Social Security Reform: Analysis of a Trust Fund Exhaustion	 
Scenario Illustrates the Difficult Choices and the Need for Early
Action (29-JUL-03, GAO-03-1038T).				 
                                                                 
Social Security is an important social insurance program	 
affecting virtually every American family. It is the foundation  
of the nation's retirement income system and also provides	 
millions of Americans with disability insurance and survivors'	 
benefits. Over the long term, as the baby boom generation	 
retires, Social Security's financing shortfall presents a major  
program solvency and sustainability challenge. The Chairman of	 
the Senate Special Committee on Aging asked GAO to discuss Social
Security's long-term financing challenges and the results of	 
GAO's analysis of an illustrative "Trust Fund Exhaustion"	 
scenario. Under this scenario, benefits are reduced		 
proportionately for all beneficiaries by the shortfall in	 
revenues occurring upon exhaustion of the combined Old-Age and	 
Survivors Insurance and Disability Insurance Trust Funds. This	 
scenario was developed for analytic purposes and is not a legal  
determination of how benefits would be paid in the event of trust
fund exhaustion. GAO's analysis used the framework it has	 
developed to analyze the implications of reform proposals. This  
framework consists of three criteria: (1) the extent to which the
proposal achieves sustainable solvency and how it would affect	 
the U.S. economy and the federal budget, (2) the balance struck  
between the twin goals of income adequacy and individual equity, 
and (3) how readily changes could be implemented, administered,  
and explained to the public.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-1038T					        
    ACCNO:   A07774						        
  TITLE:     Social Security Reform: Analysis of a Trust Fund	      
Exhaustion Scenario Illustrates the Difficult Choices and the	 
Need for Early Action						 
     DATE:   07/29/2003 
  SUBJECT:   Administrative remedies				 
	     Disability benefits				 
	     Federal social security programs			 
	     Financial analysis 				 
	     Financial management				 
	     Funds management					 
	     Future budget projections				 
	     Program management 				 
	     Retirement benefits				 
	     Social security benefits				 
	     Trust funds					 
	     Trust fund sustainable solvency			 
	     Old Age and Survivors Insurance Trust		 
	     Fund						 
                                                                 
	     Social Security Disability Insurance		 
	     Trust Fund 					 
                                                                 
	     Social Security Program				 

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GAO-03-1038T

Testimony Before the Special Committee on Aging U. S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 10: 00 a. m. EDT Tuesday, July 29,
2003 SOCIAL SECURITY

REFORM Analysis of a Trust Fund Exhaustion Scenario Illustrates the
Difficult Choices and the Need for Early Action

Statement of David M. Walker Comptroller General of the United States

GAO- 03- 1038T

Although the Trustees* 2003 intermediate estimates show that the combined
Social Security Trust Funds will be solvent until 2042, program spending
will constitute a growing share of the budget and the economy much sooner.
Within 5 years, the first baby boomers will become eligible for Social
Security. By 2018, Social Security*s tax income is projected to be
insufficient to pay currently scheduled benefits. This shift from positive
to negative cash flow will place increased pressure on the federal budget
to raise the resources necessary to meet the program*s ongoing costs. In
the long term, Social Security, together with rapidly growing federal
health programs, will dominate our nation*s fiscal outlook. Absent reform,
the nation will ultimately have to choose between persistent, escalating
federal deficits, significant tax increases, and/ or dramatic budget cuts
of unprecedented magnitude.

The Trust Fund Exhaustion scenario we analyzed dramatically illustrates
the need for action sooner rather than later. (See Social Security Reform:
Analysis of a Trust Fund Exhaustion Scenario. GAO- 03- 907. Washington,

D. C.: July 29, 2003.) Under this scenario, after the combined trust funds
had been fully depleted, benefit payments would be adjusted each year to
equal annual tax income. Under this scenario, after trust fund exhaustion
those

receiving benefits would experience large and sudden benefit reductions.
Additional smaller reductions in the following years would result in
benefits equal to about two- thirds of currently scheduled levels by the
end of the 75-

year simulation period. The Trust Fund Exhaustion scenario raises
significant intergenerational equity issues. The timing of the benefit
adjustments means the Trust Fund Exhaustion scenario places a much greater
burden on younger generations. Lifetime benefits would be reduced much
more for younger generations. In

addition, under the Trust Fund Exhaustion scenario, benefits would be
adjusted proportionately for all recipients, increasing the likelihood of
hardship for lower income retirees and the disabled, especially those who
rely on Social Security as their primary or sole source of retirement
income. Fundamentally, the Trust Fund Exhaustion scenario illustrates
trade- offs

between achieving sustainable solvency and maintaining benefit adequacy.
The longer we wait to take action, the sharper these trade- offs will
become. 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.* Finally, 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.
Social Security is an important

social insurance program affecting virtually every American family. It is
the foundation of the nation*s retirement income system and also provides
millions of Americans with disability insurance and survivors*

benefits. Over the long term, as the baby boom generation retires, Social
Security*s financing shortfall presents a major program solvency and
sustainability challenge.

The Chairman of the Senate Special Committee on Aging asked GAO to discuss
Social Security*s long- term financing challenges and the results of GAO*s
analysis of an illustrative *Trust Fund Exhaustion* scenario. Under this
scenario, benefits are

reduced proportionately for all beneficiaries by the shortfall in revenues
occurring upon exhaustion of the combined Old- Age and

Survivors Insurance and Disability Insurance Trust Funds. This scenario
was developed for analytic purposes and is not a legal determination of
how benefits would be paid in the event of trust

fund exhaustion. GAO*s analysis used the framework it has developed to
analyze the implications of reform proposals. This framework consists of
three criteria: (1) the extent to which the proposal achieves sustainable
solvency and how it would affect the U. S. economy and the federal budget,
(2) the balance struck between the twin goals of income adequacy and
individual equity, and (3) how readily changes could be implemented,
administered, and explained to the public.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 1038T. To view the full product,
including the scope and methodology, click on the link above. For more
information, contact Barbara Bovbjerg at (202) 512* 5491 or Susan Irving
at (202) 512- 9142. Highlights of GAO- 03- 1038T, a testimony

for the Special Committee on Aging, United States Senate

July 29, 2003

SOCIAL SECURITY REFORM

Analysis of a Trust Fund Exhaustion Scenario Illustrates the Difficult
Choices and the Need for Early Action

Page 1 GAO- 03- 1038T Social Security Reform Mr. Chairman and Members of
the Committee: Thank you for inviting me here to talk about 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 survivors* benefits. As a result, Social Security
provides benefits that are critical to the current and future well- being
of tens of millions of Americans. As I have said in congressional
testimonies over the past several years, 1 this important program faces
both solvency and sustainability challenges in the longer term that
require our attention

today. Last January, I testified before this Committee on the need for
early action to reform Social Security. 2 That testimony presented GAO*s
analysis of the reform models developed by the President*s Commission to
Strengthen Social Security. Since that time, the Social Security Trustees
have issued their 2003 report, which showed that the program*s financial
condition remains virtually unchanged since last year. Under the Trustees*
2003 intermediate estimates, the actuarial balance of the combined trust
funds 3 over the 75- year period deteriorated from last year*s estimate of
*1.87

percent of taxable payroll to this year*s estimate of *1.92 percent of
taxable payroll. The present value of this actuarial deficit is $3.8
trillion over the 75- year period. Absent legislative action, within 15
years projected Social Security outlays will begin to exceed projected tax
receipts, and by 2042 the combined Old- Age and Survivors Insurance and
Disability Insurance (OASDI) trust funds are projected to be exhausted.
These new estimates once more underscore the program*s unsustainability as
Social Security continues to await reform.

Today we are issuing a report you requested using the same criteria and
framework we used in our report on the Commission reform models to

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); Social Security: Long- Term Financing Shortfall Drives
Need for Reform

GAO- 02- 845T (Washington, D. C.: June 19, 2002). 2 U. S. General
Accounting Office, Social Security: Analysis of Issues and Selected Reform
Proposals, GAO- 3- 376T (Washington, D. C.: Jan. 15, 2003). 3 In this
testimony, the term *trust funds* refers to the combined Old- Age and
Survivors Insurance and Disability Insurance (OASDI) Trust Funds.

Page 2 GAO- 03- 1038T Social Security Reform analyze the potential effects
over the long term if no program reform takes place. 4 For this analysis,
we applied our criteria to a scenario in which the

Trust Fund reaches exhaustion, after which only benefits equal to cash
available from program income are paid. The scenario illustrates some
potential outcomes of a lack of action to address the serious imbalance
between Social Security*s projected revenues and the costs of paying
currently scheduled benefits.

Before I summarize the findings from this analysis, let me first highlight
a number of important points in connection with the Social Security
challenge.

 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 focusing on trust fund solvency alone 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.
5  Social Security reform is part of a broader fiscal and economic

challenge. If you look ahead in the federal budget, the combined Social
Security or 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. 4 As in our
report on the Commission reform models, we used the 2001 Trustees*
intermediate assumptions in analyzing the Trust Fund Exhaustion scenario.
5 In addition to assessing a proposal*s likely effect on Social Security*s
actuarial balance, a standard of sustainable solvency involves looking at
(1) the balance between program income and cost beyond the 75th year and
(2) the share of the budget and economy consumed by Social Security
spending.

Page 3 GAO- 03- 1038T Social Security Reform  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
46 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 over 68 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 wellbeing

of millions of others.  Acting sooner rather than later would help 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 in 2042. The program*s annual cash flow is
projected to be negative beginning in 2018. 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 to only those choices that
are the

most difficult. It could also contribute to further delay the really tough
decisions on health programs (e. g., Medicare, Medicaid). 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.* It would also help to assure that the *miracle of
compounding* works for us rather than against us. Finally, 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.

The Trust Fund Exhaustion scenario analyzed in our report 6 dramatically
illustrates the need for action sooner rather than later. Under this
scenario, once the combined trust funds had been fully depleted, benefit
payments would be adjusted each year to equal annual tax income. 7 After

6 U. S. General Accounting Office, Social Security Reform: Analysis of a
Trust Fund Exhaustion Scenario, GAO- 03- 907 (Washington, D. C.: July 29,
2003). 7 The Trust Fund Exhaustion scenario is intended as an analytic
tool, not a legal determination.

Page 4 GAO- 03- 1038T Social Security Reform trust fund exhaustion, those
receiving benefits would experience a large and sudden benefit reduction
of about 27 percent (to 73 percent of

currently scheduled levels) in 2039. 8 By the end of the 75- year period,
smaller reductions in successive years after trust fund exhaustion would
mean that benefits would be about two- thirds of what they would have been
under current benefit formulas (or 67 percent of currently scheduled
levels).

The Trust Fund Exhaustion scenario raises significant intergenerational
equity issues. The timing of the benefit adjustments means the Trust Fund
Exhaustion scenario places a much greater burden on younger generations.
For example, those born in 1955 would receive currently scheduled benefits
until they reached age 83, while those born in 1985 would always receive
benefits in retirement lower than currently scheduled benefits. This means
that lifetime benefits would be reduced more for younger generations. In
addition, under the Trust Fund

Exhaustion scenario, benefits would be adjusted proportionately for all
recipients, increasing the likelihood of hardship for lower income
retirees and the disabled, especially those who rely on Social Security as
their primary or sole source of retirement income.

As we all know, fixing Social Security 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 and their families from living their
retirement years in poverty. Proposals to restore the long- term financial
stability and viability of the Social Security system must also be
considered in terms of how potential changes affect different types of
beneficiaries. The Trust Fund Exhaustion scenario illustrates trade- offs
between the criterion of achieving sustainable solvency and the criterion
of maintaining benefit adequacy and equity. The longer we wait to take
action, the sharper these trade- offs will become. We need to put the

8 In our analysis of the Trust Fund Exhaustion scenario, as in our January
report on the Commission models, we used the Trustees* 2001 intermediate
assumptions, under which the combined OASDI trust funds are projected to
reach exhaustion in 2038. Under the 2001 intermediate assumptions, in 2038
the benefit reduction would be about 7 percent because trust fund assets
would be available for part of the year to pay benefits. In 2039, the
first full year after trust fund exhaustion, benefits would fall sharply,
to about 27 percent (or 73 percent of currently scheduled levels). Under
the Trustees* 2003 intermediate assumptions, the projected exhaustion date
for the combined trust funds is 2042, and the overall drop is
approximately the same.

Page 5 GAO- 03- 1038T Social Security Reform program on a path toward
sustainable solvency as soon as possible to assure that future
policymakers would not have to face these difficult

questions on a recurring basis. I hope my testimony will help clarify some
of the key issues in the debate about how to restructure this critically
important program.

Today the Social Security program faces a long- range and 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. 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.

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 1950, before the Social Security system was
mature, the ratio was 16.5: 1. In the 1960s, the ratio averaged 4. 2: 1.
Today it is 3.3: 1 and it is expected to drop to around 2.2: 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 3
children per woman. Today it is a little over 2, 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.) Social Security*s Long- Term Financing

Problem Is Truly Urgent

Demographic Trends Drive Social Security*s LongTerm Financing Problem

Page 6 GAO- 03- 1038T Social Security Reform Figure 1: Social Security
Workers per Beneficiary

Note: Projections based on the intermediate assumptions of the 2003
Trustees* Report.

The combination of these trends means that labor force growth will begin
to slow after 2010 and by 2025 is expected to be less than a third of what
it is today. (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.

Page 7 GAO- 03- 1038T Social Security Reform Figure 2: Labor Force Growth
Is Expected to be Negligible by 2050 Note: GAO analysis based on the
intermediate assumptions of The 2003 Annual Report of the Board of
Trustees of the Federal Old- Age and Survivors Insurance and the Federal
Disability Insurance Trust Funds. Percentage change is calculated as a
centered 5- year moving average. This slowing labor force growth is not
always recognized 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.

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. Although the Trustees* 2003 intermediate
estimates project that the combined Social Security Trust Funds will be
solvent until 2042, 9 program spending will constitute a rapidly growing
share of the budget and the economy well before that

9 Separately, the DI fund is projected to be exhausted in 2028 and the
OASI fund in 2044. Social Security*s Cash

Flow Is Expected To Turn Negative in 2018

Page 8 GAO- 03- 1038T Social Security Reform date. In 2008, the first baby
boomers will become eligible for Social Security benefits, and the future
costs of serving them are already

becoming a factor in the Congressional Budget Office*s (CBO) 10- year
projections. Under the Trustees* 2003 intermediate estimates, Social
Security*s cash surplus* the difference between program tax income and the
costs of paying scheduled benefits* will begin a permanent decline in

2009. To finance the same level of federal spending as in the previous
year, additional revenues and/ or increased borrowing will be needed.

By 2018, Social Security*s tax income is projected to be insufficient to
pay currently scheduled benefits. At that time, Social Security will join
Medicare*s Hospital Insurance Trust Fund (whose outlays are projected to
begin to exceed revenues in 2013) as a net claimant on the rest of the

federal budget. The combined OASDI 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. The Treasury

will need to obtain cash for those redeemed securities either through
increased taxes, and/ or spending cuts, and/ or more borrowing from the
public than would have been the case had Social Security*s cash flow
remained positive. 10 Neither the decline in the cash surpluses nor the
cash deficit will affect the payment of benefits. The shift from positive
to negative cash flow, however, will place increased pressure on the
federal budget to raise the resources necessary to meet the program*s
ongoing

costs. 10 If the unified budget is in surplus at this point, then
financing the excess benefits will require less debt redemption rather
than increased borrowing.

Page 9 GAO- 03- 1038T Social Security Reform Figure 3: Social Security*s
(OASDI) Trust Funds Face Cash Deficits as Baby Boomers Retire

Ultimately, the critical question is not how much a trust fund has in
assets, but whether the government as a whole can afford the 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.

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. In 1963, prior to the creation of the
Medicare and Medicaid programs, spending for mandatory programs plus net
interest accounted for about 32 percent of Decline in Budgetary

Flexibility Absent Entitlement Reform

Page 10 GAO- 03- 1038T Social Security Reform total federal spending. By
2003, this share had almost doubled to approximately 61 percent of the
budget. (See fig. 4.)

Figure 4: Federal Spending for Mandatory and Discretionary Programs,
Fiscal Years 1963, 1983, and 2003

*Estimate for 2003 includes $41 billion in discretionary spending and
about $1 billion in mandatory spending for the Iraq war supplemental.
Includes $11 billion in mandatory spending for the Jobs and Growth Tax
Relief Reconciliation Act of 2003.

In much of the last decade, reductions in defense spending helped
accommodate the growth in these entitlement programs. Even before the
events of September 11, 2001, however, this ceased to be a viable option.
Indeed, spending on defense and homeland security will grow as we seek

to combat new threats to our nation*s security. GAO prepares long- term
budget simulations that seek to illustrate the likely fiscal consequences
of the coming demographic tidal wave and rising health care costs. These
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 in 2001 do not sunset and discretionary spending keeps
pace with the economy, by midcentury

Page 11 GAO- 03- 1038T Social Security Reform federal revenues may only be
adequate to pay Social Security and interest on the federal debt. 11 To
obtain balance, massive spending cuts, tax increases, or some combination
of the two would be necessary. (See fig.

5.) Neither slowing the growth of discretionary spending nor allowing the
tax reductions to sunset eliminates the imbalance.

Figure 5: Composition of Spending as a Share of Gross Domestic Product
(GDP) Assuming Discretionary Spending Grows with GDP, the 2001 Tax Cuts Do
Not Sunset, and Payment of Currently Scheduled Social Security Benefits

Note: Assumes currently scheduled Social Security benefits are paid in
full throughout the simulation period. Social Security and Medicare
projections are based on the Trustees* 2003 intermediate assumptions.

Although this figure assumes payment of currently scheduled Social
Security benefits, the long- term fiscal imbalance would not be eliminated
even if Social Security benefits were to be limited to currently projected

11 This simulation assumes that all currently scheduled benefits would be
paid in full throughout the 75- year projection period. The simulation
does not reflect the effects of any legislation enacted after March 2003,
e. g., the tax reductions in the Jobs and Growth Tax Relief Reconciliation
Act of 2003.

Page 12 GAO- 03- 1038T Social Security Reform trust fund revenues. This is
because Medicare (and Medicaid)* spending for which is driven by both
demographics and rising health care costs*

present an even greater problem. 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. 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. GAO
is developing a health care framework to help focus additional attention
on this important area and to help educate key policymakers and the public
on the current system and related challenges.

Indeed, long- term budget flexibility is about more than Social Security
and Medicare. While these programs dominate the long- term outlook, they
are not the only federal programs or activities that bind the future. The
federal government undertakes a wide range of programs, responsibilities,
and activities that obligate it to future spending or create an
expectation for spending. A recent GAO report describes the range and
measurement of such fiscal exposures* from explicit liabilities such as
environmental cleanup requirements to the more implicit obligations
presented by lifecycle costs of capital acquisition or disaster
assistance. 12 Making government fit the challenges of the future will
require not only dealing with the drivers* entitlements for the elderly*
but also looking at the range of federal activities. A fundamental review
of what the federal government does and how it does it will be needed.

At the same time it is important to look beyond the federal budget to the
economy as a whole. Figure 6 shows the total future draw on the economy
represented by Social Security, Medicare, and Medicaid. Under the 2003
Trustees* intermediate estimates and CBO*s long- term Medicaid estimates,
spending for these entitlement programs combined will grow to 14 percent

12 U. S. General Accounting Office, Fiscal Exposures: Improving the
Budgetary Focus on Long- Term Costs and Uncertainties, GAO- 03- 213
(Washington, D. C.: Jan. 24, 2003).

Page 13 GAO- 03- 1038T Social Security Reform of GDP in 2030 from today*s
8.4 percent. Taken together, Social Security, Medicare, and Medicaid
represent an unsustainable burden on future

generations. Figure 6: Social Security, Medicare, and Medicaid Spending as
a Percent of GDP

Note: Projections based on the intermediate assumptions of the 2003
Trustees* Reports, CBO*s March 2003 short- term Medicaid estimates, and
CBO*s June 2002 long- term Medicaid projections under midrange
assumptions.

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, i. e., as the
economy returns to a higher growth path, a much more balanced and
disciplined fiscal policy that recognizes our long- term challenges can
help provide a strong foundation for future economic growth and can
enhance

future budgetary flexibility. In the short term, we need to realize that
we 13 Testimony before the Committee on Banking, Housing, and Urban
Affairs, U. S. Senate, July 24, 2001.

Page 14 GAO- 03- 1038T Social Security Reform are already facing a huge
fiscal hole (gap). The first thing that we should do is stop digging.

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. Some of the
benefits of early action* and the costs of delay* can be seen in figure 7.
This compares what it would take to achieve actuarial balance at different
points in time by either raising payroll taxes or reducing benefits. 14 If
we did nothing until 2042* 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 46 percent. As figure 7 shows,
earlier action shrinks the size of the adjustment.

Figure 7: Size of Action Needed to Achieve Social Security Solvency

Note: Based on the intermediate assumptions of the 2003 Trustees* Report.
The benefit adjustments in this graph represent a one- time, permanent
change to all existing and future benefits beginning in the first year
indicated.

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 7.

Page 15 GAO- 03- 1038T Social Security Reform Thus both sustainability
concerns and solvency considerations drive us to act sooner rather than
later. Trust Fund exhaustion may be almost 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.

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 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 $454 billion in
benefits to more than 46 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. Evaluating Social

Security Reform Proposals

Page 16 GAO- 03- 1038T Social Security Reform Our sustainable solvency
standard encompasses several different ways of looking at the Social
Security program*s financing needs. While 75- year

actuarial balance is generally used in evaluating the long- term financial
outlook of the Social Security program and reform proposals, it is not
sufficient in gauging the program*s solvency after the 75th year. For
example, under the Trustees* intermediate assumptions, each year the
75year actuarial period changes, and a year with a surplus is replaced by
a new 75th year that has a significant deficit. As a result, changes made
to restore trust fund solvency only for the 75- year period can result in
future actuarial imbalances almost immediately. Reform plans that lead to
sustainable solvency would be those that consider the broader issues of
fiscal sustainability and affordability over the long term. Specifically,
a standard of sustainable solvency also involves looking at (1) the
balance between program income and cost beyond the 75th year and (2) the
share of the budget and economy consumed by Social Security spending.

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.

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* preretirement 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
Financing Sustainable

Solvency Balancing Adequacy and Equity

Page 17 GAO- 03- 1038T Social Security Reform 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.

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. 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. Implementing and

Administering Proposed Reforms

Page 18 GAO- 03- 1038T Social Security Reform As you requested, we applied
our criteria to a scenario of Trust Fund Exhaustion. This scenario
dramatically illustrates the need to take action

sooner rather than later to address the program*s long- term fiscal
imbalance. Under this scenario, currently scheduled benefits would be paid
in full until the combined OASDI Trust Funds are exhausted. After
exhaustion, monthly benefit checks are reduced in proportion to the annual
shortfall. In effect, after trust fund exhaustion, all beneficiaries would
experience a sharp drop in benefits. Additional reductions in the
following years would result in benefits equal to about two- thirds of
currently scheduled levels by the end of the 75- year simulation period.
(See fig. 8.)

Figure 8: Change in Currently Scheduled Benefits under the Trust Fund
Exhaustion Scenario

We used our long- term economic model in assessing the Trust Fund
Exhaustion scenario against the first criterion, that of financing
sustainable solvency. To examine how the Commission reform models balance
adequacy and equity concerns, we used the GEMINI model, a dynamic
microsimulation model for analyzing the lifetime implications of Social
Security policies for a large sample of people born in the same year.

Our analysis examined the effects of the reform models for the 1955, 1970,
and 1985 birth cohorts. For this analysis, as in our report on the
Commission reform models, we used the 2001 Trustees* intermediate
assumptions. Under these assumptions, the combined trust funds are
projected to reach exhaustion in 2038. Social Security*s Long- Term
Financing Shortfall Requires

Action Sooner Rather Than Later

Page 19 GAO- 03- 1038T Social Security Reform Our analysis of the scenario
used the same three benchmarks as in our January report on the Commission
reform models: 15  The *benefit reduction benchmark* assumes a gradual
reduction in the

currently scheduled Social Security defined benefit beginning with those
newly eligible for retirement in 2005. Current tax rates are maintained. 
The *tax increase benchmark* assumes an increase in the OASDI payroll

tax beginning in 2002 sufficient to achieve an actuarial balance over the
75- year period. Currently scheduled benefits are maintained. 16  The
*baseline extended benchmark* is a fiscal policy path developed in

our earlier long- term model work that assumes payment in full of
currently scheduled Social Security benefits and no other changes in
current spending or tax policies. 17 The use of our criteria in evaluating
the Trust Fund Exhaustion scenario

underscores the need to take action sooner rather than later to address
Social Security*s financing shortfall. In so doing, it illustrates trade-
offs that exist between efforts to achieve sustainable solvency for the
OASDI Trust Funds and efforts to maintain adequate retirement income for
current and future beneficiaries.

By definition this scenario would achieve sustainable solvency because
after the combined trust funds had run out of assets, benefit payments
would be adjusted each year to equal annual tax income. Before 2038, the
Trust Fund Exhaustion scenario would result in lower unified surpluses and
higher unified deficits compared to the tax increase benchmark by the same
amounts as the baseline extended benchmark. Subsequently the Trust Fund
Exhaustion scenario would result in unified fiscal results increasingly
similar to both the tax increase benchmark and the benefit reduction
scenario over the 75- year period. Before 2038, the Trust Fund

Exhaustion scenario would require the same amounts of cash as the tax
increase or baseline extended benchmarks; subsequently, the Trust Fund

15 From the perspective of analyzing benefit adequacy, the tax increase
and baseline extended benchmarks are identical because both assume payment
in full of scheduled Social Security benefits over the 75- year simulation
period.

16 Our benchmarks are solvent for the 75- year projection period commonly
used by the Social Security Administration*s (SSA) Office of the Chief
Actuary, but they do not achieve sustainable solvency. Both the benefit
reduction and tax increase benchmarks are explicitly fully funded and we
worked closely with SSA*s Chief Actuary in their design. 17 Implicitly,
therefore, after exhaustion benefits are paid in part by increased
borrowing

from the public.

Page 20 GAO- 03- 1038T Social Security Reform Exhaustion scenario would
require less cash each year than any of the three benchmarks. Under the
Trust Fund Exhaustion scenario, the effect on benefits would

differ sharply before and after exhaustion took place. Before exhaustion,
benefits would be the same as those currently scheduled, reflected in both
the tax increase and baseline extended benchmarks. Once the combined trust
funds had run out, benefits for all would be reduced across the board and
remain below currently scheduled levels. Accordingly, those receiving
benefits at the time of trust fund exhaustion would experience a sharp

drop in benefits; under the Trustees* 2001 intermediate estimates, this
drop is estimated at 27 percent (to 73 percent of currently scheduled
levels) in 2039. Small further reductions would need to be taken in
successive years such that by 2076 benefits would be only two- thirds of
currently scheduled levels (i. e., to 67 percent of currently scheduled
levels). (See fig. 9.)

Figure 9: Monthly Benefits Under the Trust Fund Exhaustion Scenario for an
Illustrative Individual by Selected Birth Year

Note: Illustrative workers retire at age 65 and receive benefits equal to
the median for the appropriate GEMINI cohort under the Trust Fund
Exhaustion scenario. In years after 2038, real benefits are reduced
according to the Trust Fund Exhaustion scenario. In GEMINI, the median age
of death for

those living to age 65 years and receiving a retired workers benefit is
84, 85, and 86, for the 1955, 1970, and 1985 cohorts, respectively.

Page 21 GAO- 03- 1038T Social Security Reform Due to the timing of the
reductions under the Trust Fund Exhaustion scenario, younger generations
would bear greater benefit reductions.

Those born in 1955 would not experience benefit reductions until they
reached age 83, while those born in 1985 would receive lower benefits than
under either GAO*s benefit reduction or tax increase benchmarks in all
years of retirement. Consequently, lifetime benefits would be reduced more
for younger generations. Under the Trust Fund Exhaustion scenario we used,
benefits would be adjusted proportionately for all recipients,

increasing the likelihood of hardship for lower income retirees and the
disabled. Given a lack of historical precedent and legislative clarity on
how SSA would proceed in the event of trust fund exhaustion, the nature
and scope of SSA*s administrative challenges under the scenario are
difficult to describe or assess. At a minimum, a focus on cash management
would be needed for SSA to calculate and implement the ongoing benefit
adjustments required under the scenario.

It is likely that the structural changes required to restore Social
Security*s long- term viability generally will require some combination of
reductions from currently scheduled benefits, revenue increases, and may
include the use of some general revenues. The proposals we have examined,
both this year and earlier, generally reflect this. Proposals employ
possible benefit modifications within the current program structure,
including modifying

the benefit formula, reconsidering current eligibility criteria, and
reducing cost- of- living adjustments. Revenue increases might take the
form of increases in the payroll tax rate, expanding coverage to include
the relatively few workers who are still not covered under Social
Security, or allowing the trust funds to be invested in potentially
higher- yielding

securities such as stocks. 18 Similarly, some proposals rely on general
revenue transfers to increase the amount of money going towards the Social
Security program. Reforms that include individual accounts would also
involve Social Security benefit reductions and/ or revenue increases, and
the use of general revenues. Whatever approach is taken to reform, we must
be able to continue to finance ongoing benefits to retirees in the

18 About 4 percent of the workforce remains uncovered, which mostly
includes some state and local government employees and federal employees
hired before 1984. Conclusion: Choices

and Trade- Offs Will Be Part of Any Social Security Reform* Acting Soon
Would Help

Page 22 GAO- 03- 1038T Social Security Reform short term. The longer we
delay reform, the larger the *transition costs* and the more disruptive
the actions will be.

In evaluating Social Security reform proposals, the choice among various
benefit reductions and revenue increases will affect the balance between
income adequacy and individual equity. Benefit reductions could pose the
risk of diminishing adequacy, especially for specific subpopulations. Both

benefit reductions and tax increases that have been proposed could
diminish individual equity by reducing the implicit rates of return the
workers earn on their contributions to the system. In contrast, increasing
revenues by investing retirement funds in the stock market could improve
rates of return but potentially expose individuals to investment risk and
losses of expected retirement income.

Similarly, the choice among various benefit reductions and revenue
increases* for example, raising the retirement age* will ultimately
determine not just how much income retirees will have but also how long
they will be expected to continue working and how long their retirements
will be. Reforms will determine how much consumption workers will give up
during their working years to provide for more consumption during
retirement.

The use of our criteria to evaluate approaches to Social Security reform
highlights the trade- offs that exist between efforts to achieve
sustainable solvency and to maintain adequate retirement income for
current and future beneficiaries. These trade- offs can be described as
differences in the extent and nature of the risks for individuals and the
nation as a whole.

At the same time, the defined benefit under the current Social Security
system is also uncertain. The primary risk is that a significant funding
gap exists between currently scheduled and funded benefits which, although
it will not occur for a number of years, is significant and will grow over
time.

Other risks stem from uncertainty in, for example, future levels of
productivity growth, real wage growth, and demographics. The Congress has
revised Social Security many times in the past, and future Congresses
could decide to revise benefits in ways that leave those affected little
time to adjust. As the Congress deliberates various approaches to Social

Security, the national debate also needs to include discussion of the
various types of risk implicit in each approach and in the timing of
reform.

Early action to change these programs would yield the highest fiscal
dividends for the federal budget and would provide a longer period for
prospective beneficiaries to make adjustments in their own planning.

Page 23 GAO- 03- 1038T Social Security Reform Waiting to build economic
resources and reform future claims entails risks. First, we lose an
important window where today*s relatively large

workforce can increase saving and enhance productivity, two elements
critical to growing the future economy. We lose the opportunity to reduce
the burden of interest payments, thereby creating a legacy of higher debt
as well as elderly entitlement spending for the relatively smaller
workforce of the future. Most critically, we risk losing the opportunity
to phase in changes gradually so that all can make the adjustments needed
in private and public plans to accommodate this historic shift.
Unfortunately, the

long- range challenge has become more difficult, and the window of
opportunity to address the entitlement challenge is narrowing.

As the baby boom generation retires and the numbers of those entitled to
these retirement benefits grow, the difficulties of reform will be
compounded. Accordingly, it remains more important than ever to deal with
these issues over the next several years. In their March 2003 report, the
Trustees emphasized the need for action sooner rather than later, stating
that the sooner Social Security*s financial challenges are addressed, the
more varied and less disruptive can be their solutions.

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 have said before, I believe it is possible to structure a
Social Security reform proposal that will exceed the expectations of all
generations of Americans. In my view there is a window of opportunity to
craft a solution that will protect Social Security benefits for the
nation*s current and nearterm

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.

Page 24 GAO- 03- 1038T Social Security Reform 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, Members of the Committee, that concludes my
statement. I*d be happy to answer any questions you may have.

(450246)

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