Social Security: Issues in Evaluating Reform Proposals		 
(10-DEC-01, GAO-02-288T).					 
								 
This report discusses how best to ensure 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. The system faces both solvency and 	 
sustainability challenges in the longer term. Although Social	 
Security's Trust Funds will not be exhausted until 2038,	 
according to the latest trustees' report's intermediate 	 
projections, the program's cash demands on the rest of the	 
federal government will begin much sooner. Focusing on the trust 
fund solvency alone is not sufficient. Aiming for sustainable	 
solvency would increase the chance that future policymakers would
not have to face these difficult questions on a recurring basis. 
GAO has developed criteria for evaluating Social Security reform 
proposals: financing sustainable solvency, balancing adequacy and
equity, and implementing and administering reforms. These	 
criteria aim to balance financial and economic considerations	 
with benefit adequacy and equity issues and the administrative	 
challenges associated with various proposals. GAO's recent report
on Social Security and income adequacy provides some specific	 
insights on one of its criteria. First, no single measure of	 
adequacy provides a complete picture; each measure reflects a	 
different outlook on what adequacy means. Second, given the	 
currently projected long-term financial shortfall of the program,
it is important to compare proposals to both benefits at	 
currently promised levels and benefits funded at current tax	 
levels. Third, various approaches to benefit reductions, in	 
particular, would have differing effects on adequacy.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-288T					        
    ACCNO:   A02554						        
  TITLE:     Social Security: Issues in Evaluating Reform Proposals   
     DATE:   12/10/2001 
  SUBJECT:   Budget administration				 
	     Social security benefits				 
	     Income maintenance programs			 
	     Retirement benefits				 
	     Disability benefits				 
	     Evaluation criteria				 
	     Future budget projections				 
	     Medicare Program					 
	     Social Security Program				 
	     Disability Insurance Program			 
	     Social Security Trust Fund 			 
	     Old-Age and Survivors Insurance Program		 

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GAO-02-288T
     
Special Committee on Aging, U. S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 2: 00 p. m. Monday, December 10,
2001 SOCIAL SECURITY

Issues in Evaluating Reform Proposals

Statement of Barbara D. Bovbjerg, Director, Education, Workforce, and Income
Security Issues

GAO- 02- 288T

Page 1 GAO- 02- 288T

Mr. Chairman and Members of the Committee: Thank you for inviting me here
today as you continue the ongoing discussion on how best to ensure the long-
term viability of our nation?s Social Security program. 1 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 we have said in congressional testimonies over the past several
years, 2 the system faces both solvency and sustainability challenges in the
longer term. The challenges of combating terrorism and otherwise addressing
homeland security have now come to the fore as new, unexpected, and urgent
claims on the federal budget. Still, none of the changes since September 11
have lessened Social Security?s long- term pressures on the budget. In fact,
the events of September 11 have served to increase our long- range
challenges. Without reforms to Social Security and Medicare, these programs
are unsustainable, and their long- term impact on the federal budget and the
economy will be dramatic.

Over the past few years, a wide array of proposals have been put forth to
restore Social Security?s long- term solvency, and now a commission
appointed by the President is deliberating possible reform recommendations.
It is not my intention to 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. 3 To do that,
I?m going to talk about the nature and timing of the Social Security
problem, a framework and criteria for evaluating reform proposals, and
findings from our recent report on Social Security?s role in helping ensure
income adequacy. 4

1 Social Security refers here to the Old Age, Survivors, and Disability
Insurance (OASDI) program. 2 Social Security: Criteria for Evaluating Social
Security Reform Proposals

(GAO/ T- HEHS- 99- 94, Mar. 25, 1999); Social Security: The President?s
Proposal

(GAO/ T- HEHS/ AIMD- 00- 43, Nov. 9, 1999); Long- Term Budget Issues: Moving
from Balancing the Budget to Balancing Fiscal Risk (GAO- 01- 385T, Feb. 6,
2001).

3 See the list of related GAO products at the end of this statement. 4
Social Security: Program?s Role in Helping Ensure Income Adequacy (GAO- 02-
62, Nov. 30, 2001).

Page 2 GAO- 02- 288T

In summary, our Social Security challenge is more urgent than it may appear
and is part of a larger and significant fiscal and economic challenge. The
Social Security program, combined with rapid growth in Medicare and
Medicaid, will dominate the federal government?s future fiscal outlook.
Absent reform, the nation will ultimately have to choose between persistent,
escalating federal deficits, significant tax increases and/ or dramatic
budget cuts; waiting only makes it harder. Although Social Security?s Trust
Funds will not be exhausted until 2038, according to the latest trustees?
report?s intermediate projections, 5 the program?s cash demands on the rest
of the federal government will begin much sooner. 6 Beginning in 2016,
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
ongoing costs- a pressure that will continuously increase over time. Failure
to take remedial action will, in combination with other entitlement
spending, place unsustainable pressure on the government and, ultimately,
the economy. Focusing on trust fund solvency alone is not sufficient. We
need to put the program on a path toward sustainable solvency. Aiming for
sustainable solvency would increase the chance that future policymakers
would not have to face these difficult questions on a recurring basis.
Moreover, while addressing Social Security reform will not be easy, Medicare
presents a much greater, more complex, and urgent fiscal challenge.

Still, this problem is about more than finance. A comprehensive framework
for addressing the problem can help. To assist the Congress in its
deliberations, GAO has developed criteria for evaluating Social Security
reform proposals: financing sustainable solvency, balancing adequacy and
equity, and implementing and administering reforms. 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. Reform proposals
should be evaluated as packages that strike a balance among individual
reform elements, and important interactive effects should be

5 For the annual report of the Board of Trustees for the Social Security
Trust Funds, SSA actuaries project future revenues and benefits. For these
projections, they use alternative assumptions regarding economic and
demographic trends, including average earnings, mortality, fertility, and
immigration. The intermediate assumptions represent the board?s best
estimate of future trends.

6 In this testimony, the term ?Trust Funds? refers to the Old- Age and
Survivors Insurance and Disability Insurance Trust Funds.

Page 3 GAO- 02- 288T

considered. If we focus on the pros and cons of each element of reform, it
will be more difficult to build the bridges necessary to achieve consensus.
In addition, overall evaluation of each proposal depends on the weight
individual policymakers place on each criterion.

Finally, our recent report on Social Security and income adequacy provides
some specific insights on one of our criteria. First, no single measure of
adequacy provides a complete picture; each measure reflects a different
outlook on what adequacy means. So a variety of measures should be
considered. In addition, all adequacy measures depend significantly on what
types of income are counted. In particular, noncash benefits such as
Medicare play a major role in sustaining standards of living for their
beneficiaries. Any examination of income adequacy should acknowledge the
major role of noncash benefits and the needs they help support. Second,
given the currently projected long- term financial shortfall of the program,
it is important to compare proposals to both benefits at currently promised
levels and benefits funded at current tax levels. We have developed
benchmark policy scenarios to illustrate the range of possible outcomes and
used these benchmarks to examine the outlook for income adequacy. However,
since our report was focused on income adequacy, it did not examine measures
of individual equity, which should be balanced against adequacy measures.
Third, various approaches to benefit reductions, in particular, would have
differing effects on adequacy. More progressive approaches to reducing
monthly benefits would have a smaller effect on poverty rates, for example,
than less progressive approaches. Also, reductions that preserve current law
benefits for survivors, disabled workers, and the very old would help
minimize reductions to income adequacy, though they could place other
beneficiaries at greater risk of poverty.

Today the Social Security program does not face an immediate crisis but
rather a long- range and more fundamental financing problem driven largely
by known demographic trends. The lack of an immediate solvency crisis
changes the challenge, but it does not eliminate the need for action. Acting
sooner rather than later would allow changes to be phased in so the
individuals who are most likely to be affected, namely younger and future
workers, will have time to adjust their retirement planning while helping to
avoid related ?expectation gaps.? It is also important to put the overall
federal budget on a sustainable footing over the long term, thereby
promoting higher economic growth and more fiscal flexibility to finance
other priorities. Social Security?s

Long- Term Financing Problem Is More Urgent Than It May Appear

Page 4 GAO- 02- 288T

Since there is a great deal of confusion about Social Security?s current
financing arrangements and the nature of its long- term financing problem,
I?d like to spend some time describing the nature, timing, and extent of the
financing problem.

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
affect the program?s financial condition. This ratio, however, is changing:
today the ratio of workers paying Social Security taxes to beneficiaries 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. Taken together, these trends threaten the financial
solvency and sustainability of this important program. (See fig. 1.)
Demographic Trends Drive

Social Security?s LongTerm Financing Problem

Page 5 GAO- 02- 288T

Figure 1: Ratio of Covered Workers to Beneficiaries

Note: Based on the intermediate assumptions of the 2001 OASDI Trustees?
Reports. Source: GAO analysis of data from Office of the Chief Actuary,
Social Security Administration (SSA).

The combination of these trends means that labor force growth will begin to
slow after 2010 and become negligible by 2025. (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 inevitably lead to slower growth in the economy and, absent a
change in tax policy, to slower growth of federal revenues. This in turn
will only accentuate the overall pressure on the federal budget.

0 1

2 3

4 5

6 7

8 9

10 1955 1975 1995 2015 2035 2055 2075

Covered workers per OASDI beneficiary

Page 6 GAO- 02- 288T

Figure 2: Labor Force Growth Is Expected to be Negligible by 2050

Note: Based on the intermediate assumptions of the 2001 OASDI Trustees?
Reports. Source: GAO analysis of data from Office of the Chief Actuary, SSA.

This slowing labor force growth is not always considered as part of the
Social Security debate. Fundamentally, there are only two ways to mitigate
the slowdown in labor force growth: keep people in the labor force longer or
bring in more people. Given longer life expectancies, improving health
status of older workers, economic needs, and budget realities, it may be
appropriate to consider finding ways to encourage people to work longer.
Social Security?s retirement ages are often the subject of discussion and
debate. 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 finances of Social Security and Medicare would be improved, and
the expected slowdown in labor force growth might be mitigated. However, in
the case of Social Security, absent any new increases in the full retirement
age, any improvement could be offset to some degree by the higher benefits
that workers could have as a result of delaying receipt of their benefits.

0.0 0.5

1.0 1.5

2.0 2.5

3.0 1975 2000 2025 2050 2075

Percent change (5- year moving average)

Page 7 GAO- 02- 288T

Another key uncertainty is new entrants into the labor force. In domestic
social policy, we have seen an increasing focus on encouraging those
previously outside the labor force (such as welfare recipients and the
disabled) into the workforce. Concern about the slowdown in the labor force
may also lead to discussions about immigration and its role. These are
issues that the Congress may wish to explore further in the next few years.

Because of these demographic trends, 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. 7 (See fig. 3.)

7 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 2 percent of total income in 2000.

Page 8 GAO- 02- 288T

Figure 3: Social Security Income and Cost Rates

Note: Cost rates reflect the cost of Social Security benefits and other
program costs as a percent of taxable payroll, while income rates reflect
payroll tax receipts and other program revenues as a percent of taxable
payroll. Projections based on intermediate assumptions of the 2001 OASDI
Trustees? Report.

Source: Office of the Chief Actuary, Social Security Administration.

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, Social Security?s cash income
exceeds cash expenditures. The Trust Funds, by law, invest the resulting
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. Social Security Cash

Flows, Trust Funds, and the Federal Budget

0 5

10 15

20 25

2000 2015 2030 2045 2060 2075 Income rate

Cost rate Percent of taxable payroll

Page 9 GAO- 02- 288T

government and so carry no risk of default. 8 Although the Trust Funds
cannot sell their holdings in the open market, the Trust Funds face no
liquidity or interest rate risk since it can redeem its special Treasury
securities before maturity at face value. 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.

Social Security is included in the most commonly used measure of the
government?s financial balance, known as the unified budget deficit/
surplus. The unified budget measure includes all federal spending and
revenue. Between 1983 and 1998, surpluses in the Social Security trust funds
were used to partially offset a deficit in all other government accounts
within the unified budget. 9 Since 1998 when the federal government began
running unified surpluses, some or all of the Social Security surpluses have
been used to reduce federal debt held by the public. 10

I think it is useful to pause for a moment here and reflect on what the term

?trust fund? means in the federal budget. 11 Trust funds in the federal
budget are not like private trust funds. Individuals can create a private
trust fund using his or her own assets to benefit a stated individual( s).
The creator, or settlor, 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

8 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 fiscal year 2000, about 0.004 percent of OASDI trust fund
holdings were in marketable Treasury securities.

9 The interest credited to the trust fund does not currently affect the
unified surplus or deficit because it is an internal transaction of the
government. One part of the government (the Treasury) credits the interest
to another part (the trust fund), so the two transactions offset one another
and there is no net budgetary effect.

10 A portion of the Social Security surpluses offset an on- budget deficit
in fiscal year 1998. Fiscal year 1999 was the first year since 1960 that the
federal government ran an on- budget surplus.

11 For a discussion of trust funds and other earmarked funds in the budget,
see Federal Trust and Other Earmarked Funds: Answers to Frequently Asked
Questions

(GAO- 01- 199SP, Jan. 2001).

Page 10 GAO- 02- 288T

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, including the earnings of
most federal trust funds.

Under current law, when the Social Security Trust Funds? 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.

While the accumulated balances in a trust fund reflect the government?s
commitment to pay benefits, limited to the assets held in the fund, they 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.

The combined Social Security Trust Funds will be solvent through 2038
according to the Trustees? intermediate estimates. 12 However, our longterm
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 now and in the
future and at what cost to other claims on scarce

12 Separately, the DI fund is projected to be exhausted in 2026 and the OASI
fund in 2040.

Page 11 GAO- 02- 288T

resources. The future sustainability of programs is a key policy 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. General fund
transfers to the Trust Funds can improve solvency, but unless accompanied by
program reforms and/ or reductions in debt held by the public will have no
effect on the program?s overall sustainability.

Today, the Social Security Trust Funds take in more in taxes than they
spend. Largely because of the known demographic trends I have described,
this situation will change. Under the Trustees? intermediate assumptions,
combined program outlays begin to exceed program revenues in 2016. At that
time, the program will become a net claimant on the rest of the federal
budget. (See fig. 4.) Social Security?s Cash

Flow Is Expected To Turn Negative in 2016

Page 12 GAO- 02- 288T

Figure 4: Social Security?s Trust Funds Face Cash Deficits as Baby Boomers
Retire

Note: Projections based on intermediate assumptions of The 2001 Annual
Report of the Board of Trustees of the Federal Old- Age and Survivors
Insurance and Disability Insurance Trust Funds.

Source: GAO analysis of data from the Office of the Chief Actuary, Social
Security Administration.

As I noted above, the special Treasury securities represent assets for the
Trust Funds but are future claims against the Treasury. To cover the cash
shortfall, -which is expected to grow- the Trust Funds will begin drawing on
the Treasury, first relying on its interest income and eventually drawing
down its 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

-400 -300

-200 -100

0 100

200 2000 2005 2010 2015 2020 2025 2030 2035 2040

Cash surpluses Cash deficits Social Security

cash deficit 2016 Billions of 2000 dollars

Page 13 GAO- 02- 288T

remained positive. 13 The projected change in Social Security cash flow in
2016 will not mean a crisis in program financing: promised benefits will
continue to be paid in full. However, this negative cash flow will place
increased pressure on the federal budget to raise the resources necessary to
meet the program?s ongoing costs.

From the perspective of the federal budget and the economy, the expected
growth in Social Security spending is a major challenge in combination with
the even faster 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. For example, prior to the creation of the Medicare and Medicaid
programs, in 1962 mandatory spending accounted for about 33 percent of total
federal spending. By 2000, this share had more than doubled to approximately
66 percent of the budget.

The Director of the Office of Management and Budget (OMB) has recently
suggested the possibility of federal budget deficits through fiscal year
2004, and other budget analysts appear to be in agreement. While we do not
know today what the 10- year budget projections will be in the next updates
by CBO and the Office of Management and Budget (OMB), we do know the
direction: they will be considerably less optimistic than before September
11, and the long- term outlook will look correspondingly worse. For example,
if we assume that the 10- year surpluses CBO projected in August are
eliminated, by 2030 absent changes in the structure of Social Security and
Medicare, there would be virtually no room for any other federal spending
priorities, including national defense, education, and law enforcement. (See
fig. 5.) The resource demands that come from the events of September 11- and
the need to address the gaps these events surfaced- will demand tough
choices. Part of that response must be to deal with the threats to our long-
term fiscal health. Ultimately, restoring our long- term fiscal flexibility
will involve both promoting higher longterm economic growth and reforming
the federal entitlement programs.

13 If the unified budget is in surplus at this point, then financing
benefits in excess of dedicated tax revenue would result in less debt
redemption rather than increased borrowing. Decline in Budgetary

Flexibility Will Be Severely Exacerbated Absent Entitlement Reform

Page 14 GAO- 02- 288T

When Congress returns for its next session, these issues should be placed
back on the national agenda.

Figure 5: August 2001 Projection - Composition of Federal Spending Under the
?Eliminate Unified Surpluses? Simulation

Notes: Revenue as a share of GDP declines from its 2000 level of 20.6
percent due to unspecified permanent policy actions. In this display, policy
changes are allocated equally between revenue reductions and spending
increases.

Source: GAO?s August 2001 analysis.

Since Social Security will constitute claims on real resources in the future
when it redeems assets to pay benefits, taking action now to increase the
future pool of resources is important. As Federal Reserve Chairman Greenspan
has said, the crucial issue of saving in our economy relates to our ability
to build an adequate capital stock to produce enough goods and services in
the future to accommodate both retirees and workers in the

0 10

20 30

40 50

60 2000 2030 2050 Percent of GDP

Net interest Social Security Medicare & Medicaid All other spending

Revenue

Page 15 GAO- 02- 288T

future. 14 The most direct way we can raise national saving is by increasing
government saving. Saving a good portion of the surpluses would allow the
federal government to reduce the debt overhang from past deficit spending,
provide a strong foundation for future economic growth and enhance future
budgetary flexibility.

Correspondingly, taking action now on Social Security not only would promote
increased budgetary flexibility in the future and stronger economic growth
but would also require less dramatic action than if we wait. Perhaps the
best way to show this is to compare what it would take to achieve actuarial
balance at different points in time. Figure 6 shows this. If we did nothing
until 2038- the year the Trust Funds are estimated to be exhausted-
achieving actuarial balance would require benefit reductions of 30 percent
or a tax increase of 39 percent. 15 As figure 6 shows, earlier action
shrinks the size of the necessary adjustment.

Figure 6: Changes Needed to Maintain Social Security Solvency

Note: The benefit reductions in this graph represent a one- time, permanent
reduction to all existing and future benefits beginning in the year
indicated.

14 Testimony before the Committee on Banking, House, and Urban Affairs, U.
S. Senate, July 24, 2001. 15 Based on estimates of program income from both
the payroll tax and taxation of OASDI benefits.

13 16

30 14

20 39

0 5

10 15

20 25

30 35

40 2001- 2075 2016- 2075 2038- 2075

Benefit Reduction or Tax Increase Percentage

Page 16 GAO- 02- 288T

Source: GAO analysis of data from the intermediate assumptions of the 2001
OASDI Trustees Report.

Thus both sustainability concerns and solvency considerations must drive us
to act sooner rather than later. Trust Fund exhaustion may be more than 30
years away, but the squeeze on the federal budget is only 15 years in our
future. Actions taken today can ease both these pressures and the pain of
future actions. Acting sooner rather than later also provides a more
reasonable planning horizon for future retirees.

As important as financial stability may be for Social Security, it is not
the only consideration. Social Security remains the foundation of the
nation?s retirement system. Yet it is more than just a retirement program;
it also pays benefits to disabled workers and their dependents, spouses and
children of retired workers, and survivors of deceased workers. Last year,
Social Security paid almost $408 billion in benefits to more than 45 million
people. Since its inception, the program has successfully reduced poverty
among the elderly. In 1959, 35 percent of the elderly were poor. In 1999, 8
percent of beneficiaries aged 65 or older were poor, and 48 percent would
have been poor without Social Security. It is precisely because the program
is so deeply woven into the fabric of our nation that any proposed reform
must consider the program in its entirety, rather than one aspect alone.
Thus, GAO has developed a broad framework for evaluating reform proposals
that considers not only solvency but other aspects of the program as well.
Arguably, similar frameworks can also be applied to other programs like
Medicare.

The analytic framework GAO has developed to assess proposals comprises three
basic criteria:

 the extent to which a proposal achieves sustainable solvency and how it
would affect the economy and the federal budget;

 the relative balance struck between the goals of individual equity and
income adequacy; and

 how readily a proposal could be implemented, administered, and explained
to the public.

The weight that different policymakers may place on different criteria would
vary, depending on how they value different attributes. For example, if
offering individual choice and control is less important than maintaining
replacement rates for low- income workers, then a reform proposal
emphasizing adequacy considerations might be preferred. As Evaluating Social

Security Reform Proposals

Page 17 GAO- 02- 288T

they fashion a comprehensive proposal, however, policymakers will ultimately
have to balance the relative importance they place on each of these
criteria.

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

As I have already discussed, reducing the relative future burdens of Social
Security and health programs is essential to a sustainable budget policy for
the longer term. It is also critical if we are to avoid putting
unsupportable financial pressures on future workers. Reforming Social
Security and health programs is essential to reclaiming our future fiscal
flexibility to address other national priorities.

The current Social Security system?s benefit structure strikes a balance
between the goals of retirement income adequacy and individual equity. From
the beginning, benefits were set in a way that focused especially on
replacing some portion of workers? pre- retirement earnings, and over time
other changes were made that were intended to enhance the program?s role in
helping ensure adequate incomes. Retirement income adequacy, therefore, is
addressed in part through the program?s progressive benefit structure,
providing proportionately larger benefits to lower earners and certain
household types, such as those with dependents. Individual equity refers to
the relationship between contributions made and benefits received. This can
be thought of as the rate of return on individual contributions. Balancing
these seemingly conflicting objectives through the political process has
resulted in the design of the current Social Security program and should
still be taken into account in any proposed reforms. Financing Sustainable

Solvency Balancing Adequacy and Equity

Page 18 GAO- 02- 288T

Policymakers could assess income adequacy, for example, by considering the
extent to which proposals ensure benefit levels that are adequate to protect
beneficiaries from poverty and ensure higher replacement rates for low-
income workers. In addition, policymakers could consider the impact of
proposed changes on various sub- populations, such as low- income workers,
women, minorities, and people with disabilities. Policymakers could assess
equity by considering the extent to which there are reasonable returns on
contributions at a reasonable level of risk to the individual, improved
intergenerational equity, and increased individual choice and control.
Differences in how various proposals balance each of these goals will help
determine which proposals will be acceptable to policymakers and the public.

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

Program complexity can both make implementation and administration more
difficult, and make it harder to explain to the public. Some degree of
implementation and administrative complexity arises in virtually all
proposed reforms to Social Security, even those that make incremental
changes in the already existing structure. However, the greatest potential
implementation and administrative challenges are associated with proposals
that would create individual accounts. These include, for example, issues
concerning the management of the information and money flow needed to
maintain such a system, the degree of choice and flexibility individuals
would have over investment options and access to their accounts, investment
education and transitional efforts, and the mechanisms that would be used to
pay out benefits upon retirement. There is also the necessary and complex
task of harmonizing any system of individual accounts with the extensive
existing regulatory framework governing our nation?s private pension system.
In evaluating such proposals, the complexities of meshing these systems
would have to be balanced against the opportunity of extending pension
participation to millions of uncovered workers.

Continued public acceptance and confidence in the Social Security program
require that any reforms and their implications for benefits be well
understood. This means that the American people must understand what the
reforms are, why they are needed, how they are to be implemented and
administered, and how they will affect their own retirement income. All
reform proposals will require some additional Implementing and

Administering Proposed Reforms

Page 19 GAO- 02- 288T

outreach to the public so that future beneficiaries can adjust their
retirement planning accordingly. The more transparent the implementation and
administration of reform, and the more carefully such reform is phased in,
the more likely it will be understood and accepted by the American people.
From a practical stand- point, the phase- in of any reform should reflect
individual fairness and political feasibility. With regard to proposals that
involve individual accounts, an essential challenge would be to help the
American people understand the relationship between their individual
accounts and traditional Social Security benefits, thereby ensuring that we
avoid any gap in expectations about current or future benefits.

Over the past few years, we have been developing a capacity at GAO to
estimate the quantitative effects of Social Security reform on individuals.
Such estimates speak directly to applying our adequacy/ equity criterion to
reform proposals. We have just issued a new report that includes such
estimates to illustrate the varying effects of different policy scenarios on
individuals. 16 Today, I would like to share our findings regarding what
measures can be used to examine income adequacy, defining appropriate
benchmarks for assessing the future outlook for individuals? Social Security
benefits, and how varying approaches to reducing benefits could have
different effects on adequacy. Our recent report did not, however, present
estimates of effects on individual equity. 17 In addition to these points,
our report looked at how concern over income adequacy has shaped the Social
Security program over the years and how income adequacy has changed over
time, especially for different groups of beneficiaries.

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

16 Social Security: Program?s Role in Helping Ensure Income Adequacy (GAO-
02- 62, Nov. 30, 2001). 17 For information on such issues, see Social
Security: Issues in Comparing Rates of Return with Market Investments (GAO/
HEHS- 99- 110, Aug. 5, 1999). Examining Effects of

Reform on Income Adequacy

No Single Measure Gives Complete Picture of Income Adequacy

Page 20 GAO- 02- 288T

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

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

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

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

In the past, we have pointed out the importance of establishing the proper
benchmarks against which reforms must be measured. Often reform proposals
are compared to currently promised benefits, but currently promised benefits
are not fully financed. It is also necessary to use a benchmark of a fully
financed system to fairly evaluate reform proposals. To illustrate a full
range of possible outcomes, our recent report on income adequacy used
hypothetical benchmark scenarios that would restore 75- year solvency either
by only increasing payroll taxes or by only reducing benefits. Our tax-
increase- only benchmark simulated benefits at currently promised levels
while our benefit- reduction- only benchmarks simulated benefits funded at
current tax levels. These benchmarks used the program?s current benefit
structure and the 2001 OASDI Trustees? intermediate, or best- estimate,
assumptions. The benefit reductions were Benchmark Policy

Scenarios Illustrate Range of Possible Outcomes

Page 21 GAO- 02- 288T

phased in between 2005 and 2035 to strike a balance between the size of the
incremental reductions each year and the size of the ultimate reduction. At
our request, SSA actuaries scored our benchmark policies and determined the
parameters for each that would achieve 75- year solvency. For our benefit
reduction scenarios, the actuaries determined these parameters assuming that
disabled and survivor benefits would be reduced on the same basis as retired
worker and dependent benefits. If disabled and survivor benefits were not
reduced at all, reductions in retired worker benefits would be deeper than
shown in this analysis. 18

Future benefit levels and income adequacy will depend considerably on how
any benefit reductions are made. Figure 7 shows the percentage of retired
workers 19 with Social Security benefits that fall below the official
poverty threshold for various benchmarks. Note that this graph does not show
poverty rates, which would require projections of total income; 20 instead,
it focuses only on Social Security benefits. The percentage with total
incomes below the poverty threshold would be lower if other forms of
retirement income were included. The figure shows that the percentage with
benefits below the poverty threshold would be greater under a proportional
benefit reduction than under a progressive benefit reduction. The
proportional benefit- reduction- only benchmark would reduce benefits by the
same proportion for all beneficiaries born in the same year. The progressive
benefit- reduction- only benchmark would reduce benefits by a smaller
proportion for lower earners and a higher proportion for higher

18 See Social Security: Program?s Role in Helping Ensure Income Adequacy
(GAO- 02- 62, Nov. 30, 2001), appendix III, for more details on the
alternative benefit reduction benchmarks.

19 We used retired workers for simplicity. Our focus is on the difference
between benefit reduction approaches, holding everything else equal, and not
on the type of beneficiary. We use age 62 as the retirement age because most
retired worker beneficiaries retire at that age. Because of a variety of
complexities concerning beneficiary and household type, our estimates should
not be interpreted as poverty rates. See Social Security: Program?s Role in
Helping Ensure Income Adequacy (GAO- 02- 62, Nov. 30, 2001), appendixes III
and IV.

20 Given that our analysis examined only Social Security benefits and not
total income, the focus should not be on the specific estimates of adequacy
measures but rather the differences between them across types of measures,
across beneficiary groups, and across policy scenarios. . See Social
Security: Program?s Role in Helping Ensure Income Adequacy (GAO- 02- 62,
Nov. 30, 2001). Varying Approaches to

Benefit Reductions Would Have Different Effects on Adequacy

Page 22 GAO- 02- 288T

earners. The tax- increase- only (no benefit reduction) benchmark estimates
are shown for reference. 21

Figure 7: Adequacy of Income in Future Depends on Benefit Reduction Approach
(Retired Workers, All Retiring at Age 62)

Notes: The rates shown in the graph are not poverty rates because they
reflect only Social Security income, not total income. For the 1935 birth
cohort, which reached age 62 in 1997, 51 percent of our simulated sample had
Social Security benefits below poverty. Under the proportional reduction
approach, all beneficiaries in a given birth year are subject to a benefit
reduction that is a constant proportion of their benefits. Under the
progressive reduction, beneficiaries with lower benefits receive a smaller
proportional reduction than those with higher benefits. See appendix III in
Social Security: Program?s Role in Helping Ensure Income Adequacy (GAO- 02-
62, Nov. 30, 2001) for more details on the alternative benefit reduction
benchmarks.

Source: GAO?s analysis using the GEMINI model.

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

21 Figure 7 also shows that percentage of workers with benefits below the
poverty threshold would be slightly higher in our simulations for those
retiring in 2032 rather than 2017. This reflects primarily that the benefit
reductions in our benchmarks are more fully phased in for the 2032 group
than for the later group. The declines in the percentages from the 2032 to
2047 retirement years largely reflects that initial benefit levels increase
with wages while the poverty threshold increases with prices, which are
assumed to grow more slowly than wages. Since the benefit reductions are
fully phased in by 2035, the last two age groups experience nearly the same
benefit reductions.

29.7 31.8 24.6 28.5 29.5

21.8 22.4 17.5

11.5 0 5

10 15

20 25

30 35

1955 (2017) 1970 (2032) 1985 (2047)

Birth year (age 62 year)

Proportional reduction Progressive reduction Tax-increase only Percent of
cohort with Social Security benefits below poverty

Page 23 GAO- 02- 288T

Figure 8 illustrates how different approaches would have benefit reductions
that would vary by benefit levels (which are directly related to earnings).
The proportional benchmark would reduce benefits by an identical percentage
for all earnings levels. In contrast, the two alternative, progressive
benchmarks would reduce benefits less for lower earners than for higher
earners. The so- called ?limited- proportional? benefit- reduction benchmark
would be even more progressive than the progressive benefitreduction
benchmark because a portion of benefits below a certain level are protected
from any reductions while reductions above that level are proportional. 22
Moreover, different benefit reduction approaches would have varying effects
on different beneficiary groups according to the variation in the typical
earnings levels of those subgroups. For example, women, minorities, and
never married individuals all tend to have lower lifetime earnings than men,
whites, and married individuals, respectively. Therefore, benefit reductions
that favor lower earners would help minimize adequacy reductions for such
groups that typically have lower earnings.

22 The 1985 birth cohort will be subject to the largest benefit reductions
of the four cohorts we simulated; therefore, it best illustrates the
potential disparity in benefit reductions by benefit level.

Page 24 GAO- 02- 288T

Figure 8: Benefit Reduction Approaches Have Different Effects on Different
Benefit Levels (Retired Workers Born in 1985, All Retire at Age 62)

Notes: Quintiles are by benefit levels. Percentage reductions are calculated
for beneficiaries closest to the median of each quintile that appear in each
scenario?s sample. For the 1985 birth cohort, all benefit reductions are
fully phased- in under our benchmark scenarios. Under the proportional
reduction approach, all beneficiaries in a given birth year are subject to a
benefit reduction that is a constant proportion of their benefits. Under the
progressive reduction, beneficiaries with lower benefits receive a smaller
proportional reduction than those with higher benefits. Under the limited
proportional reduction, a portion of benefits below a certain level are
protected from any reductions while reductions above that level are
proportional. See appendix III in Social Security: Program?s Role in Helping
Ensure Income Adequacy (GAO- 02- 62, Nov. 30, 2001) for more details on the
alternative benefit reduction benchmarks.

Source: GAO?s analysis using the GEMINI model.

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

24 16

11 24

21 23 24 23 28

24 25 31

24 30

32 0 5

10 15

20 25

30 35

Proportional reduction Progressive reduction Limited proportional reduction

Lowest quintile Second Third Fourth Highest quintile Percentage reduction in
Social Securitybenefits

Page 25 GAO- 02- 288T

current benefit formula, initial benefit levels would grow faster on average
than the poverty threshold and poverty rates would fall, assuming that wages
increase faster than prices on average, as the Social Security trustees?
report assumes they will.

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

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

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

Page 26 GAO- 02- 288T

income adequacy should acknowledge the major role of noncash benefits and
the needs they help support.

In finding ways to restore Social Security?s long- term solvency and
sustainability, the Congress will address a key question, whether explicitly
or implicitly:

What purpose does it want Social Security to serve in the future?

 to minimize the need for means- tested public assistance programs;

 to minimize poverty; using what standard of poverty;

 to replace pre- retirement earnings;

 to maintain a certain standard of living; or

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

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

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

Page 27 GAO- 02- 288T

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

Staff Acknowledgments

Page 28 GAO- 02- 288T

Social Security: Program?s Role in Helping Ensure Income Adequacy

(GAO- 02- 62, Nov. 30, 2001).

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

Social Security Reform: Evaluation of the Nick Smith Proposal.

(GAO- AIMD/ HEHS- 00- 102R, Feb. 29, 2000).

Social Security Reform: Evaluation of the Gramm Proposal

(GAO/ AIMD/ HEHS- 00- 71R, Feb. 1, 2000).

Social Security Reform: Information on the Archer- Shaw Proposal

(GAO/ AIMD/ HEHS- 00- 56, Jan. 18, 2000).

Social Security: The President?s Proposal (GAO/ T- HEHS/ AIMD- 00- 43, Nov.
9, 1999).

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

Social Security Reform: Implications of Raising the Retirement Age

(GAO/ HEHS- 99- 112, Aug. 27, 1999).

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

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

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

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

Social Security Reform: Implementation Issues for Individual Accounts

(GAO/ HEHS- 99- 122, June 18, 1999).

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

Page 29 GAO- 02- 288T

Social Security: Individual Accounts as an Element of Long- Term Financing
Reform (GAO/ T- HEHS- 99- 86, Mar. 16, 1999).

Social Security: Different Approaches for Addressing Program Solvency

(GAO/ HEHS- 98- 33, July 22, 1998).

Social Security Financing: Implications of Government Stock Investing for
the Trust Fund, the Federal Budget, and the Economy

(GAO/ AIMD/ HEHS- 98- 74, Apr. 22, 1998).

Social Security: Restoring Long- Term Solvency Will Require Difficult
Choices (GAO/ T- HEHS- 98- 95, Feb. 10, 1998).

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