure as a way to close the gap.
    You can help close the gap, you can help deal with the 
rate-of-return issue with a funded system. That doesn't 
necessarily solve your problem.
    Mr. Toomey. I didn't mean to suggest that there wasn't a 
significant transitional cost. There is.
    My point is that it can be done in a fashion that is for a 
finite period of time with a finite amount of money. It is 
large, but it is finite and then it leads you to a system in 
which you have a fundamentally different structure, where you 
have a prefunded system, where you can assure generous benefit 
system. You have just got to get to that structure.
    Mr. Walker. It is possible to reform Social Security with 
individual accounts coupled with other reform changes and 
achieve sustainable solvency and other objectives over time.
    Mr. Toomey. Thanks. I would like to go back to a chart 
briefly, then--I am going to run out of time soon--which is the 
chart that you have on page 15. If it is possible for us to 
bring that back up, I would appreciate that. That is the bar 
chart, I am thinking of.
    Mr. Walker. The one that deals with the percentage of the 
economy?
    Mr. Toomey. That is correct. That is the one.
    Let me ask a question. First of all, my assumption is that 
you are referring--those numbers refer to Federal Government 
spending.
    Mr. Walker. That is correct.
    Mr. Toomey. There is no representation here, no attempt to 
represent State and local government spending.
    Mr. Walker. Neither spending nor taxation.
    Mr. Toomey. Right. Now, I might be off on this, but in very 
rough terms, the number that comes to my mind for the total 
amount of State and local spending in our country as a 
percentage of GDP is something around 20 percent; is that 
around the right ball park?
    Mr. Walker. My director of budget says closer to 10.
    Mr. Toomey. For the combined, all State and local?
    Mr. Walker. Ten to 15 percent.
    Mr. Toomey. Education systems, 10 to 15. If we took 10 to 
15, if we assume that we maintain that level and we look at the 
number for 2050, what are we up to? About 35, maybe more?
    Mr. Walker. About 35 percent at the Federal level alone.
    Mr. Toomey. We added the State and local component, we 
would probably be--in excess of 50 percent of our GDP would be 
in the hands of government and outside of the private sector.
    Do you think that that is a formula--under that scenario, 
we could probably have robust economic growth?
    Mr. Walker. No.
    Mr. Toomey. Thank you.
    Mr. Hastings [presiding]. Mr. Price.
    Mr. Price. Thank you, Mr. Chairman. Mr. Walker, welcome. I 
apologize for my late arrival and hope that I won't be 
redundant in the questions that I pose, but I would like to 
pick up on the question of privatization.
    Assuming for the purposes of discussion the three 
alternative privatization schemes put forward by the 
President's Commission, can you give some fix on the problems 
that privatization might pose for the cash-flow of Social 
Security revenues, the dates at which the cash-flow reverses, 
and the dates at which we really do have a solvency problem?
    The dates that we often hear discussed for the cash-flow 
reversal are 2017, when the receipts coming in no longer exceed 
the benefits going out, and then around 2040 or 2041, when the 
trust fund is depleted. What effect would the privatization 
schemes that the Commission put forward have on those dates, 
those dates when real trouble develops?
    Mr. Walker. We are in the process of conducting a 
comprehensive analysis of those proposals based upon the 
criteria that we recommended for Congress to consider, 
including coming up with those dates that you are talking 
about, those key dates, as well as whether or not they would 
achieve sustainable solvency over time. That is not going to be 
released for several more months, and so I would be happy to 
make that available to you when we have it, but we don't have 
it yet.*
---------------------------------------------------------------------------
    *Note.--This report will not be available until 2003.
---------------------------------------------------------------------------
    Mr. Price. Well, there may be some differences among the 
three plans. The date that has been widely discussed is 2008. 
That is when the cash-flow problems would develop almost 10 
years earlier under a privatization scheme that would basically 
skim off 2 percentage points from the payroll tax. Does that 
seem like a plausible assumption?
    Mr. Walker. It clearly would accelerate--and only two of 
the three plans would restore solvency over time. I mean, we 
know that based upon what we have seen right now, the dates 
will change. We know only two of the three plans would restore 
solvency over time, and we also know that two of the three 
plans also proposed changes in the benefit structure whereas 
the other plan is nothing more than really an add-on feature to 
the existing program.
    Mr. Price. I think the goal of giving people incentives to 
save for their retirement is a widely shared goal. I don't 
think there is any question our country needs to do that and 
the Congress needs to do that. The question is should that come 
out of Social Security or should we leave the basic structure 
of Social Security intact and then provide additional 
incentives for that kind of saving?
    Nobody should assume that Social Security in and of itself 
is an adequate retirement plan. It was never designed that way, 
although many people today are solely dependent on Social 
Security for retirement income. We clearly need to shore up 
those other two legs of the proverbial three-legged stool, that 
is private pension plans and also private savings.
    Do you have any observations on the financial implications 
of those two tracks above and beyond Social Security as opposed 
to skimming off 2 percentage points from the payroll tax, which 
would be a major change in Social Security?
    Mr. Walker. Let me give you some general remarks on that. 
First, you are correct in noting that Social Security is only 
one leg of the so-called three-legged stool. You are also 
correct in noting that we need to increase personal savings 
because our personal savings rate is abysmally low, especially 
as compared to other developed countries. I would respectfully 
suggest that we are headed to a future where there is going to 
be a four-legged stool for retirement income security. And, 
that fourth leg is earnings from part-time employment. If 
people don't end up doing more from the standpoint of trying to 
increase their personal savings and given the fact that we have 
been stuck at about a 50 percent coverage rate under the 
private pension system and I think unrealistic--I mean I think 
it is unrealistic to expect you are going to get much higher 
than that under a voluntary system, and I am not saying it 
shouldn't be voluntary. Why? Because of health care costs. The 
No. 1 benefit of choice on behalf of employees is health care. 
No. 2 is health care, No. 3 is health care. To the extent that 
employers have to end up spending more money on health care, 
they have less money for pensions and individuals have less 
money for savings.
    So one of the things we have to do here is to recognize 
that this Social Security problem is a subset of a much bigger 
problem, and the biggest problem is probably Medicare, Medicaid 
and other health care issues.
    Mr. Price. My time has expired. Thank you.
    Mr. Hastings. Mr. Walker, thank you for being here and, Mr. 
Spratt, thank you for encouraging this hearing to happen. I 
just want to ask or make an observation and ask you to 
elaborate on a statement that you made earlier. But before I do 
that I have to say that I am a bit optimistic that something 
can be done because there was a time not too ago that I can 
recall where people were to even mention Social Security, that 
you could almost be assured that if you are in a political 
season there could be ads, leaflets or something saying that if 
an individual talked about reforming Social Security that that 
individual was throwing old people out on the streets. We have 
come a long, long way from that.
    In fact, the 2000 election, this was part of the debate and 
there were potential solutions out there. So I tend to be 
optimistic. I am not foolish enough to think that this won't be 
a political issue in the future. But your observation with your 
experience in the past having town hall meetings where the 
American people understand I think is very encouraging. I, too, 
have had the experience that you have suggested when I have had 
my town hall meetings, and I will say in every one of my town 
hall meetings the issue of Social Security comes up. And my 
response has been, well, if we keep three principles in mind as 
we start this process of reforming, number one, those that are 
in the system or very near the system you don't change the 
benefits. My parents, for example, are in their late 80s. You 
simply can't change the rules. But for the boomers coming in 
you have to figure out a time period when you say you are not a 
boomer, but you give them flexibility.
    That is the term I use with Social Security, and then we 
can have some resolution to this. But the maximum of 
flexibility has to be the younger generation. My children are 
in their early 30s and 20s and they know this is not a good 
deal over a period of time. They instinctively know that. I 
think you alluded to that observation because where we are 
heading unless we try to reform this system is we are going to 
have a political debate of pitting grandparent against 
grandchild, and the country simply ought not to get into that 
debate.
    What I would like you to do is elaborate more because you 
said this is really an easy solution compared to the others 
when you responded to Mr. Price of the Medicare challenges that 
we have. Would you elaborate more on how you say this is easy 
and what we should take from that from your perspective in 
order to try to resolve this?
    Mr. Walker. Part of it is building on what you just said, 
and that is in my opinion, first, that Social Security is a 
defined benefit promise. It is not like health care where it is 
a defined level of coverage and where you really don't know 
what your costs are going to be. So you have a lot more of an 
ability to estimate what the current cost of this program is 
likely to be than you do for Medicare and some other health 
care programs. So that is a good start.
    Secondly, if you assume that for people who are currently 
retired and nearing retirement, you are not going to change the 
promise. You are going to deliver on the promise. You are going 
to give them what they expect. Then you take away the fear 
factor that a lot of people have about Social Security reform. 
If you then say baby boomers like myself who are discounting 
Social Security--because they know there is a difference 
between promised benefits and funded benefits--if you look at 
my kids, you know Xers and Y generation who know it; who are 
discounting the program even more, that means you have an 
opportunity to reform the program with or without individual 
accounts, although younger people are more accustomed to 
individual accounts and that is something they can identify 
with, and you could potentially use the power of compounding 
over time to help deal with the problem. If you end up 
reforming the program so you make relatively more dramatic 
reforms and provide additional choices potentially for younger 
people, then you have a way to reform the program which 
provides for sustainable solvency over time and allows people 
to do what they need to do to adjust for any changes in the 
program that otherwise are going to occur. That, to me, is 
exceeding the expectations of all generations of Americans. On 
the other hand, Medicare is the opposite, but that is the 
subject for a different hearing.
    Mr. Hastings. Would you say as evidence of your observation 
of how the boomers and the Gen X and Yers would respond to this 
is the evidence of more people that have investments, whether 
it is 401(k)s or IRAs or you name it, than what we have seen in 
the past, would that be evidence to support your position?
    Mr. Walker. Well, I think I try to base mine on facts, and 
if you just look at the facts from the standpoint of what 
percent are private employers have pension plans for their 
employees and what is the nature of those plans, on a relative 
basis there is a larger portion of defined contribution plans 
today than there used to be 20 and 30 years ago. In addition, 
there has been an increase in the percentage of those plans 
that have 401(k) type salary reduction features where the 
individuals have an opportunity to be able to select among 
several different investment choices for the future.
    One example of that is the Federal Thrift Savings Plan. The 
Federal Thrift Savings Plan is the Federal Government's 401(k) 
plan. I wouldn't call that as being privatized per se. It does 
have individual accounts. It does have active investment, but 
the government obviously is running it and it has a government 
oversight board, although the assets are largely managed by 
private sector investment managers.
    So those would be a few of my thoughts on the subject.
    Mr. Hastings. Thank you. Mr. Moran.
    Mr. Moran. Thank you, Mr. Chairman. We have gotten so high 
tech and these new chairs now--has it been asked of the 
witnesses--I am sorry, we were in an appropriations markup 
earlier this morning--the relative cost of these proposals, 
because I would like to measure the effect of the tax cuts 
versus having used part of that tax cut for financing the 
general revenue requirements for a reasonable privatization 
proposal.
    Mr. Walker. Mr. Moran, we are in the process of analyzing 
the three proposals that came out of the President's Commission 
on a variety of bases, including some of the factors that you 
talk about, but that has not been completed and won't be 
completed for several months. But when it is I will be happy to 
make it available to you.
    Mr. Moran. I appreciate that, Mr. Walker. I appreciate 
everything you do and Dan and all of the witnesses we are going 
to be hearing from. The problem is that--and at least it is my 
concern about these proposals, all of which I think have some 
merit, some more than others--is that the option of doing this 
was precluded by the premature actions that we have taken by 
reducing Federal revenue flow by $2 trillion for the next 10 
years and by 4 to $7 trillion for the subsequent 10 years. It 
seems to me we are going to need something in the range of a 
trillion dollars to pay for the creation of individual savings 
accounts to complement Social Security and eventually 
transition to those accounts, those complementary accounts. But 
to do so you can't reduce benefits, so you have to have an 
infusion of general revenue money. And by the rate cuts which 
take effect--start to take effect in a few years and hit us 
most strikingly just as the baby boom generation joins the 
Social Security rolls, that was the money that we had the 
option of putting into a privatization proposal that could have 
worked.
    Politically, I don't think you can do any of these 
proposals without that infusion of general revenue money, and 
that is my problem with these proposals. By the actions that 
the Congress took over the last 2 years, I think we have 
precluded that option, particularly the actions that we have 
just taken the last couple of weeks to make permanent all of 
these rate cuts in the estate tax cuts.
    So I would like to hear your response to that.
    Mr. Walker. Well, as you know, Mr. Moran, I am not going to 
get into the business of whether or not tax cuts are a good or 
bad idea.
    Mr. Moran. Well, in the context of the money we need to 
make this work.
    Mr. Walker. I can provide some information. If you look at 
where we are today versus where we were a year ago there are at 
least three contributing factors. One, the economy is weaker 
than it was projected to be. No. 2, revenues are lower in part 
due to the economy and in part due to tax changes and stock 
market declining. Finally, expenditures are greater partly in 
response to the tragic events of September 11. So if you look 
at the combined effect of all of those, what was projected 
which was going to be a significant excess of funds that would 
be available to fund a transition obligation, to pay down debt 
held by the public or some combination thereof, is largely 
gone.
    But that still doesn't mean that we shouldn't be engaging 
in a fundamental debate about how this system should be 
reformed and whether or not from an economic standpoint, not 
from a budget scoring standpoint, but from an economic 
standpoint, using discounted present value analyses and all, 
what makes the most sense for how you end up reforming this 
program over time.
    One of the real concerns that I have, Mr. Moran, is the way 
that our budget rules work is they are largely cash-flow based 
and they are based on a 10-year horizon. And so I think some of 
the things we need to be thinking about are, how can we bring 
additional metrics to bear. How can we bring longer range 
horizons to bear and how can we consider other options that 
could cause you to reach different solutions as to what the 
right thing to do is? You need another set of metrics to be 
able to consider the long range implications of different 
alternative actions rather than just the implications over the 
next 10 years.
    Mr. Moran. I don't want to be argumentative with you and I 
don't have any problems with you or your judgment nor with Mr. 
Crippen's, and I know we are going to hear from Mr. Steuerle 
and I am anxious to hear from him, representing the Urban 
Institute, and he was a member of the Commission. But I am 
going to ask the same question of everyone. But when you say 
even longer term, I don't know how far out you are going unless 
it is 2030 or something like that. But even at that with these 
lower revenue flows, given the reduction of the work force, not 
just in quantity, but in quality, a much higher proportion of 
our work force is non-native born, and nothing wrong with being 
nonnative born, but less likely to have the benefits of a 
quality education and as a result probably less capable of the 
value-added productivity that gives us the growth.
    So I am afraid we have set in motion a situation where we 
are always going to be too strapped to achieve the kind of 
transition that I agree in the long run makes sense. I 
appreciate your response and I know that you don't want to get 
into the tax cut itself, but I do think that has the most 
relevance to the option the Congress has before it.
    But I won't belabor the point and I thank you, Mr. 
Chairman.
    Mr. Hastings. Thank you.
    Mr. Moran. Did Mr. Walker want to respond?
    Mr. Walker. I would commend to you, Mr. Moran, a couple of 
the charts that are in the testimony and that we showed, one of 
which is how the composition of spending has changed as well as 
what our simulation shows for the long range budget outlook, 
which underscores some of the concerns you have. But I would 
also come back and say that shows that we need to start dealing 
with some of these problems sooner than later because the 
longer we wait the tougher it is going to be and the more 
dramatic the changes are going to have to be.
    And your comment about the workforce is very relevant. We 
have now moved into a knowledge-based economy. With a 
knowledge-based economy it is people and brain power that make 
the difference in connection with ours competitive advantage. 
So things like education and things like other skills and 
knowledge are going to be key to help fuel economic growth, 
enhance productivity and help us deal with these longer range 
problems.
    Mr. Moran. There was a scientific study that came out 
confirms that it was directed primarily at third world 
countries, but they said it applies equally to the United 
States, that investments in education and health care create 
economic growth in themselves to a greater extent than the 
reverse economic growth creating greater investments in 
education and health care. They find that the former is an even 
stronger impetus than the latter. And I am concerned that we 
are not going to have much money to invest in nondefense 
discretionary domestic programs.
    But with that, thank you Mr. Walker, and thank you Mr. 
Chairman.
    Mr. Hastings. Mr. Bentsen wanted to have a follow-up 
question. But I wanted to ask one very direct question in line 
of the question with the gentleman from Virginia, and that is 
this: Did the tax relief plan that we passed have a direct 
relationship--negative or positive--on the Social Security 
trust fund?
    Mr. Walker. On the Social Security trust fund itself, no, 
because the Social Security trust fund obviously just deals 
primarily with payroll tax revenue.
    Mr. Hastings. Has the tax relief plan that we passed had a 
positive or negative effect on any benefits that anybody is 
receiving?
    Mr. Walker. Not at the present time, no.
    Mr. Hastings. Thank you. Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman. Mr. Toomey in his 
line of questioning and your response talked about, if we go to 
privatization, individual account, prefunded program, although 
I don't know that prefunded is the right term, but we would--he 
alluded that in effect future retirees would be held harmless 
or perhaps even better off. You responded ``well, of course you 
have transition costs that have to be accounted for and you 
have other issues that have to be accounted for.'' And Mr. 
Toomey--and I don't want to characterize his comments, 
particularly with him not being here, he said ``fine, well, let 
us lay off the transition costs.'' Assume those are absorbed 
over a period of time. And if you make that assumption, I think 
you still said, and what I would like you to do is clarify for 
us, that there are other costs associated with this. One are 
the administrative costs that you talked about, but are you 
also stating that--and this is a perception that is out there 
that needs to be clarified, the more--that whatever Congress 
does with Social Security needs to be addressed because there 
is an argument being made that well, if you stick with the 
current defined benefit system through the trust fund, you are 
either going to have to raise payroll taxes, cut benefits, 
increase debt substantially or a combination thereof. But if 
you go to a privatized account you can make a one-for-one 
transfer and in fact you may well be better off.
    Isn't it true you are just as likely to be worse off than 
better off? And we get into discussions about return on 
investment. And if you look at Treasury return versus an S&P 
index return, the S&P index is always better, which of course 
is not true, because for the last 2 years the S&P has been 
below the Treasury return. So my question is, what are the 
other--are you stating that you would have to go through a 
wholesale benefit plan change, which very likely could result 
in no longer a guaranteed minimum benefit or a benefit 
reduction of some sort?
    Mr. Walker. It obviously depends on the assumptions. Let me 
give you a specific example. As you know, the President's 
Commission's proposals that we are analyzing involve the 
creation of an individual account element under the current 
system. But in order to achieve sustainable solvency over time, 
they propose certain other changes to the benefit structure of 
the current defined benefit system. One of the proposals 
proposes to index benefits based upon cost of living rather 
than wages, which is a change. The other proposal talks about 
indexing benefits based upon longevity and makes certain other 
adjustments. This comes back to the point that I made before. 
When you are comparing Social Security reform proposals, I 
think to be fair you have to look at how does that reform 
proposal compare against not just promised benefits, but also 
funded benefits, because a lot of the promised benefits have 
not been funded. So what is going to happen when you have run 
out of money?
    Mr. Bentsen. With the chairman's indulgence, one, the 
change in the indexing would apply not to just Social Security 
benefits but benefits under the new privatized program?
    Mr. Walker. Defined benefit portion.
    Mr. Bentsen. Of the non-cut, 10 percent.
    Mr. Walker. Right.
    Mr. Bentsen. But there would be a reduction in using a new 
indexing method?
    Mr. Walker. In other words, they would receive less money 
under the defined benefit program than otherwise they would 
have as is currently promised. But not all of those promises 
are funded, but in addition to that, they would receive an 
individual account that would earn a rate of return.
    Mr. Bentsen. I think it is very important and I am glad you 
are making this--the other point is whether we should look at 
this in comparison to funded benefits, not in relation to 
promised benefits because funded benefits are far below--it is 
an unfunded liability, because a lot of times in the debate 
over this issue advocates of individual accounts and 
privatization make the assumption or the argument that we are 
replacing promised benefits with a new promise that will be 
fulfilled, and that is not necessarily accurate. I mean the 
magic of compounding interest is there, but it is not always 
there.
    Mr. Walker. I think to be fair and balanced about it, you 
have to look at the proposal against the criteria that we 
established and you have to consider both funded benefits as 
well as promised benefits. If you don't do that, you are 
effectively assuming either a tax increase or a general revenue 
infusion or a benefit cut that may or may not happen. Now under 
the current system under current law, you can only pay Social 
Security benefits to the extent that you have got assets in the 
trust fund. So therefore, if you waited until 2041 when all the 
bonds were gone, unless there was a change in the law that 
would allow for additional revenue infusion, general revenues 
or whatever else, you couldn't pay all the benefits.
    Mr. Bentsen. What you are saying is whether you keep the 
current system the way it is or you change it or you privatize 
it or whatever you do, these changes are coming. So anyone who 
is making the assumption that there is a magic fix out there 
that can give you what you have today and even more in the 
future does not exist except for a huge cost on the economy?
    Mr. Walker. I don't think many Americans are assuming that 
there aren't going to be changes that won't affect their future 
benefits. I am talking about baby boomers and generation Xers. 
I don't know very many boomers or generation Xers that don't 
think there is going to be a significant change to this program 
that will affect them. What is important is that people that 
are currently retired and are nearing retirement, I would argue 
it wouldn't be fair to change the deal for them because they 
don't have time to make adjustments. Obviously you get elected 
and I don't, so you have to make these decisions, but there are 
obviously political problems with changing promises for people 
who don't have time to make adjustments.
    Mr. Bentsen. Thank you. Thank you, Mr. Chairman.
    Mr. Hastings. Mr. Walker, thank you very much for your 
testimony. If it wasn't already done, without objection, your 
full report will appear in the record. And I appreciate very 
much your candor and your work on this and we will dismiss you.
    Mr. Walker. Thank you very much.
    Mr. Hastings. Next we will hear from three experts who have 
a great deal of knowledge of the annual report of the Social 
Security trustees. First will be Mr. Gene Steuerle, who is a 
Senior Fellow at the Urban Institute; Maya MacGuineas, Senior 
Fellow at the New America Foundation; and third and certainly 
not least, a former colleague of ours, Barbara Kennelly, who is 
currently the President of the National Committee to Preserve 
Social Security and Medicare.
    I want to thank all of you for appearing here today, and 
why don't we just go--without objection, your full statements 
will appear in the record. Let me recognize first Mr. Steuerle.

  STATEMENTS OF C. EUGENE STEUERLE, SENIOR FELLOW, THE URBAN 
   INSTITUTE; MAYA C. MACGUINEAS, SENIOR FELLOW, NEW AMERICA 
   FOUNDATION; AND THE HON. BARBARA B. KENNELLY, PRESIDENT, 
  NATIONAL COMMITTEE TO PRESERVE SOCIAL SECURITY AND MEDICARE

                 STATEMENT OF C. EUGENE STEUERLE

    Mr. Steuerle. Thank you, Mr. Chairman and members of the 
committee. It is indeed a privilege to testify before you today 
on the trustees' report on Social Security. And let me mention 
also that I am an admirer of both of my colleagues, one of whom 
I used to testify before, so it is nice to testify with her. My 
testimony will assess several points which I will only 
summarize here.
    The integrity of the process leading to the trustees' 
report is indeed a national asset. There is a question that 
arises as to why we make projections for 75 years, and the 
simple answer is we make projections for that long because past 
Congresses and Presidents have essentially built internal 
growth into these programs, and one simply has to account for 
what one is promising.
    Now when it comes to Social Security, another question that 
arises is what are the key dates we want to emphasize. I would 
argue that the key dates are today and 2008, when the baby 
boomers start retiring. The main economic issue, as opposed to 
an accounting issue, is that programs for the elderly and near 
elderly are absorbing ever increasing portions of the national 
income and of the Federal budget, and when they absorb more of 
these resources, that burden has to be paid for.
    The fundamental new long-term problem facing Social 
Security is a rapidly declining number of workers relative to 
beneficiaries, and it is a mistake to believe that this labor 
market problem is going to be easily solved by any capital 
market solution, whether we are talking about trust funds or 
individual accounts. Scheduled declines in the Nation's 
employment rate affect the affordability of Social Security not 
simply through Social Security taxes and benefits, which is 
what the trust funds measure, but also because the declining 
number of workers reduces income taxes, it reduces national 
output, and it reduces the private assets and income of the 
elderly as well.
    Now there are several other items that are in my report 
that I am only going to very briefly summarize and I believe 
need to be highlighted. One is that Social Security continues 
to provide smaller and smaller shares of total benefits to 
those people who are most needy; that is, those people who are 
most elderly. The tables showing annual benefit levels need to 
take into account lifetime, not just annual benefits, which for 
Social Security and Medicare are now approaching for younger 
couples about $1 million in current dollars in terms of their 
value. The disability insurance program is often forgotten, and 
yet it is showing increasing prevalence of disability insurance 
receipts even while we have improved health care. And this 
program also has widely disparate payments according to 
geographic location. Social Security and Medicare already 
depend a good deal on general revenue financing.
    My final additional point is the uncertainty of 
projections, which we often debate but pay little attention to, 
is something that is amenable to reform, for instance, by 
having years of benefit receipts simply indexed for how long 
people are living.
    Having given that summary, let me go quickly through the 
main points. The public policy process behind the issuance of 
the trustees' report is one of the most balanced and non-
partisan in this Nation. This achievement is made possible by 
the involvement of a variety of institutions and individuals. I 
was fortunate enough to participate in two technical panels and 
to Chair one of them.
    Let me also mention the national asset that is involved in 
the integrity of the Office of the Actuary of the Social 
Security Administration. Now there are some who question why 
this process leads to projections for 75 years, given that many 
factors are hard to estimate for so long a period of time. The 
most obvious answer is that we project for so long because past 
Congresses and Presidents have made promises for so long, 
indeed for centuries into the future. As members of this Budget 
Committee, you are well aware that this can be contrasted with 
what we do on the discretionary side of the budget, where 
promises are generally made for 1 year only. Making promises 
that can only be met uncertainly in the far distant future 
requires projections that have a great deal of uncertainty.
    Now from an economic perspective the key Social Security 
issue facing the Nation is what share of the Nation's economic 
resources are demanded by programs for the elderly. If that 
share goes up, then mathematically some other share must go 
down. Someone must pay. In terms of the elderly share it has 
been going up for some time and it is projected to continue for 
a considerable period of time. That is shown in figure 1 in my 
testimony. Of course the rate of increase for the elderly share 
begins to accelerate once the baby boomers begin to retire in 
2008. Many of the dates in the trustees' report are mainly key 
points, markers, or signposts along that path.
    Now built-in growth in particular programs act as a serious 
impediment to shifting resources to meet other new needs and 
priorities, whether that is education or reinvigoration of our 
foreign policy in defense of freedom. But I also want to note 
that it also deters us from fixing up the programs themselves, 
such as to additional aid those who have significant 
impairments in old age, to provide a drug benefit--which you 
have already discussed--or to remove some of the very strong 
discrimination in Social Security against single working heads 
of households. I discuss this discrimination in my testimony, 
but I will not go into the details here.
    Even the budget debates in Congress this year prove how the 
pressure of these growing entitlement programs affect 
discretionary choices. These issues are not postponed until 
some year like 2017.
    Now several times I have mentioned the labor market 
problem. Social Security faces a significant labor market 
problem that is hidden in trust fund accounting. Indeed, too 
much emphasis on the trust funds implies that there is some 
sort of capital market solution to this issue. Simply put, it 
is the scheduled decline in the number of workers to retirees 
that forms the core of the new dilemma facing Social Security. 
The typical worker now fully retires in late middle age, at 
least if we define old age and middle age by life expectancy. 
When he does so, our current Federal programs encourage him to 
become dependent upon other taxpayers because we have a pay-as-
you-go system. His drop in output reduces the amount of 
transfers that is making to support government programs, but it 
is not just Social Security that he no longer finances, it is 
also other programs that he used to finance through Federal 
income and other State and local taxes. Meanwhile his own 
after-tax income falls, the rate of growth of GDP falls, and it 
is this multiple hit that affects the Social Security and 
Medicare affordability.
    The United States was lucky in the post-World War II 
period. Despite substantial decreases in the male labor force 
participation as males acquired more and more years of 
retirement, females entered the labor force in increasing 
numbers. So if you look at the numbers on the employment rate 
that is a later graph in my testimony, you will see that the 
adult employment rate actually increased over this post-World 
War II period and is scheduled to decline quite rapidly. In 
fact, the rate of decline, assuming there is no adjustment in 
this labor market behavior, is so strong and so long that it is 
equivalent to an increase in the unemployment rate of just 
short of one-half of 1 percent of the labor force every year 
for almost 20 years running. And we have not had that type of 
labor market hit since the time of the Great Depression.
    Now, as I mentioned, I have several other issues in my 
report but there is no time to discuss them here in depth. So I 
would just give one or two sentences on each one.
    First, the program is now designed to provide continually 
higher and higher levels of benefits to those further and 
further from likely death. I don't believe that is necessarily 
a good way to have a program adjust over time.
    Second, the expected value of lifetime benefits reveals 
much more about the program and much more about what needs to 
be reformed than annual benefits. As I mentioned, these 
lifetime benefits have climbed from about $290,000 for an 
average income couple in 1970 to close to $540,000 today and to 
nearly a million dollars for a couple retiring in 2030.
    Third, prevalence rates of disability insurance coverage 
are actually expected to grow in a population that is growing 
more healthy over time. Meanwhile, there are vast geographical 
differences in the incidence and prevalence of DI receipts, and 
these issues need attention as well.
    Fourth, Social Security and Medicare depend already to a 
significant extent on general revenues, and these need to be 
highlighted, I believe, better in the trustees' reports.
    And finally, the trustees' reports do not make clear that 
the uncertainty of projections is itself an item that can be 
reformed through the process itself. The most obvious example 
is that these predictions are uncertain in part because we 
don't know how long people will live in the future. If we 
simply index the program for life expectancy, we can remove 
this source of uncertainty in the program. There are countries 
like Sweden that have also reduced the uncertainty in 
projections by adjusting their systems not simply for life 
expectancy but even for fertility rates and the amount of taxes 
that will be available in the future.
    In summary, the process leading to the development of the 
trustees' reports is one of the finest in government. Here I 
have emphasized that the key economic dates coming out of the 
report are today and 2008, when the baby boomers begin to 
retire, basically any date when the programs for the elderly 
are growing and taking an increased share of national income 
out of the budget. I have also suggested that Social Security 
funding problems relate primarily to a remarkable drop in labor 
force participation, and the trust fund accounting tends to 
hide that problem.
    Various aspects of the Social Security program could also 
be better clarified in the trustees' reports: How increasing 
shares of total benefits are being spent on those who are 
younger and with less relative needs; how growth in cost is 
better reflected in lifetime than annual benefits; how 
prevalence rates in disability insurance are growing but are 
masked by the way they are reported today; how much these 
programs are scheduled to be supported by general revenues over 
time; and finally, how the uncertainty of actuarial estimates 
can actually be reduced through policy design.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Steuerle follows:]

  Prepared Statement of C. Eugene Steuerle, Senior Fellow, the Urban 
Institute, Former Chair, Social Security Technical Panel on Methods and 
         Assumptions, President of the National Tax Association

    Mr. Chairman and members of the committee, it is privilege to 
testify before you today on the Trustees' Report on Social Security. 
Through the various Social Security and Medicare Trustees' Reports we 
gain a fuller understanding of the long-run costs and benefits 
reflected in the current design of these programs. My testimony will 
emphasize several basic points:
     The integrity of the process leading to the Trustees' 
Report--including the input of the highly respected Office of the Chief 
Actuary--is a national asset. The report must contain projections for 
75 years or longer because past Congresses and Presidents have built 
eternal growth into these programs, and one should try to account for 
what one is promising.
     When it comes to Social Security, the key dates that one 
should emphasize are today and 2008, when the baby boomers start 
retiring. The main economic issue is that programs for the elderly and 
near-elderly continue to absorb increasing portions of the Nation's 
output and of the Federal budget, which necessarily means that other 
portions are already being reduced, soon at ever faster rates.
     The fundamental new long-term problem facing Social 
Security is a rapidly declining number of workers relative to 
beneficiaries, and it is a mistake to believe that this labor market 
problem can easily be solved by a capital market solution. Scheduled 
declines in the Nation's employment rate affect the affordability of 
Social Security not simply through increases in Social Security 
benefits and declines in Social Security taxes (a ``trust fund'' 
concept), but through declines in national output, income tax 
collections, and the private assets and income of the elderly, as well.
    There are several additional items that I believe are worthy of 
highlighting within the Trustees' Reports:
     That Social Security continues to schedule smaller and 
smaller shares of benefits to those with greater needs, such as people 
near poverty and the truly old (say, those with less than 10 years of 
life expectancy);
     That tables showing annual benefit levels tend to disguise 
the promised growth in lifetime benefits under Social Security and 
Medicare, which are approaching $1 million for younger couples today;
     That the Disability Insurance program projections imply 
increasing prevalence of disability insurance receipt in most age 
groups in a program with widely disparate payments according to 
geographic location;
     That Social Security and Medicare already depend a good 
deal upon general revenue financing, largely through transfers of 
income taxes collected on Social Security benefits, through the 
financing of Part B, Medicare, and through future interest payments;
     That the uncertainty of projections is a consequence of 
program design, such as the failure simply to adjust years of benefit 
receipt by changes in life expectancy.
                              the process
    The public policy process behind the issuance of the Trustees' 
Report is one of the most balanced and nonpartisan in this Nation. The 
achievement is made possible by the involvement of a variety of 
individuals and institutions: trustees from the Cabinet, outside 
``public'' trustees, and departmental staffs, such as the Office of 
Economic Policy within the Treasury Department. Special note should be 
made of the long-standing reputation for integrity of the Office of the 
Chief Actuary of the Social Security Administration (SSA). I have also 
been privileged to participate in two technical panels, one of which I 
Chaired. These panels are invited by SSA to provide an external review 
of its methods and assumptions--a process now called by the Social 
Security Advisory Board and in which SSA cooperates fully.
    There are some who question why projections are made for 75 years 
when certain factors are very hard to predict for such a long period of 
time. The first answer is the most obvious one: we project for that 
long because past Congresses and Presidents have made promises for so 
long--indeed for centuries--into the future. This can be contrasted 
with the discretionary side of the budget, where promises are generally 
made for 1 year only. Making promises that can only meet uncertainly in 
the far distant future requires projections filled with uncertainty, 
not the other way around. Second, we do know a fair amount about the 
future since birth rates today affect such matters as the maximum 
number of non-foreign born 50-year-olds who will be alive in 50 years 
or 75-year olds alive in 75 years. Some of these demographic factors 
can be projected with a modest degree of certainty for well into the 
future.
                               key dates
    From an economic perspective, the key ``Social Security'' issue 
facing the Nation is what share of the Nation's economic resources are 
demanded by programs for the elderly. If that share goes up, then 
mathematically some other share or sets of shares must decline. It 
turns out that the elderly share has been going up for several decades 
and is projected to continue along that path even today (figure 1). 
When the elderly share of the budget was much smaller, it put less 
pressure on other parts of the budget. Now that the share is more than 
half of all non-interest domestic spending and growing, the pressure on 
other programs is rising. Of course, the rate of increase in the 
elderly share begins to accelerate once the baby boomers start retiring 
in 2008.


    Many of the dates in the Trustees' Reports are mainly signposts 
along this path and have no great meaning relative to the path itself. 
Some have meaning for individuals--such as 2043 when current law 
requires a reduction of more than one-quarter in annual Social Security 
benefit payments to all retirees then alive.
    Built-in growth in particular programs acts as a serious impediment 
to shifting resources to new needs or priorities, whether it be 
education or reinvigoration of our foreign policy in defense of 
freedom. But it also largely deters a shifting of resources within 
elderly programs themselves, such as to help those with significant 
impairments because of old age, to provide a drug benefit, or to remove 
some of the clear discrimination in Social Security against single 
working heads of household--who may work, pay taxes, and raise 
children, and yet get lower benefits than other beneficiaries who do 
none of these activities. These are issues for today, not just decades 
into the future. Even the budget debates in Congress this year prove 
how the pressure of these automatically growing entitlement programs 
affects discretionary choices. The issues aren't postponed until some 
year like 2017.
                        the labor market problem
    Social Security faces a significant labor market problem that is 
somewhat hidden in trust fund accounting. Indeed, too much emphasis on 
``trust funds'' implies that that there is some sort of capital market 
solution. Simply put, it is the scheduled decline in the number of 
workers to retirees that forms the core of the new dilemma facing 
Social Security.
    Now it is true that our mandated retirement system--unfortunately 
in my view--has always had only very modest funding or saving levels 
relative to potential liabilities. This has led to a worthy debate both 
about saving the temporary and relatively small surpluses now being 
generated on a cash flow (but not liability) basis or trying to put 
more money aside in individual accounts or in the trust funds. But, 
quite bluntly, the adoption of dozens of saving incentives over the 
past few decades has shown that the government of a free society has 
trouble mandating net increases in national saving rates, since private 
individuals may with one hand offset what the government does or 
requires them to do with their other hand.
    The typical worker now fully retires in late middle age--at least 
if old age and middle age are defined by life expectancy. When he does 
so, our current Federal programs encourage him to become dependent upon 
other taxpayers. His drop in output reduces the amount of transfers he 
is making to support government through Social Security taxes, Federal 
income taxes, and other taxes, including those paid to State and local 
governments. In addition, his own after-tax income falls, thus reducing 
the amount of earnings he has to spend that year or to put aside to 
support himself more in later years (see example in figure 2). It is 
this multiple hit that so dramatically affects the affordability of 
Social Security and Medicare.
    The United States was lucky in the post-World War II era. Despite 
substantial decreases in male labor force participation due to more and 
more years in retirement, females entered the labor force in such 
numbers that the employment rate among adults still increased. If no 
adjustments in retirement behavior are made, however, this Nation faces 
the reverse situation--a decline in the percentage of adults employed 
along with an increase in the percentage of those more dependent upon 
government. The potential scheduled decline in the employment rate is 
so strong and so long that it is equivalent to an increase in the 
unemployment rate of about 0.4 percentage points per year every year 
for over two decades running (see figure 3).
                              other issues
    Serving the Less Needy. The Social Security Trustees report is 
mainly focused on whether assets and liabilities of the system come 
into balance. However, it does contain some data on projected benefit 
levels for workers and couples at different income levels. These data 
tend to show some aspects of the distribution of benefits but mask a 
number of potential problems and inequities in the program. In 
particular, the program as now designed continually provides higher and 
higher percentages of benefits to those further and further from likely 
death (see figure 4). The antipoverty effectiveness of each additional 
dollar spent is declining.






    The system also strongly discriminates against divorced and 
unmarried individuals, many of whom work, pay taxes, and raise children 
by themselves, yet in the end get fewer benefits than individuals who 
do none of these. The discrimination is caused by the design of spousal 
and survivor benefits, which are available for no additional tax 
contributions but only to certain individuals (those who remain married 
to a worker for more than 10 years). Another problem caused by this 
same structural design of spousal and survivor benefits is that smaller 
levels of benefits are provided for two-earner couples than for one-
earner couples with the same amounts of earnings and taxes paid into 
Social Security.
    Lifetime benefits. The Trustees' Reports have traditionally shown 
the value of annual Social Security benefits over time. However, a 
large share of the growing costs of Social Security (as well as 
Medicare) has come from an expansion in the number of years of benefit 
support. The expected value of lifetime benefits conveys much more 
about the nature of Social Security promises being made than do annual 
benefits, and I--along with the technical panel I chaired--have 
recommended inclusion of these amounts in the Trustees' Reports. These 
lifetime benefits have climbed from about $290,000 for an average-
income couple retiring in 1960 to about $650,000 today and are 
scheduled to grow to over $1 million for an average-income couple 
retiring in 2030 (figure 5).
    An additional reason for showing these lifetime figures is that 
policy makers considering reform should focus considerable attention on 
what type of package of benefits they want to provide for the future, 
not just on individual pieces of a package. A benefit of $25,000 a year 
for 20 years, for instance, might provide more protection against 
poverty than a benefit package of $20,000 a year for 25 years, even if 
the lifetime cost is the same.


    Directions for Disability Insurance (DI). Almost all the recent 
public attention to OASDI is on the old age or OASI part of the 
program. However, the Trustees' Report on OASDI does cover DI, and it 
demonstrates, among other things, the incidence levels of disability 
insurance. Incidence levels reflect mainly the number of new recipients 
added per year to the system, and these projections tend to show a 
leveling out in the program for numbers of new beneficiaries. However, 
this can be misleading, as can be understood theoretically by thinking 
about moving from 99 percent to 100 percent of the population being 
covered. Upon hitting 100 percent, the incidence rate would show a 
decline to zero, but the program clearly would not be declining in cost 
or in percentage of the population covered. In other words, the 
incidence of new recipients must be added to the stock of people who 
remain in the program to figure out the prevalence of DI within the 
population. A steady incidence rate can mean a growing stock or 
prevalence rate.
    The Social Security Administration calculates prevalence--the 
percentage of the population of different ages who receive DI (figure 
6)--but it doesn't show these figures in the Trustees' Reports. These 
prevalence rates are projected to grow in most age groups even while 
health care improves. That age-adjusted prevalence rates of disability 
insurance go up over time even while there is no projected increase in 
age-adjusted prevalence of actual disability implies either that people 
today are being under-served or people tomorrow are being over-served. 
These difficulties within DI, as well as the wide geographical 
differences in incidence and prevalence of DI recently brought to light 
by the Social Security Advisory Board, imply that serious thinking 
needs to be applied to this program as well.


    Dependence Upon All Revenue Sources. One issue often debated with 
Social Security and other elderly programs is whether they are adding 
to net saving or not. Although the answer is unclear, any potential 
savings of these programs are reduced substantially by the general 
revenue sources that they already tap. Other than interest payments, 
the largest among these are those that derive from the income taxation 
of Social Security benefits and the general revenue financing of the 
Supplementary Medical Insurance (SMI) program (figure 7).
    Interest payments to Social Security also essentially come out of 
general revenues. The trust fund concept tends to hide the nature of 
all these general revenue obligations, although the reports do show the 
figures in separate tables on income and cost. The total effect should 
be shown together in a separate table, perhaps following along the 
lines of presentation of general revenue effects already in the HI and 
SMI report. After all, the more that comes out of general revenues, the 
less that such revenues are available for other societal needs and 
obligations.
    One can graphically display the dependence of Social Security and 
Medicare on all tax sources. Figure 1 shows the demands of Social 
Security and Medicare over time. Of course, if all obligations in 
elderly programs were to be counted, we would also add in Medicaid 
(long-term care) and civil service and military retirement systems. 
These elderly programs as a whole are essentially scheduled to absorb 
almost all taxes, which remain relatively constant as a percentage of 
national income.
    The Uncertainty of Projections. Commendably, SSA calculates 
projections not only for some average or intermediate set of 
circumstances but for various alternatives as well. Following upon the 
advice of several groups, including the Technical Panel which I 
chaired, SSA is investigating ways to improve upon its measures of the 
risk that the system will do worse or better than projected.
    As currently presented, however, policy makers who focus almost 
entirely on intermediate projections ignore most of this analysis. What 
the Trustees' Reports do not make clear is that these risks and 
uncertainties about future imbalances are a consequence of program 
design. Therefore, they can largely be built out of the program. For 
instance, there is significant risk that people will live longer (or 
shorter) lives than projected and the system will be further out of (or 
in) balance than projected. But there is no reason this financial risk 
has to be in the program. If the program were ``indexed'' so that as 
people lived longer, they did not receive more years of benefits, then 
that additional ``risk'' of imbalance would be eliminated (figure 8).




    Similarly, it is possible to adjust the system over time so that it 
pays out benefits according to the number of workers and taxpayers in 
the economy, which itself is affected by demographic and economic 
factors such as the fertility rate. Sweden recently enacted a sweeping 
reform that makes that type of adjustment so that the risk of long-term 
imbalance is significantly reduced, if not eliminated, for a whole 
variety of demographic and economic factors.
    By the way, the current Social Security system already is 
essentially adjusted for changes in economic growth levels. For 
instance, when the rate of wage growth declines, then so does the rate 
of future benefits--which is why the sensitivity of the system to 
changes in economic assumptions is not great (see p. 151 of the 2002 
OASDI Trustees' Report). On the flip side, when wages increase 
unexpectedly, so do future benefits. It turns out that if unexpected 
growth in wages in the last part of the 1990s hadn't been allowed to 
raise substantially the level of future benefits promised to such 
people as those of us sitting in this room today, then the long-run 
actuarial deficit of Social Security would have been cut almost in 
half. Thus, Social Security could have shared in the same budgetary 
gains that in the late 1990s created substantial slack in the non-
entitlement part of the budget.
                                summary
    The process leading to the development of the Trustees' Reports is 
one of the finest in government. That individuals like myself are able 
to make recommendations on improvements speaks well of the process 
itself. Here I have emphasized that the key economic dates coming out 
of the reports are today and 2008, when the baby boomers begin to 
retire--basically any dates when the programs for the elderly as a 
whole force reduced shares of national income to be spent on other 
items. I have also suggested that Social Security funding problems 
relate primarily to a remarkable scheduled drop in labor force 
participation, and trust fund accounting tends to hint a bit 
misleadingly that this problem can be met by a capital market solution.
    Various aspects of Social Security programs could also be better 
clarified within the Trustees' Reports: how increasing shares of total 
benefits are being spent on those who are younger and have less 
relative needs, how growth in costs is better reflected in lifetime 
than annual benefits, how prevalence rates of Disability Insurance are 
growing but are masked by more constant ``incidence'' rates, how much 
these programs are scheduled to be supported by general revenues over 
time, and how the uncertainty of actuarial estimates can be reduced 
through policy design.

    Mr. Hastings. Thank you, Mr. Steuerle.
    Ms. MacGuineas.

                STATEMENT OF MAYA C. MACGUINEAS

    Ms. MacGuineas. Good morning. My name is Maya MacGuineas, 
and I am a Senior Fellow at the New America Foundation, a 
nonpartisan think tank in Washington, where I work on fiscal 
policy. Thank you for inviting me to testify. It is a privilege 
to appear before the committee today.
    I have been asked to talk about the trustees' report in 
particular. The trustees' report is the single most important 
and influential source of information about the financial 
health of the Social Security programs. And given the attention 
the report receives, it is certainly worthwhile to discuss not 
only the implications of the findings, but whether there are 
ways to improve either the content or the presentation.
    Furthermore, given the unbiased analysis, the trustees' 
report can and should provide a framework for comparing various 
reform proposals as we move forward with the necessary 
discussion about how best to reform Social Security.
    In my comments today, I am going to discuss ways to provide 
more information about Social Security's effect on the unified 
budget, an analysis that extends beyond the actuarial window, a 
more detailed breakout of the sensitivity analysis of various 
economic and demographic assumptions and additional information 
with regard to benefits.
    The main purpose of the annual report is to shed light on 
the overall financial health of Social Security, and the report 
is unquestionably the most comprehensive source of such 
unbiased information. In addition to evaluating short range 
trust fund adequacy, the analysis relies primarily on five 
measures, those being: trust fund exhaustion dates, income and 
cost rates, trust fund ratios, actuarial balance and Social 
Security as a percentage of GDP.
    In my opinion, some of these are more useful than others. 
Income and cost rate, for instance, are reasonably 
straightforward. They show that benefits will exceed taxes as a 
percentage of payroll by 6.42 percent at the end of the 75-year 
period. Likewise, viewing Social Security as a percentage of 
GDP is extremely useful because it shows the level of resources 
the program will transfer across the entire economy, and this 
transfer will grow from 4.5 percent today to 7 percent at the 
end of the time period.
    On the other hand, trust fund ratios, actuarial solvency 
and exhaustion dates seem to cause as much confusion as they do 
clarity. And while I do not take issue with the assumptions, 
these numbers are based on, or the methodological approaches 
used to derive them, I am concerned they may divert attention 
away from some of the more relevant issues. The trust fund 
ratio is expected to peak at 471 percent in 2015 and decline 
thereafter. The trust fund exhaustion date is 2041. The 
actuarial balance, which measures Social Security's financial 
status over a 75-year time period and expressed as difference 
between expected income and cost rates as a percentage of 
taxable payroll in present value, is in a deficit of 1.87 
percent.
    These numbers, however, do not convey the full burden to 
the budget or the economy of meeting future obligations, and 
their inclusion of the trust funds, while appropriate in an 
accounting sense, masks the extent of the larger problems. To 
illustrate this point, you merely need to look at the idea that 
has been floated occasionally to increase interest rates. Such 
a change would improve trust fund ratios, extend exhaustion 
dates and decreases the actuarial deficit. Increase the 
interest rate by a fraction and the problem would improve. 
Increase the interest rate by enough and it would appear on 
paper to disappear completely.
    Would we have really made any meaningful improvements in 
the situation we are facing? Of course not. The overflowing 
trust funds would not do a thing to make the task of paying 
benefits any easier. The money to pay the higher interest cost 
would have to come from somewhere, but neither trust fund 
ratios, actuarial solvency or exhaustion dates reflect this.
    So on to this table. One of the recommendations I do have 
would be to include a year-by-year cash-flow analysis in the 
report. This table shows it in 10 years, but I would suggest 
that it be done for every year. Also this table is in 2002 
dollars. One would want to include both current and constant 
dollars. Such a cash-flow table would show the tax revenues 
that will flow to the Social Security as well as their sources 
and the annual costs. The surplus or deficit numbers I believe 
are particularly helpful because they illustrate how much 
Social Security contributes to the rest of the budget in the 
short run and how much it will drain from the rest of the 
budget in the future. It is also useful to view how these 
deficits translate into payroll tax increases or benefit 
reductions necessary to keep the program balanced.
    In addition to showing the cash-flow numbers in dollars, I 
suggest showing them as a share of total government revenues. 
And by incorporating CBO assumptions one can see that spending 
on Social Security will rise from 23 percent of the budget 
today to 33 percent by 2025 and continues to rise thereafter. 
The cash-flow deficit will grow to 6 percent of total revenues 
over the time period and then double over the next 50 years.
    While in my mind viewing these numbers as a share of the 
budget is the most helpful, you could also calculate it as a 
share of GDP or covered payroll or any other denominator deemed 
appropriate.
    I also in my written testimony include how this would be 
helpful in improving the details that we receive on the 
sensitivity analysis. The actuaries include this in Appendix D, 
but they do so for only certain time periods. I think it would 
be helpful to look at this on an annual basis, particularly 
because reporting these results in a cash-flow framework would 
be very useful in conveying both the timing and magnitude of 
the effects and also, I think, clarifying some common 
misconceptions such as the notion that we can actually grow our 
way out of this problem without changes to the program or that 
the financing challenges result solely from a demographic 
bubble that we can weather with a few minor changes.
    Furthermore, these cash-flow tables would be extremely 
helpful in comparing and contrasting specific policy 
recommendations. In evaluating the effect of increasing the 
payroll tax cap, for instance, one could see how much the top 
line, income from payroll tax, would increase. Similarly, this 
analysis would convey the extent to which shifting from wage 
indexing to price indexing would affect benefits over time.
    And finally, proposals to create private accounts could 
also be evaluated in the same manner. If a private account plan 
specified revenue or benefit changes they would be reflected 
above the line. To the extent the plan depended on general 
revenue transfers, that would be reflected below the line and 
shown as a share of the budget. Over time the money available 
from the accounts would provide another source of income to be 
added to revenue on top of the line.
    In addition to cash-flow tables, I think there are a few 
other changes that could be helpful, and I will speak to these 
briefly. One, the concept of actuarial solvency is somewhat 
confusing, both because it includes the trust funds as assets 
without showing where the money to pay for them will come from 
and, two, because it is calculated over a 75-year time period, 
which can produce a ``cliff effect,'' where if you extend this 
evaluation period for a single year, new policy changes are 
necessary and the whole program again falls out of balance. 
Arguably, I believe it would be better to show actuarial 
solvency in perpetuity. Calculations reported in recent work by 
Kent Smetters and Kevin Brennan of the University of 
Pennsylvania have found that this would alter the calculation 
of the present value of the unfunded liabilities from $3.3 
trillion to $6 trillion.
    Additionally, the trustees could consider including tables 
that show both lifetime benefits and net transfers on a 
generational basis. Gene spoke about lifetime benefits and gave 
some examples of how dramatic it would be to see how these 
benefits grow with life expectancies. Net transfers, the 
present value of a generation's benefit less the taxes they 
pay, would be useful at looking at the program from the 
perspective of generational equity. We could, for instance, 
make Social Security appear to be healthy by all evaluation 
techniques, including cash-flow by simply passing a law that 
the payroll tax would be increased as necessary to cover 
promised benefits. The program would be actuarially solvent, 
cash-flow deficits would be zero, and the trust fund would 
never be depleted. But younger workers and future generations 
would suffer huge losses which would be captured in a net 
transfer evaluation while missed in other assessments.
    To conclude, the integrity with which the trustees' report 
is constructed and its unbiased content play a crucial role in 
providing the information needed to evaluate the financial 
health of Social Security. My suggestions here should in no way 
be taken as a criticism of the work that is currently done but 
rather a suggestion of other information that might be useful 
for purposes of comparison and analysis.
    [The prepared statement of Ms. MacGuineas follows:]

 Prepared Statement of Maya C. MacGuineas, Senior Fellow, New America 
                               Foundation

    Good morning, Mr. Chairman and members of the committee. My name is 
Maya MacGuineas and I am a Senior Fellow at the New America Foundation, 
a nonpartisan think tank here in Washington, where I work on fiscal 
policy. Thank you for inviting me to testify today. It is a privilege 
to appear before the committee.
    The Social Security Trustees' Report is the single most important 
and influential source of information about the financial health of the 
Old-Age and Survivors Insurance and Disability Insurance programs. 
Given the attention the report receives, it is certainly worthwhile to 
discuss not only the implications of the findings but also whether 
there are ways to improve either the content or presentation. 
Furthermore, given its unbiased analysis, the Trustees' Report can and 
should provide a framework for comparing various proposals as we move 
forward with the discussion about how best to reform Social Security.
    In my comments today, I am going to discuss ways to provide more 
information about Social Security's effects on the unified budget, an 
analysis that extends beyond the actuarial window, a more detailed 
breakout of the sensitivity analysis of various economic and 
demographic assumptions, and some additional information with regard to 
benefits.
    The main purpose of the annual report is to shed light on the 
overall financial health of the Old-Age and Survivors Insurance and 
Disability Insurance programs. The Trustees' Report is unquestionably 
the most comprehensive source of such information. In addition to 
evaluating short-range trust fund adequacy, the analysis relies 
primarily on five tools including: 1. Trust fund exhaustion dates; 2. 
Income and cost rates; 3. Trust fund ratios; 4. Actuarial balance; and 
5. Social Security costs as a percentage of GDP.
    In my opinion, some of these are more useful than others. Income 
and cost rates for instance, are reasonably straightforward and quite 
useful. They show that while taxes as a percentage of payroll currently 
exceed benefits by 1.88 percent of covered payroll, this relationship 
will deteriorate over time and that by 2025, benefits will exceed non-
interest income by 2.90 percent. By 2080, the number will have grown to 
6.68 percent. Likewise, viewing the Social Security program as a 
percentage of GDP is an extremely useful tool because it shows the 
level of resources the program will transfer across the entire economy. 
The Trustees report that Social Security will transfer 7 percent of the 
economy at the end of their 75-year valuation period as opposed to 4.5 
percent today. Both of these sets of numbers are relatively easy to 
understand.
    On the other hand, trust fund ratios, actuarial solvency, and 
exhaustion dates seem to cause at least as much confusion as clarity. 
While I do not take issue with the assumptions these numbers are based 
on, or the methodological approaches used to derive them, I am 
concerned they may divert attention away from more relevant issues.
    The trust fund ratio is expected to peak at 471 percent in 2015, 
and decline thereafter. The trust fund exhaustion date, 2041, is the 
year when the trust funds' assets will be depleted. Actuarial balance 
measures Social Security's financial status over a 75-year time period, 
expressed as the difference between the expected income and costs as a 
percentage of taxable payroll in present value terms. Currently, the 
actuarial deficit is 1.87 percent.
    But these numbers do not convey the full burden to the budget or 
the economy of meeting future obligations. Their inclusion of the trust 
funds, while appropriate in an accounting sense, masks the extent of 
the larger problem. One must also consider the burden the trust funds 
represent in order to view the funding problem in its entirety. To 
illustrate this point, you merely need to look at the idea that has 
been floated occasionally to increase the rate of interest paid on the 
bonds in the trust funds. Such a change would improve trust fund 
ratios, extend the exhaustion date, and decrease the actuarial deficit. 
Increase the interest rate by a fraction, and things would look a bit 
better. Increase the rate by enough, and all problems would appear on 
paper to evaporate. Would this change make any meaningful improvements 
to the situation we are facing? Of course not. The overflowing trust 
funds would not do a thing to make the task of paying benefits any 
easier. The money to pay the higher interest costs would have to come 
from somewhere, but neither trust fund ratios, actuarial solvency, or 
exhaustion dates reflect this.
    One recommendation I would make, then, is to include a year-by-year 
cash flow analysis. Almost all of the information necessary for such an 
analysis is contained in the Trustees' Report but could be combined in 
a way that illuminates some important issues (See Table 1).
    A cash flow presentation would lay out the tax revenues that will 
flow to the program as well as their sources, and the annual costs. I 
show the numbers here in 2002 dollars; if this format were adopted, 
they would presumably be shown in both current and constant dollars. 
The surplus or deficit numbers are particularly helpful because they 
illustrate how much Social Security contributes to the rest of the 
budget in the short run and how much it will drain from it in the 
future. It is also useful to view how these deficits translate into 
payroll tax increases or benefit reductions necessary to keep the 
program balanced on an annual basis.
    In additional to showing the cash flow numbers in dollars, I would 
suggest showing them as a share of total government revenue. Since the 
government's actual tax base is only a little more than half the value 
of GDP, showing cash flow numbers as a share of total government 
revenue gives a more realistic picture of the tax rates required to 
achieve balance. By incorporating Congressional Budget Office 
assumptions, one can see that spending on Social Security will rise 
from 23 percent of the budget today to 33 percent by 2025 and continues 
to rise thereafter. The cash flow deficit will grow to 6 percent as a 
share of total revenues over that time period and then double over the 
next fifty years. While in my mind viewing these numbers as a share of 
the budget is most helpful, they could also be calculated as a share of 
GDP, covered payroll, or any other denominator deemed appropriate.
    This format would not only be helpful in viewing trends in a way 
that is relevant to Social Security and the unified budget, it could 
also serve as a useful benchmark for comparing the effects that changes 
in assumptions or policies would have on the program. For instance, the 
Trustees include in their report high, low and intermediary cost 
assumptions for their underlying economic and demographic assumptions. 
In Appendix D of the report they perform a sensitivity analysis by 
altering one variable at a time. The findings are reported in terms of 
summarized income and cost rates and actuarial balance over 25, 50, and 
75-year periods. Reporting these results using the annual cash flow 
framework would be more useful in conveying the timing and magnitude of 
these effects. This analysis would be helpful in clarifying some 
misconceptions, such as the notion that we can grow our way out of the 
problem without other changes to the program, or that the financing 
challenges result solely from a demographic bubble that we can weather 
with a few minor changes.
    Furthermore, cash flow tables would be extremely helpful when 
comparing and contrasting specific policy recommendations. In 
evaluating the effect of increasing the payroll tax cap, for instance, 
one could see by how much the top line--income from payroll tax--would 
increase. Similarly, this analysis would convey the extent to which 
shifting from wage indexing to price indexing would affect benefits 
over time. Proposals to create private accounts could be evaluated in 
the same manner. If a private account plan specified revenue or benefit 
changes, they would be reflected above the line and to the extent a 
plan depended on general revenue transfers, that would be reflected 
below the line and shown as a share of the budget. Over time, the money 
available from the accounts would provide another source of income to 
be added to tax revenue.
    In addition to adding cash flow tables, there are a few other 
changes that would be helpful. First, actuarial solvency is somewhat 
confusing not only because it takes into account the Social Security 
trust funds while ignoring where those funds will come from, but also 
because it is evaluated over a 75-year period. This focuses attention 
on policy changes necessary to keep the program balanced over that 
period and that period only. This approach to reform suffers from the 
problem of the ``cliff effect'' where when the evaluation period is 
lengthened by a single year, the program promptly falls out of balance, 
thus making further changes necessary. It would arguably be better to 
evaluate the program's well being in perpetuity, shifting attention 
away from actuarial solvency over a limited time period to 
sustainability--a far more important objective. Calculations reported 
in recent work by Kent Smetters and Kevin Brennan show that the 
actuarial shortfall is twice as large when evaluated in perpetuity. In 
particular, the shortfall increases from around $3.3 trillion over the 
next 75 years to over $6 trillion when evaluated in perpetuity.
    Finally, the Trustees should consider including tables that show 
both lifetime benefits and net transfers on a generational basis. 
Lifetime benefits rather than average annual benefits would be helpful 
in reflecting how costs rise along with increases in life expectancies.
    Net transfers--the present value of a generation's benefits less 
the taxes they pay--would be useful in evaluating generational equity. 
Smetters and Brennan show that this measure gives a more objective view 
of liabilities than standard trust fund accounting.* We could, for 
instance, make Social Security appear to be healthy by all evaluation 
techniques including cash flow by simply passing a law that the payroll 
tax would be increased as necessary to cover promised benefits. The 
program would be actuarially solvent, cash flow deficits would be zero, 
and the trust fund would never dip below zero. But younger workers and 
future generations would suffer huge losses, which would be captured in 
a net transfer evaluation while missed in other assessments.
---------------------------------------------------------------------------
    *Note.--See, Smetters, Kent and Kevin Brennan. ``Analyzing Social 
Security Reform on a Cohort Basis: Toward Objective Accounting.'' 
University of Pennsylvania, Manuscript, Forthcoming.
---------------------------------------------------------------------------
    To conclude, the integrity with which the Trustees' Report is 
constructed and its unbiased content play a crucial role in providing 
the information needed to evaluate the financial health of Social 
Security. My suggestions here should in no way be taken as a criticism 
of the work that is currently done, but rather as suggestions about 
other information that might be useful for the purposes of analysis and 
comparison. I look forward to your questions, and once again, thank you 
for holding this hearing and inviting me to testify.

    Mr. Hastings. Thank you very much for your testimony. And 
now it is my pleasure to recognize our former colleague Barbara 
Kennelly.

           STATEMENT OF THE HON. BARBARA B. KENNELLY

    Ms. Kennelly. Thank you, and as a former member of this 
committee, I want to say to you that I know you are here, you 
are the unsung heroes of Capitol Hill.
    For nearly 70 years, Social Security has guaranteed working 
families that they would have income in the event of old age, 
death of a family wage earner, or a disability. Social Security 
provides benefits in a manner that is both progressive and 
fair. No other wage replacement program, public or private, 
offers the protections of the Social Security old age, survivor 
and disability insurance program. In addition to retirement 
income, I want to emphasize this: that 38 percent of all Social 
Security benefits are paid to the disabled individuals, spouses 
of the disabled individuals or dependent children or survivors. 
I emphasize that because of the earlier conversation that this 
committee had with the previous witness. I don't know how many 
of these people, this 38 percent, had low expectations of 
having Social Security there for them, but I do know they 
probably had no expectation that they would have an early death 
or be disabled.
    Today Social Security, as you know, continues to meet the 
challenge that it faces and it still has a surplus. And even, 
in fact, with the recent economic sluggishness, it continues to 
keep that surplus. We know from the Social Security trustees' 
report that we can probably expect full solvency until 2041. By 
2017, Social Security will have accumulated over $5 trillion in 
Treasury bonds backed by the full faith and credit of the 
United States of America. And I think I can speak with 
certainty that the millions of members of the national 
committee certainly expect that these bonds can be collected 
upon because they understand that is the law. In 2017, the 
program will begin to call in its interest on these bonds.
    Beginning in 2027, as we said often this morning, interest 
and tax revenues combined will be insufficient to meet demands 
and the program will need to redeem the bonds that we have been 
talking about. In the year 2041, if no changes are made, the 
trust fund will be exhausted and incoming revenues will meet 
only about 72 percent of current benefit obligations. Even at 
this point, Social Security isn't broken.
    What is happening to Social Security is because of 
longevity and because of low birth rates. It has a cash 
shortfall, as has been mentioned. Benefit adjustments and/or 
new revenues equivalent to 1.86 percent of payroll or 0.72 
percent of the gross national domestic product would be 
sufficient to cover the costs of currently promised benefits 
for the next 75 years.
    Long range Social Security solvency is directly linked to 
the strength of the economy. But continued economic growth 
alone will not solve all Social Security's long-term problems. 
We must begin a real debate, beyond the debate of 
privatization, to make the adjustments that can be made today 
to ensure that the program will be intact for future 
generations, and the sooner we begin to do it the better.
    And as I look at the Members of Congress here, I know that 
John Spratt and I are probably the only two here that were in 
the Congress in 1983. I know Mr. Spratt remembers, like I do, 
how we waited too long to address the problems of solvency in 
Social Security. You have to remember how hard it was to vote 
for what we had to vote for because in that 1983 vote that we 
had to vote for was for the first time to tax Social Security 
and citizens are still outraged by that. For the first time, we 
said if you go to college full time you can have Social 
Security, which had been up to that point the fact. And for the 
first time, we raised the age from 65 to 67. So if we don't 
start acting sooner rather than later, some very difficult 
decisions will have to be made as were made in 1983. And in the 
meantime we must move back toward efforts to pay down our 
mounting Federal debt not attributed to the trust funds.
    During the last year of the previous administration, the 
Clinton administration, and during the first year of the Bush 
administration, our Nation was on track to completely repay 
public debt by 2012.
    This would have taken a tremendous burden off future 
generations expected to repay obligations to Social Security 
trust funds, and also cover their needs as well.
    Last year's 10-year $1.7 trillion tax cut, combined with 
the sagging economy and the subsequent need to respond to the 
horrific events of 9/11 completely erased a projected 10-year 
$5.7 trillion surplus.
    Now, instead of paying down debt, we are increasing debt, 
and the related interest cost to our younger generations. 
Therefore, the National Committee, the committee that I am 
president of, opposes efforts to extend last year's tax cuts 
beyond 2010.
    This extended tax cut is estimated by the Center on Budget 
and Policy Priorities to cost an additional $4 trillion to the 
general fund in the decade beginning in 2012. Ironically, that 
decade is at the same time that those baby boomers that we 
constantly refer to are coming down the pike. We must put our 
priorities in order.
    All of the demands of future revenue should be laid aside 
until this task is accomplished. Diverting Social Security 
payroll taxes to private individual investment accounts also 
worsens Social Security's long-term projected shortfall and 
requires even more revenue to maintain current promises.
    Funneling even 2 percentage points of payroll tax out of 
Social Security and into private accounts more than doubles the 
long-term shortfall, today's promised benefits.
    Of the three plans put forward by the President's 
Commission to Strengthen Social Security, the Social Security 
actuary has found that if implemented today, during the period 
from 2003 to 2012, the plan boosts the unified deficit by $1.2 
trillion, plan 2 by $1.5 trillion, and plan 3 by $1.3 trillion.
    All three plans called for large reductions in the 
guaranteed benefit as great as 43 percent for those retiring in 
2075. Even for those who do not opt for the voluntary account, 
this happens. Thus, the solution proposed by private accounts 
only digs the hole deeper, requiring even greater cuts in 
defined benefits and lawyer demands on future revenue sources.
    While the goal of expanding national savings is laudable, 
private accounts in lieu of guaranteed benefits merely 
substitutes one form of retirement savings for another. We must 
improve incentives for younger workers to invest and save on 
top of, not in place of, currently promised Social Security 
benefits in order to expand both individual and national 
savings.
    In closing, I say to the members of the Budget Committee, I 
agree with Chairman Nussle that this has been a marvelous, 
educational conversation. I hope you will keep having this 
conversation about future solvency, because there is no doubt 
in my mind that a developed country like the United States of 
America is going to have some sort of retirement-guaranteed 
government program for the old and the disabled.
    But, I do hope that you can keep the debate separate, the 
conversation separate between these--you know, some of us 
disagree about how you go about ways, we often have honest 
disagreements. But the fact of the matter is, there are those 
who want to have a different system, who want to have a 
different structure. And there probably will be many other 
suggestions along the way. But I urge you to continue to think 
about solvency. Continue to think about the fact that there 
always will be elderly people. There always be poor and 
disabled people.
    I thank you very much for allowing me to speak today.
    [Prepared statement of Ms. Kennelly follows:]

  Prepared Statement of Hon. Barbara B. Kennelly, President and CEO, 
      National Committee to Preserve Social Security and Medicare

    Chairman Nussle, Ranking Member Spratt, members of the committee, I 
appreciate the opportunity to testify before the House Budget Committee 
on this issue of critical importance, the long-term budget outlook for 
Social Security. On behalf of the millions members and supporters of 
the National Committee to Preserve Social Security and Medicare, I am 
delighted to be back in the halls of Congress with my former 
colleagues. Thank you for holding this timely and important hearing.
    Most Americans who have any recollection of the Great Depression 
will understand that Social Security was created to guard against what 
President Franklin Roosevelt described as the ``hazards and 
vicissitudes of life.'' For nearly 70 years Social Security has 
guaranteed working families would have some income in the event of old 
age, death of a family wage earner or disability.
    Social Security provides benefits in a manner that is both 
progressive and fair. No other wage replacement program, public or 
private, offers the protections of the Social Security Old Age, 
Survivors and Disability Insurance program. In addition to retirement 
income, 38 percent of all Social Security benefits are paid to disabled 
individuals, spouses of retired and disabled workers, dependent 
children and survivors.
    Today Social Security continues to meet this challenge, and despite 
recent economic sluggishness, the 2002 Social Security Trustees' Report 
shows an improved forecast for the system with full solvency extended 
another 3 years to 2041. By 2017, Social Security will have accumulated 
over $5 trillion in treasury bonds, backed by the full faith and credit 
of the United States Government.
    In 2017, the program will begin to tap its interest on these bonds. 
Beginning in the year 2027, interest and tax revenues combined will be 
insufficient to meet benefit demands and the program will need to 
redeem bonds held by the trust funds. In the year 2041, if no changes 
are made, the trust funds will be exhausted and incoming revenues will 
meet only about 72 percent of current benefit obligations. Even at this 
point, Social Security will not be ``broken.'' This shortfall, if 
addressed today is quite manageable. Benefit adjustments and/or new 
revenues equivalent to 1.86 percent of payroll or 0.72 percent of GDP 
would be sufficient to cover the cost of currently promised benefits 
for the next 75 years.
    Long-range Social Security solvency is directly linked to the 
strength of the economy. The prosperity of the late 1990s dramatically 
improved the financial outlook of Social Security, with the date of 
insolvency improving 14 years (2027 to 2041) in the past 6 years, on 
the strength of the economy alone.
    But continued economic growth alone will not solve all of Social 
Security's long-term problems. We must begin a real debate, beyond 
privatization, to make the adjustments that can be made today, to 
ensure that the program will be intact for future generations. The 
sooner we begin, the less difficult the decisions will be.
    First, we must move back toward efforts to pay down our mounting 
Federal debt not attributed to the trust funds. During the last year of 
the previous administration, and the first year of this one, our nation 
was on track to completely repay public debt by 2012. This would have 
taken a tremendous burden off of future generations expected repay 
obligations to Social Security trust funds and cover their other needs 
as well.
    Last year's 10-year, $1.7 trillion tax cut combined with a sagging 
economy, and the subsequent need to respond to the horrific events of 
9/11 completely erased a projected 10-year $5.6 trillion surplus. Now 
instead of paying down debt, we are increasing debt and the related 
interest costs on our younger generations. As the power of compound 
interest also works in reverse, this huge change in our budget outlook 
will mean $1 trillion in new interest on the debt in just the next 10 
years.
    Therefore, as the National Committee opposed the tax cuts enacted 
last year, we must also oppose efforts to extend of those tax cuts 
beyond 2010. This tax package is estimated by the Center on Budget and 
Policy Priorities (CBPP) to cost of an additional $4 trillion to the 
general fund in the decade beginning in 2012, ironically the same 
decade in which we are concerned about the general fund's ability to 
cover the cost of interest owed to the Social Security trust funds. In 
fact, the CBPP analysis has found that the cost of the tax cuts, if 
extended 75 years, is more than twice as large as the long-term deficit 
in Social Security.
    It is not that we oppose tax cuts in principle, but more a 
recognition that we must place our priorities in order. If meeting our 
future obligations to Social Security and Medicare without having to 
resort to painful benefit cuts is our number one priority, we strongly 
believe that all other demands on future revenues should be laid aside 
until that task is accomplished.
    Today Social Security remains fully self-financed and is not 
responsible for even one penny of the Federal debt. While Social 
Security surpluses accumulated since 1983 were intended to pay down 
debt held by the public to reduce future burdens related to the 
retirement of the baby boom, with the brief exception of the past few 
years this has not happened. Our recent return to spending Social 
Security trust funds on general needs marks a return to using the 
regressive payroll tax to finance general revenue programs.
    Although we have many fundamental problems with the concept of 
privatization, perhaps the biggest argument against transforming part 
of Social Security into a system of individual retirement accounts is 
the tremendous cost of the transition. Although individual accounts are 
often presented as a way to ``save'' Social Security, diverting money 
to individual accounts actually worsens Social Security's long-term 
projected shortfall and requires even more revenue to maintain current 
promises. Indeed, funneling 2 percentage points of payroll out of 
Social Security and into private accounts more than doubles the long-
term shortfall for today's promised benefits.
    Of the three plans put forward by the President's Commission to 
Strengthen Social Security, the Social Security Actuary has found that, 
if implemented today, during the period from 2003-2012 plan 1 boosts 
the unified deficit by $1.2 trillion, plan 2 by $1.5 trillion, and plan 
3 by $1.3 trillion. All three plans call for large reductions in the 
guaranteed benefit as great as 43 percent for those retiring in 2075, 
even for those who do not opt for the voluntary account. Plans 2 and 3 
have been deemed ``solvent'' only because they call upon the general 
fund for trillions of dollars in general revenue transfers with no 
specified source. Under plan 1, program expenses exceed tax revenues as 
early as 2009, plan 2 by 2006, and plan 3 in 2011. Thus the 
``solution'' proposed by private accounts only digs the hole deeper, 
requiring even greater cuts in defined benefits and larger demands on 
future revenue sources.
    Further, the level of individual risk privatization would introduce 
to Social Security is unacceptable. Although proponents of 
privatization like to talk about market averages, there is no such 
thing as an investor who earns the market average every year. Even if 
individual accounts could work well for upper-income earners and 
earners without dependents, they would not work as well for low-income 
workers, people of color, disabled workers or families.
    While the goal of expanding national savings is laudable, private 
accounts in lieu of guaranteed benefits merely substitutes one form of 
retirement savings for another. We must improve incentives for younger 
workers to invest and save, on top of, not in place of currently 
promised Social Security benefits in order to expand both individual 
and national savings.
                         solvency alternatives
    I urge you to keep the security in Social Security and focus on 
changes that do not dismantle its principles of shared risk. A few of 
the solvency alternatives (in addition to debt retirement) we have 
suggested Congress consider include:
    1. Supplementing payroll taxes with general revenue. An influx of 
dollars from general revenues would help meet the increased demands of 
an aging population. If the same level of general revenue commitment 
contained in various private account proposals now on the table were 
directly applied to solvency of the current program, solvency could be 
extended without exposing beneficiaries to benefit cuts or the vagaries 
of the market.
    2. Increasing the maximum wage base. Currently, the first $80,400 
of earned income is subject to payroll tax. The base could be increased 
so that 90 percent of covered earnings are taxable and indexed 
thereafter.
    3. Expanding coverage. Newly hired state and local workers could be 
brought into the Social Security program. This would provide these 
workers with increased retirement security, greater freedom in changing 
jobs and added protection from the eroding effects of inflation on 
income.
    4. Government investment of a portion of the trust fund reserves. 
Private investment of a portion of the reserves should be seriously 
considered and debated. We could invest some of the reserves in an 
indexed selection of stocks and allow Social Security to realize a 
higher return on its investments, without appreciably increasing 
individual risk.
    Chairman Nussle, Congressman Spratt, thank you for holding this 
important hearing today. We look forward to working with you toward a 
truly bipartisan effort to reinforce Social Security as the bedrock 
safety net for all of America's working families. I would be pleased to 
answer any questions you may have.

    Mr. Hastings [presiding]. Thank you. I want to thank all 
three of you for your testimony. Mr. Spratt, in line with the 
precedent that the chairman started, I will recognize you 
first.
    Mr. Spratt. Well, I first want to first say to Gene 
Steuerle and Maya MacGuineas, I didn't put the question to you 
about the trust fund report, and about the actuaries. But I 
think you have added something to the understanding of our 
process by devoting your attention to it, both in terms of 
process and particularly as to the integrity of it. When Tim 
Penny spoke to me about the possibility of being on the 
President's Commission, and asked me if I had any ideas about 
it, my only recommendation to him was that they should use the 
Social Security actuaries to do whatever analysis they did. We 
need to have one scorekeeper so that we can keep some 
commonality and comparability about the wealth of different 
proposals that have been put out there.
    Gene Steuerle, you have actually proposed a Social Security 
solution that has a number of different elements. I want to 
give you an opportunity to explain your concept of it as you 
formulated it several years ago. I know it appears in different 
versions today. I think you were probably the grandfather, if 
not the father of the Stenholm proposal as it is called in the 
House. Would you explain how it would work?
    Mr. Steuerle. Mr. Spratt, I should say that I was on the 
National Commission on Retirement Policy which Mr. Stenholm was 
the co-Chair. I agreed to sign onto that proposal. But we had 
disagreements on the Commission as well. So I have never come 
out with an exact proposal.
    But I can tell you the elements of a proposal that I would 
tend to believe are fair and ``do-able.'' Quite honestly, I 
believe there is a lot of room for compromise. I believe that 
this huge debate, for instance, that we have over individual 
accounts is exaggerated on both sides, and that there are 
really compromises that are available.
    The fundamental way that I start off looking at this 
program--that I use to address the system--is, to ask myself, 
``what are the principles under which a system can work?'' 
There is a core set of public finance principles. We want equal 
treatment of equals--which is sort of an equal justice 
principle--and some progressivity. We want to take care of the 
poor, we want the system to be efficient, and we want it to be 
as simple as possible.
    Mr. Spratt. You also took the opportunity, as long as you 
were at it, of changing the benefit structure as I recall, to 
deal with some inequities in it today.
    Mr. Steuerle. My fear, again, on both sides of the aisle, 
is the fight over preserving the system or only adding 
individual accounts ignores that the core of the system, which 
would remain, which would still be very large, whether you have 
individual accounts or not. That core basically needs some 
substantial reform. Particularly the system has substantial 
discrimination, as I stated in my testimony, against single 
heads of household who can work, pay taxes, raise children--do 
all of these things we think we might be worth subsidizing--and 
get lower benefits than people who don't do any of those 
things.
    That is among the types of reforms. Another concern is the 
system at the margin does a very poor job in attacking poverty. 
It has become more and more of a middle-aged retirement system, 
and it gives higher and higher levels of benefits to everyone 
overtime. There is substantial money in the system already with 
which we could solve poverty, whether we lower benefits over 
time or not. We already pay out enough that we can eliminate 
poverty among the elderly altogether, and we don't.
    So there are a lot of issues in the core Social Security 
program--which is going to be this pay-as-you-go system--that I 
think we should deal with, have been put to the side in this 
constant debate over individual accounts or no individual 
accounts.
    Having said that, I think the case can be made for 
individual accounts as put forward in the Stenholm-type 
proposal. I tend to favor them, partly because as this 
committee would understand, it gives honest budget accounting. 
When the money goes into the account, it is recognized as an 
outlay of government, and therefore deters the type of action 
where people make promises in the future but don't have to fund 
them. So you make a promise, it has to be funded.
    Now, the related problem the individual account advocates 
have is that if we are going to put money in these accounts, we 
have got to fund them. Now they are asking us how we are going 
to do that. That is an honest scorekeeping aspect that I don't 
think you have in the current system.
    I also tend to favor individual accounts a little bit 
because it is a back-door way of dealing with some of the 
fundamental problems in our private pension system, which is 
the issue just off the table. Well over half of the population 
gets almost nothing or gets very little in the way of private 
pension benefits. We need to figure out a way to increase 
saving among them. So I am willing to and actually quite 
supportive of efforts to try to put these type of accounts in 
the system. But it is for these particular reasons.
    In sum, I want to have a core system that does a better job 
in removing poverty among the elderly. I want it to remove some 
of this discrimination against single heads of households, and 
along the way, as a budget accounting rule, I tend to be 
someone who supports a lower growth rate of benefits, primarily 
because I think these entitlement programs are deterring us 
from spending more on education and other more vital needs of 
our society.
    I really do not believe that giving people like myself a 
17th, 18th, 19th year in retirement is a priority of our 
society, and it should not be. The current system has that as a 
priority over what I believe to be more fundamental needs.
    So for that reason, I am quite willing to support a lower 
rate of growth of benefits, primarily, in my view, through 
increasing the retirement age and aiming for some fixed number 
of years of retirement support--15, 16, something like that.
    Mr. Spratt. Let me ask each of you: The actuaries have 
indicated that if 14 percent of the trust funds were invested 
in equities, 46 percent of the estimated shortfall would be 
resolved. Is that a viable solution? Let me turn first to 
Barbara Kennelly. Does the National Committee regard this as, 
at least, something worthy of consideration?
    Ms. Kennelly. Yes. And what Gene has said is what I agree 
with. That the debate has just got off of hand, we are not 
addressing the real problems. And you can disagree. But the 
National Committee is not saying don't do anything. The 
National Committee is saying, and I agree with Mr. Walker, when 
you do something, it has to be a package of some things that 
you do, because we all know come 2041, we are short 27 percent 
of funds we need to pay for full Social Security.
    Mr. Spratt. That was the wisdom of 1983 which you referred 
to. Everybody had a stake in this solution.
    Ms. Kennelly. But I really felt very badly, because when 
the previous Commission on Social Security came out, one of the 
strong recommendations, they also had three suggestions, but 
one of the strong recommendations was investment by Social 
Security, or by the government, into the market. And 
unfortunately practically the next day, Mr. Greenspan came out 
and said, ``oh, no, no, we can't do that. I mean, how could 
this happen? And how could we have a board that could control 
this?'' I felt like saying, ``do you think you are the only 
honest man in Washington? You are the Federal Reserve.''
    But, it just sunk like that. But in my list of things, 
there are many ways of filling in the gap. I definitely say 
that we should look at the market.
    Mr. Spratt. Gene.
    Mr. Steuerle. I am not arguing that one can't put stocks 
and bonds in the trust funds. My concern is if the goal is to 
have more ownership of stocks and bonds, I think that that 
probably is better served on the private or the individual 
side. And my reason is that simply transferring money to buying 
stocks doesn't increase saving in society. All that happens 
there is, in an accounting sense, the government now lays a 
greater claim upon national resources than it does, say, if it 
is investing in bonds. So it doesn't necessarily improve the 
economy.
    Mr. Spratt. But it improves the rate of return in the trust 
fund's assets.
    Mr. Steuerle. Because now the trust fund owning stocks mean 
people in the private sector own less stock, so the private 
sector gets a little lower income than goes to the trust fund. 
Again the question is whether we increase saving in the 
process. If we don't increase saving, there is no net gain for 
the economy or for citizens, we just get a little more money on 
the trust fund side.
    My concern--and I have to say it is an issue of political 
economy and not economics, I have to be quite honest about it--
is that I think every nation that has tried to do this has run 
into problems of how you control what the government is going 
to buy or not buy. Admittedly, we do it when people put money 
in the Thrift Saving Plan. State and local governments do it. 
But you do get this problem: if you invest in the Standard and 
Poors 500 Index; what happens if you are company number 501 and 
the government is not investing in you? Or you are a small 
start-up company, you are not listed on the stock market, you 
don't get this government investment. Or the whole question of 
social investment in tobacco companies.
    These issues will not remain off the table. So I think 
politically it is probably easier if we can figure out ways to 
resolve them with individual accounts.
    I don't necessarily mean they have to be individual 
accounts along the lines of any one proposal or another. You 
could have individual accounts along the lines of President 
Clinton's proposal if you want. But I just think if you are 
going to control where the stock is going to be invested, it is 
better to leave that choice to the individuals.
    Mr. Spratt. Ms. MacGuineas.
    Ms. MacGuineas. I will be brief because Gene made the same 
points I would make. But I think the suggestion suffers from 
the popular misconception that we can get out of this problem 
by merely increasing rates of return. That is not what it is 
about. It is not about switching investments in one place for a 
different kind in another place. That is purely an asset 
shuffle. You are going to have the government owning more stock 
and, therefore the public owning more of the government bonds 
that were there before, and the returns on the assets are going 
to converge as necessary.
    So you can't sort of switch with one hand your investments 
to your other hand and resolve the problem. If the discussion 
is about how best to prefund the system through private 
accounts or centralized trust funds, that is a good discussion 
to have. But we have to be talking about what consumption we 
are going to reduce in order to improve saving. And that comes 
from policy changes, either in taxes or benefits, it doesn't 
come from shifting.
    Then finally, I do tend to agree with the Greenspan 
concerns of the political economy issues at hand. This is 
trillions of dollars that would be invested centrally by the 
government. And I am quite concerned that it would, over time, 
compromise the ability of the capital markets to allocate 
capital as efficiently as possible.
    Mr. Spratt. Both of you have indirectly undercut an 
argument that Martin Feldstein makes for one of his proposals. 
Namely, he assumes that the transfer of Social Security assets 
into the equity markets would have an effect on the economy, 
and that the Treasury and the next stage would be able to reap 
higher returns from corporate returns as a result of this, cost 
of capital would go down, companies would become more 
productive and efficient, they would become more profitable, 
and consequently, the Treasury would reap some of the return 
for this in income taxes.
    I take it from what you said you don't think there will be 
an economic effect like that by simply investing in the market, 
using these assets to invest in the market?
    Mr. Steuerle. In Dr. Feldstein's case, he is actually 
making an assumption that there is also some shift out of 
consumption. Under some analyses he has performed, he assumes 
that government spends less on other consumption items. That is 
really the source of the additional savings that lead to this 
investment. Again, if it can be done the right way, this 
attempt to lower consumption is in both the attempt to put 
Social Security off-budget on the one side and the attempt to 
put money in individual accounts on the other.
    The common goal is to successfully change the target, the 
deficit target of Congress, which both sides of the aisle 
attempted to do last year by defining a non-Social Security 
budget surplus as one way of getting there. Or individual 
accounts might do that by having the money counted, as I said, 
immediately as an outflow of government.
    If you can change the accounting so Congress has a tighter 
target, than the savings come from the fact that Congress 
basically, somewhere in this system--it might be in the non-
Social Security part of the system--is spending less or taxing 
more. But it is getting the government in more balance. And 
that is really the source of saving that Dr. Feldstein relies 
upon.
    If that occurs, it probably would improve the economy. 
However, my concern is not that we don't work on these savings 
issues. I think they are vital. But I have been in this town 
now 30 years, essentially working on saving proposals from one 
administration to the next; one Congress to next. Quite 
honestly, we cannot totally control net national savings. We 
can control government saving. We can mandate individuals do 
certain things with one hand, but we can't control what they do 
on the other because we are in a democratic society.
    We can only do things to try to improve net savings.
    Mr. Spratt. Let me ask each of you, do you then support, as 
a first step, the idea of using the surplus to buy up 
outstanding government bonds, pay down debt held by the public 
and add to national savings?
    Ms. Kennelly. We did that for 2 years. What resulted is we 
were going to be able to pay off the debt by 2012. We saw that 
in action when we did have the surplus, because by law, when 
you have certain amounts of money, you can only use it to pay 
down the debt. But I would like to go back to your previous 
question for a minute and say one thing--we always talk about 
the picture in Washington, because we are dealing with the big 
picture. But if you look at the individual out in the country, 
nothing was mentioned when you asked that question about 
investing in the market about risk. And why one of the reasons 
that we are for looking at the investing in--the government 
investing in the market is the risk would be shared.
    In the individual accounts, the risk is there for each 
individual, and if they retire at a time when the market is 
down, they have to pay for that by themselves and they lose 
their dollars. And there really is no insurance for them in the 
individual accounts.
    Ms. MacGuineas. From an economic perspective, I think the 
approach of paying down the debt was a very solid, well 
thought-out approach. I did, at the time we were talking about 
it, spend a little time worrying about what was going to happen 
when all of the debt was bought up, but I am not so worried in 
the short term any more.
    Mr. Spratt. As Larry Summers said, that was like his 
worrying about going on a diet and losing too much weight.
    Ms. MacGuineas. So yes, paying down is debt is the way to 
increase public saving. That has the same kind of effects as 
creating private accounts that create new saving in the private 
sector. But, I think the question is, what mechanism can create 
the budgetary discipline necessary to accomplish this in a 
sustainable way. My concern is we have had those trust funds 
for decades. We have seen that the presence of the Social 
Security surplus not only leads to the use of that surplus, it 
may, some academic research has shown, lead to more than--
spending more than just in the Social Security surplus, because 
of the psychological effects of feeling like there is more 
money at hand.
    I believe one of the fundamental advantages of private 
accounts is that it would take that money out of the budget and 
wall it off, if you will, in a way that I think makes sustained 
savings far more likely.
    Mr. Spratt. Thank you; all three. I appreciate your 
participation. Let me give others a chance to ask questions.
    Mr. Hastings. I want to thank you all for being here. Let 
me ask a question of all three of you, if any of you have 
hopefully the answer to this. All of you alluded to the 75-year 
projections that were in this trustees' report. Social Security 
is nearly 70 years old now.
    Has there been a study that you are aware of going back to 
the--when Social Security started of what these projections 
would be, recognizing, of course, that there were changes in 
the benefits over a period of time, and obviously a new study? 
I mean we remind ourselves we were in the Second World War when 
Social Security was founded.
    So are you aware of any in-depth study as to what the 
projections were at the time of Social Security, on what it 
would be, say, 75 years, I don't know if they looked at 75 
years in the 1930s or not. Are you aware of any of those 
studies?
    Ms. Kennelly. I would go back to the previous actuary 
reports. Because that is exactly why we have them, so that we 
can do those projections. But, as you say, so much has changed. 
When Social Security began the lifespan was 67, say, so you 
were only going to be paying 2 years. The whole demographic 
picture continues to evolve. But I think your actuarial reports 
are about as good as they get.
    Mr. Hastings. Mr. Steuerle.
    Mr. Steuerle. Early on, the system was not indexed as it is 
today. The early system had a tax rate of 2 or 3 percentage 
points of payroll. There were projections that that would be 
insufficient if there wasn't some funding because the costs 
were going to rise at that time to 6 percent of payroll.
    But after that point in time, there were substantial 
benefit increases that were enacted by a number of Congresses.
    Mr. Hastings. Starting when, roughly?
    Mr. Steuerle. Probably the biggest increase came early in 
the Eisenhower administration. Now mind you, by the way, that 
Social Security's long-run costs were quite moderate when it 
was established. Then we had these increases in the Eisenhower 
administration, partly to make up for the fact that inflation 
through World War II had substantially reduced benefits. We 
didn't have automatic growth. Congress was able to act a bit 
more in a discretionary manner as in other parts of the budget.
    Then we started enacting a number of increases in Social 
Security. In particular, as the defense budget kept shrinking, 
we had more and more money that we shifted off to domestic 
policy and that we could afford in the broader budget context.
    In the late 1970s and early 1980s, we decided to try to 
move more to a system of indexing because we weren't quite 
happy with the way that we were having these constant 
enactments by Congress. So there was an attempt to create an 
automatic mechanism that would be cleaner, in some sense, and 
create a more equitable benefit.
    In some sense it did. But the consequence was, we built all 
of this growth into the system.
    Mr. Hastings. How accurate were the projections at these 
times, because we are looking at a 75-year projection? We will 
be making decisions on this as this debate goes forward based 
on those 75-year projections. What I am asking is how accurate 
were those projections when they were made at these given 
times?
    Mr. Steuerle. I would have to check with the Social 
Security Administration. My guess is they were probably fairly 
accurate, that most of the changes came about because of 
enactments by Congress.
    Mr. Hastings. OK.
    Ms. MacGuineas. I would have thought if there were a study, 
Gene would have done it.
    Mr. Hastings. Let me ask another question to all three of 
you. Mr. Walker, when he was up here, made, I thought, a rather 
profound observation, when he said the expectations of the 
boomers to some extent and the expectations of the Gen-Y and 
the Gen-Xs to a larger extent are of the idea that their 
expectations of receiving full benefits from Social Security 
will not be there, and therefore, the potential fix that we 
have may be easier than what would be otherwise thought.
    I hope I characterized that correctly. I would like your 
observations on that.
    Ms. MacGuineas. Two points on that. I believe that that is 
probably the case. Actually, though, the literature I have seen 
is slightly different. People's expectations tend to be wrong 
about what they are going to receive, but they are wrong on 
both sides. Many people think it is more. Many people are 
surprised to learn how low the benefits are.
    Many people think they are going to do much worse because 
they think that Social Security is not going to be there for 
them. So I have seen huge discrepancies in our expectations as 
compared to reality, but on both sides and also along the 
income spectrum.
    Mr. Hastings. In that train of thought, then, are those 
that as you described that are higher expectations, lower 
expectations, what percentage of the people feel that way?
    Ms. MacGuineas. I would have to check the specific numbers. 
I was just struck with how few people actually knew what they 
should expect from Social Security.
    Mr. Hastings. I interrupted you.
    Ms. MacGuineas. But to your bigger point, I am not sure if 
the fairest way to figure out how to spread the costs of 
reforming the system is to say let's do it based on what 
people's expectations are, because you may have an expectation 
for something that is going to be very negative because of 
information they have received. I am not sure that giving 
somebody something that is just a tiny bit better than very 
negative still means that we have done the best in for making 
the system as fair as possible.
    I think one of the crucial things in keeping support for 
Social Security is making people feel like they are treated 
fairly. And in this difficult situation which we are currently 
in, I think that is going to involve spreading the whole cost 
of reform between individuals and in particular, generations.
    Mr. Hastings. OK.
    Ms. Kennelly. Congressman, I agree, probably that many, 
many young people don't think Social Security is going to be 
there when they get older. And one of the reasons for that is 
that millions of dollars have been spent on this message to say 
Social Security won't be there. And I have to take that a step 
further, these advocates of the individual account are very 
much active, such as CATO in saying that very thing. But I 
would disagree with Mr. Walker that the baby boomers don't 
expect Social Security to be there. I think that they do. I 
think the lower the income of the individual, the more they 
expect that it will be there for them.
    We are a country that has always had a Social Security 
system as every other developed country has had a Social 
Security system. I can't imagine this great Nation not having 
it. I know that when I was younger, I certainly never thought 
about retirement.
    But we have so much talk, every magazine, all of the 
magazines on the stand about retirement policy, about 
investing. This morning the talk about the 401(k) plans. But 
there are so many people out there. The average median income--
the average income for families in this country is $30,000. 
People with a couple of kids can't afford some of these things 
that some of us take for granted, like 401(k) plans.
    So I think there is certain--a great deal of expectation, 
middle age and lower and middle income people, that it will be 
there.
    Mr. Steuerle. Three very quick anecdotes on expectations. 
The first is that the retirement age is increasing right now. 
You can hardly even pick up a comment, at least on increases in 
what is called the normal retirement age, in the paper. Few 
notice this is happening. That is because it has been taken out 
of a political context. People's expectations haven't been 
dashed, at least as far as I can tell there.
    Second is that the system between 1995 and 2000 basically 
increased its future benefits for people by about 10 percent 
above what they were expecting in 1995. Nobody is even aware of 
this, as best I can tell, essentially because the system is 
wage indexed. When the economy grew about 10-percent more over 
those 5 or 6 years than we expected, it did all sorts of 
wonders for the non-Social Security part of the budget.
    In Social Security, it basically raised everybody's 
benefit, your benefits, my benefit, by 10-percent beyond what 
we would have projected, even in our Social Security statement 
in 1995. Almost no one noticed that 10 percent bonus, which was 
probably the largest single decision made by Congress between 
1995 and 2000 in terms of spending, and it came about 
automatically.
    So in terms of expectations, I think that people do not 
have great expectations.
    And the final example is that few people are aware that the 
system is automatically increasing benefits. In the debate over 
reform, few people note that we are basically talking about 
cutting the rate of growth of benefits. We are not cutting real 
benefits.
    Mr. Hastings. Maybe that leads into what you talked about, 
Mr. Steuerle, about the annual benefits and lifetime benefits 
and the differentiation between that and the focal point of our 
debate. Would you elaborate on that difference between the 
annual benefits and lifetime benefits?
    Mr. Steuerle. Well, there were two aspects to my note. The 
first was that I was arguing simply that we should count 
lifetime benefits because that is the basic insurance policy 
that people are getting. And people should understand what 
their lifetime benefits are and not just look at an annual 
benefit, just as if we were putting money in our 401(k) plan. 
We want to know what is in the account.
    The advantage of that is that I think it gives a more 
honest accounting of how Social Security is adjusting over 
time. It is not just adjusting annual benefits, it is adjusting 
for the fact that we generally don't increase--the law actually 
has a temporary increase--but the normal retirement age for 
longevity. And the biggest growth in the system has come from 
providing people with more and more years in retirement.
    The second reason for calculating lifetime benefits is 
geared toward helping those people engaged in reform actions. I 
would much prefer these reform commissions aim for a target of 
what they think lifetime benefits should offer first, and then 
back up to what they think the system should be in the way of 
annual benefits rather than first looking at annual benefits.
    That way, they can decide whether we want to get more money 
in late old age, when people have more severe problems of long-
term care. They may have lower incomes then, so do we want to 
boost that benefit up relative to giving more money early in 
their retirement.
    If you start with a lifetime package of benefits, you 
naturally think, just as you and I would, in drawing down our 
401(k) plan. When you think only in terms of annual benefits, 
you didn't think along those lines. You design a package, as I 
said earlier, where and more and more of the resources go to 
the younger among the elderly--really people in late middle age 
who really need the resources much less.
    Mr. Hastings. Thank you very much.
    Mr. Moran.
    Mr. Moran. Thank you, Mr. Chairman. In that regard, Mr. 
Steuerle, you have a chart here showing that in the year 2000 a 
two-earner couple would get total lifetime benefits of 
approximately two-thirds of $1 million, apparently $650,000.
    Do you have a comparable figure for how much they would 
have paid into the system at that point?
    Mr. Steuerle. In present value, for an average income 
couple in Social Security, this depends on your discount rate. 
But if you take a 2 percent discount rate--assume a 2 percent 
rate on return--I think they would almost have paid in most of 
the Social Security money.
    In terms of Medicare, they would fall far short because the 
Medicare tax is very low in its rate of growth, while the 
projected rate of growth of health costs is very high. That is 
what is driving the Social Security number--excuse me, I mean 
driving the Medicare number.
    Mr. Moran. So they would have paid in about $300,000 in 
terms of the Social Security, FICA taxes, but any estimate of 
how much less than the $350,000 they would have paid in versus 
benefits that they received?
    Mr. Steuerle. They probably wouldn't even have paid in a 
third of it. But it can get a little complex there. Some of it 
is coming from what they may have paid in income tax to support 
the Medicare Part B system that was very low cost in the past. 
I can send you the numbers.
    Mr. Moran. That might be useful for us to understand. Now, 
part of the reason that we have--at least equal to benefits, at 
least equal to what is being paid in, and let me ask one other 
question here. As we get to much later out, 2030 is the figure 
that you show, are we paying in a higher percentage or a lower 
percentage of what we are getting out of the system? I know 
people are living longer, and so you would assume that you are 
going to get a lot more back in terms of your annuity benefit 
that you paid in later years. Is that the case?
    Mr. Steuerle. As you move to the future, people pay at a 
much higher percentage. They pay in more than they get back, 
even at these moderate discount rates. That is because the tax 
rate has continually gone up over time. Social Security created 
very, very large windfalls to the early generations--in 
particular to the rich of earlier generations, interestingly 
enough.
    But future generations don't get that windfall, because 
they come to the point where they have to pay more for the 
system now. This analysis is made very complex by the fact the 
system is still out of balance. So you have to ask, what is the 
actual tax rate that would apply in the future if you maintain 
this benefit? It is higher than what is in the current law.
    Mr. Moran. What I am getting at is, if you did do it on an 
annuity basis, what in terms of FICA taxes will it take to 
treat it as though it were an annuity, a tax-free annuity?
    You are saying that you are actually--it is less of an 
annuity, less of a good investment, from the perspective of it 
being a private annuity, the longer you go out, because wages 
are going up, you are paying a higher percentage despite the 
income cap, and so your return is less you are telling us, 
except for Medicare.
    Mr. Steuerle. It is also very complex. Because ultimately 
Social Security is designed so that the rate of return you get 
in the future is determined by the birth rate. If birth rates 
fall, your rate of return falls. So as birth rates have fallen, 
our rate of return is lower than previous generations and on 
into the future. So that is one of the consequences of Social 
Security's pay-as-you-go design. Because it is not funded, it 
is dependent on this money coming into the system.
    Mr. Moran. Someone was saying, I remember people were 
talking about it for a while, that you recover after the first 
2\1/2\ years of being on retirement virtually of what you have 
paid into the system. Now, the numbers you are telling us--that 
is not consistent with that assumption at all.
    Mr. Steuerle. I don't think people are counting the fact 
that you as an employee really pay the employer tax. The 
employer doesn't pay it, the employee pays it as a reduced 
wage. Also, I don't think they are using interest rates. If you 
paid money 30 years ago, it would be compounded at some rate.
    Mr. Moran. So they are just looking at what the employee 
has paid and not the comparable employer?
    Mr. Steuerle. I am guessing. I am almost certain that they 
don't compound the taxes, they don't use interest. The question 
whether they use employer and employee taxes, I am not certain.
    Mr. Moran. So that is a bogus statement that you are 
getting back from the system, in just a few years of 
retirement, what you paid in, the rest is coming out of 
subsequent generations' incomes. That is just not the case.
    Mr. Steuerle. I think for new retirees, I think the case is 
weak. For older retirees, it is more true----
    Mr. Moran. So it would been true for earlier retirees. That 
is helpful to know. I am very sympathetic with your concern 
about the efficiency and equity aspect of Social Security that 
a lot of it is going to people who don't need it. And vis-a-vis 
our other national priorities, it is a real question whether we 
should and can be continuing such a system from that 
perspective. But, just as the one of the principal reasons we, 
or at least I consistently vote against vouchers or anything 
else that is going to undermine the public participation in our 
public--widespread participation in public school system, is if 
you didn't have widespread benefit, then the people who need a 
quality school system the most are going to be less likely to 
be able to get that revenue flow that they need from general 
taxes, similar case applies to Social Security.
    If you don't have widespread benefits you are going to have 
less political support for maintaining a system that, in fact, 
in the long run, really does benefit lower income people to a 
greater extent than it does upper. There is some income 
transfer taking place within the system. You probably wouldn't 
be able to sustain that politically if you don't have 
widespread benefits at the level that we are paying out. Is 
that not an accurate statement?
    Mr. Steuerle. I think the concept of social insurance--and 
I agree with it--is that you need to have a mandated system. 
But there is a case with individual accounts where it is also 
part of a mandated system. So the question is, what balance 
would you achieve? I agree with you, you can't allow people to 
opt out, because the people who opt out would be the people who 
are paying for some of this redistribution. So people can't opt 
out entirely from the system.
    However, you could set up or design individual account 
Social Security that also deals with some of the issues you 
talk about, both with respect to progressivity and mandated 
participation.
    Mr. Moran. But my concern is any kind of testing system is 
going to undermine the kind of political support that you have 
today for the benefit distribution that you have. Let me ask 
one other question. I don't want to go to far beyond my time 
here.
    But, on disability insurance--well, let's go to a broader 
question. If we went--if we increased the retirement age at the 
pace at which the health of our senior citizens is--the 
longevity our senior citizens is increasing, which we don't do, 
but if we geared it to the greater longevity that is being 
achieved through improved health care, a lot of it paid out of 
Medicare, et cetera; if we geared it to that, and you today you 
would probably be in the 70s because the--I think when it was 
established, the average length of age was only about 48 or 
something.
    So if you geared it to improved longevity figures, the 
problem we would run into, and which I think is an untenable 
situation, is that even though it is a declining proportion, 
those people who work with their backs to do manual labor, men 
and women, and oftentimes we think of men, but it is women who 
are performing domestic work and so on.
    The human body gives out, if you are performing that kind 
of work in your late 50s, your early 60s, and it is not fair 
really for these people to expect them to stay in the work 
force at a level consistent with the general health of the 
workforce, even through a greater proportion of people are not 
performing manual labor in the United States today.
    I would like for you to address that, and Barbara as well, 
if I could have the indulgence of the chairman--thank you, 
Chairman Hastings--if we could have a more liberalized 
definition, for example, of disability so that people who are 
in that kind of situation could, in fact, retire early, albeit 
with a slightly reduced benefit level. I think we could then 
kick in a more rational extension of age eligibility. I am not 
sure, but I would like you to address that.
    Ms. Kennelly. I hear what you are saying, Congressman. If, 
in fact, we continue to increase the retirement age, disability 
claims will increase. That argument has been made. But, getting 
back to those individual accounts, I have read an awful lot of 
material on individual accounts. We understand the market, 
because most of us are in the market. What you put in, you get 
more if your stock performs well, and if your stock doesn't 
perform well, you get less.
    I haven't figured out how you, in a practical way, can 
bring people on disability to make any money in the individual 
accounts. So I think that is a whole another avenue.
    Mr. Moran. I happen to agree with you. That is one of the 
major problems. But it is part of a larger problem with people 
who are best able to manipulate within the field of investment 
judgment are those that are----
    Ms. Kennelly. Even if they don't have any income. But to 
get back to the raising of the age, on my long list of things 
that you can do to address solvency, one of them is that in 
this increase that began to raise the age to 67, there is a gap 
between 66 and 67.
    And possibly to bring some money in, we might be able to 
close that gap. But, I wouldn't like to suggest yet that we 
raise the age any higher than 67, because we have no studies to 
show exactly what you are saying. Did this make people go more 
to disability? Would this change help people? Take for instance 
the 62 retirement in regard to the 65 retirement, which will be 
the 67 retirement. So I think that is a very difficult question 
to address. But the disability question will have to be 
addressed.
    Mr. Moran. Well, we do know that people are living longer. 
But as you say, it is this issue that really has to be 
addressed if you are going to increase in a correlative way to 
longevity. Thank you.
    Mr. Steuerle.
    Mr. Steuerle. If you look at the statistics when Social 
Security was first established--that is, when benefits were 
first paid in 1940--about 70 to 80 percent of men age 65 were 
working. That has dropped to about 30 percent. Work then was 
tougher. It was far more physically demanding.
    Mr. Moran. You said 70 to 80?
    Mr. Steuerle. It is something like 70 to 80 percent of men 
at age 65 were working when benefits were first paid. The 
average age of retirement in 1940 was 68. The average age of 
retirement today--when people have longer life expectancy and 
greater health--is 62 to 63 depending on how you count 
disability insurance. So people are retiring earlier, several 
years earlier, and they are living several years longer, even 
while the physical demands of the jobs have been declining 
quite substantially.
    I can send you all of these data. Because I realize I am 
being very quick here. The difficulty is, do we really need for 
most people in the population, as I say, this 15th, 16th, 17th 
or 18th year in retirement? I understand your sympathy for this 
group in the population, whether it is 10 percent or 20 percent 
of the population--that may have some physical impairments. But 
it is very expensive to subsidize 100 percent of people who are 
not in need for the 10 or 20 percent who are in need.
    It is an issue. It is just that the system has become so 
expensive that a number of years of support just seems to me 
not a tenable result. I will say, however, that increasing the 
retirement age does have an impact because we waited so long to 
reform, and people retire now so much earlier. We have allowed 
them earlier retirement even while they are living some much 
longer. We are so close to the point in time when the baby 
boomers retire that the adjustments have to be much faster and 
much more swift than just simply indexing. The adjustment is 
somewhat substantial.
    Let me finally say that I think the main change that needs 
to be made is in the early retirement age, not so-called 
``normal'' retirement age. The age of 62 is the age that needs 
to be bumped up more than worrying about what the so-called 
normal retirement age is.
    Mr. Moran. That is very helpful. Incidentally, let me say, 
Mr. Chairman, I appreciate your inviting Mr. Steuerle, and 
obviously, our colleague, Mrs. Kennelly. I don't know Ms. 
MacGuineas, but I know that she was a player on the Commission. 
Mr. Steuerle with the Urban Study has given us so much creative 
information that it is a pleasure to have him testify before 
us, I appreciate that. You have told me a number of things that 
I actually wasn't aware of, and some of them are 
counterintuitive.
    Did you have anything further to add, Ms. MacGuineas?
    Ms. MacGuineas. The only thing I would add would be that 
one way to think about this may be to rather than just 
increasing the retirement age, indexing benefits to life 
expectancy, but allowing for a more flexible retirement age, 
because obviously, I share your concerns, everyone would.
    At the same time, as Gene said, it is unfortunate to not 
understand this as a labor market problem and not create the 
incentives to stay in the workforce longer when we know that 
that would resolve part of the problem to protect one group.
    I also think ensuring that we strengthen disability so it 
can kick in for the people who need it is probably an important 
part of the equation.
    Mr. Moran. I do think that at least unless you deal with 
that situation, even though it may be 10 percent it is a sine 
qua non of reform. You have got to address that element of the 
workforce. Thank you. Thank you, Mr. Chairman.
    Mr. Hastings. Mr. Steuerle, in responding to Mr. Moran's 
request on statistics as to retirement age, going back to, I 
think you said the 1940s, my assumptions is that you probably 
have those statistics for probably every year, that can be 
found some place. Am I correct in that assumption?
    Mr. Steuerle. I will try to find what I can. As you might 
know, in many cases, I just rely on data that are kept by the 
Social Security Administration. But I will be glad to.
    Mr. Hastings. Whatever you can. I, as one Member would 
certainly like to have these statistics, because, inevitably as 
we proceed in this debate, that is going to come up. There is 
no question about that. As we have to make some of those 
decisions. I want to thank the panel for joining us. Barbara, 
it was good seeing you once again.
    Chairman Nussle [presiding]. That is a good suggestion. 
Thank you. We do have two votes. I don't want to be 
disrespectful. So why don't we--first of all, we are pleased to 
have you. You also, as I said in the opening, there have been a 
few people that have just been in the forefront of sounding the 
alarm and letting folks know in a constructive way about some 
of the challenges. And you certainly have added to that 
greatly. I want to welcome you and thank you for your testimony 
today. We will accept it. And then if we have questions we will 
come back after the vote.
    Director Crippen, welcome back to the committee.

  STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET 
                             OFFICE

    Mr. Crippen. Thank you, and Mr. Moran as well. I will, as I 
said, put aside much of which I intended to say and try and 
make probably just one point.
    There is an advertisement running, I was reminded this 
morning as many of your witnesses talked on disability 
insurance, that uses Yogi Berra as the central figure in the 
ad. Among the other Yogi Berrisms, he said, when you get sick 
or if you can't go to work, this plan will give you cash, which 
is almost like money--or just as good as money.
    What we heard from most of the witnesses today--I can only 
reiterate--is, you have to think about the cash. How we account 
for current taxes and future obligations is important. But when 
it comes down to it, it is very simple, I think. When I retire, 
my children will pay for my benefits.
    There is no way around that. Whether it is payroll taxes up 
until 2017, whether it is payroll taxes and general revenues 
after that, income taxes to pay interest, whether we end up 
borrowing from my kids in order to pay my benefit, it is my 
kids who will be funding my benefit.
    We can argue about and think about all of the accounting we 
want. But at the end of the day, my two kids are unfortunately 
going to pay for me. Those of you who don't have two kids 
should probably take a benefit cut.
    But one way we can think about that--the way that I have 
been talking about it for the past 3\1/2\ years, with this poor 
bedraggled chart that has gone with me to virtually every 
hearing--is as a percentage of the economy, how much is the 
Federal Government transferring to retirees?
    All of that has to come from workers, my children. There is 
no magic way, there is no dollar stuffed in a mattress, there 
are no offshore accounts here. It will be the current economy 
at the time that is important both in my children's ability to 
finance my benefit and, if you want to think about it another 
way, in producing the goods that I will be consuming, because 
what I consume, they can't.
    So in that light, Mr. Chairman, I just want to say a couple 
of things about what CBO is doing that I think will help that 
debate when you all get around to having it in a more concrete 
way.
    One, we have been publishing a number of documents that I 
hope will be helpful. We put out one last year called ``Social 
Security: A Primer.'' It is aimed at policymakers, policy 
analysts, and press. It has a lot of charts, graphs, colors, 
and an attempt to explain Social Security from an economic 
point of view.
    We have done reports--like the one that is on the screen 
now--looking at the uncertainty in Social Security. I think it 
is important to note that while introducing individual 
accounts, for example, might introduce new uncertainties into 
the system, the system is already very uncertain in many ways, 
and we don't know what the net effect would be.
    We have just begun a series of 3- and 4-page reports--there 
should be about 15 of these--looking at particular aspects of 
the long-term implications of Social Security. We are putting 
out about one a week.
    Last and most important, we have spent the past 3 years 
building a new long-term model that will be able to answer most 
of the questions that you heard raised here today. We will be 
able to look at the effects of reform on the economy. We will 
be able to look at the effects of reform on individuals, any 
given cohort of the population. We will be able to look at the 
effects of reform across populations, across generations. We 
will be able to do much of what Gene Steurele called for and 
more perhaps.
    We are in the throes of finalizing that model. It should be 
ready for you when you are ready to do Social Security. With 
that I will quit.
    [The prepared statement of Mr. Crippen follows:]

 Prepared Statement of Dan L. Crippen, Director, Congressional Budget 
                                 Office

    Mr. Chairman, Ranking Member Spratt, and members of the committee, 
I appreciate the opportunity to appear before you to discuss the Social 
Security program. The Social Security Act of 1935, enacted in the midst 
of the Depression, is widely seen as one of the most important 
legislative accomplishments in U.S. history. Since its inception, 
Social Security has grown to become by far the largest Federal program. 
Over the next 30 years, the aging of the baby boom generation will pose 
new challenges for Social Security, the Federal Government, and the 
U.S. economy.
    The Congressional Budget Office (CBO) has examined those challenges 
in a number of recent reports. Late last year, we published ``Social 
Security: A Primer'' and ``Uncertainty in Social Security's Long-Term 
Finances: A Stochastic Analysis.'' Last week, we released a policy 
brief on the long-range picture of the Federal Government's share of 
the economy. My testimony today summarizes some of the findings of 
those reports; it will make the following major points.
    Once the baby boom generation retires, the portion of the Nation's 
output that the Federal Government will spend on Social Security is 
expected to rise by 50 percent from about 4 percent of gross domestic 
product (GDP) today to an estimated 6 percent in 2030.
    Addressing the growing cost of Social Security would not by itself 
eliminate the economic and budgetary pressure caused by the aging of 
the U.S. population. The rapidly escalating costs of the government's 
health care programs are a major source of that pressure. CBO projects 
that Federal spending for Social Security, Medicare, and Medicaid 
combined will account for about 14 percent of GDP by 2030 nearly double 
the current share.
    Looking farther ahead, CBO projects that government spending 
(excluding interest on the Federal debt) will rise from about 18 
percent of GDP today to 28 percent in 2075 under current policies. If 
revenues remain within their historical range relative to GDP, the 
total cost of government (including interest) could double as a share 
of the economy: from about 19 percent of GDP today to about 40 percent 
in 2075. However, modest reductions in the growth of spending for 
Federal programs could significantly slow the growth of interest costs 
and total outlays.
    Projections of Social Security's finances are highly uncertain, but 
the range of uncertainty is not adequately reflected in the low-, 
medium-, and high-cost scenarios used by the Social Security trustees.


    Uncertainty about long-term budgetary outcomes derives from many 
factors, including rates of mortality, fertility, inflation, and real 
wage growth. Social Security's finances are most influenced by 
variables, such as mortality rates, that move independently of economic 
growth, because outlays are affected more than receipts when people 
live longer. That aspect of the system's finances is important to keep 
in mind when designing proposals to reform Social Security. For 
instance, a change in the retirement age that was linked to life 
expectancy could automatically resolve the budgetary consequences of 
any future changes in mortality rates.
    The expected increase in Medicare spending highlights the 
divergence between economic growth and budgetary pressures even more 
clearly, because most of that increase results from health care costs 
per beneficiary growing faster than GDP per capita. No mechanism in law 
exists that will slow down that growth.
    Although policymakers have many goals, if they want to limit the 
growth of Federal spending as a share of GDP, they have only two 
options: slow the growth of that spending or increase the growth of the 
economy. The Nation's ability to sustain an aging population will 
ultimately depend on how many goods and services the economy produces 
and how they will be distributed, not on how much money is credited to 
Social Security's trust funds.

                  The Pressures of an Aging Population

    Over the next three decades, the aging of the baby boomers (the 
large group born between 1946 and 1964) will put new pressure on Social 
Security, the Federal Government, and the U.S. economy. The Social 
Security Administration projects that the number of people age 65 or 
older will rise by more than 90 percent during that period (from about 
36 million now to 69 million in 2030), according to its intermediate 
assumptions (see figure 1). At the same time, the number of adults 
under age 65 who will largely be the ones paying the payroll taxes to 
support their elders will grow by only about 14 percent (from 172 
million to 196 million). Moreover, even after all of the baby boomers 
have retired, the number of elderly people is expected to keep rising 
at a faster rate than the number of non-elderly people as life spans 
continue to lengthen.
    Perhaps even more important, as the population ages, spending on 
Medicare and Medicaid is likely to rise rapidly because of increases in 
Federal costs per beneficiary as well as in the percentage of the 
population eligible for benefits (unless major changes are made to 
those programs). Medicare provides health insurance to most U.S. 
residents age 65 or older and to eligible disabled people, most of whom 
also receive Social Security benefits. Medicaid is a joint Federal/
State program that provides medical assistance to low-income people; in 
recent years, a large share of its payments have gone to provide long-
term care, mainly for elderly or disabled people.

              A Long-Range Picture of the Fiscal Situation

    How will those pressures of demographics and health care costs 
affect the U.S. budget and economy? To help address that question, CBO 
has developed a new long-range model. Using the model, we recently 
prepared a 125 year picture of the budget that extends from 1950 to 
2075. Those projections illustrate a potential path for the budget that 
highlights the implications of maintaining current policies. Of course, 
the future path of the budget is highly uncertain and subject to wide 
variation. Thus, the path shown in those projections is simply a 
representation based on an illustrative set of key assumptions.
    Although my testimony focuses on long-range projections of spending 
under current policies, CBO is about to unveil an expanded version of 
the model that will be capable of simulating the budgetary and economic 
effects of policy changes including detailed proposals for Social 
Security, such as the introduction of private accounts. One of the more 
innovative features of the expanded model is its ability to perform 
stochastic simulation analysis, which shows the probabilities of 
alternative outcomes based on a statistical distribution of alternative 
assumptions about such factors as returns on stocks and bonds, 
mortality, fertility, and wage growth. The model will also include 
equations that reflect how people alter their work and saving in 
response to increases in taxes and cuts in benefits. We expect to begin 
releasing analyses from that model sometime this fall.
    In CBO's current long-range model, Social Security spending 
reflects growth in the number of recipients and in wages, which 
determine benefits. Medicare and Medicaid spending reflects the 
increasing number of recipients and the age profile of enrollees as 
well as the rising costs of medical care. For the long-range 
projections described below, the growth in health care costs for each 
recipient of a given age is assumed to slow to a rate 1 percentage 
point faster than the growth rate of per capita GDP. Although seemingly 
high, that rate is lower than it has been in recent decades. The budget 
figures in these projections are expressed as a share of GDP so that 
the magnitude of Federal revenues and spending can be observed in 
relation to the country's total economic activity in any given year and 
over time.
    The projections show that it is spending for the major entitlement 
programs and for interest because of the commitments involved and their 
sheer magnitude that has the largest potential to constrain future 
Congresses. Moreover, much of the government's remaining spending 
consists of discretionary outlays, the levels for which are determined 
annually. Given the wide array of discretionary programs, that category 
of spending (unlike the major entitlement programs) does not easily 
lend itself to projections that merge economic and demographic 
assumptions with legislative rules for the payment of benefits. Thus, 
CBO's long-range projections assume that defense, nondefense 
discretionary, and all other spending (that is, other than for Social 
Security, Medicare, Medicaid, and interest) will remain fixed as a 
share of GDP beginning in 2012, the last year of the 10-year baseline 
projections that CBO published in March 2002. The projections do not 
incorporate the recently enacted farm bill and economic stimulus 
package.
                     historical trends in spending
    Spending by the Federal Government grew from approximately 3 
percent of GDP in 1925 to about 16 percent in 1950. (Following the 
Depression, World War II abruptly boosted Federal spending to about 42 
percent of GDP, but afterward, that spending dropped and resumed a less 
volatile growth trend). Since then, Social Security, Medicare, and 
Medicaid have together become the largest component of the Federal 
budget (see figure 2). In 1962, when Social Security outlays 
represented only 2.5 percent of GDP, and Medicare and Medicaid had not 
yet been created, spending for all other government activities made up 
about 85 percent of Federal non-interest outlays. The largest share was 
for national defense, which accounted for half of non-interest outlays 
and represented 9.2 percent of GDP. By 2001, total spending for Social 
Security, Medicare, and Medicaid equaled 7.8 percent of GDP, about 
triple the 1962 share for Social Security alone. Although still 
constituting less than half of all Federal spending, the three programs 
combined accounted for the largest share of total outlays. Defense 
spending had fallen to 3 percent of GDP, and all other non-interest 
spending stood at 6.3 percent. Interest costs, whose share of GDP had 
risen steadily from 1.2 percent in 1962 to a high of 3.3 percent in 
1991, stood at 2.0 percent in 2001.


                          projections to 2075
    Looking ahead, CBO projects that outlays for Social Security, 
Medicare, and Medicaid (based on the current rules for benefits) could 
nearly double as a share of GDP by 2030, rising to about 14 percent. If 
spending for all other government activities in 2030 remained at 
roughly the same share of GDP as projected for 2012 (about 7 percent), 
Social Security, Medicare, and Medicaid would account for almost 70 
percent of the government's non-interest spending. By 2050, outlays for 
the three programs would constitute nearly 17 percent of GDP, and by 
2075, about 21 percent exceeding the share of GDP now absorbed by all 
Federal revenues (see figure 3).
    Under the assumptions that CBO made for its long-range picture of 
government finances, the projected rise in spending for Social 
Security, Medicare, and Medicaid would drive total Federal outlays well 
above the level seen throughout much of the post-World War II period. 
The government's core costs (that is, ignoring net interest on the 
debt) could rise from about 18 percent of GDP today to about 24 percent 
in 2050 and 28 percent in 2075. Left unattended, that steady escalation 
in spending could cause major deficits to emerge, pushing the 
government's debt, and its interest spending on that debt, to 
unprecedented levels. If revenues remain within their historical range 
relative to GDP, the total cost of government (including interest) 
could double as a share of the economy from about 19 percent of GDP 
today to about 40 percent in 2075 (see figure 4).




            Issues to Consider in Reforming Social Security

    Several aspects of Social Security and the outlook for it as the 
population ages are especially important in considering changes to the 
program. First, throughout its long history, Social Security has had 
multiple goals some related to redistributing income, others related to 
offsetting lost earnings. In 2000, only about two-thirds of Social 
Security's beneficiaries were retired workers; the rest were disabled 
workers, survivors of deceased workers, and workers' spouses and minor 
children (see figure 5). Policymakers will need to decide whether the 
program's goals are still appropriate and, if so, how changes to Social 
Security would aid or hinder the achievement of those goals and affect 
various types of beneficiaries and taxpayers. Those decisions will also 
need to take into account the dramatic increase in the elderly 
population that is expected in the coming decades.
    Second, issues about how to prepare for an aging population 
ultimately concern the amount of goods and services that the economy 
will produce and how they will be distributed, not how much money is 
credited to the Social Security trust funds. In that sense, the 
projected depletion of those funds which is the focus of much of the 
popular debate about Social Security's future is irrelevant. The 
challenges of adjusting to an aging population would need to be faced 
even if the trust funds never existed.
    Third, deciding how to prepare for an aging population is likely to 
require weighing the interests of today's workers and Social Security 
beneficiaries against the interests of future workers and 
beneficiaries. No matter how it is packaged, any plan to increase 
national saving today means that the U.S. population will consume fewer 
goods and services now so that consumption can be greater in the 
future, when a larger share of the population is retired. Gone are the 
days when expansion of the labor force could pay for the growth of 
Social Security benefits. (In past decades, Social Security's payroll 
tax revenues grew substantially as the baby boom generation and women 
of various ages entered the labor force in large numbers). As the 
Congress looks at policy changes, one consideration is that future 
workers and Social Security beneficiaries are likely to have higher 
standards of living, on average, than current workers and beneficiaries 
do, because of future increases in productivity.


            Strategies for Dealing with an Aging Population

    Spending more on elderly people may be appropriate in light of 
their increasing numbers, but questions can be raised about the extent 
to which that spending should rise. Policymakers have many goals, but 
if they want to limit the growth of spending on the elderly as a share 
of the economy, they can do so in only two ways: either by slowing the 
growth of that spending or by increasing the growth rate of the 
economy. Different options for reform would have different effects on 
economic growth. To the extent that those options boosted the future 
size of the economy and increased the Nation's accumulation of assets, 
they could lessen the burden on future workers from government programs 
that serve the elderly.
    My testimony focuses on three ways to prepare for an aging 
population that have generated a lot of public attention: paying down 
Federal debt, creating private retirement accounts, and making changes 
to the benefits or revenues of the current Social Security program. 
Those approaches are not mutually exclusive; they could be combined in 
any number of ways. (In addition, many people have put forward 
proposals to curb the rising costs of Federal health care programs. 
Such proposals could also help the Nation deal with its impending 
demographic changes, but they are beyond the scope of this testimony).
    Regardless of which approach policymakers decide to take, a number 
of key questions should be raised about any proposed policy option:
     How would it affect economic growth over the long run?
     Would the proposed policy improve the long-term fiscal 
outlook faced by succeeding generations? How would it alter the taxes 
they pay and the benefits they receive?
     Would the policy improve the ability of Social Security 
and Medicare to respond to unanticipated changes in demographics (such 
as life expectancy) and in the economy (such as productivity growth)? 
Some proposals could help make those programs more adaptable to change; 
other proposals could reduce their flexibility.
                             pay down debt
    One strategy for preparing for the needs of an aging population is 
to pay down Federal debt. If the government spends less than it 
receives in revenues (and private saving does not fall too much in 
response), national saving will rise, boosting the stock of private 
capital and expanding the productive capacity of the economy in the 
long run. Indeed, Federal debt held by the public has fallen sharply in 
recent years from about 50 percent of GDP in 1995 to about 33 percent 
today. That decline has freed up funds for investment in private 
capital.
    CBO will soon update its 10-year projections for the budget, but it 
does not expect any significant surpluses to be available for paying 
down debt for at least a few years. However, if current tax and 
spending policies are maintained, significant budget surpluses could 
reemerge at some point in the next 10 years. But even paying off all of 
the Federal debt available for redemption would not provide enough 
interest savings or additional economic growth to finance Social 
Security, Medicare, and Medicaid spending over the long run.
                        create private accounts
    A second strategy is to encourage private saving. A prominent set 
of proposals envisions creating private retirement accounts. Those 
proposals differ in many ways, but they share a common feature: the 
income from an account would depend on the payments made into it and 
the rate of return on the account's assets. Many types of accounts are 
possible, and their effects would vary widely.
    One of the central issues is how private retirement accounts would 
be financed. Many proposals include a contribution from the government 
to help people pay for accounts. According to supporters of private 
accounts, diverting payroll tax revenues from the government could 
prevent policymakers from spending those revenues on other programs and 
could thus provide many of the same economic benefits as paying down 
debt. In addition, they argue, private accounts could allow the 
government to encourage asset accumulation while avoiding the problems 
of having the government own shares in private companies. However, 
because national saving consists of both private and government saving, 
a proposal that simply moved dollars from government saving to private 
saving (by financing private accounts through an increase in Federal 
debt) would have no direct effect on national saving or capital 
accumulation. To raise national saving, a proposal would have to cut 
either government consumption, private consumption, or both.
    Some people argue that private accounts would offer higher rates of 
return than the traditional Social Security system does, but that 
argument can be misleading. Social Security has a low rate of return 
largely because initial generations received benefits far greater than 
the payroll taxes they paid. That difference would have to be made up 
even if the Social Security system was entirely replaced by private 
accounts. Moreover, investing in the stock market either through 
private accounts or through government purchases of stock for the 
Social Security trust funds would be no panacea. Simply raising the 
average rate of return on assets by taking on more risk would not 
change the economic fundamentals. Only if the investment proposal 
increased national saving and enlarged the economy would it reduce 
future burdens.
    In setting up a system of private accounts, policymakers would have 
to address many practical issues. How much would the system cost to 
administer? Would it provide insurance against downturns in the stock 
market? Would the system require that accounts be converted into 
annuities and, if so, under what conditions? How would it handle 
benefits for workers' families, for survivors of deceased workers, and 
for disabled workers? Would the system give subsidies to people with 
low income and intermittent work histories? How would the system be 
regulated and investors informed?
    The answers to those questions could have implications for the 
economy. For example, government guarantees that people would receive a 
minimum level of retirement income in the event of a market downturn 
would probably reduce national saving below what it would be without 
those guarantees. And subsidies to low-income workers that were phased 
out as wages rose could impose implicit taxes on work and could 
discourage some people from working more.
                       make programmatic changes
    A third approach is to modify the current Social Security program. 
Changes that have been proposed include reducing benefits (for example, 
by raising the retirement age, calculating initial benefits using a 
price index rather than a wage index, or reducing annual cost-of-living 
adjustments) or increasing payroll taxes. The effect on the economy 
would depend on the particular kind of change.
    Many types of benefit reductions could increase the size of the 
economy in the long run because they could encourage some people to 
save more. However, those long-term gains could take a couple of 
decades to materialize fully, and the effect in the near term would be 
uncertain. Slowing the growth of Social Security benefits could reduce 
the lifetime resources of some transitional generations, but it could 
also lead to higher wages and lower tax burdens for later generations. 
If benefits were to be cut, changing the law now rather than later 
would give workers time to adjust their plans for saving and 
retirement.
    Raising taxes to pay for future Social Security benefits would have 
an uncertain effect on the size of the economy in the long run. 
Moreover, the effect would depend on the type of tax increase and other 
factors. If the revenues from a tax increase did not change the 
government's decisions about other spending or taxes, national saving 
could rise. But the extra revenues could encourage more government 
spending, which would limit any rise in national saving. In addition, 
increases in marginal tax rates on payroll or income could reduce 
people's incentives to work or save, also dampening any increase in 
national saving.
    Although long-term projections of the Federal budget and the 
economy carry huge uncertainties, one fact seems certain: the U.S. 
population will age significantly over the next 30 years, and unless 
policies are changed, spending on the elderly will rise sharply, posing 
new challenges for the Federal Government and the Nation's economy.

    Chairman Nussle. Mr. Moran, do you have any questions that 
you would like to ask at this time?
    Mr. Moran. Mr. Chairman, the answer is yes. But, given the 
fact that Mr. Crippen has been here all morning, we have got a 
vote, it seems to me that I can--I will have another 
opportunity to ask them. But I do appreciate him being here, 
and I appreciate all of the work that he has done in 
elucidating the Social Security issue for us as well as 
everything else with regard to the budget. Thank you, Mr. 
Chairman.
    Chairman Nussle. Thank you. I appreciate your coming and 
your interest obviously.
    Let me ask then, I just have one question so I will ask it 
now and then we can--we probably have more questions. This 
conversation will continue, I have no doubt.
    In your testimony, I believe it was last December to the 
Special Committee on Aging in the Senate, you said the 
following--and I am interested in your elaboration on it. 
``Issues about how to prepare for an aging population 
ultimately concern the amount of goods and services that the 
economy will produce and how they will be distributed, not how 
much money is credited to the Social Security trust funds. In 
that sense, the projected depletion of those trust funds, which 
is the focus of much of the popular debate about Social 
Security's future, is irrelevant. The challenge of adjusting to 
an aging population would need to be faced, even if the trust 
funds never existed.''
    So would you elaborate on that just for the purposes of 
this hearing, and then that is basically what I was interested 
in hearing from you about.
    Mr. Crippen. Obviously, just cut me off whenever you need 
to leave. As many of the other witnesses said, the way to think 
about this clearly, I think, is to follow the cash.
    There is no cash in the trust funds. There are assets; 
there are obligations. Those certainly will be made good. Think 
of 2017, when it looks like we won't have enough payroll taxes 
to fund benefits. The Social Security Administration will, 
figuratively speaking, go to the Treasury and say, ``Give me 
some interest payments for cashing in bonds actually or debt 
instruments that pay interest.'' To do so, the Treasury will 
have to raise taxes, cut other spending or borrow from my kids 
in order to pay the interest.
    If there were no trust funds, no interest, no bonds, and 
the Social Security Administration didn't have enough cash, 
they would essentially--assuming the benefit is paid--come to 
the Treasury and say, ``we need cash.'' The Treasury would have 
to raise taxes, cut other spending or borrow from my kids.
    So the effect on the economy and the budget is identical, 
whether or not you have these trust funds. The point is that, 
as that poor bedraggled chart shows, there are only two moving 
parts, if you think of the world the way most economists do: 
the level of obligations to the elderly and the size of the 
economy.
    Anything else is noise below that; some of it is 
interesting; some of it is informative, some of it is useful. 
But it is not necessarily the right question.
    I would argue that if you have reform in front of you or 
you are questioning policy effects, whether they are current or 
future, on Social Security, you have to look at the chart and 
say, does it change either of those two things? Does it change 
the obligations to the elderly, the retirees or does it change 
the size of the economy? Other questions are less important.
    Chairman Nussle. One final thing that I just thought of 
that I am interested in your--I think I know the answer, but, I 
expressed, and you were here, which I appreciate, when David 
Walker was here, about the fact that there is a lot of focus on 
solvency, and that seems to be the primary focus on the part of 
many Members, but more especially the media which is getting 
this message then therefore out to the public.
    Is that a proper focus? And if there are other focuses that 
we should have as far as just general guideposts, what should 
they be? Let's start with that.
    Mr. Crippen. I would suggest that it is not the proper 
focus. In fact, in some venues, I have argued that it is 
distracting. Indeed, I and others have perpetuated that as a 
policy objective for a long time. I was involved in the 1983 
Commission, as I think you know. Howard Baker, who I worked for 
in the other body, as you say, actually proposed the 
Commission. He sold it to President Reagan, and we made the 
first call to Alan Greenspan to see if he would Chair it. So we 
were very much a part of that.
    And the only question we asked of the Commission for any 
proposals was, does this ensure 75-year actuarial or long-run 
solvency? We didn't ask other questions about its effect on the 
economy, we didn't think about that. We didn't ask what the 
trust fund build-ups were going to be invested in.
    We thought only of solvency as the primary objective, 
because the fund was almost insolvent. I think we convinced 
ourselves and our constituents of the same thing--that solvency 
was a very important issue. But since then, at least I have 
come to understand better that the implications for my children 
are not so much what is in the trust funds, but clearly what 
they are able to pay for at that time.
    And the difference really is one of consumption. You and I 
can save in individual accounts of our own or of somebody 
else's construction, but to do so we have to give up spending, 
we have to give up consumption, and hope that that helps 
capital investment and the economy grow. It is not necessarily 
true, however, that in generating trust fund surpluses the 
government has collectively given up consumption. And so unless 
we actually do something to help the economy, my share of 
Microsoft, which I will have to sell to my kids, will be worth 
more or less depending on how the economy performs largely.
    And their ability to buy it from me will depend on how much 
they can make out of the economy. So whether the assets are so-
called real in equities or whether the assets are in government 
bonds matters much, much less than how gib is the economy at 
the time.
    Chairman Nussle. Again, thank you for your testimony. I 
would like to thank, again, Mr. Spratt for the atmosphere in 
which this hearing was held. We all, I think, came to this with 
an interest in trying to solve the problem, understood the 
problem, and start looking at some solutions. If we would start 
learning from that experience, Congress may be able to function 
in dealing with this in a much better way.
    I would also like to thank Tori Gorman. This has been a 
good hearing. It takes a lot of staff work on both sides to get 
this all put together. Our witnesses have done a great job and 
the members participated in a very constructive way, and I 
appreciate that.
    So with that we are adjourned.
    [Whereupon, at 1:19 p.m., the committee was adjourned.]

                                
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